Ares Capital Corporation 10-Q Summary
Business Context and Reporting Period
Company: Ares Capital Corporation (ARCC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006
Business Model: Closed-end, non-diversified management investment company regulated as a Business Development Company (BDC). The Company invests primarily in first and second lien senior loans, mezzanine debt, and equity in private U.S. middle-market companies. It is externally managed by Ares Capital Management LLC.
Key Financial Metrics
| Metric | Q1 2006 | Q1 2005 |
|---|---|---|
| Total Investment Income | $20,191,305 | $5,750,592 |
| Total Expenses | $8,290,890 | $2,220,763 |
| Net Investment Income | $11,691,535 | $3,529,829 |
| Net Realized Gains | $610,886 | $409,030 |
| Net Unrealized Gains | $1,540,612 | $4,565,047 |
| Net Increase in Stockholders' Equity | $13,843,033 | $8,503,906 |
| Earnings Per Share (Basic & Diluted) | $0.36 | $0.69 |
| Net Assets (Total Equity) | $571,375,338 | $346,320,100 |
| Net Asset Value Per Share | $15.03 | $14.96 |
| Total Assets | $778,620,556 | $613,645,144 |
| Total Liabilities | $207,245,218 | $44,032,945 |
| Cash and Cash Equivalents | $19,034,286 | $16,613,334 |
| Outstanding Borrowings | $185,200,000 | $18,000,000 |
Portfolio Yield: The weighted average yield on the entire portfolio was 11.07% as of March 31, 2006. The weighted average yield on new income-producing investments funded in Q1 2006 was approximately 12.12%.
Material Changes vs. Prior Period
- Investment Income Surge: Total investment income increased 251% to $20.2 million, driven by a significant expansion in portfolio size (average investments at fair value grew from $198.2 million in Q1 2005 to $647.0 million in Q1 2006).
- Expense Growth: Total expenses increased 273% to $8.3 million. This was primarily due to higher base management fees ($2.5M vs $0.8M) and incentive fees ($2.9M vs $0.2M) resulting from the larger asset base, as well as increased interest expense ($1.3M vs $0.4M) due to higher borrowings.
- Leverage Increase: Outstanding borrowings jumped from $18.0 million to $185.2 million. This includes $109.2 million under the CP Funding Facility and $76.0 million under a new Revolving Credit Facility established in late 2005.
- Unrealized Gains: Net unrealized gains decreased to $1.5 million from $4.6 million in the prior year. This was due to a $4.0 million increase in unrealized appreciation for CICQ, LP, partially offset by a $2.4 million increase in unrealized depreciation for Making Memories Wholesale, Inc.
- EPS Dilution: While total net increase in equity grew, EPS decreased from $0.69 to $0.36 due to a significant increase in weighted average shares outstanding (from 12.3 million to 38.0 million) following public offerings in 2005.
Guidance, Outlook, Risks, and Unusual Items
- Investment Activity: The Company issued 13 new commitments totaling $209.6 million in Q1 2006, funding $195.4 million. Remaining unfunded commitments were $14.2 million.
- Dividends: A dividend of $0.36 per share was declared for the quarter, totaling $13.7 million. The Company maintains a dividend reinvestment plan.
- Regulatory Inquiry: The SEC's Fort Worth District Office raised issues regarding the clarity of the Advisory Agreement concerning the calculation of the capital gains portion of the incentive fee. The Investment Adviser agreed to use the calculation method resulting in the lowest fee until stockholders vote to amend the agreement. Management does not expect a material adverse effect.
- Interest Rate Risk: Approximately 61% of the portfolio is at variable rates. A 100 basis point increase in base rates would increase interest income by ~$5.0 million and interest expense by ~$1.9 million over the next 12 months. The Company utilizes a costless collar agreement to manage fixed-rate exposure.
- Commitments: The Company has $37.5 million in unfunded commitments for revolving senior secured loans and $2.3 million in standby letters of credit outstanding.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with the 200% asset coverage ratio required by the 1940 Act and specific covenants of the new Revolving Credit Facility.
- Portfolio Valuation: Review the Board's fair value determination process for non-publicly traded securities, which constitute the majority of the portfolio.
- Incentive Fee Resolution: Monitor the upcoming stockholder vote to amend the Advisory Agreement regarding the capital gains incentive fee calculation methodology.
- Liquidity Position: Assess the impact of the CP Funding Facility expiration (November 1, 2006) and the Company's ability to refinance or extend the facility.
- Concentration Risk: Note that the portfolio is non-diversified; verify the performance of top holdings such as CICQ, LP (11.60% of net assets) and American Renal Associates.