ARCC

Business Context and Reporting Period

Ares Capital Corporation (ARCC) is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC). The filing covers the quarterly period ended March 31, 2010. During this period, the Company completed a public add-on equity offering and was in the final stages of acquiring Allied Capital Corporation, a transaction consummated on April 1, 2010.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased 19% to $66.5 million, driven primarily by an 18% increase in interest income from investments due to a larger portfolio (average fair value increased from $2.0 billion to $2.2 billion).
• Expense Increase: Total expenses rose 36% to $35.0 million. This included a $3.8 million increase in professional fees specifically related to the Allied Capital acquisition and higher interest expense due to debt amortization.
• Unrealized Gains: The Company reported a significant swing from a $19.9 million unrealized loss in Q1 2009 to a $49.6 million unrealized gain in Q1 2010. Key contributors to appreciation included R3 Education, Inc. ($14.4 million) and Things Remembered, Inc. ($4.6 million).
• Debt Reduction: Total debt decreased by approximately $198 million to $771.4 million, aided by the February 2010 equity offering which raised $277.2 million in net proceeds.

Guidance, Outlook, and Risks

• Allied Capital Acquisition: The Company consummated the acquisition of Allied Capital on April 1, 2010, for approximately $907 million in stock. This transaction significantly expanded the Company's portfolio and market capitalization. The Company assumed approximately $745 million of Allied Capital's unsecured notes.
• Capital Resources: Following the equity offering and debt repayments, the Company had approximately $509.9 million available for additional borrowings under its facilities as of March 31, 2010. The Revolving Credit Facility was amended to increase capacity to $690 million (with potential to reach $740 million).
• Portfolio Valuation Risks: The Company notes that substantially all investments are valued at fair value determined by the Board of Directors. Due to the lack of readily available market values, these valuations involve uncertainty and may differ materially from values realized upon liquidation.
• Legal Proceedings: Several shareholder lawsuits challenging the Allied Acquisition were filed. As of the filing date, the Company had reached agreements in principle to settle these actions, subject to court approval.
• Interest Rate Risk: Approximately 51% of the portfolio was at fixed rates and 33% at variable rates as of March 31, 2010. The Company utilizes an interest rate swap agreement to mitigate exposure to adverse rate fluctuations.

Investor Verification Checklist

• Acquisition Integration: Verify the final accounting treatment and fair value adjustments for the Allied Capital acquisition, as initial accounting was not complete at the time of filing.
• Debt Covenants: Confirm continued compliance with asset coverage ratios (303% as of March 31, 2010) and borrowing base restrictions under the Revolving Credit Facility and CP Funding Facility.
• Portfolio Valuation: Review the specific valuation methodologies and independent firm reviews for the top unrealized gain contributors (e.g., R3 Education, Things Remembered) to assess sustainability.
• Settlement Costs: Monitor the final approval and cost of the shareholder litigation settlements related to the Allied Acquisition.
• Dividend Sustainability: Assess the impact of the acquisition on future dividend coverage, noting the Company declared a $0.35 per share dividend for the quarter.