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Oaktree Specialty Lending Corp - Annual Report: 2013 (Form 10-K)


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the fiscal year ended September 30, 2013
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-33901
Fifth Street Finance Corp.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
DELAWARE
(State or jurisdiction of
incorporation or organization)
 
26-1219283
(I.R.S. Employer
Identification No.)

 
 
 
10 Bank Street, 12th Floor
White Plains, NY
(Address of principal executive office)
 
10606
(Zip Code)
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:
(914) 286-6800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class
 
Name of Each Exchange
on Which Registered
Common Stock, par value $0.01 per share
5.875% Unsecured Notes due 2024
6.125% Unsecured Notes due 2028

 
The NASDAQ Global Select Market
The New York Stock Exchange
The NASDAQ Global Select Market
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨        No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨        No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ        No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨        No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  þ
 
        Accelerated filer  ¨
 
Non-accelerated filer  ¨
 
Smaller reporting company  ¨
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)    Yes  ¨        No  þ
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of March 29, 2013 is $1,080,788,148. The registrant had 139,182,861 shares of common stock outstanding as of November 25, 2013.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.


TABLE OF CONTENTS
 
 
 
 
 
 
Page
 
 
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
 
Item 15.
Exhibit Index
 

 


PART I

Item 1.     Business
General
We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We define small and mid-sized companies as those with annual revenues between $25 million and $250 million. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments. We are externally managed and advised by Fifth Street Management LLC, which we also refer to as our “investment adviser.”
From inception and through September 30, 2013, we had originated $3.3 billion of funded debt and equity investments. Our portfolio totaled $1.9 billion at fair value at September 30, 2013 and was comprised of 99 investments, 86 of which were in operating companies and 13 of which were in private equity funds. The 13 investments in private equity funds represented less than 1% of the fair value of our assets at September 30, 2013. The 81 debt investments in our portfolio as of September 30, 2013 had a weighted average debt to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) multiple of 4.14x calculated at the time of origination of the investment. The weighted average annual yield of our debt investments as of September 30, 2013 was approximately 11.1%, of which 10.0% represented cash payments and 1.1% represented payment-in-kind, or PIK, interest and other non-cash items. As of September 30, 2013, there were no investments on which we had stopped accruing interest.
Our investments generally range in size from $10 million to $100 million and are principally in the form of first lien, second lien (collectively, "senior secured") and subordinated debt investments, which may also include an equity component. We generally invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “high yield” or “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. As of September 30, 2013, 56.5% of our debt portfolio at fair value consisted of debt securities for which issuers were not required to make principal payments until the maturity of such debt securities, which could result in a substantial loss to us if such issuers are unable to refinance or repay their debt at maturity. Although our focus could change, we are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection. As of September 30, 2013, 77.5% of our portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of our portfolio companies. Moreover, we held equity investments consisting of common stock, preferred stock or other equity interests in 44 of our 99 portfolio companies as of September 30, 2013.
Fifth Street Mezzanine Partners III, L.P., our predecessor fund, commenced operations as a private partnership on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into us. We were formed in late 2007 for the purpose of acquiring Fifth Street Mezzanine Partners III, L.P. and continuing its business as a public entity. We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, or the “1940 Act.”
As a business development company, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to continue to, finance our investments through borrowings. However, as a business development company, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the Investment Company Act of 1940, as amended (the "1940 Act") equals at least 200% after such borrowing. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of September 30, 2013, we had a debt to equity ratio (excluding debentures issued by our small business investment company, or SBIC, subsidiaries) of 0.34x (i.e., one dollar of equity for each $0.34 of non-SBIC debt outstanding). See “Business Development Company Regulations.”
 We have also elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code, or the Code. See “Taxation as a Regulated Investment Company.” As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders if we meet certain source-of-income, distribution and asset diversification requirements.
In addition, we maintain wholly-owned subsidiaries that are licensed as SBICs and regulated by the Small Business Administration, or the SBA. See “Regulation — Small Business Investment Company Regulations.” The SBIC licenses allow us, through our wholly-owned subsidiaries, to issue SBA-guaranteed debentures. We have received exemptive relief from the

1

Securities and Exchange Commission, or SEC, to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. Pursuant to the 200% asset coverage ratio limitation, we are permitted to borrow one dollar for every dollar we have in assets less all liabilities and indebtedness not represented by debt securities issued by us or loans obtained by us. For example, as of September 30, 2013, we had approximately $1.8 billion in assets less all liabilities and indebtedness not represented by debt securities issued by us or loans obtained by us, which would permit us to borrow up to approximately $1.8 billion, notwithstanding other limitations on our borrowings pursuant to our credit facilities.
As a result of our receipt of exemptive relief from the SEC for our SBA debt, we have increased capacity to fund up to $225 million (the maximum amount of SBA-guaranteed debentures our SBICs may currently have outstanding once certain conditions have been met) of investments with SBA-guaranteed debentures in addition to being able to fund investments with borrowings up to the maximum amount of debt that the 200% asset coverage ratio limitation would allow us to incur. As a result, we, in effect, are permitted to have a lower asset coverage ratio than the 200% asset coverage ratio limitation under the 1940 Act and, therefore, we can have more debt outstanding than assets to cover such debt. For example, we are able to borrow up to $225 million more than the approximately $1.8 billion permitted under the 200% asset coverage ratio limit as of September 30, 2013. For additional information on SBA regulations that affect our access to SBA-guaranteed debentures, see “Risk Factors — Risks Relating to Our Business and Structure — Any failure to comply with SBA regulations could have a material adverse effect on our SBIC subsidiaries’ operations.”
Our SBIC subsidiaries held approximately $312.5 million, or 15.1%, of our total assets at September 30, 2013.
The following diagram depicts our organizational structure at September 30, 2013:
Our principal executive office is located at 10 Bank Street, 12th Floor, White Plains, New York 10606 and our telephone number is (914) 286-6800.

2

The Investment Adviser
Our investment adviser, Fifth Street Management LLC (the "investment adviser"), is registered as an investment adviser under the Investment Advisers Act of 1940, as amended, or the “Advisers Act.” Our investment adviser serves pursuant to the investment advisory agreement in accordance with the Advisers Act, under which it receives a management fee as a percentage of our gross assets and incentive fees as a percentage of our ordinary income and capital gains from us. Additionally, our investment adviser is affiliated with Fifth Street Capital LLC, a private investment firm founded and managed by Leonard M. Tannenbaum who has led the investment of over $3.6 billion in small and mid-sized companies, including the investments made by us, since 1998. Mr. Tannenbaum and his respective private investment firms have originated over 160 investments.
Our investment adviser also currently serves as the investment adviser to Fifth Street Senior Floating Rate Corp. ("FSFR"), a business development company focused on making senior loans to middle market companies that bear interest on the basis of a floating base lending rate as compared to our primary investment focus which is more generally on debt and equity investments in small and mid-sized companies. However, there may be overlap in terms of our targeted investments. See “— Material Conflicts of Interest.”
We benefit from our investment adviser’s ability to identify attractive investment opportunities, conduct diligence on and value prospective investments, negotiate investments and manage a diversified portfolio of those investments. The principals of our investment adviser have broad investment backgrounds, with prior experience at investment funds, investment banks and other financial services companies and have developed a broad network of contacts within the private equity community. This network of contacts provides our principal source of investment opportunities.
The key principals and members of senior management of our investment adviser are Leonard M. Tannenbaum, our chief executive officer and our investment adviser’s managing partner, Bernard D. Berman, our president and a partner of our investment adviser, Ivelin M. Dimitrov, our chief investment officer and a partner of our investment adviser, Juan E. Alva, a partner of our investment adviser, Sunny K. Khorana, a partner of our investment adviser, Casey J. Zmijeski, a partner of our investment adviser, Alexander C. Frank, our chief financial officer and a partner of our investment adviser, and Frederick D. Buffone, a managing director of our investment adviser.
 Business Strategy
Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments. We have adopted the following business strategy to achieve our investment objective:
•
Capitalize on our investment adviser’s strong relationships with private equity sponsors.    Our investment adviser has developed an extensive network of relationships with private equity sponsors that invest in small and mid-sized companies. We believe that the strength of these relationships is due to a common investment philosophy, a consistent market focus, a rigorous approach to diligence and a reputation for delivering on commitments. In addition to being our principal source of originations, we believe that private equity sponsors provide significant benefits including incremental due diligence, additional monitoring capabilities and a potential source of capital and operational expertise for our portfolio companies.
•
Focus on established small and mid-sized companies.    We believe that there are fewer finance companies focused on transactions involving small and mid-sized companies than larger companies, and that this is one factor that allows us to negotiate favorable investment terms. Such favorable terms include higher debt yields and lower leverage levels, more significant covenant protection and greater equity grants than typical of transactions involving larger companies. We generally invest in companies with established market positions, seasoned management teams, proven products and services and strong regional or national operations. We believe that these companies possess better risk-adjusted return profiles than newer companies that are in the early stages of building management teams and/or a revenue base.
•
Continue our growth of direct originations.    Over the last several years, the principals of our investment adviser have developed an origination strategy that allows us to directly originate a significant portion of our investments. We believe that the benefits of direct originations include, among other things, our ability to control the structuring of investment protections and to generate origination and exit fees.
•
Employ disciplined underwriting policies and rigorous portfolio management.    Our investment adviser has developed an extensive underwriting process which includes a review of the prospects, competitive position, financial performance and industry dynamics of each potential portfolio company. In addition, we perform substantial diligence on potential investments, and seek to invest alongside private equity sponsors who have proven capabilities in building value. As part of the monitoring process, our investment adviser will analyze monthly and quarterly financial statements versus the previous periods and year, review financial projections, compliance certificates and covenants, meet with management and attend board meetings.

3

•
Structure our debt investments to minimize risk of loss and achieve attractive risk-adjusted returns.    We structure our debt investments on a conservative basis with high cash yields, cash advisory fees, low leverage levels and strong investment protections, including prepayment fees. As of September 30, 2013, the weighted average yield of our debt investments was approximately 11.1%, which includes a cash component of 10.0%. Our debt investments have strong protections, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. We believe these protections, coupled with the other features of our investments described above, should allow us to reduce our risk of capital loss and achieve attractive risk adjusted returns; however, there can be no assurance that we will be able to successfully structure our investments to minimize risk of loss and achieve attractive risk-adjusted returns.
•
Benefit from lower, fixed, long-term cost of capital.    The SBIC licenses held by our wholly-owned SBIC subsidiaries allows them to issue SBA-guaranteed debentures. SBA-guaranteed debentures carry long-term fixed rates that are generally lower than rates on comparable bank and other debt. Because lower cost SBA leverage is a significant part of our capital base, our relative cost of debt capital may be lower than many of our competitors. In addition, SBIC leverage represents a stable, long-term component of our capital structure that should permit the proper matching of duration and cost compared to our portfolio investments.
•
Leverage the skills and experience of our investment adviser.    The principals of our investment adviser have broad investment backgrounds, with prior experience at private investment funds, investment banks and other financial services companies and they also have experience managing distressed companies. We believe that our investment adviser’s expertise in valuing, structuring, negotiating and closing transactions provides us with a competitive advantage by allowing us to provide financing solutions that meet the needs of our portfolio companies while adhering to our underwriting standards.
Investment Criteria
The principals of our investment adviser have identified the following investment criteria and guidelines for use in evaluating prospective portfolio companies and they use these criteria and guidelines in evaluating investment opportunities for us. However, not all of these criteria and guidelines were, or will be, met in connection with each of our investments.
 
•
Established companies with a history of positive operating cash flow.    We seek to invest in established companies with sound historical financial performance. We typically focus on companies with a history of profitability on an operating cash flow basis.
•
Ability to exert meaningful influence.    We primarily target investment opportunities in which we will be the lead/sole investor in our tranche and in which we can add value through active participation in the direction of the company, often through advisory positions.
•
Private equity sponsorship.    We generally seek to invest in companies in connection with private equity sponsors who have proven capabilities in building value. We believe that a private equity sponsor can serve as a committed partner and advisor that will actively work with the company and its management team to meet company goals and create value. We assess a private equity sponsor’s commitment to a portfolio company by, among other things, the capital contribution it has made or will make in the portfolio company.
•
Seasoned management team.    We generally will require that our portfolio companies have a seasoned management team, with strong corporate governance. We also seek to invest in companies that have proper incentives in place, including having significant equity interests, to motivate management to act in accordance with our interests.
•
Defensible and sustainable business.    We seek to invest in companies with proven products and/or services and strong regional or national operations.
•
Exit strategy.    We generally seek to invest in companies that we believe possess attributes that will provide us with the ability to exit our investments. We expect to exit our investments typically through one of three scenarios: (i) the sale of the company resulting in repayment of all outstanding debt, (ii) the recapitalization of the company through which our loan is replaced with debt or equity from a third party or parties or (iii) the repayment of the initial or remaining principal amount of our loan then outstanding at maturity. In some investments, there may be scheduled amortization of some portion of our loan which would result in a partial exit of our investment prior to the maturity of the loan.
Deal Origination
Our deal originating efforts are focused on building relationships with private equity sponsors that are focused on investing in the small and mid-sized companies that we target. We divide the country geographically into Eastern, Central and

4

Western regions and emphasize active, consistent sponsor coverage. The investment professionals of our investment adviser have developed an extensive network of relationships with these private equity sponsors. We estimate that there are approximately 1,500 of such private equity firms and our investment adviser has active relationships with approximately 240 of them. An active relationship is one through which our investment adviser has received at least one investment opportunity from the private equity sponsor within the last year.
Our investment adviser reviewed over 800 potential investment transactions with private equity sponsors during the year ended September 30, 2013. A significant portion of the investment transactions that we have completed to date were originated through our investment adviser’s relationships with private equity sponsors. We believe that our investment adviser has a reputation as a reliable, responsive and efficient source of funding to support private equity investments. We believe that this reputation and the relationships of our investment adviser with private equity sponsors will provide us with significant investment opportunities.
Our origination process is designed to efficiently evaluate a large number of opportunities and to identify the most attractive of such opportunities. A significant number of opportunities that clearly do not fit our investment criteria are screened by the partners of our investment adviser when they are initially identified. If an originator believes that an opportunity fits our investment criteria and merits consideration, the investment is presented to our investment adviser’s Investment Committee. This is the first stage of our origination process, the “Review” stage. During this stage, the originator gives a preliminary description of the opportunity. This is followed by preliminary due diligence, from which an investment summary is created. The opportunity may be discussed several times by the full Investment Committee of our investment adviser, or subsets of that Committee. At any point in this stage, we may reject the opportunity, and, indeed, we have historically decided not to proceed with more than 80% of the investment opportunities reviewed by our investment adviser’s Investment Committee.
For the subset of opportunities that we decide to pursue, we issue preliminary term sheets and classify them in the “Term Sheet Issued” stage. This term sheet serves as a basis for negotiating the critical terms of a transaction. At this stage we begin our underwriting and investment approval process, as more fully described below. After the term sheet for a potential transaction has been fully negotiated, the transaction is presented to our investment adviser’s Investment Committee for approval. If the deal is approved, the term sheet is signed. Approximately half of the term sheets we issue result in an executed term sheet. Our underwriting and investment approval process is ongoing during this stage, during which we begin documentation of the loan. The final stage, “Closings,” culminates with the funding of an investment only after all due diligence is satisfactorily completed and all closing conditions, including the sponsor’s funding of its investment in the portfolio company, have been satisfied.
Investment Underwriting
Investment Underwriting Process and Approval
We make our investment decisions only after consideration of a number of factors regarding the potential investment including, but not limited to: (i) historical and projected financial performance; (ii) company and industry specific characteristics, such as strengths, weaknesses, opportunities and threats; (iii) composition and experience of the management team; and (iv) track record of the private equity sponsor leading the transaction. Our investment adviser uses a proprietary scoring system that evaluates each opportunity. This methodology is employed to screen a high volume of potential investment opportunities on a consistent basis.
If an investment is deemed appropriate to pursue, a more detailed and rigorous evaluation is made along a variety of investment parameters, not all of which may be relevant or considered in evaluating a potential investment opportunity. The following outlines the general parameters and areas of evaluation and due diligence for investment decisions, although not all will necessarily be considered or given equal weighting in the evaluation process.
Management Assessment
Our investment adviser makes an in-depth assessment of the management team, including evaluation along several key metrics:
•
The number of years in their current positions;
•
Track record;
•
Industry experience;
•
Management incentive, including the level of direct investment in the enterprise;
•
Background investigations; and
•
Completeness of the management team (lack of positions that need to be filled).

5

Industry Dynamics
An evaluation of the industry is undertaken by our investment adviser that considers several factors. If considered appropriate, industry experts will be consulted or retained. The following factors are analyzed by our investment adviser:
 
•
Sensitivity to economic cycles;
•
Competitive environment, including number of competitors, threat of new entrants or substitutes;
•
Fragmentation and relative market share of industry leaders;
•
Growth potential; and
•
Regulatory and legal environment.
Business Model and Financial Assessment
Prior to making an investment decision, our investment adviser will undertake a review and analysis of the financial and strategic plans for the potential investment. There is significant evaluation of and reliance upon the due diligence performed by the private equity sponsor and third party experts including accountants and consultants. Areas of evaluation include:
 
•
Historical and projected financial performance;
•
Quality of earnings, including source and predictability of cash flows;
•
Customer and vendor interviews and assessments;
•
Potential exit scenarios, including probability of a liquidity event;
•
Internal controls and accounting systems; and
•
Assets, liabilities and contingent liabilities.
Private Equity Sponsor
Among the most critical due diligence investigations is the evaluation of the private equity sponsor making the investment. A private equity sponsor is typically the controlling shareholder upon completion of an investment and as such is considered critical to the success of the investment. The private equity sponsor is evaluated along several key criteria, including:
 
•
Investment track record;
•
Industry experience;
•
Capacity and willingness to provide additional financial support to the company through additional capital contributions, if necessary; and
•
Reference checks.
Investments
We target debt investments that will yield meaningful current income and also provide the opportunity for capital appreciation through our ownership of equity securities in our portfolio companies. We typically structure our debt investments with the maximum seniority and collateral that we can reasonably obtain while seeking to achieve our total return target. In most cases, our debt investment will be collateralized by a first or second lien on the assets of the portfolio company. As of September 30, 2013, 77.5% of our portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of the portfolio company.
Debt Investments
We tailor the terms of our debt investments to the facts and circumstances of the transaction and prospective portfolio company, negotiating a structure that seeks to protect our rights and manage our risk while creating incentives for the portfolio company to achieve its business plan. A substantial source of return is monthly cash interest that we collect on our debt investments. As of September 30, 2013, we had directly originated a majority of our debt investments. We are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection.
 
•
First Lien Loans.    Our first lien loans generally have terms of four to six years, provide for a variable or fixed interest rate, contain prepayment penalties and are secured by a first priority security interest in all existing and future assets of

6

the borrower. Our first lien loans may take many forms, including revolving lines of credit, term loans and acquisition lines of credit.
•
Second Lien Loans.    Our second lien loans generally have terms of four to six years, primarily provide for a fixed interest rate, contain prepayment penalties and are secured by a second priority security interest in all existing and future assets of the borrower. Our second lien loans often include payment-in-kind, or PIK, interest, which represents contractual interest accrued and added to the principal that generally becomes due at maturity.
•
Unsecured Loans.    Our unsecured investments generally have terms of five to six years and provide for a fixed interest rate. We may make unsecured investments on a stand-alone basis, or in connection with a senior secured loan, a junior secured loan or a “one-stop” financing. Our unsecured investments may include PIK interest and an equity component, such as warrants to purchase common stock in the portfolio company.
We typically structure our debt investments to include covenants that seek to minimize our risk of capital loss. Our debt investments have strong protections, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. Our debt investments also have substantial prepayment penalties designed to extend the life of the average loan, which we believe will help to grow our portfolio.
Equity Investments
When we make a debt investment, we may be granted equity in the company in the same class of security as the sponsor receives upon funding. In addition, we may from time to time make non-control, equity co-investments in connection with private equity sponsors. We generally seek to structure our equity investments, such as direct equity co-investments, to provide us with minority rights provisions and event-driven put rights. We also seek to obtain limited registration rights in connection with these investments, which may include “piggyback” registration rights.
Private Equity Fund Investments
We make investments in the private equity funds of certain private equity sponsors we partner with in making investments in small and mid-sized companies. In general, we make these investments where we have a long term relationship and are comfortable with the sponsor’s business model and investment strategy. As of September 30, 2013, we had investments in 13 private equity funds, which represented less than 1% of the fair value of our assets as of such date.
Portfolio Management
Active Involvement in our Portfolio Companies
As a business development company, we are obligated to offer to provide managerial assistance to our portfolio companies and to provide it if requested. In fact, we provide managerial assistance to our portfolio companies as a general practice and we seek investments where such assistance is appropriate. We monitor the financial trends of each portfolio company to assess the appropriate course of action for each company and to evaluate overall portfolio quality. We have several methods of evaluating and monitoring the performance of our investments, including but not limited to, the following:
•
review of monthly and quarterly financial statements and financial projections for portfolio companies;
•
periodic and regular contact with portfolio company management to discuss financial position requirements and accomplishments;
•
attendance at board meetings;
•
periodic formal update interviews with portfolio company management and, if appropriate, the private equity sponsor; and
•
assessment of business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan.
Ranking Criteria
In addition to various risk management and monitoring tools, we use an investment ranking system to characterize and monitor the credit profile and our expected level of returns on each investment in our portfolio. We use a four-level numeric ranking scale. The following is a description of the conditions associated with each investment ranking:
•
Investment Ranking 1 is used for investments that are performing above expectations and/or capital gains are expected.
•
Investment Ranking 2 is used for investments that are performing substantially within our expectations, and whose risks remain materially consistent with the potential risks at the time of the original or restructured investment. All

7

new investments are initially ranked 2.
•
Investment Ranking 3 is used for investments that are performing below our expectations and for which risk has materially increased since the original or restructured investment. The portfolio company may be out of compliance with debt covenants and may require closer monitoring. To the extent that the underlying agreement has a PIK interest provision, investments with a ranking of 3 are generally those on which we are not accruing PIK interest.
•
Investment Ranking 4 is used for investments that are performing substantially below our expectations and for which risk has increased substantially since the original or restructured investment. Investments with a ranking of 4 are those for which some loss of principal is expected and are generally those on which we are not accruing cash interest.
In the event that we determine that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, we will undertake more aggressive monitoring of the affected portfolio company. While our investment ranking system identifies the relative risk for each investment, the ranking alone does not dictate the scope and/or frequency of any monitoring that we perform. The frequency of our monitoring of an investment is determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing our investment, if any.
The following table shows the distribution of our investments on the 1 to 4 investment ranking scale at fair value as of September 30, 2013:
Investment Ranking
 
Fair Value
(thousands)
 
% of Portfolio
1
 
$
122,769

 
6.49
%
2
 
1,770,277

 
93.51

3
 
—

 
—

4
 
—

 
—

Total
 
$
1,893,046

 
100.00
%
Valuation of Portfolio Investments
As a business development company, we generally invest in illiquid securities including debt and equity investments of small and mid-sized companies. All of our investments are recorded at fair value as determined in good faith by our Board of Directors.
Authoritative accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available or reliable, valuation techniques are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the investments or market and the investments’ complexity.
In accordance with authoritative accounting guidance, we perform detailed valuations of our debt and equity investments on an individual basis, using bond yield, income and market approaches as appropriate. In general, we utilize a bond yield method for the majority of our investments, as long as it is appropriate. If, in our judgment, the bond yield approach is not appropriate, we may use the market approach, income approach, or, in certain cases, an alternative methodology potentially including market quotations, asset liquidation model, expected recovery model or other alternative approaches.
Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.
Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of earnings before interest, taxes, depreciation and amortization (EBITDA), cash flows, net income, revenues, or in limited cases, book value. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.
Under the income approach, we generally prepare and analyze discounted cash flow models based on projections of the future free cash flows of the business.

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Our Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of our investments:
 
•
The quarterly valuation process begins with each portfolio company or investment being initially valued by our finance department;
•
Preliminary valuations are then reviewed and discussed with principals of the investment adviser;
•
Separately, independent valuation firms engaged by our Board of Directors prepare preliminary valuations on a selected basis and submit the reports to us;
•
Our finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;
•
Our finance department prepares a valuation report for the Audit Committee of our Board of Directors;
•
The Audit Committee of our Board of Directors is apprised of the preliminary valuations of the independent valuation firms;
•
The Audit Committee of our Board of Directors reviews the preliminary valuations, and our finance department responds and supplements the preliminary valuations to reflect any comments provided by the Audit Committee;
•
The Audit Committee of our Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in our portfolio; and
•
Our Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith.
The fair value of all of our investments at September 30, 2013 and September 30, 2012 was determined by our Board of Directors. Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and a consistently applied valuation process.

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We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued over the course of each fiscal year. The percentages of our portfolio, at fair value, valued by independent valuation firms each period during the current and two preceding fiscal years were as follows:
For the quarter ended December 31, 2010
 
73.9
%
 
For the quarter ended March 31, 2011
 
82.0
%
 
For the quarter ended June 30, 2011
 
82.9
%
 
For the quarter ended September 30, 2011
 
91.2
%
 
For the quarter ended December 31, 2011
 
89.1
%
 
For the quarter ended March 31, 2012
 
87.3
%
 
For the quarter ended June 30, 2012
 
84.3
%
 
For the quarter ended September 30, 2012
 
79.6
%
 
For the quarter ended December 31, 2012
 
79.5
%
 
For the quarter ended March 31, 2013
 
73.8
%
 
For the quarter ended June 30, 2013
 
76.4
%
 
For the quarter ended September 30, 2013
 
86.5
%
 
Determination of fair values involves subjective judgments and estimates. The notes to our financial statements refer to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.
Competition
We compete for investments with a number of business development companies and investment funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial banks and other sources of financing. Many of these entities have greater financial and managerial resources than we do. We believe we are able to be competitive with these entities primarily on the basis of the experience and contacts of our management team, our responsive and efficient investment analysis and decision-making processes, the investment terms we offer, and our willingness to make smaller investments.
We believe that some of our competitors make loans with interest rates and returns that are comparable to or lower than the rates and returns that we target. Therefore, we do not seek to compete solely on the interest rates that we offer to potential portfolio companies. For additional information concerning the competitive risks we face, see “Risk Factors — Risks Relating to Our Business and Structure — We may face increasing competition for investment opportunities, which could reduce returns and result in losses.”
Employees
We do not have any employees. Our day-to-day investment operations are managed by our investment adviser. See “- Investment Advisory Agreement.” Our investment adviser employs over 30 investment professionals, including its principals. In addition, we reimburse our administrator, FSC, Inc., for the allocable portion of overhead and other expenses incurred by it in performing its obligations under an administration agreement, including our allocable portion of the costs of compensation of our chief financial officer and chief compliance officer and their staffs. For a more detailed discussion of the administration agreement, see “- Administration Agreement.”
Properties
We do not own any real estate or other physical properties material to our operations. We utilize office space that is leased by our affiliates for our principal executive office at 10 Bank Street, 12th Floor, White Plains, NY 10606, as well as additional office space at 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831, 311 South Wacker Drive, Suite 3380, Chicago, IL 60606 and 250 Cambridge Avenue, Suite 201, Palo Alto, CA 94306. We believe that our office facilities are adequate for our business as presently conducted, although we are actively evaluating alternative options.
Investment Advisory Agreement
Overview of Our Investment Adviser
Management Services

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Our investment adviser, Fifth Street Management LLC, is registered as an investment adviser under the Advisers Act. Our investment adviser serves pursuant to an investment advisory agreement in accordance with the Advisers Act. Subject to the overall supervision of our Board of Directors, our investment adviser manages our day-to-day operations and provides us with investment advisory services. Under the terms of the investment advisory agreement, our investment adviser:
 
•
determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;
•
determines what securities we purchase, retain or sell;
•
identifies, evaluates and negotiates the structure of the investments we make; and
•
executes, monitors and services the investments we make.
Our investment adviser’s services under the investment advisory agreement may not be exclusive and it is free to furnish similar services to other entities so long as its services to us are not impaired.
Management Fee
We pay our investment adviser a fee for its services under the investment advisory agreement consisting of two components — a base management fee and an incentive fee. The cost of both the base management fee payable to our investment adviser and any incentive fees earned by our investment adviser will ultimately be borne by our common stockholders.
Base Management Fee
The base management fee is calculated at an annual rate of 2% of our gross assets, which includes any borrowings for investment purposes. The base management fee is payable quarterly in arrears and the fee for any partial month or quarter is appropriately prorated. Our investment adviser permanently waived the portion of the base management fee attributable to cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements) as of the end of each quarter beginning March 31, 2010. As a result, our base management fee is calculated at an annual rate of 2% of our gross assets, including any investments made with borrowings, but excluding any cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements) as of the end of each quarter.
Incentive Fee
The incentive fee has two parts. The first part is calculated and payable quarterly in arrears based on our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including (i) any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, advisory, diligence and consulting fees or other fees that we receive from portfolio companies), (ii) any gain realized on the extinguishment of our own debt and (iii) any other income of any kind that we are required to distribute to our stockholders in order to maintain our RIC status) accrued during the quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, or OID, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding 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 quarter. Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to calculate the 2% base management fee. The operation of the incentive fee with respect to our Pre-Incentive Fee Net Investment Income for each quarter is as follows:
 
•
no incentive fee is payable to the investment adviser in any quarter in which our Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);
•
100% of our Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than or equal to 2.5% in any quarter (10% annualized) is payable to the investment adviser. We refer to this portion of our Pre-Incentive Fee Net Investment Income (which exceeds the hurdle rate but is less than or equal to 2.5%) as the “catch-up.” The “catch-up” provision is intended to provide our investment adviser with an incentive fee of 20% on all of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when our Pre-Incentive Fee Net Investment Income exceeds 2.5% in any quarter; and

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•
20% of the amount of our Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.5% in any quarter (10% annualized) is payable to the investment adviser once the hurdle is reached and the catch-up is achieved.
The following is a graphical representation of the calculation of the income-related portion of the incentive fee:


The second part of the incentive fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date) and equals 20% of our realized capital gains, if any, on a cumulative basis from inception through the end of each fiscal year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees, provided that, the incentive fee determined as of September 30, 2008 was calculated for a period of shorter than twelve calendar months to take into account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation from inception.
Example 1: Income Related Portion of Incentive Fee for Each Fiscal Quarter
Scenario 1
Assumptions
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate(1) = 2%
Management fee(2) = 0.5%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-Incentive Fee Net Investment Income
(investment income – (management fee + other expenses) = 0.55%
Pre-Incentive Fee Net Investment Income does not exceed hurdle rate, therefore there is no income-related incentive fee.
Scenario 2
Assumptions
Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate(1) = 2%
Management fee(2) = 0.5%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-Incentive Fee Net Investment Income
(investment income – (management fee + other expenses) = 2.2%

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Incentive fee
 
=100% × Pre-Incentive Fee Net Investment Income (subject to “catch-up”)(4)
=100% × (2.2% – 2%)
=0.2%
Pre-Incentive Fee Net Investment Income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision, therefore the income related portion of the incentive fee is 0.2%.
Scenario 3
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2%
Management fee(2) = 0.5%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-Incentive Fee Net Investment Income
(investment income – (management fee + other expenses) = 2.8%
Incentive fee = 100% × Pre-Incentive Fee Net Investment Income (subject to “catch-up”)(4)
Incentive fee = 100% × “catch-up” + (20% × (Pre-Incentive Fee Net Investment Income – 2.5%))
Catch up
=
2.5% – 2%
 
=
0.5%
Incentive fee
=
(100% × 0.5%) + (20% × (2.8% – 2.5%))
 
=
0.5% + (20% × 0.3%)
 
=
0.5% + 0.06%
 
=
0.56%
Pre-Incentive Fee Net Investment Income exceeds the hurdle rate, and fully satisfies the “catch-up” provision, therefore the income related portion of the incentive fee is 0.56%.
 _________________
(1)
Represents 8% annualized hurdle rate.
(2)
Represents 2% annualized base management fee.
(3)
Excludes organizational and offering expenses.
(4)
The “catch-up” provision is intended to provide our investment adviser with an incentive fee of 20% on all Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter.
Example 2: Capital Gains Portion of Incentive Fee(*):
Scenario 1
Assumptions
Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment B”)
Year 2: Investment A sold for $50 million and fair market value (“FMV”) of Investment B determined to be $32 million
Year 3: FMV of Investment B determined to be $25 million
Year 4: Investment B sold for $31 million
The capital gains portion of the incentive fee would be:
Year 1: None
Year 2: Capital gains incentive fee of $6 million — ($30 million realized capital gains on sale of Investment A multiplied by 20%)
Year 3: None — $5 million (20% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital depreciation)) less $6 million (previous capital gains fee paid in Year 2)
Year 4: Capital gains incentive fee of $200,000 — $6.2 million ($31 million cumulative realized capital gains multiplied by 20%) less $6 million (capital gains incentive fee taken in Year 2)
Scenario 2

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Assumptions
Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”) and $25 million investment made in Company C (“Investment C”)
Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million
Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million
Year 4: FMV of Investment B determined to be $24 million
Year 5: Investment B sold for $20 million
The capital gains incentive fee, if any, would be:
Year 1: None
Year 2: $5 million capital gains incentive fee — 20% multiplied by $25 million ($30 million realized capital gains on Investment A less unrealized capital depreciation on Investment B)
Year 3: $1.4 million capital gains incentive fee(1) — $6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains less $3 million unrealized capital depreciation)) less $5 million capital gains incentive fee received in Year 2
Year 4: None
Year 5: None — $5 million (20% multiplied by $25 million (cumulative realized capital gains of $35 million less realized capital losses of $10 million)) less $6.4 million cumulative capital gains incentive fee paid in Year 2 and Year 3(2)
_______________
*
The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those shown in this example.
(1)
As illustrated in Year 3 of Scenario 1 above, if we were to be wound up on a date other than its fiscal year end of any year, we may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if we had been wound up on its fiscal year end of such year.
(2)
As noted above, it is possible that the cumulative aggregate capital gains fee received by our investment adviser ($6.4 million) is effectively greater than $5 million (20% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($25 million)).
Payment of Our Expenses
Our primary operating expenses are the payment of a base management fee and any incentive fees under the investment advisory agreement and the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement. Our investment management fee compensates our investment adviser for its work in identifying, evaluating, negotiating, executing and servicing our investments. We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:
 
•
offering expenses;
•
the investigation and monitoring of our investments;
•
the cost of calculating our net asset value;
•
the cost of effecting sales and repurchases of shares of our common stock and other securities;
•
management and incentive fees payable pursuant to the investment advisory agreement;
•
fees payable to third parties relating to, or associated with, making investments and valuing investments (including third-party valuation firms);
•
transfer agent, trustee and custodial fees;
•
interest payments and other costs related to our borrowings;
•
fees and expenses associated with marketing efforts (including attendance at investment conferences and similar events);
•
federal and state registration fees;
•
any exchange listing fees;
•
federal, state and local taxes;
•
independent directors’ fees and expenses;

14

•
brokerage commissions;
•
costs of proxy statements, stockholders’ reports and notices;
•
costs of preparing government filings, including periodic and current reports with the SEC;
•
fidelity bond, liability insurance and other insurance premiums; and
•
printing, mailing, independent accountants and outside legal costs and all other direct expenses incurred by either our investment adviser or us in connection with administering our business, including payments under the administration agreement that will be based upon our allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement and the compensation of our chief financial officer and chief compliance officer, and their staffs.
Duration and Termination
The investment advisory agreement was first approved by our Board of Directors on December 13, 2007 and by a majority of the limited partners of Fifth Street Mezzanine Partners III, L.P. through a written consent first solicited on December 14, 2007. On March 14, 2008, our Board of Directors, including all of the directors who are not “interested persons” as defined in the 1940 Act, approved an amendment to the investment advisory agreement that revised the investment advisory agreement to clarify the calculation of the base management fee. Such amendment was also approved by a majority of our outstanding voting securities through a written consent first solicited on April 7, 2008. On May 2, 2011, the investment advisory agreement was further amended, as approved by our Board of Directors, to exclude management fees on any assets held in the form of cash and cash equivalents. Most recently, at a meeting of the Board of Directors held on January 14, 2013, the Board of Directors, including a majority of the independent directors, approved the annual continuation of the investment advisory agreement. Unless earlier terminated as described below, the investment advisory agreement, as amended, will remain in effect from year-to-year if approved annually by the Board of Directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case, approval by a majority of our directors who are not interested persons. The investment advisory agreement will automatically terminate in the event of its assignment. The investment advisory agreement may be terminated by either party without penalty upon not more than 60 days’ written notice to the other. The investment advisory agreement may also be terminated, without penalty, upon the vote of a majority of our outstanding voting securities.
Indemnification
The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of their respective duties or by reason of the reckless disregard of their respective duties and obligations, our investment adviser and its officers, managers, agents, employees, controlling persons, members (or their owners) and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our investment adviser’s services under the investment advisory agreement or otherwise as our investment adviser.
Organization of our Investment Adviser
Our investment adviser is a Delaware limited liability company that registered as an investment adviser under the Advisers Act. The principal address of our investment adviser is 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831.
Board Approval of the Investment Advisory Agreement
At a meeting of our Board of Directors held on January 14, 2013, our Board of Directors unanimously voted to approve the investment advisory agreement. In reaching a decision to approve the investment advisory agreement, the Board of Directors reviewed a significant amount of information and considered, among other things:
 
•
the nature, quality and extent of the advisory and other services to be provided to us by Fifth Street Management LLC;
•
the fee structures of comparable externally managed business development companies that engage in similar investing activities;
•
our projected operating expenses and expense ratio compared to business development companies with similar investment objectives;
•
any existing and potential sources of indirect income to Fifth Street Management LLC from its relationship with us and the profitability of that relationship, including through the investment advisory agreement;
•
information about the services to be performed and the personnel performing such services under the investment advisory agreement;

15

•
the organizational capability and financial condition of Fifth Street Management LLC and its affiliates; and
•
various other matters.
Based on the information reviewed and the discussions detailed above, the Board of Directors, including all of the directors who are not “interested persons” as defined in the 1940 Act, concluded that the investment advisory fee rates and terms are reasonable in relation to the services provided and approved the investment advisory agreement as being in the best interests of our stockholders.
Administration Agreement
We have also entered into an administration agreement with FSC, Inc. under which FSC, Inc. provides administrative services for us, including office facilities and equipment and clerical, bookkeeping and record-keeping services at such facilities. Under the administration agreement, FSC, Inc. also performs, or oversees the performance of, our required administrative services, which includes being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, FSC, Inc. assists us in determining and publishing our net asset value, overseeing the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others. For providing these services, facilities and personnel, we reimburse FSC, Inc. the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement, including rent and our allocable portion of the costs of compensation and related expenses of our chief financial officer and chief compliance officer, and their staffs. Such reimbursement is at cost, with no profit to, or markup by, FSC, Inc. Our allocable portion of FSC, Inc.’s costs is determined based upon costs attributable to our operations versus costs attributable to the operations of other entities for which FSC, Inc. provides administrative services.
FSC, Inc. may also provide on our behalf managerial assistance to our portfolio companies. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.
The administration agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of their respective duties or by reason of the reckless disregard of their respective duties and obligations, FSC, Inc. and its officers, managers, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of services under the administration agreement or otherwise as administrator for us.
License Agreement
We have also entered into a license agreement with Fifth Street Capital LLC pursuant to which Fifth Street Capital LLC has agreed to grant us a non-exclusive, royalty-free license to use the name “Fifth Street.” Under this agreement, we will have a right to use the “Fifth Street” name, for so long as Fifth Street Management 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.
Material Conflicts of Interest
Our executive officers and directors, and certain members of our investment adviser, serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. For example, Fifth Street Management presently serves as investment adviser to FSFR, a publicly-traded BDC with total assets of approximately $100 million as of September 30, 2013, that invests in in senior secured loans, including first lien, unitranche and second lien debt instruments, that pay interest at rates which are determined periodically on the basis of a floating base lending rate, made to private middle market companies whose debt is rated below investment grade, similar to those we target for investment. Specifically, FSFR targets private leveraged middle market companies with approximately $20 million to $100 million of EBITDA and targets investment sizes generally ranging from $3 million and $20 million. We generally target small and mid-sized companies with annual revenues between $25 million and $250 million and target investment sizes generally ranging from $10 million to $100 million. In addition, though not the primary focus of our investment portfolio, our investments also include floating rate senior loans. Therefore, there may be certain investment opportunities that satisfy the investment criteria for both FSFR and us. FSFR operates as a distinct and separate public company and any investment in our common stock will not be an investment in FSFR. In addition, our executive officers and two of our independent directors serve in substantially similar capacities for FSFR. Fifth Street Management and its affiliates also manage private investment funds, and may manage other funds in the future, that have investment mandates that are similar, in whole and in part, with ours. Accordingly, they may have obligations to investors in those entities, the fulfillment of

16

which might not be in the best interests of us or our stockholders. For example, the principals of our investment adviser may face conflicts of interest in the allocation of investment opportunities to us and such other funds.

To the extent an investment opportunity is appropriate for us or FSFR or any other investment fund managed by our affiliates, and co-investment is not possible, Fifth Street Management will adhere to its investment allocation policy in order to determine to which entity to allocate the opportunity. Any such opportunity will be allocated first to the entity whose investment strategy is the most consistent with the opportunity being allocated, and second, if the terms of the opportunity are consistent with more than one entity's investment strategy, on an alternating basis. Although our investment professionals will endeavor to allocate investment opportunities in a fair and equitable manner, we and our common stockholders could be adversely affected to the extent investment opportunities are allocated among us and other investment vehicles managed or sponsored by, or affiliated with, our executive officers, directors and members of our investment adviser.

The 1940 Act prohibits us from making certain negotiated co-investments with affiliates, including FSFR, unless we receive an order from the SEC permitting us to do so. Fifth Street Management and certain of its affiliates have submitted an exemptive application to the SEC to permit us to co-invest with other funds managed by Fifth Street Management or its affiliates in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors. There can be no assurance that any such exemptive order will be obtained. Prior to receiving any such exemptive order from the SEC, Fifth Street Management will offer us the right to participate in all investment opportunities that it determines are appropriate for us in view of our investment objective, policies and strategies and other relevant factors. These offers will be subject to the exception that, in accordance with Fifth Street Management’s investment allocation policy, we might not participate in each individual opportunity, but will, on an overall basis, be entitled to participate equitably with other entities managed by Fifth Street Management and its affiliates.

Fifth Street Management’s policies are also designed to manage and mitigate the conflicts of interest associated with the allocation of investment opportunities if we are able to co-invest, either pursuant to SEC interpretive positions or an exemptive order, with other accounts managed by our investment adviser and its affiliates. Generally, under the investment allocation policy, a portion of each opportunity that is appropriate for us and any affiliated fund, which may vary based on asset class and liquidity, among other factors, will be offered to us and such other eligible accounts, as determined by Fifth Street Management. The investment allocation policy further provides that allocations among us and other eligible accounts will generally be made in accordance with SEC interpretive positions or an exemptive order. Fifth Street Management seeks to treat all clients fairly and equitably in a manner consistent with its fiduciary duty to each of them; however, in some instances, especially in instances of limited liquidity, the factors may not result in pro rata allocations or may result in situations where certain accounts receive allocations where others do not.
Exchange Act Reports
We maintain a website at http://www.fifthstreetfinance.com. The information on our website is not incorporated by reference in this annual report on Form 10-K.
We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the SEC in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.
Business Development Company Regulations
We have elected to be regulated as a business development company under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates, principal underwriters and affiliates of those affiliates or underwriters. The 1940 Act requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a business development company unless approved by a majority of our outstanding voting securities.
The 1940 Act defines “a majority of the outstanding voting securities” as the lesser of (i) 67% or more of the voting securities present at a meeting if the holders of more than 50% of our outstanding voting securities are present or represented by proxy or (ii) more than 50% of our outstanding voting securities.
As a business development company, we will not generally be permitted to invest in any portfolio company in which our investment adviser or any of its affiliates currently have an investment or to make any co-investments with our investment

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adviser or its affiliates without an exemptive order from the SEC. Fifth Street Management has submitted an exemptive application to the SEC to permit us to co-invest with other funds managed by Fifth Street Management or its affiliates in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors. There can be no assurance that any such exemptive order will be obtained.
Qualifying Assets
Under the 1940 Act, a business development company may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are any of the following:
(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:
(a) is organized under the laws of, and has its principal place of business in, the United States;
(b) is not an investment company (other than a small business investment company wholly owned by the business development company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
(c) satisfies any of the following:
(i) does not have any class of securities that is traded on a national securities exchange;
(ii) has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million;
(iii) is controlled by a business development company or a group of companies including a business development company and the business development company has an affiliated person who is a director of the eligible portfolio company; or
(iv) is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million;
(2) Securities of any eligible portfolio company that we control;
(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements;
(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company;
(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities; or
(6) Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.
In addition, a business development company must be operated for the purpose of making investments in the types of securities described in (1), (2) or (3) above.
Managerial Assistance to Portfolio Companies
In order to count portfolio securities as qualifying assets for the purpose of the 70% test, we must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where we purchase such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the business development

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company, through its directors, officers or employees (if any), offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.
Temporary Investments
Pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. We may invest in U.S. Treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement (which is substantially similar to a secured loan) involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests in order to qualify as a RIC for U.S. federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Our investment adviser will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of debt and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we may be prohibited from making distributions to our stockholders or repurchasing such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a business development company and RIC affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth” and “— Because we borrow money, the potential for loss on amounts invested in us will be magnified and may increase the risk of investing in us.”
We received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the United States Small Business Administration, or SBA, from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. This provides us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $225 million more than we would otherwise be able to under the 1940 Act absent the receipt of this exemptive relief.
Common Stock
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in our best interests and that of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount). We may also make rights offerings to our stockholders at prices per share less than the net asset value per share, subject to applicable requirements of the 1940 Act. See “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a business development company affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.”
Code of Ethics
We have adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act and we have also approved the investment adviser’s code of ethics that was adopted by it under Rule 17j-1 under the 1940 Act and Rule 204A-1 of the Advisers Act. These codes establish procedures for personal investments and restrict certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. You may read and copy the codes of ethics at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the codes of

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ethics are available on the EDGAR Database on the SEC’s Internet site at http://www.sec.gov and are available on our corporate governance webpage at http:/ir.fifthstreetfinance.com/governance.cfm.
Compliance Policies and Procedures
We and our investment adviser have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws and are required to review these compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Our chief compliance officer is responsible for administering these policies and procedures.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to our investment adviser. The proxy voting policies and procedures of our investment adviser are set forth below. The guidelines are reviewed periodically by our investment adviser and our non-interested directors, and, accordingly, are subject to change.
Introduction
As an investment adviser registered under the Advisers Act, our investment adviser has a fiduciary duty to act solely in the best interests of its client. As part of this duty, it recognizes that it must vote client securities in a timely manner free of conflicts of interest and in the best interests of its client.
These policies and procedures for voting proxies for the investment advisory clients of our investment adviser are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy policies
Our investment adviser will vote proxies relating to our securities in the best interest of our stockholders. It will review on a case-by-case basis each proposal submitted for a stockholder vote to determine its impact on the portfolio securities held by us. Although our investment adviser will generally vote against proposals that may have a negative impact on our portfolio securities, it may vote for such a proposal if there exists compelling long-term reasons to do so.
The proxy voting decisions of our investment adviser are made by the senior officers who are responsible for monitoring each of our investments. To ensure that its vote is not the product of a conflict of interest, it will require that: (a) anyone involved in the decision-making process disclose to its chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (b) employees involved in the decision making process or vote administration are prohibited from revealing how our investment adviser intends to vote on a proposal in order to reduce any attempted influence from interested parties.
Proxy voting records
You may obtain information, without charge, regarding how we voted proxies with respect to our portfolio securities by making a written request for proxy voting information to: Fifth Street Finance Corp. Chief Compliance Officer, 10 Bank Street, 12th Floor, White Plains, NY 10606.
Other
We are subject to periodic examination by the SEC for compliance with the 1940 Act.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
Securities Exchange Act and Sarbanes-Oxley Act Compliance
We are subject to the reporting and disclosure requirements of the Exchange Act, including the filing of quarterly, annual and current reports, proxy statements and other required items. In addition, we are subject to the Sarbanes-Oxley Act, which imposes a wide variety of regulatory requirements on publicly-held companies and their insiders. For example:
 
•
pursuant to Rule 13a-14 of the Exchange Act, our chief executive officer and chief financial officer are required to certify the accuracy of the financial statements contained in our periodic reports;

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•
pursuant to Item 307 of Regulation S-K, our periodic reports are required to disclose our conclusions about the effectiveness of our disclosure controls and procedures; and
•
pursuant to Rule 13a-15 of the Exchange Act, our management is required to prepare a report regarding its assessment of our internal control over financial reporting. Our independent registered public accounting firm is required to audit our internal control over financial reporting.
Small Business Investment Company Regulations
Our wholly-owned subsidiaries’ SBIC licenses allow them to obtain leverage by issuing SBA-guaranteed debentures, subject to customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $18 million and have average annual fully taxed net income not exceeding $6 million for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller” concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6 million and has average annual fully taxed net income not exceeding $2 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.
SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when they have at least $112.5 million in regulatory capital. As of September 30, 2013, one of our SBIC subsidiaries had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $130.9 million. As of September 30, 2013, our other SBIC subsidiary had $37.5 million in regulatory capital and $31.8 million in SBA-guaranteed debentures outstanding, which had a fair value of $25.2 million.
We have received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $225 million more than we would otherwise be able to absent the receipt of this exemptive relief.
The SBA restricts the ability of SBICs to repurchase their capital stock. SBA regulations also include restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in accordance with SBA regulations. In addition, our SBIC subsidiaries may also be limited in their ability to make distributions to us if they do not have sufficient capital, in accordance with SBA regulations.
Our SBIC subsidiaries are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of SBIC licenses does not assure that our SBIC subsidiaries will receive SBA guaranteed debenture funding, which is dependent upon our SBIC subsidiaries continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will have a superior claim to our SBIC subsidiaries’ assets over our stockholders in the event we liquidate our SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by our SBIC subsidiaries upon an event of default.

The NASDAQ Global Select Market Corporate Governance Regulations
The NASDAQ Global Select Market has adopted corporate governance regulations that listed companies must comply with. We are in compliance with such corporate governance listing standards applicable to business development companies.
Taxation as a Regulated Investment Company
As a business development company, we have elected to be treated, and intend to continue to qualify annually, as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any income that we distribute to our stockholders as dividends. To continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable

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income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).
If we qualify as a RIC and satisfy the Annual Distribution Requirement, then we generally will not be subject to U.S. federal income tax on the portion of our income we distribute (or are deemed to distribute) to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.
We will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (3) any income recognized, but not distributed, in preceding years (the “Excise Tax Avoidance Requirement”). We generally will endeavor in each taxable year to make sufficient distributions to our stockholders to avoid any U.S. federal excise tax on our earnings.
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
 
•
continue to qualify as a business development company under the 1940 Act at all times during each taxable year;
•
derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to loans of certain securities, gains from the sale of stock or other securities, net income from certain “qualified publicly traded partnerships,” or other income derived with respect to our business of investing in such stock or securities (the “90% Income Test”); and
•
diversify our holdings so that at the end of each quarter of the taxable year:
•
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and
•
no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification Tests”).
Qualified earnings may exclude such income as management fees received in connection with our SBIC or other potential outside managed funds and certain other fees.
We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as PIK interest and deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy the distribution requirements. However, under the 1940 Act, we are not permitted in certain circumstances to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
Item 1A. Risk Factors
RISK FACTORS
Investing in our securities involves a number of significant risks. In addition to the other information contained in this annual report on Form 10-K, you should consider carefully the following information before making an investment in our securities. The risks set out below are not the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us might also impair our operations and performance. If any of the following events occur,

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our business, financial condition and results of operations could be materially and adversely affected. In such case, our net asset value and the trading price of our securities could decline, and you may lose part or all of your investment.

Risks Relating to Economic Conditions
Economic recessions or downturns may have a material adverse effect on our business, financial condition and results of operations, and could impair the ability of our portfolio companies to repay loans.
Economic recessions or downturns may result in a prolonged period of market illiquidity which could have a material adverse effect on our business, financial condition and results of operations. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could limit our investment originations, limit our ability to grow and negatively impact our operating results.
In addition, to the extent that recessionary conditions return, the financial results of small and mid-sized companies, like those in which we invest, will likely experience deterioration, which could ultimately lead to difficulty in meeting debt service requirements and an increase in defaults. Additionally, the end markets for certain of our portfolio companies’ products and services would likely experience negative economic trends. The performances of certain of our portfolio companies have been, and may continue to be, negatively impacted by these economic or other conditions, which may ultimately result in our receipt of a reduced level of interest income from our portfolio companies and/or losses or charge offs related to our investments, and, in turn, may adversely affect distributable income. Further, adverse economic conditions may decrease the value of collateral securing some of our loans and the value of our equity investments. As a result, we may need to modify the payment terms of our investments, including changes in payment-in-kind interest provisions and/or cash interest rates. These factors may result in our receipt of a reduced level of interest income from our portfolio companies and/or losses or charge offs related to our investments, and, in turn, may adversely affect distributable income and have a material adverse effect on our results of operations.
Further downgrades of the U.S. credit rating, impending automatic spending cuts or another government shutdown could negatively impact our liquidity, financial condition and earnings.
Recent U.S. debt ceiling and budget deficit concerns have increased the possibility of additional credit-rating downgrades and economic slowdowns, or a recession in the U.S. Although U.S. lawmakers passed legislation to raise the federal debt ceiling on multiple occasions, ratings agencies have lowered or threatened to lower the long-term sovereign credit rating on the United States. The impact of this or any further downgrades to the U.S. government’s sovereign credit rating or its perceived creditworthiness could adversely affect the U.S. and global financial markets and economic conditions. Absent further quantitative easing by the Federal Reserve, these developments could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms. In addition, disagreement over the federal budget has caused the U.S. federal government to shut down for periods of time. Continued adverse political and economic conditions could have a material adverse effect on our business, financial condition and results of operations.
Global economic, political and market conditions may adversely affect our business, results of operations and financial condition, including our revenue growth and profitability.
The current worldwide financial market situation, as well as various social and political tensions in the United States and around the world, may continue to contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets, and may cause further economic uncertainties or deterioration in the United States and worldwide. Since 2010, several European Union (“EU”) countries, including Greece, Ireland, Italy, Spain, and Portugal, have faced budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries. There is continued concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal policy of foreign nations, such as China, may have a severe impact on the worldwide and United States financial markets. We do not know how long the financial markets will continue to be affected by these events and cannot predict the effects of these or similar events in the future on the United States economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Risks Relating to Our Business and Structure
Changes in interest rates may affect our cost of capital and net investment income.
Because we may borrow to fund our investments, a portion of our net investment income may be dependent upon the difference between the interest rate at which we borrow funds and the interest rate at which we invest these funds. Portions of our investment portfolio and our borrowings will likely have floating rate components from time to time. As a result, a significant change in market interest rates could have a material adverse effect on our net investment income. In periods of

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rising interest rates, our cost of funds could increase, which would reduce our net investment income. We may hedge against such interest rate fluctuations by using standard hedging instruments such as interest rate swap agreements, futures, options and forward contracts, subject to applicable legal requirements, including without limitation, all necessary registrations (or exemptions from registration) with the Commodity Futures Trading Commission. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged borrowings. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations.
A significant portion of our investment portfolio is and will continue to be recorded at fair value as determined in good faith by our Board of Directors and, as a result, there is and will continue to be uncertainty as to the value of our portfolio investments.
Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined by our Board of Directors. Typically, there is not a public market for the securities of the privately held companies in which we have invested and will generally continue to invest. As a result, we value these securities quarterly at fair value as determined in good faith by our Board of Directors.
Certain factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to comparable publicly-traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Due to this uncertainty, our fair value determinations may cause our net asset value on a given date to materially understate or overstate the value that we may ultimately realize upon the sale of one or more of our investments. As a result, investors purchasing our common stock based on an overstated net asset value would pay a higher price than the realizable value of our investments might warrant.
Our ability to achieve our investment objective depends on our investment adviser’s ability to support our investment process; if our investment adviser were to lose any of its principals, our ability to achieve our investment objective could be significantly harmed.
We depend on the investment expertise, skill and network of business contacts of the principals of our investment adviser. The principals of our investment adviser evaluate, negotiate, structure, execute, monitor and service our investments. Our future success will depend to a significant extent on the continued service and coordination of the principals of our investment adviser. The departure of any of these individuals could have a material adverse effect on our ability to achieve our investment objective.
Our ability to achieve our investment objective depends on our investment adviser’s ability to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. Our investment adviser’s capabilities in structuring the investment process, providing competent, attentive and efficient services to us, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our investment objective, our investment adviser may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. Our investment adviser may not be able to find investment professionals in a timely manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.
Our business model depends to a significant extent upon strong referral relationships with private equity sponsors, and the inability of the principals of our investment adviser to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We expect that the principals of our investment adviser will maintain and develop their relationships with private equity sponsors, and we will rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the principals of our investment adviser fail to maintain their existing relationships or develop new relationships with other sponsors or sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the principals of our investment adviser have relationships are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.
We may face increasing competition for investment opportunities, which could reduce returns and result in losses.
We compete for investments with other business development companies and investment funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial banks and other sources of

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funding. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than we are able to do. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ pricing, terms and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. A significant part of our competitive advantage stems from the fact that the market for investments in small and mid-sized companies is underserved by traditional commercial banks and other financial sources. A significant increase in the number and/or the size of our competitors in this target market could force us to accept less attractive investment terms. Furthermore, many of our competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a business development company.
Our incentive fee may induce our investment adviser to make speculative investments.
The incentive fee payable by us to our investment adviser may create an incentive for it to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement, which could result in higher investment losses, particularly during cyclical economic downturns. The way in which the incentive fee payable to our investment adviser is determined, which is calculated separately in two components as a percentage of the income (subject to a hurdle rate) and as a percentage of the realized gain on invested capital, may encourage our investment adviser to use leverage to increase the return on our investments or otherwise manipulate our income so as to recognize income in quarters where the hurdle rate is exceeded. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor the holders of our common stock.
The incentive fee payable by us to our investment adviser also may create an incentive for our investment adviser to invest on our behalf in instruments that have a deferred interest feature. Under these investments, we would accrue the interest over the life of the investment but would not receive the cash income from the investment until the end of the investment’s term, if at all. Our net investment income used to calculate the income portion of our incentive fee, however, includes accrued interest. Thus, a portion of the incentive fee would be based on income that we have not yet received in cash and may never receive in cash if the portfolio company is unable to satisfy such interest payment obligation to us. While we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a formal “clawback” right against our investment adviser per se, the amount of accrued income written off in any period will reduce the income in the period in which such write-off was taken and thereby reduce such period’s incentive fee payment.
In addition, our investment adviser receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on income, there is no performance threshold applicable to the portion of the incentive fee based on net capital gains. As a result, our investment adviser may have a tendency to invest more in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
Given the subjective nature of the investment decisions made by our investment adviser on our behalf, we will be unable to monitor these potential conflicts of interest between us and our investment adviser.
Our base management fee may induce our investment adviser to incur leverage.
The fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage our investment adviser to use leverage to make additional investments. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which would disfavor holders of our common stock. Given the subjective nature of the investment decisions made by our investment adviser on our behalf, we may not be able to monitor this potential conflict of interest.
Because we borrow money, the potential for loss on amounts invested in us will be magnified and may increase the risk of investing in us.
Borrowings, also known as leverage, magnify the potential for loss on invested equity capital. If we continue to use leverage to partially finance our investments, through borrowings from banks and other lenders, you will experience increased risks of investing in our common stock. We, through our SBIC subsidiaries, issue debt securities guaranteed by the SBA and sold in the capital markets. As a result of its guarantee of the debt securities, the SBA has fixed dollar claims on the assets of our SBIC subsidiaries that are superior to the claims of our common stockholders. We also borrow under our credit facilities, have issued the Convertible Notes, 2024 Notes and 2028 Notes, and may issue other debt securities or enter into other types of borrowing arrangements in the future. If the value of our assets decreases, leveraging would cause net asset value to decline

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more sharply than it otherwise would have had we not leveraged. Similarly, any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock distributions or scheduled debt payments. Leverage is generally considered a speculative investment technique and we only intend to use leverage if expected returns will exceed the cost of borrowing.
Substantially all of our assets are subject to security interests under secured credit facilities or subject to a superior claim over our stockholders by the SBA and if we default on our obligations under the facilities or with respect to our SBA-guaranteed debentures, we may suffer adverse consequences, including foreclosure on our assets.
As of September 30, 2013, substantially all of our assets were pledged as collateral under our credit facilities or subject to a superior claim over our stockholders by the SBA. If we default on our obligations under these facilities or our SBA-guaranteed debentures, the lenders and/or the SBA may have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests or their superior claim. In such event, we may be forced to sell our investments to raise funds to repay our outstanding borrowings in order to avoid foreclosure and these forced sales may be at times and at prices we would not consider advantageous. Moreover, such deleveraging of our company could significantly impair our ability to effectively operate our business in the manner in which we have historically operated. As a result, we could be forced to curtail or cease new investment activities and lower or eliminate the dividends that we have historically paid to our stockholders.
In addition, if the lenders exercise their right to sell the assets pledged under our credit facilities, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the credit facilities.
Pending legislation may allow us to incur additional leverage.
As a BDC, under the 1940 Act we generally are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). Recent legislation introduced in the U.S. House of Representatives, if passed, would modify this section of the 1940 Act and increase the amount of debt that BDCs may incur by modifying the asset coverage percentage from 200% to 150%. In addition, recent legislation introduced in the U.S. Senate would modify SBA regulations in a manner that may permit us to incur additional SBA leverage. As a result, we may be able to incur additional indebtedness in the future and therefore your risk of an investment in us may increase.
Because we intend to distribute between 90% and 100% of our income to our stockholders in connection with our election to be treated as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow will be impaired.
In order to qualify for the tax benefits available to RICs and to minimize corporate-level taxes, we intend to distribute to our stockholders between 90% and 100% of our annual taxable income, except that we may retain certain net capital gains for investment, and treat such amounts as deemed distributions to our stockholders. If we elect to treat any amounts as deemed distributions, we must pay income taxes at the corporate rate on such deemed distributions on behalf of our stockholders. As a result of these requirements, we will likely need to raise capital from other sources to grow our business. As a business development company, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which includes all of our borrowings and any outstanding preferred stock, of at least 200%. These requirements limit the amount that we may borrow. Because we will continue to need capital to grow our investment portfolio, these limitations may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so.
While we expect to be able to issue additional equity securities, we cannot assure you that equity financing will be available to us on favorable terms, or at all. Also, as a business development company, we generally are not permitted to issue equity securities priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new investment activities, and our net asset value and share price could decline.
Our ability to enter into transactions with our affiliates is restricted.
We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of the members of our independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any securities (other than our securities) from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we are prohibited from buying or selling any security (other than any security of which we are the issuer) from or to such person or

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certain of that person’s affiliates, or entering into prohibited joint transactions with such person, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security (other than any security of which we are the issuer) from or to any portfolio company of a private equity fund managed by our investment adviser without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.
Fifth Street Management has submitted an exemptive application to the SEC to permit us to co-invest with other funds managed by Fifth Street Management or its affiliates in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors. There can be no assurance that any such exemptive order will be obtained.
There are significant potential conflicts of interest which could adversely impact our investment returns.
Our executive officers and directors, and certain members of our investment adviser, serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. For example, Fifth Street Management presently serves as investment adviser to FSFR, a publicly-traded BDC with total assets of approximately $100 million as of September 30, 2013, that invests in in senior secured loans, including first lien, unitranche and second lien debt instruments, that pay interest at rates which are determined periodically on the basis of a floating base lending rate, made to private middle market companies whose debt is rated below investment grade, similar to those we target for investment. Specifically, FSFR targets private leveraged middle market companies with approximately $20 million to $100 million of EBITDA and targets investment sizes generally ranging from $3 million and $20 million. We generally target small and mid-sized companies with annual revenues between $25 million and $250 million and target investment sizes generally ranging from $10 million to $100 million. In addition, though not the primary focus of our investment portfolio, our investments also include floating rate senior loans. Therefore, there may be certain investment opportunities that satisfy the investment criteria for both FSFR and us. FSFR operates as a distinct and separate public company and any investment in our common stock will not be an investment in FSFR. In addition, our executive officers and two of our independent directors serve in substantially similar capacities for FSFR. Fifth Street Management and its affiliates also manage private investment funds, and may manage other funds in the future, that have investment mandates that are similar, in whole and in part, with ours. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders. For example, the principals of our investment adviser may face conflicts of interest in the allocation of investment opportunities to us and such other funds.
To the extent an investment opportunity is appropriate for us or FSFR or any other investment fund managed by our affiliates, and co-investment is not possible, Fifth Street Management will adhere to its investment allocation policy in order to determine to which entity to allocate the opportunity. Any such opportunity will be allocated first to the entity whose investment strategy is the most consistent with the opportunity being allocated, and second, if the terms of the opportunity are consistent with more than one entity's investment strategy, on an alternating basis. Although our investment professionals will endeavor to allocate investment opportunities in a fair and equitable manner, we and our common stockholders could be adversely affected to the extent investment opportunities are allocated among us and other investment vehicles managed or sponsored by, or affiliated with, our executive officers, directors and members of our investment adviser.
As discussed above, the 1940 Act prohibits us from making certain negotiated co-investments with affiliates, including FSFR, unless we receive an order from the SEC permitting us to do so. Fifth Street Management and certain of its affiliates have submitted an exemptive application to the SEC for such an order but there can be no assurance that any such exemptive order will be obtained.
The incentive fee we pay to our investment adviser relating to capital gains may be effectively greater than 20%.
As a result of the operation of the cumulative method of calculating the capital gains portion of the incentive fee we pay to our investment adviser, the cumulative aggregate capital gains fee received by our investment adviser could be effectively greater than 20%, depending on the timing and extent of subsequent net realized capital losses or net unrealized depreciation. For additional information on this calculation, see the disclosure in footnote 2 to Example 2 under the caption "Item 1. Business - Investment Advisory Agreement — Management Fee — Incentive Fee.” We cannot predict whether, or to what extent, this payment calculation would affect your investment in our stock.
A failure on our part to maintain our qualification as a business development company would significantly reduce our operating flexibility.
If we fail to continuously qualify as a business development company, we might be subject to regulation as a registered closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility. In addition, failure to comply with the requirements imposed on business development companies by the 1940 Act could cause the SEC to bring an enforcement action against us. For additional information on the qualification requirements of a business development company, see the disclosure under the caption “Regulation — Business Development Company Regulations.”

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Regulations governing our operation as a business development company and RIC affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.
As a result of the annual distribution requirement to qualify for tax free treatment at the corporate level on income and gains distributed to stockholders, we need to periodically access the capital markets to raise cash to fund new investments. We generally are not able to issue or sell our common stock at a price below net asset value per share, which may be a disadvantage as compared with other public companies or private investment funds. If our common stock trades at a discount to net asset value, this restriction could adversely affect our ability to raise capital. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors and independent directors determine that such sale is in our best interests and the best interests of our stockholders, and our stockholders as well as those stockholders that are not affiliated with us approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our Board of Directors, closely approximates the market value of such securities (less any underwriting commission or discount). See “— Stockholders may incur dilution if we issue securities to subscribe to, convert to or purchase shares of our common stock” for a discussion of a proposal approved by our stockholders that permits us to issue warrants, options or rights to acquire our common stock at a price below the current net asset value per share.
We also may make rights offerings to our stockholders at prices less than net asset value, subject to applicable requirements of the 1940 Act. If we raise additional funds by issuing more shares of our common stock or issuing senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our stockholders may decline at that time and such stockholders may experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity securities in the future, on terms favorable to us or at all.
In addition, we may issue “senior securities,” including borrowing money from banks or other financial institutions only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. Our ability to issue different types of securities is also limited. Compliance with these requirements may unfavorably limit our investment opportunities and reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend. As a business development company, therefore, we may need to issue equity more frequently than our privately owned competitors, which may lead to greater stockholder dilution.
We expect to continue to borrow for investment purposes. If the value of our assets declines, we may be unable to satisfy the asset coverage test, which could prohibit us from paying dividends and could prevent us from qualifying as a RIC. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
In addition, we may in the future seek to securitize our portfolio securities to generate cash for funding new investments. To securitize loans, we would likely create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. We would then sell interests in the subsidiary on a non-recourse basis to purchasers and we would retain all or a portion of the equity in the subsidiary. An inability to successfully securitize our loan portfolio could limit our ability to grow our business or fully execute our business strategy and may decrease our earnings, if any. The securitization market is subject to changing market conditions and we may not be able to access this market when we would otherwise deem appropriate. Moreover, the successful securitization of our portfolio might expose us to losses as the residual investments in which we do not sell interests will tend to be those that are riskier and more apt to generate losses. The 1940 Act also may impose restrictions on the structure of any securitization.
Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiaries’ operations.
Through wholly-owned subsidiaries, we hold two licenses from the SBA to operate SBIC subsidiaries. On February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. received a license, effective February 1, 2010, and on May 15, 2012, our wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. received a license, effective May 10, 2012, from the SBA to operate as SBICs under Section 301(c) of the Small Business Investment Act of 1958. The SBIC licenses allow our SBIC subsidiaries to obtain leverage by issuing SBA-guaranteed debentures. The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBIC requirements may cause our SBIC subsidiaries to forgo attractive investment opportunities that are not permitted under SBA regulations.
Further, SBA regulations require that an SBIC be periodically examined and audited by the SBA to determine its compliance with the relevant SBA regulations. The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of an SBIC. If our SBIC subsidiaries fail to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit their use of debentures, declare outstanding debentures immediately due and

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payable, and/or limit them from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiaries are our wholly-owned subsidiaries.
We may experience fluctuations in our quarterly results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our market and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Our Board of Directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval, the effects of which may be adverse.
Our Board of Directors has the authority to modify or waive our current investment objective, operating policies and strategies without prior notice and without stockholder approval. We cannot predict the effect any changes to our current investment objective, operating policies and strategies would have on our business, net asset value, operating results and value of our stock. However, the effects might be adverse, which could negatively impact our ability to pay you distributions and cause you to lose part or all of your investment.
We will be subject to corporate-level income tax if we are unable to maintain our qualification as a RIC under Subchapter M of the Code or do not satisfy the annual distribution requirement.
To maintain RIC status and be relieved of federal taxes on income and gains distributed to our stockholders, we must meet the following annual distribution, income source and asset diversification requirements:
•
The annual distribution requirement for a RIC will be satisfied if we distribute to our stockholders on an annual basis at least 90% of our net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and we may be subject to certain financial covenants under our debt arrangements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
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The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.
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The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.
If we fail to qualify for or maintain RIC status or to meet the annual distribution requirement for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.
We may not be able to pay you distributions, our distributions may not grow over time and a portion of our distributions may be a return of capital.
We intend to pay distributions to our stockholders out of assets legally available for distribution. We cannot assure you that we will achieve investment results that will allow us to sustain a specified level of cash distributions or periodic increases in cash distributions. Our ability to pay distributions might be adversely affected by, among other things, the impact of one or more of the risk factors described in this prospectus. In addition, the inability to satisfy the asset coverage test applicable to us as a business development company can limit our ability to pay distributions. All distributions will be paid at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our RIC status, compliance with applicable business development company regulations and such other factors as our Board of Directors may deem relevant from time to time. We cannot assure you that we will continue to pay distributions to our stockholders.

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When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain.
We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.
For federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as original issue discount or accruals on a contingent payment debt instrument, which may occur if we receive warrants in connection with the origination of a loan or possibly in other circumstances. Such original issue discount is included in income before we receive any corresponding cash payments. In addition, our loans typically contain payment-in-kind (“PIK”) interest provisions. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income.We also may be required to include in income certain other amounts that we do not receive, and may never receive, in cash.
Since, in certain cases, we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the annual distribution requirement necessary to be relieved of federal taxes on income and gains distributed to our stockholders. Accordingly, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to satisfy the annual distribution requirement and thus become subject to corporate-level income tax.
We may in the future choose to pay distributions partly in our own stock, in which case you may be required to pay tax in excess of the cash you receive.
We may distribute taxable distributions that are payable in part in our stock. In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the distribution paid in stock will be equal to the amount of cash that could have been received instead of stock. Taxable stockholders receiving such distributions will be required to include the full amount of the distribution as ordinary income (or as long-term capital gain to the extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such distributions in excess of any cash received. If a U.S. stockholder sells the stock it receives as a distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such distribution, including in respect of all or a portion of such distribution that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on distribution, it may put downward pressure on the trading price of our stock.

Our wholly-owned SBIC subsidiaries may be unable to make distributions to us that will enable us to maintain RIC status, which could result in the imposition of an entity-level tax.
In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we are required to distribute substantially all of our net taxable income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiaries. We are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver and if our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC tax treatment and a consequent imposition of an entity-level tax on us.
We may be unable to invest a significant portion of the net proceeds from an offering of our securities on acceptable terms within an attractive timeframe.

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Delays in investing the net proceeds raised in an offering of our securities may cause our performance to be worse than that of other fully invested business development companies or other lenders or investors pursuing comparable investment strategies. We cannot assure you that we will be able to identify any investments that meet our investment objective or that any investment that we make will produce a positive return. We may be unable to invest the net proceeds of any offering on acceptable terms within the time period that we anticipate or at all, which could harm our financial condition and operating results.
We anticipate that, depending on market conditions, it may take us a substantial period of time to invest substantially all of the net proceeds of any offering in securities meeting our investment objective. During this period, we will invest the net proceeds of an offering primarily in cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, which may produce returns that are significantly lower than the returns which we expect to achieve when our portfolio is fully invested in securities meeting our investment objective. As a result, any distributions that we pay during this period may be substantially lower than the distributions that we may be able to pay when our portfolio is fully invested in securities meeting our investment objective. In addition, until such time as the net proceeds of an offering are invested in securities meeting our investment objective, the market price for our common stock may decline. Thus, the return on your investment may be lower than when, if ever, our portfolio is fully invested in securities meeting our investment objective.
Changes in laws or regulations governing our operations may adversely affect our business or cause us to alter our business strategy.
We and our portfolio companies are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make or that impose limits on our ability to pledge a significant amount of our assets to secure loans, any of which could harm us and our stockholders, potentially with retroactive effect.
Additionally, any changes to the laws and regulations governing our operations relating to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth in this prospectus and may result in our investment focus shifting from the areas of expertise of our investment adviser to other types of investments in which our investment adviser may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.
Future control deficiencies could prevent us from accurately and timely reporting our financial results.
We may identify deficiencies in our internal control over financial reporting in the future, including significant deficiencies and material weaknesses. A “significant deficiency” is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of a company’s financial reporting. A “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Our failure to identify deficiencies in our internal control over financial reporting in a timely manner or remediate any deficiencies, or the identification of material weaknesses or significant deficiencies in the future could prevent us from accurately and timely reporting our financial results.
Risks Relating to Our Investments
Our investments in portfolio companies may be risky, and we could lose all or part of our investment.
The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies are not rated by any rating agency. If such investments were rated, we believe that they would likely receive a rating from a nationally recognized statistical rating organization of below investment grade (i.e., below BBB- or Baa), which is often referred to as “junk.” Exposure to below investment grade securities involves certain risks, and those securities are viewed as having predominately speculative characteristics with respect to the issuer's capacity to pay interest and repay principal. Investing in small and mid-sized companies involves a number of significant risks. Among other things, these companies:
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may have limited financial resources and may be unable to meet their obligations under their debt instruments that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing any guarantees from subsidiaries or affiliates of our portfolio companies that we may have obtained in connection with our investments, as well as a corresponding decrease in the value of the equity components of our investments;

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•
may have shorter operating histories, narrower product lines, smaller market shares and/or significant customer concentrations than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns;
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are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;
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generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position; and
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generally have less publicly available information about their businesses, operations and financial condition. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and as a result may lose part or all of our investment.
In addition, in the course of providing significant managerial assistance to certain of our portfolio companies, certain of our officers and directors may serve as directors on the boards of such companies. To the extent that litigation arises out of our investments in these companies, our officers and directors may be named as defendants in such litigation, which could result in an expenditure of funds (through our indemnification of such officers and directors) and the diversion of management time and resources.
We may incur greater risk with respect to investments we acquire through assignments or participations of interests.
Although we originate a substantial portion of our loans, we may acquire loans through assignments or participations of interests in such loans. The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a lender under the credit agreement with respect to such debt obligation. However, the purchaser’s rights can be more restricted than those of the assigning institution, and we may not be able to unilaterally enforce all rights and remedies under an assigned debt obligation and with regard to any associated collateral. A participation typically results in a contractual relationship only with the institution participating out the interest and not directly with the borrower. Sellers of participations typically include banks, broker-dealers, other financial institutions and lending institutions. In purchasing participations, we generally will have no right to enforce compliance by the borrower with the terms of the loan agreement against the borrower, and we may not directly benefit from the collateral supporting the debt obligation in which we have purchased the participation. As a result, we will be exposed to the credit risk of both the borrower and the institution selling the participation. Further, in purchasing participations in lending syndicates, we will not be able to conduct the same level of due diligence on a borrower or the quality of the loan with respect to which we are buying a participation as we would conduct if we were investing directly in the loan. This difference may result in us being exposed to greater credit or fraud risk with respect to such loans than we expected when initially purchasing the participation.
An investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about these companies.
We invest primarily in privately held companies. Generally, little public information exists about these companies, including typically a lack of audited financial statements and ratings by third parties. We must therefore rely on the ability of our investment adviser to obtain adequate information to evaluate the potential risks of investing in these companies. These companies and their financial information may not be subject to the Sarbanes-Oxley Act and other rules that govern public companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. These factors could affect our investment returns.
If we make unsecured debt investments, we may lack adequate protection in the event our portfolio companies become distressed or insolvent and will likely experience a lower recovery than more senior debtholders in the event our portfolio companies defaults on their indebtedness.
We have made, and may in the future make, unsecured debt investments in portfolio companies. Unsecured debt investments are unsecured and junior to other indebtedness of the portfolio company. As a consequence, the holder of an unsecured debt investment may lack adequate protection in the event the portfolio company becomes distressed or insolvent and will likely experience a lower recovery than more senior debtholders in the event the portfolio company defaults on its indebtedness. In addition, unsecured debt investments of small and mid-sized companies are often highly illiquid and in adverse market conditions may experience steep declines in valuation even if they are fully performing.
If we invest in the securities and obligations of distressed or bankrupt companies, such investments may be subject to significant risks, including lack of income, extraordinary expenses, uncertainty with respect to satisfaction of debt, lower-than expected investment values or income potentials and resale restrictions.
We are authorized to invest in the securities and other obligations of distressed or bankrupt companies. At times, distressed debt obligations may not produce income and may require us to bear certain extraordinary expenses (including legal,

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accounting, valuation and transaction expenses) in order to protect and recover our investment. Therefore, to the extent we invest in distressed debt, our ability to achieve current income for our stockholders may be diminished.
We also will be subject to significant uncertainty as to when and in what manner and for what value the distressed debt we invest in will eventually be satisfied (e.g., through a liquidation of the obligor’s assets, an exchange offer or plan of reorganization involving the distressed debt securities or a payment of some amount in satisfaction of the obligation). In addition, even if an exchange offer is made or plan of reorganization is adopted with respect to distressed debt held by us, there can be no assurance that the securities or other assets received by us in connection with such exchange offer or plan of reorganization will not have a lower value or income potential than may have been anticipated when the investment was made.
Moreover, any securities received by us upon completion of an exchange offer or plan of reorganization may be restricted as to resale. As a result of our participation in negotiations with respect to any exchange offer or plan of reorganization with respect to an issuer of distressed debt, we may be restricted from disposing of such securities.
The lack of liquidity in our investments may adversely affect our business.
We invest, and will continue to invest, in companies whose securities are not publicly traded, and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. In fact, all of our assets may be invested in illiquid securities. The illiquidity of these investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. Our investments are usually subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market for such investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.
We may not have the funds or ability to make additional investments in our portfolio companies.
After our initial investment in a portfolio company, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment through the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio company in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected yield on the investment.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We invest primarily in first lien, second lien and subordinated debt issued by small and mid-sized companies. Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payments of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt instruments in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
The disposition of our investments may result in contingent liabilities.
Most of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.
Even though we have structured some of our investments as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or instances where we exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken in rendering significant managerial assistance.

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Second priority liens on collateral securing loans that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.
Certain loans that we make to portfolio companies will be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken with respect to the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.
Our investments in the healthcare sector face considerable uncertainties including substantial regulatory challenges.
As of September 30, 2013, our investments in portfolio companies that operate in the healthcare sector represent approximately 20% of our total portfolio. Our investments in the healthcare sector are subject to substantial risks. The laws and rules governing the business of healthcare companies and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Existing or future laws and rules could force our portfolio companies engaged in healthcare to change how they do business, restrict revenue, increase costs, change reserve levels and change business practices.
Healthcare companies often must obtain and maintain regulatory approvals to market many of their products, change prices for certain regulated products and consummate some of their acquisitions and divestitures. Delays in obtaining or failing to obtain or maintain these approvals could reduce revenue or increase costs. Policy changes on the local, state and federal level, such as the expansion of the government’s role in the healthcare arena and alternative assessments and tax increases specific to the healthcare industry or healthcare products as part of federal health care reform initiatives, could fundamentally change the dynamics of the healthcare industry.
We generally do not, and do not expect to, control our portfolio companies.
We do not, and do not expect to, control most of our portfolio companies, even though we may have board representation or board observation rights, and our debt agreements may contain certain restrictive covenants. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as a debt investor. Due to the lack of liquidity for our investments in non-traded companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.
Defaults by our portfolio companies would harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
We may not realize gains from our equity investments.
Certain investments that we have made in the past and may make in the future include warrants or other equity securities. In addition, we have made in the past and may make in the future direct equity investments in companies. Our goal is ultimately to realize gains upon our disposition of such equity interests. However, the equity interests we receive may not

34


appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We also may be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which would allow us to sell the underlying equity interests. We may seek puts or similar rights to give us the right to sell our equity securities back to the portfolio company issuer. We may be unable to exercise these put rights for the consideration provided in our investment documents if the issuer is in financial distress.
We are subject to certain risks associated with foreign investments.
We may make investments in foreign companies. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in foreign exchange rates, exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the U.S., higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility.
Our success will depend, in part, on our ability to anticipate and effectively manage these and other risks. We cannot assure you that these and other factors will not have a material adverse effect on our business as a whole.
We may expose ourselves to risks if we engage in hedging transactions.
We have and may in the future enter into hedging transactions, which may expose us to risks associated with such transactions. We may utilize instruments such as forward contracts and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions and amounts due under our credit facilities from changes in market interest rates. Use of these hedging instruments may include counterparty credit risk. Utilizing such hedging instruments does not eliminate the possibility of fluctuations in the values of such positions and amounts due under our credit facilities or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
The success of any hedging transactions will depend on our ability to correctly predict movements and interest rates. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings or credit facilities being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. See also “— Changes in interest rates may affect our cost of capital and net investment income.”
We are a non-diversified investment company within the meaning of the 1940 Act, and therefore have few restrictions with respect to the proportion of our assets that may be invested in securities of a single industry or issuer.
We are classified as a non-diversified investment company within the meaning of the 1940 Act, which means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in securities of a single industry or issuer, excluding limitations on investments in other investment companies. To the extent that we assume large positions in the securities of a small number of industries or issuers, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the industry or issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company. Beyond RIC diversification requirements, we do not have fixed guidelines for diversification, and our investments could be concentrated in relatively few industries or issuers.

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

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Investing in our common stock may involve an above average degree of risk.
The investments we make in accordance with our investment objective may result in a higher amount of risk than alternative investment options and a higher risk of volatility or loss of principal. Our investments in portfolio companies involve higher levels of risk, and therefore, an investment in our shares may not be suitable for someone with lower risk tolerance.
The market price of our common stock may fluctuate significantly.
The market price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
•
significant volatility in the market price and trading volume of securities of business development companies or other companies in our sector, which are not necessarily related to the operating performance of these companies;
•
inability to obtain any exemptive relief that may be required by us from the SEC;
•
changes in regulatory policies, accounting pronouncements or tax guidelines, particularly with respect to RICs, business development companies and SBICs;
•
loss of our business development company or RIC status or the status of our SBIC subsidiaries as SBICs;
•
changes in earnings or variations in operating results;
•
changes in the value of our portfolio of investments;
•
any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
•
departure of our investment adviser’s key personnel; and
•
general economic trends and other external factors.
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.
Sales of substantial amounts of our common stock, or the availability of such common stock for sale, could adversely affect the prevailing market prices for our common stock. If this occurs and continues for a sustained period of time, it could impair our ability to raise additional capital through the sale of securities should we desire to do so.

Certain provisions of our restated certificate of incorporation and amended and restated bylaws as well as the Delaware General Corporation Law could deter takeover attempts and have an adverse impact on the price of our common stock.
Our restated certificate of incorporation and our amended and restated bylaws as well as the Delaware General Corporation Law contain provisions that may have the effect of discouraging a third party from making an acquisition proposal for us. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price for our common stock.
Stockholders may incur dilution if we issue securities to subscribe to, convert to or purchase shares of our common stock.
The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value per share of such stock with certain exceptions. One such exception is prior stockholder approval of issuances of securities to subscribe to, convert to or purchase shares of our common stock even if the subscription, conversion or purchase price per share of our common stock is below the net asset value per share of our common stock at the time of any such subscription, conversion or purchase. At our 2011 annual meeting of stockholders, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings, including under such circumstance. Such authorization has no expiration. Any decision to sell securities to subscribe to, convert to, or purchase shares of our common stock will be subject to the determination by our board of directors that such issuance is in our and our stockholders’ best interests. If we issue securities to subscribe to, convert to or purchase shares of common stock, the exercise or conversion of such securities would increase the number of outstanding shares of our common stock. Any such exercise or conversion would be dilutive on the voting power of existing stockholders, and could be dilutive with regard to dividends and our net asset value, and other economic aspects of the common stock.
Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted; however, the table below illustrates the impact on the net asset value per common share of a business development company that would be experienced upon the exercise of a warrant to acquire shares of common stock of the business development company.
Example of Impact of Exercise of Warrant to Acquire Common Stock on Net Asset Value Per Share

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The example assumes that the business development company has 1,000,000 shares of common stock outstanding, $15,000,000 in total assets and $5,000,000 in total liabilities at the time of the exercise of the warrant. As a result, the net asset value and net asset value per common share of the business development company are $10,000,000 and $10.00, respectively.
Further, the example assumes that the warrant permits the holder thereof to acquire 250,000 common shares under the following three different scenarios: (i) with an exercise price equal to a 10% premium to the business development company’s net asset value per share at the time of exercise, or $11.00 per share, (ii) with an exercise price equal to the business development company’s net asset value per share at the time of exercise, or $10.00 per share, and (iii) with an exercise price equal to a 10% discount to the business development company’s net asset value per share at the time of exercise, or $9.00 per share.
Warrant Exercise Price
 
Net Asset Value Per Share
Prior To Exercise
 
Net Asset Value Per Share
After Exercise
10% premium to net asset value per common share
 
$
10.00

 
$
10.20

Net asset value per common share
 
$
10.00

 
$
10.00

10% discount to net asset value per common share
 
$
10.00

 
$
9.80

Although have we chosen to demonstrate the impact on the net asset value per common share of a business development company that would be experienced by existing stockholders of the business development company upon the exercise of a warrant to acquire shares of common stock of the business development company, the results noted above would be similar in connection with the exercise or conversion of other securities exercisable or convertible into shares of the business development company’s common stock. In addition, the example does not take into account the impact of other securities that may be issued in connection with the issuance of exercisable or convertible securities (e.g., the issuance of shares of common stock in conjunction with the issuance of warrants to acquire shares of common stock).
Risks Related to Our Convertible Notes
Our stockholders may experience dilution upon the conversion of our convertible notes.
Our convertible notes are convertible into shares of our common stock beginning January 1, 2016 or, under certain circumstances, earlier. Upon conversion, we must deliver shares of our common stock. The conversion rate of our convertible notes was initially, and currently is, 67.7415 shares of our common stock per $1,000 principal amount of our convertible notes (equivalent to a conversion price of approximately $14.76 per share of common stock), subject to adjustment in certain circumstances. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115.0 million convertible debt currently outstanding is 7,790,273. If we deliver shares of common stock upon a conversion at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our convertible notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance.
We may not have, or have the ability to raise, the funds necessary to repurchase our convertible notes upon a fundamental change, and our debt may contain limitations on our ability to deliver shares of our common stock upon conversion or pay cash upon repurchase of our convertible notes.
Holders of our convertible notes will have the right to require us to repurchase their notes upon the occurrence of certain significant corporate events involving us, including if our common stock ceases to trade on any national securities exchange or we consolidate or merge into another entity in certain circumstances, at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any. We refer to such a corporate event as a “fundamental change.” However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of convertible notes surrendered therefor. In addition, our ability to repurchase our convertible notes or deliver shares of our common stock upon conversions of the convertible notes may be limited by law, by regulatory authority or by agreements governing our indebtedness, including our credit facilities. In this regard, the ING facility prohibits us from repurchasing our convertible notes in certain circumstances upon the occurrence of a fundamental change. Our failure to repurchase the notes at a time when the repurchase is required by the indenture relating to the convertible notes or to deliver any shares of our common stock deliverable on future conversions of the convertible notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the occurrence of a fundamental change itself could also lead to a default under agreements governing our indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase our convertible notes.
Provisions of our convertible notes could discourage an acquisition of us by a third party.
Certain provisions of our convertible notes could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of a fundamental change, the holders of our convertible notes will have the right, at their option, to require

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us to repurchase all or a portion of their convertible notes, plus accrued and unpaid interest. We may also be required to increase the conversion rate of the convertible notes in certain other circumstances, including in the event of certain fundamental changes. These provisions could discourage an acquisition of us by a third party.
Certain adverse consequences could result if our convertible notes are treated as equity interests in us for purposes of regulations under the Employee Retirement Income Security Act of 1974.
Pursuant to regulations under the Employee Retirement Income Security Act of 1974 (“ERISA”), it is possible that, due to their convertibility feature, our convertible notes could be treated as equity interests in us. In that event, if employee benefit plans subject to Title I of ERISA, plans that are not subject to ERISA but that are subject to Section 4975 of the Internal Revenue Code (the “Code”), such as individual retirement accounts, and entities that are deemed to hold the assets of such plans or accounts (such plans, accounts, and entities, “Benefit Plan Investors”) were to acquire 25% or more of the aggregate value of our convertible notes, among other consequences, we and our management would be subject to ERISA fiduciary duties, and certain transactions we might enter into, or may have entered into, in the ordinary course of our business might constitute non-exempt “prohibited transactions” under Section 406 of ERISA or Section 4975 of the Code and might have to be rescinded at significant cost to us. Moreover, if our underlying assets were deemed to be assets constituting plan assets, (i) our assets could be subject to ERISA’s reporting and disclosure requirements, (ii) a fiduciary causing a Benefit Plan Investor to make an investment in our equity interests could be deemed to have delegated its responsibility to manage the assets of the Benefit Plan Investor, and (iii) various providers of fiduciary or other services to us, and any other parties with authority or control with respect to our assets, could be deemed to be plan fiduciaries or otherwise parties in interest or disqualified persons by virtue of their provision of such services.
We do not believe that our convertible notes should be treated as equity interests in us for purposes of ERISA in light of the relevant regulations. No assurance can be given, however, that our convertible notes will not be so treated.
The accounting for convertible debt securities is complex and subject to uncertainty.
The accounting for convertible debt securities is complex and subject to frequent scrutiny by the accounting regulatory bodies and is subject to change. The issuance of our convertible notes may have an accounting effect on our earnings per share on a fully diluted basis. Further, we cannot predict if or when changes in the accounting for convertible debt securities could be made and whether any such change could have an adverse impact on our reported or future financial results. Any such impacts could adversely affect the market price or value of our common stock.
Risks Related to Our Notes
The Notes are unsecured and therefore are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future.
Our Notes are not secured by any of our assets or any of the assets of our subsidiaries. As a result, the Notes are effectively subordinated to any secured indebtedness we or our subsidiaries have currently incurred and may incur in the future (or any indebtedness that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness and the secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Notes. As of September 30, 2013, we had $20.0 million of outstanding borrowings under our Wells Fargo facility, $168.0 million of outstanding borrowings under our ING facility, no borrowings outstanding under our Sumitomo facility and $181.8 million of outstanding SBA-guaranteed debentures.
The Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The Notes are obligations exclusively of Fifth Street Finance Corp. and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the Notes and the Notes are not required to be guaranteed by any subsidiaries we may acquire or create in the future. A portion of the indebtedness required to be consolidated on our balance sheet is held through our SBIC subsidiaries. The assets of such subsidiaries are not directly available to satisfy the claims of our creditors, including holders of the Notes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources” for more detail on the SBA-guaranteed debentures.
Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors (including trade creditors) and holders of preferred stock, if any, of our subsidiaries have priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders of the Notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our subsidiaries, our claims are effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, the Notes are structurally subordinated to all indebtedness and other liabilities (including

38


trade payables) of any of our subsidiaries and any subsidiaries that we may in the future acquire or establish as financing vehicles or otherwise.
In addition, our subsidiaries may incur substantial additional indebtedness in the future, all of which would be structurally senior to the Notes.
The indenture under which the Notes are issued contains limited protection for holders of the Notes.
The indenture under which the Notes are issued offers limited protection to holders of the Notes. The terms of the indenture and the Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on investments in the Notes. In particular, the terms of the indenture and the Notes do not place any restrictions on our or our subsidiaries’ ability to:
•
issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to the Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the SEC (currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings);
•
pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the Notes, including subordinated indebtedness, in each case, while the 2024 Notes remain outstanding, other than dividends, purchases, redemptions or payments that would cause a violation of Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions giving effect to any exemptive relief granted to us by the SEC (these provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 200% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase);
•
sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);
•
enter into transactions with affiliates;
•
create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;
•
make investments; or
•
create restrictions on the payment of dividends or other amounts to us from our subsidiaries.
In addition, the indenture does not require us to offer to purchase the Notes in connection with a change of control or any other event.
Furthermore, the terms of the indenture and the Notes do not protect holders of the Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow or liquidity.
Our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by the terms of the Notes may have important consequences for holders of the Notes, including making it more difficult for us to satisfy our obligations with respect to the Notes or negatively affecting the trading value of the Notes.
Certain of our current debt instruments include more protections for their holders than the indenture and the Notes. In addition, other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for and trading levels and prices of the Notes.
An active trading market for the Notes may not exist, which could limit your ability to sell the Notes or affect the market price of the Notes.

39


We cannot provide any assurances that an active trading market for the Notes will exist in the future or that you will be able to sell your Notes. Even if an active trading market does exist, the Notes may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial condition, performance and prospects and other factors. To the extent an active trading market does not exist, the liquidity and trading price for the Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the Notes for an indefinite period of time.
If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.
Any default under the agreements governing our indebtedness, including a default under the Wells Fargo facility, the ING facility, the Sumitomo facility, and our Convertible Notes or other indebtedness to which we may be a party that is not waived by the required lenders or holders, and the remedies sought by the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the Notes and substantially decrease the market value of the Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Wells Fargo facility, the ING facility, the Sumitomo facility or other debt we may incur in the future could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to seek to obtain waivers from the required lenders under the Wells Fargo facility, the ING facility, or the Sumitomo facility or the required holders of our Convertible Notes or other debt that we may incur in the future to avoid being in default. If we breach our covenants under the Wells Fargo facility, the ING facility, the Sumitomo facility, or our Convertible Notes or other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders. If this occurs, we would be in default and our lenders or debt holders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations, including the lenders under the Wells Fargo facility, the ING facility, or the Sumitomo facility, could proceed against the collateral securing the debt. Because the Wells Fargo facility, the ING facility, the Sumitomo facility and our Convertible Notes have, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness thereunder or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due.


40



Item 1B. Unresolved Staff Comments
None.

Item 2. Properties
We do not own any real estate or other physical properties material to our operations. We utilize office space that is leased by our affiliates for our principal executive office at 10 Bank Street, 12th Floor, White Plains, NY 10606, as well as additional office space at 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831, 311 South Wacker Drive, Suite 3380, Chicago, IL 60606 and 250 Cambridge Avenue, Suite 201, Palo Alto, CA 94306. We may from time to time, through our affiliates, lease satellite office space elsewhere, but these leases are generally not material to our operations. We believe that our office facilities are adequate for our business as presently conducted, although we are actively evaluating alternative options.

Item 3.     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 4.     Mine Safety Disclosures
Not applicable.


41


PART II

Item 5.     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range of Common Stock
Our common stock traded on the New York Stock Exchange under the symbol “FSC” until November 28, 2011 when we transferred the listing to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.” The following table sets forth, for each fiscal quarter during the last two most recently completed fiscal years, the range of high and low sales prices of our common stock as reported on the New York Stock Exchange and NASDAQ Global Select Market:
 
 
 
High
 
Low
Fiscal year ended September 30, 2013
 
 
 
 
First quarter
 
$
11.08

 
$
9.80

Second quarter
 
$
11.07

 
$
10.33

Third quarter
 
$
11.13

 
$
9.66

Fourth quarter
 
$
10.96

 
$
10.04

Fiscal year ended September 30, 2012
 
 
 
 
First quarter
 
$
10.24

 
$
8.60

Second quarter
 
$
10.60

 
$
9.54

Third quarter
 
$
10.00

 
$
8.99

Fourth quarter
 
$
11.01

 
$
9.93

The last reported price for our common stock on November 21, 2013 was $10.17 per share. As of November 18, 2013, we had 72 stockholders of record, which did not include stockholders for whom shares are held in nominee or “street” name.
Sales of Unregistered Securities
While we did not engage in any sales of unregistered securities during the fiscal year ended September 30, 2013, we issued a total of 1,188,872 shares of common stock under our dividend reinvestment plan (“DRIP”). This issuance was not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value the shares of our common stock issued under our DRIP was approximately $12.1 million.
Distributions
Our dividends, if any, are determined by our Board of Directors.
In addition, we have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
To maintain RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income. Any such carryover taxable income must be distributed through a dividend declared prior to filing the final tax return related to the year in which such taxable income was generated. We may, in the future, make actual distributions to our stockholders of our net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. See “Item 1. Business — Regulation — Taxation as a Regulated Investment Company.”
We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we make a cash distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions.
In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to

42


all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.
The following table reflects the distributions per share including any return of capital, that our Board of Directors has declared, including shares issued under our DRIP, on our common stock since October 1, 2011:
 
Date Declared
 
Record Date
 
Payment Date
 
Amount
per Share
 
Cash
Distribution
 
DRIP Shares
Issued
 
 
 
DRIP Shares
Value
November 10, 2011
 
January 13, 2012
 
January 31, 2012
 
 $ 0.0958

 
$ 6.6 million
 
29,902

 
(1)
 
$ 0.3 million
November 10, 2011
 
February 15, 2012
 
February 29, 2012
 
0.0958

 
7.4 million
 
45,071

 
  
 
0.4 million
November 10, 2011
 
March 15, 2012
 
March 30, 2012
 
0.0958

 
7.5 million
 
41,807

 
(1)
 
0.4 million
February 7, 2012
 
April 13, 2012
 
April 30, 2012
 
0.0958

 
7.4 million
 
48,328

 
(1)
 
0.5 million
February 7, 2012
 
May 15, 2012
 
May 31, 2012
 
0.0958

 
7.4 million
 
47,877

 
(1)
 
0.5 million
February 7, 2012
 
June 15, 2012
 
June 29, 2012
 
0.0958

 
7.5 million
 
41,499

 
  
 
0.4 million
May 7, 2012
 
July 13, 2012
 
July 31, 2012
 
0.0958

 
7.4 million
 
49,217

 
  
 
0.5 million
May 7, 2012
 
August 15, 2012
 
August 31, 2012
 
0.0958

 
7.5 million
 
41,359

 
  
 
0.4 million
May 7, 2012
 
September 14, 2012
 
September 28, 2012
 
0.0958

 
8.3 million
 
43,952

 
  
 
0.5 million
August 6, 2012
 
October 15, 2012
 
October 31, 2012
 
0.0958

 
8.2 million
 
51,754

 
  
 
0.5 million
August 6, 2012
 
November 15, 2012
 
November 30, 2012
 
0.0958

 
8.2 million
 
53,335

 
  
 
0.5 million
August 6, 2012
 
December 14, 2012
 
December 28, 2012
 
0.0958

 
9.5 million
 
64,680

 
  
 
0.6 million
August 6, 2012
 
January 15, 2013
 
January 31, 2013
 
0.0958

 
9.5 million
 
61,782

 
  
 
0.6 million
August 6, 2012
 
February 15, 2013
 
February 28, 2013
 
0.0958

 
9.1 million
 
103,356

 
  
 
1.0 million
January 14, 2013
 
March 15, 2013
 
March 29, 2013
 
0.0958

 
9.1 million
 
100,802

 
 
 
1.1 million
January 14, 2013
 
April 15, 2013
 
April 30, 2013
 
0.0958

 
10.3 million
 
111,167

 
 
 
1.2 million
January 14, 2013
 
May 15, 2013
 
May 31, 2013
 
0.0958

 
10.3 million
 
127,152

 
 
 
1.3 million
May 6, 2013
 
June 14, 2013
 
June 28, 2013
 
0.0958

 
10.5 million
 
112,821

 
 
 
1.1 million
May 6, 2013
 
July 15, 2013
 
July 31, 2013
 
0.0958

 
10.2 million
 
130,944

 
 
 
1.3 million
May 6, 2013
 
August 15, 2013
 
August 30, 2013
 
0.0958

 
10.3 million
 
136,052

 
 
 
1.3 million
August 5, 2013
 
September 13, 2013
 
September 30, 2013
 
0.0958

 
10.3 million
 
135,027

 
 
 
1.3 million
August 5, 2013
 
October 15, 2013
 
October 31, 2013
 
0.0958

 
11.9 million
 
142,320

 
 
 
1.4 million
August 5, 2013
 
November 15, 2013
 
November 29, 2013
 
0.0958

 
 
 
 
 
 
 
 
November 21, 2013
 
December 13, 2013
 
December 30, 2013
 
0.05

 
 
 
 
 
 
 
 
November 21, 2013
 
January 15, 2014
 
January 31, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
February 14, 2014
 
February 28, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
March 14, 2014
 
March 31, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
April 15, 2014
 
April 30, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
May 15, 2014
 
May 30, 2014
 
0.0833

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

43


Stock Performance Graph
The following graph compares the cumulative 5 year total return provided shareholders on Fifth Street Finance Corp’s common stock relative to the cumulative total returns of the NYSE Composite index, the NASDAQ Financial index and a customized peer group of six companies that includes: Apollo Investment Corp., Ares Capital Corp., Blackrock Kelso Capital Corp., Gladstone Capital Corp., MCG Capital Corp. and MVC Capital Inc. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock, in each index and in the peer group on September 30, 2008 and its relative performance is tracked through September 30, 2013.
*$100 invested on 9/30/08 in stock or index, including reinvestment of dividends.
 
 
Sep 2008

Dec 2008

Mar 2009

Jun 2009

Sep 2009

Dec 2009

Mar 2010

Jun 2010

Sep 2010

Dec 2010

Fifth Street Finance Corp.
 
100.00

78.91

80.90

107.89

120.53

121.66

135.07

131.71

134.37

150.48

NYSE Composite
 
100.00

77.03

67.14

80.32

94.53

98.81

102.98

90.05

101.92

112.05

NASDAQ Financial
 
100.00

81.29

65.20

72.97

79.80

81.66

89.14

79.87

80.72

92.60

Peer Group
 
100.00

63.25

37.62

60.38

87.11

95.90

123.06

104.71

125.18

135.94

 
 
 
Mar 2011

Jun 2011

Sep 2011

Dec 2011

Mar 2012

Jun 2012

Sep 2012

Dec 2012

Mar 2013

Jun 2013

Sep 2013

Fifth Street Finance Corp. (cont.)
 
169.47

151.11

123.94

131.44

137.89

145.29

164.31

160.24

174.01

169.55

171.42

NYSE Composite (cont.)
 
118.87

118.43

97.27

107.74

118.99

114.03

121.39

124.97

135.65

137.45

145.20

NASDAQ Financial (cont.)
 
93.55

90.52

74.26

83.99

95.11

92.74

97.14

97.89

112.23

118.67

123.53

Peer Group (cont.)
 
141.99

131.71

107.98

116.07

129.24

133.23

143.04

150.31

157.50

153.05

159.20


44


Selected unaudited quarterly financial data for Fifth Street Finance Corp. for the years ended September 30, 2013, 2012 and 2011 are below:
 
For the three months ended
(dollars in thousands,
except per share
amounts)
September  30, 2013
June 30,
2013
March 31,
2013
December  31, 2012
September  30, 2012
June 30,
2012
March 31,
2012
December  31, 2011
September  30, 2011
June 30,
2011
March 31,
2011
December  31, 2010
Total investment income
$
57,092

$
58,050

$
54,687

$
51,783

$
42,531

$
41,008

$
42,080

$
39,497

$
37,686

$
32,442

$
29,701

$
25,335

Net investment income
28,699

30,394

29,303

26,556

22,315

21,910

22,791

20,989

19,989

16,526

16,556

14,056

Realized and unrealized gain (loss)
(2,561
)
(4,388
)
2,531

(8,713
)
4,757

179

(2,735
)
(10,805
)
(43,733
)
4,306

(885
)
3,392

Net increase (decrease) in net assets resulting from operations
26,138

26,006

31,834

17,843

27,072

22,089

20,056

10,184

(23,744
)
20,832

15,671

17,448

Net assets
1,368,872

1,197,268

1,050,961

1,046,879

903,570

812,071

813,322

715,665

728,627

775,649

711,748

574,920

Total investment income per common share
$
0.47

$
0.49

$
0.52

$
0.55

$
0.51

$
0.50

$
0.53

$
0.55

$
0.52

$
0.48

$
0.48

$
0.46

Net investment income per common share
0.24

0.26

0.28

0.28

0.27

0.27

0.29

0.29

0.28

0.25

0.27

0.26

Earnings (loss) per common share
0.21

0.22

0.30

0.19

0.32

0.27

0.25

0.14

(0.33
)
0.31

0.25

0.32

Net asset value per common share at period end
9.85

9.90

9.90

9.88

9.92

9.85

9.87

9.89

10.07

10.72

10.68

10.44

Open Market Stock Repurchase Program
On May 6, 2013, upon expiration of its previous stock repurchase program, the Company's Board of Directors authorized a stock repurchase program to acquire up to $50 million of its outstanding common stock. Stock repurchases under this program would be made through the open market at times and in such amounts as the Company's management deems appropriate, provided they are below the most recently published net asset value per share. Unless extended by the Board of Directors, the stock repurchase program will expire on May 7, 2014 and may be limited or terminated at any time without prior notice. As of September 30, 2013, we had not repurchased any shares of our common stock pursuant to this repurchase program.

45


Item 6.     Selected Financial Data
The following selected financial data should be read together with our financial statements and the related notes and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which is included elsewhere in this annual report on Form 10-K. The financial information as of and for the fiscal years ended September 30, 2009, 2010, 2011, 2012 and 2013 set forth below was derived from our audited financial statements and related notes for Fifth Street Finance Corp.
 
 
 
As of and for the Year Ended
 
(dollars in thousands, except per share amounts)
 

September 30,
2013
 
September 30,
2012
 
September 30,
2011
 
September 30,
2010
 
September 30,
2009
 
Statement of Operations data:
 
 
 
 
 
 
 
 
 
 
 
Total investment income
 
$
221,612

 
$
165,116

 
$
125,165

 
$
70,538

 
$
49,828

 
Base management fee, net
 
33,427

 
23,799

 
19,656

 
9,275

 
5,889

 
Incentive fee
 
28,158

 
22,001

 
16,782

 
10,756

 
7,841

 
All other expenses
 
45,074

 
32,882

 
23,080

 
7,483

 
4,736

 
Gain on extinguishment of unsecured convertible notes
 
—

 
1,571

 
1,480

 
—

 
—

 
Net investment income
 
114,953

 
88,005

 
67,127

 
43,024

 
31,362

 
Unrealized appreciation (depreciation) on interest rate swap
 
—

 
—

 
773

 
(773
)
 
—

 
Realized loss on interest rate swap
 
—

 
—

 
(1,335
)
 
—

 
—

 
Net unrealized appreciation (depreciation) on investments
 
13,397

 
55,974

 
(7,299
)
 
(1,054
)
 
(10,795
)
 
Realized loss on investments
 
(26,529
)
 
(64,578
)
 
(29,059
)
 
(18,781
)
 
(14,373
)
 
Net increase in net assets resulting from operations
 
101,821

 
79,401

 
30,207

 
22,416

 
6,194

 
Per share data:
 
 
 
 
 
 
 
 
 
 
 
Net asset value per common share at period end
 
9.85

 
9.92

 
10.07

 
10.43

 
10.84

 
Market price at period end
 
10.29

 
10.98

 
9.32

 
11.14

 
10.93

 
Net investment income
 
1.04

 
1.11

 
1.05

 
0.95

 
1.27

 
Net realized and unrealized loss on investments and interest rate swap
 
(0.12
)
 
(0.11
)
 
(0.58
)
 
(0.46
)
 
(1.02
)
 
Net increase in partners’ capital/net assets resulting from operations
 
0.92

 
1.00

 
0.47

 
0.49

 
0.25

 
Dividends paid per share
 
1.15

 
1.18

 
1.26

 
0.96

 
1.20

 
Balance Sheet data at period end:
 
 
 
 
 
 
 
 
 
 
 
Total investments at fair value
 
$
1,893,046

 
$
1,288,108

 
$
1,119,837

 
$
563,821

 
$
299,611

 
Cash and cash equivalents
 
147,359

 
74,393

 
67,644

 
76,765

 
113,205

 
Other assets
 
31,928

 
26,501

 
22,236

 
11,340

 
3,071

 
Total assets
 
2,072,333

 
1,389,002

 
1,209,717

 
651,926

 
415,887

 
Total liabilities
 
703,461

 
485,432

 
481,090

 
82,754

 
5,331

 
Total net assets
 
1,368,872

 
903,570

 
728,627

 
569,172

 
410,556

 
Other data:
 
 
 
 
 
 
 
 
 
 
 
Weighted average yield on debt investments(1)
 
11.1
%
 
12.0
%
 
12.4
%
 
14.0
%
 
15.7
%
 
Number of investments at period end
 
99

 
78

 
65

 
38

 
28

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

46



Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in connection with our Consolidated Financial Statements and the notes thereto included elsewhere in this annual report on Form 10-K.
Some of the statements in this annual report on Form 10-K constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K may include statements as to:
 
•
our future operating results and dividend projections;
•
our business prospects and the prospects of our portfolio companies;
•
the impact of the investments that we expect to make;
•
the ability of our portfolio companies to achieve their objectives;
•
our expected financings and investments;
•
the adequacy of our cash resources and working capital; and
•
the timing of cash flows, if any, from the operations of our portfolio companies.
In addition, words such as “anticipate,” “believe,” “expect,” “seek,” “plan,” “should,” “estimate,” “project” and “intend” indicate forward-looking statements, although not all forward-looking statements include these words. The forward-looking statements contained in this annual report on Form 10-K 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 “Item 1A. Risk Factors” and elsewhere in this annual report on Form 10-K. Other factors that could cause actual results to differ materially include:
 
•
changes in the economy and the financial markets;
•
risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters;
•
future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to business development companies, SBICs or RICs; and
•
other considerations that may be disclosed from time to time in our publicly disseminated documents and filings.
We have based the forward-looking statements included in this annual report on Form 10-K on information available to us on the date of this annual 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 SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Except as otherwise specified, references to the “Company,” “we,” “us,” and “our,” refer to Fifth Street Finance Corp.
All amounts are in thousands, except share and per share amounts, percentages and as otherwise indicated.
Overview
We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.
We were formed as a Delaware limited partnership (Fifth Street Mezzanine Partners III, L.P.) on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp. At the time of the merger, all outstanding partnership interests in Fifth Street Mezzanine Partners III, L.P. were exchanged for 12,480,972 shares of common stock in Fifth Street Finance Corp.
 
On June 17, 2008, we completed an initial public offering of 10,000,000 shares of our common stock at the offering price of $14.12 per share. Our stock was listed on the New York Stock Exchange until November 28, 2011 when we transferred the listing to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.”
Market Conditions
The global economy has experienced economic uncertainty in recent years. Economic uncertainty impacts our business in many ways, including changing spreads, structures and purchase multiples as well as the overall supply of investment capital. See "Risk Factors -- Risks Relating to Economic Conditions."

47


Despite the economic uncertainty, our deal pipeline remains robust, with high quality transactions backed by private equity sponsors in small to mid-sized companies. As always, we remain cautious in selecting new investment opportunities, and will only deploy capital in deals which we believe are consistent with our disciplined philosophy of pursuing superior risk-adjusted returns.
We expect to grow the investment portfolio by strategically investing in small and mid-sized companies when and where appropriate, as evidenced by our recent investment activities. Although we believe that we currently have sufficient capital available to fund investments, a prolonged period of market disruptions may cause us to reduce the volume of loans we originate and/or fund, which could have an adverse effect on our business, financial condition and results of operations. In this regard, because our common stock has at times traded at a price below our then current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.
Critical Accounting Policies
Basis of Presentation
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires management to make certain estimates and assumptions affecting amounts reported in the Consolidated Financial Statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.
Investment Valuation
We are required to report our investments that are not publicly traded or for which current market values are not readily available at fair value. The fair value is deemed to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
In accordance with authoritative accounting guidance, we perform detailed valuations of our debt and equity investments on an individual basis, using bond yield, market and income approaches as appropriate. In general, we utilize a bond yield method for the majority of our investments, as long as it is appropriate. If, in our judgment, the bond yield approach is not appropriate, we may use the market approach, income approach, or, in certain cases, an alternative methodology potentially including market quotations, asset liquidation model, expected recovery model or other alternative approaches.
Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.
Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), cash flows, net income or revenues. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.
Under the income approach, we generally prepare and analyze discounted cash flow models based on our projections of the future free cash flows of the business.
 
Our Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of our investments:
•
The quarterly valuation process begins with each portfolio company or investment being initially valued by our finance department;
•
Preliminary valuations are then reviewed and discussed with principals of the investment adviser;
•
Separately, independent valuation firms are engaged by our Board of Directors to prepare preliminary valuations on a selected basis and submit the reports to us;
•
Our finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;

48


•
Our finance department prepares a valuation report for the Audit Committee of our Board of Directors;
•
The Audit Committee of our Board of Directors is apprised of the preliminary valuations of the independent valuation firms;
•
The Audit Committee of our Board of Directors reviews the preliminary valuations, and our finance department responds and supplements the preliminary valuations to reflect any comments provided by the Audit Committee;
•
The Audit Committee of our Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in our portfolio; and
•
Our Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith.
The fair value of all of our investments at September 30, 2013, and September 30, 2012, was determined by our Board of Directors. Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and a consistently applied valuation process.
We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued over the course of each fiscal year. The percentages of our portfolio, at fair value, valued by independent valuation firms each period during the current and two preceding fiscal years were as follows:
For the quarter ended December 31, 2010
 
73.9
%
For the quarter ended March 31, 2011
 
82.0
%
For the quarter ended June 30, 2011
 
82.9
%
For the quarter ended September 30, 2011
 
91.2
%
For the quarter ended December 31, 2011
 
89.1
%
For the quarter ended March 31, 2012
 
87.3
%
For the quarter ended June 30, 2012
 
84.3
%
For the quarter ended September 30, 2012
 
79.6
%
For the quarter ended December 31, 2012
 
79.5
%
For the quarter ended March 31, 2013
 
73.8
%
For the quarter ended June 30, 2013
 
76.4
%
For the quarter ended September 30, 2013
 
86.5
%
As of September 30, 2013 and September 30, 2012, approximately 91.3% and 92.7%, respectively, of our total assets represented investments in portfolio companies valued at fair value.
Revenue Recognition
Interest and Dividend Income
Interest income, adjusted for accretion of original issue discount, or OID, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We stop accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.
Fee Income
We receive a variety of fees in the ordinary course of business including servicing, advisory, structuring and prepayment fees, which are classified as fee income and recognized as they are earned.
We have also structured exit fees across certain of our portfolio investments to be received upon the future exit of those investments. Exit fees are payable upon the exit of a debt security. These fees are to be paid to us upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan. As of September 30, 2013, we had structured $4.2 million in aggregate exit fees across six portfolio investments upon the future exit of those investments.
Payment-in-Kind (PIK) Interest

49


Our loans typically contain contractual PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We generally cease accruing PIK interest if there is insufficient value to support the accrual or if we do not expect the portfolio company to be able to pay all principal and interest due. Our decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; our assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by us in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, we determine whether to cease accruing PIK interest on a loan or debt security. Our determination to cease accruing PIK interest on a loan or debt security is generally made well before our full write-down of such loan or debt security. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest.
For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments.” In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest. The accrual of PIK interest on our debt investments increases the recorded cost basis of these investments in our consolidated financial statements and, as a result, increases the cost basis of these investments for purposes of computing the capital gains incentive fee payable by us to our investment adviser.
To maintain our status as a RIC, PIK income must be paid out to our stockholders in the form of dividends even though we have not yet collected the cash and may never collect the cash relating to the PIK interest. Accumulated PIK interest was $23.9 million and represented 1.3% of the fair value of our portfolio of investments as of September 30, 2013 and $18.4 million or 1.4% as of September 30, 2012. The net increases in loan balances as a result of contractual PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

50


Portfolio Composition
Our investments principally consist of loans, purchased equity investments and equity grants in privately-held companies. Our loans are typically secured by a first, second or subordinated lien on the assets of the portfolio company and generally have terms of up to six years (but an expected average life of between three and four years). We are currently focusing our origination efforts on a prudent mix of senior secured and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection. The mix may change over time based on market conditions and management’s view of where the best risk adjusted returns are available.
A summary of the composition of our investment portfolio at cost and fair value as a percentage of total investments is shown in the following tables:
 
 
 
September 30,
2013

September 30,
2012
Cost:
 
 
 
 
Senior secured debt
 
78.33
%
 
80.77
%
Subordinated debt
 
15.76

 
15.92

Purchased equity
 
3.86

 
2.72

Collateralized loan obligation ("CLO") debt
 
1.59

 
—

Equity grants
 
0.23

 
0.37

Limited partnership interests
 
0.23

 
0.22

Total
 
100.00
%
 
100.00
%
 
 
 
September 30,
2013

September 30,
2012
Fair value:
 
 
 
 
Senior secured debt
 
77.53
%
 
80.41
%
Subordinated debt
 
15.65

 
15.95

Purchased equity
 
4.74

 
3.00

CLO debt
 
1.56

 
—

Equity grants
 
0.30

 
0.43

Limited partnership interests
 
0.22

 
0.21

Total
 
100.00
%
 
100.00
%

51


The industry composition of our portfolio at cost and fair value as a percentage of total investments was as follows:

 
 
September 30,
2013
 
September 30,
2012
Cost:
 
 
 
 
Healthcare services
 
14.35
%
 
13.32
%
Diversified support services
 
9.15

 
8.78

Education services
 
8.97

 
7.81

Advertising
 
8.28

 
4.23

Specialized finance
 
6.68

 
—

Internet software & services
 
5.87

 
5.81

IT consulting & other services
 
4.43

 
3.55

Oil & gas equipment services
 
4.06

 
4.75

Healthcare equipment
 
3.79

 
6.53

Specialty stores
 
3.68

 
2.60

Human resources & employment services
 
3.49

 
1.53

Pharmaceuticals
 
2.77

 
3.18

Leisure products
 
2.54

 
4.38

Other diversified financial services
 
2.25

 
3.03

Auto parts & equipment
 
1.78

 
0.08

Construction & engineering
 
1.75

 
3.65

Household products
 
1.60

 
2.34

Asset management & custody banks
 
1.59

 
—

Home improvement retail
 
1.54

 
2.24

Apparel, accessories & luxury goods
 
1.53

 
2.99

Airlines
 
1.32

 
—

Data processing & outsources services
 
1.25

 
—

Specialty chemicals
 
1.08

 
—

Food distributors
 
0.99

 
1.43

Research & consulting services
 
0.94

 
1.09

Industrial machinery
 
0.91

 
1.66

Air freight & logistics
 
0.90

 
1.49

Security & alarm services
 
0.71

 
—

Application software
 
0.69

 
—

Environmental & facilities services
 
0.47

 
1.66

Construction materials
 
0.39

 
0.55

Multi-sector holdings
 
0.20

 
0.21

Building products
 
0.04

 
0.06

Thrift & mortgage finance
 
0.01

 
—

Leisure facilities
 
0.00

 
2.34

Electronic equipment & instruments
 
—

 
2.85

Integrated telecommunication services
 
—

 
2.52

Restaurants
 
—

 
1.51

Distributors
 
—

 
1.51

Electronic manufacturing services
 
—

 
0.30

Movies & entertainment
 
—

 
0.02

Total
 
100.00
%
 
100.00
%

52


 
 
September 30,
2013
 
September 30,
2012
Fair value:
 
 
 
 
Healthcare services
 
14.47
%
 
13.58
%
Diversified support services
 
9.04

 
8.77

Education services
 
8.90

 
7.71

Advertising
 
8.18

 
4.20

Specialized finance
 
6.57

 
—

Internet software & services
 
6.03

 
6.15

IT consulting & other services
 
4.43

 
3.55

Oil & gas equipment services
 
4.04

 
4.82

Healthcare equipment
 
3.74

 
6.53

Specialty stores
 
3.65

 
2.65

Human resources & employment services
 
3.45

 
1.57

Pharmaceuticals
 
2.79

 
3.18

Leisure products
 
2.64

 
4.38

Other diversified financial services
 
2.22

 
3.05

Construction & engineering
 
2.16

 
3.88

Auto parts & equipment
 
1.90

 
0.12

Asset management & custody banks
 
1.56

 
—

Household products
 
1.55

 
2.32

Home improvement retail
 
1.51

 
2.19

Apparel, accessories & luxury goods
 
1.46

 
2.98

Airlines
 
1.29

 
—

Data processing & outsources services
 
1.23

 
—

Specialty chemicals
 
1.06

 
—

Food distributors
 
0.99

 
1.43

Industrial machinery
 
0.96

 
1.69

Research & consulting services
 
0.95

 
1.10

Air freight & logistics
 
0.74

 
1.24

Application software
 
0.71

 
—

Security & alarm services
 
0.69

 
—

Environmental & facilities services
 
0.43

 
0.95

Construction materials
 
0.39

 
0.56

Multi-sector holdings
 
0.21

 
0.22

Building products
 
0.04

 
0.06

Leisure facilities
 
0.01

 
2.36

Thrift & mortgage finance
 
0.01

 
—

Electronic equipment & instruments
 
—

 
2.82

Integrated telecommunication services
 
—

 
2.55

Distributors
 
—

 
1.56

Restaurants
 
—

 
1.51

Electronic manufacturing services
 
—

 
0.30

Movies & entertainment
 
—

 
0.02

Total
 
100.00
%
 
100.00
%
Portfolio Asset Quality
We employ a ranking system to assess and monitor the credit risk of our investment portfolio. We rank all investments on a scale from 1 to 4. The system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loan, and other factors considered relevant to making a credit judgment. We have determined that there should be an individual ranking assigned to

53


each tranche of securities in the same portfolio company where appropriate. This may arise when the perceived risk of loss on the investment varies significantly between tranches due to their respective seniority in the capital structure.
•
Investment Ranking 1 is used for investments that are performing above expectations and/or capital gains are expected.
•
Investment Ranking 2 is used for investments that are performing substantially within our expectations, and whose risks remain materially consistent with the potential risks at the time of the original or restructured investment. All new investments are initially ranked 2.
•
Investment Ranking 3 is used for investments that are performing below our expectations and for which risk has materially increased since the original or restructured investment. The portfolio company may be out of compliance with debt covenants and may require closer monitoring. To the extent that the underlying agreement has a PIK interest provision, investments with a ranking of 3 are generally those on which we are not accruing PIK interest.
•
Investment Ranking 4 is used for investments that are performing substantially below our expectations and for which risk has increased substantially since the original or restructured investment. Investments with a ranking of 4 are those for which some loss of principal is expected and are generally those on which we are not accruing cash interest.
The following table shows the distribution of our investments on the 1 to 4 investment ranking scale at fair value as of September 30, 2013 and September 30, 2012:
Investment Ranking
 
September 30, 2013
 
 
 
September 30, 2012 (2)
 
 
Fair Value
 
% of Portfolio
 
Leverage Ratio
 
 
 
Fair Value
 
% of Portfolio
 
Leverage Ratio
 
 
1
 
$
122,769

 
6.49
%
 
2.67

 
  
 
$
68,685

 
5.33
%
 
2.72

 
  
2
 
1,770,277

 
93.51

 
4.70

 
  
 
1,212,993

 
94.17

 
3.96

 
  
3
 
—

 
—

 
—

 
 
 
3,193

 
0.25

 
NM

 
(1)
4
 
—

 
—

 
—

 
  
 
3,237

 
0.25

 
NM

 
(1)
Total
 
$
1,893,046

 
100.00
%
 
4.57

 
  
 
$
1,288,108

 
100.00
%
 
3.89

 
  
 
(1)
Due to operating performance this ratio is not measurable and, as a result, is excluded from the total portfolio calculation.
(2)
Prior year investment rankings were initially ranked on a 1 to 5 ranking scale and have been conformed to the current 1 to 4 ranking scale. This did not result in a material change to the prior year rankings.
We may from time to time modify the payment terms of our investments, either in response to current economic conditions and their impact on certain of our portfolio companies or in accordance with tier pricing provisions in certain loan agreements. As of September 30, 2013, we had modified the payment terms of our investments in 17 portfolio companies. Such modified terms may include increased PIK interest provisions and reduced cash interest rates. These modifications, and any future modifications to our loan agreements, may limit the amount of interest income that we recognize from the modified investments, which may, in turn, limit our ability to make distributions to our stockholders.
Loans and Debt Securities on Non-Accrual Status
As of September 30, 2013, there were no investments on which we had stopped accruing cash interest, PIK interest or OID income. As of September 30, 2012, we had stopped accruing PIK interest on one investment. As of September 30, 2011, we had stopped accruing cash interest, PIK interest and OID on four investments that had not paid all of their scheduled cash interest payments for the period ended September 30, 2011.
The percentages of our debt investments at cost and fair value by accrual status for the periods ended September 30, 2013, September 30, 2012 and September 30, 2011 were as follows:
 
 
 
September 30, 2013
 
September 30, 2012
September 30, 2011
 
 
Cost
% of Debt
Portfolio
 
Fair
Value
% of Debt
Portfolio
 
Cost
% of Debt
Portfolio
 
Fair
Value
% of Debt
Portfolio
 
Cost
% of
Portfolio
 
Fair
Value
% of Debt
Portfolio
Accrual
 
$
1,779,201

100.00
%
 
$
1,793,463

100.00
%
 
$
1,217,393

99.26
%
 
$
1,237,961

99.74
%
 
$
1,098,434

96.54
%
 
$
1,091,857

99.29
%
PIK non-accrual
 
—

—

 
—

—

 
9,096

0.74

 
3,236

0.26

 
—

—

 
—

—

Cash non-accrual(1)
 
—

—

 
—

—

 
—

—

 
—

—

 
39,320

3.46

 
7,851

0.71

Total
 
$
1,779,201

100.00
%
 
$
1,793,463

100.00
%
 
$
1,226,489

100.00
%
 
$
1,241,197

100.00
%
 
$
1,137,754

100.00
%
 
$
1,099,708

100.00
%
 __________________
(1)
Cash non-accrual status is inclusive of PIK and other noncash income, where applicable.

54


The non-accrual status of the Company’s portfolio investments as of September 30, 2013, September 30, 2012, and September 30, 2011 was as follows:
 
 
  
September 30, 2013
  
September 30, 2012
  
September 30, 2011
Coll Materials Group LLC(1)
  
—

  
PIK non-accrual
  
 
—
Lighting by Gregory, LLC(1)
  
—

  
—

  
Cash non-accrual
O’Currance, Inc.(1)
  
—

  
—

  
Cash non-accrual
Premier Trailer Leasing, Inc.(1)
  
—

  
—

  
Cash non-accrual
Repechage Investments Limited(1)
  
—

  
—

  
Cash non-accrual
 ___________________
(1)
We no longer hold this investment as of September 30, 2013. See “— Discussion and Analysis of Results and Operations — Comparison of the years ended September 30, 2013 and September 30, 2012 — Realized Gain (Loss) on Investments and Interest Rate Swap” for a discussion of our recent realization events.
Income non-accrual amounts for the years ended September 30, 2013, September 30, 2012 and September 30, 2011 were as follows:
 


Year ended
September 30, 2013 (1)

Year ended
September 30, 2012

Year ended
September 30, 2011
Cash interest income

$
280


$
3,068


$
5,815

PIK interest income

745


4,198


851

OID income

—


96


105

Total

$
1,025


$
7,362


$
6,771

 ___________________
(1)
Income non-accrual amounts for the year ended September 30, 2013 include amounts for investments that were no longer held at year end.
Discussion and Analysis of Results and Operations
Results of Operations
The principal measure of our financial performance is the net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income is the difference between our income from interest, dividends, fees, and other investment income and total expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Net unrealized appreciation (depreciation) is the net change in the fair value of our investment portfolio.
Comparison of Years ended September 30, 2013 and September 30, 2012
Total Investment Income
Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, administrative fees, unused fees, amendment fees, advisory fees, structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.
Total investment income for the years ended September 30, 2013 and September 30, 2012 was $221.6 million and $165.1 million, respectively. For the year ended September 30, 2013, this amount primarily consisted of $173.7 million of interest income from portfolio investments (which included $16.8 million of PIK interest) and $45.9 million of fee income. For the year ended September 30, 2012, this amount primarily consisted of $133.2 million of interest income from portfolio investments (which included $13.8 million of PIK interest) and $31.7 million of fee income.
The increase in our total investment income for the year ended September 30, 2013 as compared to the year ended September 30, 2012 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of 18 debt investments in our portfolio and fees related to debt payoffs, partially offset by amortization repayments received on our debt investments and a decrease in the weighted average yield of our debt investments from 12.0% to 11.1% during the year-over-year period.

55


Expenses
Net expenses for the years ended September 30, 2013 and September 30, 2012 were $106.7 million and $78.7 million, respectively. Net expenses increased for the year ended September 30, 2013 as compared to the year ended September 30, 2012 by $28.0 million. This was due primarily to increases in:
 
•
Base management fee (net of waivers), which was attributable to a 47.0% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;
•
Incentive fee, which was attributable to a 30.1% increase in pre-incentive fee net investment income for the year-over-year period; and
•
Interest expense, which was attributable to a 41.8% increase in weighted average debt outstanding for the year-over-year period.
Gain on Extinguishment of Convertible Notes
During the year ended September 30, 2013, we did not repurchase any of our unsecured convertible notes ("Convertible Notes") in the open market. During the year ended September 30, 2012, we repurchased $20.0 million in principal amount of our Convertible Notes in the open market and surrendered them to the trustee for cancellation. The aggregate purchase price of these Convertible Notes was $17.9 million because they were trading at a discount due to what we believe were volatile market conditions. As such, we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded for the year ended September 30, 2012 was $1.6 million. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such fees. This type of net gain, and corresponding income incentive fee, may occur again in the future. Any repurchase of our 2024 Notes or 2028 Notes (as each is defined below) at a discount will be treated in a similar manner.
Net Investment Income
As a result of the $56.5 million increase in total investment income, the $1.6 million decrease in the gain on extinguishment of debt and the $28.0 million increase in net expenses, net investment income for the year ended September 30, 2013 reflected a $26.9 million, or 30.6%, increase compared to the year ended September 30, 2012.
Realized Gain (Loss) on Investments and Interest Rate Swap
Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and interest rate swaps and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.
During the year ended September 30, 2013, we recorded investment realization events, including the following:
•
In October 2012, we received a cash payment of $4.2 million from Rail Acquisition Corp. in full satisfaction of all obligations related to the revolving loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In October 2012, we received a cash payment of $5.4 million from Bojangles in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In October 2012, we received a cash payment of $21.9 million from Blue Coat Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In October 2012, we received a cash payment of $9.9 million from Insight Pharmaceuticals LLC in full satisfaction of all obligations related to the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In November 2012, we received a cash payment of $8.5 million from SolutionSet, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

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•
In January 2013, we received a cash payment of $30.2 million from NDSSI Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction. We also received an additional $3.0 million in connection with the sale of our preferred equity investment (including accumulated PIK of $0.9 million), realizing a gain of $0.1 million;
•
In January 2013, we received a cash payment of $44.6 million from Welocalize, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2013, we received a cash payment of $14.6 million from Edmentum, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2013, we received a cash payment of $7.1 million from Advanced Pain Management Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In March 2013, we received a cash payment of $10.0 million from eResearch Technology, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2013, we received a cash payment of $15.0 million from AdVenture Interactive, Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In March 2013, we received a cash payment of $19.5 million from idX Corporation in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
•
In April 2013, we realized a loss in the amount of $11.2 million after the senior-most creditors foreclosed on the assets of Coll Materials Group, LLC. The Company maintains a $1.0 million receivable related to a financial guarantee related to the transaction;
•
In April 2013, we received a cash payment of $14.1 million from Huddle House, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In April 2013, we received a cash payment of $20.4 million from Slate Pharmaceuticals Acquisition Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In April 2013, we received a cash payment of $12.5 million from Securus Technologies Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, we received a cash payment of $9.6 million from ConvergeOne Holdings Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2013, we received a cash payment of $30.9 million from CompuCom Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, we received a cash payment of $31.1 million from Cardon Healthcare Network, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, we restructured its investment in Trans-Trade Brokers, Inc.  As part of the restructuring, we exchanged cash and our debt and equity securities for debt and equity securities in the restructured entity, TransTrade Operators, Inc., and recorded a realized loss in the amount of $6.1 million on this transaction;

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•
In June 2013, we received a cash payment of $33.6 million from U.S. Retirement Partners, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In June 2013, we received a cash payment of $14.6 million from Traffic Solutions Holdings, Inc. in full satisfaction of all obligations related to the Term Loan A and Revolver under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2013, we received a cash payment of $9.1 million from U.S. Collections, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In July 2013, we received a cash payment of $9.9 million from Ikaria Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited (plus additional fees) at par and no realized gain or loss was recorded on this transaction;
•
In July 2013, we received a cash payment of $5.5 million from Miche Bag, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In July 2013, we received a cash payment of $43.9 million from Tegra Medical, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2013, we received a cash payment of $27.0 million from MX USA, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In August 2013, we restructured our investment in Eagle Hospital Physicians, Inc. As part of the restructuring, we exchanged cash and our debt securities for debt and equity securities in the successor entity, Eagle Hospital Physicians, LLC, and recorded a realized loss in the amount of $9.8 million on this transaction;
•
In August 2013, we received a cash payment of $43.5 million from InvestRx Corporation in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In September 2013, we received a cash payment of $43.1 million from Titan Fitness, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction; and
•
During the year ended September 30, 2013, we received cash payments of $59.9 million in connection with partial sales of debt investments in the open market and recorded a net realized gain of $0.4 million.
During the year ended September 30, 2012, we recorded investment realization events, including the following:
 
•
In November 2011, we recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on our investment in Premier Trailer Leasing, Inc.;
•
In November 2011, we received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and we received an additional $1.3 million proceeds from our equity investment, realizing a gain of $0.8 million;
•
In December 2011, we received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In December 2011, we received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

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•
In December 2011, we received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In January 2012, we received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2012, we received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and we recorded a realized loss in the amount of $10.7 million on this transaction;
•
In February 2012, we received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, we received a cash payment of $28.9 million from JTC Education, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, we received a cash payment of $6.1 million from Fitness Edge, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In June 2012, we received a cash payment of $20.2 million from Caregiver Services, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2012, we received a cash payment of $1.0 million from Best Vinyl Fence & Deck, LLC. The Term Loan B debt investment was exited below par and we recorded a realized loss in the amount of $3.3 million on this transaction;
•
In July 2012, we received a cash payment of $8.7 million from Pacific Architects & Engineers, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In August 2012, we restructured our investment in Traffic Control & Safety Corp. As part of the restructuring, we exchanged cash and our debt and equity securities for debt and equity securities in the successor entity, Statewide Holdings, Inc., and recorded a realized loss in the amount of $10.9 million on this transaction;
•
In August 2012, we received a cash payment of $18.0 million from Stackpole Powertrain International ULC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In September 2012, we received a cash payment of $0.1 million in connection with the exit of our investment in Lighting by Gregory, LLC. The investment was exited below par and we recorded a realized loss in the amount of $5.3 million on this transaction;

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•
In September 2012, we received total consideration of $0.6 million in connection with the exit of our investment in Repechage Investments Limited. The investment was exited below par and we recorded a realized loss in the amount of $3.6 million on this transaction; and
•
In September 2012, we received total consideration of $1.8 million in connection with the sale of our Rail Acquisition Corp. term loan investment. The debt investment was exited below par and we recorded a realized loss in the amount of $13.9 million on this transaction. The proceeds related to this sale had not yet been received as of September 30, 2012 and are recorded as receivables from unsettled transactions in the Consolidated Statement of Assets and Liabilities
Net Unrealized Appreciation (Depreciation) on Investments and Interest Rate Swap
Net unrealized appreciation or depreciation is the net change in the fair value of our investments and interest rate swap during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
During the year ended September 30, 2013, we recorded net unrealized appreciation of $13.4 million. This consisted of $16.4 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation) and $10.9 million of net unrealized appreciation on equity investments, offset by $13.9 million of net unrealized depreciation on debt investments. During the year ended September 30, 2012, we recorded net unrealized appreciation of $56.0 million. This consisted of $66.6 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation) and $0.1 million of net unrealized appreciation on equity investments, offset by $10.7 million of net unrealized depreciation on debt investments.
Comparison of Years ended September 30, 2012 and September 30, 2011
Total Investment Income
Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, administrative fees, unused fees, amendment fees, advisory fees, structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.
Total investment income for the years ended September 30, 2012 and September 30, 2011 was $165.1 million and $125.2 million, respectively. For the year ended September 30, 2012, this amount primarily consisted of $133.2 million of interest income from portfolio investments (which included $13.8 million of PIK interest) and $31.7 million of fee income. For the year ended September 30, 2011, this amount primarily consisted of $108.3 million of interest income from portfolio investments (which included $13.7 million of PIK interest) and $16.7 million of fee income.
The increase in our total investment income for the year ended September 30, 2012 as compared to the year ended September 30, 2011 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of eight debt investments in our portfolio and fees related to debt payoffs, partially offset by amortization repayments received on our debt investments and a decrease in the weighted average yield of our debt investments from 12.4% to 12.0% during the year-over-year period.
Expenses
Expenses for the years ended September 30, 2012 and September 30, 2011 were $78.7 million and $59.5 million, respectively. Expenses increased for the year ended September 30, 2012 as compared to the year ended September 30, 2011 by $19.2 million. This was due primarily to increases in:
 
•
Base management fee, which was attributable to a 15.0% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;
•
Incentive fee, which was attributable to a 31.1% increase in pre-incentive fee net investment income for the year-over-year period; and
•
Interest expense, which was attributable to a 70.2% increase in weighted average debt outstanding for the year-over-year period.
Gain on Extinguishment of Convertible Notes
During the years ended September 30, 2012 and September 30, 2011, we repurchased $20.0 million and $17.0 million in principal amount, respectively, of our Convertible Notes in the open market and surrendered them to the trustee for cancellation. The aggregate purchase price of these Convertible Notes was $17.9 million and $15.1 million in 2012 and 2011, respectively, because they were trading at a discount due to what we believe were volatile market conditions. As such, we recorded a gain in the amount of the

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difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded for the years ended September 30, 2012 and September 30, 2011 was $1.6 million and $1.5 million, respectively. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such fees. This type of net gain, and corresponding income incentive fee, may occur again in the future.
Net Investment Income
As a result of the $39.9 million increase in total investment income and the $0.1 million increase in the gain on extinguishment of debt, as compared to the $19.2 million increase in total expenses, net investment income for the year ended September 30, 2012 reflected a $20.9 million, or 31.1%, increase compared to the year ended September 30, 2011.
Realized Gain (Loss) on Investments and Interest Rate Swap
Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and interest rate swaps and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.
During the year ended September 30, 2012, we recorded investment realization events, including the following:
 
•
In November 2011, we recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on our investment in Premier Trailer Leasing, Inc.;
•
In November 2011, we received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and we received an additional $1.3 million proceeds from our equity investment, realizing a gain of $0.8 million;
•
In December 2011, we received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In December 2011, we received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In December 2011, we received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In January 2012, we received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2012, we received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and we recorded a realized loss in the amount of $10.7 million on this transaction;
•
In February 2012, we received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, we received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

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•
In March 2012, we received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, we received a cash payment of $28.9 million from JTC Education, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, we received a cash payment of $6.1 million from Fitness Edge, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In June 2012, we received a cash payment of $20.2 million from Caregiver Services, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2012, we received a cash payment of $1.0 million from Best Vinyl Fence & Deck, LLC. The Term Loan B debt investment was exited below par and we recorded a realized loss in the amount of $3.3 million on this transaction;
•
In July 2012, we received a cash payment of $8.7 million from Pacific Architects & Engineers, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In August 2012, we restructured our investment in Traffic Control & Safety Corp. As part of the restructuring, we exchanged cash and our debt and equity securities for debt and equity securities in the successor entity, Statewide Holdings, Inc., and recorded a realized loss in the amount of $10.9 million on this transaction;
•
In August 2012, we received a cash payment of $18.0 million from Stackpole Powertrain International ULC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In September 2012, we received a cash payment of $0.1 million in connection with the exit of our investment in Lighting by Gregory, LLC. The investment was exited below par and we recorded a realized loss in the amount of $5.3 million on this transaction;
•
In September 2012, we received total consideration of $0.6 million in connection with the exit of our investment in Repechage Investments Limited. The investment was exited below par and we recorded a realized loss in the amount of $3.6 million on this transaction; and
•
In September 2012, we received total consideration of $1.8 million in connection with the sale of our Rail Acquisition Corp. term loan investment. The debt investment was exited below par and we recorded a realized loss in the amount of $13.9 million on this transaction. The proceeds related to this sale had not yet been received as of September 30, 2012 and are recorded as receivables from unsettled transactions in the Consolidated Statement of Assets and Liabilities.
During the year ended September 30, 2011, we recorded investment realization events, including the following:
 
•
In October 2010, we received a cash payment of $8.7 million from Goldco, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In November 2010, we received a cash payment of $11.0 million from TBA Global, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In November 2010, we restructured our investment in Vanguard Vinyl, Inc. The restructuring resulted in a realized loss in the amount of $1.7 million;
•
In December 2010, we restructured our investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a realized loss in the amount of $3.9 million;
•
In December 2010, we received a cash payment of $25.3 million from Boot Barn in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In December 2010, we received a cash payment of $11.7 million from Western Emulsions, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;
•
In December 2010, we restructured our investment in Lighting by Gregory, LLC. The restructuring resulted in a realized loss in the amount of $7.8 million;
•
In March 2011, we received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a realized loss in the amount of $0.3 million;

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•
In March and April 2011, we received cash payments totaling $1.1 million from MK Network, LLC as part of a settlement of the loan agreement. In April 2011, we recorded a realized loss on this investment in the amount of $14.1 million;
•
In July 2011, we received a cash payment of $7.3 million from Filet of Chicken in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In July 2011, we received a cash payment of $19.8 million from Cenegenics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In August 2011, we terminated our interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation;
•
In September 2011, we received a cash payment of $19.1 million from Flatout, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction; and
•
In September 2011, we received a cash payment of $0.1 million in connection with the sale of our investment in CPAC, Inc. We recorded a realized loss on this investment in the amount of $1.0 million.
Net Unrealized Appreciation (Depreciation) on Investments and Interest Rate Swap
Net unrealized appreciation or depreciation is the net change in the fair value of our investments and interest rate swap during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
During the year ended September 30, 2012, we recorded net unrealized appreciation of $56.0 million. This consisted of $66.6 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation) and $0.1 million of net unrealized appreciation on equity investments, offset by $10.7 million of net unrealized depreciation on debt investments. During the year ended September 30, 2011, we recorded net unrealized depreciation of $6.5 million. This consisted of $34.6 million of net unrealized depreciation on debt investments, offset by $25.6 million of net reclassifications to realized losses on debt and equity investments and interest rate swaps (resulting in unrealized appreciation) and $2.5 million of net unrealized appreciation on equity investments.
Financial Condition, Liquidity and Capital Resources
Cash Flows
We have a number of alternatives available to fund the growth of our investment portfolio and our operations, including, but not limited to, raising equity, increasing debt and funding from operational cash flow. Additionally, we may reduce investment size by syndicating a portion of any given transaction. We intend to fund our future distribution obligations through operating cash flow or with funds obtained through future equity and debt offerings or credit facilities, as we deem appropriate.
For the year ended September 30, 2013, we experienced a net increase in cash and cash equivalents of $73.0 million. During that period, we used $459.2 million of cash in operating activities, primarily for the funding of $1.28 billion of investments and net revolvers, partially offset by $687.2 million of principal and PIK payments received and $115.0 million of net investment income. During the same period, cash provided by financing activities was $532.2 million, primarily consisting of $479.9 million of proceeds from issuances of our common stock, $155.8 million of proceeds from the issuances of unsecured notes and $31.8 million of net borrowings under our SBA debentures, partially offset by $13.3 million of net repayments under our credit facilities, $115.4 million of cash dividends paid, $1.1 million of offering costs paid and $5.6 million of deferred financing costs paid.
For the year ended September 30, 2012, we experienced a net increase in cash and cash equivalents of $6.7 million. During that period, we used $90.2 million of cash in operating activities, primarily for the funding of $530.9 million of investments and net revolvers, partially offset by $376.5 million of principal and PIK payments received and $88.0 million of net investment income. During the same period, cash provided by financing activities was $97.0 million, primarily consisting of $188.7 million of proceeds from issuances of our common stock and $23.2 million of net borrowings under our credit facilities, partially offset by $91.9 million of cash dividends paid, $17.9 million of net repurchases of our Convertible Notes, $1.1 million of offering costs paid and $4.0 million of deferred financing costs paid.
As of September 30, 2013, we had $147.4 million in cash and cash equivalents, portfolio investments (at fair value) of $1.89 billion, $10.4 million of interest and fees receivable, $181.8 million of SBA debentures payable, $188.0 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable, $161.3 million of unsecured notes payable and unfunded commitments of $149.5 million.

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As of September 30, 2012, we had $74.4 million in cash and cash equivalents, portfolio investments (at fair value) of $1.29 billion, $7.7 million of interest and fees receivable, $150.0 million of SBA debentures payable, $201.3 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable and unfunded commitments of $102.5 million.
Other Sources of Liquidity
We intend to continue to generate cash primarily from cash flows from operations, including interest earned, future borrowings and future offerings of securities. We maintain a universal shelf registration statement that allows for the public offering and sale of our common stock, debt securities and warrants to purchase such securities. We may from time to time issue securities pursuant to the shelf registration statement or otherwise pursuant to private offerings. The issuance of debt or equity securities will depend on future market conditions, funding needs and other factors and there can be no assurance that any such issuance will occur or be successful. In the future, we may also securitize a portion of our investments in first and second lien senior loans or unsecured debt or other assets. To securitize loans, we would likely create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. We would then sell interests in the subsidiary on a non-recourse basis to purchasers and we would retain all or a portion of the equity in the subsidiary. Our primary use of funds is investments in our targeted asset classes and cash distributions to holders of our common stock.
Although we expect to fund the growth of our investment portfolio through the net proceeds from future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, because our common stock has at times traded at a price below our then-current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.
In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. See “Regulated Investment Company Status and Distributions” below. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.
Also, as a business development company, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. As of September 30, 2013, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.
Significant Capital Transactions That Have Occurred Since October 1, 2011
The following table reflects the dividend distributions per share that our Board of Directors has declared, including shares issued under our DRIP, on our common stock since October 1, 2011:
 

64


Date Declared
 
Record Date
 
Payment Date
 
Amount
per Share
 
Cash
Distribution
 
DRIP Shares
Issued
 
 
 
DRIP Shares
Value
November 10, 2011
 
January 13, 2012
 
January 31, 2012
 
 $ 0.0958

 
$ 6.6 million
 
29,902

 
(1)
 
$ 0.3 million
November 10, 2011
 
February 15, 2012
 
February 29, 2012
 
0.0958

 
7.4 million
 
45,071

 
  
 
0.4 million
November 10, 2011
 
March 15, 2012
 
March 30, 2012
 
0.0958

 
7.5 million
 
41,807

 
(1)
 
0.4 million
February 7, 2012
 
April 13, 2012
 
April 30, 2012
 
0.0958

 
7.4 million
 
48,328

 
(1)
 
0.5 million
February 7, 2012
 
May 15, 2012
 
May 31, 2012
 
0.0958

 
7.4 million
 
47,877

 
(1)
 
0.5 million
February 7, 2012
 
June 15, 2012
 
June 29, 2012
 
0.0958

 
7.5 million
 
41,499

 
  
 
0.4 million
May 7, 2012
 
July 13, 2012
 
July 31, 2012
 
0.0958

 
7.4 million
 
49,217

 
  
 
0.5 million
May 7, 2012
 
August 15, 2012
 
August 31, 2012
 
0.0958

 
7.5 million
 
41,359

 
  
 
0.4 million
May 7, 2012
 
September 14, 2012
 
September 28, 2012
 
0.0958

 
8.3 million
 
43,952

 
  
 
0.5 million
August 6, 2012
 
October 15, 2012
 
October 31, 2012
 
0.0958

 
8.2 million
 
51,754

 
  
 
0.5 million
August 6, 2012
 
November 15, 2012
 
November 30, 2012
 
0.0958

 
8.2 million
 
53,335

 
  
 
0.5 million
August 6, 2012
 
December 14, 2012
 
December 28, 2012
 
0.0958

 
9.5 million
 
64,680

 
  
 
0.6 million
August 6, 2012
 
January 15, 2013
 
January 31, 2013
 
0.0958

 
9.5 million
 
61,782

 
  
 
0.6 million
August 6, 2012
 
February 15, 2013
 
February 28, 2013
 
0.0958

 
9.1 million
 
103,356

 
  
 
1.0 million
January 14, 2013
 
March 15, 2013
 
March 29, 2013
 
0.0958

 
9.1 million
 
100,802

 
 
 
1.1 million
January 14, 2013
 
April 15, 2013
 
April 30, 2013
 
0.0958

 
10.3 million
 
111,167

 
 
 
1.2 million
January 14, 2013
 
May 15, 2013
 
May 31, 2013
 
0.0958

 
10.3 million
 
127,152

 
 
 
1.3 million
May 6, 2013
 
June 14, 2013
 
June 28, 2013
 
0.0958

 
10.5 million
 
112,821

 
 
 
1.1 million
May 6, 2013
 
July 15, 2013
 
July 31, 2013
 
0.0958

 
10.2 million
 
130,944

 
 
 
1.3 million
May 6, 2013
 
August 15, 2013
 
August 30, 2013
 
0.0958

 
10.3 million
 
136,052

 
 
 
1.3 million
August 5, 2013
 
September 13, 2013
 
September 30, 2013
 
0.0958

 
10.3 million
 
135,027

 
 
 
1.3 million
August 5, 2013
 
October 15, 2013
 
October 31, 2013
 
0.0958

 
11.9 million
 
142,320

 
 
 
1.4 million
August 5, 2013
 
November 15, 2013
 
November 29, 2013
 
0.0958

 
 
 
 
 
 
 
 
November 21, 2013
 
December 13, 2013
 
December 30, 2013
 
0.05

 
 
 
 
 
 
 
 
November 21, 2013
 
January 15, 2014
 
January 31, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
February 14, 2014
 
February 28, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
March 14, 2014
 
March 31, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
April 15, 2014
 
April 30, 2014
 
0.0833

 
 
 
 
 
 
 
 
November 21, 2013
 
May 15, 2014
 
May 30, 2014
 
0.0833

 
 
 
 
 
 
 
 
 ______________
(1)
Shares were purchased on the open market and distributed.
The following table reflects share transactions that occurred from October 1, 2011 through September 30, 2013:
 
Date
 
Transaction
 
Shares
 
Share Price
 
 
 
Gross Proceeds
January 26, 2012
 
Public offering
 
10,000,000

 
10.07

 
  
 
100.7 million
September 14, 2012
 
Public offering(1)
 
8,451,486

 
10.79

 
  
 
91.2 million
December 7, 2012
 
Public offering(1)
 
14,725,000

 
10.68

 
 
 
157.3 million
April 2013
 
Public offering(1)
 
14,435,253

 
10.85

 
 
 
156.5 million
September 26, 2013
 
Public offering(1)
 
17,643,000

 
10.31

 
 
 
181.9 million
  ______________
(1)
Includes the underwriters’ partial exercise of their over-allotment option
Borrowings
SBIC Subsidiaries
Through wholly-owned subsidiaries, we sought and obtained two licenses from the SBA to operate SBIC subsidiaries. Specifically, on February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. (“FSMP IV”), received a license, effective February 1, 2010, from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Act of 1958. On May 15, 2012, our wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. (“FSMP V”), received a license, effective May 10, 2012, from the SBA to operate as an SBIC. SBICs are designated to stimulate the flow of private equity capital to

65


eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.
The SBIC licenses allow our SBIC subsidiaries to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when they have at least $112.5 million in regulatory capital. As of September 30, 2013, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $130.9 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows: 
Rate Fix Date
 
Debenture
 Amount
 
Fixed
 Interest
 Rate
 
 
SBA
 Annual
 Charge
 
September 2010
 
$
73,000

 
3.215
%
 
0.285
%
March 2011
 
65,300

 
4.084
%
 
0.285
%
September 2011
 
11,700

 
2.877
%
 
0.285
%
As of September 30, 2013, FSMP V had $37.5 million in regulatory capital and $31.8 million in SBA-guaranteed debentures outstanding, which had a fair value of $25.2 million. In March 2013, the SBA fixed the interest rate on the SBIC subsidiary’s $31.8 million of drawn leverage at an interest rate of 2.351% (excluding the SBA annual charge of 0.804%). As a result, the $181.8 million of SBA-guaranteed debentures held by our SBIC subsidiaries carry a weighted average interest rate of 3.355% as of September 30, 2013.
For the years ended September 30, 2013 and 2012, we recorded interest expense of $7.1 million and $6.4 million, respectively, related to the SBA-guaranteed debentures of both subsidiaries.
We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $225 million more than we would otherwise be able to absent the receipt of this exemptive relief.
Wells Fargo Facility
On November 16, 2009, we and Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote special purpose subsidiary (“Funding”), entered into a Loan and Servicing Agreement (“Wells Agreement”) with respect to a revolving credit facility (as subsequently amended, the “Wells Fargo facility”) with Wells Fargo Bank, National Association (“Wells Fargo”), as successor to Wachovia Bank, National Association (“Wachovia”), Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time.
As of September 30, 2013, the Wells Fargo facility permitted up to $150 million of borrowings (subject to collateral requirements) with an accordion feature allowing for future expansion of the facility up to a total of $250 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-month) plus 2.50% per annum, with no LIBOR floor. Unless extended, the period during which we may make and reinvest borrowings under the facility will expire on April 23, 2014 and the maturity date of the facility is April 25, 2016.
The Wells Fargo facility provides for the issuance from time to time of letters of credit for the benefit of our portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million.
In connection with the Wells Fargo facility, we concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which we have sold and will continue to sell to Funding certain loan assets we have originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which we pledged all of our equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.
The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of

66


assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Wells Fargo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or us to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.
The Wells Fargo facility is secured by all of the assets of Funding, and all of our equity interest in Funding. We use the Wells Fargo facility to fund a portion of our loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of September 30, 2013, we had $20.0 million of borrowings outstanding under the Wells Fargo facility, which had a fair value of $20.0 million. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 2.917% for the year ended September 30, 2013. For the years ended September 30, 2013, 2012 and 2011 we recorded interest expense of $3.1 million, $2.8 million and $2.4 million, respectively related to the Wells Fargo facility.
ING Facility
On May 27, 2010, we entered into a secured syndicated revolving credit facility (as subsequently amended, the “ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allows us to request letters of credit from ING Capital LLC, as the issuing bank.
As of September 30, 2013, the ING facility permitted up to $480 million of borrowings with an accordion feature allowing for future expansion of the facility up to a total of $800 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-, 2-, 3- or 6-month, at our option) plus 2.25% per annum, with no LIBOR floor, assuming we maintain our current credit rating. Unless extended, the period during which we may make and reinvest borrowings under the facility will expire on August 6, 2017 and the maturity date of the facility is August 6, 2018.
The ING facility is secured by substantially all of our assets, as well as the assets of our wholly-owned subsidiary, FSFC Holdings, Inc. ("Holdings,") and our indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC ("Fund of Funds,") subject to certain exclusions for, among other things, equity interests in any of our SBIC subsidiaries and equity interests in Funding and Fifth Street Funding II, LLC (which is defined and discussed below) as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among Holdings, ING Capital LLC, as collateral agent, and us. None of our SBIC subsidiaries, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.
Pursuant to the ING Security Agreement, Holdings and Fund of Funds guaranteed the obligations under the ING Security Agreement, including our obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, we pledged our entire equity interest in Holdings and Holdings pledged its entire equity interest in Fund of Funds to the collateral agent pursuant to the terms of the ING Security Agreement.
The ING Credit Agreement and related agreements governing the ING facility required Holdings, Fund of Funds and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) agree to comply with various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by us to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.
Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the ING facility at any particular time or at all. As of September 30, 2012, we had $141.0 million of borrowings outstanding under the ING facility, which had a fair value of $141.0 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of 3.141% for the year ended September 30, 2013. For the years ended September 30, 2013, 2012 and 2011, we recorded interest expense of $7.7 million, $5.7 million and $3.3 million, respectively, related to the ING facility.
Sumitomo Facility
On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit

67


facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto.
As of September 30, 2013, the Sumitomo facility permitted up to $200 million of borrowings (subject to collateral requirements), and borrowings under the facility bore interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor. Unless extended, the period during which we may make and reinvest borrowings under the facility will expire on September 16, 2014, and the maturity date of the facility is September 16, 2018, with an option for a one-year extension.
In connection with the Sumitomo facility, we concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which we will sell to Funding II certain loan assets we have originated or acquired, or will originate or acquire.
The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or us to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.
The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of September 30, 2013, we had no borrowings outstanding under the Sumitomo facility. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 3.066% for the year ended September 30, 2013. For the years ended September 30, 2013 and 2012, we recorded interest expense of $1.7 million and $1.2 million, respectively, related to the Sumitomo facility. For the year ended September 30, 2011, the Company did not record interest expense related to the Sumitomo facility.
As of September 30, 2013, except for assets that were funded through our SBIC subsidiaries, substantially all of our assets were pledged as collateral under the Wells Fargo facility, the ING facility or the Sumitomo facility. With respect to the assets funded through our SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over our stockholders.Interest expense for the years ended September 30, 2013, 2012 and 2011 was $33.5 million, $23.2 million and $15.1 million, respectively.
The following table describes significant financial covenants with which we must comply under the Wells Fargo facility and ING facility on a quarterly basis. The Sumitomo facility does not require us to comply with significant financial covenants.
Facility
  
Financial Covenant
 
Description
 
Target Value
  
Reported Value (1)
Wells Fargo facility
  
Minimum shareholders’ equity (inclusive of affiliates)
 
Net assets shall not be less than $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 25, 2011
 
$788 million
  
$1,197 million
 
  
Minimum shareholders’ equity (exclusive of affiliates)
 
Net assets exclusive of affiliates other than Funding shall not be less than $250 million
 
$250 million
  
$882 million
 
  
Asset coverage ratio
 
Asset coverage ratio shall not be less than 2.00:1
 
2.00:1
  
3.43:1
ING facility
  
Minimum shareholders’ equity
 
Net assets shall not be less than the greater of (a) 40% of total assets; and (b) $825 million plus 50% of the aggregate net proceeds of all sales of equity interests after August 6, 2013
 
$825 million
  
$1,197 million
 
  
Asset coverage ratio
 
Asset coverage ratio shall not be less than 2.10:1
 
2.10:1
  
3.43:1
 
  
Interest coverage ratio
 
Interest coverage ratio shall not be less than 2.50:1
 
2.50:1
  
5.33:1
 ______________
(1)
As contractually required, we report financial covenants based on the last filed quarterly or annual report, in this case our Form 10-Q for the quarter ended June 30, 2013. We were also in compliance with all financial covenants under these credit facilities based on the financial information contained in this Form 10-K for the year ended September 30, 2013.
We and our SBIC subsidiaries are also subject to certain regulatory requirements relating to our borrowings. For a discussion of such requirements, see “Item 1. Business — Regulation — Business Development Company Regulations” and “— Small Business Investment Company Regulations.”
The following table reflects material credit facility and SBA debenture transactions that have occurred since October 1, 2009. Amounts available are as of September 30, 2013.
 

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Facility
 
Date
 
Transaction
 
Total
Facility
Amount
 
Upfront
fee Paid
 
Total  Facility
Availability
 
Amount
Drawn
Remaining
Availability
Interest Rate
Wells Fargo facility
 
11/16/2009
 
Entered into credit facility
 
50 million
 
0.8 million

 
 
 
 
 
LIBOR + 4.00%
 
 
5/26/2010
 
Expanded credit facility
 
100 million
 
0.9 million

 
 
 
 
 
LIBOR + 3.50%
 
 
2/28/2011
 
Amended credit facility
 
100 million
 
0.4 million

 
 
 
 
 
LIBOR + 3.00%
 
 
11/30/2011
 
Amended credit facility
 
100 million
 
—

 
 
 
 
 
LIBOR + 2.75%
 
 
4/23/2012
 
Amended credit facility
 
150 million
 
1.2 million

 
 
 
 
 
LIBOR + 2.75%
 
 
6/20/2013
 
Amended credit facility
 
150 million
 
—

 
55 million
(1)
20 million

35 million
LIBOR (5) + 2.50%
ING facility
 
5/27/2010
 
Entered into credit facility
 
90 million
 
0.8 million

 
 
 
 
 
LIBOR + 3.50%
 
 
2/22/2011
 
Expanded credit facility
 
215 million
 
1.6 million

 
 
 
 
 
LIBOR + 3.50%
 
 
7/8/2011
 
Expanded credit facility
 
230 million
 
0.4 million

 
 
 
 
 
LIBOR + 3.00%/3.25%(2)
 
 
2/29/2012
 
Amended credit facility
 
230 million
 
1.5 million

 
 
  
 
 
LIBOR + 3.00%/3.25%(2)
 
 
11/30/2012
 
Amended credit facility
 
385 million
 
2.2 million

 
 
 
 
 
LIBOR + 2.75%( 3)
 
 
1/7/2013
 
Expanded credit facility
 
445 million
 
0.3 million

 
 
 
 
 
LIBOR + 2.75%( 3)
 
 
8/6/2013
 
Amended credit facility
 
480 million
 
1.8 million

 
480 million
 
168 million

312 million
LIBOR (6) + 2.25%
SBA
 
2/16/2010
 
Received capital commitment
 
75 million
 
0.8 million

 
 
 
 
 
 
 
 
9/21/2010
 
Received capital commitment
 
150 million
 
0.8 million

 
 
 
 
 
 
 
 
7/23/2012
 
Received capital commitment
 
225 million
 
0.8 million

 
225 million
  
150 million

75 million
3.355% (4)
Sumitomo facility
 
9/16/2011
 
Entered into credit facility
 
200 million
 
2.5 million

 
82 million
(1)
—

82 million
LIBOR (5) + 2.25%
 _______________
(1)
Availability to increase upon our decision to further collateralize the facility
(2)
LIBOR plus 3.0% when the facility is drawn more than 35%. Otherwise, LIBOR plus 3.25%
(3)
Assuming we maintain our current credit rating
(4)
Weighted average interest rate of 3.355% (excludes the SBA annual charge)
(5)
1-month
(6)
1-, 2-, 3- or 6-month, at our option
Convertible Notes
On April 12, 2011, we issued $152 million in unsecured convertible notes (“Convertible Notes,”) including $2 million issued to Leonard M. Tannenbaum, our Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between us and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”).
The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per year payable semiannually in arrears on April 1 and October 1 of each year. The Convertible Notes are our senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles.
Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when our shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, we will deliver shares of our common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of our common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115.0 million Convertible Notes outstanding at September 30, 2013 is 7,790,273. If we deliver shares of common stock upon a conversion at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our Convertible Notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.
We may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect to us, holders of the Convertible Notes may require us to repurchase for cash all or part of their

69


Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
The Indenture contains certain covenants, including covenants requiring us to provide financial information to the holders of the Convertible Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture. We may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any Convertible Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the Indenture. We did not repurchase any Convertible Notes during the year ended September 30, 2013. During the year ended September 30, 2012, we repurchased $20.0 million in principal amount of the Convertible Notes in the open market for an aggregate purchase price of $17.9 million and surrendered them to the Trustee for cancellation.
For the years ended September 30, 2013, 2012 and 2011, we recorded interest expense of $6.8 million, $7.1 million, and $4.1 million, respectively, related to the Convertible Notes.
As of September 30, 2013, there were $115.0 million Convertible Notes outstanding, which had a fair value of $122.3 million.
2024 Notes
On October 18, 2012, we issued $75.0 million in aggregate principal amount of our 5.875% 2024 Notes for net proceeds of $72.5 million after deducting underwriting commissions of $2.2 million and offering costs of $0.3 million.
The 2024 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the first supplemental indenture, dated October 18, 2012 (collectively, the “2024 Notes Indenture”), between us and the Trustee. The 2024 Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 2024 Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the 2024 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 5.875% per annum. The 2024 Notes mature on October 30, 2024 and may be redeemed in whole or in part at any time or from time to time at our option on or after October 30, 2017. The 2024 Notes are listed on the New York Stock Exchange under the trading symbol “FSCE” with a par value of $25.00 per share.
The 2024 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring us to provide financial information to the holders of the 2024 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2024 Notes Indenture. We may repurchase the 2024 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2024 Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any 2024 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2024 Notes Indenture. During the year ended September 30, 2013, we did not repurchase any of the 2024 Notes in the open market.
For the year ended September 30, 2013, we recorded interest expense of $4.4 million related to the 2024 Notes.
As of September 30, 2013, there were $75.0 million 2024 Notes outstanding, which had a fair value of $72.9 million.
2028 Notes
In April and May 2013, we issued $86.3 million in aggregate principal amount of our 6.125% unsecured notes due 2028 (the "2028 Notes") for net proceeds of $83.4 million after deducting underwriting commissions of $2.6 million and offering costs of $0.3 million. The proceeds included the underwriters’ full exercise of their overallotment option.
The 2028 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the second supplemental indenture, dated April 4, 2013 (collectively, the “2028 Notes Indenture”), between us and the Trustee. The 2028 Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 2028 Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness

70


(including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the 2028 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 6.125% per annum. The 2028 Notes mature on April 30, 2028 and may be redeemed in whole or in part at any time or from time to time at our option on or after April 30, 2018. The 2028 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FSCFL” with a par value of $25.00 per share.
The 2028 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring us to provide financial information to the holders of the 2028 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2028 Notes Indenture. We may repurchase the 2028 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2028 Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any 2028 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2028 Notes Indenture. During the year ended September 30, 2013, we did not repurchase any of the 2028 Notes in the open market.
For the year ended September 30, 2013, we recorded interest expense of $2.7 million related to the 2028 Notes.
As of September 30, 2013, there were $86.3 million 2028 Notes outstanding, which had a fair value of $78.1 million.
Off-Balance Sheet Arrangements
We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of September 30, 2013, our only off-balance sheet arrangements consisted of $149.5 million of unfunded commitments, which was comprised of $126.8 million to provide debt financing to certain of our portfolio companies and $22.7 million related to unfunded limited partnership interests. As of September 30, 2012, our only off-balance sheet arrangements consisted of $102.5 million, which was comprised of $94.3 million to provide debt financing to certain of our portfolio companies and $8.2 million related to unfunded limited partnership interests. Such commitments are subject to our portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on our Consolidated Statement of Assets and Liabilities.
A summary of the composition of unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of September 30, 2013 and September 30, 2012 is shown in the table below:

71


 
 
September 30, 2013
 
September 30, 2012
Drugtest, Inc.
 
$
20,000

 
$
4,000

Pingora MSR Opportunity Fund I, LP (limited partnership interest)
 
9,792

 
—

RP Crown Parent, LLC
 
9,000

 
—

Deltek, Inc.
 
8,667

 
—

Refac Optical Group
 
8,000

 
5,500

Yeti Acquisition, LLC
 
7,500

 
7,500

ISG Services, LLC
 
6,000

 
—

I Drive Safely, LLC
 
5,000

 
5,000

HealthEdge Software, Inc.
 
5,000

 
—

First American Payment Systems, LP
 
5,000

 
—

Teaching Strategies, LLC
 
5,000

 
—

Adventure Interactive, Corp.
 
5,000

 
—

Charter Brokerage, LLC
 
4,000

 
7,353

World 50, Inc.
 
4,000

 
4,000

Enhanced Recovery Company, LLC
 
3,500

 
4,000

Phoenix Brands Merger Sub LLC
 
3,429

 
4,071

Personable Holdings, Inc.
 
3,409

 
—

2Checkout.com, Inc.
 
2,850

 
—

Reliance Communications, LLC
 
2,750

 
—

CPASS Acquisition Company
 
2,500

 
1,000

Olson + Co., Inc.
 
2,105

 
2,105

Mansell Group, Inc.
 
2,000

 
2,000

Physicians Pharmacy Alliance, Inc.
 
2,000

 
2,000

Beecken Petty O'Keefe Fund IV, LP (limited partnership interest)
 
2,000

 
—

Chicago Growth Partners III, LP (limited partnership interest)
 
2,000

 
—

Eagle Hospital Physicians, LLC
 
1,867

 
1,400

Riverside Fund V, LP (limited partnership interest)
 
1,712

 
2,000

Sterling Capital Partners IV, LP (limited partnership interest)
 
1,528

 
—

CCCG, LLC
 
1,520

 
—

Miche Bag, LLC
 
1,500

 
3,500

Milestone Partners IV, LP (limited partnership interest)
 
1,414

 
1,343

BMC Acquisition, Inc.
 
1,250

 
900

Ansira Partners, Inc.
 
1,190

 
1,190

Discovery Practice Management, Inc.
 
1,000

 
2,600

Psilos Group Partners IV, LP (limited partnership interest)
 
1,000

 
1,000

Genoa Healthcare Holdings, LLC
 
1,000

 
—

Bunker Hill Capital II (QP), LP (limited partnership interest)
 
786

 
934

HealthDrive Corporation
 
734

 
750

ACON Equity Partners III, LP (limited partnership interest)
 
671

 
753

Riverlake Equity Partners II, LP (limited partnership interest)
 
638

 
760

RCP Direct, LP (limited partnership interest)
 
524

 
615

Baird Capital Partners V, LP (limited partnership interest)
 
351

 
513

Riverside Fund IV, LP (limited partnership interest)
 
287

 
323

Welocalize, Inc.
 
—

 
10,000

Rail Acquisition Corp.
 
—

 
6,165

Traffic Solutions Holdings, Inc.
 
—

 
5,000

InvestRx Corporation
 
—

 
5,000

Titan Fitness, LLC
 
—

 
3,500

Cardon Healthcare Network, LLC
 
—

 
3,000

Tegra Medical, LLC
 
—

 
1,500

Specialty Bakers, LLC
 
—

 
750

Advanced Pain Management Holdings, Inc.
 
—

 
400

Saddleback Fence and Vinyl Products, Inc.
 
—

 
100

Total
 
$
149,474

 
$
102,525


72


Contractual Obligations
The following table reflects information pertaining to our debt outstanding under the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes, our 2024 Notes and our 2028 Notes:
 
 
 
Debt Outstanding
as of  September 30,
2012
 
Debt Outstanding
as of September 30,
2013
 
Weighted average  debt
outstanding for the
year ended
September 30, 2013
 
Maximum
debt
outstanding
for the year
ended
September 30,
2013
SBA debentures payable
 
$
150,000

 
$
181,750

 
$
175,273

 
$
181,750

Wells Fargo facility
 
60,251

 
20,000

 
52,210

 
114,713

ING facility
 
141,000

 
168,000

 
127,526

 
185,000

Sumitomo facility
 
—

 
—

 
14,398

 
82,339

Convertible Notes
 
115,000

 
115,000

 
115,000

 
115,000

2024 Notes
 
—

 
75,000

 
71,302

 
75,000

2028 Notes
 
—

 
86,250

 
41,887

 
86,250

Total debt
 
$
466,251

 
$
646,000

 
$
597,596

 
$
771,500

The following table reflects our contractual obligations arising from the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes, our 2024 Notes and our 2028 Notes:
 
 
 
Payments due by period as of September 30, 2013
 
 
Total
 
< 1 year
 
1-3 years
 
3-5 years
 
> 5 years
SBA debentures payable
 
$
181,750

 
$
—

 
$
—

 
$
—

 
$
181,750

Interest due on SBA debentures
 
51,780

 
6,780

 
13,578

 
13,559

 
17,863

Wells Fargo facility
 
20,000

 
—

 
20,000

 
—

 
—

Interest due on Wells Fargo facility
 
1,377

 
536

 
841

 
—

 
—

ING facility
 
168,000

 
—

 
—

 
168,000

 
—

Interest due on ING facility
 
12,981

 
4,095

 
8,190

 
696

 
—

Sumitomo facility
 
—

 
—

 
—

 
—

 
—

Interest due on Sumitomo facility
 
—

 
—

 
—

 
—

 
—

Convertible Notes
 
115,000

 
—

 
115,000

 
—

 
—

Interest due on Convertible Notes
 
15,479

 
6,181

 
9,298

 
—

 
—

2024 Notes
 
75,000

 
—

 
—

 
—

 
75,000

Interest due on 2024 Notes
 
48,867

 
4,406

 
8,813

 
8,813

 
26,835

2028 Notes
 
86,250

 
—

 
—

 
—

 
86,250

Interest due on 2028 Notes
 
77,086

 
5,283

 
10,566

 
10,566

 
50,671

Total
 
$
853,570

 
$
27,281

 
$
186,286

 
$
201,634

 
$
438,369

Regulated Investment Company Status and Dividends
We elected, effective as of January 2, 2008, to be treated as a RIC under Subchapter M of the Code. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.
To maintain RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distribution requirements of our

73


taxable income on a calendar year basis (e.g., calendar year 2012). We anticipate timely distribution of our taxable income in accordance with tax rules; however, we incurred a de minimis U.S. federal excise tax for calendar year 2010. We did not incur a federal excise tax for calendar years 2011 and 2012 and do not expect to incur a federal excise tax for the calendar year 2013. We may incur a federal excise tax in future years.
We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, we are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to enable us to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility and Sumitomo facility could, under certain circumstances, restrict Funding and Funding II from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividend distributions for that fiscal year, a portion of those distributions may be deemed a return of capital to our stockholders.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in our credit facilities and debt instruments. If we do not distribute a certain percentage of our taxable income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.
In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.
Related Party Transactions
We have entered into an investment advisory agreement with Fifth Street Management LLC, our investment adviser. Fifth Street Management LLC is controlled by Leonard M. Tannenbaum, its managing member and the chairman of our Board of Directors and our chief executive officer. Pursuant to the investment advisory agreement, fees payable to our investment adviser equal to (a) a base management fee of 2.0% of the value of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents, and (b) an incentive fee based on our performance. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee. The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the years ended September 30, 2013, 2012 and 2011, we incurred fees of $63.9 million, $45.8 million and $36.5 million, respectively, under the investment advisory agreement. During the year ended September 30 2013, the Investment Adviser voluntarily waived the portion of the base management fee attributable to certain new investments that closed prior to period end, which resulted in waivers of $2.3 million, respectively.
Pursuant to the administration agreement with FSC, Inc., which is controlled by Mr. Tannenbaum, FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping

74


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. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the years ended September 30, 2013, 2012 and 2011, we have incurred expenses of $4.3 million, $3.9 million and $2.9 million, respectively, under the administration agreement.
We have also entered into a license agreement with Fifth Street Capital LLC pursuant to which Fifth Street Capital LLC has agreed to grant us a non-exclusive, royalty-free license to use the name “Fifth Street.” Under this agreement, we will have a right to use the “Fifth Street” name, for so long as Fifth Street Management LLC or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we will have no legal right to the “Fifth Street” name. Fifth Street Capital LLC is controlled by Mr. Tannenbaum, its managing member.
Recent Developments
In October 2013, three new lenders joined the ING facility and one existing lender increased its commitment, increasing our borrowing capacity to $605 million from $480 million.
On October 30, 2013, we amended the terms of the Sumitomo facility, to, among other things:
•
reduce the size of the facility from $200 million to $125 million. This reduction was balanced, in part, by an increase of Sumitomo's commitment under the ING facility by $45 million;
•
extend the period during which we may make and reinvest borrowings through September 16, 2016 from September 16, 2014; and
•
extend the maturity date to September 16, 2020 from September 16, 2018.
On November 21, 2013, our Board of Directors declared the following dividends:
•
$0.05 per share, payable on December 30, 2013 to stockholders of record on December 13, 2013;
•
$0.0833 per share, payable on January 31, 2014 to stockholders of record on January 15, 2014;
•
$0.0833 per share, payable on February 28, 2014 to stockholders of record on February 14, 2014;
•
$0.0833 per share, payable on March 31, 2014 to stockholders of record on March 14, 2014;
•
$0.0833 per share, payable on April 30, 2014 to stockholders of record on April 15, 2014; and
•
$0.0833 per share, payable on May 30, 2014 to stockholders of record on May 15, 2014;
On November 21, 2013, our Board of Directors terminated our existing $50 million stock repurchase program and approved a new $100 million stock repurchase program. Any stock repurchases under this program would be made through the open market at times and in such amounts as our management would deem appropriate, provided they are below the most recently published net asset value per share. Unless extended by the Board of Directors, the stock repurchase program will expire on November 21, 2014 and may be limited or terminated at any time without prior notice.
Recently Issued Accounting Standards
See Note 2 to the Consolidated Financial Statements for a description of recent accounting pronouncements, including the expected dates of adoption and the anticipated impact on the Consolidated Financial Statements.
 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent our debt investments include floating interest rates. In addition, our investments are carried at fair value as determined in good faith by our Board of Directors in accordance with the 1940 Act (See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Investment Valuation”). Our

75


valuation methodology utilizes discount rates in part in valuing our investments, and changes in those discount rates may have an impact on the valuation of our investments.
As of September 30, 2013, 67.4% of our debt investment portfolio (at fair value) and 67.3% of our debt investment portfolio (at cost) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of September 30, 2013 and September 30, 2012 was as follows: 
 
 
September 30, 2013
 
September 30, 2012
 
 
Fair Value
 
% of Floating
Rate Portfolio
 
Fair Value
 
% of Floating
Rate Portfolio
Under 1%
 
$
115,659

 
9.57
%
 
$
72,609

 
8.35
%
1% to under 2%
 
1,007,366

 
83.35

 
554,315

 
63.72

2% to under 3%
 
48,649

 
4.03

 
111,262

 
12.79

3% and over
 
36,913

 
3.05

 
131,686

 
15.14

Total
 
$
1,208,587

 
100.00
%
 
$
869,872

 
100.00
%
Based on our Consolidated Statement of Assets and Liabilities as of September 30, 2013, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investment and capital structure: 
Basis point increase(1)
 
Interest
income
 
Interest
expense
 
Net increase
(decrease)
500
 
$
46,100

 
$
(9,400
)
 
$
36,700

400
 
33,900

 
(7,500
)
 
26,400

300
 
21,700

 
(5,600
)
 
16,100

200
 
9,800

 
(3,800
)
 
6,000

100
 
1,300

 
(1,900
)
 
(600
)
 
(1)
A decline in interest rates would not have a material impact on our Consolidated Financial Statements.
We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of September 30, 2013 and September 30, 2012: 
 
 
September 30, 2013
 
September 30, 2012
 
 
Interest Bearing
Cash and
Investments
 
Borrowings
 
Interest Bearing
Cash and
Investments
 
Borrowings
Money market rate
 
$
147,359

 
$
—

 
$
74,393

 
$
—

Prime rate
 
2,886

 
—

 
6,832

 
60,000

LIBOR
 
 
 
 
 
 
 
 
30 day
 
57,604

 
188,000

 
32,753

 
141,251

90 day
 
1,143,068

 
—

 
822,867

 
—

Fixed rate
 
582,340

 
458,000

 
377,522

 
265,000

Total
 
$
1,933,257

 
$
646,000

 
$
1,314,367

 
$
466,251

On August 16, 2010, we entered into an interest rate swap agreement that was scheduled to expire on August 15, 2013, for a total notional amount of $100 million, for the purposes of hedging the interest rate risk related to the Wells facility and the ING facility. Under the interest rate swap agreement, we paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR. In August 2011, we terminated our interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation. As of September 30, 2013, we were no longer party to any interest rate swap agreements.

76



Item 8. Consolidated Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
 
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Assets and Liabilities as of September 30, 2013 and 2012
Consolidated Statements of Operations for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Statements of Changes in Net Assets for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Schedule of Investments as of September 30, 2013
Consolidated Schedule of Investments as of September 30, 2012
Notes to Consolidated Financial Statements

77


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Fifth Street Finance Corp.:

In our opinion, the accompanying consolidated statement of assets and liabilities, including the consolidated schedules of investments, and the related consolidated statements operations, changes in net assets and cash flows, present fairly, in all material respects, the financial position of Fifth Street Finance Corp. and its subsidiaries (the “Company”) at September 30, 2013 and September 30, 2012, and the results of their operations, the changes in net assets and their cash flows for each of the three years in the period ended September 30, 2013 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule appearing under Item 15(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2013, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A(b) of the Annual Report to stockholders. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. Our procedures included confirmation of securities at September 30, 2013 by correspondence with the custodians, and where replies were not received, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinions.


A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

New York, New York
November 25, 2013


78


Fifth Street Finance Corp.
Consolidated Statements of Assets and Liabilities
(in thousands, except per share amounts)
 
 
 
September 30, 2013
 
September 30, 2012
ASSETS
Investments at fair value:
 
 
 
 
Control investments (cost September 30, 2013: $207,518; cost September 30, 2012: $58,557)
 
$
215,502

 
$
53,240

Affiliate investments (cost September 30, 2013: $29,807; cost September 30, 2012: $29,496)
 
31,932

 
31,187

Non-control/Non-affiliate investments (cost September 30, 2013: $1,622,326; cost September 30, 2012: $1,180,436)
 
1,645,612

 
1,203,681

Total investments at fair value (cost September 30, 2013: $1,859,651; cost September 30, 2012: $1,268,489)
 
1,893,046

 
1,288,108

Cash and cash equivalents
 
147,359

 
74,393

Interest and fees receivable
 
10,379

 
7,652

Due from portfolio company
 
1,814

 
3,292

Receivables from unsettled transactions
 
—

 
1,750

Deferred financing costs
 
19,548

 
13,751

Other assets
 
187

 
56

Total assets
 
$
2,072,333

 
$
1,389,002

LIABILITIES AND NET ASSETS
Liabilities:
 
 
 
 
Accounts payable, accrued expenses and other liabilities
 
$
1,166

 
$
1,180

Base management fee payable
 
9,625

 
6,573

Incentive fee payable
 
7,175

 
5,579

Due to FSC, Inc.
 
840

 
1,630

Interest payable
 
2,939

 
4,219

Payables from unsettled transactions
 
35,716

 
—

Credit facilities payable
 
188,000

 
201,251

SBA debentures payable
 
181,750

 
150,000

Unsecured convertible notes payable
 
115,000

 
115,000

Unsecured notes payable
 
161,250

 
—

Total liabilities
 
703,461

 
485,432

Commitments and contingencies (Note 3)
 
 
 
 
Net assets:
 
 
 
 
Common stock, $0.01 par value, 250,000 and 150,000 shares authorized, at September 30, 2013 and September 30, 2012, respectively; 139,041 and 91,048 shares issued and outstanding at September 30, 2013 and September 30, 2012, respectively
 
1,390

 
910

Additional paid-in-capital
 
1,509,546

 
1,019,053

Net unrealized appreciation on investments
 
33,395

 
19,998

Net realized loss on investments and interest rate swap
 
(154,591
)
 
(128,062
)
Accumulated overdistributed net investment income

 
(20,868
)
 
(8,329
)
Total net assets (equivalent to $9.85 and $9.92 per common share at September 30, 2013 and September 30, 2012, respectively) (Note 12)
 
1,368,872

 
903,570

Total liabilities and net assets
 
$
2,072,333

 
$
1,389,002

See notes to Consolidated Financial Statements.


79

Fifth Street Finance Corp.
Consolidated Statements of Operations
(in thousands, except per share amounts)
 
 
Year ended
September 30,
2013
 
Year ended
September 30,
2012
 
Year ended
September 30,
2011
 
Interest income:
 
 
 
 
 
 
 
Control investments
 
$
5,614

 
$
927

 
$
89

 
Affiliate investments
 
2,792

 
2,804

 
4,265

 
Non-control/Non-affiliate investments
 
148,467

 
115,625

 
90,224

 
Interest on cash and cash equivalents
 
23

 
34

 
19

 
Total interest income
 
156,896

 
119,390

 
94,597

 
PIK interest income:
 
 
 
 
 
 
 
Control investments
 
2,764

 
309

 
347

 
Affiliate investments
 
1,404

 
916

 
989

 
Non-control/Non-affiliate investments
 
12,619

 
12,570

 
12,339

 
Total PIK interest income
 
16,787

 
13,795

 
13,675

 
Fee income:
 
 
 
 
 
 
 
Control investments
 
4,271

 
1,285

 
127

 
Affiliate investments
 
48

 
642

 
667

 
Non-control/Non-affiliate investments
 
41,551

 
29,779

 
15,888

 
Total fee income
 
45,870

 
31,706

 
16,682

 
Dividend and other income:
 
 
 
 
 
 
 
Non-control/Non-affiliate investments
 
2,059

 
225

 
211

 
Total dividend and other income
 
2,059

 
225

 
211

 
Total investment income
 
221,612

 
165,116

 
125,165

 
Expenses:
 
 
 
 
 
 
 
Base management fee
 
35,748

 
23,799

 
19,656

 
Incentive fee
 
28,158

 
22,001

 
16,782

 
Professional fees
 
4,182

 
2,890

 
2,709

 
Board of Directors fees
 
576

 
551

 
452

 
Interest expense
 
33,470

 
23,245

 
15,137

 
Administrator expense
 
1,925

 
2,425

 
1,699

 
General and administrative expenses
 
4,921

 
3,771

 
3,083

 
Total expenses
 
108,980

 
78,682

 
59,518

 
Base management fee waived
 
(2,321
)
 
—

 
—

 
Net expenses
 
106,659

 
78,682

 
59,518

 
Gain on extinguishment of unsecured convertible notes
 
—

 
1,571

 
1,480

 
Net investment income
 
114,953

 
88,005

 
67,127

 
Unrealized appreciation on interest rate swap
 
—

 
—

 
773

 
Realized loss on interest rate swap
 
—

 
—

 
(1,335
)
 
Unrealized appreciation (depreciation) on investments:
 
 
 
 
 
 
 
Control investments
 
13,302

 
(6,096
)
 
9,437

 
Affiliate investments
 
434

 
12,944

 
(5,374
)
 
Non-control/Non-affiliate investments
 
(339
)
 
49,126

 
(11,362
)
 
Net unrealized appreciation (depreciation) on investments
 
13,397

 
55,974

 
(7,299
)
 
Realized loss on investments:
 
 
 
 
 
 
 
Control investments
 
(11,224
)
 
(5,316
)
 
(7,806
)
 
Affiliate investments
 
—

 
(10,620
)
 
(14,146
)
 
Non-control/Non-affiliate investments
 
(15,305
)
 
(48,642
)
 
(7,107
)
 
Net realized loss on investments
 
(26,529
)
 
(64,578
)
 
(29,059
)
 
Net increase in net assets resulting from operations
 
$
101,821

 
$
79,401

 
$
30,207

 
Net investment income per common share — basic
 
$
1.04

 
$
1.11

 
$
1.05

 
Earnings per common share — basic
 
$
0.92

 
$
1.00

 
$
0.47

 
Weighted average common shares outstanding — basic
 
110,270

 
79,570

 
64,057

 
Net investment income per common share — diluted
 
$
1.01

 
$
1.07

 
$
1.01

 
Earnings per common share — diluted
 
$
0.90

 
$
0.97

 
$
0.47

 
Weighted average common shares outstanding — diluted
 
118,061

 
87,719

 
68,716

 
See notes to Consolidated Financial Statements.

80


Fifth Street Finance Corp.
Consolidated Statements of Changes in Net Assets
(in thousands, except per share amounts)
 
 
 
Year ended
September 30,
2013
 
Year ended
September 30,
2012
 
Year ended
September 30,
2011
 
Operations:
 
 
 
 
 
 
 
Net investment income
 
$
114,953

 
$
88,005

 
$
67,127

 
Net unrealized appreciation (depreciation) on investments and interest rate swap
 
13,397

 
55,974

 
(6,526
)
 
Net realized loss on investments and interest rate swap
 
(26,529
)
 
(64,578
)
 
(30,394
)
 
Net increase in net assets resulting from operations
 
101,821

 
79,401

 
30,207

 
Stockholder transactions:
 
 
 
 
 
 
 
Distributions to stockholders from ordinary income
 
(100,430
)
 
(78,906
)
 
(71,650
)
 
Tax return of capital
 
(27,063
)
 
(15,172
)
 
(9,140
)
 
Net decrease in net assets from stockholder transactions
 
(127,493
)
 
(94,078
)
 
(80,790
)
 
Capital share transactions:
 
 
 
 
 
 
 
Issuance of common stock, net
 
478,919

 
187,408

 
205,947

 
Issuance of common stock under dividend reinvestment plan
 
12,055

 
2,212

 
4,091

 
Net increase in net assets from capital share transactions
 
490,974

 
189,620

 
210,038

 
Total increase in net assets
 
465,302

 
174,943

 
159,455

 
Net assets at beginning of period
 
903,570

 
728,627

 
569,172

 
Net assets at end of period
 
$
1,368,872

 
$
903,570

 
$
728,627

 
Net asset value per common share
 
$
9.85

 
$
9.92

 
$
10.07

 
Common shares outstanding at end of period
 
139,041

 
91,048

 
72,376

 
See notes to Consolidated Financial Statements.


81
Fifth Street Finance Corp.
Consolidated Statements of Cash Flows
(in thousands, except per share amounts)


 
 
Year ended
September 30,
2013
 
Year ended
September 30,
2012
 
Year ended
September 30,
2011
Cash flows from operating activities:
 
 
 
 
 
 
Net increase in net assets resulting from operations
 
$
101,821

 
$
79,401

 
$
30,207

Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:
 
 
 
 
 
 
Gain on extinguishment of unsecured convertible notes
 
—

 
(1,571
)
 
(1,480
)
Net unrealized (appreciation) depreciation on investments and interest rate swap
 
(13,397
)
 
(55,974
)
 
6,526

Net realized losses on investments and interest rate swap
 
26,529

 
64,578

 
30,394

PIK interest income
 
(16,787
)
 
(13,795
)
 
(13,675
)
Recognition of fee income
 
(45,870
)
 
(31,706
)
 
(16,681
)
Accretion of original issue discount on investments
 
(612
)
 
(1,497
)
 
(2,063
)
Amortization of deferred financing costs
 
5,198

 
4,456

 
2,747

Changes in operating assets and liabilities:
 
 
 
 
 
 
Fee income received
 
38,558

 
24,841

 
21,890

Increase in interest and fees receivable
 
(2,249
)
 
(1,204
)
 
(1,715
)
(Increase) decrease in due from portfolio company
 
1,478

 
(2,740
)
 
(449
)
(Increase) decrease in receivables from unsettled transactions
 
1,750

 
(1,750
)
 
—

(Increase) decrease in other assets
 
(131
)
 
207

 
358

Increase (decrease) in accounts payable, accrued expenses and other liabilities
 
28

 
(191
)
 
(667
)
Increase in base management fee payable
 
3,052

 
863

 
2,834

Increase in incentive fee payable
 
1,596

 
582

 
2,138

Increase (decrease) in due to FSC, Inc.
 
(790
)
 
150

 
397

Increase (decrease) in interest payable
 
(1,280
)
 
(450
)
 
4,386

Increase in payables from unsettled transactions
 
35,716

 
—

 
—

Purchases of investments and net revolver activity, net of syndications
 
(1,281,029
)
 
(530,866
)
 
(703,461
)
Principal payments received on investments (scheduled payments)
 
46,911

 
42,625

 
31,718

Principal payments received on investments (payoffs)
 
571,396

 
316,978

 
78,635

PIK interest income received in cash
 
8,514

 
5,477

 
9,988

Proceeds from the sale of investments
 
60,373

 
11,370

 
50

Net cash used in operating activities
 
(459,225
)
 
(90,216
)
 
(517,923
)
Cash flows from financing activities:
 
 
 
 
 
 
Distributions paid in cash
 
(115,438
)
 
(91,866
)
 
(76,699
)
Borrowings under SBA debentures payable
 
31,750

 
—

 
77,000

Borrowings under credit facilities
 
1,067,144

 
580,897

 
658,500

Repayments of borrowings under credit facilities
 
(1,080,395
)
 
(557,669
)
 
(480,476
)
Proceeds from the issuance of unsecured convertible notes
 
—

 
—

 
152,000

Repurchases of unsecured convertible notes
 
—

 
(17,939
)
 
(15,070
)
Proceeds from the issuance of unsecured notes
 
155,824

 
—

 
—

Proceeds from the issuance of common stock
 
479,949

 
188,700

 
206,788

Deferred financing costs paid
 
(5,570
)
 
(4,029
)
 
(12,400
)
Offering costs paid
 
(1,073
)
 
(1,129
)
 
(841
)
Net cash provided by financing activities
 
532,191

 
96,965

 
508,802

Net increase (decrease) in cash and cash equivalents
 
72,966

 
6,749

 
(9,121
)
Cash and cash equivalents, beginning of period
 
74,393

 
67,644

 
76,765

Cash and cash equivalents, end of period
 
$
147,359

 
$
74,393

 
$
67,644

Supplemental information:
 
 
 
 
 
 
Cash paid for interest
 
$
29,946

 
$
20,775

 
$
7,553

Non-cash operating activities:
 
 
 
 
 
 
Non-cash exchange of investments
 
$
30,521

 
$
38,437

 
$
—

Non-cash financing activities:
 
 
 
 
 
 
Issuance of shares of common stock under dividend reinvestment plan
 
$
12,055

 
$
2,212

 
$
4,091

See notes to Consolidated Financial Statements.

82
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost
 
Fair Value
Control Investments (3)
 
 
 
 
 
 
 
 
 Traffic Solutions Holdings, Inc.
 
Construction and engineering
 
 
 
 
 
 
 Second Lien Term Loan, 12% cash 3% PIK due 12/31/2016
 
 
 
$
14,494


$
14,480


$
14,499

 LC Facility, 8.5% cash due 12/31/2016 (10)
 
 
 



(5
)

—

 746,114 Series A Preferred Units
 
 
 



12,786


15,891

 746,114 Class A Common Stock Units
 
 
 



5,316


10,529

 
 
 
 



32,577


40,919

 TransTrade Operators, Inc.
 
Air freight and logistics
 








 First Lien Term Loan, 11% cash 3% PIK due 5/31/2016
 
 
 
13,660


13,660


13,524

 596.67 Series A Common Units in TransTrade Holding LLC
 
 
 



—


—

 3,033,333.33 Preferred Units in TransTrade Holding LLC
 
 



3,033


539

 
 
 
 



16,693


14,063

 HFG Holdings, LLC
 
Specialized finance
 








 First Lien Term Loan, 6% cash 4% PIK due 6/10/2019
 
 
 
93,135


93,135


93,297

 860,000 Class A Units
 
 
 



22,347


22,346

 
 
 
 



115,482


115,643

 First Star Aviation, LLC
 
Airlines
 








 First Lien Term Loan, 9% cash 3% PIK due 1/9/2018
 
 
 
19,211


19,211


19,211

 5,264,207 Common Units
 
 
 



5,264


5,264

 
 
 
 



24,475


24,475

 Eagle Hospital Physicians, LLC (13)
 
Healthcare services
 








 First Lien Term Loan A, 8% PIK due 8/1/2016
 
 
 
11,150


11,150


11,149

 First Lien Term Loan B, 8.1% PIK due 8/1/2016
 
 
 
3,041


3,041


3,050

 First Lien Revolver, 8% cash due 8/1/2016
 
 
 



—


—

 4,100,000 Class A Common Units
 
 
 



4,100


6,203

 
 
 
 



18,291


20,402

 Total Control Investments (15.7% of net assets)
 
 
 



$
207,518


$
215,502

 Affiliate Investments (4)
 
 
 
 
 
 
 
 
 Caregiver Services, Inc.
 
Healthcare services
 
 
 
 
 
 
 1,080,399 shares of Series A Preferred Stock
 
 
 



$
1,080


$
3,256

 
 
 
 



1,080


3,256

 AmBath/ReBath Holdings, Inc. (9)
 
Home improvement retail
 






 First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2016
 
 
 
$
3,223


3,219


3,272

 First Lien Term Loan B, 12.5% cash 2.5% PIK due 4/30/2016
 
 
 
25,515


25,508


25,317

 4,668,788 Shares of Preferred Stock
 
 
 



—


87

 
 
 
 



28,727


28,676

 Total Affiliate Investments (2.3% of net assets)
 
 
 
 
 
$
29,807


$
31,932

 Non-Control/Non-Affiliate Investments (7)
 
 
 
 
 
 
 
 
 Fitness Edge, LLC
 
Leisure facilities
 
 
 
 
 
 
 1,000 Common Units (6)
 
 
 



$
43


$
190

 
 
 
 



43


190

 Capital Equipment Group, Inc. (9)
 
Industrial machinery
 






 Second Lien Term Loan, 12% cash 2.75% PIK due 12/27/2015
 
 
 
$
4,007


4,007


4,003

 33,786 shares of Common Stock
 
 
 



345


1,206

 
 
 
 



4,352


5,209

 Western Emulsions, Inc.
 
Construction materials
 






 Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014
 
 
 
7,200


7,170


7,297

 
 
 
 



7,170


7,297

 HealthDrive Corporation (9)
 
Healthcare services
 






 First Lien Term Loan A, 10% cash due 7/17/2014
 
 
 
4,151


4,148


4,213

 First Lien Term Loan B, 12% cash 1% PIK due 7/17/2014
 
 
 
10,573


10,573


10,497

 First Lien Revolver, 12% cash due 7/17/2014
 
 
 
2,266


2,266


2,266

 
 
 
 



16,987


16,976


See notes to Consolidated Financial Statements.

83
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

Cenegenics, LLC
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, 9.75% cash due 9/30/2019
 
 
 
$
33,500


$
33,468


$
33,527

414,419 Common Units (6)
 
 
 



598


1,317

 
 
 
 



34,066


34,844

Riverlake Equity Partners II, LP
 
Multi-sector holdings
 








1.78% limited partnership interest (6)(12)
 
 
 



362


325

 
 
 
 



362


325

Riverside Fund IV, LP
 
Multi-sector holdings
 








0.34% limited partnership interest (6)(12)
 
 
 



713


658

 
 
 
 



713


658

Psilos Group Partners IV, LP
 
Multi-sector holdings
 








2.35% limited partnership interest (11)(12)
 
 
 



—


—

 
 
 
 



—


—

Mansell Group, Inc. (9)
 
Advertising
 








First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015
 
 
 
6,551


6,498


6,616

First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015
 
 
 
9,424


9,362


9,510

First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015 (10)
 
 
 
—


(13
)

—

 
 
 
 



15,847


16,126

Enhanced Recovery Company, LLC
 
Diversified support services
 








First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015
 
 
 
11,500


11,398


11,522

First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015
 
 
 
16,013


15,913


15,999

First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015
 
 
 
500


463


500

 
 
 
 



27,774


28,021

Specialty Bakers LLC
 
Food distributors
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015
 
 
 
3,720


3,596


3,721

First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015
 
 
 
11,000


10,882


11,011

First Lien Revolver, LIBOR+8.5% cash due 9/15/2015
 
 
 
4,000


3,957


4,000

 
 
 
 



18,435


18,732

Welocalize, Inc.
 
Internet software & services
 








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



3,393


7,695

 
 
 
 



3,393


7,695

Miche Bag, LLC (9)
 
Apparel, accessories & luxury goods
 
 
 
 
 
 
First Lien Term Loan B, LIBOR+10% (3% floor) 3% PIK due 12/7/2015
 
 
 
17,576


16,307


17,514

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015 (10)
 
 
 



(33
)

—

10,371 Series A Preferred Equity units in Miche Bag Holdings, LLC
 
 
 



1,037


419

1,358.854 Series C Preferred Equity units in Miche Bag Holdings, LLC
 
 
 



136


—

19,417 Series A Common Equity units in Miche Bag Holdings, LLC
 
 
 



—


—

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



1,463


—

 
 
 
 



18,910


17,933




See notes to Consolidated Financial Statements.














84
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

Bunker Hill Capital II (QP), LP
 
Multi-sector holdings
 
 
 
 
 
 
0.51% limited partnership interest (12)
 
 
 



$
214


$
121

 
 
 
 



214


121

Drugtest, Inc. (9)
 
Human resources & employment services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 6/27/2018
 
 
 
$
38,809


38,702


38,864

First Lien Term Loan B, LIBOR+10% (1% floor) 1.5% PIK due 6/27/2018
 
 
 
15,752


15,682


15,899

First Lien Revolver, LIBOR+6% (1% floor) cash due 6/27/2018 (10)
 
 
 



(34
)

—

 
 
 
 



54,350


54,763

Saddleback Fence and Vinyl Products, Inc. (9)
 
Building products
 








First Lien Term Loan, 8% cash due 11/30/2013
 
 
 
635


635


635

First Lien Revolver, 8% cash due 11/30/2013
 
 
 
100


100


100

 
 
 
 



735


735

Physicians Pharmacy Alliance, Inc. (9)
 
Healthcare services
 








First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016
 
 
 
11,435


11,266


11,399

First Lien Revolver, LIBOR+6% cash due 1/4/2016 (10)
 
 
 



(20
)

—

 
 
 
 



11,246


11,399

Cardon Healthcare Network, LLC
 
Diversified support services
 








65,903 Class A Units
 
 
 



250


523

 
 
 
 



250


523

Phoenix Brands Merger Sub LLC (9)
 
Household products
 








Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016
 
 
 
5,518


5,432


5,423

Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017
 
 
 
21,610


21,323


20,842

Senior Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016
 
 
 
3,000


2,922


3,000

 
 
 
 



29,677


29,265

CCCG, LLC (9)
 
Oil & gas equipment services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 12/29/2017
 
 
 
35,148


34,717


34,988

First Lien Revolver, LIBOR+5.5% (1.75% floor) cash due 12/31/2014
 
 
 



—


—

 
 
 
 



34,717


34,988

Maverick Healthcare Group, LLC
 
Healthcare equipment
 








First Lien Term Loan A, LIBOR+9% (1.75% floor) cash due 12/31/2016
 
 
 
9,950


9,950


9,956

First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 12/31/2016
 
 
 
38,900


38,546


38,838

 
 
 
 



48,496


48,794

Refac Optical Group (14)
 
Specialty stores
 








First Lien Term Loan A, LIBOR+7.5% cash due 9/30/2018
 
 
 
24,674


24,510


24,923

First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 9/30/2018
 
 
 
32,932


32,639


33,205

First Lien Term Loan C, 12% cash due 12/31/2014
 
 
 
10,000


10,000


10,013

First Lien Revolver, LIBOR+7.5% cash due 9/30/2018 (10)
 
 
 



(69
)

—

1,550.9435 Shares of Common Stock in Refac Holdings, Inc.
 
 
 



1


—

500.9435 Shares of Series A-2 Preferred Stock in Refac Holdings, Inc.
 
 
 



305


—

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



999


884

 
 
 
 



68,385


69,025

GSE Environmental, Inc. (9)
 
Environmental & facilities services
 








First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016
 
 
 
8,812


8,755


8,113

 
 
 
 



8,755


8,113

Baird Capital Partners V, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.40% limited partnership interest (12)
 
 
 



649


728

 
 
 
 



649


728


See notes to Consolidated Financial Statements.


85
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

Charter Brokerage, LLC
 
Oil & gas equipment services
 
 
 
 
 
 
Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 10/10/2016
 
 
 
$
28,914


$
28,828


$
29,462

Subordinated Term Loan, 11.75% cash 2% PIK due 10/10/2017
 
 
 
11,976


11,921


12,004

Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 10/10/2016 (10)
 
 
 



(40
)

—

 
 
 
 



40,709


41,466

Stackpole Powertrain International Holding, L.P.
 
Auto parts & equipment
 
 
 
 
 
 
1,000 Common Units (12)
 
 
 



1,000


3,200

 
 
 
 



1,000


3,200

Discovery Practice Management, Inc. (9)
 
Healthcare services
 








First Lien Term Loan A, LIBOR+7.5% cash due 8/8/2016
 
 
 
5,756


5,706


5,761

First Lien Term Loan B, 12% cash 3% PIK due 8/8/2016
 
 
 
6,606


6,559


6,608

First Lien Revolver, LIBOR+7% cash due 8/8/2016
 
 
 
3,000


2,977


3,000

 
 
 
 



15,242


15,369

CTM Group, Inc.
 
Leisure products
 








Subordinated Term Loan A, 11% cash 2% PIK due 2/10/2017
 
 
 
10,966


10,896


11,024

Subordinated Term Loan B, 18.4% PIK due 2/10/2017
 
 
 
4,553


4,532


4,559

 
 
 
 



15,428


15,583

Milestone Partners IV, LP
 
Multi-sector holdings
 








0.86% limited partnership interest (6)(12)
 
 
 



586


638

 
 
 
 



586


638

Insight Pharmaceuticals LLC
 
Pharmaceuticals
 








Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017
 
 
 
13,517


13,439


13,607

 
 
 
 



13,439


13,607

National Spine and Pain Centers, LLC
 
Healthcare services
 
 
 
 
 
 
Subordinated Term Loan, 11% cash 1.6% PIK due 9/27/2017
 
 
 
29,263


29,084


29,535

317,282.97 Class A Units
 
 
 



317


404

 
 
 
 



29,401


29,939

RCPDirect, LP
 
Multi-sector holdings
 








0.91% limited partnership interest (6)(12)
 
 
 



476


569

 
 
 
 



476


569

The MedTech Group, Inc. (9)
 
Healthcare equipment
 








Senior Term Loan, LIBOR+5.5% (1.25% floor) cash due 9/7/2016
 
 
 
12,448


12,379


12,454

 
 
 
 



12,379


12,454

Digi-Star Acquisition Holdings, Inc.
 
Industrial machinery
 
 
 
 
 
 
Subordinated Term Loan, 12% cash 1.5% PIK due 11/18/2017
 
 
 
12,316


12,231


12,439

264.37 Class A Preferred Units
 
 
 



264


304

2,954.87 Class A Common Units
 
 
 



36


246

 
 
 
 



12,531


12,989

CPASS Acquisition Company
 
Internet software & services
 








First Lien Term Loan, LIBOR+9% (1.5% floor) cash 1% PIK due 11/21/2016
 
 
 
8,069


8,005


8,166

First Lien Revolver, LIBOR+9% (1.5% floor) cash due 11/21/2016 (10)
 
 
 



(12
)

—

 
 
 
 



7,993


8,166

Genoa Healthcare Holdings, LLC
 
Pharmaceuticals
 








Senior Term Loan, LIBOR+5.25% (1.25% floor) cash due 12/1/2016
 
 
 
8,775


8,775


8,797

Subordinated Term Loan, 12% cash 2% PIK due 6/1/2017
 
 
 
12,973


12,890


13,206

Senior Revolver, LIBOR+5.25% (1.25% floor) cash due 12/1/2016
 
 
 



—


—

500,000 Preferred units (6)
 
 
 



261


275

500,000 Class A Common Units
 
 
 



25


466

 
 
 
 



21,951


22,744




See notes to Consolidated Financial Statements.


86
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

ACON Equity Partners III, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.15% limited partnership interest (6)(12)
 
 
 



$
329


$
361

 
 
 
 



329


361

CRGT, Inc.
 
IT consulting & other services
 
 
 
 
 
 
Subordinated Term Loan, 12.5% cash 3% PIK due 3/9/2018
 
 
 
$
26,741


26,553


27,445

 
 
 
 



26,553


27,445

Riverside Fund V, LP
 
Multi-sector holdings
 








0.48% limited partnership interest (12)
 
 
 



288


239

 
 
 
 



288


239

World 50, Inc.
 
Research & consulting services
 








First Lien Term Loan A, LIBOR+6.25% (1.5% floor) cash due 3/30/2017
 
 
 
10,718


10,622


10,834

First Lien Term Loan B, 12.5% cash due 3/30/2017
 
 
 
7,000


6,941


7,078

Senior Revolver, LIBOR+6.25% (1.5% floor) cash due 3/30/2017 (10)
 
 
 



(42
)

—

 
 
 
 



17,521


17,912

Nixon, Inc.
 
Apparel, accessories & luxury goods
 
 
 
 
 
 
First Lien Term Loan, 8.75% cash 2.75% PIK due 4/16/2018
 
 
 
9,551


9,476


9,791

 
 
 
 



9,476


9,791

JTC Education, Inc. (9)
 
Education services
 








Subordinated Term Loan, 13% cash due 11/1/2017
 
 
 
14,500


14,415


14,503

17,391 Shares of Series A-1 Preferred Stock
 
 
 



313


174

17,391 Shares of Common Stock
 
 
 



187


—

 
 
 
 



14,915


14,677

BMC Acquisition, Inc.
 
Diversified financial services
 
 
 
 
 
 
Senior Term Loan, LIBOR+5.5% (1% floor) cash due 5/1/2017
 
 
 
5,315


5,285


5,311

Senior Revolver, LIBOR+5% (1% floor) cash due 5/1/2017 (10)
 
 
 



(7
)

—

500 Series A Preferred Shares
 
 
 



500


534

50,000 Common Shares
 
 
 



1


—

 
 
 
 



5,779


5,845

Ansira Partners, Inc. (9)
 
Advertising
 








First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/4/2017
 
 
 
10,593


10,529


10,580

First Lien Revolver, LIBOR+5.5% (1.5% floor) cash due 5/4/2017 (10)
 
 
 



(6
)

—

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



250


334

 
 
 
 



10,773


10,914

 Edmentum, Inc.
 
Education services
 








 Second Lien Term Loan, L+9.75% (1.5% floor) cash due 5/17/2019
 
 
 
17,000


17,000


17,288

 
 
 
 



17,000


17,288









See notes to Consolidated Financial Statements.


87
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

I Drive Safely, LLC
 
Education services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+8.5% (1.5% floor) cash due 5/25/2017
 
 
 
$
27,000


26,975


$
27,521

First Lien Revolver, LIBOR+6.5% (1.5% floor) cash due 5/25/2017 (10)
 
 
 



(5
)

—

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



750


755

 
 
 
 



27,720


28,276

Yeti Acquisition, LLC (9)
 
Leisure products
 








First Lien Term Loan A, LIBOR+8% (1.25% floor) cash due 6/15/2017
 
 
 
18,345


18,317


18,523

First Lien Term Loan B, LIBOR+11.25% (1.25% floor) cash 1% PIK due 6/15/2017
 
 
 
12,000


11,988


12,089

First Lien Revolver, LIBOR+8% (1.25% floor) cash due 6/15/2017 (10)
 
 
 



(10
)

—

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



1,500


3,755

 
 
 
 



31,795


34,367

Specialized Education Services, Inc.
 
Education services
 








Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 6/28/2017
 
 
 
8,988


8,988


9,056

Subordinated Term Loan, 11% cash 1.5% PIK due 6/28/2018
 
 
 
17,839


17,839


18,200

 
 
 
 



26,827


27,256

PC Helps Support, LLC
 
IT consulting & other services
 








Subordinated Term Loan, 12% cash 1.5% PIK due 9/5/2018
 
 
 
18,804


18,804


18,989

675 Series A Preferred Units of PCH Support Holdings, Inc.
 
 
 



675


674

7,500 Class A Common Stock Units of PCH Support Holdings, Inc.
 
 
 



75


—

 
 
 
 



19,554


19,663

Olson + Co., Inc.
 
Advertising
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 9/30/2017
 
 
 
12,853


12,853


12,853

First Lien Revolver, LIBOR+5.5% (1.5% floor) cash due 9/30/2017
 
 
 



—


—

 
 
 
 



12,853


12,853

Beecken Petty O’Keefe Fund IV, L.P.
 
Multi-sector holdings
 








0.5% limited partnership interest (11)(12)
 
 
 



—


—

 
 
 
 



—


—

Deltek, Inc. (9)
 
IT consulting & other services
 








Second Lien Term Loan, LIBOR+8.75% (1.25% floor) cash due 10/10/2019
 
 
 
25,000


25,000


25,415

First Lien Revolver, LIBOR+4.75% (1.25% floor) cash due 10/10/2017
 
 
 
1,333


1,333


1,333

 
 
 
 



26,333


26,748

First American Payment Systems, LP
 
Diversified support services
 
 
 


 


Second Lien Term Loan, LIBOR+9.5% (1.25% floor) cash due 4/12/2019
 
 
 
25,000


25,000


25,130

First Lien Revolver, LIBOR+4.5% (1.25% floor) cash due 10/12/2017
 
 
 



—


—

 
 
 
 



25,000


25,130

Dexter Axle Company
 
Auto parts & equipment
 








Subordinated Term Loan, 11.25% cash 2% PIK due 11/1/2019
 
 
 
30,561


30,561


31,009

1,500 Common Shares in Dexter Axle Holding Company
 
 
 



1,500


1,795

 
 
 
 



32,061


32,804

IG Investments Holdings, LLC
 
IT consulting & other services
 








Second Lien Term Loan, LIBOR+9% (1.25% floor) cash due 10/31/2020
 
 
 
10,000


10,000


10,059

 
 
 
 



10,000


10,059



See notes to Consolidated Financial Statements.


88
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

SumTotal Systems, LLC
 
Internet software & services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+9% (1.25% floor) cash due 5/16/2019
 
 
 
$
20,000


$
20,000


$
20,015

 
 
 
 



20,000


20,015

Comprehensive Pharmacy Services, LLC
 
Pharmaceuticals
 








Subordinated Term Loan, 11.25% cash 1.5% PIK due 11/30/2019
 
 
 
14,148


14,148


14,401

20,000 Common Shares in MCP CPS Group Holdings, Inc. (6)
 
 
 



2,000


2,036

 
 
 
 



16,148


16,437

Reliance Communications, LLC
 
Internet software & services
 








First Lien Term Loan A, LIBOR+7% (1% floor) cash due 12/18/2017
 
 
 
21,774


21,769


21,898

First Lien Term Loan B, LIBOR+11.5% (1% floor) cash due 12/18/2017
 
 
 
11,333


11,331


11,398

First Lien Revolver, LIBOR+7% (1% floor) cash due 12/18/2017
 
 
 
2,250


2,249


2,250

 
 
 
 



35,349


35,546

Garretson Firm Resolution Group, Inc.
 
Diversified support services
 








First Lien Term Loan, LIBOR+5% (1.25% floor) cash due 12/20/2018
 
 
 
7,264


7,264


7,283

Subordinated Term Loan, 11% cash 1.5% PIK due 6/20/2019
 
 
 
5,019


5,019


5,025

First Lien Revolver, LIBOR+5% (1.25% floor) cash due 12/20/2017
 
 
 
1,250


1,250


1,250

4,950,000 Preferred Units in GRG Holdings, LP
 
 
 



495


489

50,000 Common Units in GRG Holdings, LP
 
 
 



5


—

 
 
 
 



14,033


14,047

Teaching Strategies, LLC
 
Education services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+6% (1.25% floor) cash due 12/21/2017
 
 
 
36,662


36,656


37,173

First Lien Term Loan B, LIBOR+8.35% (1.25% floor) cash 3.15% PIK due 12/21/2017
 
 
 
19,605


19,603


19,888

First Lien Revolver, LIBOR+6% (1.25% floor) cash due 12/21/2017 (10)
 
 
 



(1
)

—

 
 
 
 



56,258


57,061

Omniplex World Services Corporation
 
Security & alarm services
 








Subordinated Term Loan, 12.25% cash 1.25% PIK due 12/21/2018
 
 
 
12,624


12,624


12,627

500 Class A Common Units in Omniplex Holdings Corp.
 
 
 



500


477

 
 
 
 



13,124


13,104

Dominion Diagnostics, LLC
 
Healthcare services
 








Subordinated Term Loan, 11% cash 2% PIK due 12/21/2018
 
 
 
15,746


15,746


16,016

 
 
 
 



15,746


16,016

Affordable Care, Inc.
 
Healthcare services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+9.25% (1.25% floor) cash due 12/26/2019
 
 
 
21,500


21,500


21,957

 
 
 
 



21,500


21,957

Aderant North America, Inc.
 
Internet software & services
 








Second Lien Term Loan, LIBOR+8.75% (1.25% floor) cash due 6/20/2019
 
 
 
7,000


7,000


7,067

 
 
 
 



7,000


7,067

AdVenture Interactive, Corp.
 
Advertising
 








First Lien Term Loan, LIBOR+6.75% (1.25% floor) cash due 3/22/2018
 
 
 
112,575


112,555


112,760

First Lien Revolver, LIBOR+6.75% (1.25% floor) cash due 3/22/2018 (10)
 
 
 



(1
)

—

2,000 Preferred Units of AVI Holdings, L.P. (6)
 
 
 



2,000


2,123

 
 
 
 



114,554


114,883



See notes to Consolidated Financial Statements.


89
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013


Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)

 
Cost

 
Fair Value

CoAdvantage Corporation
 
Human resources & employment services
 
 
 
 
 
 
Subordinated Term Loan, 11.5% cash 1.25% PIK due 12/31/2018
 
 
 
$
10,094


$
10,094


$
10,229

50,000 Class A Units in CIP CoAdvantage Investments LLC
 
 
 



500


400

 
 
 
 



10,594


10,629

EducationDynamics, LLC
 
Education services
 








Subordinated Term Loan, 12% cash 6% PIK due 1/16/2017
 
 
 
11,062


11,062


10,961

 
 
 
 



11,062


10,961

Vestcom International, Inc.
 
Data processing & outsourced services
 








First Lien Term Loan, LIBOR+5.75% (1.25% floor) cash due 12/26/2018
 
 
 
9,950


9,950


10,010

 
 
 
 



9,950


10,010

Sterling Capital Partners IV, L.P.
 
Multi-sector holdings
 








0.20% limited partnership interest (6)(12)
 
 
 



472


517

 
 
 
 



472


517

Devicor Medical Products, Inc.
 
Healthcare equipment
 








First Lien Term Loan, LIBOR+5% (2% floor) cash due 7/8/2015
 
 
 
9,619


9,619


9,618

 
 
 
 



9,619


9,618

RP Crown Parent, LLC
 
Application software
 








First Lien Revolver, LIBOR+5.5% (1.25% floor) cash due 12/21/2017
 
 
 
1,000


379


1,000

 
 
 
 



379


1,000

SESAC Holdco II LLC
 
Diversified support services
 








Second Lien Term Loan, LIBOR+8.75% (1.25% floor) cash due 6/28/2019
 
 
 
4,000


4,000


4,097

 
 
 
 



4,000


4,097

Advanced Pain Management Holdings, Inc.
 
Healthcare services
 
 
 


 


First Lien Term Loan, LIBOR+8.5% (1.25% floor) cash due 2/26/2018
 
 
 
24,000


24,000


24,454

 
 
 
 



24,000


24,454

Rocket Software, Inc.
 
Internet software & services
 








Second Lien Term Loan, LIBOR+8.75% (1.5% floor) cash due 2/8/2019
 
 
 
10,475


10,435


10,482

 
 
 
 



10,435


10,482

TravelClick, Inc.
 
Internet software & services
 








Second Lien Term Loan, LIBOR+8.5% (1.25% floor) cash due 3/26/2018
 
 
 
15,000


15,000


15,106

 
 
 
 



15,000


15,106

ISG Services, LLC
 
Diversified support services
 








First Lien Term Loan, LIBOR+8% (1% floor) cash due 3/28/2018
 
 
 
95,000


94,972


95,111

First Lien Revolver, LIBOR+8% (1% floor) cash due 3/28/2018
 
 
 
4,000


3,997


4,000

 
 
 
 



98,969


99,111

Joerns Healthcare, LLC
 
Healthcare services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+8.75% (1.25% floor) cash due 9/28/2018
 
 
 
20,000


20,000


19,965

 
 
 
 



20,000


19,965

Pingora MSR Opportunity Fund I, LP
 
Thrift & mortgage finance
 








1.90% limited partnership interest (12)
 
 
 



208


139

 
 
 
 



208


139

Chicago Growth Partners III, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.50% limited partnership interest (11)(12)
 
 
 



—


—

 
 
 
 



—


—

Credit Infonet, Inc.
 
Data processing & outsourced services
 
 
 
 
 
 
Subordinated Term Loan, 12.25% cash due 10/26/2018
 
 
 
13,250


13,250


13,285

 
 
 
 



13,250


13,285

See notes to Consolidated Financial Statements.

90
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
Harden Healthcare, LLC
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.5% (1.25% floor) cash due 5/1/2018
 
 
 
$
8,888


$
8,888


$
8,929

 
 
 
 



8,888


8,929

H.D. Vest, Inc.
 
Specialized finance
 








Second Lien Term Loan, LIBOR+8% (1.25% floor) cash due 6/18/2019
 
 
 
8,750


8,750


8,757

 
 
 
 



8,750


8,757

2Checkout.com, Inc.
 
Diversified support services
 








First Lien Revolver, LIBOR+5% cash due 6/26/2016
 
 
 
150


148


150

 
 
 
 



148


150

Meritas Schools Holdings, LLC
 
Education services
 








First Lien Term Loan, LIBOR+5.75% (1.25% floor) cash due 6/25/2019
 
 
 
12,968


12,968


12,973

 
 
 
 



12,968


12,973

 Personable Holdings, Inc.
 
Other diversified financial services
 
 
 
 
 
 
 First Lien Term Loan, LIBOR+6% (1.25% floor) cash due 5/16/2018
 
 
 
11,109


11,109


11,109

 First Lien Revolver, LIBOR+6% (1.25% floor) cash due 5/16/2018
 
 
 



—


—

 
 
 
 



11,109


11,109

 Ikaria Acquisition, Inc.
 
Healthcare services
 








 First Lien Term Loan B, LIBOR+6% (1.25% floor) cash due 7/3/2018
 
 
 
9,875


9,875


9,875

 Second Lien Term Loan, LIBOR+9.75% (1.25% floor) cash due 7/3/2019
 
 
8,000


8,000


8,000

 
 
 
 



17,875


17,875

 Blue Coat Systems, Inc.
 
Internet software & services
 








 Second Lien Term Loan, LIBOR+8.5% (1% floor) cash due 6/28/2020
 
 
 
10,000


10,000


10,000

 
 
 
 



10,000


10,000

 Royal Adhesives and Sealants, LLC
 
Specialty chemicals
 








 Second Lien Term Loan, LIBOR+8.5% (1.25% floor) cash due 1/31/2019
 
 
20,000


20,000


20,000

 
 
 
 



20,000


20,000

 Bracket Holding Corp.
 
Healthcare services
 








 Second Lien Term Loan, LIBOR+8.25% (1% floor) cash due 2/15/2020
 
 
 
32,000


32,000


32,000

 50,000 Common Units in AB Group Holdings, LP
 
 
 



500


500

 
 
 
 



32,500


32,500

 Digital Insight Corporation
 
Other diversified financial services
 








 First Lien Term Loan, LIBOR+4.25% (1.25% floor) cash due 8/1/2019
 
 
 
5,000


5,000


5,000

 Second Lien Term Loan, LIBOR+8.25% (1.25% floor) cash due 8/1/2020
 
 
20,000


20,000


20,000

 
 
 
 



25,000


25,000

 Salus CLO 2012-1, Ltd.
 
Asset management & custody banks
 








 Class F Deferrable Notes - A, LIBOR+11.5% cash due 3/5/2021 (12)
 
 
 
7,500


7,500


7,500

 Class F Deferrable Notes - B, LIBOR+10.85% cash due 3/5/2021 (12)
 
 
 
22,000


22,000


22,000

 
 
 
 



29,500


29,500

 HealthEdge Software, Inc.
 
Application software
 








 Second Lien Term Loan, 12% cash due 9/30/2018
 
 
 
12,500


12,500


12,500

 
 
 
 



12,500


12,500

Total Non-Control/Non-Affiliate Investments (120.2% of net assets)
 
 
 
 
 
$
1,622,326


$
1,645,612

Total Portfolio Investments (138.3% of net assets)
 
 
 
 
 
$
1,859,651


$
1,893,046


See notes to Consolidated Financial Statements.

91
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2013

(1)
All debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.
(2)
See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.
(3)
Control Investments are defined by the Investment Company Act of 1940 (“1940 Act”) as investments in companies in which the Company owns more than 25% of the voting securities or maintains greater than 50% of the board representation.
(4)
Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.
(5)
Equity ownership may be held in shares or units of companies related to the portfolio companies.
(6)
Income producing through payment of dividends or distributions.
(7)
Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.
(8)
Principal includes accumulated PIK interest and is net of repayments.
(9)
Interest rates have been adjusted on certain term loans and revolvers. These rate adjustments are temporary in nature due to tier pricing arrangements or 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
Phoenix Brands Merger Sub LLC
 
July 31, 2013
 
+ 2.25% on Senior Term Loan
+ 2.25% on Revolver
+ 0.75% on Subordinated Term
Loan
 
 
 
Per loan agreement
GSE Environmental, Inc.
 
July 30, 2013
 
+ 2.0% on Term Loan
 
 
 
Per loan amendment
Miche Bag, LLC
 
July 26, 2013
 
- 3.0% on Term Loan B
 
- 1.0% on Term Loan B
 
Per loan amendment
Ansira Partners, Inc.
 
June 30, 2013
 
- 0.5% on Term Loan & Revolver
 
 
 
Tier pricing per loan agreement
Drugtest, Inc.
 
June 27, 2013
 
- 1.5% on Term Loan A
- 0.75% on Term Loan B
- 0.25% on Revolver
 
- 0.5% on Term Loan B
 
Per loan amendment
The MedTech Group, Inc.
 
June 12, 2013
 
- 0.50% on Term Loan
 
 
 
Per loan amendment
Physicians Pharmacy Alliance, Inc.
 
April 1, 2013
 
+ 3.0% on Term Loan & Revolver
 
+ 1.0% on Term Loan
 
Per loan agreement
Discovery Practice Management, Inc.
 
April 1, 2013
 
- 1.0% on Term Loan A
- 1.0% on Revolver
 
- 1.0% on Term Loan B
 
Tier pricing per loan agreement
Deltek, Inc.
 
February 1, 2013
 
- 1.0% on Revolver
 
 
 
Per loan amendment
HealthDrive Corporation
 
January 1, 2013
 
+ 2.0% on Term Loan A
 
+ 1.0% on Term Loan B
 
Per loan amendment
JTC Education, Inc.
 
January 1, 2013
 
+ 0.25% on Term Loan
 
 
 
Per loan amendment
Mansell Group, Inc.
 
January 1, 2013
 
+ 2.0% on Term Loan A,
   Term Loan B & Revolver
 
 
 
Per loan agreement
Saddleback Fence & Vinyl Products, Inc.
 
December 1, 2012
 
+ 4.0% on Term Loan
+ 4.0% on Revolver
 
 
 
Per loan amendment
Capital Equipment Group, Inc.
 
November 30, 2012
 
 
 
– 1.25% on Term Loan
 
Per loan amendment
CCCG, LLC
 
November 15, 2012
 
+ 0.5% on Term Loan
 
+ 1.0% on Term Loan
 
Per loan amendment
Yeti Acquisition, LLC
 
October 1, 2012
 
– 1.0% on Term Loan A,
   Term Loan B & Revolver
 
 
 
Tier pricing per loan 
agreement
Ambath/Rebath Holdings, Inc.
 
April 1, 2012
 
– 2.0% on Term Loan A
– 4.5% on Term Loan B
 
+ 2.0% on Term Loan A
+ 4.5% on Term Loan B
 
Per loan amendment
(10)
Investment has undrawn commitments and a negative cost basis as a result of unamortized fees. Unamortized fees are classified as unearned income which reduces cost basis.
(11)
Represents an unfunded commitment to fund limited partnership interest.
(12)
Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.
(13)
Eagle Hospital Physicians, LLC, is the successor entity to Eagle Hospital Physicians, Inc. and was formed as part of the restructuring process.
(14)
Prior to year end, the Company closed on a $33.4 million incremental investment in Refac Optical Group that had not yet settled as of September 30, 2013. As such, this amount is recorded in "Payables from unsettled transactions" in the Statements of Assets and Liabilities.
See notes to Consolidated Financial Statements.

92
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
Control Investments (3)
 
 
 
 
 
 
 
 
Coll Materials Group LLC (9)(12)
 
Environmental & facilities services
 
 
 
 
 
 
Second Lien Term Loan A, 12% cash due 11/1/2014
 
 
 
$7,372
 
$
7,096

 
$
1,238

Second Lien Term Loan B, 14% PIK due 11/1/2014
 
 
 
2,040
 
2,000

 
1,999

50% Membership interest in CD Holdco, LLC
 
 
 
 
 
3,127

 
—

 
 
 
 
 
 
12,223

 
3,237

Statewide Holdings, Inc. (formerly Traffic Control and Safety Corp.)
 
Construction and Engineering
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8.5% (1.25% floor) cash due 8/10/2015
 
 
 
15,000
 
14,981

 
15,023

First Lien Term Loan B, 12% cash 3% PIK due 8/10/2015
 
 
 
14,059
 
14,042

 
14,068

First Lien Revolver, LIBOR+8.5% (1.25% floor) cash due 8/10/2015 (10)
 
 
 
 
 
(6)

 
—

LC Facility, 8.5% cash due 8/10/2015 (10)
 
 
 
 
 
(6)

 
—

746,114 Series A Preferred Units
 
 
 
 
 
12,007

 
14,377

746,114 Common Stock Units
 
 
 
 
 
5,316

 
6,535

 
 
 
 
 
 
46,334

 
50,003

Total Control Investments (5.9% of net assets)
 
 
 
 
 
$
58,557

 
$
53,240

Affiliate Investments (4)
 
 
 
 
 
 
 
 
Caregiver Services, Inc.
 
Healthcare services
 
 
 
 
 
 
1,080,399 shares of Series A Preferred Stock
 
 
 
 
 
$
1,080

 
$
2,924

 
 
 
 
 
 
1,080

 
2,924

Ambath/Rebath Holdings, Inc. (9)
 
Home improvement retail
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014
 
 
 
$4,293
 
4,290

 
4,268

First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014
 
 
 
24,134
 
24,126

 
23,995

4,668,788 shares of Preferred Stock
 
 
 
 
 
—

 
—

 
 
 
 
 
 
28,416

 
28,263

Total Affiliate Investments (3.5% of net assets)
 
 
 
 
 
$
29,496

 
$
31,187

Non-Control/Non-Affiliate Investments (7)
 
 
 
 
 
 
 
 
TBA Global, LLC
 
Advertising
 
 
 
 
 
 
53,994 Senior Preferred Shares
 
 
 
 
 
$
216

 
—

191,977 Shares A Shares
 
 
 
 
 
192

 
—

 
 
 
 
 
 
408

 
—

Fitness Edge, LLC
 
Leisure Facilities
 
 
 
 
 
 
1,000 Common Units (6)
 
 
 
 
 
43

 
200

 
 
 
 
 
 
43

 
200

Capital Equipment Group, Inc. (9)
 
Industrial machinery
 
 
 
 
 
 
Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013
 
 
 
$10,489
 
10,430

 
10,577

33,786 shares of Common Stock
 
 
 
 
 
345

 
568

 
 
 
 
 
 
10,775

 
11,145

Rail Acquisition Corp.
 
Electronic manufacturing services
 
 
 
 
 
 
First Lien Revolver, 7.85% cash due 9/1/2013
 
 
 
3,835
 
3,835

 
3,835

 
 
 
 
 
 
3,835

 
3,835

Western Emulsions, Inc.
 
Construction materials
 
 
 
 
 
 
Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014
 
 
 
7,020
 
6,951

 
7,200

 
 
 
 
 
 
6,951

 
7,200

Storyteller Theaters Corporation
 
Movies & entertainment
 
 
 
 
 
 
1,692 shares of Common Stock
 
 
 
 
 
—

 
62

20,000 shares of Preferred Stock
 
 
 
 
 
200

 
200

 
 
 
 
 
 
200

 
262

HealthDrive Corporation (9)
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan A, 10% cash due 7/17/2013
 
 
 
4,601
 
4,511

 
4,697

First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013
 
 
 
10,387
 
10,357

 
10,473

First Lien Revolver, 12% cash due 7/17/2013
 
 
 
1,250
 
1,247

 
1,268

 
 
 
 
 
 
16,115

 
16,438

idX Corporation
 
Distributors
 
 
 
 
 
 
Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014
 
 
 
19,283
 
19,115

 
20,153

 
 
 
 
 
 
19,115

 
20,153



See notes to Consolidated Financial Statements.
 

93
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
Cenegenics, LLC
 
Healthcare services
 
 
 
 
 
 
414,419 Common Units (6)
 
 
 
 
 
598

 
1,394

 
 
 
 
 
 
598

 
1394

Trans-Trade Brokers, Inc.
 
Air freight & logistics
 
 
 
 
 
 
First Lien Term Loan A, 13% cash 2.5% PIK due 9/10/2014
 
 
 
12,845
 
12,700

 
12,738

First Lien Term Loan B, 12% cash due 9/10/2014
 
 
 
6,226
 
6,203

 
3,193

 
 
 
 
 
 
18,903

 
15,931

Riverlake Equity Partners II, LP
 
Multi-sector holdings
 
 
 
 
 
 
1.78% limited partnership interest (13)
 
 
 
 
 
240

 
240

 
 
 
 
 
 
240

 
240

Riverside Fund IV, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.34% limited partnership interest (6)(13)
 
 
 
 
 
677

 
677

 
 
 
 
 
 
677

 
677

Tegra Medical, LLC (9)
 
Healthcare equipment
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014
 
 
 
19,581
 
19,402

 
19,604

First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014
 
 
 
23,190
 
22,997

 
23,052

First Lien Term Loan C, 30% PIK due 12/31/2014
 
 
 
1,111
 
1,111

 
1,083

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014
 
 
 
2,500
 
2,465

 
2,483

 
 
 
 
 
 
45,975

 
46,222

Psilos Group Partners IV, LP
 
Multi-sector holdings
 
 
 
 
 
 
2.35% limited partnership interest (11)(13)
 
 
 
 
 
—

 
—

 
 
 
 
 
 
—

 
—

Mansell Group, Inc.
 
Advertising
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015
 
 
 
9,467
 
9,362

 
9,659

First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015
 
 
 
9,282
 
9,181

 
9,464

First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015 (10)
 
 
 
 
 
(21)

 
—

 
 
 
 
 
 
18,522

 
19,123

NDSSI Holdings, LLC (9)
 
Electronic equipment & instruments
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012
 
 
 
21,864
 
21,774

 
21,809

First Lien Term Loan B, LIBOR+9.75% (3% floor) cash 3.75% PIK due 12/31/2012
 
 
 
8,231
 
8,231

 
8,281

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012
 
 
 
3,500
 
3,487

 
3,504

2,000 Series D Preferred Units
 
 
 
 
 
2,671

 
2,671

 
 
 
 
 
 
36,163

 
36,265

Eagle Hospital Physicians, Inc. (14)
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015
 
 
 
24,256
 
23,890

 
24,184

First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015
 
 
 
1,100
 
1,068

 
1,060

 
 
 
 
 
 
24,958

 
25,244

Enhanced Recovery Company, LLC
 
Diversified support services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015
 
 
 
10,764
 
10,597

 
10,804

First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015
 
 
 
11,080
 
10,935

 
11,098

First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015 (10)
 
 
 
 
 
(53)

 
—

 
 
 
 
 
 
21,479

 
21,902

Specialty Bakers LLC (14)
 
Food distributors
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015
 
 
 
4,301
 
4,103

 
4,277

First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015
 
 
 
11,000
 
10,826

 
10,888

First Lien Revolver, LIBOR+8.5% cash due 9/15/2015
 
 
 
3,250
 
3,187

 
3,236

 
 
 
 
 
 
18,116

 
18,401

Welocalize, Inc.
 
Internet software & services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015
 
 
 
20,553
 
20,297

 
21,037

First Lien Term Loan B, LIBOR+9% (2% floor) 1.25% PIK due 11/19/2015
 
 
 
24,048
 
23,755

 
24,669

First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015 (10)
 
 
 
 
 
(155)

 
—

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

 
6,278

 
 
 
 
 
 
47,290

 
51,984

 




 See notes to Consolidated Financial Statements.

94
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
Miche Bag, LLC
 
Apparel, accessories & luxury goods
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013
 
 
 
8,008
 
7,854
 
8,039

First Lien Term Loan B, LIBOR+10% (3% floor) 3% PIK due 12/7/2015
 
 
 
17,964
 
16,108
 
17,818

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015
 
 
 
1,500
 
1,420
 
1,513

10,371 Preferred Equity units in Miche Holdings, LLC
 
 
 
 
 
1,037
 
878

146,289 Series D Common Equity units in Miche Holdings, LLC
 
 
 
 
 
1,463
 
—

 
 
 
 
 
 
27,882
 
28,248

Bunker Hill Capital II (QP), LP
 
Multi-sector holdings
 
 
 
 
 
 
0.51% limited partnership interest(13)
 
 
 
 
 
66
 
66

 
 
 
 
 
 
66
 
66

Advanced Pain Management Holdings
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015
 
 
 
7,271
 
7,177
 
7,402

First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015 (10)
 
 
 
 
 
(4)
 
—

 
 
 
 
 
 
7,173
 
7,402

Drugtest, Inc. (formerly DISA, Inc.)
 
Human resources & employment services
 
 
 
 
 
 
First Lien Term Loan A LIBOR+7.5% (0.75% floor) cash due 12/30/2015
 
 
 
11,215
 
11,066
 
11,445

First Lien Term Loan B, LIBOR+10% (1% floor) 1.5% PIK due 12/30/2015
 
 
 
8,524
 
8,424
 
8,751

First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015 (10)
 
 
 
 
 
(49)
 
—

 
 
 
 
 
 
19,441
 
20,196

Saddleback Fence and Vinyl Products, Inc. (9)
 
Building products
 
 
 
 
 
 
First Lien Term Loan, 8% cash due 11/30/2013
 
 
 
648
 
648
 
648

First Lien Revolver, 8% cash due 11/30/2012
 
 
 
100
 
100
 
102

 
 
 
 
 
 
748
 
750

Physicians Pharmacy Alliance, Inc.
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016
 
 
 
13,653
 
13,419
 
13,654

First Lien Revolver, LIBOR+6% cash due 1/4/2016 (10)
 
 
 
 
 
(28)
 
—

 
 
 
 
 
 
13,391
 
13,654

Cardon Healthcare Network, LLC (9)
 
Diversified support services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+10% (1.75% floor) cash due 1/24/2017
 
 
 
10,395
 
10,239
 
10,601

First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 1/24/2017
 
 
 
21,719
 
21,521
 
22,016

First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/24/2017 (10)
 
 
 
 
 
(37)
 
—

65,903 Class A Units (6)
 
 
 
 
 
250
 
456

 
 
 
 
 
 
31,973
 
33,073

U.S. Retirement Partners, Inc.
 
 
 
 
 
 
 
 
First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016
 
Diversified financial services
 
32,350
 
31,991
 
32,767

 
 
 
 
 
 
31,991
 
32,767

Phoenix Brands Merger Sub LLC (9)
 
Household products
 
 
 
 
 
 
Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016
 
 
 
6,804
 
6,671
 
6,803

Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017
 
 
 
21,194
 
20,821
 
20,630

Senior Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016
 
 
 
2,357
 
2,245
 
2,447

 
 
 
 
 
 
29,737
 
29,880

U.S. Collections, Inc.
 
Diversified support services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016
 
 
 
9,885
 
9,772
 
9,871

 
 
 
 
 
 
9,772
 
9,871

CCCG, LLC (9)
 
Oil & gas equipment services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015
 
 
 
34,748
 
34,111
 
35,280

 
 
 
 
 
 
34,111
 
35,280

Maverick Healthcare Group, LLC
 
Healthcare equipment
 
 
 
 
 
 
First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016
 
 
 
24,563
 
24,121
 
24,859

 
 
 
 
 
 
24,121
 
24,859

 

 See notes to Consolidated Financial Statements.


95
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
Refac Optical Group
 
Specialty stores
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016
 
 
 
12,431
 
12,191
 
12,530

First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016
 
 
 
20,322
 
19,939
 
20,565

First Lien Revolver, LIBOR+7.5% cash due 3/23/2016 (10)
 
 
 
 
 
(96)
 
—

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

1,000 Shares of Preferred Stock in Refac Holdings, Inc.
 
 
 
 
 
999
 
1,011

 
 
 
 
 
 
33,034
 
34,106

Securus Technologies, Inc. (9)
 
Integrated telecommunication services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018
 
 
 
22,500
 
22,119
 
22,952

 
 
 
 
 
 
22,119
 
22,952

Gundle/SLT Environmental, Inc.
 
Environmental & facilities services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016
 
 
 
8,880
 
8,803
 
8,939

 
 
 
 
 
 
8,803
 
8,939

Titan Fitness, LLC
 
Leisure facilities
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8.75% (1.25% floor) cash due 6/30/2016
 
 
 
14,906
 
14,779
 
14,969

First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016
 
 
 
11,722
 
11,626
 
11,919

First Lien Term Loan C, 18% PIK due 6/30/2016
 
 
 
3,254
 
3,232
 
3,271

First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016 (10)
 
 
 
 
 
(29)
 
—

 
 
 
 
 
 
29,608
 
30,159

Baird Capital Partners V, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.40% limited partnership interest (13)
 
 
 
 
 
487
 
487

 
 
 
 
 
 
487
 
487

Charter Brokerage, LLC (9)
 
Oil & gas equipment services
 
 
 
 
 
 
Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016
 
 
 
16,150
 
16,019
 
16,408

Subordinated Term Loan, 11.75% cash 2% PIK due 7/13/2017
 
 
 
10,246
 
10,171
 
10,399

Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016 (10)
 
 
 
 
 
(55)
 
—

 
 
 
 
 
 
26,135
 
26,807

Stackpole Powertrain International ULC
 
Auto parts & equipment
 
 
 
 
 
 
1,000 Common Units (13)
 
 
 
 
 
1,000
 
1,550

 
 
 
 
 
 
1,000
 
1,550

Discovery Practice Management, Inc.
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7.5% cash due 8/8/2016
 
 
 
6,417
 
6,350
 
6,451

First Lien Term Loan B, 12% cash 3% PIK due 8/8/2016
 
 
 
6,441
 
6,380
 
6,602

First Lien Revolver, LIBOR+7% cash due 8/8/2016
 
 
 
400
 
370
 
452

 
 
 
 
 
 
13,100
 
13,505

CTM Group, Inc.
 
Leisure products
 
 
 
 
 
 
Subordinated Term Loan A, 11% cash 2% PIK due 2/10/2017
 
 
 
10,746
 
10,654
 
10,750

Subordinated Term Loan B, 18.4% PIK due 2/10/2017
 
 
 
3,807
 
3,780
 
3,916

 
 
 
 
 
 
14,434
 
14,666

Bojangles
 
Restaurants
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017
 
 
 
5,385
 
5,291
 
5,386

 
 
 
 
 
 
5,291
 
5,386

Milestone Partners IV, LP
 
Multi-sector holdings
 
 
 
 
 
 
1.36% limited partnership interest (13)
 
 
 
 
 
657
 
657

 
 
 
 
 
 
657
 
657

Insight Pharmaceuticals LLC
 
Pharmaceuticals
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016
 
 
 
9,900
 
9,839
 
9,901

Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017
 
 
 
17,500
 
17,363
 
17,502

 
 
 
 
 
 
27,202
 
27,403

National Spine and Pain Centers, LLC
 
Healthcare services
 
 
 
 
 
 
Subordinated Term Loan, 11% cash 1.6% PIK due 9/27/2017
 
 
 
27,049
 
26,824
 
27,407

300,700.98 Class A Units (6)
 
 
 
 
 
301
 
247

 
 
 
 
 
 
27,125
 
27,654



 See notes to Consolidated Financial Statements.


96
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
RCPDirect, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.91% limited partnership interest (6)(13)
 
 
 
 
 
385

 
385

 
 
 
 
 
 
385

 
385

The MedTech Group, Inc.
 
Healthcare equipment
 
 
 
 
 
 
Senior Term Loan, LIBOR+5.5% (1.5% floor)cash due 9/7/2016
 
 
 
12,805
 
12,713

 
13,003

 
 
 
 
 
 
12,713

 
13,003

Digi-Star Acquisition Holdings, Inc.
 
Industrial machinery
 
 
 
 
 
 
Subordinated Term Loan, 12% cash 1.5% PIK due 11/18/2017
 
 
 
10,133
 
10,027

 
10,290

225 Class A Preferred Units
 
 
 
 
 
225

 
241

2,500 Class A Common Units
 
 
 
 
 
25

 
74

 
 
 
 
 
 
10,277

 
10,605

CPASS Acquisition Company
 
Internet software & services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+9% (1.5% floor) cash 1% PIK due 11/21/2016
 
 
 
4,856
 
4,772

 
4,969

First Lien Revolver, LIBOR+9% (1.5% floor) cash due 11/21/2016 (10)
 
 
 
 
 
(16
)
 
—

 
 
 
 
 
 
4,756

 
4,969

Genoa Healthcare Holdings, LLC
 
Pharmaceuticals
 
 
 
 
 
 
Subordinated Term Loan, 12% cash 2% PIK due 6/1/2017
 
 
 
12,712
 
12,606

 
12,926

500,000 Preferred units
 
 
 
 
 
475

 
516

500,000 Class A Common Units
 
 
 
 
 
25

 
155

 
 
 
 
 
 
13,106

 
13,597

SolutionSet, Inc. (9)
 
Advertising
 
 
 
 
 
 
Senior Term Loan, LIBOR+6% (1% floor) cash due 12/21/2016
 
 
 
8,522
 
8,441

 
8,561

 
 
 
 
 
 
8,441

 
8,561

Slate Pharmaceuticals Acquisition Corp.
 
Healthcare services
 
 
 
 
 
 
Subordinated Term Loan, 12% cash 1.5% PIK due 12/29/2017
 
 
 
20,231
 
20,059

 
20,882

 
 
 
 
 
 
20,059

 
20,882

ACON Equity Partners III, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.31% limited partnership interest (13)
 
 
 
 
 
247

 
247

 
 
 
 
 
 
247

 
247

Blue Coat Systems, Inc.
 
Internet software & services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 2/15/2018
 
 
 
14,906
 
14,770

 
15,060

Second Lien Term Loan, LIBOR+10% (1.5% floor) cash due 8/15/2018
 
 
 
7,000
 
6,937

 
7,208

 
 
 
 
 
 
21,707

 
22,268

CRGT, Inc.
 
IT consulting & other services
 
 
 
 
 
 
Subordinated Term Loan, 12.5% cash 3% PIK due 3/9/2018
 
 
 
25,939
 
25,709

 
26,476

 
 
 
 
 
 
25,709

 
26,476

Riverside Fund V, LP
 
Multi-sector holdings
 
 
 
 
 
 
0.48% limited partnership interest (11)(13)
 
 
 
 
 
—

 
—

 
 
 
 
 
 
—

 
—

World 50, Inc.
 
Research & consulting services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+6.25% (1.5% floor) cash due 3/30/2017
 
 
 
8,638
 
8,514

 
8,667

First Lien Term Loan B, 12.5% cash due 3/30/2017
 
 
 
5,500
 
5,425

 
5,522

First Lien Revolver, LIBOR+6.25% (1.5% floor) cash due 3/30/2017 (10)
 
 
 
 
 
(54
)
 
—

 
 
 
 
 
 
13,885

 
14,189

Huddle House, Inc.
 
Restaurants
 
 
 
 
 
 
Subordinated Term Loan, 11% cash 1.6% PIK due 3/30/2018
 
 
 
13,964
 
13,839

 
14,082

 
 
 
 
 
 
13,839

 
14,082

Nixon, Inc.
 
Apparel, accessories & luxury goods
 
 
 
 
 
 
First Lien Term Loan, 8.75% cash 2.75% PIK due 4/16/2018
 
 
 
10,128
 
10,036

 
10,164

 
 
 
 
 
 
10,036

 
10,164






 See notes to Consolidated Financial Statements.


97
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
JTC Education, Inc.
 
Education services
 
 
 
 
 
 
Subordinated Term Loan, 13% cash due 11/1/2017
 
 
 
11,500
 
11,394

 
11,573

17,391 Shares of Series A-1 Preferred Stock
 
 
 
 
 
313

 
290

17,391 Shares of Common Stock
 
 
 
 
 
187

 
—

 
 
 
 
 
 
11,894

 
11,863

BMC Acquisition, Inc.
 
Diversified financial services
 
 
 
 
 
 
Senior Term Loan, LIBOR+5.5% (1% floor) cash due 5/1/2017
 
 
 
5,685
 
5,646

 
5,668

Senior Revolver, LIBOR+5% (1% floor) cash due 5/1/2017
 
 
 
350
 
341

 
396

500 Series A Preferred Shares
 
 
 
 
 
499

 
456

50,000 Common Shares
 
 
 
 
 
1

 
—

 
 
 
 
 
 
6,487

 
6,520

Ansira Partners, Inc.
 
Advertising
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/4/2017
 
 
 
12,243
 
12,158

 
12,320

First Lien Revolver, LIBOR+5.5% (1.5% floor) cash due 5/4/2017 (10)
 
 
 
 
 
(8
)
 
—

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

 
227

 
 
 
 
 
 
12,400

 
12,547

MX USA, Inc.
 
Healthcare services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+10.5% (1.25% floor) cash due 10/31/2017
 
 
 
22,000
 
21,815

 
22,336

 
 
 
 
 
 
21,815

 
22,336

PLATO, Inc.
 
Education services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 5/17/2018
 
 
 
14,812
 
14,812

 
14,804

Second Lien Term Loan, LIBOR+9.75% (1.5% floor) cash due 5/17/2019
 
 
 
17,000
 
17,000

 
17,093

 
 
 
 
 
 
31,812

 
31,897

I Drive Safely, LLC
 
Education services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+8.5% (1.5% floor) cash due 5/25/2017
 
 
 
27,000
 
27,007

 
27,352

First Lien Revolver, LIBOR+6.5% (1.5% floor) cash due 5/25/2017
 
 
 
 
 
1

 
—

75,000 Class A Common Units of IDS Investments, LLC
 
 
 
 
 
750

 
591

 
 
 
 
 
 
27,758

 
27,943

ConvergeOne Holdings Corp.
 
Integrated telecommunication services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+7% (1.5% floor) cash due 6/8/2017
 
 
 
9,875
 
9,875

 
9,940

 
 
 
 
 
 
9,875

 
9,940

Yeti Acquisition, LLC
 
Leisure products
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+8% (1.25% floor) cash due 6/15/2017
 
 
 
27,650
 
27,622

 
28,036

First Lien Term Loan B, LIBOR+11.25% (1.25% floor) cash 1% PIK due 6/15/2017
 
 
 
12,000
 
11,988

 
12,275

First Lien Revolver, LIBOR+8% (1.25% floor) cash due 6/15/2017 (10)
 
 
 
 
 
(10
)
 
—

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

 
1,500

 
 
 
 
 
 
41,100

 
41,811

Specialized Education Services, Inc.
 
Education services
 
 
 
 
 
 
Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 6/28/2017
 
 
 
10,000
 
10,000

 
10,026

Subordinated Term Loan, 11% cash 1.5% PIK due 6/28/2018
 
 
 
17,569
 
17,569

 
17,597

 
 
 
 
 
 
27,569

 
27,623

InvestRx Corporation
 
Diversified support services
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7.75% (1.25% floor) cash due 7/2/2017
 
 
 
24,805
 
24,786

 
24,805

First Lien Term Loan B, LIBOR+9.75% (1.25% floor) cash 1% PIK due 7/2/2017
 
 
 
18,370
 
18,356

 
18,370

First Lien Delayed Draw Term Loan, LIBOR+8.25% (1.25% floor) cash due 7/2/2014
 
 
 
 
 
—

 
—

First Lien Revolver, LIBOR+7.75% (1.25% floor) cash due 7/2/2017 (10)
 
 
 
 
 
(5
)
 
—

 
 
 
 
 
 
43,137

 
43,175

eResearch Technology, Inc.
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 5/2/2018
 
 
 
13,500
 
13,500

 
13,500

 
 
 
 
 
 
13,500

 
13,500

Connolly, LLC
 
Diversified support services
 
 
 
 
 
 
Second Lien Term Loan, LIBOR+9.25% (1.25% floor) cash due 7/15/2019
 
 
 
5,000
 
5,000

 
5,000

 
 
 
 
 
 
5,000

 
5,000

 




  See notes to Consolidated Financial Statements.

98
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

Portfolio Company/Type of Investment (1)(2)(5)
 
Industry
 
Principal (8)
 
Cost
 
Fair Value
PC Helps Support, LLC
 
IT consulting & other services
 
 
 
 
 
 
Subordinated Term Loan, 12% cash 1.5% PIK due 9/5/2018
 
 
 
18,520
 
18,520

 
18,520

675 Series A Preferred Units of PCH Support Holdings, Inc.
 
 
 
 
 
675

 
675

7,500 Class A Common Stock Units of PCH Support Holdings, Inc.
 
 
 
 
 
75

 
75

 
 
 
 
 
 
19,270

 
19,270

Ikaria Acquisition, Inc.
 
Healthcare services
 
 
 
 
 
 
First Lien Term Loan, LIBOR+6.5% (1.25% floor) cash due 9/25/2017
 
 
 
10,000
 
10,000

 
10,000

 
 
 
 
 
 
10,000

 
10,000

Olson + Co., Inc.
 
Advertising
 
 
 
 
 
 
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 9/30/2017
 
 
 
13,895
 
13,895

 
13,895

First Lien Revolver, LIBOR+5.5% (1.5% floor) cash due 9/30/2017
 
 
 
 
 
—

 
—

 
 
 
 
 
 
13,895

 
13,895

Total Non-Control/Non-Affiliate Investments (133.2% of net assets)
 
 
 
 
 
$
1,180,436

 
$
1,203,681

Total Portfolio Investments (142.6% of net assets)
 
 
 
 
 
$
1,268,489

 
$
1,288,108

_____________
(1)    All debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.
(2)     See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.
(3)
Control Investments are defined by the 1940 Act as investments in companies in which the Company owns more than 25% of the voting securities or maintains greater than 50% of the board representation.
(4)
Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.
(5)
Equity ownership may be held in shares or units of companies related to the portfolio companies.
(6)
Income producing through payment of dividends or distributions.
(7)
Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.
(8)
Principal includes accumulated PIK interest and is net of repayments.

















 See notes to Consolidated Financial Statements.


99
Fifth Street Finance Corp.
Consolidated Schedule of Investments
(dollar amounts in thousands)
September 30, 2012

(9)    Interest rates have been adjusted on certain term loans and revolvers. These rate adjustments are temporary in nature due to tier pricing arrangements or 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
SolutionSet, Inc.
 
September 13, 2012
 
– 0.5% on Term Loan
 
 
 
Tier pricing per loan agreement
Securus Technologies Holdings, Inc.
 
June 6, 2012
 
+ 0.75% on Term Loan
 
 
 
Per loan amendment
Charter Brokerage, LLC
 
May 9, 2012
 
– 0.5% on Senior Term
  Loan & Revolver
 
 
 
Tier pricing per loan
agreement
Coll Materials Group LLC
 
July 1, 2012
 
– 12.0% on Term Loan A
 
+ 15.0% on Term Loan A
 
Per loan amendment
HealthDrive Corporation
 
April 1, 2012
 
+ 2.0% on Term Loan A
 
 
 
Tier pricing per loan agreement
Ambath/Rebath Holdings, Inc.
 
April 1, 2012
 
– 2.0% on Term Loan A
– 4.5% on Term Loan B
 
+ 2.0% on Term Loan A
   4.5% on Term Loan B
 
Per loan amendment
Cardon Healthcare Network, LLC
 
April 1, 2012
 
– 2.25% on Term Loan A
– 1.25% on Term Loan B
 
 
 
Tier pricing per loan agreement
Tegra Medical, LLC
 
January 1, 2012
 
 
 
+ 0.5% on Term Loan B
 
Per loan amendment
NDSSI Holdings, LLC
 
December 31, 2011
 
 
 
– 1.0% on Term Loan A
 
Per loan amendment
Phoenix Brands Merger Sub LLC
 
December 22, 2011
 
+ 0.75% on
   Subordinated Term Loan
+ 0.5% on Senior Term
   Loan & Revolver
 
 
 
Per loan amendment
CCCG, LLC
 
November 15, 2011
 
+ 0.5% on Term Loan
 
 
 
Per loan amendment
Saddleback Fence and Vinyl Products, Inc.
 
October 31, 2011
 
+ 4.0% on Revolver
 
 
 
Per loan amendment
Eagle Hospital Physicians, Inc.
 
July 1, 2011
 
– 0.25% on Term Loan
  & Revolver
 
 
 
Per loan amendment
Capital Equipment Group, Inc.
 
July 1, 2010
 
– 2.0% on Term Loan
 
– 0.75% on Term Loan
 
Per waiver agreement
(10)
Investment has undrawn commitments and a negative cost basis as a result of unamortized fees. Unamortized fees are classified as unearned income which reduces cost basis.
(11)
Represents an unfunded commitment to fund limited partnership interest.
(12)
Investment was on PIK non-accrual status as of September 30, 2012.
(13)
Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.
(14)
The loan agreements for the Eagle Hospital Physicians, Inc. and Specialty Bakers LLC credit facilities state that the revolvers are structurally junior to the term loans in the respective capital structures. Thus, the unrealized appreciation (depreciation) on the loan tranches of these facilities has been allocated accordingly.




 See notes to Consolidated Financial Statements.


100
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Note 1. Organization
Fifth Street Mezzanine Partners III, L.P. (the “Partnership”), a Delaware limited partnership, was organized on February 15, 2007 to primarily invest in debt securities of small and middle market companies. FSMPIII GP, LLC was the Partnership’s general partner (the “General Partner”). The Partnership’s investments were managed by Fifth Street Management LLC (the “Investment Adviser”). The General Partner and Investment Adviser were under common ownership.
Effective January 2, 2008, the Partnership merged with and into Fifth Street Finance Corp. (the “Company”), an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940 (the “1940 Act”). Fifth Street Finance Corp. is managed by the Investment Adviser. Prior to January 2, 2008, references to the Company are to the Partnership.
The Company also has certain wholly-owned subsidiaries, including subsidiaries that are not consolidated for income tax purposes, which hold certain portfolio investments of the Company. The subsidiaries are consolidated with the Company for accounting purposes, and the portfolio investments held by the subsidiaries are included in the Company’s Consolidated Financial Statements. All significant intercompany balances and transactions have been eliminated.
On November 28, 2011, the Company transferred the listing of its common stock from the New York Stock Exchange to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.” The following table reflects common stock offerings that have occurred from inception through September 30, 2013:
 
Date
 
Transaction
 
Shares
 
Offering
 price
 
 
 
Gross 
proceeds
June 17, 2008
 
Initial public offering
 
10,000,000

 
$
14.12

 
  
 
141.2 million
July 21, 2009
 
Follow-on public offering (including underwriters’ exercise of over-allotment option)
 
9,487,500

 
9.25

 
  
 
87.8 million
September 25, 2009
 
Follow-on public offering (including underwriters’ exercise of over-allotment option)
 
5,520,000

 
10.5

 
  
 
58.0 million
January 27, 2010
 
Follow-on public offering
 
7,000,000

 
11.2

 
  
 
78.4 million
February 25, 2010
 
Underwriters’ partial exercise of over-allotment option
 
300,500

 
11.2

 
  
 
3.4 million
June 21, 2010
 
Follow-on public offering (including underwriters’ exercise of over-allotment option)
 
9,200,000

 
11.5

 
  
 
105.8 million
December 2010
 
At-the-Market offering
 
429,110

 
11.87

 
(1
)
 
5.1 million
February 4, 2011
 
Follow-on public offering (including underwriters’ exercise of over-allotment option)
 
11,500,000

 
12.65

 
  
 
145.5 million
June 24, 2011
 
Follow-on public offering (including underwriters’ partial exercise of over-allotment option)
 
5,558,469

 
11.72

 
  
 
65.1 million
January 26, 2012
 
Follow-on public offering
 
10,000,000

 
10.07

 
  
 
100.7 million
September 14, 2012
 
Follow-on public offering (including underwriters’ partial exercise of over-allotment option)
 
8,451,486

 
10.79

 
  
 
91.2 million
December 7, 2012
 
Follow-on public offering
 
14,000,000

 
10.68

 
 
 
149.5 million
December 14, 2012
 
Underwriters’ partial exercise of over-allotment option
 
725,000

 
10.68

 
 
 
7.7 million
April 15, 2013
 
Follow-on public offering
 
13,500,000

 
10.85

 
 
 
146.5 million
April 26, 2013
 
Underwriters’ partial exercise of over-allotment option
 
935,253

 
10.85

 
 
 
10.1 million
September 26, 2013
 
Follow-on public offering (including underwriters’ partial exercise of over-allotment option)
 
17,643,000

 
10.31

 
 
 
181.9 million
 
(1)
Average offering price.

On February 3, 2010, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. (“FSMP IV”), received a license, effective February 1, 2010, from the United States Small Business Administration, or SBA, to operate as a small business investment company, or SBIC, under Section 301(c) of the Small Business Investment Act of 1958. On May 15, 2012, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. (“FSMP V”), received a license, effective May 10, 2012, from the SBA to operate as an SBIC. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.
The SBIC licenses allow the Company’s SBIC subsidiaries to obtain leverage by issuing SBA-guaranteed debentures, subject to the satisfaction of certain customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a 10-year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.

101
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


SBA regulations currently limit the amount of SBA-guaranteed debentures that an SBIC may issue to $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when they have at least $112.5 million in regulatory capital. As of September 30, 2013, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $130.9 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:
Rate Fix Date
 
Debenture
Amount
 
Fixed
Interest
Rate
 
SBA
Annual
Charge
September 2010
 
$
73,000

 
3.215
%
 
0.285
%
March 2011
 
65,300

 
4.084

 
0.285

September 2011
 
11,700

 
2.877

 
0.285

As of September 30, 2013, FSMP V had $37.5 million in regulatory capital and $31.8 million in SBA-guaranteed debentures outstanding, which had a fair value of $25.2 million. In March 2013, the SBA fixed the interest rate on such SBIC subsidiary’s $31.8 million of drawn leverage at an interest rate of 2.351% (excluding the SBA annual charge of 0.804%). As a result, the $181.8 million of SBA-guaranteed debentures held by the Company’s SBIC subsidiaries carry a weighted average interest rate of 3.355% as of September 30, 2013.
For the years ended September 30 2013, 2012 and 2011, the Company recorded interest expense of $7.1 million, $6.4 million and $4.7 million, respectively, related to the SBA-guaranteed debentures of both subsidiaries.
The SBA restricts the ability of SBICs to repurchase their capital stock. SBA regulations also include restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in accordance with SBA regulations. In addition, the Company’s SBIC subsidiaries may also be limited in their ability to make distributions to the Company if they do not have sufficient capital, in accordance with SBA regulations.
The Company’s SBIC subsidiaries are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that the SBIC subsidiaries will receive SBA-guaranteed debenture funding and is further dependent upon the SBIC subsidiaries continuing to be in compliance with SBA regulations and policies.
The SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiaries upon an event of default.
The Company has received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit it to exclude the debt of the SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the Company’s 200% asset coverage test under the 1940 Act. This allows the Company increased flexibility under the 200% asset coverage test by permitting it to borrow up to $225 million more than it would otherwise be able to under the 1940 Act absent the receipt of this exemptive relief.
Note 2. Significant Accounting Policies
Basis of Presentation:
The Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the requirements for reporting on Form 10-K and Regulation S-X. In the opinion of management, all adjustments of a normal recurring nature considered necessary for the fair presentation of the Consolidated Financial Statements have been made. The financial results of the Company’s portfolio investments are not consolidated in the Company’s Consolidated Financial Statements.
Use of Estimates:
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the financial statements and accompanying notes. These estimates are based on the information that is currently available to the Company and on various other assumptions that the Company believes to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions and conditions. The most significant estimates inherent in the preparation of the Company’s Consolidated Financial Statements are the valuation of investments and revenue recognition.

102
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The Consolidated Financial Statements include portfolio investments at fair value of $1.89 billion and $1.29 billion at September 30, 2013 and September 30, 2012, respectively. The portfolio investments represent 138.3% and 142.6% of net assets at September 30, 2013 and September 30, 2012, respectively, and their fair values have been determined by the Company’s Board of Directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.
The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation; “Affiliate Investments” are defined as investments in companies in which the Company owns between 5% and 25% of the voting securities; and “Non-Control/Non-Affiliate Investments” are defined as investments that are neither Control Investments nor Affiliate Investments.
 
Fair Value Measurements:
The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820 Fair Value Measurements and Disclosures (“ASC 820”) defines fair value as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available or reliable, valuation techniques are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the investments or market and the investments’ complexity.
Assets recorded at fair value in the Company’s Consolidated Financial Statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value.
Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
 
•
Level 1 — Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
•
Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.
•
Level 3 — Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Under ASC 820, the Company performs detailed valuations of its debt and equity investments on an individual basis, using bond yield, market and income approaches as appropriate. In general, the Company utilizes the bond yield method in determining the fair value of its debt investments, as long as it is appropriate. If, in the Company’s judgment, the bond yield approach is not appropriate, it may use the market or income approach in determining the fair value of the Company’s investment in the portfolio company. Investments for which market quotations are readily available may be valued at such market quotations. In order to validate market quotations, the Company looks at a number of factors to determine if the quotations are representative of fair value, including the source and nature of the quotations. In certain instances, the Company may use alternative methodologies, including an asset liquidation, expected recovery model or other alternative approaches.
Under the bond yield approach, the Company uses bond yield models to determine the present value of the future cash flow streams of its debt investments. The Company reviews various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assesses the information in the valuation process.
Under the market approach, the Company estimates the enterprise value of the portfolio companies in which it invests. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which the Company derives a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, the Company analyzes various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization), cash flows, net income or revenues. The Company generally requires portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year. The Company determines the fair value of its limited partnership interests based on the most recently available net asset value of the partnership.

103
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Under the income approach, the Company generally prepares and analyzes discounted cash flow models based on projections of the future free cash flows of the business.
The Company’s Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of the Company’s investments:
•
The quarterly valuation process begins with each portfolio company or investment being initially valued by the Company’s finance department;
•Preliminary valuations are then reviewed and discussed with principals of the Investment Adviser;
•
Separately, independent valuation firms are engaged by the Board of Directors to prepare preliminary valuations on a selected basis and submit the reports to the Company;
•
The finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;
•
The finance department prepares a valuation report for the Audit Committee of the Board of Directors;
•
The Audit Committee of the Board of Directors is apprised of the preliminary valuations of the independent valuation firms;
•
The Audit Committee of the Board of Directors reviews the preliminary valuations, and the finance department responds and supplements the preliminary valuations to reflect any comments provided by the Audit Committee;
•
The Audit Committee of the Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in the Company’s portfolio; and
•
The Board of Directors discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith.
The fair value of each of the Company’s investments at September 30, 2013 and September 30, 2012 was determined by the Board of Directors. The Board of Directors has authorized the engagement of independent valuation firms to provide valuation assistance. The Company will continue to engage independent valuation firms to provide assistance regarding the determination of the fair value of selected portfolio securities each quarter; however, the Board of Directors is ultimately and solely responsible for the valuation of the portfolio investments at fair value as determined in good faith pursuant to the Company’s valuation policy and a consistently applied valuation process.
A portion of the Company's portfolio is valued by independent third parties on a quarterly basis, with a substantial portion being valued over the course of each fiscal year.
Investment Income:
Interest income, adjusted for accretion of original issue discount or “OID,” is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. In connection with its investment, the Company sometimes receives nominal cost equity that is valued as part of the negotiation process with the particular portfolio company. When the Company receives nominal cost equity, the Company allocates its cost basis in its investment between its debt securities and its nominal cost equity at the time of origination. Any resulting discount from recording the loan, or otherwise purchasing a security at a discount, is accreted into interest income over the life of the loan.
Distributions of earnings from portfolio companies are recorded as dividend income when the distribution is received.
The Company has investments in debt securities which contain payment-in-kind (“PIK”) interest provisions. PIK interest is computed at the contractual rate specified in each investment agreement and added to the principal balance of the investment and recorded as income.
Fee income consists of the monthly servicing fees, advisory fees, structuring fees and prepayment fees that the Company receives in connection with its debt investments. These fees are recognized as earned.
The Company has also structured exit fees across certain of its portfolio investments to be received upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt security. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.

104
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Gain on Extinguishment of Convertible Notes:
The Company may repurchase its convertible notes (“Convertible Notes”) in accordance with the 1940 Act and the rules promulgated thereunder and may surrender these Convertible Notes to Deutsche Bank Trust Company Americas (the “Trustee”), as trustee, for cancellation. If the repurchase occurs at a purchase price below par value, a gain on the extinguishment of these Convertible Notes is recorded. The amount of the gain recorded is the difference between the reacquisition price and the net carrying amount of the Convertible Notes, net of the proportionate amount of unamortized debt issuance costs.
Cash and Cash Equivalents:
Cash and cash equivalents consist of demand deposits and highly liquid investments with maturities of three months or less, when acquired. The Company places its cash and cash equivalents with financial institutions and, at times, cash held in bank accounts may exceed the Federal Deposit Insurance Corporation insured limit. Included in cash and cash equivalents is $2.2 million that was held at Wells Fargo Bank, National Association (“Wells Fargo”) in connection with the Company’s Wells Fargo facility and $1.9 million that was held at U.S. Bank, National Association in connection with the Company’s Sumitomo facility (as defined in Note 6 — Lines of Credit). The Company is restricted in terms of access to this cash until such time as the Company submits its required monthly reporting schedules and Wells Fargo and Sumitomo Mitsui Banking Corporation verify the Company’s compliance per the terms of their respective credit agreements with the Company.
Deferred Financing Costs:
Deferred financing costs consist of fees and expenses paid in connection with the closing or amending of credit facilities and debt offerings, and are capitalized at the time of payment. Deferred financing costs are amortized using the straight line method over the terms of the respective credit facilities and debt securities. This amortization expense is included in interest expense in the Company’s Consolidated Statements of Operations.
Interest Rate Swap:
The Company does not utilize hedge accounting and marks its interest rate swaps to fair value on a quarterly basis through its Consolidated Statement of Operations. As of September 30, 2013, the Company was not party to any interest rate swap agreements.

Offering Costs:
Offering costs consist of fees and expenses incurred in connection with the public offer and sale of the Company’s common stock, including legal, accounting and printing fees. There were $1.0 million of offering costs charged to capital during the year ended September 30, 2013.
Income Taxes:
As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company intends to distribute between 90% and 100% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a 4% federal excise tax based on distribution requirements of its taxable income on a calendar year basis. The Company anticipates timely distribution of its taxable income within the tax rules; however, the Company incurred a de minimis federal excise tax for calendar year 2010. The Company did not incur a federal excise tax for calendar years 2011 and 2012 and does not expect to incur a federal excise tax for calendar year 2013. The Company may incur a federal excise tax in future years.
The purpose of the Company’s taxable subsidiaries is to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for federal tax purposes in order to comply with the “source income” requirements contained in the RIC tax requirements. The taxable subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense as a result of their ownership of certain portfolio investments. This income tax expense, if any, would be reflected in the Company’s Consolidated Statements of Operations. The Company uses the asset and liability method to account for its taxable subsidiaries’ income taxes. Using this method, the Company recognizes deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and tax bases of assets and liabilities. In addition, the Company recognizes deferred tax benefits associated with net operating carry forwards that it may use to offset future tax obligations. The Company measures deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences.
ASC 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the Company’s Consolidated Financial Statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax

105
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax benefit or expense in the current year. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. The Company recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years 2010, 2011 or 2012. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months.    
Recent Accounting Pronouncements
In June 2013, the FASB issued ASU 2013-08, “Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements,” which amends the criteria that define an investment company and clarifies the measurement guidance and requires new disclosures for investment companies. Under ASU 2013-08, an entity already regulated under the 1940 Act will be automatically deemed an investment company under the new GAAP definition. As such, the Company anticipates no impact from adopting this standard on the Company’s consolidated financial results. The Company is currently assessing the additional disclosure requirements. ASU 2013-08 will be effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013.
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 amends ASC 820, and requires entities to change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements related to the application of the highest and best use and valuation premise concepts for financial and nonfinancial instruments, measuring the fair value of an instrument classified in shareholders’ equity and disclosures about fair value measurements. ASU 2011-04 changes the measurement of the fair value of financial instruments that are managed within a portfolio and the application of premiums and discounts in a fair value measurement related to size as a characteristic of the reporting entity’s holding rather than a characteristic of the asset or liability. ASU 2011-04 requires additional disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy including the valuation processes used by the reporting entity, the sensitivity of the fair value to changes in unobservable inputs, and the interrelationships between those unobservable inputs, if any. All the amendments to ASC 820 made by ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011. The adoption of this disclosure-only guidance is included in Note 3 – Portfolio Investments and did not have an impact on the Company’s consolidated financial results.
In February 2011, the FASB issued Accounting Standards Update 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (“ASU 2011-02”). ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 provides guidance to clarify whether the creditor has granted a concession and whether a debtor is experiencing financial difficulties. ASU 2011-02 also clarifies that a creditor is precluded from using the effective interest rate test, as described in the debtors guidance on restructuring payables, when evaluating whether a restructuring constitutes a troubled debt restructuring. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The clarified guidance may affect the accounting for certain restructurings that were previously accounted for under the aforementioned debtor guidance on restructuring payables and provide for enhanced disclosure around such restructurings. The adoption of ASU 2011-02 did not have a material impact on the Company’s financial condition and results of operations.
Note 3. Portfolio Investments
At September 30, 2013, 138.3% of net assets or $1.89 billion was invested in 99 portfolio investments and 10.8% of net assets or $147.4 million was invested in cash and cash equivalents. In comparison, at September 30, 2012, 142.6% of net assets or $1.29 billion was invested in 78 portfolio investments and 8.2% of net assets or $74.4 million was invested in cash and cash equivalents. As of September 30, 2013, 77.5% of the Company’s portfolio at fair value consisted of senior secured debt investments that were secured by priority liens on the assets of the portfolio companies. Moreover, the Company held equity investments in certain of its portfolio companies consisting of common stock, preferred stock, limited partnership interests or limited liability company interests. These instruments generally do not produce a current return but are held for potential investment appreciation and capital gain.

106
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


During the years ended September 30, 2013, 2012 and 2011, the Company recorded net realized losses of $26.5 million, $64.6 million and $30.4 million, respectively. During the years ended September 30, 2013, 2012 and 2011, the Company recorded net unrealized appreciation (depreciation) of $13.4 million, $56.0 million and ($6.5 million), respectively.
 
The composition of the Company’s investments as of September 30, 2013 and September 30, 2012 at cost and fair value was as follows:
 
 
 
September 30, 2013
 
September 30, 2012
 
 
Cost
 
Fair Value
 
Cost
 
Fair Value
Investments in debt securities
 
$
1,779,201

 
$
1,793,463

 
$
1,226,489

 
$
1,241,197

Investments in equity securities
 
80,450

 
99,583

 
42,000

 
46,911

Total
 
$
1,859,651

 
$
1,893,046

 
$
1,268,489

 
$
1,288,108

The composition of the Company’s debt investments as of September 30, 2013 and September 30, 2012 at fixed rates and floating rates was as follows:
 
 
 
September 30, 2013
 
September 30, 2012
 
 
Fair Value
 
% of Debt
Portfolio
 
Fair Value
 
% of Debt
Portfolio
Fixed rate debt securities
 
$
584,876

 
32.61
%
 
$
371,325

 
29.92
%
Floating rate debt securities
 
1,208,587

 
67.39

 
869,872

 
70.08

Total
 
$
1,793,463

 
100.00
%
 
$
1,241,197

 
100.00
%
The following table presents the financial instruments carried at fair value as of September 30, 2013, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Investments in debt securities (senior secured)
 
$
—

 
$
—

 
$
1,467,665

 
$
1,467,665

Investments in debt securities (subordinated)
 
—

 
—

 
296,298

 
296,298

Investments in debt securities (Collateralized loan obligation, or CLO)
 
—

 
—

 
29,500

 
29,500

Investments in equity securities (preferred)
 
—

 
—

 
25,648

 
25,648

Investments in equity securities (common)
 
—

 
—

 
73,935

 
73,935

Total investments at fair value
 
$
—

 
$
—

 
$
1,893,046

 
$
1,893,046

The following table presents the financial instruments carried at fair value as of September 30, 2012, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820:
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Investments in debt securities (senior secured)
 
$
—

 
$
—

 
$
1,035,750

 
$
1,035,750

Investments in debt securities (subordinated)
 
—

 
—

 
205,447

 
205,447

Investments in equity securities (preferred)
 
—

 
—

 
24,240

 
24,240

Investments in equity securities (common)
 
—

 
—

 
22,671

 
22,671

Total investments at fair value
 
$
—

 
$
—

 
$
1,288,108

 
$
1,288,108

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the fact that the unobservable factors are the most significant to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated by external sources). Accordingly, the appreciation (depreciation) in the tables below includes changes in fair value due in part to observable factors that are part of the valuation methodology.
The following table provides a roll-forward in the changes in fair value from September 30, 2012 to September 30, 2013, for all investments for which the Company determines fair value using unobservable (Level 3) factors:
 

107
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


 
 
Senior Secured Debt
 
Subordinated
Debt
 
CLO Debt
 
Preferred
Equity
 
Common
Equity
 
Total
Fair value as of September 30, 2012
 
$
1,035,750

 
$
205,447

 
$
—

 
$
24,240

 
$
22,671

 
$
1,288,108

New investments & net revolver activity
 
1,102,143

 
119,093

 
29,500

 
6,010

 
38,282

 
1,295,028

Redemptions/repayments
 
(664,614
)
 
(35,016
)
 
—

 
(2,510
)
 
—

 
(702,140
)
Net accrual of PIK interest income
 
2,973

 
5,193

 
—

 
107

 
—

 
8,273

Accretion of original issue discount
 
612

 
—

 
—

 
—

 
—

 
612

Net change in unearned income
 
6,251

 
583

 
—

 
—

 
—

 
6,834

Net unrealized appreciation (depreciation)
 
(278
)
 
(168
)
 
—

 
(2,079
)
 
16,301

 
13,776

Unrealized adjustments due to deal exits
 
(15,172
)
 
1,166

 
—

 
(120
)
 
(3,319
)
 
(17,445
)
Transfer into (out of) Level 3
 
—

 
—

 
—

 
—

 
—

 
—

Fair value as of September 30, 2013
 
$
1,467,665

 
$
296,298

 
$
29,500

 
$
25,648

 
$
73,935

 
$
1,893,046

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at September 30, 2013 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the year ended September 30, 2013
 
$
(15,450
)
 
$
998

 
$
—

 
$
(2,199
)
 
$
12,982

 
$
(3,669
)
 
The following table provides a roll-forward in the changes in fair value from September 30, 2011 to September 30, 2012, for all investments for which the Company determines fair value using unobservable (Level 3) factors.
 
 
 
Senior Secured Debt
 
Subordinated
Debt
 
Preferred
Equity
 
Common
Equity
 
Total
Fair value as of September 30, 2011
 
$
1,018,475

 
$
81,233

 
$
7,167

 
$
12,962

 
$
1,119,837

New investments & net revolver activity
 
405,503

 
137,016

 
13,883

 
12,901

 
569,303

Redemptions/repayments
 
(389,389
)
 
(18,001
)
 
(1,954
)
 
(66
)
 
(409,410
)
Net accrual of PIK interest income
 
4,101

 
3,593

 
624

 
—

 
8,318

Accretion of original issue discount
 
1,497

 
—

 
—

 
—

 
1,497

Net change in unearned income
 
7,430

 
(677
)
 
—

 
—

 
6,753

Net unrealized appreciation (depreciation)
 
45,051

 
7,814

 
4,829

 
(1,720
)
 
55,974

Unrealized adjustments due to deal exits
 
(56,918
)
 
(5,531
)
 
(309
)
 
(1,406
)
 
(64,164
)
Transfer into (out of) Level 3
 
—

 
 
 
 
 
 
 
—

Fair value as of September 30, 2012
 
$
1,035,750

 
$
205,447

 
$
24,240

 
$
22,671

 
$
1,288,108

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at September 30, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the year ended September 30, 2012
 
$
(11,867
)
 
$
2,283

 
$
4,520

 
$
(3,126
)
 
$
(8,190
)
The Company generally utilizes a bond yield model to estimate the fair value of its debt investments when there is not a readily available market value (Level 3) which model is based on the present value of expected cash flows from the debt investments. The significant observable inputs into the model are market interest rates for debt with similar characteristics, which are adjusted for the portfolio company’s credit risk. The credit risk component of the valuation considers several factors including financial performance, business outlook, debt priority and collateral position. These factors are incorporated into the calculation of the capital structure premium, tranche specific risk premium/(discount), size premium and industry premium/(discount), which are significant unobservable inputs into the model.


108
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Significant Unobservable Inputs for Level 3 Investments
The following table provides quantitative information related to the significant unobservable inputs for Level 3 investments, which are carried at fair value as of September 30, 2013:
Asset
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range
 
Weighted
Average (d)
Senior secured debt
 
1,467,665

 
Bond yield approach
 
Capital structure premium
 
(a)
0.0%
-
2.0%
 
0.5%
 
 
 
 
 
 
Tranche specific risk premium/(discount)
 
(a)
(4.0)%
-
13.0%
 
2.0%
 
 
 
 
 
 
Size premium
 
(a)
0.5%
-
2.0%
 
1.1%
 
 
 
 
 
 
Industry premium/(discount)
 
(a)
(1.1)%
-
3.3%
 
0.3%
Subordinated debt
 
296,298

 
Bond yield approach
 
Capital structure premium
 
(a)
2.0%
-
2.0%
 
2.0%
 
 
 
 
 
 
Tranche specific risk premium
 
(a)
1.0%
-
11.0%
 
4.7%
 
 
 
 
 
 
Size premium
 
(a)
0.5%
-
2.0%
 
1.1%
 
 
 
 
 
 
Industry premium/(discount)
 
(a)
(1.0)%
-
1.4%
 
0.0%
CLO debt
 
29,500

(c)
Recent market transaction
 
Market yield
 
 
11.4%
 
11.4%
 
11.4%
Preferred & common equity
 
99,583

 
Market and income approach
 
Weighted average cost of capital
 
 
11.0%
-
31.0%
 
17.4%
 
 
 
 
 
 
Company specific risk premium
 
(a)
1.0%
-
15.0%
 
2.4%
 
 
 
 
 
 
Revenue growth rate
 
 
0.6%
-
81.9%
 
8.4%
 
 
 
 
 
 
EBITDA multiple
 
(b)
5.4x
-
15.3x
 
7.4x
 
 
 
 
 
 
Revenue multiple
 
(b)
4.1x
 
5.3x
 
4.7x
 
 
 
 
 
 
Book value multiple
 
(b)
0.9x
 
1.1x
 
1.0x
Total
 
$
1,893,046

 
 
 
 
 
 
 
 
 
 
 
 
(a)
Used when market participant would take into account this premium or discount when pricing the investment.
(b)
Used when market participant would use such multiples when pricing the investment.
(c)
The Company's $29.5 million CLO debt investment in Salus CLO 2012-1, Ltd. was valued at its acquisition price as it closed near year end.
(d)
Weighted averages are calculated based on fair value of investments.


109
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The following table provides quantitative information related to the significant unobservable inputs for Level 3 investments, which are carried at fair value as of September 30, 2012:
Asset
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range
 
Weighted
 Average (c)
Senior secured debt
 
$
1,027,484

 
Bond yield approach
 
Capital structure premium
 
(a)
0.0
 %
-
2.0%
 
0.6
%
 
 
 
 
 
 
Tranche specific risk premium/(discount)
 
(a)
(4.0
)%
-
25.5%
 
2.3
%
 
 
 
 
 
 
Size premium
 
(a)
0.5
 %
-
2.0%
 
1.2
%
 
 
 
 
 
 
Industry premium/(discount)
 
(a)
(1.5
)%
-
4.7%
 
0.0
%
 
 
8,266

 
Market approach
 
EBITDA multiple
 
(b)
6.2x

-
6.2x
 
6.2x

Subordinated debt
 
205,447

 
Bond yield approach
 
Capital structure premium
 
(a)
2.0
 %
-
2.0%
 
2.0
%
 
 
 
 
 
 
Tranche specific risk premium
 
(a)
1.8
 %
-
7.8%
 
3.1
%
 
 
 
 
 
 
Size premium
 
(a)
0.5
 %
-
2.0%
 
1.1
%
 
 
 
 
 
 
Industry premium/(discount)
 
(a)
(1.4
)%
-
1.1%
 
0.1
%
Preferred & common equity
 
46,911

 
Market and income approach
 
Weighted average cost of capital
 
 
13.0
 %
-
33.0%
 
19.1
%
 
 
 
 
 
 
Company specific risk premium
 
(a)
1.0
 %
-
24.0%
 
4.0
%
 
 
 
 
 
 
Revenue growth rate
 
 
1.9
 %
-
44.5%
 
11.0
%
 
 
 
 
 
 
EBITDA multiple
 
(b)
4.8x

-
9.7x
 
7.5x

Total
 
$
1,288,108

 
 
 
 
 
 
 
 
 
 
____________________
(a)
Used when market participant would take into account this premium or discount when pricing the investment
(b)
Used when market participant would use such multiples when pricing the investment.
(c)
Weighted averages are calculated based on fair value of investments.
Under the bond yield approach, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt securities are capital structure premium, tranche specific risk premium/(discount), size premium and industry premium/(discount). Significant increases or decreases in any of those inputs in isolation may result in a significantly lower or higher fair value measurement, respectively.
Under the market and income approaches, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt or equity securities are the weighted average cost of capital, company specific risk premium, revenue growth rate and EBITDA multiple. Significant increases or decreases in a portfolio company’s weighted average cost of capital or company specific risk premium in isolation may result in a significantly lower or higher fair value measurement, respectively. Significant increases or decreases in the revenue growth rate or valuation multiples in isolation may result in a significantly higher or lower fair value measurement, respectively.
 
Financial Instruments Disclosed, But Not Carried, At Fair Value
The following table presents the carrying value and fair value of the Company’s financial liabilities disclosed, but not carried, at fair value as of September 30, 2013 and the level of each financial liability within the fair value hierarchy:
 
 
 
Carrying
Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Credit facilities payable
 
$
188,000

 
$
188,000

 
$
—

 
$
—

 
$
188,000

SBA debentures payable
 
181,750

 
156,073

 
—

 
—

 
156,073

Unsecured convertible notes payable
 
115,000

 
122,331

 
—

 
—

 
122,331

Unsecured notes payable
 
161,250

 
151,008

 
—

 
151,008

 
—

Total
 
$
646,000

 
$
617,412

 
$
—

 
$
151,008

 
$
466,404

The carrying values of credit facilities payable approximates their fair values and are included in Level 3 of the hierarchy.
The Company utilizes the bond yield approach to estimate the fair value of its SBA debentures payable, which are included in Level 3 of the hierarchy. Under the bond yield approach, the Company uses bond yield models to determine the present value of the

110
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


future cash flows streams for the debentures. The Company reviews various sources of data involving investments with similar characteristics and assesses the information in the valuation process.
The Company uses the non-binding indicative quoted price as of the valuation date to estimate the fair value of the unsecured convertible notes payable, which are included in Level 3 of the hierarchy.
The Company uses the unadjusted quoted price as of the valuation date to calculate the fair value of its 5.875% unsecured notes due 2024 and its 6.125% unsecured notes due 2028, which trade under the symbol "FSCE" on the New York Stock Exchange and the symbol "FSCFL" on the NASDAQ Stock Exchange, respectively. As such, these securities are included in Level 2 of the hierarchy.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements consisted of $149.5 million and $102.5 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of September 30, 2013 and September 30, 2012, respectively. Such commitments are subject to the portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected in the Company’s Consolidated Statements of Assets and Liabilities. A summary of the composition of the unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of September 30, 2013 and September 30, 2012 is shown in the table below:

111
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


 
 
September 30, 2013
 
September 30, 2012
Drugtest, Inc.
$
20,000

 
$
4,000

Pingora MSR Opportunity Fund I, LP (limited partnership interest)
9,792

 
—

RP Crown Parent, LLC
9,000

 
—

Deltek, Inc.
8,667

 
—

Refac Optical Group
8,000

 
5,500

Yeti Acquisition, LLC
7,500

 
7,500

ISG Services, LLC
6,000

 
—

I Drive Safely, LLC
5,000

 
5,000

HealthEdge Software, Inc.
5,000

 
—

First American Payment Systems, LP
5,000

 
—

Teaching Strategies, LLC
5,000

 
—

Adventure Interactive, Corp.
5,000

 
—

Charter Brokerage, LLC
4,000

 
7,353

World 50, Inc.
4,000

 
4,000

Enhanced Recovery Company, LLC
3,500

 
4,000

Phoenix Brands Merger Sub LLC
3,429

 
4,071

Personable Holdings, Inc.
3,409

 
—

2Checkout.com, Inc.
2,850

 
—

Reliance Communications, LLC
2,750

 
—

CPASS Acquisition Company
2,500

 
1,000

Olson + Co., Inc.
2,105

 
2,105

Mansell Group, Inc.
2,000

 
2,000

Physicians Pharmacy Alliance, Inc.
2,000

 
2,000

Beecken Petty O'Keefe Fund IV, LP (limited partnership interest)
2,000

 
—

Chicago Growth Partners III, LP (limited partnership interest)
2,000


—

Eagle Hospital Physicians, LLC
1,867

 
1,400

Riverside Fund V, LP (limited partnership interest)
1,712

 
2,000

Sterling Capital Partners IV, LP (limited partnership interest)
1,528

 
—

CCCG, LLC
1,520

 
—

Miche Bag, LLC
1,500

 
3,500

Milestone Partners IV, LP (limited partnership interest)
1,414

 
1,343

BMC Acquisition, Inc.
1,250

 
900

Ansira Partners, Inc.
1,190

 
1,190

Discovery Practice Management, Inc.
1,000

 
2,600

Psilos Group Partners IV, LP (limited partnership interest)
1,000

 
1,000

Genoa Healthcare Holdings, LLC
1,000

 
—

Bunker Hill Capital II (QP), LP (limited partnership interest)
786

 
934

HealthDrive Corporation
734

 
750

ACON Equity Partners III, LP (limited partnership interest)
671

 
753

Riverlake Equity Partners II, LP (limited partnership interest)
638

 
760

RCP Direct, LP (limited partnership interest)
524

 
615

Baird Capital Partners V, LP (limited partnership interest)
351

 
513

Riverside Fund IV, LP (limited partnership interest)
287

 
323

Welocalize, Inc.
—

 
10,000

Rail Acquisition Corp.
—

 
6,165

Traffic Solutions Holdings, Inc.
—

 
5,000

InvestRx Corporation
—

 
5,000

Titan Fitness, LLC
—

 
3,500

Cardon Healthcare Network, LLC
—

 
3,000

Tegra Medical, LLC
—

 
1,500

Specialty Bakers, LLC
—

 
750

Advanced Pain Management Holdings, Inc.
—

 
400

Saddleback Fence and Vinyl Products, Inc.
—

 
100

Total
$
149,474

 
$
102,525


112
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


 
Summaries of the composition of the Company’s investment portfolio at cost and fair value as a percentage of total investments are shown in the following tables:
 
 
 
September 30, 2013
 
September 30, 2012
Cost:
 
 
 
 
 
 
 
 
Senior secured debt
 
$
1,456,710

 
78.33
%
 
$
1,024,518

 
80.77
%
Subordinated debt
 
292,991

 
15.76

 
201,971

 
15.92

Purchased equity
 
71,835

 
3.86

 
34,516

 
2.72

CLO debt
 
29,500

 
1.59

 
—

 
—

Equity grants
 
4,316

 
0.23

 
4,724

 
0.37

Limited partnership interests
 
4,299

 
0.23

 
2,760

 
0.22

Total
 
$
1,859,651

 
100.00
%
 
$
1,268,489

 
100.00
%
Fair Value:
 
 
 
 
 
 
 
 
Senior secured debt
 
$
1,467,665

 
77.53
%
 
$
1,035,750

 
80.41
%
Subordinated debt
 
296,298

 
15.65

 
205,447

 
15.95

Purchased equity
 
89,688

 
4.74

 
38,600

 
3.00

CLO debt
 
29,500

 
1.56

 
—

 
—

Equity grants
 
5,599

 
0.30

 
5,551

 
0.43

Limited partnership interests
 
4,296

 
0.22

 
2,760

 
0.21

Total
 
$
1,893,046

 
100.00
%
 
$
1,288,108

 
100.00
%
The Company primarily invests in portfolio companies located in North America. The following tables show the portfolio composition by geographic region at cost and fair value as a percentage of total investments. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business.
 
 
September 30, 2013
 
September 30, 2012
Cost:
 
 
 
 
 
 
 
 
Northeast U.S.
 
$
744,582

 
40.04
%
 
$
440,689

 
34.74
%
Midwest U.S.
 
314,653

 
16.92

 
137,860

 
10.87

Southwest U.S.
 
279,369

 
15.02

 
251,751

 
19.85

Southeast U.S.
 
277,342

 
14.91

 
230,667

 
18.18

West U.S.
 
242,705

 
13.05

 
206,522

 
16.28

Canada
 
1,000

 
0.06

 
1,000

 
0.08

Total
 
$
1,859,651

 
100.00
%
 
$
1,268,489

 
100.00
%
 
 
 
 
 
 
 
 
 
Fair Value:
 
 
 
 
 
 
 
 
Northeast U.S.
 
$
753,263

 
39.79
%
 
$
442,111

 
34.32
%
Midwest U.S.
 
317,958

 
16.80

 
140,191

 
10.88

Southwest U.S.
 
280,247

 
14.80

 
254,509

 
19.76

Southeast U.S.
 
285,648

 
15.09

 
236,808

 
18.38

West U.S.
 
252,730

 
13.35

 
212,939

 
16.53

Canada
 
3,200

 
0.17

 
1,550

 
0.13

Total
 
$
1,893,046

 
100.00
%
 
$
1,288,108

 
100.00
%
 

113
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The composition of the Company’s portfolio by industry at cost and fair value as of September 30, 2013 and September 30, 2012 were as follows:
 
 
 
September 30, 2013
 
 
September 30, 2012
 
Cost:
 
 
 
 
 
 
 
 
 
 
Healthcare services
 
$
266,823

 
14.35
%
 
 
$
168,914

 
13.32
%
 
Diversified support services
 
170,174

 
9.15

 
 
111,362

 
8.78

 
Education services
 
166,750

 
8.97

 
 
99,033

 
7.81

 
Advertising
 
154,026

 
8.28

 
 
53,665

 
4.23

 
Specialized finance
 
124,232

 
6.68

 
 
—

 
—

 
Internet software & services
 
109,170

 
5.87

 
 
73,753

 
5.81

 
IT consulting & other services
 
82,440

 
4.43

 
 
44,979

 
3.55

 
Oil & gas equipment services
 
75,426

 
4.06

 
 
60,245

 
4.75

 
Healthcare equipment
 
70,494

 
3.79

 
 
82,808

 
6.53

 
Specialty stores
 
68,386

 
3.68

 
 
33,034

 
2.60

 
Human resources & employment services
 
64,944

 
3.49

 
 
19,441

 
1.53

 
Pharmaceuticals
 
51,538

 
2.77

 
 
40,309

 
3.18

 
Leisure products
 
47,222

 
2.54

 
 
55,534

 
4.38

 
Other diversified financial services
 
41,888

 
2.25

 
 
38,479

 
3.03

 
Auto parts & equipment
 
33,061

 
1.78

 
 
1,000

 
0.08

 
Construction & engineering
 
32,577

 
1.75

 
 
46,334

 
3.65

 
Household products
 
29,677

 
1.60

 
 
29,738

 
2.34

 
Asset management & custody banks
 
29,500

 
1.59

 
 
—

 
—

 
Home improvement retail
 
28,726

 
1.54

 
 
28,415

 
2.24

 
Apparel, accessories & luxury goods
 
28,385

 
1.53

 
 
37,919

 
2.99

 
Airlines
 
24,475

 
1.32

 
 
—

 
—

 
Data processing & outsources services
 
23,200

 
1.25

 
 
—

 
—

 
Specialty chemicals
 
20,000

 
1.08

 
 
—

 
—

 
Food distributors
 
18,435

 
0.99

 
 
18,115

 
1.43

 
Research & consulting services
 
17,521

 
0.94

 
 
13,885

 
1.09

 
Industrial machinery
 
16,883

 
0.91

 
 
21,052

 
1.66

 
Air freight & logistics
 
16,693

 
0.90

 
 
18,903

 
1.49

 
Security & alarm services
 
13,124

 
0.71

 
 
—

 
—

 
Application software
 
12,879

 
0.69

 
 
—

 
—

 
Environmental & facilities services
 
8,755

 
0.47

 
 
21,026

 
1.66

 
Construction materials
 
7,170

 
0.39

 
 
6,951

 
0.55

 
Multi-sector holdings
 
4,091

 
0.20

 
 
2,759

 
0.21

 
Building products
 
735

 
0.04

 
 
748

 
0.06

 
Thrift & mortgage finance
 
208

 
0.01

 
 
—

 
—

 
Leisure facilities
 
43

 
0.00

 
 
29,651

 
2.34

 
Electronic equipment & instruments
 
—

 
—

 
 
36,163

 
2.85

 
Integrated telecommunication services
 
—

 
—

 
 
31,994

 
2.52

 
Restaurants
 
—

 
—

 
 
19,130

 
1.51

 
Distributors
 
—

 
—

 
 
19,115

 
1.51

 
Electronic manufacturing services
 
—

 
—

 
 
3,835

 
0.30

 
Movies & entertainment
 
—

 
—

 
 
200

 
0.02

 
Total
 
$
1,859,651

 
100.00
%
 
 
$
1,268,489

 
100.00
%
 

 

114
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


 
September 30, 2013
 
 
September 30, 2012
 
Fair Value:
 
 
 
 
 
 
 
 
 
Healthcare services
$
273,880

 
14.47
%
 
$
174,933

 
13.58
%
Diversified support services
171,078

 
9.04
 
 
113,021

 
8.77
 
Education services
168,492

 
8.90
 
 
99,327

 
7.71
 
Advertising
154,777

 
8.18
 
 
54,125

 
4.20
 
Specialized finance
124,400

 
6.57
 
 
—

 
—
 
Internet software & services
114,077

 
6.03
 
 
79,220

 
6.15
 
IT consulting & other services
83,916

 
4.43
 
 
45,746

 
3.55
 
Oil & gas equipment services
76,454

 
4.04
 
 
62,087

 
4.82
 
Healthcare equipment
70,866

 
3.74
 
 
84,084

 
6.53
 
Specialty stores
69,024

 
3.65
 
 
34,106

 
2.65
 
Human resources & employment services
65,391

 
3.45
 
 
20,196

 
1.57
 
Pharmaceuticals
52,787

 
2.79
 
 
41,000

 
3.18
 
Leisure products
49,952

 
2.64
 
 
56,477

 
4.38
 
Other diversified financial services
41,954

 
2.22
 
 
39,288

 
3.05
 
Construction & engineering
40,919

 
2.16
 
 
50,003

 
3.88
 
Auto parts & equipment
36,004

 
1.90
 
 
1,550

 
0.12
 
Asset management & custody banks
29,500

 
1.56
 
 
—

 
—
 
Household products
29,264

 
1.55
 
 
29,880

 
2.32
 
Home improvement retail
28,677

 
1.51
 
 
28,263

 
2.19
 
Apparel, accessories & luxury goods
27,724

 
1.46
 
 
38,413

 
2.98
 
Airlines
24,475

 
1.29
 
 
—

 
—
 
Data processing & outsources services
23,295

 
1.23
 
 
—

 
—
 
Specialty chemicals
20,000

 
1.06
 
 
—

 
—
 
Food distributors
18,732

 
0.99
 
 
18,400

 
1.43
 
Industrial machinery
18,197

 
0.96
 
 
21,750

 
1.69
 
Research & consulting services
17,912

 
0.95
 
 
14,189

 
1.10
 
Air freight & logistics
14,063

 
0.74
 
 
15,931

 
1.24
 
Application software
13,500

 
0.71
 
 
—

 
—
 
Security & alarm services
13,104

 
0.69
 
 
—

 
—
 
Environmental & facilities services
8,113

 
0.43
 
 
12,175

 
0.95
 
Construction materials
7,297

 
0.39
 
 
7,200

 
0.56
 
Multi-sector holdings
4,158

 
0.21
 
 
2,760

 
0.22
 
Building products
735

 
0.04
 
 
750

 
0.06
 
Leisure facilities
190

 
0.01
 
 
30,359

 
2.36
 
Thrift & mortgage finance
139

 
0.01
 
 
—

 
—
 
Electronic equipment & instruments
—

 
—
 
 
36,265

 
2.82
 
Integrated telecommunication services
—

 
—
 
 
32,892

 
2.55
 
Distributors
—

 
—
 
 
20,153

 
1.56
 
Restaurants
—

 
—
 
 
19,468

 
1.51
 
Electronic manufacturing services
—

 
—
 
 
3,835

 
0.30
 
Movies & entertainment
—

 
—
 
 
262

 
0.02
 
Total
$
1,893,046

 
100.00
%
 
$
1,288,108

 
100.00
%
The Company’s investments are generally in small and mid-sized companies in a variety of industries. At September 30, 2013 and September 30, 2012, the Company had no single investment that represented greater than 10% of the total investment portfolio at fair value. Income, consisting of interest, dividends, fees, other investment income and realization of gains or losses, can fluctuate upon repayment or sale of an investment and in any given year can be highly concentrated among several investments. For the years ended September 30, 2013 and September 30, 2012, no individual investment produced income that exceeded 10% of investment income.

115
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Unconsolidated Significant Subsidiaries
In accordance with SEC Regulation S-X Rules 3-09 and 4-08(g), the Company must determine which of its portfolio companies, if any, are considered "significant subsidiaries". After performing this analysis for all periods presented, the Company determined that HFG Holdings, LLC is a significant subsidiary for the year ended September 30, 2013 under Rule 4-08(g). As such, the Company must provide summary financial information as shown below:
Balance sheet items
 
September 30, 2013
Cash
 
$1,652
Loans receivable
 
298,906
Other assets
 
44,292
Total liabilities
 
323,351
Members' capital
 
21,499
 
 
 
Statement of operations items
 
For the period June 12, 2013 (date of acquisition) through September 30, 2013
Total income
 
$8,559
Total expenses, before interest expense due to the Company
 
6,851
Net income before interest expense due to the Company
 
1,708
Interest expense due to the Company
 
2,811
Net loss
 
(1,103)
Note 4. Fee Income
The Company receives a variety of fees in the ordinary course of business including servicing, advisory, structuring and prepayments fees, which are classified as fee income and recognized as they are earned.
As of September 30, 2013, the Company had structured $4.2 million in aggregate exit fees across six portfolio investments upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt investment. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.
 Note 5. Share Data
Effective January 2, 2008, the Partnership merged with and into the Company. At the time of the merger, all outstanding partnership interests in the Partnership were exchanged for 12,480,972 shares of common stock of the Company. An additional 26 fractional shares were payable to the stockholders in cash.
On June 17, 2008, the Company completed an initial public offering of 10,000,000 shares of its common stock at the offering price of $14.12 per share. The net proceeds totaled $129.5 million after deducting underwriting commissions of $9.9 million and offering costs of $1.8 million.
On April 20, 2010, at the Company’s 2010 Annual Meeting, the Company’s stockholders approved, among other things, amendments to the Company’s restated certificate of incorporation to increase the number of authorized shares of common stock from 49,800,000 shares to 150,000,000 shares and to remove the Company’s authority to issue shares of Series A Preferred Stock.
On March 19, 2013, the Company amended its Restated Certificate of Incorporation to increase the number of authorized shares of common stock from 150,000,000 shares to 250,000,000 shares.

116
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The following table sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10 Earnings per Share, for the years ended September 30, 2013, 2012 and 2011:
 
 
Year ended
September 30,
2013
 
Year ended
September 30,
2012
 
Year ended
September 30,
2011
Earnings per common share — basic:
 
 
 
 
 
 
Net increase in net assets resulting from operations
 
$
101,821

 
$
79,401

 
$
30,207

Weighted average common shares outstanding — basic
 
110,270

 
79,570

 
64,057

Earnings per common share — basic
 
0.92

 
1.00

 
0.47

Earnings per common share — diluted:
 
 
 
 
 
 
Net increase in net assets resulting from operations, before adjustments
 
$
101,821

 
$
79,401

 
$
30,207

Adjustments for interest on convertible notes, base management fees, incentive fees and gain on extinguishment of convertible notes
 
4,079

 
5,855

 
2,124

Net increase in net assets resulting from operations, as adjusted
 
$
105,900

 
$
85,256

 
$
32,331

Weighted average common shares outstanding — basic
 
110,270

 
79,570

 
64,057

Adjustments for dilutive effect of convertible notes
 
7,791

 
8,149

 
4,659

Weighted average common shares outstanding — diluted
 
118,061

 
87,719

 
68,716

Earnings per common share — diluted
 
$
0.90

 
$
0.97

 
$
0.47

The following table reflects the distributions per share that the Board of Directors of the Company has declared and the Company paid, including shares issued under the dividend reinvestment plan (“DRIP”), on its common stock from October 1, 2011 to September 30, 2013:
Date Declared
 
Record Date
 
Payment Date
 
Amount
per Share
 
Cash
Distribution
 
DRIP Shares
Issued
 
 
 
DRIP Shares
Value
November 10, 2011
 
January 13, 2012
 
January 31, 2012
 
 $ 0.0958

 
$ 6.6 million
 
29,902

 
(1)
 
$ 0.3 million
November 10, 2011
 
February 15, 2012
 
February 29, 2012
 
0.0958

 
7.4 million
 
45,071

 
  
 
0.4 million
November 10, 2011
 
March 15, 2012
 
March 30, 2012
 
0.0958

 
7.5 million
 
41,807

 
(1)
 
0.4 million
February 7, 2012
 
April 13, 2012
 
April 30, 2012
 
0.0958

 
7.4 million
 
48,328

 
(1)
 
0.5 million
February 7, 2012
 
May 15, 2012
 
May 31, 2012
 
0.0958

 
7.4 million
 
47,877

 
(1)
 
0.5 million
February 7, 2012
 
June 15, 2012
 
June 29, 2012
 
0.0958

 
7.5 million
 
41,499

 
  
 
0.4 million
May 7, 2012
 
July 13, 2012
 
July 31, 2012
 
0.0958

 
7.4 million
 
49,217

 
  
 
0.5 million
May 7, 2012
 
August 15, 2012
 
August 31, 2012
 
0.0958

 
7.5 million
 
41,359

 
  
 
0.4 million
May 7, 2012
 
September 14, 2012
 
September 28, 2012
 
0.0958

 
8.3 million
 
43,952

 
  
 
0.5 million
August 6, 2012
 
October 15, 2012
 
October 31, 2012
 
0.0958

 
8.2 million
 
51,754

 
  
 
0.5 million
August 6, 2012
 
November 15, 2012
 
November 30, 2012
 
0.0958

 
8.2 million
 
53,335

 
  
 
0.5 million
August 6, 2012
 
December 14, 2012
 
December 28, 2012
 
0.0958

 
9.5 million
 
64,680

 
  
 
0.6 million
August 6, 2012
 
January 15, 2013
 
January 31, 2013
 
0.0958

 
9.5 million
 
61,782

 
  
 
0.6 million
August 6, 2012
 
February 15, 2013
 
February 28, 2013
 
0.0958

 
9.1 million
 
103,356

 
  
 
1.0 million
January 14, 2013
 
March 15, 2013
 
March 29, 2013
 
0.0958

 
9.1 million
 
100,802

 
 
 
1.1 million
January 14, 2013
 
April 15, 2013
 
April 30, 2013
 
0.0958

 
10.3 million
 
111,167

 
 
 
1.2 million
January 14, 2013
 
May 15, 2013
 
May 31, 2013
 
0.0958

 
10.3 million
 
127,152

 
 
 
1.3 million
May 6, 2013
 
June 14, 2013
 
June 28, 2013
 
0.0958

 
10.5 million
 
112,821

 
 
 
1.1 million
May 6, 2013
 
July 15, 2013
 
July 31, 2013
 
0.0958

 
10.2 million
 
130,944

 
 
 
1.3 million
May 6, 2013
 
August 15, 2013
 
August 30, 2013
 
0.0958

 
10.3 million
 
136,052

 
 
 
1.3 million
August 5, 2013
 
September 13, 2013
 
September 30, 2013
 
0.0958

 
10.3 million
 
135,027

 
 
 
1.3 million
 __________
(1) Shares were purchased on the open market and distributed.
On May 6, 2013, upon expiration of its previous stock repurchase program, the Company's Board of Directors authorized a stock repurchase program to acquire up to $50 million of its outstanding common stock. Stock repurchases under this program would be

117
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


made through the open market at times and in such amounts as the Company's management deems appropriate, provided they are below the most recently published net asset value per share. Unless extended by the Board of Directors, the stock repurchase program will expire on May 7, 2014 and may be limited or terminated at any time without prior notice.
Note 6. Lines of Credit
 Wells Fargo Facility
On November 16, 2009, Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding”), and the Company entered into a Loan and Servicing Agreement (“Wells Agreement”), with respect to a revolving credit facility, as subsequently amended, (the “Wells Fargo facility”) with Wells Fargo, as successor to Wachovia Bank, National Association, Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time.
As of September 30, 2013, the Wells Fargo facility permitted up to $150 million of borrowings (subject to collateral requirements) with an accordion feature allowing for future expansion of the facility up to a total of $250 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-month) plus 2.50% per annum, with no LIBOR floor. Unless extended, the period during which the Company may make and reinvest borrowings under the facility will expire on April 23, 2014 and the maturity date of the facility is April 25, 2016.
 
The Wells Fargo facility provides for the issuance from time to time of letters of credit for the benefit of the Company's portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million.
In connection with the Wells Fargo facility, the Company concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which the Company has sold and will continue to sell to Funding certain loan assets it has originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which the Company pledged all of its equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.
The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of their businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Wells Fargo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or the Company to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. The Company is currently in compliance with all financial covenants under the Wells Fargo facility.
The Wells Fargo facility is secured by all of the assets of Funding, and all of the Company’s equity interest in Funding. The Company uses the Wells Fargo facility to fund a portion of its loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. The Company cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of September 30, 2013, the Company had $20.0 million of borrowings outstanding under the Wells Fargo facility, which had a fair value of $20.0 million. The Company’s borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 2.917% for the year ended September 30, 2013. For the years ended September 30, 2013, 2012 and 2011, the Company recorded interest expense of $3.1 million, $2.8 million, and $2.4 million, respectively, related to the Wells Fargo facility.
 
ING Facility
On May 27, 2010, the Company entered into a secured syndicated revolving credit facility (as subsequently amended, the “ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allows the Company to request letters of credit from ING Capital LLC, as the issuing bank.
As of September 30, 2013, the ING facility permitted up to $480 million of borrowings with an accordion feature allowing for future expansion of the facility up to a total of $800 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-, 2-, 3- or 6-month, at the Company's option) plus 2.25% per annum, with no LIBOR floor. Unless extended, the period during

118
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


which the Company may make and reinvest borrowings under the facility will expire on August 6, 2017 and the maturity date of the facility is August 6, 2018.
The ING facility is secured by substantially all of the Company’s assets, as well as the assets of the Company’s wholly-owned subsidiary, FSFC Holdings, Inc. ("Holdings"), and its indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC ("Fund of Funds"), subject to certain exclusions for, among other things, equity interests in the Company’s SBIC subsidiaries, and equity interests in Funding and Funding II (which is defined and discussed below) as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and the Company. Fifth Street Fund of Funds LLC and FSFC Holdings, Inc. were formed to hold certain of the Company’s portfolio companies for tax purposes and have no other operations. None of the Company’s SBIC subsidiaries, Funding or Funding II is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that the Company may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.
 
Pursuant to the ING Security Agreement, Holdings and Fund of Funds guaranteed the obligations under the ING Security Agreement, including the Company’s obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, the Company pledged its entire equity interest in Holdings and Holdings, Inc. pledged its entire equity interest in Fund of Funds to the collateral agent pursuant to the terms of the ING Security Agreement.
The ING Credit Agreement and related agreements governing the ING facility required Holdings, Fund of Funds and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of the Company’s businesses, (ii) agree to certain indemnification obligations, and (iii) agree to comply with various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by the Company to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. The Company is currently in compliance with all financial covenants under the ING facility.
Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. The Company cannot be assured that it will be able to borrow funds under the ING facility at any particular time or at all.
As of September 30, 2013, the Company had $168.0 million of borrowings outstanding under the ING facility, which had a fair value of $168.0 million. The Company’s borrowings under the ING facility bore interest at a weighted average interest rate of 3.141% for the year ended September 30, 2013. For the years ended September 30, 2013, 2012 and 2011 the Company recorded interest expense of $7.7 million, $5.7 million and $3.3 million, respectively, related to the ING facility.
 
Sumitomo Facility
On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto, in the amount of $200 million.
As of September 30, 2013, the Sumitomo facility permitted up to $200 million of borrowings (subject to collateral requirements), and borrowings under the facility bore interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor. Unless extended, the period during which the Company may make and reinvest borrowings under the facility will expire on September 16, 2014 and the maturity date of the facility is September 16, 2018, with an option for a one-year extension.
In connection with the Sumitomo facility, the Company concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which it has sold and will continue to sell to Funding II certain loan assets the Company has originated or acquired, or will originate or acquire.
  
The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of its businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or the Company to materially perform

119
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.
The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. There is no assurance that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of September 30, 2013, the Company did not have any borrowings outstanding under the Sumitomo facility. The Company’s borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 3.066% for the year ended September 30, 2013. For the years ended September 30, 2013 and 2012, the Company recorded interest expense of $1.7 million and $1.2 million, respectively, related to the Sumitomo facility. For the year ended September 30, 2011, the Company did not record interest expense related to the Sumitomo facility.
As of September 30, 2013, except for assets that were funded through the Company’s SBIC subsidiaries, substantially all of the Company’s assets were pledged as collateral under the Wells Fargo facility, the ING facility or the Sumitomo facility. With respect to the assets funded through the Company’s SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over the Company’s stockholders.
Interest expense for the years ended September 30, 2013, 2012 and 2011 was $33.5 million, $23.2 million and $15.1 million, respectively.
Note 7. Interest and Dividend Income
Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. In accordance with the Company’s policy, accrued interest is evaluated periodically for collectability. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.
The Company holds debt in its portfolio that contains PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. The Company generally ceases accruing PIK interest if there is insufficient value to support the accrual or if the Company does not expect the portfolio company to be able to pay all principal and interest due. The Company’s decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; the Company’s assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by the Company in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, the Company determines whether to cease accruing PIK interest on a loan or debt security. The Company’s determination to cease accruing PIK interest on a loan or debt security is generally made well before the Company’s full write-down of such loan or debt security.
 
Accumulated PIK interest activity for the years ended September 30, 2013 and September 30, 2012 was as follows:
 
 
Year Ended
September 30,
2013
 
Year Ended
September 30,
2012
PIK balance at beginning of period
 
$
18,431

 
$
22,672

Gross PIK interest accrued
 
17,532

 
17,993

PIK income reserves(1)
 
(745
)
 
(4,198
)
PIK interest received in cash
 
(8,514
)
 
(5,477
)
Loan exits and other PIK adjustments
 
(2,769
)
 
(12,559
)
PIK balance at end of period
 
$
23,935

 
$
18,431

 ___________________
(1)
PIK income is generally reserved for when a loan is placed on PIK non-accrual status.
As of September 30, 2013, there were no investments on which the Company had stopped accruing cash interest, PIK interest or OID income. As of September 30, 2012, the Company had stopped accruing PIK interest on one investment. As of September 30, 2011, the Company had stopped accruing cash interest, PIK interest and OID on four investments that had not paid all of their scheduled cash interest payments for the period ended September 30, 2011.

120
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The percentages of the Company’s portfolio debt investments at cost and fair value by accrual status for the years ended September 30, 2013, 2012 and 2011 were as follows:
 
 
 
September 30, 2013
 
September 30, 2012
September 30, 2011
 
 
Cost
% of Debt
Portfolio
 
Fair
Value
% of Debt
Portfolio
 
Cost
% of Debt
Portfolio
 
Fair
Value
% of Debt
Portfolio
 
Cost
% of
Portfolio
 
Fair
Value
% of Debt
Portfolio
Accrual
 
$
1,779,201

100.00
%
 
$
1,793,463

100.00
%
 
$
1,217,393

99.26
%
 
$
1,237,961

99.74
%
 
$
1,098,434

96.54
%
 
$
1,091,857

99.29
%
PIK non-accrual
 
—

—

 
—

—

 
9,096

0.74

 
3,236

0.26
%
 
—

—

 
—

—

Cash non-accrual(1)
 
—

—

 
—

—

 
—

—

 
—

—

 
39,320

3.46

 
7,851

0.71

Total
 
$
1,779,201

100.00
%
 
$
1,793,463

100.00
%
 
$
1,226,489

100.00
%
 
$
1,241,197

100.00
%
 
$
1,137,754

100.00
%
 
$
1,099,708

100.00
%
 ___________________
(1)
Cash non-accrual status is inclusive of PIK and other noncash income, where applicable.
The non-accrual status of the Company’s portfolio investments as of September 30, 2013, 2012 and 2011 was as follows:
 
 
  
September 30, 2013
  
September 30, 2012
  
September 30, 2011
Coll Materials Group LLC(1)
  
—

  
PIK non-accrual
  
 
—
Lighting by Gregory, LLC(1)
  
—

  
—

  
Cash non-accrual
O’Currance, Inc.(1)
  
—

  
—

  
Cash non-accrual
Premier Trailer Leasing, Inc.(1)
  
—

  
—

  
Cash non-accrual
Repechage Investments Limited(1)
  
—

  
—

  
Cash non-accrual
  ___________________
(1)
The Company no longer holds this investment. See Note 9 for a discussion of the Company’s recent realization events.
 
Income non-accrual amounts for the years ended September 30, 2013, 2012 and 2011 were as follows:
 


Year ended
September 30, 2013 (1)

Year ended
September 30, 2012

Year ended
September 30, 2011
Cash interest income

$
280


$
3,068


$
5,815

PIK interest income

745


4,198


851

OID income

—


96


105

Total

$
1,025


$
7,362


$
6,771

 ___________________
(1)
Income non-accrual amounts for the year ended September 30, 2013 include amounts for investments that were no longer held at year end.
Note 8. Taxable/Distributable Income and Dividend Distributions
Taxable income differs from net increase (decrease) in net assets resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in taxable income until they are realized; (2) origination and exit fees received in connection with investments in portfolio companies; (3) organizational and deferred offering costs; (4) recognition of interest income on certain loans; and (5) income or loss recognition on exited investments.
At September 30, 2013, the Company has net loss carryforwards of $107.4 million to offset net capital gains, to the extent provided by federal tax law. Of the capital loss carryforwards, $1.5 million will expire on September 30, 2017, $10.3 million will expire on September 30, 2019, and $95.6 million will not expire. During the year ended September 30, 2013, the Company realized capital losses from the sale of investments after October 31, 2012 and prior to year end (“post-October capital losses”) of $21.3 million, which for tax purposes are treated as arising on the first day of the following year.
Listed below is a reconciliation of “net increase in net assets resulting from operations” to taxable income for the year ended September 30, 2013.

121
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


 
Net increase in net assets resulting from operations
$
101,821

Net unrealized appreciation
(13,397
)
Book/tax difference due to loan fees
(12,069
)
Book/tax difference due to organizational and deferred offering costs
(87
)
Book/tax difference due to interest income on certain loans
424

Book/tax difference due to capital losses not recognized
26,529

Other book-tax differences
(2,181
)
 
 
Taxable/Distributable Income(1)
$
101,040

 
 
 
(1)
The Company’s taxable income for 2013 is an estimate and will not be finally determined until the Company files its tax return for the fiscal year ended September 30, 2013. Therefore, the final taxable income may be different than the estimate.
As of September 30, 2013, the components of accumulated undistributed income on a tax basis were as follows:
 
Undistributed ordinary income, net (RIC status)
$
—

Realized capital losses
(107,433
)
Unrealized gains, net
32,393

The Company uses the asset and liability method to account for its taxable subsidiaries’ income taxes. Using this method, the Company recognizes deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and tax bases of assets and liabilities. In addition, the Company recognizes deferred tax benefits associated with net operating carry forwards that it may use to offset future tax obligations. The Company measures deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences. The Company has recorded a deferred tax asset for the difference in the book and tax basis of certain equity investments and tax net operating losses held by its taxable subsidiaries of $1.4 million. However, this amount has been fully offset by a valuation allowance of $1.4 million, since it is more likely than not that these deferred tax assets will not be realized.
On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the “Act”) was enacted, which changed various technical rules governing the tax treatment of RICs. The changes are generally effective for taxable years beginning after the date of enactment. Under the Act, the Company is permitted to carry forward any net capital losses, if any, incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment net loss carryforwards may be more likely to expire unused.
Distributions to stockholders are recorded on the record date. The Company is required to distribute annually to its stockholders at least 90% of its net taxable income and net realized short-term capital gains in excess of net realized long-term capital losses for each taxable year in order to be eligible for the tax benefits allowed to a RIC under Subchapter M of the Code. The Company anticipates paying out as a dividend all or substantially all of those amounts. The amount to be paid out as a dividend is determined by the Board of Directors and is based on management’s estimate of the Company’s annual taxable income. The Company maintains an “opt out” dividend reinvestment plan for its stockholders.

122
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The Company’s Board of Directors has declared and the Company has paid the following distributions from inception to September 30, 2013: 
Distribution Type
 
Date Declared
 
 
Record Date
 
 
Payment Date
 
 
Amount Per Share
 
Quarterly
 
 
5/1/2008
 
 
 
5/19/2008
 
 
 
6/3/2008
 
 
$
0.30
 
Quarterly
 
 
8/6/2008
 
 
 
9/10/2008
 
 
 
9/26/2008
 
 
 
0.31
 
Quarterly
 
 
12/9/2008
 
 
 
12/19/2008
 
 
 
12/29/2008
 
 
 
0.32
 
Quarterly
 
 
12/9/2008
 
 
 
12/30/2008
 
 
 
1/29/2009
 
 
 
0.33
 
Special
 
 
12/18/2008
 
 
 
12/30/2008
 
 
 
1/29/2009
 
 
 
0.05
 
Quarterly
 
 
4/14/2009
 
 
 
5/26/2009
 
 
 
6/25/2009
 
 
 
0.25
 
Quarterly
 
 
8/3/2009
 
 
 
9/8/2009
 
 
 
9/25/2009
 
 
 
0.25
 
Quarterly
 
 
11/12/2009
 
 
 
12/10/2009
 
 
 
12/29/2009
 
 
 
0.27
 
Quarterly
 
 
1/12/2010
 
 
 
3/3/2010
 
 
 
3/30/2010
 
 
 
0.30
 
Quarterly
 
 
5/3/2010
 
 
 
5/20/2010
 
 
 
6/30/2010
 
 
 
0.32
 
Quarterly
 
 
8/2/2010
 
 
 
9/1/2010
 
 
 
9/29/2010
 
 
 
0.10
 
Monthly
 
 
8/2/2010
 
 
 
10/6/2010
 
 
 
10/27/2010
 
 
 
0.10
 
Monthly
 
 
8/2/2010
 
 
 
11/3/2010
 
 
 
11/24/2010
 
 
 
0.11
 
Monthly
 
 
8/2/2010
 
 
 
12/1/2010
 
 
 
12/29/2010
 
 
 
0.11
 
Monthly
 
 
11/30/2010
 
 
 
1/4/2011
 
 
 
1/31/2011
 
 
 
0.1066
 
Monthly
 
 
11/30/2010
 
 
 
2/1/2011
 
 
 
2/28/2011
 
 
 
0.1066
 
Monthly
 
 
11/30/2010
 
 
 
3/1/2011
 
 
 
3/31/2011
 
 
 
0.1066
 
Monthly
 
 
1/30/2011
 
 
 
4/1/2011
 
 
 
4/29/2011
 
 
 
0.1066
 
Monthly
 
 
1/30/2011
 
 
 
5/2/2011
 
 
 
5/31/2011
 
 
 
0.1066
 
Monthly
 
 
1/30/2011
 
 
 
6/1/2011
 
 
 
6/30/2011
 
 
 
0.1066
 
Monthly
 
 
5/2/2011
 
 
 
7/1/2011
 
 
 
7/29/2011
 
 
 
0.1066
 
Monthly
 
 
5/2/2011
 
 
 
8/1/2011
 
 
 
8/31/2011
 
 
 
0.1066
 
Monthly
 
 
5/2/2011
 
 
 
9/1/2011
 
 
 
9/30/2011
 
 
 
0.1066
 
Monthly
 
 
8/1/2011
 
 
 
10/14/2011
 
 
 
10/31/2011
 
 
 
0.1066
 
Monthly
 
 
8/1/2011
 
 
 
11/15/2011
 
 
 
11/30/2011
 
 
 
0.1066
 
Monthly
 
 
8/1/2011
 
 
 
12/13/2011
 
 
 
12/23/2011
 
 
 
0.1066
 
Monthly
 
 
11/10/2011
 
 
 
1/13/2012
 
 
 
1/31/2012
 
 
 
0.0958
 
Monthly
 
 
11/10/2011
 
 
 
2/15/2012
 
 
 
2/29/2012
 
 
 
0.0958
 
Monthly
 
 
11/10/2011
 
 
 
3/15/2012
 
 
 
3/30/2012
 
 
 
0.0958
 
Monthly
 
 
2/7/2012
 
 
 
4/13/2012
 
 
 
4/30/2012
 
 
 
0.0958
 
Monthly
 
 
2/7/2012
 
 
 
5/15/2012
 
 
 
5/31/2012
 
 
 
0.0958
 
Monthly
 
 
2/7/2012
 
 
 
6/15/2012
 
 
 
6/29/2012
 
 
 
0.0958
 
Monthly
 
 
5/7/2012
 
 
 
7/13/2012
 
 
 
7/31/2012
 
 
 
0.0958
 
Monthly
 
 
5/7/2012
 
 
 
8/15/2012
 
 
 
8/31/2012
 
 
 
0.0958
 
Monthly
 
 
5/7/2012
 
 
 
9/14/2012
 
 
 
9/28/2012
 
 
 
0.0958
 
Monthly
 
 
8/6/2012
 
 
 
10/15/2012
 
 
 
10/31/2012
 
 
 
0.0958
 
Monthly
 
 
8/6/2012
 
 
 
11/15/2012
 
 
 
11/30/2012
 
 
 
0.0958
 
Monthly
 
 
8/6/2012
 
 
 
12/14/2012
 
 
 
12/28/2012
 
 
 
0.0958
 
Monthly
 
 
8/6/2012
 
 
 
1/15/2013
 
 
 
1/31/2013
 
 
 
0.0958
 
Monthly
 
 
8/6/2012
 
 
 
2/15/2013
 
 
 
2/28/2013
 
 
 
0.0958
 
Monthly
 
 
1/14/2013
 
 
 
3/15/2013
 
 
 
3/29/2013
 
 
 
0.0958
 
Monthly
 
 
1/14/2013
 
 
 
4/15/2013
 
 
 
4/30/2013
 
 
 
0.0958
 
Monthly
 
 
1/14/2013
 
 
 
5/15/2013
 
 
 
5/31/2013
 
 
 
0.0958
 
Monthly
 
 
5/6/2013
 
 
 
6/14/2013
 
 
 
6/28/2013
 
 
 
0.0958
 
Monthly
 
 
5/6/2013
 
 
 
7/15/2013
 
 
 
7/31/2013
 
 
 
0.0958
 
Monthly
 
 
5/6/2013
 
 
 
8/15/2013
 
 
 
8/30/2013
 
 
 
0.0958
 
Monthly
 
 
8/5/2013
 
 
 
9/13/2013
 
 
 
9/30/2013
 
 
 
0.0958
 


123
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


For income tax purposes, the Company estimates that its distributions for the calendar year 2013 will be composed primarily of ordinary income, and will be reflected as such on the Form 1099-DIV for the calendar year 2013.
As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis. Because the Company did not satisfy these distribution requirements for calendar year 2010, the Company incurred a de minimis federal excise tax. The Company did not incur a federal excise tax for calendar years 2011 and 2012 and does not expect to incur a federal excise tax for calendar year 2013.
Note 9. Realized Gains or Losses and Net Unrealized Appreciation or Depreciation on 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. Realized losses may also be recorded in connection with the Company’s determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.
Net unrealized appreciation or depreciation reflects the net change in the valuation of the portfolio pursuant to the Company’s valuation guidelines and the reclassification of any prior period unrealized appreciation or depreciation.
During the year ended September 30, 2013, the Company recorded investment realization events, including the following:
•
In October 2012, the Company received a cash payment of $4.2 million from Rail Acquisition Corp. in full satisfaction of all obligations related to the revolving loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In October 2012, the Company received a cash payment of $5.4 million from Bojangles in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In October 2012, the Company received a cash payment of $21.9 million from Blue Coat Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In October 2012, the Company received a cash payment of $9.9 million from Insight Pharmaceuticals LLC in full satisfaction of all obligations related to the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In November 2012, the Company received a cash payment of $8.5 million from SolutionSet, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In January 2013, the Company received a cash payment of $30.2 million from NDSSI Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction. The Company also received an additional $3.0 million in connection with the sale of its preferred equity investment (including accumulated PIK of $0.9 million), realizing a gain of $0.1 million;
•
In January 2013, the Company received a cash payment of $44.6 million from Welocalize, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2013, the Company received a cash payment of $14.6 million from Edmentum, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2013, the Company received a cash payment of $7.1 million from Advanced Pain Management Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In March 2013, the Company received a cash payment of $10.0 million from eResearch Technology, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

124
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


•
In March 2013, the Company received a cash payment of $15.0 million from AdVenture Interactive, Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In March 2013, the Company received a cash payment of $19.5 million from idX Corporation in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
•
In April 2013, the Company realized a loss in the amount of $11.2 million after the senior-most creditors foreclosed on the assets of Coll Materials Group, LLC. The Company maintains a $1.0 million receivable related to a financial guarantee related to the transaction;
•
In April 2013, the Company received a cash payment of $14.1 million from Huddle House, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In April 2013, the Company received a cash payment of $20.4 million from Slate Pharmaceuticals Acquisition Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In April 2013, the Company received a cash payment of $12.5 million from Securus Technologies Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, the Company received a cash payment of $9.6 million from ConvergeOne Holdings Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2013, the Company received a cash payment of $30.9 million from CompuCom Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, the Company received a cash payment of $31.1 million from Cardon Healthcare Network, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In May 2013, the Company restructured its investment in Trans-Trade Brokers, Inc.  As part of the restructuring, the Company exchanged cash and its debt and equity securities for debt and equity securities in the restructured entity, TransTrade Operators, Inc., and recorded a realized loss in the amount of $6.1 million on this transaction;
•
In June 2013, the Company received a cash payment of $33.6 million from U.S. Retirement Partners, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In June 2013, the Company received a cash payment of $14.6 million from Traffic Solutions Holdings, Inc. in full satisfaction of all obligations related to the Term Loan A and Revolver under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2013, the Company received a cash payment of $9.1 million from U.S. Collections, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In July 2013, the Company received a cash payment of $9.9 million from Ikaria Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2013, the Company received a cash payment of $5.5 million from Miche Bag, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

125
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


•
In July 2013, the Company received a cash payment of $43.9 million from Tegra Medical, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2013, the Company received a cash payment of $27.0 million from MX USA, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In August 2013, the Company restructured its investment in Eagle Hospital Physicians, Inc. As part of the restructuring, the Company exchanged cash and its debt securities for debt and equity securities in the successor entity, Eagle Hospital Physicians, LLC, and recorded a realized loss in the amount of $9.8 million on this transaction;
•
In August 2013, the Company received a cash payment of $43.5 million from InvestRx Corporation in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In September 2013, the Company received a cash payment of $43.1 million from Titan Fitness, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction; and
•
During the year ended September 30, 2013, the Company received cash payments of $59.9 million in connection with partial sales of debt investments in the open market and recorded a net realized gain of $0.4 million.
During the year ended September 30, 2012, the Company recorded investment realization events, including the following:
 
•
In November 2011, the Company recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on the Company’s investment in Premier Trailer Leasing, Inc.;
•
In November 2011, the Company received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and the Company received an additional $1.3 million proceeds from its equity investment, realizing a gain of $0.8 million;
•
In December 2011, the Company received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In December 2011, the Company received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In December 2011, the Company received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In January 2012, the Company received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In February 2012, the Company received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and the Company recorded a realized loss in the amount of $10.7 million on this transaction;
•
In February 2012, the Company received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, the Company received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction; 

126
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


•
In March 2012, the Company received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, the Company received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In March 2012, the Company received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, the Company received a cash payment of $28.9 million from JTC Education, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In May 2012, the Company received a cash payment of $6.1 million from Fitness Edge, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In June 2012, the Company received a cash payment of $20.2 million from Caregiver Services, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In July 2012, the Company received a cash payment of $1.0 million from Best Vinyl Fence & Deck, LLC. The Term Loan B debt investment was exited below par and the Company recorded a realized loss in the amount of $3.3 million on this transaction;
•
In July 2012, the Company received a cash payment of $8.7 million from Pacific Architects & Engineers, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In August 2012, the Company restructured its investment in Traffic Control & Safety Corp. As part of the restructuring, the Company exchanged cash and its debt and equity securities for debt and equity securities in the successor entity, Statewide Holdings, Inc., and recorded a realized loss in the amount of $10.9 million on this transaction;
•
In August 2012, the Company received a cash payment of $18.0 million from Stackpole Powertrain International ULC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In September 2012, the Company received a cash payment of $0.1 million in connection with the sale of its investment in Lighting by Gregory, LLC. The investment was exited below par and the Company recorded a realized loss in the amount of $5.3 million on this transaction;
•
In September 2012, the Company received total consideration of $0.6 million in connection with the exit of its investment in Repechage Investments Limited. The investment was exited below par and the Company recorded a realized loss in the amount of $3.6 million on this transaction; and
•
In September 2012, the Company received a total consideration of $1.8 million in connection with the sale of its Rail Acquisition Corp. term loan investment. The debt investment was exited below par and the Company recorded a realized loss in the amount of $13.9 million on this transaction. The proceeds related to this sale had not yet been received as of September 30, 2012 and were recorded as receivables from unsettled transactions in the Consolidated Statement of Assets and Liabilities.
 During the year ended September 30, 2011, the Company recorded investment realization events, including the following:
•
In October 2010, the Company received a cash payment of $8.7 million from Goldco, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

127
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


•
In November 2010, the Company received a cash payment of $11.0 million from TBA Global, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In November 2010, the Company restructured its investment in Vanguard Vinyl, Inc. The restructuring resulted in a realized loss in the amount of $1.7 million;
•
In December 2010, the Company restructured its investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a realized loss in the amount of $3.9 million;
•
In December 2010, the Company received a cash payment of $25.3 million from Boot Barn in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In December 2010, the Company received a cash payment of $11.7 million from Western Emulsions, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;
•
In December 2010, the Company restructured its investment in Lighting by Gregory, LLC. The restructuring resulted in a realized loss in the amount of $7.8 million;
•
In March 2011, the Company received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a realized loss in the amount of $0.3 million;
•
In March and April 2011, the Company received cash payments totaling $1.1 million from MK Network, LLC as part of a settlement of the loan agreement. In April 2011, the Company recorded a realized loss on this investment in the amount of $14.1 million;
•
In July 2011, the Company received a cash payment of $7.3 million from Filet of Chicken in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
•
In July 2011, the Company received a cash payment of $19.8 million from Cenegenics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
•
In August 2011, the Company terminated its interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation;
•
In September 2011, the Company received a cash payment of $19.1 million from Flatout, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction; and 
•
In September 2011, the Company received a cash payment of $0.1 million in connection with the sale of its investment in CPAC, Inc. The Company recorded a realized loss on this investment in the amount of $1.0 million.
During the years ended September 30, 2013, 2012 and 2011, the Company recorded net unrealized appreciation (depreciation) of $13.4 million, $56.0 million and ($6.5 million), respectively. For the year ended September 30, 2013, the Company’s net unrealized appreciation consisted of $16.4 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation) and $10.9 million of net unrealized appreciation on equity investments, offset by $13.9 million of net unrealized depreciation on debt investments.
For the year ended September 30, 2012, the Company’s net unrealized appreciation consisted of $66.6 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation), $0.1 million of net unrealized appreciation on equity investments, offset by $10.7 million of net unrealized depreciation on debt investments.
For the year ended September 30, 2011, the Company’s net unrealized depreciation consisted of $34.6 million of net unrealized depreciation on debt investments, offset by $25.6 million of net reclassifications to realized losses on investments and interest rate swaps (resulting in unrealized appreciation) and $2.5 million of net unrealized appreciation on equity investments.
Note 10. Concentration of Credit Risks

128
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


The Company places its cash in financial institutions and at times such balances may be in excess of the FDIC insured limit. The Company limits its exposure to credit loss by depositing its cash with high credit quality financial institutions and monitoring their financial stability.
Note 11. Related Party Transactions
The Company has entered into an investment advisory agreement with the Investment Adviser. Under the investment advisory agreement, the Company pays the Investment Adviser a fee for its services consisting of two components — a base management fee and an incentive fee.
Base management Fee
The base management fee is calculated at an annual rate of 2% of the Company’s gross assets, which includes any borrowings for investment purposes but excludes any cash and cash equivalents held at the end of each quarter. The base management fee is payable quarterly in arrears and the fee for any partial month or quarter is appropriately prorated.
For the year ended September 30, 2013, the Investment Adviser voluntarily waived the portion of the base management fee attributable to certain new investments, which resulted in aggregate waivers of $2.3 million.
For the years ended September 30, 2013, 2012 and 2011, base management fees (net of waivers) were $33.4 million, $23.8 million and $19.7 million, respectively. At September 30, 2013 and September 30, 2012, the Company had liabilities on its Consolidated Statements of Assets and Liabilities in the amounts of $9.6 million and $6.6 million, respectively, reflecting the unpaid portion of the base management fee payable to the Investment Adviser.
Incentive Fee
The incentive fee portion of the investment advisory agreement has two parts. The first part is calculated and payable quarterly in arrears based on the Company’s “Pre-Incentive Fee Net Investment Income” for the immediately preceding fiscal quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies) accrued during the fiscal quarter, minus the Company’s operating expenses for the quarter (including the base management fee, expenses payable under the Company’s administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding indebtedness or preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding fiscal quarter, will be compared to a “hurdle rate” of 2% per quarter (8% annualized), subject to a “catch-up” provision measured as of the end of each fiscal quarter. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of its gross assets used to calculate the 2% base management fee. The operation of the incentive fee with respect to the Company’s Pre-Incentive Fee Net Investment Income for each quarter is as follows:
•
No incentive fee is payable to the Investment Adviser in any fiscal quarter in which the Company’s Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);
•
100% of the Company's Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than or equal to 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser. The Company refers to this portion of its Pre-Incentive Fee Net Investment Income (which exceeds the hurdle rate but is less than or equal to 2.5%) as the “catch-up.” The “catch-up” provision is intended to provide the Investment Adviser with an incentive fee of 20% on all of the Company's Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when the Company's Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and
•
20% of the amount of the Company's Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser once the hurdle is reached and the catch-up is achieved (20% of all Pre-Incentive Fee Net Investment Income thereafter is allocated to the Investment Adviser).
The second part of the incentive fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date) and equals 20% of the Company’s realized capital gains, if any, on a

129
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


cumulative basis from inception through the end of each fiscal year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees.
GAAP requires the Company to accrue for the theoretical capital gains incentive fee that would be payable after giving effect to the net realized and unrealized capital appreciation. It should be noted that a fee so calculated and accrued would not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of capital gains incentive fees in subsequent periods. Amounts ultimately paid under the investment advisory agreement will be consistent with the formula reflected in the investment advisory agreement. The Company does not currently accrue for capital gains incentive fees due to the accumulated realized losses in the portfolio.
For the years ended September 30, 2013, 2012 and 2011, incentive fees were $28.2 million, $22.0 million and $16.8 million, respectively. At September 30, 2013 and September 30, 2012, the Company had liabilities on its Consolidated Statements of Assets and Liabilities in the amounts of $7.2 million and $5.6 million, respectively, reflecting the unpaid portion of the incentive fee payable to the Investment Adviser.
Indemnification
The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of their respective duties or by reason of the reckless disregard of their respective duties and obligations, the Company’s Investment Adviser and its officers, managers, agents, employees, controlling persons, members (or their owners) and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Investment Adviser’s services under the investment advisory agreement or otherwise as the Company’s Investment Adviser.
Administration Agreement
The Company has also entered into an administration agreement with FSC, Inc. under which FSC, Inc. provides administrative services for the Company, including office facilities and equipment, and clerical, bookkeeping and recordkeeping services at such facilities. Under the administration agreement, FSC, Inc. also performs or oversees the performance of the Company’s required administrative services, which includes being responsible for the financial records which the Company is required to maintain and preparing reports to the Company’s stockholders and reports filed with the SEC. In addition, FSC, Inc. assists the Company in determining and publishing the Company’s net asset value, overseeing the preparation and filing of the Company’s tax returns and the printing and dissemination of reports to the Company’s stockholders, and generally overseeing the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. For providing these services, facilities and personnel, the Company reimburses FSC, Inc. the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement, including rent and the Company’s allocable portion of the costs of compensation and related expenses of the Company’s chief financial officer and chief compliance officer and their staffs. Such reimbursement is at cost with no profit to, or markup by, FSC, Inc. FSC, Inc. may also provide, on the Company’s behalf, managerial assistance to the Company’s portfolio companies. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.
For the year ended September 30, 2013, the Company accrued administrative expenses of $4.3 million, including $2.3 million of general and administrative expenses, which are due to FSC, Inc. At September 30, 2013, $0.8 million was included in Due to FSC, Inc. in the Consolidated Statement of Assets and Liabilities. For the year ended September 30, 2013, the Company accrued administrative expenses of $4.1 million, including $2.1 million of general and administrative expenses, which were due to FSC, Inc. 

130
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Note 12. Financial Highlights
 
 
Year Ended
September 30,
2013
 
Year Ended
September 30,
2012
 
Year Ended
September 30,
2011
 
Year Ended
September 30,
2010
 
Year Ended
September 30,
2009
Net asset value at beginning of period
 
$9.92
 
$10.07
 
$10.43
 
$10.84
 
$13.02
Net investment income
 
1.04
 
1.11
 
1.05
 
0.95
 
1.27
Net unrealized appreciation (depreciation) on investments and interest rate swap
 
0.12
 
0.70
 
(0.10)
 
(0.04)
 
(0.44)
Net realized loss on investments and interest rate swap
 
(0.24)
 
(0.81)
 
(0.47)
 
(0.42)
 
(0.58)
Distributions of ordinary income
 
(0.90)
 
(1.04)
 
(1.20)
 
(0.96)
 
(1.19)
Tax return of capital
 
(0.25)
 
(0.14)
 
(0.06)
 
—
 
(0.01)
Net issuance of common stock
 
0.16
 
0.03
 
0.42
 
0.06
 
(1.23)
Net asset value at end of period
 
$9.85
 
$9.92
 
$10.07
 
$10.43
 
$10.84
Per share market value at beginning of period
 
$10.98
 
$9.32
 
$11.14
 
$10.93
 
$10.05
Per share market value at end of period
 
$10.29
 
$10.98
 
$9.32
 
$11.14
 
$10.93
Total return(1)
 
4.89%
 
32.59%
 
(6.76)%
 
11.22%
 
26.86%
Common shares outstanding at beginning of period
 
91,048
 
72,376
 
54,550
 
37,879
 
22,614
Common shares outstanding at end of period
 
139,041
 
91,048
 
72,376
 
54,550
 
37,879
Net assets at beginning of period
 
$903,570
 
$728,627
 
$569,172
 
$410,556
 
$294,336
Net assets at end of period
 
$1,368,872
 
$903,570
 
$728,627
 
$569,172
 
$410,556
Average net assets(2)
 
$1,095,225
 
$790,921
 
$677,354
 
$479,004
 
$291,401
Ratio of net investment income to average net assets
 
10.50%
 
11.13%
 
9.91%
 
8.98%
 
10.76%
Ratio of total expenses to average net assets(3)
 
9.74%
 
9.95%
 
8.79%
 
5.74%
 
6.34%
Ratio of portfolio turnover to average investments at fair value
 
38.22%
 
29.74%
 
7.26%
 
2.24%
 
—%
Weighted average outstanding debt(4)
 
$597,596
 
$421,366
 
$247,549
 
$22,592
 
$5,019
Average debt per share
 
$5.42
 
$5.30
 
$3.86
 
$0.50
 
$0.20
 __________
(1)
Total return equals the increase or decrease of ending market value over beginning market value, plus distributions, divided by the beginning market value, assuming dividend reinvestment prices obtained under the Company's dividend reinvestment plan.
(2)
Calculated based upon the weighted average net assets for the period.
(3)
The ratio of total expenses to average net assets excluding voluntary fee waivers would be 9.95% for the year ended September 30, 2013.
(4)
Calculated based upon the weighted average of loans payable for the period.

131
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


Note 13. Interest Rate Swap
In August 2010, the Company entered into a three-year interest rate swap agreement to mitigate its exposure to adverse fluctuations in interest rates for a total notional amount of $100.0 million. Under the interest rate swap agreement, the Company paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR.
Swaps contain varying degrees of off-balance sheet risk which could result from changes in the market values of underlying assets, indices or interest rates and similar items. As a result, the amounts recognized in the Consolidated Statement of Assets and Liabilities at any given date may not reflect the total amount of potential losses that the Company could ultimately incur.
In August 2011, the Company terminated the interest rate swap agreement and realized a loss of $1.3 million, which includes a reclassification of $0.8 million of prior unrealized depreciation.
As of September 30, 2013, the Company was no longer party to any interest rate swap agreements.
Note 14. Convertible Notes
On April 12, 2011, the Company issued $152 million unsecured convertible notes, including $2 million issued to Leonard M. Tannenbaum, the Company’s Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between the Company and the Trustee.
The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per annum payable semiannually in arrears on April 1 and October 1 of each year. The Convertible Notes are the Company’s unsecured obligations and rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including existing unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries or financing vehicles.
Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when the Company’s shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, the Company will deliver shares of its common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of the Company’s common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115 million convertible debt outstanding at September 30, 2013 is 7,790,273. If the Company delivers shares of common stock upon a conversion at the time that net asset value per share exceeds the conversion price in effect at such time, the Company’s stockholders may incur dilution. In addition, the Company’s stockholders will experience dilution in their ownership percentage of common stock upon the issuance of common stock in connection with the conversion of the Company’s convertible notes and any dividends paid on common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.
The Company may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect of the Company, holders of the Convertible Notes may require the Company to repurchase for cash all or part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
The Indenture contains certain covenants, including covenants requiring the Company to provide financial information to the holders of the Convertible Notes, and the Trustee if the Company ceases to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture.
For the years ended September 30, 2013, 2012 and 2011, the Company recorded interest expense of $6.8 million, $7.1 million, and $4.1 million, respectively, related to the Convertible Notes.

132
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)



The Company may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by the Company may, at the Company’s option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by the Company. Any Convertible Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the indenture. The Company did not repurchase Convertible Notes during the year ended September 30, 2013. During the year ended September 30, 2012, the Company repurchased $20.0 million principal of the Convertible Notes in the open market for an aggregate purchase price of $17.9 million and surrendered them to the Trustee for cancellation. The Company recorded a gain on the extinguishment of these Convertible Notes in the amount of the difference between the reacquisition price and the net carrying amount, net of the proportionate amount of unamortized debt issuance costs. The net gain recorded was $1.6 million.
As of September 30, 2013, there were $115.0 million Convertible Notes outstanding, which had a fair value of $122.3 million.
Note 15. Unsecured Notes
2024 Notes
On October 18, 2012, the Company issued $75.0 million in aggregate principal amount of its 5.875% unsecured notes due 2024 (the “2024 Notes”) for net proceeds of $72.5 million after deducting underwriting commissions of $2.2 million and offering costs of $0.3 million.
The 2024 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the first supplemental indenture, dated October 18, 2012 (collectively, the “2024 Notes Indenture”), between the Company and the Trustee. The 2024 Notes are the Company’s unsecured obligations and rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the 2024 Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including existing unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries or financing vehicles.
Interest on the 2024 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 5.875% per annum. The 2024 Notes mature on October 30, 2024 and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after October 30, 2017. The 2024 Notes are listed on the New York Stock Exchange under the trading symbol “FSCE” with a par value of $25.00 per share.
The 2024 Notes Indenture contains certain covenants, including covenants requiring the Company’s compliance with (regardless of whether the Company is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring the Company to provide financial information to the holders of the 2024 Notes and the Trustee if the Company ceases to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2024 Notes Indenture. The Company may repurchase the 2024 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2024 Notes repurchased by the Company may, at the Company’s option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by the Company. Any 2024 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2024 Notes Indenture. During the years ended September 30, 2013, the Company did not repurchase any of the 2024 Notes in the open market.
For the year ended September 30, 2013, the Company recorded interest expense of $4.4 million related to the 2024 Notes.
As of September 30, 2013, there were $75.0 million 2024 Notes outstanding, which had a fair value of $72.9 million.
2028 Notes
In April and May 2013, the Company issued $86.3 million in aggregate principal amount of its 6.125% unsecured notes due 2028 (the "2028 Notes") for net proceeds of $83.4 million after deducting underwriting commissions of $2.6 million and offering costs of $0.3 million. The proceeds included the underwriters’ full exercise of their overallotment option.
The 2028 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the second supplemental indenture, dated April 4, 2013 (collectively, the “2028 Notes Indenture”), between the Company and the Trustee. The 2028 Notes are the Company's unsecured obligations and rank senior in right of payment to the Company's existing and future indebtedness that is expressly subordinated in right of payment to the 2028 Notes; equal in right of payment to the Company's existing and future unsecured

133
FIFTH STREET FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts, percentages and as otherwise indicated)


indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company's secured indebtedness (including existing unsecured indebtedness that it later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company's subsidiaries or financing vehicles. Interest on the 2028 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 6.125% per annum. The 2028 Notes mature on April 30, 2028 and may be redeemed in whole or in part at any time or from time to time at the Company's option on or after April 30, 2018. The 2028 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FSCFL” with a par value of $25.00 per share.
The 2028 Notes Indenture contains certain covenants, including covenants requiring the Company's compliance with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring the Company to provide financial information to the holders of the 2028 Notes and the Trustee if it ceases to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2028 Notes Indenture. The Company may repurchase the 2028 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2028 Notes repurchased by the Company may, at its option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by the Company. Any 2028 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2028 Notes Indenture. During the year ended September 30, 2013, the Company did not repurchase any of the 2028 Notes in the open market.
For the year ended September 30, 2013, the Company recorded interest expense of $2.7 million related to the 2028 Notes.
As of September 30, 2013, there were $86.3 million 2028 Notes outstanding, which had a fair value of $78.1 million.

Note 16. Subsequent Events
The Company’s management evaluated subsequent events through the date of issuance of these Consolidated Financial Statements. There have been no subsequent events that occurred during such period that would require disclosure in, or would be required to be recognized in, the Consolidated Financial Statements as of and for the year ended September 30, 2013.


134


Schedule 12-14
Fifth Street Finance Corp.
(in thousands, except share and per share amounts, percentages and as otherwise indicated)
Schedule of Investments in and Advances to Affiliates
Year ended September 30, 2013
 
Portfolio Company/Type of Investment(1)
 
Amount of
Interest,
Fees or
Dividends
Credited in
Income(2)
 
Fair Value
at October 1,
2012
 
Gross
Additions(3)
 
Gross
Reductions(4)
 
Fair Value
at September 30,
2013
Control Investments
 
 
 
 
 
 
 
 
 
 
Coll Materials Group LLC
 
 
 
 
 
 
 
 
 
 
Second Lien Term Loan A, 12% cash due 11/1/2014
 
230

 
1,238

 
—

 
(1,238
)
 
—

Second Lien Term Loan B, 14% PIK due 11/1/2014
 
58

 
1,999

 
—

 
(1,999
)
 
—

50% interest in CD HOLDCO, LLC
 
—

 
—

 
—

 
—

 
—

Traffic Solutions Holdings, Inc. (formerly Statewide Holdings, Inc.)
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, L+8.5% (1.25% floor) cash due 8/10/2015
 
1,326

 
15,023

 
524

 
(15,547
)
 
—

Second Lien Term Loan, 12% cash 3% PIK due 12/31/2016
 
2,283

 
14,068

 
607

 
(176
)
 
14,499

First Lien Revolver, L+8.5% (1.25% floor) cash due 8/10/2015
 
35

 
—

 
146

 
(146
)
 
—

LC Facility, 8.5% cash due 12/31/2016
 
341

 
—

 
14

 
(14
)
 
—

746,114 Series A Preferred Units
 
778

 
14,377

 
1,514

 
—

 
15,891

746,114 Common Stock Units
 
—

 
6,535

 
4,920

 
(926
)
 
10,529

TransTrade Operators, Inc.
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan, 11% cash 3% PIK due 5/31/2016
 
655

 
—

 
13,666

 
(142
)
 
13,524

596.67 Series A Common Units in TransTrade Holding LLC
 
—

 
—

 
—

 
—

 
—

3,033,333.33 Preferred Units in TransTrade Holding LLC
 
—

 
—

 
3,033

 
(2,494
)
 
539

HFG Holdings, LLC
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan, 6% cash 4% PIK due 6/10/2019
 
5,837

 
—

 
96,297

 
(3,000
)
 
93,297

860,000 Class A Units
 
—

 
—

 
22,347

 
(1
)
 
22,346

 First Star Aviation, LLC
 
 
 
 
 
 
 
 
 
 
 First Lien Term Loan, 9% cash 3% PIK due 1/9/2018
 
874

 
—

 
19,742

 
(531
)
 
19,211

 5,264,207 Common Units
 
—

 
—

 
5,264

 
—

 
5,264

 Eagle Hospital Physicians, LLC
 
 
 
 
 
 
 
 
 
 
 First Lien Term Loan A, 8% PIK due 8/1/2016
 
150

 
—

 
11,150

 
(1
)
 
11,149

 First Lien Term Loan B, 8.1% PIK due 8/1/2016
 
41

 
—

 
3,050

 
—

 
3,050

 First Lien Revolver, 8% cash due 8/1/2016
 
41

 
—

 
—

 
—

 
—

 4,100,000 Class A Common Units
 
—

 
—

 
6,203

 
—

 
6,203

Total Control Investments
 
$
12,649

 
$
53,240

 
$
188,477

 
$
(26,215
)
 
$
215,502

Affiliate Investments
 
 
 
 
 
 
 
 
 
 
Caregiver Services, Inc.
 
 
 
 
 
 
 
 
 
 
1,080,399 shares of Series A Preferred Stock
 
—

 
2,924

 
350

 
(18
)
 
3,256

AmBath/ReBath Holdings, Inc.
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2016
 
438

 
4,268

 
112

 
(1,108
)
 
3,272

First Lien Term Loan B, 12.5% cash 2.5% PIK due 4/30/2016
 
3,806

 
23,995

 
1,415

 
(93
)
 
25,317

4,668,788 shares of Preferred Stock
 
—

 
—

 
87

 
—

 
87

Total Affiliate Investments
 
$
4,244

 
$
31,187

 
$
1,964

 
$
(1,219
)
 
$
31,932

Total Control & Affiliate Investments
 
$
16,893

 
$
84,427

 
$
190,441

 
$
(27,434
)
 
$
247,434


135


This schedule should be read in connection with the Company’s Consolidated Financial Statements, including the Consolidated Schedules of Investments and Notes to the Consolidated Financial Statements.
______________________
(1)
The principal amount and ownership detail as shown in the Consolidated Schedules of Investments.
(2)
Represents the total amount of interest, fees and dividends credited to income for the portion of the year an investment was included in the Control or Non-Control/Non-Affiliate categories, respectively.
(3)
Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on Investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as the movement of an existing portfolio company into this category or out of a different category.
(4)
Gross reductions include decreases in the cost basis of investment resulting from principal payments or sales and exchanges of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.


136


Schedule 12-14
Fifth Street Finance Corp.
(in thousands, except share and per share amounts, percentages and as otherwise indicated)
Schedule of Investments in and Advances to Affiliates
Year ended September 30, 2012
Portfolio Company/Type of Investment(1)
 
Amount of
Interest,
Fees or
Dividends
Credited in
Income(2)
 
Fair Value
at October 1,
2011
 
Gross
Additions(3)
 
Gross
Reductions(4)
 
Fair Value
at September 30,
2012
Control Investments
 
 
 
 
 
 
 
 
 
 
Lighting by Gregory, LLC
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, 9.75% PIK due 2/28/2013
 
$
60

 
$
2,526

 
$
3,318

 
$
(5,844
)
 
$
—

First Lien Bridge Loan, 8% PIK due 3/31/2012
 
6

 
—

 
113

 
(113
)
 
—

97.38% membership interest
 
—

 
—

 
1,210

 
(1,210
)
 
—

Nicos Polymers & Grinding, Inc.(5)
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan, 8% cash due 12/4/2017
 
110

 
5,190

 
200

 
(5,390
)
 
—

First Lien Revolver, 8% cash due 12/4/2017
 
10

 
1,551

 
—

 
(1,551
)
 
—

50% membership interest
 
—

 
5,233

 
—

 
(5,233
)
 
—

Coll Materials Group LLC(5)
 
 
 
 
 
 
 
 
 
 
Second Lien Term Loan A, 12% cash due 11/1/2014
 
558

 
—

 
7,103

 
(5,865
)
 
1,238

Second Lien Term Loan B, 14% PIK due 11/1/2014
 
40

 
—

 
2,040

 
(41
)
 
1,999

50% interest in CD HOLDCO, LLC
 
—

 
—

 
8,709

 
(8,709
)
 
—

Statewide Holdings, Inc.
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, L+8.5% (1.25% floor) cash due 8/10/2014
 
661

 
—

 
15,496

 
(473
)
 
15,023

First Lien Term Loan B, 12% cash 3% PIK due 8/10/2014
 
721

 
—

 
14,510

 
(442
)
 
14,068

First Lien Revolver, L+8.5% (1.25% floor) cash due 8/10/2014
 
157

 
—

 
157

 
(157
)
 
—

LC Facility, 8.5% cash due 8/10/2014
 
198

 
—

 
157

 
(157
)
 
—

746,114 Series A Preferred Units
 
—

 
—

 
14,377

 
—

 
14,377

746,114 Common Stock Units
 
—

 
—

 
6,535

 
—

 
6,535

Total Control Investments
 
$
2,521

 
$
14,500

 
$
73,925

 
$
(35,185
)
 
$
53,240

Affiliate Investments
 
 
 
 
 
 
 
 
 
 
O’Currance, Inc.
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012
 
25

 
3,173

 
9,320

 
(12,493
)
 
—

First Lien Term Loan B, 12.875% cash 4% PIK due 3/21/2012
 
13

 
324

 
953

 
(1,277
)
 
—

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

 
—

 
130

 
(130
)
 
—

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

 
—

 
250

 
(250
)
 
—

Caregiver Services, Inc.
 
 
 
 
 
 
 
 
 
 
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013
 
643

 
5,843

 
185

 
(6,028
)
 
—

Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013
 
2,645

 
15,067

 
1,184

 
(16,251
)
 
—

1,080,399 shares of Series A Preferred Stock
 
—

 
1,490

 
1,434

 
—

 
2,924

AmBath/ReBath Holdings, Inc.
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014
 
113

 
—

 
4,268

 
—

 
4,268

First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014
 
923

 
—

 
24,126

 
(131
)
 
23,995

4,668,788 shares of Preferred Stock
 
—

 
—

 
—

 
—

 
—

Total Affiliate Investments
 
$
4,362

 
$
25,897

 
$
41,850

 
$
(36,560
)
 
$
31,187

Total Control & Affiliate Investments
 
$
6,883

 
$
40,397

 
$
115,775

 
$
(71,745
)
 
$
84,427


137


This schedule should be read in connection with the Company’s Consolidated Financial Statements, including the Consolidated Schedules of Investments and Notes to the Consolidated Financial Statements.
_____________________
(1)
The principal amount and ownership detail as shown in the Consolidated Schedules of Investments.
(2)
Represents the total amount of interest, fees and dividends credited to income for the portion of the year an investment was included in the Control or Non-Control/Non-Affiliate categories, respectively.
(3)
Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on Investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as the movement of an existing portfolio company into this category or out of a different category.
(4)
Gross reductions include decreases in the cost basis of investment resulting from principal payments or sales and exchanges of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.
(5)
Coll Materials Group LLC is the successor entity to Nicos Polymers & Grinding, Inc.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.

Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
 As of September 30, 2013 (the end of the period covered by this report), management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, at the end of such period, our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls and procedures.
(b) Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f), and for performing an assessment of the effectiveness of internal control over financial reporting as of September 30, 2013. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management performed an assessment of the effectiveness of our internal control over financial reporting as of September 30, 2013 based upon the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment, management determined that our internal control over financial reporting was effective as of September 30, 2013.
(c) Report of the Independent Registered Public Accounting Firm

138


The effectiveness of our internal control over financial reporting as of September 30, 2013 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
(d) Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal control over financing reporting that occurred during the fourth fiscal quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information
None.
PART III
We will file a definitive Proxy Statement for our 2014 Annual Meeting of Stockholders with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are incorporated by reference.

Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

Item 11. Executive Compensation
The information required by Item 11 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

Item 14. Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2014 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

PART IV

Item 15. Exhibits and Financial Statement Schedules
The following documents are filed or incorporated by reference as part of this Annual Report:

1. Consolidated Financial Statements

139


 
 
 
Page
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Assets and Liabilities as of September 30, 2013 and 2012
Consolidated Statements of Operations for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Statements of Changes in Net Assets for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the Years Ended September 30, 2013, 2012 and 2011
Consolidated Schedules of Investments as of September 30, 2013
Consolidated Schedules of Investments as of September 30, 2012
Notes to Consolidated Financial Statements
 
2. Financial Statement Schedule

The following financial statement schedule is filed herewith:
 
 
 
Schedule 12-14 — Investments in and advances to affiliates

3. Exhibits required to be filed by Item 601 of Regulation S-K
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:
 

140


 
 
 
 
 
3.1

  
Restated Certificate of Incorporation of the Registrant (Incorporated by reference to Exhibit 3.1 filed with Registrant’s Form 8-A (File No. 001-33901) filed on January 2, 2008).
 
 
3.2

  
Amended and Restated Bylaws of the Registrant (Incorporated by reference to Exhibit 3.2 filed with Registrant’s Form 8-A (File No. 001-33901) filed on January 2, 2008).
 
 
3.3

  
Certificate of Amendment to the Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit(a)(2) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-146743) filed on June 6, 2008).
 
 
3.4

  
Certificate of Correction to the Certificate of Amendment to the Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit(a)(3) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-146743) filed on June 6, 2008).
 
 
3.5

  
Certificate of Amendment to Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 filed with Registrant’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 5, 2010).
 
 
 
3.6

  
Certificate of Amendment to Registrant’s Certificate of Incorporation (Incorporated by reference to Exhibit (a)(5) filed with the Registrant’s Registration Statement on Form N-2 (File No. 333-180267) filed on April 2, 2013).

 
 
4.1

  
Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 filed with Registrant’s Form 8-A (File No. 001-33901) filed on January 2, 2008).
 
 
4.2

  
Indenture, dated April 12, 2011, relating to the 5.375% Convertible Notes due 2016, between Registrant and Deutsche Bank Trust Company Americas, as trustee (Incorporated by reference to Exhibit 4.1 filed with Registrant’s Form 8-K (File No. 001-33901) filed on April 12, 2011).
 
 
4.3

  
Form of 5.375% Convertible Notes due 2016 (Incorporated by reference to Exhibit 4.2 filed with Registrant’s Form 8-K (File No. 001-33901) filed on April 12, 2011).
 
 
4.4

  
Indenture, dated April 30, 2012, between Registrant and Deutsche Bank Trust Company Americas, as trustee (Incorporated by reference to Exhibit(d)(4) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-180267) filed on July 27, 2012).
 
 
4.5

  
Form of First Supplemental Indenture relating to the 5.875% Notes due 2024, between the Registrant and Deutsche Bank Trust Company Americas, as trustee (including Form of 5.875% Notes due 2024) (Incorporated by reference to Exhibit (d)(5) filed with the Registrant’s Registration Statement on Form N-2 (File No. 333-180267) filed on October 18, 2012).

 
 
4.6

  
Form of Second Supplemental Indenture relating to the 6.125% Notes due 2028, between the Registrant and Deutsche Bank Trust Company Americas, as trustee (including Form of 6.125% Notes due 2028) (Incorporated by reference to Exhibit (d)(7) filed with the Registrant’s Registration Statement on Form N-2 (File No. 333-180267) filed on April 2, 2013).
 
 
10.1

  
Second Amended and Restated Investment Advisory Agreement by and between Registrant and Fifth Street Management LLC (Incorporated by reference to Exhibit 10.5 filed with Registrant’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 4, 2011).
 
 

141


10.2

  
Amended and Restated Administration Agreement by and between Registrant and FSC, Inc. (Incorporated by reference to Exhibit 10.6 filed with Registrant’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 4, 2011).
 
 
10.3

  
Form of License Agreement by and between Registrant and Fifth Street Capital LLC (Incorporated by reference to Exhibit(k)(2) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-146743) filed on May 8, 2008).
 
 
10.4

  
Custody Agreement (Incorporated by reference to Exhibit 10.1 filed with Registrant’s Form 10-Q (File No. 001-33901) filed on January 31, 2011).
 
 
10.5

  
Amended and Restated Dividend Reinvestment Plan (Incorporated by reference to Exhibit(10.1) filed with Registrant’s Form 8-K (File No. 001-33901) filed on October 28, 2010).
 
 
10.6

  
Purchase and Sale Agreement by and between Registrant and Fifth Street Funding, LLC, dated as of November 16, 2009 (Incorporated by reference to Exhibit 10.7 filed with Registrant’s Annual Report on Form 10-K (File No. 001-33901) filed on December 9, 2009).
 
 
10.7

  
Amendment No. 1 to the Purchase and Sale Agreement by and between Registrant and Fifth Street Funding, LLC, dated as of November 30, 2011 (Incorporated by reference to Exhibit 10.2 filed with Registrant’s Form 8-K (File No. 001-33901) filed on December 5, 2011).
 
 
10.8

  
Pledge Agreement by and between Registrant and Wells Fargo Bank, N.A., dated as of November 16, 2009 (Incorporated by reference to Exhibit 10.8 filed with Registrant’s Annual Report on Form 10-K (File No. 001-33901) filed on December 9, 2009).
 
 
10.9

  
Omnibus Amendment No. 1 relating to Registrant’s credit facility with Wells Fargo Bank, N.A., dated as of May 26, 2010 (Incorporated by reference to Exhibit(k)(6) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-166012) filed on June 4, 2010).
 
 
10.10

  
Amended and Restated Loan and Servicing Agreement among Fifth Street Funding, LLC, Registrant, Wells Fargo Securities, LLC, and Wells Fargo Bank, N.A., dated as of November 5, 2010 (Incorporated by reference to Exhibit 10.6 filed with Registrant’s Annual Report on Form 10-K (File No. 001-33901) filed on December 2, 2010).
 
 
10.11

  
Amendment No. 1 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of February 25, 2011. (Incorporated by reference to Exhibit(k)(4) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).
 
 
10.12

  
Amendment No. 3 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of November 30, 2011. (Incorporated by reference to Exhibit 10.1 filed with Registrant’s Form 8-K (File No. 001-33901) filed on December 5, 2011).
10.13

  
Amendment No. 4 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of April 23, 2012 (Incorporated by reference to Exhibit 10.1 filed with Registrant’s Form 8-K (File No. 001-33901) filed on April 25, 2012).
 
 
 
10.14

 
Amendment No. 6 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of June 20, 2013 (Incorporated by reference to Exhibit 10.1 filed with the Registrant’s Form 8-K (File No. 001-33901) filed on June 24, 2013).


142


 
 
10.15

  
Guarantee, Pledge and Security Agreement among Registrant, FSFC Holdings, Inc., and ING Capital LLC, dated as of May 27, 2010 (Incorporated by reference to Exhibit(k)(8) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-166012) filed on June 4, 2010).
 
 
10.16

  
Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, ING Capital LLC, Royal Bank of Canada, UBS Loan Finance, LLC, Morgan Stanley Bank, N.A., Key Equipment Finance Inc., Deutsche Bank Trust Company Americas and Patriot National Bank, dated as of February 22, 2011 (Incorporated by reference to Exhibit(k)(8) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).
 
 
10.17

  
Amendment and Reaffirmation Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC and ING Capital LLC, dated as of February 22, 2011 (Incorporated by reference to Exhibit(k)(10) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).
 
 
10.18

  
Amendment No. 1 to Amended and Restated Senior Secured Revolving Credit Agreement and Amendment No. 2 to the Guarantee, Pledge and Security Agreement, among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Royal Bank of Canada, UBS Loan Finance LLC, Morgan Stanley Bank, N.A., Key Equipment Finance, Inc., Deutsche Bank Trust Company Americas and Patriot National Bank, dated as of July 8, 2011 (Incorporated by reference to Exhibit 10.1 filed with Registrant’s Form 8-K (File No. 001-33901) filed on July 14, 2011).
 
 
10.19

  
Amendment No. 2 to Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Key Equipment Finance, Inc. and UBS Loan Finance LLC, dated as of November 29, 2011 (Incorporated by reference to Exhibit 10.15 filed with Registrant’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).
 
 
10.2

  
Amendment No. 3 to Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of February 29, 2012 (Incorporated by reference to Exhibit 10.1 filed with Registrant’s Form 8-K (File No. 001-33901) filed on March 2, 2012).
 
 
 
10.21

 
Amendment No. 4 to Amended and Restated Senior Secured Revolving Credit Agreement among the Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of November 30, 2012 (Incorporated by reference to Exhibit 10.1 filed with the Registrant’s Form 8-K (File No. 001-33901) filed on December 4, 2012).

 
 
 
10.22

 
Amendment No. 5 to Amended and Restated Senior Secured Revolving Credit Agreement among the Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of August 6, 2013 (Incorporated by reference to Exhibit 10.2 filed with the Registrant’s Form 10-Q (File No. 814-00755) filed on August 7, 2013).

 
 
 
10.23

 
Amendment No. 6 to Amended and Restated Senior Secured Revolving Credit Agreement among the Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of September 13, 2013 (Incorporated by reference to Exhibit(k)(20) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-186101) filed on September 26, 2013).
 
 
10.24

  
Form of Incremental Assumption Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC and Increasing/Assuming Lender (Incorporated by reference to Exhibit 10.1 filed with the Registrant’s Form 8-K (File No. 001-33901) filed on October 24, 2013).
 
 

143


10.25

  
Waiver Letter among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Royal Bank of Canada and Key Equipment Finance, Inc., dated as of August 3, 2011 (Incorporated by reference to Exhibit 10.17 filed with Registrant’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).
 
 
10.26

  
Loan and Servicing Agreement among Registrant, Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of September 16, 2011 (Incorporated by reference to Exhibit 10.18 filed with Registrant’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).
 
 
10.27

  
Amendment No. 1 and Waiver to the Loan and Servicing Agreement among Registrant, Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of March 16, 2012 (Incorporated by reference to Exhibit 10.2 filed with Registrant’s Form 10-Q (File No. 001-33901) filed on May 8, 2012).
 
 
 
10.28

 
Amendment No. 2 to the Loan and Servicing Agreement among Registrant, Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of October 30, 2013 (Incorporated by reference to Exhibit 10.1 filed with the Registrant’s Form 8-K (File No. 001-33901) filed on October 24, 2013).

10.29

  
Purchase and Sale Agreement by and between Registrant and Fifth Street Funding II, LLC, dated as of September 16, 2011 (Incorporated by reference to Exhibit 10.19 filed with Registrant’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).
 
 
14.1

  
Joint Code of Ethics of the Registrant and Fifth Street Senior Floating Rate Corp. (Incorporated by reference to Exhibit(r)(1) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-186101) filed on September 26, 2013).
 
 
14.2

  
Code of Ethics of Fifth Street Management LLC (Incorporated by reference to Exhibit(r)(2) filed with Registrant’s Registration Statement on Form N-2 (File No. 333-159720) filed on June 4, 2009).
 
 
21

  
Subsidiaries of Registrant and jurisdiction of incorporation/organizations:
Fifth Street Funding, LLC — Delaware
Fifth Street Funding II, LLC — Delaware
Fifth Street Fund of Funds LLC — Delaware
Fifth Street Mezzanine Partners IV, L.P. — Delaware
Fifth Street Mezzanine Partners V, L.P. — Delaware
FSMP IV GP, LLC — Delaware
FSMP V GP, LLC — Delaware
FSFC Holdings, Inc. — Delaware
 
 
31.1*

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

  
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
 
 
 
32.1*

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

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

144


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
FIFTH STREET FINANCE CORP.
 
 
By:
 
/s/    Leonard M. Tannenbaum
 
 
Leonard M. Tannenbaum
 
 
Chairman and Chief Executive Officer
 
 
By:
 
/s/    Alexander C. Frank
 
 
Alexander C. Frank
 
 
Chief Financial Officer
Date: November 25, 2013
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 
 
 
 
 
Signature
  
Title
 
Date
 
 
 
/s/    LEONARD M. TANNENBAUM
Leonard M. Tannenbaum
  
Chairman and Chief Executive Officer
(principal executive officer)
 
November 25, 2013
 
 
 
/s/    ALEXANDER C. FRANK
Alexander C. Frank
  
Chief Financial Officer
(principal financial officer and
principal accounting officer)
 
November 25, 2013
 
 
 
/s/    BERNARD D. BERMAN
Bernard D. Berman
  
President and Secretary
 
November 25, 2013
 
 
 
/s/    BRIAN S. DUNN
Brian S. Dunn
  
Director
 
November 25, 2013
 
 
 
/s/    RICHARD P. DUTKIEWICZ
Richard P. Dutkiewicz
  
Director
 
November 25, 2013
 
 
 
/s/    BYRON J. HANEY
Byron J. Haney
  
Director
 
November 25, 2013
 
 
 
/s/    FRANK C. MEYER
Frank C. Meyer
  
Director
 
November 25, 2013
 
 
 
/s/    DOUGLAS F. RAY
Douglas F. Ray
  
Director
 
November 25, 2013

145