ARES CAPITAL CORP - 10-Q Summary (Period Ended Sep 30, 2005)
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) under the Investment Company Act of 1940. The company invests primarily in first and second lien senior loans, mezzanine debt, and equity in private U.S. middle-market companies. This report covers the quarterly period ended September 30, 2005, and the nine months ended on that date. The company commenced substantial investment operations in October 2004; therefore, there is no comparable prior-year period for the three or nine months ended September 30, 2005.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2005 | Nine Months Ended Sep 30, 2005 |
|---|---|---|
| Total Investment Income | $11,607,989 | $26,960,196 |
| Total Expenses | $5,363,711 | $11,417,954 |
| Net Investment Income | $6,244,278 | $15,542,242 |
| Net Realized Gains | $3,188,703 | $10,343,115 |
| Net Unrealized Gains | $448,909 | $102,696 |
| Net Increase in Stockholders' Equity | $9,881,890 | $25,988,053 |
| Earnings Per Share (Basic & Diluted) | $0.42 | $1.33 |
| Net Assets Per Share | $15.08 (Sep 30, 2005) | $14.43 (Dec 31, 2004) |
| Total Assets | $444,927,588 | $220,455,614 (Dec 31, 2004) |
| Cash and Cash Equivalents | $15,408,955 | $26,806,160 (Dec 31, 2004) |
| Debt (Credit Facility Payable) | $82,000,000 | $55,500,000 (Dec 31, 2004) |
| Portfolio Yield (Weighted Average) | 10.67% | N/A |
Material Changes and Portfolio Activity
- Capital Raising: The company completed an add-on offering in March 2005, raising net proceeds of approximately $183.9 million. A subsequent offering in October 2005 (post-period) raised approximately $213.8 million.
- Investment Growth: Total investments at fair value increased from $182.6 million at year-end 2004 to $424.4 million at September 30, 2005. The portfolio now consists of 30 portfolio companies.
- Debt Utilization: Borrowings under the credit facility increased from $55.5 million to $82.0 million. The facility capacity was increased to $225.0 million in April 2005 and subsequently to $350.0 million in November 2005.
- Realized Gains: The company generated significant net realized gains of $10.3 million for the nine-month period, driven by sales and repayments totaling $104.1 million.
- Payment-in-Kind (PIK) Interest: Non-cash PIK interest income recorded was $2.2 million for the nine months ended September 30, 2005.
Outlook, Risks, and Contingencies
- SEC Inquiry: The Fort Worth District Office of the SEC conducted an examination regarding the clarity of the Advisory Agreement and the calculation method for the capital gains portion of the incentive fee. The Investment Adviser has agreed to use the calculation method resulting in the lowest fee payment until the next stockholder meeting to clarify the agreement. Management does not expect a material adverse effect.
- Interest Rate Risk: Approximately 55% of the portfolio is at variable rates. A 100 basis point increase in base rates would increase interest income by approximately $2.2 million and interest expense by $0.8 million over the next 12 months. The company utilizes a costless collar agreement to manage fixed-rate exposure.
- Valuation Risk: Substantially all portfolio investments are valued at fair value by the board of directors due to the lack of readily available market prices. Actual realized values may differ materially from current valuations.
- Commitments: As of September 30, 2005, the company had $27.9 million in unfunded commitments for revolving senior secured loans.
Key Facts for Investor Verification
- Verify the resolution of the SEC inquiry regarding the incentive fee calculation methodology and the outcome of the upcoming stockholder vote.
- Monitor the deployment of capital from the October 2005 add-on offering ($213.8 million) and its impact on portfolio yield and leverage ratios.
- Review the credit quality of the portfolio, noting the weighted average investment grade is 3.0 (on a scale of 1-4, where 4 is lowest risk).
- Assess the impact of the credit facility maturity extension to November 1, 2006, and the reduction in interest rate spread (CP rate + 75 bps).
- Confirm the sustainability of the dividend payout, which totaled $0.96 per share for the nine-month period, against net investment income.