UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
For the transition period to
Commission File No. 000-50697
ARES CAPITAL CORPORATION
(Exact name of Registrant as specified in its charter)
Maryland
33-1089684
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
280 Park Avenue, 22nd Floor, New York, NY 10017
(Address of principal executive office) (Zip Code)
(212) 750-7300
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at August 8, 2006
Common stock, $0.001 par value
48,988,504
INDEX
Part I.
Financial Information
Item 1.
Financial Statements.
Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005
Consolidated Schedules of Investments as of June 30, 2006 (unaudited) and December 31, 2005
Consolidated Statement of Operations for the three and six months ended June 30, 2006 (unaudited) and June 30, 2005 (unaudited)
Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2006 (unaudited) and June 30, 2005 (unaudited)
Consolidated Statement of Cash Flows for the six months ended June 30, 2006 (unaudited) and June 30, 2005 (unaudited)
Notes to Consolidated Financial Statements (unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
Item 4.
Controls and Procedures.
Part II.
Other Information
Legal Proceedings.
Item 1A.
Risk Factors.
Unregistered Sales of Equity Securities and Use of Proceeds.
Defaults Upon Senior Securities.
Submission of Matters to a Vote of Security Holders.
Item 5.
Other Information.
Item 6.
Exhibits.
1
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
ARES CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of
June 30, 2006
December 31, 2005
(unaudited)
ASSETS
Investments at fair value (amortized cost of $888,483,712 and $581,351,865, respectively)
Non-control/Non-affiliate investments
$
714,898,704
515,184,991
Affiliate investments
163,261,927
70,783,384
Total investments at fair value
878,160,631
585,968,375
Cash and cash equivalents
44,844,697
16,613,334
Receivable for open trades
6,962,236
1,581,752
Interest receivable
7,854,038
5,828,098
Other assets
4,608,731
3,653,585
Total assets
942,430,333
613,645,144
LIABILITIES
Credit facilities payable
345,200,000
18,000,000
Reimbursed underwriting costs payable to the Investment Adviser
—
2,475,000
Dividend payable
12,889,225
Payable for open trades
5,500,000
Accounts payable and accrued expenses
7,092,656
1,222,678
Management and incentive fees payable
10,047,596
3,478,034
Interest and facility fees payable
3,105,947
313,930
Interest payable to the Investment Adviser
154,078
Total liabilities
365,446,199
44,032,945
Commitments and contingencies (Note 6)
STOCKHOLDERS’ EQUITY
Common stock, par value $.001 per share, 100,000,000 common shares authorized, 38,207,254 and 37,909,484 common shares issued and outstanding, respectively
38,208
37,910
Capital in excess of par value
564,192,430
559,192,554
Accumulated net realized gain on sale of investments
23,076,577
5,765,225
Net unrealized (depreciation) appreciation on investments
(10,323,081
)
4,616,510
Total stockholders’ equity
576,984,134
569,612,199
Total liabilities and stockholders’ equity
NET ASSETS PER SHARE
15.10
15.03
See accompanying notes to consolidated financial statements.
2
CONSOLIDATED SCHEDULE OF INVESTMENTSAs of June 30, 2006 (unaudited)
Company {1}
Industry
Investment
Interest {13}
InitialAcquisitionDate
AmortizedCost
Fair Value
Fair ValuePer Unit
Percentage ofNet Assets
Healthcare - Services
American Renal Associates, Inc.
Dialysis provider
Senior secured loan ($3,049,180 par due 12/2010)
9.57% (Libor+ 4.00%/S)
12/14/05
3,049,180
1.00
Senior secured loan ($196,721 par due 12/2010)
9.45% (Libor + 4.00%/Q)
196,721
Senior secured loan ($180,328 par due 12/2010)
180,328
Senior secured loan ($5,836,066 par due 12/2011)
10.07% (Libor + 4.50%/S)
5,836,066
Senior secured loan ($50,820 par due 12/2011)
11.25% (Base Rate+ 3.00%/Q)
50,820
Senior secured loan ($655,738 par due 12/2011)
12.57% (Libor + 7.00%/Q)
655,738
Senior secured loan ($6,557,377 par due 12/2011)
14.25% (Base Rate + 6.00%/Q)
6,557,377
Capella Healthcare, Inc.
Acute care hospital operator
Junior secured loan ($31,000,000 par due 11/2013)
11.24% (Libor + 6.00%/Q)
12/1/05
31,000,000
DSI Renal, Inc.
Senior subordinated note ($72,336,000 par due 4/2014)
12.00% Cash, 2.00% PIK
4/4/06
72,336,000
1.00{3
}
OnCURE Medical Corp.
Radiation oncology care provider
Senior secured revolving loan ($100,000 par due 2/2011)
8.69% (Libor + 3.50%/Q)
2/14/06
100,000
Senior secured revolving loan ($200,000 par due 2/2011)
8.50% (Libor + 3.50%/S)
200,000
Senior secured loan ($4,964,286 par due 2/2012)
9.00% (Libor + 4.00%/S)
4,964,286
Senior secured loan ($35,714 par due 2/2012)
10.75% (Base Rate + 2.50%/S)
35,714
Junior secured loan ($15,080,088 par due 8/2012)
12.00% cash, 1.50% PIK
15,080,088
PHNS, Inc.
Information technology and business process outsourcing
Senior subordinated loan ($16,000,000 par due 11/2011)
13.50% cash, 2.50% PIK
10/29/04
15,797,902
16,000,000
Triad Laboratory Alliance, LLC
Laboratory services
Senior subordinated loan ($9,796,981 par due 12/2012)
12.00% cash, 1.75% PIK
12/21/05
9,796,981
Senior secured loan ($2,985,000 par due 12/2011)
8.23% (Libor + 3.25%/Q)
2,985,000
168,822,201
169,024,299
29.29
%
Manufacturing
Arrow Group Industries, Inc.
Residential and outdoor shed manufacturer
Senior secured loan ($6,000,000 par due 4/2010)
10.50% (Libor + 5.00%/M)
3/28/05
6,039,265
6,000,000
Senior secured loan ($6,000,000 par due 10/2010)
15.00% (Libor + 9.50%/Q)
Emerald Performance Materials, LLC
Polymers and performance materials manufacturer
Senior secured loan ($10,526,316 par due 5/2011)
9.52% (Libor + 4.25%/Q)
5/16/06
10,526,316
Senior secured loan ($5,263,158 par due 5/2011)
11.27% (Libor + 6.00%/Q)
5,263,158
Senior secured loan ($4,210,526 par due 5/2011)
13.00%
4,210,526
Qualitor, Inc.
Automotive aftermarket components
Senior secured loan ($1,970,000 par due 12/2011)
9.50% (Libor + 4.00%/Q)
12/29/04
1,970,000
1.00{2
supplier
Junior secured loan ($5,000,000 par due 6/2012)
12.50% (Libor + 7.00%/Q)
5,000,000
Professional Paint, Inc.
Paint manufacturer
Junior secured loan ($16,500,000 par due 5/2013)
11.38% (Libor + 5.75%/S)
5/25/06
16,500,000
Reflexite Corporation {9}
Developer and manufacturer of high visibility reflective products
Senior subordinated loan ($10,458,604 par due 12/2011)
11.00% cash, 3.00% PIK
12/30/04
10,458,604
1.00{2}{3
Common Stock (1,729,627 shares)
3/28/06
25,682,891
14.85{4
Universal Trailer Corporation {5}
Livestock and specialty trailer manufacturer
Common stock (50,000 shares)
10/8/04
6,424,645
3,113,351
62.27{4
Warrants to purchase 22,208 shares
1,505,776
1,382,826
Varel Holdings, Inc.
Drill bit manufacturer
Senior secured loan ($6,643,750 par due 12/2010)
9.15% (Libor + 4.00%/B)
5/18/05
6,643,750
Senior secured loan ($1,956,673 par due 12/2010)
9.13% (Libor + 4.00%/Q)
1,956,673
Senior secured loan ($3,333,333 par due 12/2011)
13.32% (Libor + 8.00%/Q)
3,333,333
Senior secured revolving loan ($333,333 par due 10/2010)
10.50% (Base Rate + 2.25%/D)
333,333
Preferred stock (33,245 shares)
1,088,431
32.74{3
Common stock (30,451 shares)
3,045
1,011,569
33.22{4
112,939,746
110,474,761
19.15
Containers-Packaging
Captive Plastics, Inc.
Plastics container manufacturer
Junior secured loan ($16,000,000 par due 2/2012)
12.34% (Libor + 7.25%/Q)
12/19/05
Industrial Container Services, LLC {7}
Industrial container manufacturer, reconditioner and servicer
Senior secured loan ($28,588,315 par due 9/2011)
11.92% (Libor + 6.50%/Q)
9/30/05
28,588,315
Senior secured loan ($10,000,000 par due 9/2011)
6/21/06
10,000,000
Senior secured revolving loan ($826,087 par due 9/2011)
9.79% (Libor + 4.50%/M)
826,087
9.75% (Libor + 4.50%/M)
Senior secured revolving loan ($4,130,435 par due 9/2011)
9.78% (Libor + 4.50%/M)
4,130,435
11.25% (Base Rate + 3.00%/Q)
3
Senior secured revolving loan ($1,652,174 par due 9/2011)
9.85% (Libor + 4.50%/M)
1,652,174
$1.00
Common stock (1,800,000 shares)
9/29/05
1,800,000
$1.00{4
LabelCorp Holdings, Inc.
Consumer product labels manufacturer
Senior subordinated notes ($9,180,470 par due 9/2012)
12.00% cash, 3.00% PIK
3/16/06
9,180,470
$1.00{3
74,655,742
12.94
Printing, Publishing and Broadcasting
Canon Communications LLC
Print publications services
Junior secured loan ($23,775,000 par due 11/2011)
12.37% (Libor + 6.75%/S)
5/25/05
23,775,000
$1.00{2
Daily Candy, Inc. {10}
Internet publication provider
Senior secured loan ($24,200,000 par due 5/2009)
10.62% (Libor + 5.00%/S)
24,200,000
Senior secured loan ($800,000 par due 5/2009)
10.50% (Libor + 5.00%/Q)
800,000
Common stock (1,250,000 shares)
2,375,000
$1.90
Warrants to purchase 1,381,578 shares
2,625,000
$1.90{4
National Print Group, Inc.
Printing management services
Senior secured revolving loan ($365,259 par due 3/2012)
10.75% (Base Rate + 2.50%/D)
3/2/06
365,259
Senior secured revolving loan ($859,062 par due 3/2012)
859,062
Senior secured loan ($11,230,435 par due 3/2012)
9.00% (Libor + 3.50%/Q)
11,230,435
Senior secured loan ($2,739,130 par due 8/2012)
12.32% (Libor + 7.00%/Q)
2,739,130
Senior secured loan ($2,282,609 par due 3/2012)
12.17% (Libor + 7.00%/B)
2,282,609
Preferred stock (9,344 shares)
2,000,000
$214.04{4
73,251,495
12.70
Services - Other
Diversified Collection Services, Inc.
Collections services
Senior secured loan ($5,242,026 par due 2/2011)
8.78% (Libor + 4.00%/S)
2/2/05
5,242,026
Senior secured loan ($8,500,000 par due 8/2011)
10.89% (Libor + 6.00%/S)
8,500,000
Preferred stock (14,927 shares)
5/18/06
169,123
$11.33{4
Common stock (114,004 shares)
295,270
$2.59{4
Event Rentals, Inc.
Party rental services
Senior secured loan ($2,277,902 par due 11/2011)
10.77% (Libor+ 5.25%/S)
11/17/05
2,277,902
Senior secured loan ($5,005,581 par due 11/2011)
10.69% (Libor + 5.25%/S)
5,005,581
Senior secured loan ($2,466,518 par due 11/2011)
10.80% (Libor + 5.25%/S)
2,466,518
Senior secured loan ($85,227 par due 11/2011)
12.50% (Base Rate + 4.25%/D)
85,227
Senior secured loan ($7,968,750 par due 11/2011)
10.77% (Libor + 5.25%/S)
7,968,750
GCA Services Group, Inc.
Custodial services
Senior subordinated loan ($33,236,748 par due 1/2010)
7/25/05
33,236,748
65,247,145
11.31
Consumer Products - Non-Durable
Making Memories Wholesale, Inc. {6}
Scrapbooking branded products manufacturer
Senior secured loan ($7,995,833 par due 3/2011)
10.00% (Libor + 4.50%/Q)
5/5/05
7,995,833
Senior subordinated loan ($10,100,808 par due 5/2012)
12.50% cash, 2.00% PIK
10,100,808
Preferred stock (3,500 shares)
3,758,800
1,320,000
$377.14{3
Shoes for Crews, LLC
Safety footwear and slip-related mats manufacturer
Senior secured loan ($1,370,173 par due 7/2010)
8.87% (Libor + 3.25%/S)
1,378,236
Senior secured loan ($60,747 par due 7/2010)
8.75% (Libor + 3.25%/Q)
61,104
Senior secured revolving loan ($1,333,333 par due 7/2010)
10.25% (Base Rate + 2.00%/Q)
6/16/06
1,333,333
Tumi Holdings, Inc.
Branded luggage designer, marketer and distributor
Senior secured loan ($2,500,000 par due 12/2012)
8.25% (Libor + 2.75%/Q)
5/24/05
2,500,000
Senior secured loan ($5,000,000 par due 12/2013)
3/14/05
Senior subordinated loan ($13,339,711.06 par due 12/2014)
16.50% (Libor + 6.00% cash, 5.00% PIK/Q)
13,339,711
$1.00{2}{3
UCG Paper Crafts, Inc.
Scrapbooking materials manufacturer
Senior secured loan ($2,000,000 par due 2/2013)
8.60% (Libor + 3.25%/M)
2/23/06
Junior secured loan ($12,962,500 par due 2/2013)
12.84% (Libor + 7.50%/M)
12,962,500
Junior secured loan ($32,500 par due 2/2013)
14.75% (Base Rate + 6.50%/D)
32,500
60,462,825
58,024,025
10.06
Education
Equinox SMU Partners LLC and
Medical school operator
Senior secured revolving loan ($3,232,342 par due 12/2010)
12.75% (Base Rate + 5.00%/Q)
1/25/06
3,232,342
SMU Acquisition Corp. {8}
Senior secured revolving loan ($3,000,000 par due 12/2010)
11.06% (Libor + 6.00%/S)
3,000,000
Senior secured loan ($10,500,000 par due 12/2010)
11.07% (Libor + 6.00%/S)
10,500,000
Senior secured loan ($3,000,000 par due 12/2010)
Limited liability company membership interest (17.39% interest)
4,000,000
{4
Lakeland Finance, LLC
Private school operator
Senior secured note ($33,000,000 par due 12/2012)
11.50%
12/13/05
33,000,000
56,732,342
9.83
Environmental Services
Mactec, Inc.
Engineering and environmental
Common stock (186 shares)
11/3/04
$—{4
Wastequip, Inc.
Waste management equipment manufacturer
Junior secured loan ($27,000,000 par due 7/2012)
11.00% (Libor + 5.50%/Q)
8/4/05
27,000,000
WCA Waste Systems, Inc.
Waste management services
Junior secured loan ($25,000,000 par due 10/2011)
14.25% (Base Rate + 6.00%/D)
4/25/05
25,000,000
4
52,000,000
9.01
Consumer Products - Durable
AWTP, LLC
Water treatment services
Junior secured loan ($13,600,000 par due 12/2012)
13.00% (Libor + 7.50%/Q)
13,600,000
Berkline/Benchcraft Holdings LLC
Furniture manufacturer and distributor
Junior secured loan ($5,000,000 par due 5/2012)
15.00% (Libor + 10.00%/Q)
3,250,000
0.65{2
Preferred stock (2,536 shares)
1,046,343
—{4
Warrants to purchase 483,020 shares
2,752,559
Singer Sewing Company
Sewing machine manufacturer
Senior secured revolving loan ($583,333 par due 9/2010)
9.20% (Libor + 4.00%/M)
2/9/06
583,333
Senior secured revolving loan ($250,000 par due 9/2010)
9.32% (Libor + 4.00%/M)
250,000
Senior secured revolving loan ($166,667 par due 9/2010)
9.25% (Libor + 4.00%/M)
166,667
9.14% (Libor + 4.00%/M)
9.18% (Libor + 4.00%/M)
Senior secured loan ($18,000,000 par due 9/2010)
11.18% (Libor + 6.00%/M)
41,815,569
36,266,667
6.29
Business Services
Investor Group Services, LLC
Financial services
Senior secured loan ($1,500,000 par due 6/2011)
12.00%
6/22/06
1,500,000
Limited liability company membership interest (10.00% interest)
Miller Heiman, Inc.
Sales consulting services
Senior secured loan ($3,768,072 par due 6/2010)
8.85% (Libor + 3.50%/M)
6/20/05
3,768,072
Senior secured loan ($4,037,985 par due 6/2012)
4,037,985
MR Processing Holding Corp.
Bankruptcy and foreclosure processing services
Senior subordinated note ($20,103,333 par due 2/2013)
3/23/06
20,103,333
Senior secured loan ($1,995,000 par due 2/2012)
8.63% (Libor + 3.50%/Q)
1,995,000
Preferred stock (30,000 shares)
4/11/06
100.00{4
34,404,390
`
5.96
Restaurants
ADF Capital, Inc. & ADF Restaurant Group, LLC
Restaurant owner and operator
Senior secured revolving loan ($1,200,000 par due 6/2013)
13.75% (Base Rate + 5.50%/D)
6/1/06
1,200,000
Senior secured loan ($23,000,000 par due 6/2013)
23,000,000
Warrants to purchase 0.882353 units
3,399,999.77{4
-
27,200,000
4.71
Aerospace & Defense
ILC Industries, Inc.
Industrial products provider
Junior secured loan ($15,000,000 par due 8/2012)
6/27/06
15,000,000
1.00{4
Thermal Solutions LLC and TSI Group, Inc.
Thermal management and electronics packaging manufacturer
Senior secured loan ($3,241,875 par due 3/2012)
9.07% (Libor + 4.00%/Q)
3,241,875
Senior secured loan ($1,703,947 par due 3/2011)
8.57% (Libor + 3.50%/Q)
1,703,947
Senior subordinated notes ($3,083,967 par due 9/2012)
11.50% cash, 2.75% PIK
3,091,646
3,083,967
Senior subordinated notes ($2,517,188 par due 3/2013)
11.50% cash, 2.50% PIK
3/21/06
2,517,188
Preferred stock (53,900 shares)
539,000
10.00{4
Common stock (1,100,000 shares)
11,000
0.01{4
26,104,656
26,096,977
4.52
Broadcasting and Cable
Patriot Media & Communications CNJ, LLC
Cable services
Junior secured loan ($5,000,000 par due 10/2013)
10.15% (Libor + 5.00%/M)
10/6/05
Pappas Telecasting Incorporated
Television broadcasting
Senior secured loan ($20,254,608 par due 2/2010)
14.29% (Libor + 4.00% cash, 5.00% PIK/Q)
3/1/06
20,254,608
Senior secured loan ($86,335 par due 2/2010)
14.25% (Libor + 4.00% cash, 5.00% PIK/Q)
86,335
25,340,943
4.39
Computers and Electronics
Extensity
Software manufacturer
Junior secured loan ($10,000,000 par due 9/2011)
12.51% (Libor + 7.25%/B)
3/13/06
RedPrairie Corporation
Junior secured loan ($8,500,000 par due 5/2010)
12.84% (Libor + 7.75%/B)
2/21/06
18,500,000
3.21
Cargo Transport
The Kenan Advantage Group, Inc.
Fuel transportation provider
Senior subordinated notes ($9,038,381 par due 12/2013)
9.50% cash, 3.50% PIK
12/15/05
9,038,381
Senior secured loan ($2,487,500 par due 12/2011)
8.50% (Libor + 3.00%/Q)
2,487,500
Preferred stock (10,984 shares)
1,098,400
Common stock (30,575 shares)
30,575
12,654,856
2.19
Farming and Agriculture
The GSI Group, Inc.
Agricultural equipment manufacturer
Senior notes ($10,000,000 par due 5/2013)
5/11/05
Common stock (7,500 shares)
5/12/05
750,000
10,750,000
1.86
Beverage, Food and Tobacco
Farley’s & Sathers Candy Company, Inc.
Branded candy manufacturer
Junior secured loan ($10,000,000 par due 3/2011)
11.62% (Libor + 6.00%/S)
1.73
Housing - Building Materials
HB&G Building Products
Synthetic and wood product manufacturer
Senior subordinated loan ($8,572,021 par due 3/2011)
13.00% cash, 2.00% PIK
8,566,374
8,572,021
1.00{2}{3}
Common stock (2,743 shares)
752,888
274.48{4
Warrants to purchase 4,464 shares
652,503
146.17{4
9,971,765
9,977,412
Financial
Foxe Basin CLO 2003, Ltd.
Collateralized debt obligation
Preference shares (3,000 shares)
2,682,785
894.26{11}{12
Hudson Straits CLO 2004, Ltd.
Preference shares (5,750 shares)
4,947,252
4,876,792
848.14{11}{12
7,630,037
7,559,577
1.31
Total
888,483,712
{1} We do not “Control” any of our portfolio companies, as defined in the Investment Company Act of 1940. In general, under the 1940 Act, we would “Control” a portfolio company if we owned 25% or more of its voting securities. All of our portfolio company investments are subject to legal restriction on sales which as of June 30, 2006 represented 152% of the Company’s net assets.
{2} Pledged as collateral for the CP Funding Facility and unless otherwise noted, all other investments are pledged as collateral for the Revolving Credit Facility (see Note 7 to the consolidated financial statements).
{3} Has a payment-in-kind interest feature (see Note 2 to the consolidated financial statements).
{4} Non-income producing at June 30, 2006.
{5} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, for this portfolio company there were total purchases of $5,000,000, redemptions of $7,528,880 (cost), sales of $6,054,725 (cost), interest income of $176,732, other income of $3,125, net realized gains of $47,283 and net unrealized losses of $6,118.
{6} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, for this portfolio company there were total redemptions of $1,147,917 (cost), interest income of $1,201,966, other income of $82,724 and net unrealized losses of $2,438,800.
{7} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, for this portfolio company there were total purchases of $19,500,391, redemptions of $4,899,870 (cost), interest income of $1,862,243, capital structuring service fees of $350,000 and other income of $71,540.
{8} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, for this portfolio company there were total purchases of $28,732,342, redemptions of $5,000,000 (cost), interest income of $980,353, capital structuring service fees of $583,810 and other income of $9,484.
{9} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, there were total purchases of $25,682,891 and interest income of $719,946.
{10} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the six months ended June 30, 2006, there were total purchases of $30,000,000, interest income of $295,890 and capital structuring service fees of $250,000.
{11} Non-U.S. company or principal place of business outside the U.S.
{12} Non-registered investment company.
{13} A majority of the variable rate loans to our portfolio companies bear interest at a rate that may be determined by reference to either Libor or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), at the borrower’s option, which reset semi-annually (S), quarterly (Q), bi-monthly (B) monthly (M) or daily (D). For each such loan, we have provided the current interest rate in effect at June 30, 2006.
5
CONSOLIDATED SCHEDULE OF INVESTMENTSAs of December 31, 2005
Interest {10}
FairValue
Percentageof Net Assets
Senior secured loan ($3,426,230 par due 12/2010)
8.68% (Libor+ 4.00%/Q)
3,426,230
8.50% (Libor+ 4.00%/Q)
Senior secured loan ($5,886,885 par due 12/2011)
9.18% (Libor + 4.50%/Q)
5,886,885
Senior secured loan ($14,754 par due 12/2011)
9.00% (Libor+ 4.50%/Q)
14,754
Senior secured loan ($7,213,115 par due 12/2011)
11.68% (Libor + 7.00%/Q)
7,213,115
Junior secured loan ($29,000,000 par due 11/2013)
10.45% (Libor + 6.00%/Q)
29,000,000
13.50% cash, 2.5% PIK
15,785,661
Senior subordinated loan ($9,714,888 par due 12/2012)
9,714,888
Senior secured loan ($3,000,000 par due 12/2011)
7.78% (Libor + 3.25%/Q)
74,221,861
74,436,200
13.07
11.62% (Libor + 7.25%/M)
Senior secured loan ($26,728,663 par due 9/2011)
11.00% (Libor + 6.50%/Q)
26,728,663
Senior secured loan ($4,643,479 par due 9/2011)
8.88% (Libor + 4.50%/M)
4,643,479
Senior secured revolving loan ($1,160,870 par due 9/2011)
10.25% (Base Rate + 3.00%/Q)
1,160,870
Senior secured revolving loan ($541,739 par due 9/2011)
541,739
York Label Holdings, Inc.
Senior subordinated loan ($10,368,791 par due 2/2010)
10.00% cash, 4.00% PIK
10,362,901
10,368,791
Preferred stock (650 shares)
10.00%
3,742,445
5,757.61{3
Warrants to purchase 156,000 shares
5,320,409
5,320,408
34.11{4
70,300,506
70,306,395
12.34
Engineering and environmental consulting services
0.00{4
United Site Services, Inc.
Portable restroom and site services
Senior secured loan ($5,061,957 par due 8/2011)
7.37% (Libor + 3.00%/M)
9/14/05
5,061,957
Senior secured loan ($3,043,478 par due 8/2011)
7.41% (Libor + 3.00%/Q)
3,043,478
Senior secured loan ($1,869,565 par due 8/2011)
7.28% (Libor + 3.00%/Q)
1,869,565
Junior secured loan ($13,461,538 par due 6/2010)
12.44% (Libor + 8.00%/Q)
12/1/04
13,419,063
13,461,538
Common stock (216,795 shares)
1,353,851
6.24{4
Junior secured loan ($15,000,000 par due 7/2012)
10.53% (Libor + 6.00%/Q)
64,747,914
64,790,389
11.37
CICQ, LP
Restaurant franchisor, owner and operator
Limited partnership interest (26.5% interest)
8/15/05
53,000,000
62,284,540
_
10.93
Senior secured loan ($6,300,000 par due 2/2011)
8.38% (Libor + 4.00%/M)
6,300,000
10.00% (Libor + 6.00%/Q)
Preferred stock (114,004 shares)
2.59{4
Senior secured loan ($2,676,136 par due 11/2011)
9.91% (Libor+ 5.25%/S)
2,676,136
Senior secured loan ($2,897,727 par due 11/2011)
9.92% (Libor + 5.25%Q)
2,897,727
Senior secured loan ($170,455 par due 11/2011)
11.50% (Base Rate + 4.25%/D)
170,455
Senior secured loan ($8,011,363 par due 11/2011)
9.91% (Libor + 5.25%/S)
8,011,363
GCA Services, Inc.
Senior subordinated loan ($32,743,750 par due 1/2010)
32,743,750
61,594,701
10.81
9.53% (Libor + 5.00%/Q)
6,040,153
14.03% (Libor + 9.50%/Q)
Automotive aftermarket components supplier
Senior secured loan ($827,059 par due 12/2011)
8.27% (Libor + 4.00%/Q)
827,059
6
CONSOLIDATED SCHEDULE OF INVESTMENTS
As of December 31, 2005
Initial Acquisition Date
Amortized Cost
Fair Value Per Unit
Percentage of Net Assets
Senior secured loan ($1,152,941 par due 12/2011)
8.53% (Libor + 4.00%/Q)
1,152,941
11.53% (Libor + 7.00%/Q)
Reflexite Corporation
Senior subordinated loan ($10,304,329 par due 12/2011)
10,304,329
Senior secured loan ($1,048,960 par due 3/2007)
8.39% (Libor + 4.00%/M)
1,054,725
1.01
Senior subordinated loan ($7,500,000 par due 9/2008)
13.50%
7,522,762
7,528,881
8.58% (Libor + 4.00%/S)
Senior secured loan ($2,333,333 par due 12/2010)
8.47% (Libor + 4.00%/Q)
2,333,333
12.48% (Libor + 8.00%/Q)
Preferred stock (30,451 shares)
1,046,568
34.37{3
0.10{4
59,192,419
55,724,141
9.78
Senior secured loan ($9,143,750 par due 3/2011)
8.50% (Libor + 4.00%/Q)
9,143,750
Senior subordinated loan ($10,000,000 par due 5/2012)
12.00% cash, 2.50% PIK
3,685,100
1,052.89{3
Senior secured loan ($1,478,167 par due 7/2010)
9.00% (Base Rate + 1.75%/D)
1,486,865
1.01{2
Senior secured loan ($47,247 par due 7/2010)
47,525
7.28% (Libor + 2.75%/Q)
Senior subordinated loan ($13,008,799 par due 12/2014)
15.53% (Libor + 6.00% cash, 5.00% PIK/Q)
13,008,799
44,872,039
7.88
5.79
13.50% (Base Rate + 6.25%/Q)
14.05% (Libor + 10.00%/Q)
4,500,000
0.90{2
677,643
267.21{4
1,782,640
3.69{4
22,398,902
20,560,283
3.61
2,743,440
914.48{8}{9
5,217,331
5,143,121
894.46{8}{9
MINCS-Glace Bay, Ltd.
Secured notes ($9,500,000 par due 7/2014)
7.79% (Libor + 3.60%/Q)
9,019,819
9,500,000
1.00{8}{9
16,980,590
17,386,561
3.05
Junior secured loan ($16,250,000 par due 11/2011)
12.03% (Libor + 7.50%/Q)
16,250,000
2.85
Junior secured loan ($6,500,000 par due 8/2012)
10.28% (Libor + 5.75%/Q)
8/30/05
6,529,232
6,500,000
Thermal Solutions LLC
Senior secured loan ($5,973,529 par due 3/2011)
9.71% (Libor + 5.25%/Q)
5,973,529
Senior subordinated loan ($3,062,766 par due 3/2012)
3,067,225
3,062,766
Preferred stock (29,400 shares)
294,000
Common stock (600,000 shares)
6,000
15,869,986
15,836,295
2.78
7
Company
Interest{10}
Kenan Advantage Group, Inc.
Senior subordinated loan ($8,870,968 par due 12/2013)
8,870,968
Senior secured loan ($2,500,000 par due 12/2011)
7.50% (Libor + 3.00%/Q)
12,499,943
1.89
Senior subordinated loan ($8,439,529 par due 3/2011)
13.00% cash, 4.00% PIK
8,435,645
8,439,529
9,841,036
9,844,920
Senior secured loan ($4,521,687 par due 6/2010)
8.14% (Libor + 3.75%/M)
4,521,687
Senior secured loan ($4,058,379 par due 6/2012)
8.78% (Libor + 4.25%/Q)
4,058,379
8,580,066
1.51
Cable Television
9.50% (Libor + 5.00%/Q)
0.88
Healthcare - Medical Products
Aircast, Inc.
Manufacturer of orthopedic braces, supports and vascular systems
Senior secured loan ($1,251,902 par due 12/2010)
7.20% (Libor + 2.75%/Q)
12/2/04
1,251,902
Junior secured loan ($1,000,000 par due 6/2011)
11.45% (Libor + 7.00%/Q)
1,000,000
2,251,902
0.40
581,351,865
{1} We do not “Control” any of our portfolio companies, as defined in the Investment Company Act of 1940. In general, under the 1940 Act, we would “Control” a portfolio company if we owned 25% or more of its voting securities. All of our portfolio company investments are subject to legal restriction on sales which as of December 31, 2005 represented 103% of the Company’s net assets.
{2} Pledged as collateral for the credit facility payable (see Note 7 to the consolidated financial statements).
{4} Non-income producing at December 31, 2005.
{5} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the year ended December 31, 2005, for this portfolio company there were total purchases of $2,000,000, redemptions of $2,919,939 (cost), interest income of $1,147,137, other income of $143,667, net realized losses of $4,278 and net unrealized losses of $3,429,198.
{6} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the year ended December 31, 2005, for this portfolio company there were total purchases of $26,000,000, sales of $3,000,000 (cost), redemptions of $237,500 (cost), interest income of $1,514,431, capital structuring services fees of $862,500 and other income of $2,068.
{7} As defined in the 1940 Act, we are an “Affiliate” of this portfolio company because we own more than 5% of the portfolio company’s outstanding voting securities. For the year ended December 31, 2005, for this portfolio company there were total purchases of $54,647,808, total sales of $19,000,000 (cost), redemptions of $706,069 (cost), interest income of $943,631, capital structuring services fees of $1,058,750 and other income of $44,426.
{8} Non-U.S. company or principal place of business outside the U.S.
{9} Non-registered investment company.
{10} A majority of the variable rate loans to our portfolio companies bear interest at a rate that may be determined by reference to either Libor or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), at the borrower’s option, which reset semi-annually (S), quarterly (Q), monthly (M) or daily (D). For each such loan, we have provided the current interest rate in effect at December 31, 2005.
8
CONSOLIDATED STATEMENT OF OPERATIONS
For the three
For the six
months ended
June 30, 2005
INVESTMENT INCOME:
From non-control/non-affiliate investments:
Interest from investments
20,737,226
6,027,175
35,788,359
10,947,830
Interest from cash & cash equivalents
199,948
565,412
431,177
595,768
Dividend income
1,170,000
744,818
Capital structuring service fees
4,670,493
631,333
6,416,698
935,083
Other income
244,466
62,765
287,009
122,161
Total investment income from non-control/non-affiliate investments
27,022,133
8,031,503
44,093,243
13,345,660
From affiliate investments:
2,760,198
700,871
5,237,130
1,011,464
600,000
862,500
1,183,810
107,420
6,741
166,873
132,583
Total investment income from affiliate investments
3,467,618
1,570,112
6,587,813
2,006,547
Total investment income
30,489,751
9,601,615
50,681,056
15,352,207
EXPENSES:
Base management fees
3,107,197
1,027,135
5,650,856
1,841,847
Incentive management fees
6,940,399
1,798,919
9,863,283
2,069,202
Administrative
188,488
256,115
366,025
489,387
Professional fees
676,637
320,800
1,148,088
485,794
Directors fees
73,919
85,643
137,169
157,808
Insurance
198,431
144,400
386,532
287,213
Interest and credit facility fees
4,361,907
62,979
5,684,217
438,269
31,814
25,879
83,539
Amortization of debt issuance costs
411,836
65,736
819,147
131,426
Depreciation
49,302
Other
217,105
39,940
385,612
69,759
Total expenses
16,225,221
3,833,481
24,516,110
6,054,244
NET INVESTMENT INCOME BEFORE INCOME TAXES
14,264,530
5,768,134
26,164,946
9,297,963
Income tax expense, including excise tax
4,971,635
5,180,515
NET INVESTMENT INCOME
9,292,895
20,984,431
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gains (losses):
Net realized gains from non-control/non-affiliate investment transactions
23,879,988
6,747,262
24,443,591
7,156,442
Net realized gains (losses) from affiliate investment transactions
(1,880
47,283
(2,030
Net realized gains from investment transactions
6,745,382
24,490,874
7,154,412
Net unrealized gains (losses):
Investment transactions from non-control/non-affiliate investments
(16,480,203
(4,910,024
(12,494,673
(343,793
Investment transactions from affiliate investments
(1,236
(2,444,918
(2,420
Net unrealized losses from investment transactions
(4,911,260
(14,939,591
(346,213
Net realized and unrealized gain on investments
7,399,785
1,834,122
9,551,283
6,808,199
NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM OPERATIONS
16,692,680
7,602,256
30,535,714
16,106,162
BASIC AND DILUTED EARNINGS PER COMMON SHARE (see Note 4)
0.44
0.33
0.80
0.91
WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING (see Note 4)
38,089,889
23,164,444
38,039,574
17,683,309
9
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYFor the Six Months Ended June 30, 2006 (unaudited)
Common Stock
Capital inExcess of Par
DistributionsLess Than (inExcess of) NetInvestment
AccumulatedNet RealizedGain on Sale of
Net UnrealizedAppreciation on
TotalStockholders’
Shares
Amount
Value
Income
Investments
Equity
Balance at December 31, 2005
37,909,484
Shares issued in connection with dividend reinvestment plan
297,770
298
4,999,876
5,000,174
Net increase in stockholders’ equity resulting from operations
Dividend declared ($0.74 per share)
(20,984,431
(7,179,522
(28,163,953
Balance at June 30, 2006
38,207,254
10
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYFor the Six Months Ended June 30, 2005 (unaudited)
Net UnrealizedAppreciation(Depreciation)
of Investments
Balance at December 31, 2004
11,066,767
11,067
159,602,706
(136,415
230,947
159,708,305
Issuance of common stock from add-on offering (net of offering and underwriting costs)
12,075,000
12,075
183,859,340
183,871,415
Reimbursement of underwriting costs paid by the Investment Adviser (see Note 9)
(2,475,000
26,828
27
456,506
456,533
Dividend declared ($0.62 per share)
(9,161,548
(1,572,927
(10,734,475
Balance at June 30, 2005
23,168,595
23,169
341,443,552
5,581,485
(115,266
346,932,940
11
ARES CAPITAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES:
Adjustments to reconcile net increase in stockholders’ equity resulting from operations:
Net realized gain on investment transactions
(24,490,874
(7,154,412
Net unrealized loss on investment transactions
14,939,591
346,213
Net accretion of discount on securities
(20,292
625
Increase in accrued payment-in-kind dividends and interest
(2,555,781
(1,460,731
Proceeds from sale and redemption of investments
165,065,734
63,881,989
Purchases of investments
(456,011,118
(167,055,034
Changes in operating assets and liabilities:
(2,025,940
(2,239,348
(1,823,595
256,973
5,869,978
(549,735
6,569,562
2,583,939
2,792,017
(33,197
(154,078
Net cash used in operating activities
(260,440,633
(95,101,591
FINANCING ACTIVITIES:
Net proceeds from issuance of common stock
Borrowings on credit facility payable
374,200,000
23,500,000
Repayments on credit facility payable
(47,000,000
(79,000,000
Underwriting costs payable to the Investment Adviser
Dividends paid in cash
(36,053,004
(6,184,023
Net cash provided by financing activities
288,671,996
122,187,392
CHANGE IN CASH AND CASH EQUIVALENTS
28,231,363
27,085,801
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
26,806,160
CASH AND CASH EQUIVALENTS, END OF PERIOD
53,891,961
Supplemental Information:
Interest paid during the period
2,571,846
385,265
Dividends declared during the period
28,163,953
10,734,475
12
check
Cash
Receivablefortrades
InterestRec
Otherassets
CreditFacPay
UW CostsPayable
Payablefortrade
DivPay
A/P
Mgmt pay
Int & FacFees Pay
Int pay toInv Adv
Stockholders’Equity
STATEMENT OF CASH FLOWS
(1
0
Six Months Ended
(2
292,192,256
5,380,483
2,025,940
955,146
327,200,000
(5,500,000
(12,889,225
7,371,936
Net increase in stockholders’ equity
Adjustments to reconcile net increase in SHE to net cash provided by operating activities:
Realized gain
Unrealized gain/(loss)
PIK income
Amortization of debt costs
Accretion income
(Increase) decrease in operating assets:
Escrowed funds receivable
(1,823,594
Increase (decrease) in operating liabilities:
Mgmt fee payable
Net cash provided by operating activities
30,504,753
INVESTING ACTIVITIES:
Purchase of investments
(456,011,119
(450,511,119
Sale of investments
170,446,218
(5,380,483
Net cash used in investing activities
(290,945,385
Borrowings from credit facility
Paydowns on credit facility
Net proceeds from issuance of stock
Reinvested dividends (offset against dividend paid)
(5,000,174
Credit facility financing costs
Dividends declared in period
Dividend paid during period
(36,053,005
288,671,995
INCREASE IN CASH AND CASH EQUIVALENTS
Difference
-1
-2
Net Income
(11,286,546
(0
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSAs of June 30, 2006 (unaudited)
1. ORGANIZATION
Ares Capital Corporation (the “Company” or “ARCC” or “we”) is a specialty finance company that is a closed-end, non-diversified management investment company incorporated in Maryland that is regulated as a business development company under the Investment Company Act of 1940 (“1940 Act”). We were incorporated on April 16, 2004 and were initially funded on June 23, 2004. On October 8, 2004, we completed our initial public offering (the “IPO”). On the same date, we commenced substantial investment operations.
The Company has qualified and has elected to be treated for tax purposes as a regulated investment company, or RIC, under the Internal Revenue Code of 1986 (the “Code”), as amended. The Company expects to continue to qualify and to elect to be treated for tax purposes as a RIC. Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We invest primarily in first and second lien senior loans and mezzanine debt, which in some cases may include an equity component, and, to a lesser extent, in equity investments in private middle market companies.
We are externally managed by Ares Capital Management LLC (the “Investment Adviser”), an affiliate of Ares Management LLC (“Ares Management”), an independent Los Angeles based firm that manages investment funds. Ares Technical Administration LLC (“Ares Administration”), an affiliate of Ares Management, provides the administrative services necessary for us to operate.
Interim financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim period, have been included. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending December 31, 2006.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States, and include the accounts of the Company and its wholly owned subsidiaries. The consolidated financial statements reflect all adjustments and reclassifications which, in the opinion of management, are necessary for the fair presentation of the results of the operations and financial condition for the periods presented. All significant intercompany balances and transactions have been eliminated.
Cash and Cash Equivalents
Cash and cash equivalents include short-term, liquid investments in a money market fund. Cash and cash equivalents are carried at cost which approximates fair value.
Concentration of Credit Risk
The Company places its cash and cash equivalents with financial institutions and, at times, cash held in money market accounts may exceed the Federal Deposit Insurance Corporation insured limit.
14
Investment transactions are recorded on the trade date. Realized gains or losses are computed using the specific identification method. Investments for which market quotations are readily available are valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our board of directors based on the input of our investment adviser and audit committee. In addition, the board of directors currently receives input from an independent valuation firm that has been engaged at the direction of the board to value each portfolio security at least once during a trailing 12 month period. The valuation process is conducted at the end of each fiscal quarter, with approximately a quarter of our portfolio companies subject to valuation by the independent valuation firm each quarter. The types of factors that the board may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors.
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our private equity valuation. Because there is not a readily available market value for most of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our board under a valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments, and the differences could be material.
With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:
· Our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment.
· Preliminary valuation conclusions are then documented and discussed with our senior management.
· The audit committee of our board of directors reviews these preliminary valuations as well as valuations with respect to approximately a quarter of our portfolio companies prepared by an independent valuation firm.
· The board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of our investment adviser and audit committee and the independent valuation firm.
Interest Income Recognition
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on its investments when it is determined that interest is no longer collectible. If any cash is received after it is determined that interest is no longer collectible, we will treat the cash as payment on the principal balance until the entire principal balance has been repaid, before any interest income is recognized. Discounts and premiums on securities purchased are accreted/amortized over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortizations of premium on bonds.
Payment in Kind Interest
The Company has loans in its portfolio that contain a payment-in-kind (“PIK”) provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain the Company’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash. For the three and six months ended June 30, 2006, the Company recorded $1,610,327 and $2,555,781, respectively, in PIK income. For the three and six months ended June 30, 2005, the Company recorded $771,892 and $1,460,731, respectively, in PIK income.
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Capital Structuring Service Fees
The Company’s Investment Adviser seeks to provide assistance to the portfolio companies in connection with the Company’s investments and in return the Company may receive fees for capital structuring services. These fees are normally paid at the closing of the investments, are generally non-recurring and are recognized as revenue when earned upon closing of the investment. The services that the Company’s Investment Adviser provides vary by investment, but generally consist of reviewing existing credit facilities, arranging bank financing, arranging equity financing, structuring financing from multiple lenders, structuring financing from equity investors, restructuring existing loans, raising equity and debt capital, and providing general financial advice, which concludes upon closing of the loan. The Company’s Investment Adviser may also take a seat on the board of directors of a portfolio company, or observe the meetings of the board of directors without taking a formal seat. Any services of the above nature subsequent to the closing would generally generate a separate fee payable to the Company. In certain instances where the Company is invited to participate as a co-lender in a transaction and in the event that the Company does not provide significant services in connection with the investment, a portion of loan fees paid to the Company in such situations will be deferred and amortized over the estimated life of the loan.
Foreign Currency Translation
The Company’s books and records are maintained in U.S. dollars. Any foreign currency amounts are translated into U.S. dollars on the following basis:
(1) Market value of investment securities, other assets and liabilities — at the exchange rates prevailing at the end of the day.
(2) Purchases and sales of investment securities, income and expenses — at the rates of exchange prevailing on the respective dates of such transactions.
Although the net assets and the fair values are presented at the foreign exchange rates at the end of the day, the Company does not isolate the portion of the results of the operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in fair value of investments. Such fluctuations are included with the net realized and unrealized gains or losses from investments. Foreign security and currency translations may involve certain considerations and risks not typically associated with investing in U.S. companies and U.S. Government securities. These risks include but are not limited to revaluation of currencies and future adverse political and economic developments which could cause investments in their markets to be less liquid and prices more volatile than those of comparable U.S. companies.
Offering Expenses
The Company’s offering costs were charged against the proceeds from the Add-on Offering (as defined in Note 10) when received. For the six months ended June 30, 2005, the Company incurred approximately $635,000 of such costs.
Debt Issuance Costs
Debt issuance costs are being amortized over the life of the related credit facility using the straight line method which approximates the interest method.
Federal Income Taxes
The Company has qualified and elected and intends to continue to qualify for the tax treatment applicable to regulated investment companies under Subchapter M of the Code and, among other things, has made and intends to continue to make the requisite distributions to its stockholders which will relieve the Company from Federal income taxes. In order to qualify as a RIC, among other factors, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year.
Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4%
16
excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the three and six months ended June 30, 2006, the Company recorded a provision of approximately $727,000 and $826,000, respectively, for Federal excise tax. As of June 30, 2006, the entire amount was unpaid and included in accounts payable on the accompanying consolidated balance sheet.
Our wholly owned subsidiaries ARCC Cervantes Corporation (“ACC”) and ARCC Cervantes LLC (“ACLLC”) are subject to Federal and state income taxes. For the three and six months ended June 30, 2006, we recorded a tax provision of approximately $4,244,000 and $4,354,000, respectively, for these subsidiaries.
Dividends
Dividends and distributions to common stockholders are recorded on the record date. The amount to be paid out as a dividend is determined by the board of directors each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for investment.
We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder elects to receive cash. As a result, if our board of directors authorizes, and we declare, a cash dividend, then our stockholders who have not ‘‘opted out’’ of our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash dividends.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of actual and contingent assets and liabilities at the date of the financial statements and the reported amounts of income or loss and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include the valuation of investments.
Fair Value of Financial Instruments
The carrying value of the Company’s financial instruments approximate fair value. The carrying value of interest and open trade receivables, accounts payable and accrued expenses, as well as the credit facility payable approximate fair value due to their short maturity.
3. AGREEMENTS
The Company has entered into an investment advisory agreement (the “Advisory Agreement”) with the Investment Adviser under which the Investment Adviser, subject to the overall supervision of our board of directors, provides investment advisory services to ARCC. For providing these services, the Investment Adviser receives a fee from us, consisting of two components—a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.5% of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds). For services rendered under the Advisory Agreement during the period commencing from October 8, 2004 through and including December 31, 2004, the base management fee is payable monthly in arrears. For services rendered under the Advisory Agreement after that time, the base management fee is payable quarterly in arrears. The base management fee is calculated based on the average value of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds) at the end of the two most recently completed calendar quarters.
The incentive fee has two parts. One part is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income. Pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive
17
from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the administration agreement, and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature such as market discount, debt instruments with payment-in-kind interest, preferred stock with payment-in-kind dividends and zero coupon securities, accrued income that we have not yet received in cash. The Investment Adviser is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a default by an entity on the obligation that resulted in the accrual of such income.
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding calendar quarter, is compared to a fixed “hurdle rate” of 2.00% per quarter.
We pay the Investment Adviser an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:
· no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not exceed the hurdle rate;
· 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.50% in any calendar quarter. We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle rate but is less than 2.50%) as the “catch-up” provision. The “catch-up” is meant to provide our Investment Adviser with 20% of the pre-incentive fee net investment income as if a hurdle rate did not apply if this net investment income exceeds 2.50% in any calendar quarter; and
· 20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.50% in any calendar quarter.
These calculations are adjusted for any share issuances or repurchases during the quarter.
The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the calendar year ending on December 31, 2004, and equals 20% of our realized capital gains for the calendar year, if any, computed net of all realized capital losses and unrealized capital depreciation for such year.
We defer cash payment of any incentive fee otherwise earned by the Investment Adviser if during the most recent four full calendar quarter periods ending on or prior to the date such payment is to be made the sum of (a) the aggregate distributions to the stockholders and (b) the change in net assets (defined as total assets less indebtedness) is less than 8.0% of our net assets at the beginning of such period. These calculations are appropriately pro rated during the first three calendar quarters following October 8, 2004 and are adjusted for any share issuances or repurchases.
For the three and six months ended June 30, 2006, we incurred $3,107,197 and $5,650,856, respectively, in base management fees and $4,083,937 and $7,006,821, respectively, in incentive management fees related to pre-incentive fee net investment income. For the three and six months ended June 30, 2006, we incurred $2,856,462 in incentive management fees related to realized capital gains. As of June 30, 2006, $10,047,596 was unpaid and included in management and incentive fees payable in the accompanying consolidated balance sheet.
For the three and six months ended June 30, 2005, we incurred $1,027,135 and $1,841,847, respectively, in base management fees and $633,559 and $871,300, respectively, in incentive
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management fees related to pre-incentive fee net investment income. For the three and six months ended June 30, 2005, we incurred $1,165,360 and $1,197,902, respectively, in incentive management fees related to realized capital gains.
We also entered into a separate administration agreement (the “Administration Agreement”) with Ares Administration under which Ares Administration furnishes us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Under the Administration Agreement, Ares Administration also performs or oversees the performance of our required administrative services, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, Ares Administration assists us in determining and publishing the net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the Administration Agreement, Ares Administration also provides on our behalf, managerial assistance to those portfolio companies to which we are required to provide such assistance. The Administration Agreement may be terminated by either party without penalty upon 60-days’ written notice to the other party.
For the three and six months ended June 30, 2006, we incurred $188,488 and $366,024, respectively, in administrative fees. As of June 30, 2006, $188,488 was unpaid and included in accounts payable and accrued expenses in the accompanying consolidated balance sheet.
For the three and six months ended June 30, 2005, we incurred $256,115 and $489,387, respectively, in administrative fees.
4. EARNINGS PER SHARE
The following information sets forth the computation of basic and diluted net increase in stockholders’ equity per share resulting from the three and six months ended June 30, 2006:
Three months
Six months
ended
Numerator for basic and diluted net increase in stockholders’ equity resulting from operations per share:
Denominator for basic and diluted net increase in stockholders’ equity resulting from operations per share:
Basic and diluted net increase in stockholders’ equity resulting from operations per share:
The following information sets forth the computation of basic and diluted net increase in stockholders’ equity per share resulting from the three and six months ended June 30, 2005:
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5. INVESTMENTS
For the six months ended June 30, 2006, the Company purchased (A) $303.8 million aggregate principal amount of senior term debt, (B) $103.6 million aggregate principal amount of senior subordinated debt and (C) $43.1 million of investments in equity securities.
In addition, for the six months ended June 30, 2006, (1) $49.2 million aggregate principal amount of senior term debt and (2) $17.9 million aggregate principal amount of senior subordinated debt were redeemed. Additionally, (A) $63.4 million of investments in equity securities and (B) $6.1 million aggregate principal amount of senior term debt were sold.
As of June 30, 2006, investments and cash and cash equivalents consisted of the following:
Senior term debt
587,928,282
586,139,016
Senior notes
Senior subordinated debt
217,564,146
217,764,213
Collateralized debt obligations
Equity securities
65,361,247
56,697,825
933,328,409
923,005,328
As of December 31, 2005, investments and cash and cash equivalents consisted of the following:
338,993,970
338,467,061
129,816,927
130,042,698
85,560,378
90,072,055
597,965,199
602,581,709
The amortized cost represents the original cost adjusted for the accretion of discounts and amortization of premiums on debt using the effective interest method.
The industry and geographic compositions of the portfolio at fair value at June 30, 2006 and December 31, 2005 were as follows:
Health Care
19.3
13.1
12.6
9.5
Consumer Products
10.7
11.2
Containers/Packaging
8.5
12.0
Printing/Publishing
8.3
2.8
Other Services
7.5
10.5
6.5
5.6
5.9
11.0
3.9
1.5
3.1
10.6
Aerospace and Defense
3.0
2.7
Broadcasting/Cable
2.9
0.9
Computers/Electronics
2.1
0.0
1.4
1.2
1.8
Beverage/Food/Tobacco
1.1
Homebuilding
1.7
100.0
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Geographic Region
West
28.0
38.9
Southeast
24.0
10.2
Mid-Atlantic
23.9
24.3
Midwest
13.0
12.3
Northeast
8.0
11.3
International
6. COMMITMENTS AND CONTINGENCIES
As of June 30, 2006, the Company had committed to make a total of approximately $84.0 million of investments in various revolving senior secured loans. As of June 30, 2006, $50.4 million was unfunded. Included within the $84.0 million commitment in revolving secured loans is a commitment to issue up to $3.8 million in standby letters of credit through a financial intermediary on behalf of certain portfolio companies. Under these arrangements, the Company would be required to make payments to third-party beneficiaries if the portfolio companies were to default on their related payment obligations. As of June 30, 2006, the Company had $2.8 million in standby letters of credit issued and outstanding on behalf of the portfolio companies, of which no amounts were recorded as a liability. Of these letters of credit, $2.3 million expire on September 30, 2006 and $500,000 expire on July 31, 2007. These letters of credit may be extended under substantially similar terms for additional one-year terms at the Company’s option until the revolving line of credit, under which the letters of credit were issued, matures on September 30, 2011.
As of June 30, 2006, the Company was subject to a subscription agreement to fund up to $10.0 million of equity commitments in a private equity investment partnership. As of June 30, 2006, there were no amounts funded in this partnership.
As of December 31, 2005, the Company had committed to make a total of approximately $43.0 million of investments in various revolving senior secured loans. As of December 31, 2005, $28.8 million was unfunded. Included within the $43.0 million commitment in revolving secured loans is a commitment to issue up to $3.2 million in standby letters of credit through a financial intermediary on behalf of a portfolio company. Under these arrangements, the Company would be required to make payments to third-party beneficiaries if the portfolio company was to default on its related payment obligations. As of December 31, 2005, the Company had $2.2 million in standby letters of credit issued and outstanding on behalf of the portfolio company, of which no amounts were recorded as a liability.
7. CREDIT FACILITIES PAYABLE
In accordance with the 1940 Act, with certain limited exceptions, we are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. On October 29, 2004, we formed Ares Capital CP Funding LLC (“Ares Capital CP”), a wholly owned subsidiary of the Company, through which we established a revolving credit facility (the “CP Funding Facility”). On November 3, 2004, we entered into the CP Funding Facility that, as amended, allows Ares Capital CP to issue up to $350.0 million of variable funding certificates (“VFC”). As part of the CP Funding Facility, we are subject to limitations as to how borrowed funds may be used including restrictions on geographic concentrations, sector
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concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings as well as regulatory restrictions on leverage which may affect the amount of VFC that we may issue from time to time. There are also certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early amortization of the CP Funding Facility and limit further advances under the CP Funding Facility and in some cases could be an event of default. Such limitations, requirements, and associated defined terms are as provided for in the documents governing the CP Funding Facility. As of June 30, 2006, there was $101.2 million outstanding under the CP Funding Facility and the Company continues to be in compliance with all of the limitations and requirements of the CP Funding Facility. As of December 31, 2005 there was $18.0 million outstanding under the CP Funding Facility.
The CP Funding Facility expires on November 1, 2006. If the CP Funding Facility is not extended beyond November 1, 2006, any principal amounts then outstanding will be amortized over a 24-month period from the termination date. Under the terms of the CP Funding Facility, we are required to pay a renewal fee of 0.375% of the total amount available for borrowing on or around each November 3.
The interest charged on the VFC is based on the commercial paper rate plus 0.75%. The interest charged on the VFC is payable quarterly. As of June 30, 2006 the commercial paper rate was 5.2085% and as of December 31, 2005 the commercial paper rate was 4.3223%. For the three and six months ended June 30, 2006, the average interest rate (i.e. commercial paper rate plus the spread) was 5.73% and 5.50%, respectively. For the three and six months ended June 30, 2005, the average interest rate (i.e. commercial paper rate plus the spread) was 4.27% and 4.02%, respectively. For the three and six months ended June 30, 2006, the average outstanding balance was $87,749,451 and $78,145,856, respectively. There was no balance outstanding during the three months ended June 30, 2005. For the six months ended June 30, 2005 the average outstanding balance was $17,127,072. For the three and six months ended June 30, 2006 the interest expense incurred was $1,265,069 and $2,190,906, respectively. For the three months ended June 30, 2005, no interest expense was incurred. For the six months ended June 30, 2005 the interest expense incurred was $324,734. Cash paid for interest expense during the six months ended June 30, 2006 and June 30, 2005 was $1,147,470 and $385,265, respectively.
The Company is also required to pay a commitment fee for any unused portion of the CP Funding Facility. Initially, the commitment fee was 0.175% per annum. On April 8, 2005 the Company entered into an amendment to the CP Funding Facility and in connection therewith, the commitment fee was temporarily reduced to 0.11% per annum until the earlier of (a) the date the total borrowings outstanding exceed $150.0 million or (b) October 3, 2005, after which the commitment fee was 0.175% per annum. On November 14, 2005 the Company entered into an amendment to the CP Funding Facility and in connection therewith, the commitment fee was reduced to 0.10% per annum prior to the first time that the borrowings outstanding under the CP Funding Facility equal or exceed $200.0 million and 0.125% per annum on and after the first time that the borrowings outstanding under the CP Funding Facility exceed $200.0 million. For the three months and six months ended June 30, 2006, the commitment fee incurred was $66,313 and $136,451, respectively. For the three and six months ended June 30, 2005, the commitment fee incurred was $62,979 and $113,535, respectively.
In December 2005, we entered into a senior secured revolving credit facility (the “Revolving Credit Facility”) under which the lenders have agreed to extend credit to the Company in an initial aggregate principal amount not exceeding $250 million at any one time outstanding. The Revolving Credit Facility expires on December 28, 2010 and with certain exceptions is secured by substantially all of the assets in our portfolio (other than investments held by Ares Capital CP under the CP Funding Facility). Under the Revolving Credit Facility, we have made certain representations and warranties and are required to comply with various covenants, reporting requirements and other customary requirements for similar revolving credit facilities, including, without limitation, covenants related to: (a) limitations on the incurrence of additional indebtedness and liens, (b) limitations on certain investments, (c) limitations on certain restricted payments, (d) maintaining a certain minimum stockholders’ equity, (e) maintaining a ratio of total
22
assets (less total liabilities) to total indebtedness, of the Company and its subsidiaries, of not less than 2.0:1.0, (f) maintaining minimum liquidity, and (g) limitations on the creation or existence of agreements that prohibit liens on certain properties of the Company and its subsidiaries.
In addition to the asset coverage ratio described above, borrowings under the Revolving Credit Facility (and the incurrence of certain other permitted debt) will be subject to compliance with a borrowing base that will apply different advance rates to different types of assets in our portfolio. The Revolving Credit Facility also includes an “accordion” feature that allows us to increase the size of the Revolving Credit Facility to a maximum of $500 million under certain circumstances. The Revolving Credit Facility also includes usual and customary events of default for senior secured revolving credit facilities of this nature. As of June 30, 2006, there was $244.0 million outstanding under the Revolving Credit Facility and the Company continues to be in compliance with all of the limitations and requirements of the Revolving Credit Facility. As of December 31, 2005, there were no amounts outstanding under the Revolving Credit Facility.
The interest charged under the Revolving Credit Facility is based on LIBOR (one, two, three or six month) plus 1.00%, generally. As of June 30, 2006, the one, two, three and six month LIBOR were 5.33%, 5.42%, 5.48% and 5.59%, respectively. For the three and six months ended June 30, 2006, the average interest rate was 6.73% and 6.69%, respectively. For the three and six months ended June 30, 2006, the average outstanding balance was $177,934,066 and $96,154,696, respectively. For the three and six months ended June 30, 2006, the interest expense incurred was $2,985,726 and $3,189,986, respectively. Cash paid for interest expense during the six months ended June 30, 2006 was $1,424,375. As of December 31, 2005, the one, two, three and six month LIBOR were 4.39%, 4.48%, 4.54% and 4.70%, respectively. The Company is also required to pay a commitment fee of 0.20% for any unused portion of the Revolving Credit Facility. For the three and six months ended June 30, 2006, the commitment fee incurred was $34,710 and $149,288, respectively.
As of June 30, 2006, the Company had $3.7 million in standby letters of credit issued through the Revolving Credit Facility.
8. DERIVATIVE INSTRUMENTS
In 2005, we entered into a costless collar agreement in order to manage the exposure to changing interest rates related to the Company’s fixed rate investments. The costless collar agreement is for a notional amount of $20 million, has a cap of 6.5%, a floor of 2.72% and matures in 2008. The costless collar agreement allows us to receive an interest payment for any quarterly period when the 3-month LIBOR exceeds 6.5%, and requires us to pay an interest payment for any quarterly period when the 3-month LIBOR is less than 2.72%. The costless collar resets quarterly based on the 3-month LIBOR. As of June 30, 2006, the 3-month LIBOR was 5.48%. As of June 30, 2006 these derivatives had no fair value.
9. RELATED PARTY TRANSACTIONS
Gross underwriting costs related to the IPO were $7,425,000 or $0.675 per share. As a part of the IPO, the Investment Adviser, on our behalf, agreed to pay the underwriters $0.225 of the $0.675 per share in underwriting discount and commissions for a total of approximately $2.5 million. We were obligated to repay this amount, together with accrued interest (charged at the 3-month LIBOR plus 2% starting on October 8, 2004) (a) if during any four calendar quarter period ending on or after October 8, 2005 the sum of (i) the aggregate distributions, including return of capital, if any, to the stockholders and (ii) the change in net assets (defined as total assets less indebtedness) equals or exceeds 7.0% of the net assets at the beginning of such period (as adjusted for any share issuances or repurchases) or (b) upon the Company’s liquidation. On March 8, 2005, the Company’s board of directors approved entering into an amended and restated agreement with the Investment Adviser whereby the Company would be obligated to repay the Investment Adviser for the approximate $2.5 million only if the conditions for repayment referred to above were met before the third anniversary of the IPO. If one or more such events did not occur on or before October 8, 2007, we would not be obligated to repay this amount to the Investment Adviser. For
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the year ended December 31, 2005, the sum of our aggregate distributions to our stockholders and our change in net assets exceeded 7.0% of net assets as of December 31, 2004 (as adjusted for any share issuances). As a result, in February 2006 we repaid this amount together with accrued interest.
In accordance with the Advisory Agreement, we bear all costs and expenses of the operation of the Company and reimburse the Investment Adviser for all such costs and expenses incurred in the operation of the Company. For the three and six months ended June 30, 2006, the Investment Adviser incurred such expenses totaling $93,862 and $230,727, respectively. Accordingly, the Company has recorded a liability at June 30, 2006 to the Investment Adviser for the entire amount not yet reimbursed. As of June 30, 2006, $93,862 was payable to the Investment Adviser and such payable is included in accounts payable and accrued expenses in the accompanying consolidated balance sheet. For the three and six months ended June 30, 2005, the Investment Adviser incurred such expenses totaling $31,220 and $41,912, respectively.
As of June 30, 2006, Ares Management LLC, of which the Investment Adviser is a wholly owned subsidiary, owned 666,667 shares of the Company’s common stock representing approximately 1.7% of the total shares outstanding as of June 30, 2006.
See Note 3 for a description of other related party transactions.
10. STOCKHOLDERS’ EQUITY
On March 23, 2005, we completed a public add-on offering (the “Add-on Offering”) of 12,075,000 shares of common stock (including the underwriters’ overallotment of 1,575,000 shares) at $16.00 per share, less an underwriting discount and commissions totaling $0.72 per share. Total proceeds received from the Add-on Offering, net of the underwriters’ discount and offering costs, were $183.9 million.
11. DIVIDEND
For the three months ended June 30, 2006, the Company declared a dividend on May 8, 2006 of $0.38 per share for a total of $14,481,380. The record date was June 15, 2006 and the dividend was distributed on June 30, 2006. For the three months ended March 31, 2006, the Company declared a dividend on February 28, 2006 of $0.36 per share for a total of $13,682,573. The record date was March 24, 2006 and the dividend was distributed on April 14, 2006.
For the three months ended June 30, 2005, the Company declared a dividend on June 20, 2005 of $0.32 per share for a total of $7,413,951. The record date was June 30, 2005 and the dividend was distributed on July 15, 2005. For the three months ended March 31, 2005, the Company declared a dividend on February 23, 2005 of $0.30 per share for a total of $3,320,524. The record date was March 7, 2005 and the dividend was distributed on April 15, 2005.
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12. FINANCIAL HIGHLIGHTS
The following is a schedule of financial highlights for the six months ended June 30, 2006 and for the six months ended June 30, 2005:
Per Share Data:
Net asset value, beginning of period (1)
14.43
Issuance of common stock
0.01
0.42
Effect of dilution
(0.03
Underwriting costs paid by the Investment Adviser (see Note 9) (2)
(0.14
Net investment income for period (2)
0.55
0.53
Net realized and unrealized gains for period (2)
0.25
0.38
1.16
Distributions from net investment income
(0.55
(0.53
Distributions from net realized capital gains on securities
(0.19
(0.09
Total distributions to stockholders
(0.74
(0.62
Net asset value at end of period (1)
14.97
Per share market value at end of period
16.93
17.83
Total return based on market value (3)
9.96
(5.04
)%
Total return based on net asset value (4)
5.33
6.18
Shares outstanding at end of period
Ratio/Supplemental Data:
Net assets at end of period
Ratio of operating expenses to average net assets (5) (6)
8.55
4.55
Ratio of net investment income to average net assets (5) (7)
8.78
6.98
Portfolio turnover rate (5)
40
43
(1) The net assets used equals the total stockholders’ equity on the consolidated balance sheets.
(2) Weighted average basic per share data.
(3) For the six months ended June 30, 2006, the total return based on market value equals the increase of the ending market value at June 30, 2006 of $16.93 per share over the ending market value at December 31, 2005 of $16.07, plus the declared dividend of $0.38 per share for holders of record on June 15, 2006 and the declared dividend of $0.36 per share for holders of record on March 24, 2006, divided by the market value at December 31, 2005. For the six months ended June 30, 2005, the total return based on market value equals the decrease of the ending market value at June 30, 2005 of $17.83 per share over the ending market value at December 31, 2004 of $19.43, plus the declared dividend of $0.30 per share for holders of record on March 7, 2005 and the declared dividend of $0.32 per share for holders of record on June 30, 2005, divided by the market value at December 31, 2004. Total return based on market value is not annualized. The Company’s shares fluctuate in value. The Company’s performance changes over time and currently may be different than that shown. Past performance is no guarantee of future results.
(4) For the six months ended June 30, 2006, the total return based on net asset value equals the change in net asset value during the period plus the declared dividend of $0.38 per share for holders of record on June 15, 2006 and the declared dividend of $0.36 per share for holders of record on March 24, 2006, divided by the beginning net asset value during the period. The calculation was adjusted for shares issued in connection with dividend reinvestment plan. For the six months ended June 30, 2005, the total return based on net asset value equals the change in net asset value during the period plus the declared dividend of $0.30 per share for holders of record on March 7, 2005 and the declared dividend of $0.32 per share for holders of record on June 30, 2005, divided by the beginning net asset value during the period. Total return based on net asset value is not annualized. The Company’s performance changes over time and currently may be different than that shown. Past performance is no guarantee of future results.
(5) The ratios reflect an annualized amount.
(6) For the six months ended June 30, 2006, the ratio of operating expenses to average net assets consisted of 1.97% of base management fees, 3.44% of incentive management fees, 2.27% of the cost of borrowing and other operating expenses of 0.87%. For the six months ended June 30, 2005, the ratio of operating expenses to average net assets consisted of 1.38% of base management fees, 1.55% of incentive management fees, 0.43% of the cost of borrowing and other operating expenses of 1.18%. These ratios reflect annualized amounts.
(7) The ratio of net investment income to average net assets excludes income taxes related to realized gains.
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13. IMPACT OF NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) 123R, “Share Based Payment,” which requires companies to recognize in the statement of operations the grant date fair value of stock options and other equity based compensation issued to employees. SFAS 123R is effective for annual periods beginning after June 15, 2005. As the Company does not have any options or equity based compensation plans, there was no impact from the adoption of SFAS 123R.
14. SUBSEQUENT EVENTS
On July 7, 2006, through our newly formed, wholly owned Delaware subsidiary, ARCC CLO 2006 LLC (“ARCC CLO”), we completed a $400.0 million debt securitization where approximately $314.0 million principal amount of asset-backed notes (including $50.0 million revolving notes that have not been drawn down as of the date of this report) (the ”Offered Notes”) were issued to third parties and secured by a pool of middle market loans that have been purchased or originated by the Company. We retained approximately $86.0 million of certain BBB and non-rated securities in the debt securitization. The blended pricing of the Offered Notes, excluding fees, is approximately 3 month LIBOR plus 34 basis points. The securitization is an on-balance-sheet financing for the Company.
The classes, amounts, ratings and interest rates (expressed as a spread to LIBOR) of the Offered Notes are:
Amount(millions)
Rating(S&P/Moody’s)
LIBOR Spread(basis points)
A-1A
75
AAA/Aaa
A-1A VFN
50
(1)
28
A-1B
37
A-2A
A-2B
33
35
B
AA/Aa2
C
44
A/A2
70
314
(1) Revolving class, none of which was drawn down as of the date of this report.
During the first five years from the closing date, principal collections received on the underlying collateral may be used to purchase new collateral, allowing us to maintain the initial leverage in the securitization for the entire five-year period. Under the terms of the securitization, up to 15% of the collateral may be subordinated loans that are neither first nor second lien loans.
The Class A-1A VFN Notes are a revolving class of secured notes and allow us to borrow and repay AAA/Aaa financing over the initial five-year period thereby providing more efficiency in funding costs. All of the notes are secured by the assets of ARCC Commercial Loan Trust 2006, including commercial loans currently totaling $308.1 million as of the closing date, which were sold to the trust by the Company, the originator and servicer of the assets. Additional commercial loans will be purchased by the trust from the Company primarily using the proceeds from the Class A-1A VFN Notes. The pool of commercial loans in the trust must meet certain requirements, including, but not limited to, asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.
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Approximately $243.0 million of the total proceeds from the sale of the Offered Notes (not including the revolving notes that have not yet been drawn down) were used to pay down amounts outstanding under the CP Funding Facility and the Revolving Credit Facility.
On July 18, 2006, we completed a public add-on offering of 10,781,250 shares of common stock (including the underwriters’ overallotment of 1,406,250 shares) at $15.67 per share, less an underwriting discount and commissions totaling $0.58 per share. Total proceeds received from the add-on offering, net of the underwriters’ discount and offering costs, were approximately $162.2 million.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this quarterly report. In addition, some of the statements in this report constitute forward-looking statements, which relate to future events or the future performance or financial condition of Ares Capital Corporation (the “Company,” “ARCC,” “we,” “us” and “our”). The forward-looking statements contained in this report involve risks and uncertainties, including statements as to:
· our future operating results;
· our business prospects and the prospects of our portfolio companies;
· the impact of investments that we expect to make;
· our contractual arrangements and relationships with third parties;
· the dependence of our future success on the general economy and its impact on the industries in which we invest;
· the ability of our portfolio companies to achieve their objectives;
· our expected financings and investments;
· the adequacy of our cash resources and working capital;
· the timing of cash flows, if any, from the operations of our portfolio companies; and
· the ability of our investment adviser to locate suitable investments for us and to monitor and administer our investments.
We use words such as “anticipates,” “believes,” “expects,” “intends,” “will,” “should,” “may” and similar expressions to identify forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements for any reason. We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
OVERVIEW
We are a specialty finance company that is a closed-end, non-diversified management investment company incorporated in Maryland that is regulated as a business development company (a “BDC”) under the Investment Company Act of 1940 (“1940 Act”). We were founded on April 16, 2004 and were initially funded on June 23, 2004 and on October 8, 2004, completed our initial public offering (the “IPO”).
Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We invest primarily in first and second lien senior loans and long-term mezzanine debt, which in some cases may include an equity component, and, to a lesser extent, in equity investments in private U.S. middle market companies.
We are externally managed by Ares Capital Management LLC (the “Investment Adviser”), an affiliate of Ares Management LLC, an independent Los Angeles based firm that manages investment funds. Ares Technical Administration LLC (“Ares Administration”), an affiliate of Ares Management LLC, provides the administrative services necessary for us to operate.
As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” including securities of private U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less.
We have elected to be treated as a regulated investment company, or a RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to these elections, we generally will not have to pay corporate-level taxes on any income that we distribute to our stockholders.
PORTFOLIO AND INVESTMENT ACTIVITY
For the three months ended June 30, 2006, we issued 16 new commitments in an aggregate amount of $267.5 million ($194.0 million to new portfolio companies and $73.5 million to existing portfolio companies) compared to nine new commitments in an aggregate amount of $114.8 million ($105.6 million to new portfolio companies and $9.2 million to existing portfolio companies) for the three months ended June 30, 2005. During the three months ended June 30, 2006, we funded $240.7 million of such commitments ($167.2 million to new portfolio companies and $73.5 million to existing portfolio companies) compared to $110.3 million of commitments ($101.1 million to new portfolio companies and $9.2 million to existing portfolio companies) for the three months ended June 30, 2005. We have remaining contractual obligations for $26.8 million with respect to commitments funded as of June 30, 2006. The weighted average yield of new income producing equity securities and debt funded in connection with investments purchased during the three months ended June 30, 2006 and June 30, 2005 was approximately 12.25% and 9.71%, respectively (computed as (a) annual stated interest rate yield earned plus the net annual amortization of original issue discount and market discount earned on accruing debt divided by (b) total income producing equity securities and debt at fair value).
For the three months ended June 30, 2006, the Company purchased (A) $152.3 million aggregate principal amount of senior term debt, (B) $72.0 million aggregate principal amount of senior subordinated debt and (C) $30.8 million of investments in equity securities. For the three months ended June 30, 2005, the Company purchased (1) $82.9 million aggregate principal amount of senior term debt, (2) $10.0 million aggregate principal amount of senior subordinated debt, (3) $12.2 million aggregate principal amount of senior notes and (4) $5.2 million of investments in equity securities.
During the three months ended June 30, 2006, (A) $45.7 million aggregate principal amount of senior term debt and (B) $9.0 million aggregate principal amount of collateralized debt obligation notes were redeemed, and (C) $54.4 million of investments in equity securities were sold. As of June 30, 2006, the Company held investments in 50 portfolio companies as compared to 38 portfolio companies as of December 31, 2005. During the three months ended June 30, 2005, (1) $27.6 million aggregate principal amount of senior term debt and (2) $5.3 million aggregate principal amount of senior subordinated debt were redeemed, and (3) $3.2 million of investments in equity securities were sold.
The Investment Adviser employs an investment rating system to categorize our investments. In addition to various risk management and monitoring tools, we grade all loans on a scale of 1 to 4 no less frequently than quarterly. This system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loans and other factors considered relevant. Under this system, loans with a grade of 4 involve the least amount of risk in our portfolio. The borrower is performing above expectations and the trends and risk factors are generally favorable. Loans graded 3 involve a level of risk that is similar to the risk at the time of origination. The borrower is performing as expected and the risk factors are neutral to favorable. All new loans are initially graded 3. Loans graded 2 involve a borrower performing below expectations and indicates that the loan’s risk has increased materially since origination. The borrower is generally out of compliance with debt covenants, however, loan payments are generally not more than 120 days past due. For loans graded 2, we increase procedures to monitor the borrower. A loan grade of 1 indicates that the borrower is performing materially below expectations and that the loan risk has substantially increased since origination. Most or all of the debt covenants are out of compliance and payments are substantially delinquent. Loans graded 1 are not anticipated to be repaid in full.
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We believe that as of June 30, 2006, the weighted average investment grade of the debt in our portfolio is 3.0 and the weighted average yield of such debt and income producing equity securities is approximately 12.42% (computed as (a) annual stated interest rate or yield earned plus the net annual amortization of original issue discount and market discount earned on accruing debt, divided by (b) total income producing equity securities and debt at fair value). As of June 30, 2006, the weighted average yield on our entire portfolio was 11.63%. The weighted average yield on our senior term debt, senior subordinated debt and income producing equity securities was 11.67%, 14.51% and 10.57%, respectively. Of the senior term debt, the weighted average yield attributable to first lien senior term debt and second lien senior term debt was 11.10% and 12.32%, respectively.
As of December 31, 2005, the weighted average investment grade of the debt in our portfolio was 3.1 and the weighted average yield of such debt and income producing equity securities was approximately 11.25% (computed as (a) annual stated interest rate or yield earned plus the net annual amortization of original issue discount and market discount earned on accruing debt, divided by (b) total income producing equity securities and debt at fair value). As of December 31, 2005, the weighted average yield on our entire portfolio was 10.88%. The weighted average yield on our senior term debt, senior subordinated debt and income producing equity securities was 10.56%, 14.71% and 8.82%, respectively. Of the senior term debt, the weighted average yield attributable to first lien senior term debt and second lien senior term debt was 9.38% and 11.49%, respectively.
RESULTS OF OPERATIONS
For the three and six months ended June 30, 2006 and June 30, 2005
Operating results for the three and six months ended June 30, 2006 and June 30, 2005 are as follows:
For the Three MonthsEnded June 30,
For the Six MonthsEnded June 30,
2006
2005
Total Investment Income
Total Expenses
Net Investment Income Before Income Taxes
Income Tax Expense, Including Excise Tax
Net Investment Income
Net Realized Gain
Net Unrealized Loss
Net Increase in Stockholders’ Equity Resulting From Operations
Investment Income
For the three months ended June 30, 2006, total investment income increased $20.9 million, or 218%, over the three months ended June 30, 2005. For the three months ended June 30, 2006, total investment income consisted of $23.5 million in interest income from investments, $1.2 million in dividend income, $5.3 million in capital structuring service fees, $352,000 in other income and $200,000 in interest income from cash and cash equivalents. Interest income from investments increased $16.8 million, or 249%, to $23.5 million for the three months ended June 30, 2006 from $6.7 million for the comparable period in 2005. The increase in interest income from investments was primarily due to the increase in the size of the portfolio. The average investments, at fair value, for the quarter increased from $259.2 million in the three months ended June 30, 2005 to $818.1 million in the comparable period in 2006. Capital structuring service fees increased $3.8 million, or 253%, to $5.3 million for the three months ended June 30, 2006 from $1.5 million for the comparable period in 2005. The increase in capital structuring service fees was primarily due to the increased number of originations. The number of funded
30
commitments increased from nine during the three months ended June 30, 2005 to 15 during the comparable period in 2006.
For the six months ended June 30, 2006, total investment income increased $35.3 million, or 230%, over the six months ended June 30, 2005. For the six months ended June 30, 2006, total investment income consisted of $41.0 million in interest income from investments, $7.6 million in capital structuring service fees, $454,000 in other income and $431,000 in interest income from cash and cash equivalents. Interest income from investments increased $29.1 million, or 243%, to $41.0 million for the six months ended June 30, 2006 from $12.0 million for the comparable period in 2005. The increase in interest income from investments was primarily due to the increase in the size of the portfolio. The average investments, at fair value, for the period increased from $227.7 million in the six months ended June 30, 2005 to $730.5 million in the comparable period in 2006. Capital structuring service fees increased $5.8 million, or 323%, to $7.6 million for the six months ended June 30, 2006 from $1.8 million for the comparable period in 2005. The increase in capital structuring service fees was primarily due to the increased number of originations. The number of funded commitments increased from 14 during the six months ended June 30, 2005 to 28 during the comparable period in 2006.
Expenses
For the three months ended June 30, 2006, total expenses increased $12.4 million, or 323%, over the three months ended June 30, 2005. Base management fees increased $2.1 million, or 203%, to $3.1 million for the three months ended June 30, 2006 from $1.0 million for the comparable period in 2005, primarily due to the increase in the size of the portfolio. Incentive fees related to pre-incentive fee net investment income increased $3.5 million, or 544%, to $4.1 million for the three months ended June 30, 2006 from $634,000 for the comparable period in 2005, primarily due to the increase in the size of the portfolio and the related increase in net investment income. Incentive fees related to realized gains increased $1.7 million, or 145%, to $2.9 million for the three months ended June 30, 2006 from $1.2 million for the comparable period in 2005, primarily due to higher net realized gains recognized during the three months ended June 30, 2006 as compared to the three months ended June 30, 2005. Net realized gains for the three months ended June 30, 2006 increased from $6.7 million during the three months ended June 30, 2005 to $23.9 million during the three months ended June 30, 2006. For the three months ended June 30, 2006, the net realized gains of $23.9 million were offset by $4.2 million in income tax expense related to realized gains and $3.7 million in unrealized depreciation in determining the incentive fees related to realized gains for the period. Interest expense and credit facility fees increased $4.3 million, or 6,826%, to $4.4 million for the three months ended June 30, 2006 from $63,000 for the comparable period in 2005, primarily due to the significant increase in the borrowings outstanding. There were no outstanding borrowings during the three months ended June 30, 2005 compared to average outstanding borrowings of $265.7 million in the comparable period in 2006. Amortization of debt issuance costs increased $346,000, or 527%, to $412,000 for the three months ended June 30, 2006 from $66,000 for the comparable period in 2005, primarily due to the additional debt issuance costs capitalized during the end of 2005 as a result of entering into the Revolving Credit Facility and increasing the borrowing capacity of the CP Funding Facility.
For the six months ended June 30, 2006, total expenses increased $18.5 million, or 305%, over the six months ended June 30, 2005. Base management fees increased $3.8 million, or 207%, to $5.6 million for the six months ended June 30, 2006 from $1.8 million for the comparable period in 2005, primarily due to the increase in the size of the portfolio. Incentive fees related to pre-incentive fee net investment income increased $6.1 million, or 704%, to $7.0 million for the six months ended June 30, 2006 from $871,000 for the comparable period in 2005, primarily due to the increase in the size of the portfolio and the related increase in net investment income. Incentive fees related to realized gains increased $1.7 million, or 139%, to $2.9 million for the six months ended June 30, 2006 from $1.2 million for the comparable period in 2005, primarily due to higher net realized gains recognized during the six months ended June 30, 2006 as compared to the six months ended June 30, 2005. Interest expense and credit facility fees increased $5.6 million, or 6,704%, to $5.7 million for the six months ended June 30, 2006 from $84,000 for the comparable period in 2005, primarily due to the significant increase in the borrowings outstanding. The average outstanding borrowings during the six months ended June 30, 2005 were $17.1 million compared to average outstanding borrowings of $171.6 million in the comparable period in 2006. Amortization of debt issuance costs increased $688,000, or 523%, to $819,000 for the six months ended June 30, 2006 from $131,000 for the comparable period in 2005, primarily due to the additional debt issuance costs capitalized during the end of 2005 as a result of entering into the Revolving Credit Facility and increasing the borrowing capacity of the CP Funding Facility.
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The Company has qualified and elected and intends to continue to qualify and elect for the tax treatment applicable to regulated investment companies under Subchapter M of the Internal Revenue Code of 1986 (the “Code”), as amended, and, among other things, has made and intends to continue to make the requisite distributions to its stockholders which will relieve the Company from Federal income taxes.
Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the three and six months ended June 30, 2006, a provision of approximately $727,000 and $826,000, respectively, was recorded for Federal excise tax.
Our wholly owned subsidiaries ACC and ACLLC are subject to Federal and state income taxes. For the three and six months ended June 30, 2006, we recorded a tax provision of approximately $4.2 million and $4.4 million, respectively, for these subsidiaries.
Net Unrealized Appreciation on Investments
For the three months ended June 30, 2006, the Company’s investments had a decrease in net unrealized appreciation of $16.5 million, which primarily related to the reversal of the prior period unrealized appreciation of $13.3 million for the investment in CICQ, LP, which was realized during the period, and the increase in unrealized depreciation of $3.7 million for the investment in Berkline/Benchcraft Holdings LLC, offset by the increase in unrealized appreciation in Varel Holdings, Inc of $1.0 million. For the three months ended June 30, 2005, the Company’s investments had a decrease in net unrealized appreciation of $4.9 million primarily related to the reversal of the prior period unrealized appreciation of $4.6 million for the investment in Reef Holdings, Inc., which was realized during the period.
For the six months ended June 30, 2006, the Company’s investments had a decrease in net unrealized appreciation of $14.9 million, which primarily related to the reversal of the prior period unrealized appreciation of $9.3 million for the investment in CICQ, LP, which was realized during the period, and the increase in unrealized depreciation of $6.1 million for the investments in Making Memories Wholesale, Inc. and Berkline/Benchcraft Holdings LLC. For the six months ended June 30, 2005, the Company’s investments had a decrease in net unrealized appreciation of $346,000.
Net Realized Gains/Losses
During the three months ended June 30, 2006, the Company had $133.1 million of sales and repayments resulting in $23.9 million of net realized gains. The most significant realized gains during the three months ended June 30, 2006 were the sales of the investments in CICQ, LP and United Site Services, Inc. of $18.6 million and $4.7 million, respectively. During the three months ended June 30, 2005, the Company had $45.8 million of sales and repayments resulting in $6.7 million of net realized gains. The most significant realized gains during the three months ended June 30, 2005 were the sales of the investments in Reef Holdings, Inc. and Billing Concepts, Inc. of $4.8 million and $1.9 million, respectively.
During the six months ended June 30, 2006, the Company had $170.4 million of sales and repayments resulting in $24.5 million of net realized gains. During the six months ended June 30, 2005, the Company had $55.6 million of sales and repayments resulting in $7.2 million of net realized gains.
Net increase in stockholders’ equity resulting from operations for the three and six months ended June 30, 2006 was approximately $16.7 million and $30.5 million, respectively. Based on the weighted average shares outstanding during the three and six months ended June 30, 2006, our net increase in stockholders’ equity resulting from operations per common share was $0.44 and $0.80, respectively.
Net increase in stockholders’ equity resulting from operations for the three and six months ended June 30, 2005 was approximately $7.6 million and $16.1 million, respectively. Based on the weighted average shares outstanding during the three and six months ended June 30, 2005, our net increase in stockholders’ equity resulting from operations per common share was $0.33 and $0.91, respectively.
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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company’s liquidity and capital resources were generated primarily from the remaining net proceeds of its initial public offering and subsequent add-on public offerings, advances from the CP Funding Facility and the Revolving Credit Facility, as well as cash flows from operations. We received approximately $156.4 million in proceeds net of underwriting and offering costs (net of $2.5 million in underwriting costs originally paid by the Investment Adviser and subsequently reimbursed by the Company in 2006) from our October 8, 2004 initial public offering, approximately $183.9 million in proceeds net of underwriting and offering costs from our March 23, 2005 add-on public offering, $213.5 million in proceeds net of underwriting and offering costs from our October 18, 2005 add-on public offering and $162.2 million in proceeds net of underwriting and offering costs from our July 18, 2006 add-on public offering.
A portion of the proceeds from our public offerings and the securitization were used to repay outstanding indebtedness under the CP Funding Facility and the Revolving Credit Facility. The remaining unused portion of the proceeds from our public offerings has been used to fund investments in portfolio companies in accordance with our investment objectives and strategies.
As of June 30, 2006 and December 31, 2005, the fair value of investments and cash and cash equivalents, and the outstanding borrowings under the CP Funding Facility and the Revolving Credit Facility were as follows:
Outstanding borrowings
The available amount for borrowing under the CP Funding Facility is $350.0 million (see Note 7 to the consolidated financial statements for more detail of the CP Funding Facility arrangement). As of June 30, 2006, there was $101.2 million outstanding under the CP Funding Facility. The CP Funding Facility expires on November 1, 2006 unless extended prior to such date with the consent of the lenders. The available amount for borrowing under the Revolving Credit Facility is $250 million (see Note 7 to the consolidated financial statements for more detail of the Revolving Credit Facility arrangement). As of June 30, 2006, there was $244.0 million outstanding under the Revolving Credit Facility. The Revolving Credit Facility expires on December 28, 2010.
For the six months ending June 30, 2006, average total assets was $766.6 million.
OFF BALANCE SHEET ARRANGEMENTS
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
We are subject to financial market risks, including changes in interest rates and the valuations of our investment portfolio.
Interest Rate Risk
As of June 30, 2006, approximately 32% of the investments at fair value in our portfolio were at fixed rates while approximately 60% were at variable rates. In addition, the CP Funding Facility and the Revolving Credit Facility are variable rate borrowing facilities.
To illustrate the potential impact of changes in interest rates, we have performed the following analysis based on our June 30, 2006 balance sheet and assuming no changes in our investment and borrowing structure. Under this analysis, a 100 basis point increase in the various base rates would result in an increase in interest income of approximately $5,400,000 and an increase in interest expense of $3,452,000 over the next 12 months. A 100 basis point decrease in the various base rates would result in a decrease in interest income of approximately $5,400,000 and a decrease in interest expense of $3,452,000 over the next 12 months.
On January 7, 2005, we entered into a costless collar agreement in order to manage the exposure to changing interest rates related to the Company’s fixed rate investments. The costless collar agreement was for a notional amount of $20 million, has a cap of 6.5%, a floor of 2.72% and matures in 2008. The costless collar agreement allows us to receive an interest payment when the 3-month LIBOR exceeds 6.5% and obligates us to pay an interest payment when the 3-month LIBOR is less than 2.72%. The costless collar resets quarterly based on the 3-month LIBOR. As of June 30, 2006, the 3-month LIBOR was 5.48%. As of June 30, 2006, these derivatives had no fair value.
While hedging activities may mitigate our exposure to adverse fluctuations in interest rates, certain hedging transactions that we may enter into in the future, such as interest rate swap agreements, may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio investments.
34
Portfolio Valuation
Investments for which market quotations are readily available are valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our board of directors based on the input of our investment adviser and audit committee. In addition, the board of directors currently receives input from an independent valuation firm that has been engaged at the direction of the board to value each portfolio security at least once during a trailing 12 month period. The valuation process is conducted at the end of each fiscal quarter, with approximately a quarter of our portfolio companies subject to valuation by the independent valuation firm each quarter. The types of factors that the board may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.
Item 4. Controls and Procedures.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our current disclosure controls and procedures are effective in timely alerting them of material information relating to the Company that is required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934.
There have been no changes in our internal control over financial reporting that occurred during the three months ended June 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a defendant in any pending legal proceeding, and no such proceedings are known to be contemplated.
Ite m 1A. Risk Factors.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
We did not sell any securities during the period covered in this report that were not registered under the Securities Act.
We did not repurchase any shares issued during the period covered in this report.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
On May 30, 2006, we held our Annual Meeting of Stockholders in Los Angeles, California. Stockholders voted on three matters; the substance of these matters and the results of the voting of each such matter are described below.
1. Election of Directors: Stockholders elected two Class II directors of the Company, who will each serve for three years, or until his successor is elected and qualified. Votes were cast as follows:
For
Withheld
Robert L. Rosen
25,438,258
1,023,959
Bennett Rosenthal
25,198,779
1,263,438
The following directors are continuing as directors of the Company for their respective terms — Douglas E. Coltharp, Frank E. O’Bryan and Eric B. Siegel.
2. Ratification of the selection of KPMG LLP to serve as independent registered public accounting firm for the year ending December 31, 2006. Votes were cast as follows:
Against
25,888,408
441,467
132,342
3. Approval of an amended and restated investment advisory and management agreement between the Company and the Investment Adviser. Brokers cast 6,973,644 non-votes. The remaining votes were cast as follows:
18,706,821
547,694
234,058
Item 5. Other Information.
None.
Item 6. Exhibits.
36
EXHIBIT INDEX
Number
Description
Articles of Amendment and Restatement (1)
3.2
Amended and Restated Bylaws (1)
4.1
Form of Stock Certificate (2)
10.1
Amended and Restated Investment Advisory and Management Agreement between Ares Capital Corporation and Ares Capital Management LLC (3)
Sale and Servicing Agreement, dated as of July 7, 2006, among ARCC Commercial Loan Trust 2006, as issuer, ARCC CLO 2006 LLC, as trust depositor, Ares Capital Corporation, as originator and as servicer, U.S. Bank National Association, as trustee and as collateral administrator, Lyon Financial Services, Inc. (d/b/a U.S. Bank Portfolio Services), as backup servicer, and Wilmington Trust Company, as owner trustee*
10.3
Commercial Loan Sale Agreement, dated as of July 7, 2006, between Ares Capital Corporation and ARCC CLO 2006 LLC*
10.4
Indenture, dated as of July 7, 2006, between ARCC Commercial Loan Trust 2006 and U.S. Bank National Association*
Amended and Restated Trust Agreement, dated as of July 7, 2006, among ARCC CLO 2006 LLC, Wilmington Trust Company and U.S. Bank National Association*
Collateral Administration Agreement, dated as of July 7, 2006, among ARCC Commercial Loan Trust 2006, Ares Capital Corporation and U.S. Bank National Association*
Master Participation Agreement, dated as of July 7, 2006, between Ares Capital CP Funding LLC and Ares Capital Corporation*
10.8
Class A-1A VFN Purchase Agreement, dated as of July 7, 2006, among ARCC Commercial Loan Trust 2006, U.S. Bank National Association and the other Class A-1A VFN noteholders party thereto*
31.1
Certification by President pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2
Certification by Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1
Certification by President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
* Filed herewith.
(1) Previously filed with the Registrant’s pre-effective Amendment No. 1 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on September 17, 2004.
(2) Previously filed with the Registrant’s pre-effective Amendment No. 2 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on September 28, 2004.
(3) Previously filed with the Registrant’s Form 8-K, filed on June 2, 2006.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 9, 2006
By
/s/ Michael J. Arougheti
Michael J. Arougheti
President
/s/ Daniel F. Nguyen
Daniel F. Nguyen
Chief Financial Officer
38