UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the Quarter Ended September 30, 2015
Commission File Number: 814-00754
SOLAR CAPITAL LTD.
(Exact name of registrant as specified in its charter)
(I.R.S. Employer
Identification No.)
500 Park Avenue
New York, N.Y.
(212) 993-1670
(Registrant’s telephone number, including area code)
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 and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of the registrant’s Common Stock, $.01 par value, outstanding as of November 2, 2015 was 42,465,162.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2015
TABLE OF CONTENTS
Financial Statements
Consolidated Statements of Assets and Liabilities as of September 30, 2015 (unaudited) and December 31, 2014
Consolidated Statements of Operations for the three and nine months ended September 30, 2015 (unaudited) and the three and nine months ended September 30, 2014 (unaudited)
Consolidated Statements of Changes in Net Assets for the nine months ended September 30, 2015 (unaudited) and the year ended December 31, 2014
Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 (unaudited) and the nine months ended September 30, 2014 (unaudited)
Consolidated Schedule of Investments as of September 30, 2015 (unaudited)
Consolidated Schedule of Investments as of December 31, 2014
Notes to Consolidated Financial Statements (unaudited)
Report of Independent Registered Public Accounting Firm
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Controls and Procedures
Legal Proceedings
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Other Information
Exhibits
Signatures
PART I. FINANCIAL INFORMATION
In this Quarterly Report, “Solar Capital”, “Company”, “Fund”, “we”, “us”, and “our” refer to Solar Capital Ltd. unless the context states otherwise.
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
(in thousands, except share amounts)
Assets
Investments at fair value:
Companies less than 5% owned (cost: $866,422 and $659,552, respectively)
Companies 5% to 25% owned (cost: $8,511 and $8,511, respectively)
Companies more than 25% owned (cost: $330,964 and $339,380, respectively)
Total investments (cost: $1,205,897 and $1,007,443, respectively)
Cash
Cash equivalents (cost: $422,223 and $490,000, respectively)
Foreign currency (cost: $0 and $275, respectively)
Receivable for investments sold
Interest receivable
Dividends receivable
Deferred financing costs
Prepaid expenses and other assets
Total assets
Liabilities
Revolving credit facilities (see note 6 and 8)
Unsecured senior notes (see note 8)
Senior secured notes (see note 6 and 8)
Term loan (see note 6 and 8)
Distributions payable
Payable for investments and cash equivalents purchased
Management fee payable (see note 3)
Performance-based incentive fee payable (see note 3)
Administrative services expense payable (see note 3)
Interest payable (see note 8)
Other liabilities and accrued expenses
Total liabilities
Commitments and contingencies (see note 12 and 13)
Net Assets
Common stock, par value $0.01 per share, 200,000,000 and 200,000,000 common shares authorized, respectively, and 42,465,162 and 42,465,162 shares issued and outstanding, respectively
Paid-in capital in excess of par
Distributions in excess of net investment income
Accumulated net realized loss
Net unrealized appreciation
Total net assets
Net Asset Value Per Share
See notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
INVESTMENT INCOME:
Interest:
Companies less than 5% owned
Companies 5% to 25% owned
Companies more than 25% owned
Dividends:
Other income:
Total investment income
EXPENSES:
Management fees (see note 3)
Performance-based incentive fees (see note 3)
Interest and other credit facility expenses (see note 8)
Administrative services expense (see note 3)
Other general and administrative expenses
Total expenses
Performance-based incentive fees waived (see note 3)
Net expenses
Net investment income
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, CASH EQUIVALENTS, FOREIGN CURRENCIES AND DERIVATIVES:
Net realized gain (loss) on investments and cash equivalents:
Net realized gain (loss) on investments and cash equivalents
Net realized loss on foreign currencies and derivatives:
Net realized gain (loss)
Net change in unrealized gain (loss) on investments and cash equivalents
Net change in unrealized gain (loss) on foreign currencies and derivatives
Net change in unrealized gain (loss)
Net realized and unrealized gain (loss) on investments, cash equivalents, foreign currencies and derivatives
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
EARNINGS PER SHARE (see note 5)
4
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
Increase in net assets resulting from operations:
Net realized loss
Net increase in net assets resulting from operations
Distributions to stockholders:
From net investment income
From other sources
Net distributions to stockholders
Capital transactions:
Repurchases of common stock
Net increase (decrease) in net assets resulting from capital transactions
Total decrease in net assets
Net assets at beginning of period
Net assets at end of period (1)
Capital stock activity:
Common stock repurchased
Net increase (decrease) from capital stock activity
5
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
Cash Flows from Operating Activities:
Adjustments to reconcile net increase in net assets resulting from operations:
Net realized loss on investments and cash equivalents
Net realized loss on foreign currencies and derivatives
Net change in unrealized (gain) loss on investments and cash equivalents
Net change in unrealized (gain) loss on foreign currencies and derivatives
(Increase) decrease in operating assets:
Purchase of investments
Proceeds from disposition of investments
Capitalization of payment-in-kind interest
Collections of payment-in-kind interest
Increase (decrease) in operating liabilities:
Management fee payable
Performance-based incentive fees payable
Administrative services expense payable
Interest payable
Net Cash Provided by (Used in) Operating Activities
Cash Flows from Financing Activities:
Cash distributions paid
Repurchase of common stock
Proceeds from borrowings
Repayment of borrowings
Net Cash Provided by (Used in) Financing Activities
NET DECREASE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
CASH AND CASH EQUIVALENTS AT END OF PERIOD
Supplemental disclosure of cash flow information:
Cash paid for interest
Non-cash financing activities consist of the reinvestment of distributions of $0 and $0 for the nine months ended September 30, 2015 and 2014, respectively.
6
CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited)
September 30, 2015
(in thousands, except share/unit amounts)
Description
Industry
Date
Value
Bank Debt/Senior Secured Loans — 87.3%
AccentCare, Inc
Achaogen, Inc
Aegis Toxicology Sciences Corporation
AgaMatrix, Inc
Amerilife Group, LLC
Argo Turboserve Corporation & Argo Tech, LLC
Asurion, LLC
AviatorCap SII, LLC I (3)
AviatorCap SII, LLC II (3)
Bishop Lifting Products, Inc. (9)
CAMP International Holding Company
CardioDx, Inc
Cardiva Medical, Inc
Concentra, Inc
Datapipe, Inc
Direct Buy Inc. (4)**
DISA Holdings Acquisition Subsidiary Corp
Easyfinancial Services, Inc. (6)(7)
Emerging Markets Communications, LLC
Filtration Group Corp
Genoa, A QoL Healthcare Company, LLC
Global Tel*Link Corporation
Greystone Select Holdings LLC & Greystone & Co.,Inc
Hyland Software, Inc
IHS Intermediate, Inc
Infraredx, Inc
Inmar Acquisition Sub, Inc
K2 Pure Solutions NoCal, L.P
Kore Wireless Group, Inc
Landslide Holdings, Inc
LegalZoom.com, Inc
Pharmedium Healthcare Corporation
Pronutria Biosciences, Inc.
Rapid Micro Biosystems, Inc.
Rug Doctor LLC (3)
Salient Partners, L.P
SOINT, LLC (3)
Southern Auto Finance Company (7)
Syndax Pharmaceuticals, Inc
T2 Biosystems, Inc. (7)
The Robbins Company TLA
The Robbins Company TLB
TierPoint, LLC
TMK Hawk Parent, Corp. (TriMark)
TouchTunes Interactive Networks, Inc
Trevi Therapeutics, Inc
U.S. Anesthesia Partners Inc
U.S. Anesthesia Partners Inc.
Varilease Finance, Inc
VetCor Professional Practices LLC
Total Bank Debt/Senior Secured Loan
Subordinated Debt/Corporate Notes — 7.7%
Alegeus Technologies Holdings Corp
WireCo Worldgroup Inc.
Total Subordinated Debt/Corporate Notes
Preferred Equity — 2.0%
SOAGG LLC (3)(5)(7)(8)
SOINT, LLC (3)(7)(8)
Total Preferred Equity
Common Equity/Equity Interests/Warrants — 35.0%
AgaMatrix Inc. Warrants*
Ark Real Estate Partners LP (2)(3)*
Ark Real Estate Partners II LP (2)(3)*
B Riley Financial Inc. (Great American)
CardioDx, Inc. Warrants*
Crystal Financial LLC (3)(7)(10)
Direct Buy Inc. (4)*
Radius Health Inc. (7)*
RD Holdco Inc. (Rug Doctor)(3)*
RD Holdco Inc. (Rug Doctor) Class B(3)*
RD Holdco Inc. (Rug Doctor) Warrants(3)*
Total Common Equity/Equity Interests/Warrants
Total Investments (11) — 132.0%
7
CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited)(continued)
Cash Equivalents — 46.2%
U.S. Treasury Note 2.125%
Total Investments & Cash Equivalents — 178.2%
Liabilities in Excess of Other Assets — (78.2%)
Net Assets — 100.0%
Name of Issuer
ARK Real Estate Partners LP
ARK Real Estate Partners II LP
AviatorCap SII, LLC I
AviatorCap SII, LLC II
Crystal Financial LLC
RD Holdco Inc. (Rug Doctor, common equity)
RD Holdco Inc. (Rug Doctor, class B)
RD Holdco Inc. (Rug Doctor, warrants)
Rug Doctor LLC
SOAGG LLC
SOINT, LLC
SOINT, LLC (preferred equity)
Direct Buy Inc. (common equity)
Direct Buy Inc. (senior secured loan)
DSW Group Holdings LLC
8
Industry Classification
Diversified Financial Services
Health Care Providers & Services
Wireless Telecommunications Services
IT Services
Pharmaceuticals
Internet Software & Supplies
Health Care Equipment & Supplies
Building Products
Trading Companies & Distributors
Multi-Sector Holdings
Consumer Finance
Aerospace & Defense
Health Care Facilities
Diversified Consumer Services
Health Care Technology
Insurance
Software
Communications Equipment
Life Sciences Tools & Services
Asset Management
Construction & Engineering
Air Freight & Logistics
Media
Chemicals
Professional Services
Thrifts & Mortgage Finance
Industrial Conglomerates
Multiline Retail
Diversified Real Estate Activities
Research & Consulting Services
Total Investments
9
CONSOLIDATED SCHEDULE OF INVESTMENTS
December 31, 2014
Bank Debt/Senior Secured Loans—64.1%
Bishop Lifting Products, Inc. (10)
Blue Coat Systems, Inc.
Body Central Stores, Inc
Easyfinancial Services, Inc. (6)(7).
Greystone Select Holdings LLC & Greystone & Co., Inc
Ikaria, Inc
Kore Wireless Group Inc
Wireless Telecommunication
Services
Pronutria, Inc.
Quantum Foods, LLC**
Radius Health, Inc. (7)
Rug Doctor, LLC (3)
Southern Auto Finance Company (7)(8)
U.S. Anesthesia Partners, Inc
U.S. Anesthesia Partners, Inc.
Total Bank Debt/Senior Secured Loans
10
CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)
(in thousands except share/unit amounts)
Subordinated Debt/Corporate Notes—8.1%
Alegeus Technologies Holdings Corp.
Preferred Equity—2.5%
SOAGG LLC (3)(7)(9)
SOINT, LLC (3)(7)(9)
Common Equity/Equity Interests/Warrants—34.3%
Ark Real Estate Partners LP(2)(3)†
Ark Real Estate Partners II LP(2)(3)†
B Riley Financial Inc. (fka Great American)
Crystal Financial LLC (3)(7)(11)
Direct Buy Inc. (4)†
Infraredx, Inc. Warrants†
Radius Health, Inc. (7)†
Radius Health, Inc. Warrants (7)†
RD Holdco Inc. (Rug Doctor) (3)†
RD Holdco Inc. (Rug Doctor) Class B(3)†
RD Holdco Inc. (Rug Doctor) Warrants(3)†
Total Investments (12)—109.0%
Cash Equivalents—52.3%
U.S. Treasury Bill
Total Investments & Cash Equivalents 161.3%
Liabilities in Excess of Other Assets—(61.3%)
Net Assets—100.0%
11
AviatorCap SII, LLC III
USAW 767
National Interest Security Corporation
12
Internet Software & Services
Food Products
Specialty Retail
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 1. Organization
Solar Capital LLC, a Maryland limited liability company, was formed in February 2007 and commenced operations on March 13, 2007 with initial capital of $1,200,000 of which 47.04% was funded by affiliated parties.
Immediately prior to our initial public offering, through a series of transactions, Solar Capital Ltd. merged with Solar Capital LLC, leaving Solar Capital Ltd. as the surviving entity (the “Merger”). Solar Capital Ltd. issued an aggregate of approximately 26.65 million shares of common stock and $125,000 in senior unsecured notes to the existing Solar Capital LLC unit holders in connection with the Merger. Solar Capital Ltd. had no assets or operations prior to completion of the Merger and as a result, the historical books and records of Solar Capital LLC have become the books and records of the surviving entity. The number of shares used to calculate weighted average shares for use in computations on a per share basis have been decreased retroactively by a factor of approximately 0.4022 for all periods prior to February 9, 2010. This factor represents the effective impact of the reduction in shares resulting from the Merger.
Solar Capital Ltd. (“Solar Capital”, the “Company” or “we”), a Maryland corporation formed in November 2007, is a closed-end, externally managed, non-diversified management investment company that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). Furthermore, as the Company is an investment company, it continues to apply the guidance in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946. In addition, for tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).
On February 9, 2010, Solar Capital priced its initial public offering, selling 5.68 million shares, including the underwriters’ over-allotment, at a price of $18.50 per share. Concurrent with this offering, management purchased an additional 600,000 shares through a private placement, also at $18.50 per share.
The Company’s investment objective is to generate both current income and capital appreciation through debt and equity investments. The Company invests primarily in leveraged middle market companies in the form of senior secured loans, mezzanine loans and equity securities. From time to time, we may also invest in public companies that are thinly traded.
Note 2. Significant Accounting Policies
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 of America (“GAAP”), 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. Certain prior period amounts may have been reclassified to conform to the current period presentation.
Interim consolidated financial statements are prepared in accordance with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Regulation S-X, as appropriate. Accordingly, they may not include all of the information and notes required by GAAP for annual consolidated financial statements. GAAP requires management to make estimates and assumptions that affect the reported
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
amount of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reported periods. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending on December 31, 2015.
In the opinion of management, all adjustments, which are of a normal recurring nature, considered necessary for the fair presentation of financial statements, have been included.
The significant accounting policies consistently followed by the Company are:
With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, our Board has approved a multi-step valuation process each quarter, as described below:
15
Investments in all asset classes are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, our principal market (as the reporting entity) and enterprise values, among other factors. When available, broker quotations and/or quotations provided by pricing services are considered as an input in the valuation process. For the nine months ended September 30, 2015, there has been no change to the Company’s valuation techniques and the nature of the related inputs considered in the valuation process.
ASC Topic 820 classifies the inputs used to measure these fair values into the following hierarchy:
Level 1: Quoted prices in active markets for identical assets or liabilities, accessible by the Company at the measurement date.
Level 2: Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.
Level 3: Unobservable inputs for the asset or liability.
In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to each investment. The exercise of judgment is based in part on our knowledge of the asset class and our prior experience.
The Company intends to comply with the applicable provisions of the Internal Revenue Code pertaining to regulated investment companies to make distributions of taxable income sufficient to
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17
Recent Accounting Pronouncements
In February 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. The update changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. Public companies are required to apply ASU 2015-02 for interim and annual reporting periods beginning after December 15, 2015. Accordingly, the Company is currently evaluating the impact of the adoption of ASU 2015-02 on its consolidated financial statements and disclosures.
In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs. The update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Public companies are required to apply ASU 2015-03 retrospectively for interim and annual reporting periods beginning after December 15, 2015. Accordingly, the Company is currently evaluating the impact of the adoption of ASU 2015-03 on its consolidated financial statements and disclosures.
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). The update eliminates the requirement to categorize investments in the fair value hierarchy if their fair value is measured at net asset value (NAV) per share (or its equivalent) using the practical expedient in the FASB’s fair value measurement guidance. Public companies are required to apply ASU 2015-07 retrospectively for interim and annual reporting periods beginning after December 15, 2015. Accordingly, the Company is currently evaluating the impact of the adoption of ASU 2015-07 on its consolidated financial statements and disclosures.
Note 3. Agreements
Solar Capital has an Investment Advisory and Management Agreement with the Investment Adviser, under which the Investment Adviser will manage the day-to-day operations of, and provide investment advisory services to, Solar Capital. For providing these services, the Investment Adviser receives a fee from Solar Capital, consisting of two components—a base management fee and an incentive fee. The base management fee is determined by taking the average value of Solar Capital’s gross assets at the end of the two most recently completed calendar quarters calculated at an annual rate of 2.00%. From time-to-time we may purchase U.S. Treasury bills or other high-quality, short-term debt securities at or near the end of the quarter and typically close
18
out the position on a net cash basis subsequent to quarter end. We may also utilize repurchase agreements or other balance sheet transactions, including drawing down on our credit facilities, as deemed appropriate. The amount of these transactions or such drawn cash for this purpose is excluded from total assets for purposes of computing the asset base upon which the management fee is determined.
The incentive fee has two parts, as follows: one part is calculated and payable quarterly in arrears based on Solar Capital’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus Solar Capital’s operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement, and any interest expense and distributions paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income does not include any realized capital gains or losses, or unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of return on the value of Solar Capital’s net assets at the end of the immediately preceding calendar quarter, is compared to the hurdle rate of 1.75% per quarter (7% annualized). Solar Capital pays the Investment Adviser an incentive fee with respect to Solar Capital’s pre-incentive fee net investment income in each calendar quarter as follows: (1) no incentive fee in any calendar quarter in which Solar Capital’s pre-incentive fee net investment income does not exceed the hurdle rate; (2) 100% of Solar Capital’s 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 2.1875% in any calendar quarter; and (3) 20% of the amount of Solar Capital’s pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter. These calculations are appropriately pro-rated for any period of less than three months.
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 Investment Advisory and Management Agreement, as of the termination date), and will equal 20% of Solar Capital’s cumulative realized capital gains less cumulative realized capital losses, unrealized capital depreciation (unrealized depreciation on a gross investment-by-investment basis at the end of each calendar year) and all net capital gains upon which prior performance-based capital gains incentive fee payments were previously made to the Investment Adviser. For financial statement purposes, the second part of the incentive fee is accrued based upon 20% of cumulative net realized gains and net unrealized capital appreciation. No accrual was required for the three and nine months ended September 30, 2015 and 2014.
For the three and nine months ended September 30, 2015, the Company recognized $6,254 and $18,155, respectively, in base management fees and $1,971 and $1,971, respectively, in performance-based incentive fees. For the three and nine months ended September 30, 2015, $700 and $700, respectively, of such performance-based incentive fees were waived. For the three and nine months ended September 30, 2014, the Company recognized $6,159 and $18,542, respectively, in base management fees and $0 and $3,213, respectively, in performance-based incentive fees. For the three and nine months ended September 30, 2014, $0 and $0, respectively, of such performance-based incentive fees were waived. The voluntary fee waiver was made at the Investment Adviser’s discretion and is not subject to recapture by the Investment Adviser or reimbursement by the Company.
Solar Capital has also entered into an Administration Agreement with Solar Capital Management, LLC (the “Administrator”) under which the Administrator provides administrative services to Solar Capital. For providing these services, facilities and personnel, Solar Capital reimburses the Administrator for Solar Capital’s allocable
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portion of overhead and other expenses incurred by the Administrator in performing its obligations under the Administration Agreement, including rent. The Administrator will also provide, on Solar Capital’s behalf, managerial assistance to those portfolio companies to which Solar Capital is required to provide such assistance.
For the three and nine months ended September 30, 2015, the Company recognized expenses under the Administration Agreement of $1,245 and $3,844, respectively. For the three and nine months ended September 30, 2014, the Company recognized expenses under the Administration Agreement of $1,268 and $3,879, respectively. No managerial assistance fees were accrued or collected for the three and nine months ended September 30, 2015 and 2014.
Note 4. Net Asset Value Per Share
At September 30, 2015, the Company’s total net assets and net asset value per share were $913,870 and $21.52, respectively. This compares to total net assets and net asset value per share at December 31, 2014 of $936,568 and $22.05, respectively.
Note 5. Earnings Per Share
The following table sets forth the computation of basic and diluted net increase in net assets per share resulting from operations, pursuant to ASC 260-10, for the three and nine months ended September 30, 2015 and 2014:
Earnings per share (basic & diluted)
Numerator—net increase in net assets resulting from operations:
Denominator—weighted average shares:
Earnings per share:
Note 6. Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. GAAP establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:
Level 1. Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company has the ability to access.
Level 2. Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
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Level 3. Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s and, if applicable, an independent third-party valuation firm’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3).
Gains and losses for assets and liabilities categorized within the Level 3 table below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3).
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Such reclassifications are reported as transfers in/out of the appropriate category as of the end of the quarter in which the reclassifications occur.
The following tables present the balances of assets and liabilities measured at fair value on a recurring basis, as of September 30, 2015 and December 31, 2014:
Fair Value Measurements
As of September 30, 2015
Assets:
Bank Debt/Senior Secured Loans
Subordinated Debt/Corporate Notes
Preferred Equity
Common Equity/Equity Interests/Warrants
Liabilities:
Credit Facility and Senior Secured Notes
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As of December 31, 2014
The following tables provide a summary of the changes in fair value of Level 3 assets and liabilities for the nine months ended September 30, 2015 and the year ended December 31, 2014 as well as the portion of gains or losses included in income attributable to unrealized gains or losses related to those assets and liabilities still held at September 30, 2015 and December 31, 2014:
Fair Value Measurements Using Level 3 Inputs
Fair value, December 31, 2014
Total gains or losses included in earnings:
Purchase of investment securities
Proceeds from dispositions of investment securities
Transfers in/out of Level 3
Fair value, September 30, 2015
Unrealized gains (losses) for the period relating to those Level 3 assets that were still held by the Company at the end of the period:
Net change in unrealized gain (loss):
During the nine months ended September 30, 2015, there were no transfers in and out of Levels 1 and 2.
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The following table shows a reconciliation of the beginning and ending balances for fair valued liabilities measured using significant unobservable inputs (Level 3) for the nine months ended September 30, 2015:
Beginning fair value
Net realized (gain) loss
Net change in unrealized (gain) loss
Borrowings
Repayments
Ending fair value
The Company has made an irrevocable election to apply the fair value option of accounting to the Credit Facility and the Senior Secured Notes, in accordance with ASC 825-10. On September 30, 2015, there were borrowings of $123,400 and $75,000, respectively, on the Credit Facility and the Senior Secured Notes. The Company used an independent third-party valuation firm to assist in measuring the fair value of the Credit Facility and Senior Secured Notes.
Fair value, December 31, 2013
During the fiscal year ended December 31, 2014, our investments in CT Technologies Intermediate Holdings and Renaissance Learning, Inc., with a combined fair value of $17,660, were transferred from Level 2 to Level 3. These transfers were a result of changes in the quantity and quality of information used as valuation inputs by the Investment Adviser. There were no other transfers between levels.
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The following table shows a reconciliation of the beginning and ending balances for fair valued liabilities measured using significant unobservable inputs (Level 3) for the year ended December 31, 2014:
Beginning fair value at December 31, 2013
Ending fair value at December 31, 2014
The Company has made an irrevocable election to apply the fair value option of accounting to the Credit Facility and the Senior Secured Notes, in accordance with ASC 825-10. On December 31, 2014, there were borrowings of $50,000 and $75,000, respectively, on the Credit Facility and the Senior Secured Notes. The Company used an independent third-party valuation firm to measure the fair value of the Credit Facility and Senior Secured Notes.
Quantitative Information about Level 3 Fair Value Measurements
The Company typically determines the fair value of its performing debt investments utilizing a yield analysis. In a yield analysis, a price is ascribed for each investment based upon an assessment of current and expected market yields for similar investments and risk profiles. Additional consideration is given to current contractual interest rates, relative maturities and other key terms and risks associated with an investment. Among other factors, a significant determinant of risk is the amount of leverage used by the portfolio company relative to the total enterprise value of the company, and the rights and remedies of our investment within each portfolio company.
Significant unobservable quantitative inputs typically used in the fair value measurement of the Company’s Level 3 assets and liabilities primarily reflect current market yields, including indices, and readily available quotes from brokers, dealers, and pricing services as indicated by comparable assets and liabilities, as well as enterprise values, returns on equity and earnings before income taxes, depreciation and amortization (“EBITDA”) multiples of similar companies, and comparable market transactions for equity securities.
Quantitative information about the Company’s Level 3 asset and liability fair value measurements as of September 30, 2015 is summarized in the table below:
$
1,533
Enterprise Value
EBITDA Multiple
4.5x – 5.0x (4.6x)
Subordinated Debt/Corporate Note
298,000
Return on Equity
6.5% – 13.2% (10.8%)
Credit Facility
(L+2.3%)
Senior Secured Notes
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Quantitative information about the Company’s Level 3 asset and liability fair value measurements as of December 31, 2014 is summarized in the table below:
2,400
Collateral Analysis
Collateral Value
NA
297,500
2.4% – 10.8% (11.5%)
Significant increases or decreases in any of the above unobservable inputs in isolation, including unobservable inputs used in deriving bid-ask spreads, if applicable, could result in significantly lower or higher fair value measurements for such assets and liabilities.
Note 7. Derivatives
The Company is exposed to foreign exchange risk through its investments denominated in foreign currencies. The Company may mitigate this risk through the use of foreign currency forward contracts, borrowing in local currency under its Credit Facility, or similar. As an investment company, all changes in the fair value of assets, including changes caused by foreign currency fluctuation, flow through current earnings.
As of September 30, 2015 and December 31, 2014, there were no open forward foreign currency contracts outstanding. The Company also had no derivatives designated as hedging instruments at September 30, 2015 and December 31, 2014.
Note 8. Debt
Unsecured Senior Notes
On November 16, 2012, the Company and U.S. Bank National Association entered into an Indenture and a First Supplemental Indenture relating to the Company’s issuance, offer and sale of $100,000 aggregate principal amount of its 6.75% Unsecured Senior Notes due 2042 (the “Unsecured Notes”). The Unsecured Notes will mature on November 15, 2042 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after November 15, 2017 at a redemption price of $25 per security plus accrued and unpaid interest. The Unsecured Notes bear interest at a rate of 6.75% per year payable quarterly on February 15, May 15, August 15 and November 15 of each year. The Unsecured Notes are direct senior unsecured obligations of the Company.
Revolving and Term Loan Facility
In July 2013, the Company amended its Credit Facility, composed of $440,000 of revolving credit and $50,000 in term loans. Subsequently, in December 2013, a commitment increase was executed providing an additional $50,000 of revolving credit, bringing the total revolving credit capacity to $490,000. Borrowings
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generally bear interest at a rate per annum equal to the base rate plus 2.25% or the alternate base rate plus 1.25%. The Credit Facility has no LIBOR floor requirement. The Credit Facility matures in June 2018 and includes ratable amortization in the final year. The Credit Facility may be increased up to $800,000 with additional new lenders or an increase in commitments from current lenders. The Credit Facility contains certain customary affirmative and negative covenants and events of default. In addition, the Credit Facility contains certain financial covenants that among other things, requires the Company to maintain a minimum shareholder’s equity and a minimum asset coverage ratio. The Company also pays issuers of funded term loans quarterly in arrears a commitment fee at the rate of 0.25% per annum on the average daily outstanding balance. At September 30, 2015, outstanding USD equivalent borrowings under the Credit Facility totaled $123,400.
On May 10, 2012, the Company closed a private offering of $75,000 of Senior Secured Notes with a fixed interest rate of 5.875% and a maturity date of May 10, 2017. Interest on the Senior Secured Notes is due semi-annually on May 10 and November 10. The Senior Secured Notes were issued in a private placement only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended.
Certain covenants on our issued debt may restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC under Subchapter M of the Code.
The Company has made an irrevocable election to apply the fair value option of accounting to its Credit Facility and Senior Secured Notes, in accordance with ASC 825-10. We believe accounting for the Credit Facility and Senior Secured Notes at fair value better aligns the measurement methodologies of assets and liabilities, which may mitigate certain earnings volatility. ASC 825-10 requires entities to display the fair value of the selected assets and liabilities on the face of the Consolidated Statement of Assets and Liabilities and changes in fair value of the Credit Facility are reported in the Consolidated Statement of Operations.
The average annualized interest cost for all borrowings for the nine months ended September 30, 2015 and the year ended December 31, 2014 was 5.37% and 5.52%, respectively. These costs are exclusive of other credit facility expenses such as unused fees, agency fees and other prepaid expenses related to establishing and/or amending the Credit Facility, the Unsecured Notes, and the Senior Secured Notes (collectively the “Credit Facilities”), if any. The maximum amounts borrowed on the Credit Facilities during the nine months ended September 30, 2015 and the year ended December 31, 2014 were $303,100 and $225,000, respectively.
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Note 9. Financial Highlights and Senior Securities Table
The following is a schedule of financial highlights for the nine months ended September 30, 2015 and for the year ended December 31, 2014:
Per Share Data: (a)
Net asset value, beginning of year
Net realized and unrealized loss
Anti-dilution (dilution)
Net asset value, end of period
Per share market value, end of period
Total Return (b)
Net assets, end of period
Shares outstanding, end of period
Ratios to average net assets (c):
Operating expenses
Interest and other credit facility expenses
Average debt outstanding
Portfolio turnover ratio
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Information about our senior securities is shown in the following table as of each year ended December 31 since the Company commenced operations, unless otherwise noted. The “—” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
Class and Year
Revolving Credit Facilities
Fiscal 2015 (through September 30, 2015)
Fiscal 2014
Fiscal 2013
Fiscal 2012
Fiscal 2011
Fiscal 2010
Fiscal 2009
Term Loans
Total Senior Securities
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Note 10. Crystal Financial LLC
On December 28, 2012, we completed the acquisition of Crystal Capital Financial Holdings LLC (“Crystal Financial”), a commercial finance company focused on providing asset-based and other secured financing solutions (the “Crystal Acquisition”). We invested $275,000 in cash to effect the Crystal Acquisition. Crystal Financial owns approximately 98% of the outstanding ownership interest in Crystal Financial LLC. The remaining financial interest is held by various employees of Crystal Financial LLC, through their investment in Crystal Management LP. Crystal Financial LLC had a diversified portfolio of 23 loans having a total par value of approximately $400,000 at November 30, 2012 and a $275,000 committed revolving credit facility. On January 27, 2014, the revolving credit facility was expanded to $300,000. On March 31, 2014, we exchanged $137,500 of our equity interest in Crystal Financial in exchange for $137,500 in floating rate senior secured notes in Crystal Financial bearing interest at LIBOR plus 9.50%, maturing on March 31, 2019. On May 18, 2015, the revolving credit facility was expanded to $350,000. Our financial statements, including our schedule of investments, reflect our investments in Crystal Financial on a consolidated basis.
As of September 30, 2015 Crystal Financial LLC had 30 funded commitments to 28 different issuers with a total par value of approximately $530,717 on total assets of $581,792. As of December 31, 2014, Crystal Financial LLC had 29 funded commitments to 27 different issuers with a total par value of approximately $477,945 on total assets of $542,252. As of September 30, 2015 and December 31, 2014, all loans were floating rate with the largest loan outstanding totaling $35,500 and $33,000, respectively. For the same periods, the average exposure per issuer was $18,954 and $17,702, respectively. Crystal Financial LLC’s credit facility, which is non-recourse to Solar Capital, had approximately $294,509 and $259,658 of borrowings outstanding at September 30, 2015 and December 31, 2014, respectively. For the three months ended September 30, 2015 and September 30, 2014, Crystal Financial LLC had net income of $3,896 and $8,345 on gross income of $14,593 and $13,738, respectively. For the nine months ended September 30, 2015 and September 30, 2014, Crystal Financial LLC had net income of $21,223 and $21,133 on gross income of $42,963 and $40,566, respectively. Due to timing and non-cash items, there may be material differences between GAAP net income and cash available for distributions.
Note 11. Stock Repurchase Program
On July 31, 2013, the Company’s board of directors authorized a program for the purpose of repurchasing up to $100,000 of the Company’s common stock. Under the repurchase program, the Company may, but is not obligated to, repurchase its outstanding common stock in the open market from time to time provided that the Company complies with the prohibitions under its Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 and 10b-5 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. On December 5, 2013, the Company’s board of directors extended the repurchase program to be in place until the earlier of July 31, 2014 or until $100,000 of the Company’s outstanding shares of common stock had been repurchased. On July 31, 2014, the Company’s stock repurchase
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program expired. There have been no purchases during the nine months ended September 30, 2015. During the fiscal year through July 31, 2014, the Company repurchased 1,779,033 shares at an average price of approximately $21.97 per share, inclusive of commissions. The total dollar amount of shares repurchased in that period was $39,078. During the year ended December 31, 2013, the Company repurchased 796,418 shares at an average price of approximately $21.98 per share, inclusive of commissions, for a total dollar amount of $17,508.
Note 12. Commitments and Contingencies
The Company had unfunded debt and equity commitments to various revolving and delayed draw loans as well as to Crystal Financial LLC. The total amount of these unfunded commitments as of September 30, 2015 and December 31, 2014 is $91,666 and $103,693, respectively, comprised of the following:
T2 Biosystems, Inc.
VetCor Professional Practices LLC.
AgaMatrix, Inc.
Trevi Therapeutics, Inc.
CardioDx, Inc.
Syndax Pharmaceuticals, Inc.
Southern Auto Finance Company
Body Central Stores, Inc.
Total Commitments*
As of September 30, 2015 and December 31, 2014, the Company had sufficient cash available and/or liquid securities available to fund these commitments.
Note 13. Senior Secured Unitranche Loan Program
On September 2, 2014, the Company entered into a limited liability company agreement with an affiliate (the “Investor”) of a fund managed by Pacific Investment Management Company LLC (“PIMCO”) to co-invest in middle market senior secured unitranche loans sourced by the same origination platform used by the Company. Initial funding commitments to the unitranche strategy total $600,000, consisting of direct equity investments and co-investment commitments as described below. The joint venture vehicle known as the Senior Secured Unitranche Loan Program (“SSLP”) is structured as an unconsolidated Delaware limited liability company. The Company and the Investor have initially made equity commitments to the SSLP of $300,000 and $43,250, respectively. All portfolio decisions and generally all other decisions in respect of the SSLP must be approved by an investment committee of the SSLP consisting of representatives of the Company and PIMCO (with approval from a representative of each required). As of September 30, 2015, SSLP has not commenced operations.
Note 14. Subsequent Events
The Company has evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date the consolidated financial statements were issued.
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On October 7, 2015, the Company announced a share repurchase plan to purchase common stock in the open market in an amount up to $30,000. Under the repurchase program, the Company may, but is not obligated to, repurchase its outstanding common stock in the open market from time to time provided that the Company complies with the prohibitions under its Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. Unless amended or extended by the Company’s board of directors, the Company expects the repurchase program to be in place until the earlier of October 7, 2016 or until $30,000 of the Company’s outstanding shares of common stock have been repurchased.
On October 15, 2015, the Company issued a press release announcing that it has entered into an amended and restated limited liability company agreement, dated October 15, 2015, for its SSLP to add Voya Investment Management LLC, part of Voya Financial, Inc. (NYSE: VOYA), as a partner in SSLP in place of the investor that was previously the Company’s partner in SSLP, though this investor may still co-invest up to $300,000 of equity in unitranche loans alongside SSLP. This joint venture is expected to invest primarily in senior secured unitranche loans to middle market companies predominantly owned by private equity sponsors or entrepreneurs, consistent with the Company’s core origination and underwriting mandate. In addition to the Company’s prior equity commitment of $300,000 to SSLP, Voya has made an initial equity commitment of $25,000 to SSLP, with the ability to upsize. Once the portfolio is sufficiently ramped, SSLP is expected to be levered up to approximately 1.5x-2.0x debt-to-equity, based on advanced discussions with third party debt providers.
On November 2, 2015, the Company assigned $125,000 of its $300,000 commitment to SSLP to Senior Secured Unitranche Loan Program II LLC (“SSLP II”), a newly formed Delaware limited liability company. SSLP II is currently wholly owned by Solar Capital Ltd. but may bring in outside investors at a later date.
On November 3, 2015, our Board declared a quarterly distribution of $0.40 per share payable on January 6, 2016 to holders of record as of December 17, 2015.
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The Board of Directors and Shareholders
Solar Capital Ltd.:
We have reviewed the accompanying consolidated statements of assets and liabilities, including the consolidated schedule of investments, of Solar Capital Ltd. (the “Company”) as of September 30, 2015, the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2015 and 2014, the consolidated statements of changes in net assets for the nine-month period ended September 30, 2015, and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2015 and 2014. These consolidated financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of assets and liabilities, including the consolidated schedule of investments, of Solar Capital Ltd., as of December 31, 2014 and the related consolidated statements of operations, changes in net assets, and cash flows for the year ended December 31, 2014, and in our report dated February 25, 2015, we expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
New York, New York
November 3, 2015
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The information contained in this section should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.
Some of the statements in this report constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained herein 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; and
the timing of cash flows, if any, from the operations of our portfolio companies.
We generally use words such as “anticipates,” “believes,” “expects,” “intends” 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, including any factors set forth in “Risk Factors” and elsewhere in this report.
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 any annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Overview
Solar Capital LLC, a Maryland limited liability company, was formed in February 2007 and commenced operations on March 13, 2007 with initial capital of $1.2 billion of which 47.04% was funded by affiliated parties.
Immediately prior to the initial public offering, through a series of transactions Solar Capital Ltd. merged with Solar Capital LLC, leaving Solar Capital Ltd. as the surviving entity (the “Merger”). Solar Capital Ltd. issued an aggregate of approximately 26.65 million shares of common stock and $125 million in senior unsecured notes (the “Senior Unsecured Notes”) to the existing Solar Capital LLC unit holders in connection with the Merger. Solar Capital Ltd. had no assets or operations prior to completion of the Merger and as a result, the historical books and records of Solar Capital LLC have become the books and records of the surviving entity. The number of shares used to calculate weighted average shares for use in computations on a per share basis have been decreased retroactively by a factor of approximately 0.4022 for all periods prior to February 9, 2010. This factor represents the effective impact of the reduction in shares resulting from the Merger. As of December 17, 2010, the Senior Unsecured Notes have been repaid from proceeds of a private placement transaction that we completed on November 30, 2010 and from borrowings under a credit facility established in December 2010.
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On February 9, 2010, we priced our initial public offering, selling 5.68 million shares of our common stock. Concurrent with our initial public offering, Michael S. Gross, our chairman and chief executive officer, and Bruce Spohler, our chief operating officer, collectively purchased an additional 0.6 million shares of our common stock through a private placement transaction exempt from registration under the Securities Act (the “Concurrent Private Placement”).
We invest primarily in U.S. middle-market companies, where we believe the supply of primary capital is limited and the investment opportunities are most attractive. Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We invest primarily in leveraged middle-market companies in the form of senior secured loans, mezzanine loans and equity securities. From time to time, we may also invest in public companies that are thinly traded. Our business is focused primarily on the direct origination of investments through portfolio companies or their financial sponsors. Our investments generally range between $5 million and $100 million each, although we expect that this investment size will vary proportionately with the size of our capital base and/or with strategic initiatives. We are managed by Solar Capital Partners, LLC (the “Investment Adviser”). Solar Capital Management, LLC (the “Administrator”) provides the administrative services necessary for us to operate.
In addition, we may invest a portion of our portfolio in other types of investments, which we refer to as opportunistic investments, which are not our primary focus but are intended to enhance our overall returns. These investments may include, but are not limited to, direct investments in public companies that are not thinly traded and securities of leveraged companies located in select countries outside of the United States.
As of September 30, 2015, the Investment Adviser has invested approximately $5.1 billion in more than 210 different portfolio companies since it was founded in 2006. Over the same period, the Investment Adviser completed transactions with more than 135 different financial sponsors.
Recent Developments
On October 7, 2015, the Company announced a share repurchase plan to purchase common stock in the open market in an amount up to $30 million. Under the repurchase program, the Company may, but is not obligated to, repurchase its outstanding common stock in the open market from time to time provided that the Company complies with the prohibitions under its Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. Unless amended or extended by the Company’s board of directors, the Company expects the repurchase program to be in place until the earlier of October 7, 2016 or until $30 million of the Company’s outstanding shares of common stock have been repurchased.
On October 15, 2015, the Company issued a press release announcing that it has entered into an amended and restated limited liability company agreement, dated October 15, 2015, for its SSLP to add Voya Investment Management LLC, part of Voya Financial, Inc. (NYSE: VOYA), as a partner in SSLP in place of the investor that was previously the Company’s partner in SSLP, though this investor may still co-invest up to $300 million of equity in unitranche loans alongside SSLP. This joint venture is expected to invest primarily in senior secured unitranche loans to middle market companies predominantly owned by private equity sponsors or entrepreneurs, consistent with the Company’s core origination and underwriting mandate. In addition to the Company’s prior
34
equity commitment of $300 million to SSLP, Voya has made an initial equity commitment of $25 million to SSLP, with the ability to upsize. Once the portfolio is sufficiently ramped, SSLP is expected to be levered up to approximately 1.5x-2.0x debt-to-equity, based on advanced discussions with third party debt providers.
On November 2, 2015, the Company assigned $125 million of its $300 million commitment to SSLP to Senior Secured Unitranche Loan Program II LLC (“SSLP II”), a newly formed Delaware limited liability company. SSLP II is currently wholly owned by Solar Capital Ltd. but may bring in outside investors at a later date.
Investments
Our level of investment activity can and does vary substantially from period to period depending on many factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity for such companies, the general economic environment and the competitive environment for the types of investments we make. As a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” The definition of “eligible portfolio company” includes certain public companies that do not have any securities listed on a national securities exchange and companies whose securities are listed on a national securities exchange but whose market capitalization is less than $250 million.
Revenue
We generate revenue primarily in the form of interest and dividend income from the securities we hold and capital gains, if any, on investment securities that we may sell. Our debt investments generally have a stated term of three to seven years and typically bear interest at a floating rate usually determined on the basis of a benchmark London interbank offered rate (“LIBOR”), commercial paper rate, or the prime rate. Interest on our debt investments is generally payable quarterly but may be monthly or semi-annually. In addition, our investments may provide payment-in-kind (“PIK”) interest. Such amounts of accrued PIK interest are added to the cost of the investment on the respective capitalization dates and generally become due at maturity of the investment or upon the investment being called by the issuer. We may also generate revenue in the form of commitment, origination, structuring fees, fees for providing managerial assistance and, if applicable, consulting fees, etc.
Expenses
All investment professionals of the Investment Adviser and its staff, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses of that personnel which is allocable to those services are provided and paid for by the Investment Adviser. We bear all other costs and expenses of our operations and transactions, including those relating to:
investment advisory and management fees;
expenses incurred by the Investment Adviser payable to third parties, including agents, consultants or other advisors, in monitoring our financial and legal affairs and in monitoring our investments and performing due diligence on our prospective portfolio companies;
calculation of our net asset value (including the cost and expenses of any independent valuation firm utilized);
direct costs and expenses of administration, including independent registered public accounting and legal costs;
costs of preparing and filing reports or other documents with the SEC;
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interest payable on debt, if any, incurred to finance our investments;
offerings of our common stock and other securities;
registration and listing fees;
fees payable to third parties, including agents, consultants or other advisors, relating to, or associated with, evaluating and making investments;
transfer agent and custodial fees;
taxes;
independent directors’ fees and expenses;
marketing and distribution-related expenses;
the costs of any reports, proxy statements or other notices to stockholders, including printing and postage costs;
our allocable portion of the fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
organizational costs; and
all other expenses incurred by us or the Administrator in connection with administering our business, such as our allocable portion of overhead under the administration agreement, including rent and our allocable portion of the cost of our chief financial officer and chief compliance officer and their respective staffs.
We expect our general and administrative operating expenses related to our ongoing operations to increase moderately in dollar terms. During periods of asset growth, we generally expect our general and administrative operating expenses to decline as a percentage of our total assets and increase during periods of asset declines. Incentive fees, interest expense and costs relating to future offerings of securities, among others, may also increase or reduce overall operating expenses based on portfolio performance, interest rate benchmarks, and offerings of our securities relative to comparative periods, among other factors.
Portfolio and Investment Activity
During the three months ended September 30, 2015, we invested approximately $82.5 million across 6 portfolio companies. This compares to investing approximately $207.6 million in 11 portfolio companies for the three months ended September 30, 2014. Investments sold or prepaid during the three months ended September 30, 2015 totaled approximately $32.6 million versus approximately $56.8 million for the three months ended September 30, 2014.
At September 30, 2015, our portfolio consisted of 54 portfolio companies and was invested 66.1% in senior secured loans, 5.8% in subordinated debt, 1.5% in preferred equity and 26.6% in common equity/equity interests and warrants (of which 24.8% is Crystal Financial LLC) measured at fair value versus 47 portfolio companies invested 53.5% in senior secured loans, 13.8% in subordinated debt, 2.0% in preferred equity and 30.7% in common equity/equity interests and warrants measured at fair value at September 30, 2014.
The weighted average yields on our portfolio of income producing investments were 10.1% and 10.3%, respectively, at September 30, 2015 and September 30, 2014, measured at fair value.
At September 30, 2015, 89.7% or $1,061.3 million of our income producing investment portfolio* is floating rate and 10.3% or $122.1 million is fixed rate, measured at fair value. At September 30, 2014, 77.6% or $841.1 million of our income producing investment portfolio* was floating rate and 22.4% or $242.8 million was fixed rate, measured at fair value. As of September 30, 2015 and 2014, we had one and one issuers on non-accrual status, respectively.
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Since inception, Solar Capital and its predecessor companies have invested approximately $4.2 billion in 137 portfolio companies. Over the same period, Solar Capital has completed transactions with more than 100 different financial sponsors.
On December 28, 2012, we completed the acquisition of Crystal Capital Financial Holdings LLC (“Crystal Financial”), a commercial finance company focused on providing asset-based and other secured financing solutions (the “Crystal Acquisition”). We invested $275 million in cash to effect the Crystal Acquisition. Crystal Financial owns approximately 98% of the outstanding ownership interest in Crystal Financial LLC. The remaining financial interest is held by various employees of Crystal Financial LLC, through their investment in Crystal Management LP. Crystal Financial LLC had a diversified portfolio of 23 loans having a total par value of approximately $400 million at November 30, 2012 and a $275 million committed revolving credit facility. On January 27, 2014, the revolving credit facility was expanded to $300 million. On March 31, 2014, we exchanged $137.5 million of our equity interest in Crystal Financial in exchange for $137.5 million in floating rate senior secured notes in Crystal Financial bearing interest at LIBOR plus 9.50%, maturing on March 31, 2019. On May 18, 2015, the revolving credit facility was expanded to $350 million. Our financial statements, including our schedule of investments, reflect our investments in Crystal Financial on a consolidated basis.
As of September 30, 2015, Crystal Financial LLC had 30 funded commitments to 28 different issuers with a total par value of approximately $530.7 million on total assets of $581.8 million. As of December 31, 2014, Crystal Financial LLC had 29 funded commitments to 27 different issuers with a total par value of approximately $477.9 million on total assets of $542.3 million. As of September 30, 2015 and December 31, 2014, all loans were floating rate with the largest loan outstanding totaling $35.5 million and $33.0 million, respectively. For the same periods, the average exposure per issuer was $19.0 million and $17.7 million, respectively. Crystal Financial LLC’s credit facility, which is non-recourse to Solar Capital, had approximately $294.5 million and $259.7 million of borrowings outstanding at September 30, 2015 and December 31, 2014, respectively. For the three months ended September 30, 2015 and September 30, 2014, Crystal Financial LLC had net income of $3.9 million and $8.3 million on gross income of $14.6 million and $13.7 million, respectively. For the nine months ended September 30, 2015 and September 30, 2014, Crystal Financial LLC had net income of $21.2 million and $21.1 million on gross income of $43.0 million and $40.6 million, respectively. Due to timing and non-cash items, there may be material differences between GAAP net income and cash available for distributions.
Stock Repurchase Program
On July 31, 2013, the Company’s board of directors authorized a program for the purpose of repurchasing up to $100 million of the Company’s common stock. Under the repurchase program, the Company may, but is not obligated to, repurchase its outstanding common stock in the open market from time to time provided that the Company complies with the prohibitions under its Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 and 10b-5 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. On December 5, 2013, the Company’s board of directors extended the repurchase program to be in place until the earlier of July 31, 2014 or until $100 million of the Company’s outstanding shares of common stock had been repurchased. On July 31, 2014, the Company’s stock repurchase program expired. There have been no purchases during the nine months ended September 30, 2015. During the fiscal year through July 31, 2014, the Company repurchased 1,779,033 shares at an average price of approximately $21.97 per share, inclusive of commissions. The total dollar amount of shares repurchased in that period was $39.1 million. During the year ended December 31, 2013, the Company repurchased 796,418 shares at an average price of approximately $21.98 per share, inclusive of commissions, for a total dollar amount of $17.5 million.
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Senior Secured Unitranche Loan Program
On September 2, 2014, the Company entered into a limited liability company agreement with an affiliate (the “Investor”) of a fund managed by Pacific Investment Management Company LLC (“PIMCO”) to co-invest in middle market senior secured unitranche loans sourced by the same origination platform used by the Company. Initial funding commitments to the unitranche strategy total $600 million, consisting of direct equity investments and co-investment commitments as described below. The joint venture vehicle known as the Senior Secured Unitranche Loan Program (“SSLP”) is structured as an unconsolidated Delaware limited liability company. The Company and the Investor have initially made equity commitments to the SSLP of $300 million and $43.25 million, respectively. All portfolio decisions and generally all other decisions in respect of the SSLP must be approved by an investment committee of the SSLP consisting of representatives of the Company and PIMCO (with approval from a representative of each required). As of September 30, 2015, SSLP has not commenced operations.
Critical Accounting Policies
The preparation of consolidated financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the periods reported. Actual results could materially differ from those estimates. We have identified the following items as critical accounting policies. Within the context of these critical accounting policies and disclosed subsequent events herein, we are not currently aware of any other reasonably likely events or circumstances that would result in materially different amounts being reported.
Valuation of Portfolio Investments
We conduct the valuation of our assets, pursuant to which our net asset value is determined, at all times consistent with GAAP, and the 1940 Act. Our valuation procedures are set forth in more detail below:
Under procedures established by our board of directors (the “Board”), we value investments, including certain senior secured debt, subordinated debt and other debt securities with maturities greater than 60 days, for which market quotations are readily available, at such market quotations (unless they are deemed not to represent fair value). We attempt to obtain market quotations from at least two brokers or dealers (if available, otherwise from a principal market maker or a primary market dealer or other independent pricing service). We utilize mid-market pricing as a practical expedient for fair value unless a different point within the range is more representative. If and when market quotations are deemed not to represent fair value, we typically utilize independent third-party valuation firms to assist us in determining fair value. Accordingly, such investments go through our multi-step valuation process as described below. In each case, our independent valuation firms consider observable market inputs together with significant unobservable inputs in arriving at their valuation recommendations. Debt investments with maturities of 60 days or less shall each be valued at cost plus accreted discount, or minus amortized premium, which is expected to approximate fair value, unless such valuation, in the judgment of the Investment Adviser, does not represent fair value, in which case such investments shall be valued at fair value as determined in good faith by or under the direction of our Board. Investments that are not publicly traded or whose market quotations are not readily available are valued at fair value as determined in good faith by or under the direction of our Board. Such determination of fair values involves subjective judgments and estimates.
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Accounting Standards Codification (“ASC”) Topic 820 classifies the inputs used to measure these fair values into the following hierarchy:
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Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our consolidated financial statements.
Valuation of Senior Secured Credit Facility and Senior Secured Notes
The Company has made an irrevocable election to apply the fair value option of accounting to its Credit Facility and its Senior Secured Notes, in accordance with ASC 825-10. We believe accounting for the Credit Facility and Senior Secured Notes at fair value better aligns the measurement methodologies of assets and liabilities, which may mitigate certain earnings volatility.
Revenue Recognition
The Company records dividend income and interest, adjusted for amortization of premium and accretion of discount, on an accrual basis. Investments that are expected to pay regularly scheduled interest and/or dividends in cash are generally placed on non-accrual status when principal or interest/dividend cash payments are past due 30 days or more and/or when it is no longer probable that principal or interest/dividend cash payments will be collected. Such non-accrual investments are restored to accrual status if past due principal and interest or dividends are paid in cash, and in management’s judgment, are likely to continue timely payment of their remaining interest or dividend obligations. Interest or dividend cash payments received on investments may be recognized as income or applied to principal depending upon management’s judgment. Some of our investments may have contractual PIK interest or dividends. PIK interest and dividends computed at the contractual rate is accrued into income and reflected as receivable up to the capitalization date. PIK investments offer issuers the option at each payment date of making payments in cash or in additional securities. When additional securities are received, they typically have the same terms, including maturity dates and interest rates as the original securities issued. On these payment dates, the Company capitalizes the accrued interest or dividends receivable (reflecting such amounts as the basis in the additional securities received). PIK generally becomes due at the maturity of the investment or upon the investment being called by the issuer. At the point the Company believes PIK is not expected to be realized, the PIK investment will be placed on non-accrual status. When a PIK investment is placed on non-accrual status, the accrued, uncapitalized interest or dividends is reversed from the related receivable through interest or dividend income, respectively. The Company does not reverse previously capitalized PIK interest or dividends. Upon capitalization, PIK is subject to the fair value estimates associated with their related investments. PIK investments on non-accrual status are restored to accrual status if the Company again believes that PIK is expected to be realized. Loan origination fees, original issue discount, and market discounts are capitalized and amortized into income using the interest method or straight-line, as applicable. Upon the prepayment of a loan, any unamortized loan origination fees are recorded as interest income. We record prepayment premiums on loans and other investments as interest income when we receive such amounts. Capital structuring fees are recorded as other income when earned.
The typically higher yields and interest rates on PIK securities, to the extent we invested, reflects the payment deferral and increased credit risk associated with such instruments and that such investments may represent a significantly higher credit risk than coupon loans. PIK securities may have unreliable valuations because their continuing accruals require continuing judgments about the collectability of the deferred payments and the value of any associated collateral. PIK interest has the effect of generating investment income and increasing the incentive fees payable at a compounding rate. In addition, the deferral of PIK interest also increases the loan-to-value ratio at a compounding rate. PIK securities create the risk that incentive fees will be paid to the Investment Adviser based on non-cash accruals that ultimately may not be realized, but the Investment Adviser will be under no obligation to reimburse the Company for these fees. For the three and nine months ended September 30, 2015, capitalized PIK income totaled $0.1 million and $0.4 million, respectively.
Net Realized Gain or Loss and Net Change in Unrealized Gain or Loss
We generally measure realized gain or loss by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation
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previously recognized, but considering unamortized origination or commitment fees and prepayment penalties. The net change in unrealized gain or loss reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized gain or loss, when gains or losses are realized.
Income Taxes
Solar Capital, a U.S. corporation, has elected to be treated as a RIC under Subchapter M of the Code, as amended. In order to qualify as a RIC, among other things, 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 given tax year, we may choose to carry forward taxable income in excess of current year 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 distributions, the Company accrues an estimated excise tax, if any, on estimated excess taxable income.
In February 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-02,Consolidation (Topic 810) – Amendments to the Consolidation Analysis. The update changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. Public companies are required to apply ASU 2015-02 for interim and annual reporting periods beginning after December 15, 2015. Accordingly, the Company is currently evaluating the impact of the adoption of ASU 2015-02 on its consolidated financial statements and disclosures.
RESULTS OF OPERATIONS
Results comparisons are for the three and nine months ended September 30, 2015 and 2014:
Investment Income
For the three and nine months ended September 30, 2015, gross investment income totaled $30.4 million and $84.1 million, respectively. For the three and nine months ended September 30, 2014, gross investment income totaled $28.4 million and $89.0 million, respectively. The increase in gross investment income for the year over year three month period was primarily due to a larger income producing investment portfolio. The decrease in gross investment income for the year over year nine month period was primarily due to a reduction in income from call premiums received as well as portfolio yield compression.
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Net expenses totaled $13.5 million and $36.7 million, respectively, for the three and nine months ended September 30, 2015, of which $7.5 million and $19.4 million, respectively, were management fees and net performance-based incentive fees and $3.9 million and $11.1 million, respectively, were interest and other credit facility expenses. Administrative services and other general and administrative expenses totaled $2.1 million and $6.2 million, respectively, for the three and nine months ended September 30, 2015. Net expenses totaled $12.0 million and $39.1 million, respectively, for the three and nine months ended September 30, 2014, of which $6.2 million and $21.8 million, respectively, were management fees and net performance-based incentive fees and $3.6 million and $10.8 million, respectively, were interest and other credit facility expenses. Administrative services and other general and administrative expenses totaled $2.2 million and $6.5 million, respectively, for the three and nine months ended September 30, 2014. Expenses generally consist of management and performance-based incentive fees, administrative services fees, insurance expenses, legal fees, directors’ fees, transfer agency fees, printing and proxy expenses, audit and tax services expenses, and other general and administrative expenses. Interest and other credit facility expenses generally consist of interest, unused fees, agency fees and loan origination fees, if any, among others. The increase in expenses for the three months ended September 30, 2015 versus the three months ended September 30, 2014 was primarily due to the accrual of a performance-based incentive fee in the 2015 period. The decrease in expenses for the nine months ended September 30, 2015 versus the nine months ended September 30, 2014 was primarily due to a decrease in performance-based incentive fees on lower net investment income.
Net Investment Income
The Company’s net investment income totaled $17.0 million and $47.4 million, or $0.40 and $1.12, per average share, respectively, for the three and nine months ended September 30, 2015. The Company’s net investment income totaled $16.4 million and $49.9 million, or $0.39 and $1.16, per average share, respectively, for the three and nine months ended September 30, 2014.
Net Realized Gain (Loss)
The Company had investment sales and prepayments totaling approximately $33 million and $117 million, respectively, for the three and nine months ended September 30, 2015. Net realized gains (losses) over the same periods were $0.1 million and ($6.5) million, respectively. The Company had investment sales and prepayments totaling approximately $57 million and $403 million, respectively, for the three and nine months ended September 30, 2014. Net realized losses over the same periods were $3.0 million and $30.1 million, respectively. Net realized losses for the nine months ended September 30, 2015 were primarily related to DS Waters and Quantum Foods, LLC. Net realized losses for the three months ended September 30, 2014 were primarily related to the realization of previously unrealized currency losses. Net realized losses for the nine months ended September 30, 2014 were primarily related to the partial realization of previously recognized unrealized losses on our investment in ARK Real Estate, L.P.
Net Change in Unrealized Gain (Loss)
For the three and nine months ended September 30, 2015, net change in unrealized gain (loss) on the Company’s assets and liabilities totaled $(17.0) million and $(19.1) million, respectively. For the three and nine months ended September 30, 2014, net change in unrealized gain (loss) on the Company’s assets and liabilities totaled ($0.6) million and $23.7 million, respectively. Net unrealized loss for the three months ended September 30, 2015 is primarily due to depreciation in the value of our investments in Crystal Financial LLC, WireCo Worldgroup Inc., Asurion, LLC and Bishop Lifting Products, Inc., among others. Net unrealized loss for the nine months ended September 30, 2015 is primarily due to depreciation in the value of our investments in WireCo Worldgroup Inc., Direct Buy Inc., Rug Doctor and Bishop Lifting Products, Inc., among others. Partially offsetting the net change in unrealized loss was a reversal of unrealized depreciation on our investment in Quantum Foods, LLC. Net unrealized loss for the three months ended
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September 30, 2014 is primarily due to depreciation in the value of our investments in Nuveen Investments, Direct Buy and Adams Outdoor Advertising, among others, partially offset by appreciation in Crystal Financial LLC and Tecomet, Inc., among others. Net unrealized gain for the nine months ended September 30, 2014 is primarily due to the reversal of unrealized depreciation on our investment in Ark Real Estate, L.P.
Net Increase in Net Assets From Operations
For the three and nine months ended September 30, 2015, the Company had a net increase in net assets resulting from operations of $0.1 million and $28.3 million, respectively. For the same periods, earnings per average share were $0.00 and $0.67, respectively. For the three and nine months ended September 30, 2014, the Company had a net increase in net assets resulting from operations of $12.8 million and $43.6 million, respectively. For the same periods, earnings per average share were $0.30 and $1.01, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s liquidity and capital resources are generated and generally available through its Credit Facility maturing in June 2018, through cash flows from operations, investment sales, prepayments of senior and subordinated loans, income earned on investments and cash equivalents, and periodic follow-on equity and/or debt offerings. As of September 30, 2015, we had a total of $416.6 million of unused borrowing capacity under the Credit Facility, subject to borrowing base limits.
We may from time to time issue equity and/or debt securities in either public or private offerings. The issuance of such securities will depend on future market conditions, funding needs and other factors and there can be no assurance that any such issuance will occur or be successful. The primary uses of existing funds and any funds raised in the future is expected to be for investments in portfolio companies, repayment of indebtedness, cash distributions to our shareholders, or for other general corporate purposes.
On January 11, 2013, the Company closed its most recent follow-on public equity offering of 6.3 million shares of common stock at $24.40 per share raising approximately $146.9 million in net proceeds. The primary uses of the funds raised were for investments in portfolio companies, reductions in revolving debt outstanding and for other general corporate purposes.
On November 16, 2012, we issued $100 million in aggregate principal amount of the Unsecured Notes for net proceeds of $96.9 million. Interest on the Unsecured Notes is paid quarterly on February 15, May 15, August 15 and November 15, at a rate of 6.75% per year, commencing on February 15, 2013. The Unsecured Notes mature on November 15, 2042. The Company may redeem the Unsecured Notes in whole or in part at any time or from time to time on or after November 15, 2017.
On May 10, 2012, the Company closed a private offering of $75 million of Senior Secured Notes with a fixed interest rate of 5.875% and a maturity date of May 10, 2017. Interest on the Senior Secured Notes is due semi-annually on May 10 and November 10. The Senior Secured Notes were issued in a private placement only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended.
The primary uses of existing funds and any funds raised in the future is expected to be for repayment of indebtedness, investments in portfolio companies, cash distributions to our shareholders or for other general corporate purposes.
Cash Equivalents
We deem certain U.S. Treasury bills, repurchase agreements and other high-quality, short-term debt securities as cash equivalents. From time to time, including at or near the end of each fiscal quarter, we consider using various temporary investment strategies for our business. One strategy includes taking proactive steps by utilizing cash equivalents with the objective of enhancing our investment flexibility pursuant to Section 55 of the 1940 Act. More specifically, from time-to-time we may purchase U.S. Treasury bills or other high-quality,
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short-term debt securities at or near the end of the quarter and typically close out the position on a net cash basis subsequent to quarter end. We may also utilize repurchase agreements or other balance sheet transactions, including drawing down on our credit facilities, as deemed appropriate. The amount of these transactions or such drawn cash for this purpose is excluded from total assets for purposes of computing the asset base upon which the management fee is determined. We held approximately $422 million in cash equivalents as of September 30, 2015.
Debt
Unsecured Notes
On November 16, 2012, the Company and U.S. Bank National Association entered into an Indenture and a First Supplemental Indenture relating to the Company’s issuance, offer and sale of $100 million aggregate principal amount of its Unsecured Notes. The Unsecured Notes will mature on November 15, 2042 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after November 15, 2017 at a redemption price of $25 per security plus accrued and unpaid interest. The Unsecured Notes bear interest at a rate of 6.75% per year payable quarterly on February 15, May 15, August 15 and November 15 of each year. The Unsecured Notes are direct senior unsecured obligations of the Company.
Revolving & Term Loan Facility
In July 2013, the Company amended its Credit Facility, composed of $440 million of revolving credit and $50 million in term loans. Subsequently, in December 2013, a commitment increase was executed providing an additional $50 million of revolving credit, bringing the total revolving credit capacity to $490 million. Borrowings generally bear interest at a rate per annum equal to the base rate plus 2.25% or the alternate base rate plus 1.25%. The Credit Facility has no LIBOR floor requirement. The Credit Facility matures in June 2018 and includes ratable amortization in the final year. The Credit Facility may be increased up to $800 million with additional new lenders or an increase in commitments from current lenders. The Credit Facility contains certain customary affirmative and negative covenants and events of default. In addition, the Credit Facility contains certain financial covenants that among other things, requires the Company to maintain a minimum shareholder’s equity and a minimum asset coverage ratio. The Company also pays issuers of funded term loans quarterly in arrears a commitment fee at the rate of 0.25% per annum on the average daily outstanding balance. In conjunction with the establishment of the Credit Facility, the predecessor facility and a term loan were retired, resulting in $2.3 million of non-recurring charges to expense unamortized costs in the year ended December 31, 2012. Expenses associated with the July 2013 amendment of the Credit Facility, the retirement of our $100 million revolving credit facility with Wells Fargo Securities, LLC as well as the subsequent December 2013 commitment increase totaled $2.5 million. At September 30, 2015, outstanding USD equivalent borrowings under the Credit Facility totaled $123.4 million.
Certain covenants on our issued debt may restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC under Subchapter M of the Code. At September 30, 2015, the Company was in compliance with all financial and operational covenants required by the Credit Facilities.
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Contractual Obligations
A summary of our significant contractual payment obligations is as follows as of September 30, 2015:
Payments Due by Period (in millions)
Revolving credit facility (1)
Unsecured senior notes
Senior secured notes
Term loans
Information about our senior securities is shown in the following table (in thousands) as of each year ended December 31 since the Company commenced operations, unless otherwise noted. The “—” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
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We have also entered into two contracts under which we have future commitments: the Investment Advisory and Management Agreement, pursuant to which Solar Capital Partners, LLC has agreed to serve as our investment adviser, and the Administration Agreement, pursuant to which the Administrator has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations and provide on our behalf managerial assistance to those portfolio companies to which we are required to provide such assistance. Payments under the Investment Advisory and Management Agreement are equal to (1) a percentage of the value of our average gross assets and (2) a two-part incentive fee. Payments under the Administration Agreement are equal to an amount based upon our allocable portion of the Administrator’s overhead in performing its obligations under the Administration Agreement, including rent, technology systems, insurance and our allocable portion of the costs of our chief financial officer and chief compliance officer and their respective staffs. Either party may terminate each of the investment advisory and management agreement and administration agreement without penalty upon 60 days’ written notice to the other. See note 3 to our Consolidated Financial Statements.
Off-Balance Sheet Arrangements
The Company had unfunded debt and equity commitments to various revolving and delayed draw loans as well as to Crystal Financial. The total amount of these unfunded commitments as of September 30, 2015 and December 31, 2014 is $91.7 million and $103.7 million, respectively, comprised of the following:
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In the normal course of its business, we invest or trade in various financial instruments and may enter into various investment activities with off-balance sheet risk, which may include forward foreign currency contracts. Generally, these financial instruments represent future commitments to purchase or sell other financial instruments at specific terms at future dates. These financial instruments contain varying degrees of off-balance sheet risk whereby changes in the market value or our satisfaction of the obligations may exceed the amount recognized in our consolidated Statement of Assets and Liabilities.
Distributions
The following table reflects the cash distributions per share on our common stock for the two most recent fiscal years and the current fiscal year to date:
Date Declared
Fiscal 2015
August 4, 2015
May 5, 2015
February 25, 2015
Total 2015
November 4, 2014
August 4, 2014
May 5, 2014
February 25, 2014
Total 2014
October 30, 2013
July 24, 2013
May 7, 2013
February 25, 2013
Total 2013
Tax characteristics of all distributions will be reported to shareholders on Form 1099 after the end of the calendar year. Future quarterly distributions, if any, will be determined by our Board. We expect that our distributions to stockholders will generally be from accumulated net investment income, from net realized capital gains or non-taxable return of capital, if any, as applicable.
We have elected to be taxed as a RIC under Subchapter M of the Code. To maintain our RIC status, we must distribute at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, out of the assets legally available for distribution. In addition, although we currently intend to distribute realized net capital gains (i.e., net long-term capital gains in excess of short-term capital losses), if any, at least annually, out of the assets legally available for such distributions, we may in the future decide to retain such capital gains for investment.
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We maintain an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, due to the asset coverage test applicable to us as a business development company, we may in the future be limited in our ability to make distributions. Also, our revolving credit facility may limit our ability to declare distributions if we default under certain provisions. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of the tax benefits available to us as a regulated investment company. In addition, in accordance with GAAP and tax regulations, we include in income certain amounts that we have not yet received in cash, such as contractual payment-in-kind interest, which represents contractual interest added to the loan balance that becomes due at the end of the loan term, or the accrual of original issue or market discount. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment company taxable income to obtain tax benefits as a regulated investment company.
With respect to the distributions to stockholders, income from origination, structuring, closing and certain other upfront fees associated with investments in portfolio companies are treated as taxable income and accordingly, distributed to stockholders.
Related Parties
We have entered into a number of business relationships with affiliated or related parties, including the following:
We have entered into an Investment Advisory and Management Agreement with the Investment Adviser. Mr. Gross, our chairman and chief executive officer, is a managing member and a senior investment professional of, and has financial and controlling interests in, the Investment Adviser. In addition, Mr. Spohler, our chief operating officer is a partner and a senior investment professional of, and has financial interests in, the Investment Adviser.
The Administrator provides us with the office facilities and administrative services necessary to conduct day-to-day operations pursuant to our Administration Agreement. We reimburse the Administrator for the allocable portion of overhead and other expenses incurred by it in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions, and the compensation of our chief compliance officer, our chief financial officer and any administrative support staff.
We have entered into a license agreement with the Investment Adviser, pursuant to which the Investment Adviser has granted us a non-exclusive, royalty-free license to use the name “Solar Capital.”
The Investment Adviser and its affiliates may also manage other funds in the future that may have investment mandates that are similar, in whole and in part, with ours. For example, the Investment Adviser presently serves as investment adviser to Solar Senior Capital Ltd., a publicly traded BDC, which focuses on investing primarily in senior secured loans, including first lien and second lien debt instruments. In addition, Michael S. Gross, our chairman and chief executive officer, Bruce Spohler, our chief operating officer, and Richard L. Peteka, our chief financial officer, serve in similar capacities for Solar Senior Capital Ltd. The Investment Adviser and certain investment advisory affiliates may determine that an investment is appropriate for us and for one or more of those other funds. In such event, depending on the availability of such investment and other appropriate factors, the Investment Adviser or its affiliates may determine that we should invest side-
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by-side with one or more other funds. Any such investments will be made only to the extent permitted by applicable law and interpretive positions of the SEC and its staff, and consistent with the Investment Adviser’s allocation procedures.
Related party transactions occur between Solar Capital Ltd. and Crystal Financial LLC and between Solar Capital Ltd. and Senior Secured Unitranche Loan Program. These transactions occur in the normal course of business.
In addition, we have adopted a formal code of ethics that governs the conduct of our officers and directors. Our officers and directors also remain subject to the duties imposed by both the 1940 Act and the Maryland General Corporation Law.
We are subject to financial market risks, including changes in interest rates. During the nine months ended September 30, 2015, certain of the investments in our portfolio had floating interest rates. These floating rate investments were primarily based on floating LIBOR and typically have durations of one to three months after which they reset to current market interest rates. Additionally, some of these investments have LIBOR floors. The Company also has revolving credit facilities that are generally based on floating LIBOR. Assuming no changes to our balance sheet as of September 30, 2015, a hypothetical one-quarter of one percent decrease in LIBOR on our floating rate assets and liabilities would approximately have no effect on our net investment income per average share over the next twelve months. Assuming no changes to our balance sheet as of September 30, 2015, a hypothetical one percent increase in LIBOR on our floating rate assets and liabilities would increase our net investment income by approximately four cents per average share over the next twelve months. However, we may hedge against interest rate fluctuations from time-to-time by using standard hedging instruments such as futures, options, swaps and forward contracts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in any benefits of certain changes in interest rates with respect to our portfolio of investments. At September 30, 2015, we have no interest rate hedging instruments outstanding.
Increase (Decrease) in LIBOR
Increase (Decrease) in Net Investment Income Per Share Per Year
We may also have exposure to foreign currencies (e.g., Canadian Dollars) through various investments. These investments are converted into U.S. dollars at the balance sheet date, exposing us to movements in foreign exchange rates. In order to reduce our exposure to fluctuations in foreign exchange rates, we may borrow from time-to-time in such currencies (e.g., Canadian Dollars) under our multi-currency revolving credit facility or enter into forward currency contracts.
(a) Evaluation of Disclosure Controls and Procedures
As of September 30, 2015 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the 1934 Act). Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures,
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management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls and procedures.
(b) Changes in Internal Controls Over Financial Reporting
Management has not identified any change in the Company’s internal control over financial reporting that occurred during the third quarter of 2015 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
We, Solar Capital Management, LLC and Solar Capital Partners, LLC are not currently subject to any material pending legal proceedings threatened against us. From time to time, we may be a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations beyond what has been disclosed within these financial statements.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Risk Factors” in the March 5, 2015 filing of our Registration Statement on Form N-2, which could materially affect our business, financial condition and/or operating results. The risks described in our Registration Statement on Form N-2 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 and adversely affect our business, financial condition and/or operating results.
We did not engage in unregistered sales of securities during the quarter ended September 30, 2015.
None.
Not applicable.
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The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:
Exhibit
Number
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on November 3, 2015.
/s/ MICHAEL S. GROSS
Michael S. Gross
Chief Executive Officer
(Principal Executive Officer)
/s/ RICHARD L. PETEKA
Richard L. Peteka
Chief Financial Officer
(Principal Financial and Accounting Officer)
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