Business Context and Reporting Period
Company: Apollo Investment Corporation (AIC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2017
Business Overview: AIC is a closed-end, externally managed business development company (BDC) and regulated investment company (RIC). It invests primarily in debt and equity of private middle-market companies. The company is managed by Apollo Investment Management, L.P., an affiliate of Apollo Global Management.
Key Financial Metrics
| Metric | Q2 2017 (Three Months Ended June 30) | Q2 2016 (Three Months Ended June 30) |
|---|---|---|
| Total Investment Income | $66.7 million | $76.5 million |
| Net Investment Income | $33.3 million | $36.1 million |
| Net Realized Gains (Losses) | ($233.8 million) | $8.5 million |
| Net Change in Unrealized Gains (Losses) | $229.2 million | ($86.7 million) |
| Net Increase in Net Assets from Operations | $28.8 million | ($42.1 million) |
| Earnings Per Share (Basic) | $0.13 | ($0.19) |
| Net Asset Value (NAV) Per Share | $6.73 | $6.74 (Beginning of Period) |
| Total Debt Outstanding | $938.8 million | $866.9 million (March 31, 2017) |
| Cash and Cash Equivalents | $29.9 million | $9.8 million (March 31, 2017) |
| Portfolio Turnover Rate (Annualized) | 42.70% | 23.25% (FY 2017) |
Material Changes vs. Prior Period
- Investment Income Decline: Total investment income decreased by $9.8 million (12.8%) compared to the prior year quarter. This was driven by a $5.9 million decrease in interest income due to a lower income-bearing portfolio and a decrease in overall yield to 10.3% from 11.0%. Dividend income also fell by $3.0 million due to exits from several portfolio companies.
- Expense Reduction: Net expenses decreased by $7.0 million (17.3%) to $33.4 million. This was primarily due to lower management and incentive fees (net of waivers) and a $2.6 million reduction in interest expenses following the repayment of Senior Secured Notes Series A in September 2016.
- Realized Losses: The company recognized a net realized loss of $233.8 million, a significant swing from the $8.5 million gain in the prior year. Major write-offs included Venoco, Inc. ($89.0 million), Delta Career Education Corporation ($72.8 million), and AIC SPV Holdings I, LLC ($44.3 million).
- Unrealized Gains: A net change in unrealized gains of $229.2 million offset the realized losses, largely due to the reversal of previously recorded unrealized losses on the same investments that were written off (Venoco, Delta, etc.).
- Liquidity: Cash and cash equivalents increased significantly from $9.8 million at March 31, 2017, to $29.9 million at June 30, 2017.
Guidance, Outlook, and Risks
- Management Commentary: Management noted that the decrease in investment income was due to a lower portfolio yield and exits of dividend-producing investments. The significant realized losses were attributed to write-offs where no proceeds were expected, which had been previously marked down as unrealized losses.
- Fee Waivers: The Investment Adviser waived 25% of the base management fee (reducing it from 2% to 1.5%) and up to 25% of the performance-based incentive fee for the period ending March 31, 2018, contingent on cumulative net losses.
- Distributions: On August 3, 2017, the Board declared a distribution of $0.15 per share, payable October 5, 2017. The company maintains an "opt-out" dividend reinvestment plan.
- Legal Proceedings:
- DSI Renal Holdings: Named as a defendant in a bankruptcy trustee complaint alleging fraudulent conveyance. The company intends to vigorously defend itself and has not determined the action is material.
- Energy & Exploration Partners (ENXP): Named in an adversary proceeding by the ENXP Trustee alleging fraudulent transfers. The company moved to dismiss the case.
- Risk Factors: The company faces risks related to the creditworthiness of portfolio companies, interest rate fluctuations (86% of the portfolio is floating rate), and the potential inability to maintain RIC status if distributions are insufficient.
Investor Verification Checklist
- Write-off Quality: Verify the specific reasons for the $233.8 million in realized losses, particularly the write-offs of Venoco, Delta Career Education, and AIC SPV Holdings, to assess the severity of credit deterioration in the portfolio.
- Fee Waiver Sustainability: Confirm the duration and conditions of the 25% management fee waiver and the performance fee waiver to understand future expense ratios.
- Debt Covenants: Review the asset coverage ratio and borrowing base compliance under the Senior Secured Facility, especially given the recent debt repayments and portfolio valuation changes.
- Non-Qualifying Assets: Monitor the percentage of non-qualifying assets (20.6% as of June 30, 2017) to ensure compliance with the 70% qualifying asset requirement under the 1940 Act.
- Legal Exposure: Track the status of the DSI Renal and ENXP legal proceedings to assess potential liability impacts.