OCSL

SEC Filing Summary: Fifth Street Finance Corp. (10-Q)

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Fifth Street Finance Corp. (Note: The input metadata referenced "Oaktree Specialty Lending Corp," but the document text explicitly identifies the registrant as Fifth Street Finance Corp.) for the period ended March 31, 2010. The Company is an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a Business Development Company (BDC) under the Investment Company Act of 1940 and a Regulated Investment Company (RIC) under the Internal Revenue Code. Its primary objective is to maximize total return by generating current income from debt investments and capital appreciation from equity investments in small and mid-sized companies.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total investment income increased by approximately $6.0 million (50%) for the three months ended March 31, 2010, compared to the same period in 2009. This was driven primarily by higher average levels of outstanding debt investments due to the addition of eight new portfolio investments.
• Expense Increase: Total expenses increased by approximately $2.3 million for the quarter, primarily due to increases in the base management fee, incentive fee, and general administrative expenses. However, the Investment Adviser waived approximately $727,000 of the base management fee for the six-month period.
• Realized Losses: The Company recorded a net realized loss of $2.9 million for the quarter, primarily related to the sale of a portion of its interest in CPAC, Inc. and a reduction in a previously recorded loss on American Hardwoods Industries, LLC. This compares to a $12.4 million realized loss in the same period in 2009.
• Portfolio Deployment: The Company significantly deployed capital, with new investments totaling $177.4 million during the six months ended March 31, 2010, compared to $47.9 million in the prior year period. Consequently, cash and cash equivalents decreased from $113.2 million at September 30, 2009, to $23.5 million at March 31, 2010.
• Equity Capital: The Company completed a follow-on public offering in January 2010, raising approximately $77.5 million in net proceeds, increasing common shares outstanding from 37.9 million to 45.3 million.

Guidance, Outlook, and Risks

• SBIC License: On February 3, 2010, the Company's subsidiary received a license from the Small Business Administration (SBA) to operate as a Small Business Investment Company (SBIC). The SBA has issued a capital commitment of $75 million, allowing the subsidiary to borrow up to $150 million in SBA-guaranteed debentures once examined. As of April 21, 2010, the subsidiary drew $17.5 million.
• Investment Strategy: Management expects to grow the business by increasing average investment sizes and focusing more on first-lien transactions and floating-rate facilities with rate floors to protect against interest rate decreases.
• Liquidity and Distributions: The Company intends to distribute between 90% and 100% of taxable income to maintain RIC status. A dividend of $0.30 per share was paid on March 30, 2010. A subsequent dividend of $0.32 per share was declared on May 3, 2010.
• Recent Investments: Subsequent to the period end, the Company closed two significant senior secured debt facilities: an $11.0 million facility for a technology-based marketing services company and a $35.5 million facility for a healthcare equipment manufacturing company.
• Risks:
  • Internal Controls: The Company has identified deficiencies in internal control over financial reporting, including significant deficiencies and material weaknesses in the past, which could prevent accurate and timely reporting.
  • Market Conditions: Economic uncertainty and disruptions in financial markets could impact the ability of portfolio companies to meet obligations and the Company's ability to raise capital.
  • Unfunded Commitments: The Company has $35.4 million in unfunded commitments to portfolio companies, representing off-balance sheet credit risk.

Investor Verification Checklist

• Company Identity: Verify that the filing pertains to Fifth Street Finance Corp. (Ticker: FSC), not Oaktree Specialty Lending Corp., as indicated in the document header.
• SBIC Leverage: Confirm the status of the SBA examination required to access the full $150 million borrowing capacity under the SBIC license.
• Portfolio Quality: Review the "Portfolio Asset Quality" section noting that 3.52% of the portfolio (at fair value) is rated "5" (expecting loss of principal) and 1.61% is rated "3" (performing below expectations).
• Non-Accrual Status: Verify the status of the four investments on which the Company has stopped accruing PIK interest and OID, including two that missed scheduled cash interest payments.
• Exit Fee Accrual: Note the change in accounting policy to accrue exit fees on an accrual basis (starting Q4 2009) and assess the impact on future income recognition.
• Internal Controls: Review the specific nature of the identified internal control deficiencies and the remediation plan to assess reporting reliability.