XFRA:ZSL Solar Capital Ltd. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarter Ended June 30, 2012

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 814-00754

 

 

SOLAR CAPITAL LTD.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   26-1381340
(State or Incorporation)  

(I.R.S. Employer

Identification No.)

500 Park Avenue

New York, N.Y.

  10022
(Address of principal executive offices)   (Zip Code)

(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):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller Reporting company   ¨

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 July 30, 2012 was 36,640,094.

 

 

 


Table of Contents

SOLAR CAPITAL LTD.

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2012

TABLE OF CONTENTS

 

          PAGE  

PART I. FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements

  
  

Consolidated Statements of Assets and Liabilities as of June 30, 2012 (unaudited) and December 31, 2011

     1   
  

Consolidated Statements of Operations for the three and six months ended June 30, 2012 (unaudited) and June 30, 2011 (unaudited)

     2   
  

Consolidated Statements of Changes in Net Assets for the six months ended June 30, 2012 (unaudited) and the year ended December 31, 2011

     3   
  

Consolidated Statements of Cash Flows for the six months ended June 30, 2012 (unaudited) and June 30, 2011 (unaudited)

     4   
  

Consolidated Schedule of Investments as of June 30, 2012 (unaudited)

     5   
  

Consolidated Schedule of Investments as of December 31, 2011

     9   
  

Notes to Consolidated Financial Statements (unaudited)

     13   

.

  

Report of Independent Registered Public Accounting Firm

     31   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     32   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     42   

Item 4.

  

Controls and Procedures

     43   

PART II. OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     45   

Item 1A.

  

Risk Factors

     45   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     45   

Item 3.

  

Defaults upon Senior Securities

     45   

Item 4.

  

Mine Safety Disclosures

     45   

Item 5.

  

Other Information

     45   

Item 6.

  

Exhibits

     46   
  

Signatures

     48   


Table of Contents
Item 1. Financial Statements

SOLAR CAPITAL LTD.

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

(in thousands, except shares)

 

    

 
 

June 30,

2012
(unaudited)

  

  
  

   
 
December 31,
2011
  
  

Assets

    

Investments at value:

    

Companies less than 5% owned (cost: $983,442 and $1,062,844 respectively)

   $ 920,580      $ 955,769   

Companies 5% to 25% owned (cost: $220,411 and $41,819, respectively)

     212,384        35,820   

Companies more than 25% owned (cost: $59,158 and $47,910, respectively)

     60,638        53,454   
  

 

 

   

 

 

 

Total investments (cost: $1,263,011 and $1,152,573, respectively)

     1,193,602        1,045,043   

Cash and cash equivalents

     12,019        11,787   

Interest and dividends receivable

     11,417        9,763   

Deferred credit facility costs

     1,172        3,635   

Deferred offering costs

     659        469   

Receivable for investments sold

     630        3,225   

Fee revenue receivable

     —          4,379   

Unrealized appreciation on interest rate caps and foreign exchange contracts

     94        649   

Prepaid expenses and other receivables

     290        481   
  

 

 

   

 

 

 

Total Assets

     1,219,883        1,079,431   
  

 

 

   

 

 

 

Liabilities

    

Payable for investments purchased

     124,653        22,443   

Revolving credit facilities

     119,860        201,355   

Senior secured notes

     75,000        —     

Term loan

     35,000        35,000   

Dividend payable

     21,984        —     

Investment advisory and management fee payable

     5,673        5,277   

Performance-based incentive fee payable

     3,591        5,203   

Interest payable

     1,323        1,063   

Income taxes payable

     1,035        720   

Administrative services fee payable

     1,022        1,069   

Unrealized depreciation on foreign exchange contracts

     721        —     

Deferred fee revenue

     —          318   

Other accrued expenses and payables

     5,098        1,042   
  

 

 

   

 

 

 

Total Liabilities

     394,960        273,490   
  

 

 

   

 

 

 

Net Assets

    

Common stock, par value $0.01 per share 36,640,094 and 36,608,038 shares issued and outstanding, 200,000,000 authorized

     366        366   

Paid-in capital in excess of par

     928,891        928,180   

Undistributed net investment income

     —          2,245   

Distributions in excess of net investment income

     (6,236     —     

Accumulated net realized losses

     (28,368     (18,379

Net unrealized depreciation

     (69,730     (106,471
  

 

 

   

 

 

 

Total Net Assets

   $ 824,923      $ 805,941   
  

 

 

   

 

 

 

Number of shares outstanding

     36,640,094        36,608,038   
  

 

 

   

 

 

 

Net Asset Value Per Share

   $ 22.51      $ 22.02   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

1


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(in thousands, except shares)

 

     Three months
ended

June 30, 2012
    Three months
ended

June 30, 2011
    Six months
ended
June 30, 2012
    Six months
ended
June 30, 2011
 

INVESTMENT INCOME:

        

Interest and dividends:

        

Other interest and dividend income

   $ 27,819      $ 34,530      $ 63,046      $ 66,129   

Companies 5% to 25% owned

     5,652        —          5,652        —     

Companies more than 25% owned

     1,362        753        2,444        1,448   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     34,833        35,283        71,142        67,577   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES:

        

Interest and other credit facility expenses

     9,051        1,895        11,746        3,932   

Investment advisory and management fees

     5,673        5,096        10,951        10,083   

Performance-based incentive fees

     3,591        5,269        8,866        10,057   

Other general and administrative expenses

     995        1,376        2,004        2,270   

Administrative services fees

     1,128        279        1,824        717   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     20,438        13,915        35,391        27,059   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income before income
tax expense

     14,395        21,368        35,751        40,518   

Income tax expense

     26        —          283        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     14,369        21,368        35,468        40,518   
  

 

 

   

 

 

   

 

 

   

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, DERIVATIVES AND FOREIGN CURRENCIES:

        

Net realized loss:

        

Investments:

        

Companies more than 25% owned

     (687     —          10,315        —     

Companies less than 5% owned

     (19,635     2,304        (20,360     5,106   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gain (loss) on investments

     (20,322     2,304        (10,045     5,106   

Derivatives

     1,730        (4,872     786        (9,235

Foreign currencies

     (563     (242     55        (314
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized loss before income taxes

     (19,155     (2,810     (9,204     (4,443

Income tax expense

     —          —          785        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized loss

     (19,155     (2,810     (9,989     (4,443
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gain (loss):

        

Investments:

        

Companies less than 5% owned

     17,646        (8,478     44,210        22,389   

Companies more than 25% owned

     1,508        1,478        (4,063     3,103   

Companies 5% to 25% owned

     132        (430     (2,027     (690
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gain (loss) on investments

     19,286        (7,430     38,120        24,802   

Derivatives

     159        473        (1,276     214   

Foreign currencies

     1,403        783        (103     311   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gain (loss) on investments

     20,848        (6,174     36,741        25,327   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gain (loss) on investments, derivatives and foreign currencies

     1,693        (8,984     26,752        20,884   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Increase in Net Assets Resulting
From Operations

   $ 16,062      $ 12,384      $ 62,220      $ 61,402   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share

   $ 0.44      $ 0.34      $ 1.70      $ 1.69   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

2


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(in thousands, except shares)

 

     Six months ended
June 30, 2012
(unaudited)
    Year ended
December 31, 2011
 

Increase in net assets resulting from operations:

    

Net investment income

   $ 35,468      $ 81,904   

Net realized loss

     (9,989     (2,393

Net change in unrealized gain (loss)

     36,741        (18,196
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

     62,220        61,315   
  

 

 

   

 

 

 

Dividends and distributions to shareholders:

     (43,949     (87,532
  

 

 

   

 

 

 

Capital share transactions:

    

Reinvestment of dividends

     711        5,164   
  

 

 

   

 

 

 

Net increase (decrease) in net assets

     18,982        (21,053
  

 

 

   

 

 

 

Net assets at beginning of period

     805,941        826,994   
  

 

 

   

 

 

 

Net assets at end of period

   $ 824,923      $ 805,941   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

3


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands except shares)

 

     Six months ended
June 30, 2012
    Six months ended
June 30, 2011
 

Cash Flows from Operating Activities:

    

Net increase in net assets from operations

   $ 62,220      $ 61,402   

Adjustments to reconcile net increase in net assets from operations to net cash provided by operating activities:

    

Net realized (gain) loss from investments

     10,045        (5,106

Net realized (gain) loss from foreign currency exchange

     (55     314   

Net change in unrealized (gain) on investments

     (38,120     (24,802

Net change in (gain) loss on derivatives

     1,276        (214

(Increase) decrease in operating assets:

    

Purchase of investment securities

     (362,575     (221,329

Proceeds from disposition of investment securities

     251,877        232,757   

Capitalization of payment-in-kind interest

     (16,776     (13,710

Collections of payment-in-kind interest

     7,141        3,602   

Interest and dividends receivable

     (1,654     (1,474

Purchase of interest rate cap

     —          (2,938

Fee revenue receivable

     4,379        (126

Receivable for investments sold

     2,595        8,119   

Prepaid expenses and other receivables

     191        (94

Increase (decrease) in operating liabilities:

    

Payable for investments purchased

     102,210        68,005   

Investment advisory and management fee payable

     396        204   

Performance-based incentive fee payable

     (1,612     922   

Interest payable

     260        421   

Administrative services fees

     (47     (323

Income taxes payable

     315        142   

Deferred fee revenue

     (318     (504

Other accrued expenses and payables

     4,057        (407
  

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     25,805        104,861   
  

 

 

   

 

 

 

Cash Flows from Financing Activities:

    

Cash dividends paid

     (21,965     (20,268

Deferred offering costs

     (190     (367

Deferred credit facility costs

     2,463        1,136   

Proceeds from borrowings on senior secured notes

     75,000        —     

Proceeds from borrowings on revolving/term credit facilities

     292,590        767,611   

Repayments of borrowings on revolving/term credit facilities

     (373,471     (767,255
  

 

 

   

 

 

 

Net Cash Used in Financing Activities

     (25,573     (19,143
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     232        85,718   

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

     11,787        288,732   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 12,019      $ 374,450   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid for interest

   $ 4,150      $ 1,681   
  

 

 

   

 

 

 

Cash paid for income taxes

   $ 727      $ 312   
  

 

 

   

 

 

 

Non-cash financing activity:

    

Dividends reinvestment

   $ 711      $ 1,562   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

4


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited)

June 30, 2012

(in thousands, except shares)

 

Description(1)

  

Industry

  Interest(2)     Maturity     Par Amount/
Shares
    Cost     Fair
Value
 

Bank Debt/Senior Secured Loans-62.0%

            

Asurion Corporation

   Insurance     9.00     5/24/2019      $ 40,000      $ 39,821      $ 40,900   

Airvana Network Solutions Inc.

   Telecommunications     10.00     3/25/2015        4,071        4,033        3,990   

AREP Fifty-Seventh LLC(10)(26)

   Buildings & Real Estate     14.00     8/1/2013        19,768        19,373        19,373   

ARK Real Estate Partners II LP(10)(26)

   Buildings & Real Estate     14.00     8/1/2013        8,027        7,866        7,866   

AviatorCap SII, LLC I(9)

   Aerospace & Defense     12.00     12/31/2014        3,402        3,365        3,400   

AviatorCap SII, LLC II(9)

   Aerospace & Defense     11.00     12/31/2014        5,070        5,008        5,070   

AviatorCap SII, LLC III(9)

   Aerospace & Defense     13.00     12/31/2014        6,320        6,214        6,320   

Direct Buy Inc.(18)

   Home, Office Furnishing & Durable Consumer Prds     12.00     2/1/2017        25,000        24,332        5,875   

DS Waters of America, Inc.(10)(22)

   Beverage, Food & Tobacco    

 

15% (11% Cash &

4% PIK)

  

(7) 

    2/28/2018        30,292        29,278        30,292   

Fulton Holding Corp(17)

   Retail Stores     13.37     5/28/2016        35,000        34,251        35,000   

Grakon, LLC(11)

   Machinery     12.00     12/31/2015        9,524        7,616        9,429   

Good Sam Enterprise, LLC

   Insurance     11.50     12/1/2016        7,000        6,570        7,289   

Grocery Outlet Inc.(16)

   Grocery     10.50     12/15/2017        33,264        32,329        33,264   

Isotoner Corporation

   Personal & Nondurable Consumer Products     10.75     1/8/2018        39,000        37,963        38,610   

Interactive Health Solutions, Inc.(16)(17)

   Healthcare, Education & Childcare     11.50     10/4/2016        19,894        19,488        20,013   

MYI Acquiror Corporation(4)(8)(19)

   Insurance    

 

13% (12% Cash &

1% PIK)

  

(7) 

    3/13/2017        31,643        31,073        31,801   

SMG

   Personal, Food & Misc. Services     10.75     12/7/2018        25,000        24,503        24,875   

Southern Auto Finance Company(19)

   Banking     13.50     10/19/2017        25,000        24,485        24,750   

SOINT, LLC(9)(23)

   Aerospace & Defense     15.00     6/30/2016        16,667        16,333        16,333   

Spencer Spirit Holdings, Inc.

   Retail Stores     11.00     5/1/2017        10,000        10,000        10,300   

Transplace Texas, LP(16)

   Cargo Transport     11.00     4/12/2017        20,000        19,576        19,700   

Trident USA Health Services, LLC

   Healthcare, Education & Childcare     11.75     10/30/2017        38,000        37,253        37,240   

USAW 767(9)

   Aerospace & Defense     14.50     6/30/2014        3,986        3,961        3,986   

ViaWest Inc(16)

   Personal, Food & Misc. Services    

 

13.5% (12% Cash &

1.5% PIK)

  

(7) 

    5/20/2018        40,538        39,492        40,132   

Vision Holding Corp.(16)

   Healthcare, Education & Childcare     12.00     11/23/2016        35,300        34,822        35,300   
        

 

 

   

 

 

   

 

 

 

Total Bank Debt/Senior Secured Loans

         $ 531,766      $ 519,005      $ 511,107   
        

 

 

   

 

 

   

 

 

 

Subordinated Debt/Corporate Notes – 59.0%

            

Adams Outdoor Advertising

   Diversified/Conglomerate Service     18.00     12/8/2015      $ 42,500      $ 41,827      $ 42,500   

Asurion Holdco(21)

   Insurance     11.00 %(7)      3/2/2019        12,000        11,652        12,480   

CIBT Solutions

   Leisure, Amusement, Entertainment     13.50     6/15/2018        36,200        35,429        36,200   

Crosman Corporation

   Leisure, Amusement, Entertainment    

 

13% (11% Cash &

2% PIK)

  

(7) 

    10/15/2016        15,219        14,837        14,914   

Earthbound Farm(16)

   Farming & Agriculture     14.25     6/21/2017        58,947        57,874        57,474   

Grakon Holdings LLC Sr(11)

   Machinery     14% PIK (7)      12/31/2015        1,701        1,701        1,684   

Grakon Holdings LLC Jr(11)

   Machinery     12% PIK (7)      12/31/2015        16,039        13,273        11,227   

Granite Global Solutions Corp.(3)(18)(19)

   Insurance     13.50     5/31/2016        17,859        18,493        15,180   

Midcap Financial Intermediate
Holdings, LLC(16)(19)

   Banking     13.00     7/9/2015        85,000        83,676        85,000   

ProSieben Sat.1 Media AG(3)(6)(19)

   Broadcasting & Entertainment    

 

8.43% (4.93% Cash &

3.5% PIK)

  

(7) 

    3/6/2017        21,029        20,657        13,368   

Richelieu Foods, Inc.(15)

   Beverage, Food & Tobacco    

 

14.25% (12% Cash &

2.25% PIK)

  

(7) 

    5/18/2016        22,831        22,346        21,918   

Rug Doctor L.P.(20)

   Personal, Food & Misc. Services    

 

15.50% to 20.00%

(wtd. avg. 17.54%)

  

(7) 

    10/31/2014        52,570        49,875        47,313   

Weetabix Group(3)(5)(19)

   Beverage, Food & Tobacco     9.13% PIK (7)      9/14/2016        16,862        19,353        16,525   

Weetabix Group(3)(5)(19)

   Beverage, Food & Tobacco     10.29% PIK (7)      5/3/2017        36,359        43,561        35,632   

WireCo. Worldgroup Inc.(24)

   Building Products     11.75     5/15/207        48,000        47,520        47,520   

FIS Healthcare Holdings, LLC(25)

   Healthcare Technology     12.00     2/28/2019        28,200        27,566        27,566   
        

 

 

   

 

 

   

 

 

 

Total Subordinated Debt/Corporate Notes

         $ 511,316      $ 509,640      $ 486,501   
        

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

5


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Description(1)

   Industry    Interest(2)     Maturity      Par Amount/
Shares
     Cost      Fair
Value
 

Preferred Equity – 17.6%

                

Senior Preferred 15% Units of DSW Group
Holdings LLC(10)

   Beverage, Food & Tobacco      15% PIK (7)      —           1,395,230       $ 119,196       $ 119,990   

SODO Corp.(9)(12)

   Aerospace & Defense      8.43% PIK (7)      6/30/2018         2,084         2,084         2,251   

SOCAY Limited(9)(12)(19)

   Aerospace & Defense      8.59% PIK (7)      6/30/2018         13,526         13,526         14,611   

SOINT, LLC(9)(1)(19)(23)

   Aerospace & Defense      15.00 %(7)      6/30/2018         86,667         8,667         8,667   

Wyle Laboratories

   Aerospace & Defense      8.00     7/17/2015         387         39         49   
             

 

 

    

 

 

 

Total Preferred Equity

              $ 143,512       $ 145,568   
             

 

 

    

 

 

 

Common Equity / Partnership Interests /
Warrants – 6.1%

                

Ark Real Estate Partners LP(10)(11)

   Buildings & Real Estate           44,697,684       $ 44,698       $ 34,864   

Participating Preferred Units of DSW Group
Holdings LLC(10)

   Beverage, Food & Tobacco           1,296,078         —           —     

Grakon, LLC(11)

   Machinery           1,714,286         1,714         —     

Grakon, LLC Warrants(11)

   Machinery           3,518,001         —           —     

Great American Group Inc.(13)(19)

   Personal, Food & Misc. Services           572,800         2,681         189   

Great American Group Inc.(14)(19)

   Personal, Food & Misc. Services           187,500         3         62   

Nuveen Investments, Inc.

   Finance           3,486,444         30,876         7,322   

NXP Semiconductors Netherlands B.V.(3)(19)

   Electronics           310,271         8,458         7,208   

Seven West Media Limited(3)(19)

   Broadcasting & Entertainment           437,687         2,424         781   
             

 

 

    

 

 

 

Total Common Equity/Partnerships
Interests / Warrants

              $ 90,854       $ 50,426   
             

 

 

    

 

 

 

Total Investments – (144.7%)

              $ 1,263,011       $ 1,193,602   
             

 

 

    

 

 

 

Liabilities in Excess of Other Assets – (44.7%)

                (368,679
                

 

 

 

Net Assets – 100.0%

                 $ 824,923   
                

 

 

 

 

(1) We generally acquire our investments in private transactions exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”). Our investments are therefore generally subject to certain limitations on resale, and may be deemed to be “restricted securities” under the Securities Act.
(2) A majority of the variable rate debt investments bear interest at a rate that may be determined by reference to LIBOR or EURIBOR, and which reset daily, quarterly or semi-annually. For each debt investment we have provided the current interest rate in effect as of June 30, 2012.
(3) The following entities are domiciled outside the United States and the investments are denominated in either Euro, British Pounds, Canadian Dollars or Australian Dollars: Weetabix Group in the United Kingdom; ProSieben Sat.1 Media AG in Germany; Granite Global Solutions Corp. in Canada; and Seven Media Group Limited in Australia. NXP Semiconductors Netherlands B.V. is domiciled in the Netherlands and is denominated in U.S. dollars. All other investments are domiciled in the United States.
(4) Solar Capital Ltd.’s foreign domiciled portion of MYI Aquiror Corporation is held through its wholly-owned subsidiary Solar Capital Luxembourg I S.ar.l.
(5) Solar Capital Ltd.’s investments in Weetabix Group are held through its wholly-owned subsidiary Solar Capital Luxembourg I S.a.r.l.
(6) Solar Capital Ltd.’s investment in ProSieben Sat. 1 Media AG is held through its wholly-owned subsidiary Solar Capital Luxembourg I S.a.r.l.
(7) Coupon is payable in cash and/or in kind (PIK).
(8) Includes an unfunded commitment of $6,000.
(9) Denotes a Control Investment. “Control Investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “Control.” Generally, under the Investment Company Act of 1940, as amended (the “1940 Act”), the Company is deemed to “Control” a company in which it has invested if it owns 25% or more of the voting securities of such company or has greater than 50% representation on its board.
(10) Denotes an Affiliate Investment. “Affiliate Investments” are investments in those companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, which are not “Control Investments.” The Company is deemed to be an “Affiliate” of a company in which it has invested if it owns 5% or more but less than 25% of the voting securities of such company.
(11) Investments are held in taxable subsidiaries through Solar Capital Ltd. Investment in Ark Real Estate Partners LP is held through SLRC ADI Corp and equity investment in Grakon LLC are held through Grakon TL Holding, Inc.
(12) Solar Capital Ltd.’s investments in SODO Corp. and SOCAY Corp. each include a one dollar investment in common shares.
(13) Founders Shares.
(14) Contingent Founders Shares.
(15) Indicates an investment held by Solar Capital Ltd. through its wholly-owned subsidiary Solar Capital Funding II LLC (“SC Funding”). Such investments are pledged as collateral under the Senior Secured Loan Facility (see Note 6 to the consolidated financial statements) and are not generally available to the creditors of Solar Capital Ltd. Unless otherwise noted, as of June 30, 2012, all other investments were pledged as collateral for the Senior Secured Credit Facility, Term Loan and Senior Secured Notes (see Note 6 to the consolidated financial statements).
(16) Indicates an investment partially held by Solar Capital Ltd. through its wholly-owned subsidiary SC Funding. (See note 15 above for further explanation.) Par amounts held through SC Funding include: Asurion Corp $20,224; Earthbound Farm $23,500; Fulton Holding Corp. $19,800; Grocery Outlet Inc. $19,900; Interactive Health Solutions, Inc. $14,569; Midcap Financial Intermediate Holdings, LLC $23,500; Rug Doctor L.P. $9,669; Transplace Texas, LP $18,800; ViaWest Inc. $15,354; and Vision Holding Corp $20,569. Remaining par balances are held directly by Solar Capital Ltd.

 

6


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

(17) Includes an unfunded commitment of $1,250.
(18) Investments on non-accrual status.
(19) Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company’s total assets at the time of acquisition of any additional non-qualifying assets.
(20) Includes PIK payable on $12,732 of par at 4.50% PIK, $14,769 of par at 5.25% PIK, $15,400 of par at 8.00% PIK, and $9,669 of par at 3.50% PIK.
(21) Asurion Holdco has the option to pay interest in kind at L+10.25% if certain specified conditions are met.
(22) In March 2012, Solar Capital Ltd. purchased $36,991 and participated $7,000 to a third party with no recourse to the Company.
(23) Includes an unfunded commitment of secured debt $14,979 and equity $7,789.
(24) Includes an unfunded commitment of $48,000
(25) Includes an unfunded commitment of $28,200
(26) Includes an unfunded commitment of $20,177

See notes to consolidated financial statements.

 

7


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited) (continued)

June 30, 2012

 

Industry Classification

   Pecentage of Total
Investments (at fair value) as

of June 30, 2012
 

Beverage, Food & Tobacco

     19

Insurance

     9

Banking

     9

Personal, Food & Misc. Services

     9

Healthcare, Education & Childcare

     8

Buildings & Real Estate

     5

Farming & Agriculture

     5

Aerospace & Defense

     5

Building Products

     4

Leisure, Amusement, Entertainment

     4

Retail Stores

     4

Diversified/Conglomerate Service

     4

Personal & Nondurable Consumer Products

     3

Grocery

     3

Healthcare Technology

     2

Machinery

     2

Cargo Transport

     2

Broadcasting & Entertainment

     1

Finance

     1

Electronics

     1

Telecommunications

     > 1

Home, Office Furnishing & Durable Consumer Prds

     > 1
  

 

 

 
     100
  

 

 

 

See notes to consolidated financial statements.

 

8


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS

December 31, 2011

(in thousands, except shares)

 

Description(1)

 

Industry

  Interest(2)     Maturity     Par Amount/
Shares
    Cost     Fair
Value
 

Bank Debt/Senior Secured
Loans – 39.46%

           

Asurion Corporation(18)

  Insurance     9.00     5/24/2019      $ 40,000      $ 39,811      $ 39,517   

Airvana Network
Solutions Inc.

  Telecommunications     10.00     3/25/2015        8,324        8,186        8,324   

AviatorCap SII, LLC I(10)

  Aerospace & Defense     12.00     12/31/2014        3,728        3,678        3,671   

AviatorCap SII, LLC II(10)

  Aerospace & Defense     11.00     12/31/2014        5,697        5,618        5,611   

AviatorCap SII, LLC III(10)

  Aerospace & Defense     13.00     12/31/2014        8,856        8,696        8,724   

Direct Buy Inc.(20)

  Home, Office Furnishing & Durable Consumer Prds     12.00     2/1/2017        25,000        24,332        5,875   

Fulton Holding Corp(18)

  Retail Stores     13.74     5/28/2016        35,000        34,155        35,000   

Grakon, LLC

  Machinery     12.00     12/31/2015        9,524        7,610        9,286   

Good Sam Enterprise, LLC

  Insurance     11.50     12/1/2016        7,000        6,523        6,860   

Grocery Outlet Inc.

  Grocery     10.50     12/15/2017        33,600        32,599        32,592   

Isotoner Corporation

  Personal & Nondurable Consumer Products     10.75     1/8/2018        39,000        37,895        37,830   

Interactive Health
Solutions, Inc.(18)(19)

  Healthcare, Education & Childcare     11.50     10/4/2016        20,131        19,691        19,930   

MYI Acquiror
Corporation(3)(4)(8)(21)

  Insurance    
 
13% (12% Cash &
1% PIK)
  
( 7) 
    3/13/2017        31,500        30,899        31,500   

Roundy’s Supermarkets,
Inc. – 2nd Lien(18)

  Grocery     10.00     4/16/2016        22,000        21,685        22,069   

Southern Auto Finance
Company(21)

  Banking     13.50     10/19/2017        25,000        24,453        24,437   

Spencer Spirit Holdings, Inc.

  Retail Stores     11.00     5/1/2017        10,000        10,000        10,000   

Transplace Texas, LP(18)

  Cargo Transport     11.00     4/12/2017        20,000        19,533        19,500   

USAW 767(10)

  Aerospace & Defense     14.50     12/31/2012        4,904        4,850        4,831   

ViaWest Inc(18)

  Personal, Food & Misc. Services    
 
13.5% (12% Cash
& 1.5% PIK)
  
(7) 
    5/20/2016        33,255        32,520        32,756   

Vision Holding Corp.(18)

  Healthcare, Education & Childcare     12.00     11/23/2016        37,500        36,869        37,125   

VPSI, Inc.(17)

  Personal Transportation     12.00     12/23/2015        16,958        16,598        16,958   
       

 

 

   

 

 

   

 

 

 

Total Bank Debt/Senior Secured Loans

        $ 436,977      $ 426,201      $ 412,396   
       

 

 

   

 

 

   

 

 

 

Subordinated Debt/Corporate Notes – 52.33%

           

Adams Outdoor Advertising

  Diversified/Conglomerate Service     18.00     12/8/2015      $ 42,500      $ 41,878      $ 42,075   

AMC Entertainment
Holdings, Inc.

  Leisure, Amusement, Entertainment     5.55%PIK        6/13/2012        27,141        27,086        26,462   

CIBT Solutions

  Leisure, Amusement, Entertainment     13.50     6/15/2018        36,200        35,389        35,386   

Crosman Corporation

  Leisure, Amusement, Entertainment    

 

13% (11% Cash &

2% PIK)

  

(7) 

    10/15/2016        15,219        14,808        14,762   

DSW Group, Inc.

  Beverage, Food & Tobacco     15% PIK        4/24/2012        125,106        124,972        106,340   

Earthbound Farm(18)

  Farming & Agriculture     14.25     6/21/2017        58,947        57,739        56,590   

Grakon Holdings LLC Sr

  Machinery     14% PIK        12/31/2015        1,588        1,588        1,469   

Grakon Holdings LLC Jr

  Machinery     12% PIK        12/31/2015        15,118        12,344        7,710   

Granite Global Solutions
Corp.(3)(16)(21)

  Insurance     13.50     5/31/2016        29,983        30,234        29,121   

Magnolia River, LLC

  Hotels, Motels, Inns and Gaming     14.00     4/28/2014        19,064        18,664        19,064   

Midcap Financial Intermediate
Holdings, LLC(18)

  Banking     14.25     7/9/2015        75,000        73,542        75,000   

ProSieben Sat.1
Media AG(3)(6)(21)

  Broadcasting & Entertainment    
 
8.83%(5.3% Cash
& 3.5% PIK)
  
(7) 
    3/6/2017        21,125        20,261        10,508   

Richelieu Foods, Inc.(17)

  Beverage, Food & Tobacco     13.75     5/18/2016        22,500        21,972        21,150   
      15.50% to 20.00% (7)         

Rug Doctor L.P.(18)(22)

  Personal, Food & Misc. Services     (wtd. avg. 17.54 %)      10/31/2014        51,225        48,034        47,383   

Shoes For Crews, LLC (17)

  Textiles & Leather     13.75% (7)      7/23/2016        15,650        15,318        15,650   

Weetabix Group(3)(5)(21)

  Beverage, Food & Tobacco     9.22% PIK        9/14/2016        15,986        18,589        12,469   

Weetabix Group(3)(5)(21)

  Beverage, Food & Tobacco     10.03%PIK        5/3/2017        34,294        41,739        25,720   
       

 

 

   

 

 

   

 

 

 

Total Subordinated Debt/Corporate Notes

        $ 606,646      $ 604,157      $ 546,859   
       

 

 

   

 

 

   

 

 

 

 

9


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

December 31, 2011

(in thousands, except shares)

 

Description(1)

 

Industry

  Interest(2)     Maturity     Par Amount/
Shares
    Cost     Fair
Value
 

Preferred Equity – 1.40%

           

SODO Corp.(10)(13)

  Aerospace & Defense     8.43% PIK        —          1,912      $ 2,009      $ 1,949   

SOCAY Limited(10)(13)

  Aerospace & Defense     8.59% PIK        —          12,357        13,059        12,668   

Wyle Laboratories

  Aerospace & Defense     8.00%               7/17/2015        387        39        47   
         

 

 

   

 

 

 

Total Preferred Equity

          $ 15,107      $ 14,664   
         

 

 

   

 

 

 

Common Equity / Partnership Interests / Warrants – 6.81%

           

Ark Real Estate Partners LP(9)(11)(12)

  Buildings & Real Estate         41,818,834      $ 41,819      $ 35,820   

Grakon, LLC

  Machinery         1,714,286        1,714        —     

Grakon, LLC Warrants

  Machinery         3,518,001        —          —     

Great American Group Inc.(14)

  Personal, Food & Misc. Services         572,800        2,681        69   

Great American Group Inc.(15)

  Personal, Food & Misc. Services         187,500        3        23   

National Specialty Alloys, LLC(10)

  Mining, Steel, Iron & Nonprecious Metals         1,000,000        10,000        16,000   

Nuveen Investments, Inc.

  Finance         3,486,444        30,875        7,844   

NXP Semiconductors Netherlands B.V.(3)

  Electronics         645,292        17,592        9,918   

Seven West Media Limited

  Broadcasting & Entertainment         437,687        2,424        1,450   

Total Common Equity/Partnerships Interests / Warrants

          $ 107,108      $ 71,124   
         

 

 

   

 

 

 

Total Investments

          $ 1,152,573      $ 1,045,043   
         

 

 

   

 

 

 

 

(1) We generally acquire our investments in private transactions exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”). Our investments are therefore generally subject to certain limitations on resale, and may be deemed to be “restricted securities” under the Securities Act.
(2) For each debt investment we have provided the current interest rate in effect as of December 31, 2011. Variable rate debt investments generally bear interest at a rate that may be determined by reference to LIBOR or EURIBOR, and which may reset daily, quarterly or semi-annually.
(3) The following entities are domiciled outside the United States and the investments are denominated in British Pounds, Euro, Canadian Dollars or Australian Dollars: Weetabix Group in the United Kingdom; ProSieben Sat.1 Media AG in Germany; Granite Global Solutions Corp. in Canada; and Seven West Media Group Pty Limited in Australia. NXP Semiconductors Netherlands B.V. is domiciled in the Netherlands and $14,750 of MYI Aquiror Corporation is domiciled in the United Kingdom, but these assets are denominated in US Dollars. All other investments are domiciled in the United States.
(4) Solar Capital Ltd.’s foreign domiciled portion of MYI Aquiror Corporation is held through its wholly-owned subsidiary Solar Capital Luxembourg I S.a.r.l.
(5) Solar Capital Ltd.’s investments in Weetabix Group are held through its wholly-owned subsidiary Solar Capital Luxembourg I S.a.r.l.
(6) Solar Capital Ltd.’s investments in ProSieben Sat. 1 Media AG are held through its wholly-owned subsidiary Solar Capital Luxembourg I S.a.r.l.
(7) Coupon is payable in cash and/or in kind (PIK).
(8) Includes an unfunded commitment of $6,000.
(9) Solar Capital Ltd. has an unfunded commitment of $2,879.
(10) Denotes a Control Investment. “Control Investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “Control.” Generally, under the Investment Company Act of 1940, as amended (the “1940 Act”), the Company is deemed to “Control” a company in which it has invested if it owns 25% or more of the voting securities of such company or has greater than 50% representation on its board.
(11) Denotes an Affiliate Investment. “Affiliate Investments” are investments in those companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, which are not “Control Investments.” The Company is deemed to be an “Affiliate” of a company in which it has invested if it owns 5% or more but less than 25% of the voting securities of such company.
(12) Solar Capital Ltd.’s investment in Ark Real Estate Partners LP is held through its taxable subsidiary SLRC ADI Corp.
(13) SODO Corp. and SOCAY Corp. own equity interests that represent a majority of the equity ownership in Aviator Cap SII, LLC and USAW 767. Solar Capital Ltd.’s investments in SODO Corp. and SOCAY Corp. each include a one dollar investment in common shares.
(14) Founders Shares.
(15) Contingent Founders Shares.
(16) Includes an unfunded commitment of $15,600 Canadian Dollars or $15,313 U.S Dollars as of December 31, 2011.
(17) Indicates an investment held by Solar Capital Ltd. through its wholly-owned subsidiary Solar Capital Funding II LLC. Such investments are pledged as collateral under the Senior Secured Loan Facility (see Note 6 to the consolidated financial statements) and are not generally available to the creditors of Solar Capital Ltd. Unless otherwise noted, as of December 31, 2011, all other investments were pledged as collateral for the Senior Secured Revolving Credit Facility and the Term Loan (see Note 6 to the consolidated financial statements).
(18) Indicates an investment partially held by Solar Capital Ltd. through its wholly-owned subsidiary Solar Capital Funding II LLC. (See note 17 above for further explanation.) Par amounts held through Solar Capital Funding II LLC include: Asurion $14,224; Fulton Holding Corp. $18,000; Interactive Health Solutions, Inc. $10,236; Roundy’s Supermarkets Inc. $10,000; Transplace Texas, LP $18,800; ViaWest Inc. $15,239; Vision Holding Corp $13,883; Earthbound $23,500; Midcap Financial Intermediate Holdings, LLC $23,500; and Rug Doctor L.P. $9,515. Remaining par balances are held directly by Solar Capital Ltd.
(19) Includes an unfunded commitment of $1,250.

 

10


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

December 31, 2011

(in thousands, except shares)

 

(20) Investment is on non-accrual status.
(21) Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company’s total assets at the time of acquisition of any additional non-qualifying assets.
(22) Includes PIK payable on $12,466 of par at 4.50% PIK, $14,405 of par at 5.25% PIK, $14,839 of par at 8.00% PIK, and $9,515 of par at 3.50% PIK.

See notes to consolidated financial statements.

 

11


Table of Contents

SOLAR CAPITAL LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)

December 31, 2011

 

Industry Classification

   Percentage of Total
Investments (at fair value) as
of December 31, 2011
 

Beverage, Food & Tobacco

     16

Insurance

     10

Banking

     10

Personal, Food & Misc. Services

     8

Leisure, Amusement, Entertainment

     7

Healthcare, Education & Childcare

     5

Farming & Agriculture

     5

Grocery

     5

Retail Stores

     4

Diversified/Conglomerate Service

     4

Personal & Nondurable Consumer Products

     4

Aerospace & Defense

     4

Buildings & Real Estate

     3

Cargo Transport

     2

Hotels, Motels, Inns and Gaming

     2

Machinery

     2

Personal Transportation

     2

Mining, Steel, Iron & Nonprecious Metals

     1

Textiles & Leather

     1

Broadcasting & Entertainment

     1

Electronics

     1

Telecommunications

     1

Finance

     1

Home, Office Furnishing & Durable Consumer Prds

     1
  

 

 

 
     100
  

 

 

 

See notes to consolidated financial statements.

 

12


Table of Contents

SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

June 30, 2012

(in thousands, except shares)

Note 1. Organization

Solar Capital Ltd. (“Solar Capital”, “we”, or the “Company”), 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”). 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”). In February 2010, Solar Capital Ltd. completed its initial public offering.

The Company’s 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. Our business model is focused primarily on the direct origination of investments through portfolio companies or their financial sponsors. Our investments generally range between $20 million and $100 million each, although we expect that this investment size will vary proportionately with the size of our capital base.

Note 2. Significant Accounting Policies

Basis of Presentation – The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”), and include the accounts of the Company and its wholly-owned subsidiaries, Solar Capital Luxembourg I S.a.r.l., which was incorporated under the laws of the Grand Duchy of Luxembourg on April 26, 2007, and Solar Capital Funding II LLC (“SC Funding”), a Delaware limited liability company formed on December 8, 2010. 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 have been reclassified to conform to current year presentation.

Interim financial statements are prepared in accordance with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, all adjustments, consisting solely of normal recurring accruals considered necessary for the fair presentation of financial statements for the interim period, have been included. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending December 31, 2012.

Investments – The Company applies fair value accounting in accordance with GAAP. Securities transactions are accounted for on trade date. Securities for which market quotations are readily available on an exchange are valued at such price as of the closing price on the valuation date. The Company may also obtain quotes with respect to certain of its investments from pricing services or brokers or dealers in order to value assets. When doing so, the Company determines whether the quote obtained is sufficient according to GAAP to determine the fair value of the security. If determined adequate, the Company uses the quote obtained.

Securities for which reliable market quotations are not readily available or for which the pricing source does not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of the Company’s Investment Adviser or Board of Directors (the “Board”), does not represent fair value, shall each be valued as follows:

 

  1) The quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment;

 

  2) Preliminary valuation conclusions are then documented and discussed with senior management;

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

  3) Third-party valuation firms are engaged by, or on behalf of, the Board to conduct independent appraisals and review management’s preliminary valuations and make their own independent assessment, for all material assets; and

 

  4) The Board discusses valuations and determines the fair value of each investment in the portfolio in good faith based on the input of our Investment Adviser (Note 4) and, where appropriate, the respective independent valuation firms.

Valuation methods, among other measures and as applicable, may include comparisons of financial ratios of the portfolio companies that issued such securities to peer companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flows, the markets in which the portfolio company does business, and other relevant factors.

When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the Company will consider the pricing indicated by the external event to corroborate the valuation. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

Investments of sufficient credit quality purchased within 60 days of maturity are valued at cost plus accreted discount, or minus amortized premium, which approximates fair value.

Credit Facilities – The Company has made an irrevocable election to apply the fair value option of accounting to the certain credit facilities and senior secured notes (see Note 6), in accordance with Accounting Standards Codification (“ASC”) 825-10. The Company uses an independent third-party valuation firm to measure their fair values.

Cash and Cash Equivalents – Cash and cash equivalents include investments in money market accounts or investments with original maturities of three months or less.

Revenue Recognition – The Company’s revenue recognition policies are as follows:

Sales: Gains or losses on the sale of investments are calculated by using the specific identification method.

Interest Income: Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as part of interest income. The Company has loans in its portfolio that contain a payment-in-kind (“PIK”) provision. PIK interest is accrued at the contractual rates and added to the loan principal on the reset dates.

Dividend Income: Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies or on the ex-dividend date for publicly traded portfolio companies.

Non-accrual: Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current.

Fee Revenue Receivable – Fee revenue receivable consists of premium payments owed to the Company at the maturity of certain loans. The premium payments are recorded as a receivable at the inception of the loan and are accreted into interest income over the respective terms of the applicable loans.

Deferred Fee Revenue – Deferred fee revenue represents the unearned portion of premium payments owed to the Company at the maturity of certain loans.

U.S. Federal Income Taxes – The Company has elected to be treated as a RIC under subchapter M of the Code and operates in a manner so as to qualify for the tax treatment applicable to RICs. 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 dividend distributions into the next tax year and pay a 4% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the six months ended June 30, 2012, $985 was recorded for U.S. Federal excise tax. No Federal excise tax was recorded for the three months ended June 30, 2011.

Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The Company’s inception-to-date federal tax years remain subject to examination by the Internal Revenue Service. The Company is also subject to taxes in Luxembourg, through Solar Capital Luxembourg I S.a.r.l., a wholly-owned subsidiary. Under the laws of Luxembourg, the Company pays a corporate income tax and a municipal business tax on its subsidiary’s taxable income.

The Company has formed and used certain taxable subsidiaries to be taxed as a corporation for federal income tax purposes. These taxable subsidiaries allow the Company to hold portfolio companies organized as pass-through entities and still satisfy certain RIC income requirements. The Company does not consolidate the taxable subsidiaries for income tax purposes but recognizes the results of these subsidiaries for financial reporting purposes.

The Company evaluates tax positions taken or expected to be taken in the course of preparing its financial statements to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the “more-likely-than-not” threshold are reversed and recorded as a tax benefit or expense in the current year. All penalties and interest associated with income taxes are included in income tax expense. Conclusions regarding tax positions are subject to review and may be adjusted at a later date based on factors including, but not limited to, on-going analyses of tax laws, regulations and interpretations thereof. The Company did not have any uncertain tax positions that met the recognition or measurement criteria of ASC 740-10-25 nor did it have any unrecognized tax benefits as of the periods presented herein.

Capital Accounts – Certain capital accounts including under (over) distributed net investment income, accumulated net realized gain or loss, net unrealized depreciation, and paid-in capital in excess of par, are

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

adjusted, at least annually, for permanent differences between book and tax. In addition, the character of income and gains to be distributed is determined in accordance with income tax regulations that may differ from GAAP.

During 2011, as a result of permanent book-to-tax differences, the Company decreased under (over) distributed net investment income by $4,582, decreased accumulated net realized loss by $8,555, and decreased paid-in capital in excess of par value by $3,973. Aggregate stockholders’ equity was not affected by this reclassification.

Dividends – Dividends and distributions to common stockholders are recorded on the ex-dividend date. Quarterly dividend payments are determined by the Board and are generally based upon taxable earnings estimated by management. Net realized capital gains, if any, are typically distributed at least annually, although we may decide to retain such capital gains for investment. We have adopted a dividend reinvestment plan that provides for reinvestment of any distributions we declare in cash on behalf of our stockholders, unless a stockholder elects to receive cash. As a result, if our Board authorizes, and we declare, a cash dividend, then our stockholders who have not “opted out” of our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash dividend. While we generally use newly issued shares to implement the plan (especially if our shares are trading at a premium to net asset value), we may purchase shares in the open market in connection with our obligations under the plan. In particular, if our shares are trading at a significant enough discount to net asset value and we are otherwise permitted under applicable law to purchase such shares, we intend to purchase shares in the open market in connection with our obligations under our dividend reinvestment plan.

Foreign Currency Translation – The accounting records of the Company are maintained in U.S. dollars. Foreign currency amounts are translated into U.S. dollars on the following basis:

 

  (i) Market value of investment securities, other assets and liabilities – at the current rates of exchange.

 

  (ii) Purchase and sales of investment securities, income and expenses – at the rates of exchange prevailing on the respective date of such transactions.

The Company does not isolate that portion of realized and unrealized gains or losses on investments that result from changes in market prices of investments from those that result from fluctuations in foreign exchange rates. Net realized foreign currency gains or losses arise from sales or repayments of foreign denominated investments (recorded in realized gain/loss on investments), maturities or terminations of foreign currency derivatives (recorded in realized gain/loss on derivatives), repayments of foreign denominated liabilities and other transactional gain or loss resulting from fluctuations in foreign exchange rates on amounts received or paid (recorded in realized gain/loss on foreign exchange). Net unrealized foreign exchange gains and losses arise from valuation changes in foreign denominated assets and liabilities, resulting from changes in exchange rates, including unrealized foreign exchange gains and losses on investments (recorded in unrealized gain/loss on investments), foreign currency derivatives (recorded in unrealized gain/loss on derivatives), and all other assets and liabilities (recorded in unrealized gain/loss on foreign exchange).

The Company’s investments in foreign securities may involve certain risks such as foreign exchange restrictions, expropriation, taxation or other political, social or economic risks, all of which could affect the market and/or credit risk of the investment. In addition, changes in the relationship of foreign currencies to the U.S. dollar can significantly affect the value of these investments and therefore the earnings of the Company.

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Derivative Instruments and Hedging Activity – The Company recognizes derivatives as either assets or liabilities at fair value on its Consolidated Statements of Assets and Liabilities with valuation changes recorded as realized or unrealized gains and losses. The Company currently does not have any formally documented hedges that qualify for hedge accounting treatment.

The Company generally uses foreign exchange forward contracts and/or borrowings on its multicurrency revolving credit facility to minimize foreign currency exchange risks. Changes in the values of the Company’s foreign denominated assets are recorded in current earnings as realized and unrealized gains and losses (see above); likewise, realized and unrealized gains and losses from derivatives and foreign denominated debt are also recorded in current earnings. The fair value of foreign exchange forward contracts is determined by recognizing the difference between the contract exchange rate and the current market exchange rate. Fluctuations in market values of assets and liabilities denominated in the same foreign currency offset in earnings, providing a “natural” foreign currency hedge.

The Company generally uses interest rate caps to create a synthetic “ceiling” on its borrowing rates. An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds an agreed cap rate. Interest payments on the Company’s credit facilities are primarily LIBOR based. By purchasing caps on LIBOR, if LIBOR exceeds the cap rate, the Company will pay a higher interest rate on its credit facilities but receive an offsetting payment from the cap counterparty on the notional amount above the cap rate. Caps have an initial cost. The fair value of interest rate caps is determined using option pricing models that use readily available market inputs.

Deferred Offering Costs – The Company records expenses related to shelf registration statement filings and other applicable offering costs as prepaid assets. These expenses are charged to capital upon utilization, in accordance with the ASC 946-20-25.

Receivable for Investments Sold – Receivable for investments sold represents a receivable for investments that have been sold but the proceeds have not been received.

Payable for Investments Purchased – Payable for investments purchased represents a liability for investments that have been purchased but the proceeds have not been paid and any unfunded loan commitments.

Deferred Credit Facility Costs – Deferred credit facility costs are amortized over the life of the related credit facility unless the fair value option was elected in accordance with ASC 825-10.

Use of Estimates in the Preparation of Financial Statements – The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reported period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

Subsequent Events Evaluation – The Company has evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date the financial statements were issued and determined that none are required.

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Note 3. Investments

Investments consisted of the following as of June 30, 2012 and December 31, 2011:

 

     June 30, 2012      December 31, 2011  
     Cost      Fair Value      Cost      Fair Value  

Bank Debt/Senior Secured Loans

   $ 519,005       $ 511,107       $ 426,201       $ 412,396   

Subordinated Debt/Corporate Notes

     509,640         486,501         604,157         546,859   

Preferred Equity

     143,512         145,568         15,107         14,664   

Common Equity/Partnership Interests/Warrants

     90,854         50,426         107,108         71,124   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,263,011       $ 1,193,602       $ 1,152,573       $ 1,045,043   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2012, the Company had two non-accrual assets with a total market value of $21,055. As of December 31, 2011, there was one non-accrual asset with a market value of $5,875.

Note 4. Agreements

Solar Capital has an Investment Advisory and Management Agreement with Solar Capital Partners, LLC (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%. 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 dividends 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 computed net of all realized capital losses and unrealized capital 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). Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to calculate the 2% base management fee. 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 and adjusted for any share issuances or repurchases during the relevant quarter. The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory and Management Agreement, as of the termination date), commencing on February 12, 2007, and will equal 20% of

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

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 capital gains upon which prior performance-based capital gains incentive fee payments were previously made to the adviser. For financial statement presentation purposes, a fee is accrued to include unrealized capital appreciation. No accrual was required for the capital gains based incentive fee for the six months ended June 30, 2012 or for the year ended December 31, 2011.

Solar Capital has also entered into an Administration Agreement with Solar Capital Management, LLC (the “Administrator”) under which the Administrator provides administrative services for Solar Capital. For providing these services, facilities and personnel, Solar Capital reimburses the Administrator for Solar Capital’s allocable 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.

Note 5. Derivatives

The Company is exposed to interest rate risk both as a lender and a borrower. The Company’s borrowing facilities and term loan bear interest at a floating rate, which means that rising interest rates would increase our cost of borrowing. To partially mitigate this risk, in 2011, the Company purchased two interest rate cap contracts, which effectively limit the interest rate payable on $150 million of LIBOR based borrowings. The following table highlights the outstanding interest rate caps:

 

Index Rate

  Cap Rate     Notional
Amount
    Expiration     Cost     June 30, 2012     December 31, 2011     Counterparty  
          Fair Value     Unrealized
Depreciation
    Fair Value     Unrealized
Depreciation
   

3 Month Libor

    1.0   $ 100,000        1/13/2014      $ 1,950      $ 52      $ (1,898   $ 279      $ (1,671     Wells Fargo   

3 Month Libor

    1.0     50,000        5/4/2014        988        42        (946     190        (798     Wells Fargo   
   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   
    $ 150,000        $ 2,938      $ 94      $ (2,844   $ 469      $ (2,469  
   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

The Company is also exposed to foreign exchange risk through its investments denominated in foreign currencies. The Company attempts to mitigates this risk through the use of foreign currency forward contracts. As an investment company, all changes in the fair value of assets, including changes caused by foreign currency fluctuation, flow through current earnings. The forward contracts may serve as an economic hedge with their realized and unrealized gains and losses also recorded in current earnings. During the quarter ended June 30, 2012, we entered into foreign currency forward contracts with durations of 1 month with average U.S. dollar notional amounts of $19,305. During the year ended December 31, 2011, we entered into foreign currency forward contracts with durations of 1 month with average U.S. dollar notional amounts of $30,697.

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

As of June 30, 2012, there were three open forward foreign currency contracts denominated in Euro, British Pounds and Canadian Dollar, all of which terminated on July 13, 2012. As of December 31, 2011, there were two open forward foreign currency contracts denominated in Euro and British Pounds, both of which terminated on January 10, 2012. At June 30, 2012 and December 31, 2011, there was no fixed collateral held by counterparties for the open contracts and no credit-related contingent features associated with any of the open forward contracts. The contract details are as follows:

 

    June 30, 2012     December 31, 2011  

SOLD

  Foreign
Currency
    USD Value     Unrealized
appreciation
(depreciation)
    Counterparty     Foreign
Currency
    USD Value     Unrealized
appreciation
(depreciation)
    Counterparty  

EUR

    17,250      $ 21,830      $ (191     SunTrust Bank        966      $ 1,295      $ 44        SunTrust Bank   

GBP

    21,700        33,985        (347     SunTrust Bank        12,989        20,308        136        SunTrust Bank   

CAD

    18,900        18,564        (183     SunTrust Bank        —          —          —          —     
   

 

 

   

 

 

       

 

 

   

 

 

   

Total Sold

    $ 74,379      $ (721       $ 21,602      $ 180     
   

 

 

   

 

 

       

 

 

   

 

 

   

The Company had no derivatives designated as hedging instruments at June 30, 2012 and December 31, 2011.

The following tables show the fair value and effect of the derivative instruments on the Consolidated Statements of Assets and Liabilities and the Consolidated Statements of Operations:

Fair Value of Derivative Instruments

 

     Derivative Assets  
     June 30, 2012      December 31, 2011  
     Balance Sheet Location      Fair Value      Balance Sheet Location      Fair Value  

Derivatives not designated as hedging instruments(a)

           

Foreign exchange contracts

     Derivative assets       $ —           Derivative assets       $ 180   

Interest rate caps

     Derivative assets         94         Derivative assets         469   
     

 

 

       

 

 

 

Total derivatives not designated as hedging instruments(a)

      $ 94          $ 649   
     

 

 

       

 

 

 

Total derivative assets

      $ 94          $ 649   
     

 

 

       

 

 

 
     Derivative Liabilities  
     June 30, 2012      December 31, 2011  
     Balance Sheet Location      Fair Value      Balance Sheet Location      Fair Value  

Derivatives not designated as hedging instruments(a)

           

Foreign exchange contracts

     Derivative liabilities       $ 721         Derivative liabilities       $ —     
     

 

 

       

 

 

 

Total derivatives not designated as hedging instruments(a)

      $ 721          $ —     
     

 

 

       

 

 

 

Total derivative liabilities

      $ 721          $ —     
     

 

 

       

 

 

 

 

(a) See Note 2 for additional information on the Company’s purpose for entering into derivatives not designated as hedging instruments and its overall risk management strategy.

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Effect of Derivative Instruments on the Consolidated Statements of Operations

 

Derivatives not designated
as hedging instruments(a)

 

Location of Gain or

(Loss)

Recognized in Income

on

Derivatives

                   Amount of Gain or (Loss) Recognized in Income on Derivatives                  
        Three months ended
June 30, 2012
    Three months ended
June 30, 2011
    Six months ended
June 30, 2012
    Six months ended
June 30, 2011
 

Foreign exchange contracts

  Realized gain (loss): Derivatives   $ 1,730      $ (4,872   $ 786      $ (9,235

Foreign exchange contracts

  Unrealized gain (loss): Derivatives     (277     1,876        (901     1,587   

Interest rate caps

  Unrealized gain (loss): Derivatives     118        (1,403     (375     (1,373
   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 1,571      $ (4,399   $ (490   $ (9,021
   

 

 

   

 

 

   

 

 

   

 

 

 

Note 6. Borrowing Facilities and Senior Secured Notes

Senior Secured Credit Facility – On June 29, 2012, Solar Capital Ltd. entered into a $485 million Senior Secured Revolving Credit Facility (the “$485 Million Facility”) comprised of $450 million of revolving credit and a $35 million term loan. Borrowings bear interest at a rate per annum equal to the base rate plus 2.50% or the alternate base rate plus 1.50% and has no LIBOR floor requirement. For the $485 Million Facility, Citibank N.A. acted as Administrative Agent, JPMorgan Chase Bank, N.A. acted as Syndication Agent, and SunTrust Bank acted as Documentation Agent. The $485 Million Facility matures in July 2016 and includes a ratable amortization in the fourth year.

The $485 Million Facility may be increased up to $800 million with additional new lenders or the increase in commitments of current lenders. The $485 Million Facility contains certain customary affirmative and negative covenants and events of default. In addition, the $485 Million 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.

In conjunction with the establishment of the $485 Million Facility, the predecessor facility and term loan was retired, resulting in $2,295 of non-recurring charges to expense unamortized costs. The Company will also pay the issuer of the term loan quarterly in arrears a commitment fee at the rate of 0.25% per annum on the average daily outstanding balance.

Senior Secured Notes – On May 10, 2012, the Company closed a private offering of $75,000 of Senior Secured Notes (“Private Notes”) with a fixed interest rate of 5.875% and a maturity date of May 10, 2017. Interest on the Private Notes is due semi-annually on May 10th and November 10th. The Private Notes were issued in a private placement only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended.

Senior Secured Loan Facility – On December 17, 2010, Solar Capital Ltd. entered into a $100 million senior secured credit facility (the “$100 Million Facility”) with Wells Fargo Securities LLC, as administrative agent. Solar Capital entered into (i) a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with SC Funding, pursuant to which Solar Capital will sell to SC Funding certain loans that it has originated or acquired, or will originate or acquire (the “Loans”) from time to time; (ii) a Loan and Servicing Agreement (the “Loan and

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Servicing Agreement” and, together with the Purchase and Sale Agreement, the “Agreements”) with SC Funding as borrower; and (iii) various supporting documentation. The $100 Million Facility is secured by all of the assets held by SC Funding. The $100 Million Facility, among other things, matures on December 17, 2015 and bears interest based on LIBOR plus 2.75%. Under the Agreements, Solar Capital and SC Funding, as applicable, are required to comply with various covenants, reporting requirements and other customary requirements for similar credit facilities. The Purchase and Sale Agreement includes usual and customary events of default for credit facilities of this nature.

The Company has made an irrevocable election to apply the fair value option of accounting to the $485 Million Facility and the Private Notes in accordance with ASC 825-10. Accounting for the $485 Million Facility and the Private Notes at fair value will better align the measurement methodologies of assets and liabilities, which may mitigate certain earnings volatility. As a result of this election, $3,681 and $1,128 of costs related to the establishment of the $485 Million Credit Facility and the Private Notes, respectively, were expensed during the three months ended June 30, 2012, rather than being deferred and amortized over the life of the obligation. ASC 825-10 requires entities to record the fair value of the selected assets and liabilities on the face of the Consolidated Statements of Assets and Liabilities and changes in fair value of the $485 Million Facility and the Private Notes are reported in the Consolidated Statements of Operations. For the three months ended June 30, 2012, the $485 Million Facility and the Private Notes had no net change in unrealized (appreciation) depreciation.

The weighted average annualized interest cost for all borrowings for the six months ended June 30, 2012 and 2011 was 4.40% and 3.53%, respectively. These costs are exclusive of commitment fees and for other prepaid expenses, if any, related to establishing the $485 Million Facility, the Private Notes, and the $100 Million Credit Facility (collectively the “Credit Facilities.”) This weighted average annualized interest cost reflects the average interest cost for all outstanding borrowings. For the six months ended June 30, 2012 and 2011, average debt outstanding was $170,251 and $117,092, respectively. The maximum amounts borrowed on the Credit Facilities during the six months ended June 30, 2012 and 2011 was $236,879 and $435,356, respectively. There was $229,860 drawn on the Credit Facilities as of June 30, 2012 and $236,355 as of December 31, 2011. At June 30, 2012 and December 31, 2011, the Company was in compliance with all financial and operational covenants required by the Credit Facilities.

Note 7. 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 (examples include active exchange-traded equity securities, exchange-traded derivatives, and most U.S. Government and agency securities).

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

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:

 

  a) Quoted prices for similar assets or liabilities in active markets;

 

  b) Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);

 

  c) Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including foreign exchange forward contracts); and

 

  d) Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability.

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 own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include certain of our private debt and equity investments) and long-dated or complex derivatives (including certain equity and currency derivatives).

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). Therefore gains and losses for such 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). Further, it should be noted that the following tables do not take into consideration the effect of offsetting Levels 1 and 2 financial instruments entered into by the Company that economically hedge certain exposures to the Level 3 positions.

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. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur.

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis, as of June 30, 2012 and December 31, 2011:

Fair Value Measurements

As of June 30, 2012

 

     Level 1      Level 2      Level 3      Total  

Assets:

           

Bank Debt/Senior Secured Loans

     —           48,189         462,919         511,107   

Subordinated Debt / Corporate Notes

     —           25,848         460,652         486,501   

Preferred Equity

     —           —           145,568         145,568   

Common Equity / Partnership Interests / Warrants

     8,240         —           42,186         50,426   

Derivative assets – interest rate caps and foreign exchange contracts

     —           94         —           94   

Liabilities:

           

Derivative liabilities

     —           721         —           721   

Credit Facilities

     —           —           131,860         131,860   

 

23


Table of Contents

SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Fair Value Measurements

As of December 31, 2011

 

     Level 1      Level 2      Level 3      Total  

Assets:

           

Bank Debt/Senior Secured Loans

   $ —         $ 46,377       $ 366,019       $ 412,396   

Subordinated Debt / Corporate Notes

     —           10,508         536,351         546,859   

Preferred Equity

     —           —           14,664         14,664   

Common Equity / Partnership Interests / Warrants

     11,460         —           59,664         71,124   

Derivative assets – interest rate cap

     —           469         —           469   

Derivative assets – forward contracts

     —           180         —           180   

The following table provides a summary of the changes in fair value of Level 3 assets and liabilities for the six months ended June 30, 2012 and the year ended December 31, 2011, 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 June 30, 2012 and December 31, 2011:

Fair Value Measurements Using Level 3 Inputs

As of June 30, 2012

 

     Bank Debt/
Senior Secured
Loans
    Subordinated Debt/
Corporate Notes
    Preferred Equity      Common Equity/
Partnership
Interests/
Warrants
 

Fair value, December 31, 2011

   $ 366,019      $ 536,351      $ 14,664       $ 59,664   

Total gains or losses included in earnings:

         

Net realized gain (loss)

     —          (21,047     —           11,002   

Net change in unrealized gain (loss)

     4,151        30,867        2,498         (10,358

Purchase of investment securities

     149,897        86,216        128,406         2,880   

Proceeds from dispositions of investment securities

     (57,148     (171,735     —           (21,002

Transfers in/out of Level 3

     —          —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

 

Fair value, June 30, 2012

   $ 462,919      $ 460,652      $ 145,568       $ 42,186   
  

 

 

   

 

 

   

 

 

    

 

 

 

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):

   $ 4,895      $ 30,975      $ 2,498       $ (10,358

During the six months ended June 30, 2012, there were no transfers in and out of Levels 1 and 2.

 

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SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Fair Value Measurements Using Level 3 Inputs

As of December 31, 2011

 

     Bank Debt/
Senior Secured
Loans
    Subordinated Debt/
Corporate Notes
    Preferred Equity     Common Equity/
Partnership
Interests/
Warrants
 

Fair value, December 31, 2010

   $ 200,532      $ 566,308      $ 3,934      $ 53,092   

Total gains or losses included in earnings:

        

Net realized gain (loss)

     (87     6,218        —          (4,500

Net change in unrealized gain (loss)

     (13,392     (6,991     (448     6,931   

Purchase of investment securities

     247,421        115,852        11,178        7,942   

Proceeds from dispositions of investment securities

     (68,455     (103,971     —          (3,801

Transfers in/out of Level 3

     —          (41,065     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Fair value, December 31, 2011

   $ 366,019      $ 536,351      $ 14,664      $ 59,664   
  

 

 

   

 

 

   

 

 

   

 

 

 

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):

   $ (15,535   $ (17,844   $ (448   $ 4,988   

During 2011, one investment with a fair value of $41,065 was transferred from Level 3 to Level 2 as a result of an increase in the availability and reliability of third party market quotes for this investment. During 2011, one asset with a fair value of $9,900 was transferred from Level 2 to Level 1 when trading restrictions expired on a publicly traded equity investment.

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 six months ended June 30, 2012:

 

     For the six
months ended
June 30, 2012
 

$485 Million Facility and Private Notes

  

Beginning fair value

   $ —     

Total unrealized appreciation

     —     

Borrowings

     131,860   

Repayments

     —     

Transfers in/out of Level 3

     —     
  

 

 

 

Ending fair value

   $ 131,860   
  

 

 

 

The Company has made an irrevocable election to apply the fair value option of accounting to the $485 Million Facility and the Private Notes, in accordance with ASC 825-10. On June 30, 2012, there were borrowings of $56,860 and $75,000, respectively, on the $485 Million Facility and the Private Notes. For the six months ended June 30, 2012, the $485 Million Facility and the Private Notes had no net change in unrealized (appreciation) depreciation. The Company used an independent third-party valuation firm to measure the fair value of the Private Notes.

 

25


Table of Contents

SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

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 and 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 June 30, 2012 is summarized in the table below:

Quantitative Information about Level 3 Fair Value Measurements

 

    Asset or
Liability
  Fair Value at
June 30, 2012
    Valuation
Techniques/Methodology
  Unobservable Input   Range (Weighted
Average)

Senior Secured / Bank Debt

  Asset   $ 462,919      Yield Analysis/Market
Approach/Broker quoted
  Market Yields /
Bid-Ask Spreads
  10.00% – 17.00%
(12.9%)

Subordinated Debt / Corporate Note

  Asset   $ 460,652      Yield Analysis/Market
Approach/Broker quoted
  Market Yields /
Bid-Ask Spreads
  12.00% – 20.33%
(15.1%)

Preferred Equity

  Asset   $ 145,568      Yield Analysis   Market Yields   1.04% – 15.00%
(13.4%)

Common Equity

  Asset   $ 42,186      Market Approach   Enterprise Value   4.99x – 11.36x

$485 Million Facility

  Liability   $ 56,860      Yield Analysis/Market
Approach
  Market Yields   L+0.5% – L+5.5%
(L+2.7%)

Private Notes

  Liability   $ 75,000      Yield Analysis/Market
Approach
  Market Yields   4.47% – 7.32%
(6.7%)

Significant increases or decreases in any of the above unobservable inputs in isolation, including unobservable inputs used in deriving bid-ask spreads, if applicable, would result in a significantly lower or higher fair value measurement for such assets and liabilities.

Note 10. Earnings Per Share

The following information sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10, for the three and six months ended June 30, 2012 and 2011, respectively:

 

     Three months ended
June 30, 2012
     Three months ended
June 30, 2011
     Six months ended
June 30, 2012
     Six months ended
June 30, 2011
 

Numerator for basic and diluted increase in net assets per share:

   $ 16,062       $ 12,384       $ 62,220       $ 61,402   

Denominator for basic and diluted weighted average share:

     36,639,037         36,444,775         36,623,538         36,414,137   

Basic and diluted earnings per share:

   $ 0.44       $ 0.34       $ 1.70       $ 1.69   

 

26


Table of Contents

SOLAR CAPITAL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)

June 30, 2012

(in thousands, except shares)

 

Note 11. Taxation

We did not have any uncertain tax positions that met the recognition or measurement criteria of ASC 740-10-25, Income Taxes, nor did we have any unrecognized tax benefits as of the periods presented herein. Although we file federal and state tax returns, our major tax jurisdiction is federal. Our inception-to-date federal tax years remain subject to examination by the Internal Revenue Service.

There were no deferred tax assets or liabilities as of June 30, 2012 or December 31, 2011.

Note 12. Financial Highlights

The following is a schedule of financial highlights for the six months ended June 30, 2012 and for the year ended December 31, 2011:

 

     Six months ended
June 30, 2012
    Year ended
December 31, 2011
 

Per Share Data:(a)

    

Net asset value, beginning of year

   $ 22.02      $ 22.73   

Net investment income

     0.96        2.25   

Net realized and unrealized gain (loss)

     0.73        (0.57
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

     1.69        1.68   

Dividends to shareholders

     (1.20     (2.40
  

 

 

   

 

 

 

Net asset value, end of period

   $ 22.51      $ 22.02   
  

 

 

   

 

 

 

Total return(b)

     6.29     (1.07 )% 
  

 

 

   

 

 

 

Net assets, end of period

   $ 824,923      $ 805,941   
  

 

 

   

 

 

 

Per share market value at end of period

   $ 22.26      $ 22.09   
  

 

 

   

 

 

 

Shares outstanding end of period

     36,640,094        36,608,038   
  

 

 

   

 

 

 

Ratio to average net assets:(c)

    

Expenses without incentive fees

     3.23     4.45

Incentive fees

     1.08     2.49
  

 

 

   

 

 

 

Total expenses

     4.31     6.94
  

 

 

   

 

 

 

Net investment income

     4.32     9.97
  

 

 

   

 

 

 

Portfolio turnover ratio

     30.75     34.54
  

 

 

   

 

 

 

 

(a) Calculated using the average shares outstanding method
(b) Total return is based on the change in market price per share during the period and takes into account dividends reinvested with the dividend reinvestment plan. Not annualized for periods less than one year.
(c) Not annualized for six months ended June 30, 2012

 

27


Table of Contents

SOLAR CAPITAL LTD.

SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES (unaudited)

(in thousands, except shares)

Schedule 12-14

 

              Six months  ended
June 30, 2012
       

Portfolio Company

  Investment   As of
June 30,  2012
Number of
Shares/Principal
Amount
    Amount of
dividends  and
interest included
in income
    Amount of
equity in
net profit
and loss
    As of
June 30, 2012
Fair Value
 

Investments Owned Greater than 25%

         

AviatorCap SII, LLC I

  Senior Secured Debt     3,400      $ 226      $ —        $ 3,400   

AviatorCap SII, LLC II

  Senior Secured Debt     5,070        316        —          5,070   

AviatorCap SII, LLC III

  Senior Secured Debt     6,320        552        —          6,320   

USAW 767

  Senior Secured Debt     3,986        349        —          3,986   

SODO Corp.

  Preferred Equity/Common     2,084        85        —          2,251   

SOCAY Corp.

  Preferred Equity/Common     13,526        566        —          14,611   

SOINT, LLC

  Senior Secured Debt     16,667        —          —          16,333   

SOINT, LLC

  Preferred Equity/Common     87        —          —          8,667   

National Specialty Alloys, LLC

  Equity     —          350        —          —     
     

 

 

   

 

 

   

 

 

 

Total Investments Owned Greater than 25%

      $ 2,444      $ —        $ 60,638   
     

 

 

   

 

 

   

 

 

 

Investments Owned Greater than 5% and Less than 25%

         

Ark Real Estate Partners LP

  Equity     44,697,684      $ —        $ —        $ 34,864   

AREP Fifty-Seventh LLC

  Senior Debt     19,768        128        —          19,373   

ARK Real Estate Partners II LP

  Senior Debt     8,027        —          —          7,866   

DS Waters of America, Inc.

  Senior Debt     30,292        1,515        —          30,292   

Senior Preferred 15% Units of DSW Group Holdings LLC

  Preferred Equity     13,952        4,009        —          119,990   

Participating Preferred Units of DSW Group Holdings LLC

  Common Equity     12,961        —          —          —     
     

 

 

   

 

 

   

 

 

 

Total Investments Owned Greater than 5% and Less than 25%

      $ 5,652      $ —        $ 212,384   
     

 

 

   

 

 

   

 

 

 

The table below represents the balance at the beginning of the year, December 31, 2011 and any gross additions and reductions and net unrealized gain (loss) made to such investments as well as the ending fair value as of June 30, 2012.

Gross additions represent increases in the investment from additional investments, payments in kind of interest or dividends.

 

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Table of Contents

SOLAR CAPITAL LTD.

SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES (unaudited) (continued)

(in thousands, except shares)

 

Gross reductions represent decreases in the investment from sales of investments or repayments.

 

     Beginning
Fair Value
December 31,
2011
     Gross
additions
     Gross
reductions
     Change in
Unrealized
Gain
(Loss)
    Fair Value
as of
June 30,
2012
 

AviatorCap SII, LLC I

   $ 3,671       $ 12       $ 326       $ 43      $ 3,400   

AviatorCap SII, LLC II

     5,611         19         628         68        5,070   

AviatorCap SII, LLC III

     8,724         54         2,536         78        6,320   

USAW 767

     4,831         30         918         43        3,986   

SODO Corp.

     1,949         75         —           227        2,251   

SOCAY Corp.

     12,668         465         —           1,478        14,611   

SOINT, LLC

     —           16,333         —           —          16,333   

SOINT, LLC

     —           8,667         —           —          8,667   

Ark Real Estate Partners LP

     35,820         2,879         —           (3,835     34,864   

AREP Fifty-Seventh LLC

     —           19,373         —           —          19,373   

ARK Real Estate Partners II LP

     —           7,866         —           —          7,866   

DS Waters of America, Inc.

     —           36,033         6,755         1,014        30,292   

Senior Preferred 15% Units of DSW Group Holdings LLC

     —           119,196         —           794        119,990   

Schedule 12-14

 

              Year ended December 31, 2011        

Portfolio Company

  Investment   As of
December 31, 2011
Number of

Shares/Principal
Amount
    Amount of
dividends and
interest included
in income
    Amount of
equity in
net profit
and loss
    As of
December 31,
2011

Fair Value
 

Investments Owned Greater than 25%

         

AviatorCap SII, LLC I

  Senior Debt     3,678      $ 288      $ —        $ 3,671   

AviatorCap SII, LLC II

  Senior Debt     5,618        243        —          5,611   

AviatorCap SII, LLC III

  Senior Debt     8,696        628        —          8,724   

USAW 767

  Senior Debt     4,850        920        —          4,831   

SODO Corp.

  Preferred Equity/Common     2,009        96        —          1,949   

SOCAY Corp.

  Preferred Equity/Common     13,059        686        —          12,668   

National Specialty Alloys, LLC

  Equity     10,000        4,102        —          16,000   
     

 

 

   

 

 

   

 

 

 

Total Investments Owned Greater than 25%

      $ 6,963      $ —        $ 53,454   
     

 

 

   

 

 

   

 

 

 

Investments Owned Greater than 5% and Less than 25%

         

Ark Real Estate Partners LP

  Equity     41,818,834        —          —          35,820   
     

 

 

   

 

 

   

 

 

 

Total Investments Owned Greater than 5% and Less than 25%

      $ —        $ —        $ 35,820   
     

 

 

   

 

 

   

 

 

 

 

29


Table of Contents

SOLAR CAPITAL LTD.

SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES (unaudited) (continued)

(in thousands, except shares)

 

The table below represents the balance at the beginning of the year, December 31, 2010 and any gross additions and reductions and net unrealized gain (loss) made to such investments as well as the ending fair value as of December 31, 2011.

Gross additions represent increases in the investment from additional investments, amortization and payments in kind of interest or dividends.

Gross reductions represent decreases in the investment from sales of investments or repayments.

 

     Beginning
Fair Value
December 31,
2010
     Gross
additions
     Gross
reductions
     Change in
Unrealized
Gain
(Loss)
    Fair Value
as of
December 31,
2011
 

AviatorCap SII, LLC I

   $ —         $ 4,047       $ 369         (7   $ 3,671   

AviatorCap SII, LLC II

     —           6,094         476         (7     5,611   

AviatorCap SII, LLC III

     —           10,062         1,366         28        8,724   

USAW 767

     6,618         76         1,848         (15     4,831   

SODO Corp.

     390         1,619         —           (60     1,949   

SOCAY Corp.

     3,500         9,559         —           (391     12,668   

National Specialty Alloys, LLC

     10,000         —           —           6,000        16,000   

Ark Real Estate Partners LP

     29,235         7,066         53         (428     35,820   

 

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Table of Contents

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Solar Capital Ltd.:

We have reviewed the accompanying consolidated statement of assets and liabilities, including the consolidated schedule of investments, of Solar Capital Ltd. (the Company) as of June 30, 2012, and the consolidated statements of operations for the three and six-month periods ended June 30, 2012 and 2011, the consolidated statement of changes in net assets for the six-month period ended June 30, 2012 and consolidated statements of cash flows for the six-month periods ended June 30, 2012 and 2011. These consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews 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 accounting and reporting 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 reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements in order 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 accompanying consolidated statement of assets and liabilities, including the consolidated schedule of investments, of Solar Capital Ltd. as of December 31, 2011, and the related consolidated statement of changes in net assets for the year ended December 31, 2011 and we expressed an unqualified opinion on them in our report dated February 22, 2012.

/s/ KPMG LLP

New York, New York

July 31, 2012

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the notes thereto contained elsewhere in this report.

Overview

Solar Capital Ltd. (“Solar”, 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”). In addition, for tax purposes we have elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). In February 2010, we completed our initial public offering and a concurrent private offering of shares to management.

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 model is focused primarily on the direct origination of investments through portfolio companies or their financial sponsors. Our investments generally range between $20 million and $100 million each, although we expect that this investment size will vary proportionately with the size of our capital base. We are managed by Solar Capital Partners, LLC. Solar Capital Management, LLC 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 June 30, 2012, our investments totaled $1.19 billion and our net asset value was $824.9 million. Our portfolio was comprised of debt and equity investments in 41 portfolio companies and our income producing assets, which represented 94.0% of our total portfolio, had a weighted average annualized yield on a fair value basis of approximately 13.9%.

Recent Developments

Dividend

On July 31, 2012, our board of directors declared a quarterly dividend of $0.60 per share payable on October 2, 2012 to holders of record as of September 20, 2012. We expect the dividend to be paid from taxable earnings with specific tax characteristics reported to stockholders after the end of the calendar year.

Critical Accounting Policies

The preparation of 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 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.

 

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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:

Securities for which market quotations are readily available on an exchange are valued at the closing price on the day of valuation. We may also obtain quotes with respect to certain of our investments from pricing services or brokers or dealers in order to value assets. When doing so, we determine whether the quote obtained is sufficient according to GAAP to determine the fair value of the security. If determined reliable, we use the quote obtained.

Securities for which reliable market quotations are not readily available or for which the pricing source does not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of our investment adviser or board of directors, does not represent fair value, shall be valued as follows: (i) each portfolio company or investment is initially valued by the investment professionals responsible for the portfolio investment; (ii) preliminary valuation conclusions are documented and discussed with our senior management; (iii) independent third-party valuation firms engaged by, or on behalf of, the board of directors will conduct independent appraisals and review management’s preliminary valuations and make their own assessment for all material assets; (iv) the board of directors will discuss valuations and determine the fair value of each investment in our portfolio in good faith based on the input of the investment adviser and, where appropriate, the respective third-party valuation firms.

The recommendation of fair value will generally be based on the following factors, as relevant:

 

   

the nature and realizable value of any collateral including credit risk;

 

   

the portfolio company’s ability to make payments;

 

   

the portfolio company’s earnings and discounted cash flow;

 

   

the markets in which the issuer does business and; and

 

   

comparisons to publicly traded securities.

Securities for which market quotations are not readily available or for which a pricing source is not sufficient may include, but are not limited to, the following:

 

   

private placements and restricted securities that do not have an active trading market;

 

   

securities whose trading has been suspended or for which market quotes are no longer available;

 

   

debt securities that have recently gone into default and for which there is no current market;

 

   

securities whose prices are stale;

 

   

securities affected by significant events; and

 

   

securities that the investment adviser believes were priced incorrectly.

Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our financial statements express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

GAAP fair value measurement guidance classifies the inputs used to measure these fair values into the following hierarchy:

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 (examples include active exchange-traded equity securities, exchange-traded derivatives, and most U.S. Government and agency securities).

 

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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:

a) Quoted prices for similar assets or liabilities in active markets;

b) Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);

c) Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including foreign exchange forward contracts); and

d) Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability.

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 own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include certain of our private debt and equity investments) and long-dated or complex derivatives (including certain equity and currency derivatives).

Fair Value Measurements

As of June 30, 2012

 

     Level 1      Level 2      Level 3      Total  

Assets:

           

Bank Debt/Senior Secured Loans

     —           48,188         462,919         511,107   

Subordinated Debt / Corporate Notes

     —           25,849         460,652         486,501   

Preferred Equity

     —           —           145,568         145,568   

Common Equity / Partnership Interests / Warrants

     8,240         —           42,186         50,426   

Derivative assets – interest rate caps and foreign exchange contracts

     —           94         —           94   

Liabilities:

           

Derivative liabilities

     —           721         —           721   

Credit Facilities

     —           —           131,860         131,860   

At June 30, 2012, the fair value of investments classified as Level 3 was approximately $1,111 million or 91.1% of total assets. There were no investments transferred in or out of Level 3 during the 2nd quarter of 2012.

Revenue Recognition

Our revenue recognition policies are as follows:

Sales: Gains or losses on the sale of investments are calculated by using the specific identification method.

Interest Income: Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as part of interest income. We have loans in our portfolio that contain a PIK provision. PIK interest is accrued at the contractual rates and added to the loan principal on the reset dates.

Non-accrual: Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is

 

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generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment about ultimate collectability of principal. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current.

Payment-in-Kind Interest

We have investments in our portfolio which contain a PIK interest provision. Over time, PIK interest increases the principal balance of the investment, but is recorded as interest income. For us to maintain our status as a RIC, substantially all of this income must be paid out to stockholders in the form of dividends, even though we have not currently collected cash with respect to the PIK interest.

New Accounting Pronouncements and Accounting Standards Updates

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 was issued concurrently with International Financial Reporting Standards No. 13 (“IFRS 13”), Fair Value Measurements, to provide largely identical guidance about fair value measurement and disclosure requirements as is currently required under ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). The new standards do not extend the use of fair value but, rather, provide guidance about how fair value should be applied where it already is required or permitted under IFRS or GAAP. For GAAP, most of the changes are clarifications of existing guidance or wording changes to align with IFRS 13. ASU 2011-04 eliminates the concepts of in-use and in-exchange when measuring fair value of all financial instruments. For Level 3 fair value measurements, the ASU requires that our disclosure include quantitative information about significant unobservable inputs, a qualitative discussion about the sensitivity of the fair value measurement to changes in the unobservable inputs and the interrelationship between inputs, and a description of our valuation process. Public companies are required to apply ASU 2011-04 prospectively for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a significant impact on the Company’s financial statements or its disclosures.

Portfolio Investments

The total value of our investments was approximately $1.19 billion and $1.05 billion at June 30, 2012 and December 31, 2011, respectively. During the three months ended June 30, 2012, we invested approximately $164.5 million in five new portfolio companies and $27.8 million in one existing portfolio company. During the six months ended June 30, 2012, we originated approximately $164.5 million of new investments in five new portfolio companies and approximately $89.7 million was invested in five existing portfolio companies.

In certain instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we may receive repayments of certain debt investments prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. Our portfolio activity also reflects sales of securities. For the three months ended June 30, 2012, we had approximately $5.8 million in debt repayments. For the six month ended June 30, 2012, we had approximately $112.2 million in debt repayments and sales of securities of two portfolio companies for approximately $29.4 million.

At June 30, 2012, we had investments in debt and preferred securities of 37 portfolio companies, totaling approximately $1.14 billion, and equity investments in seven portfolio companies, totaling approximately $50.4 million. At December 31, 2011, we had investments in debt and preferred securities of 34 portfolio companies, totaling approximately $973.9 million, and equity investments in seven portfolio companies, totaling approximately $71.1 million.

 

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The following table shows the fair value of our portfolio of investments by asset class as of June 30, 2012 and December 31, 2011 (in thousands):

 

     June 30, 2012      December 31, 2011  
     Cost      Fair Value      Cost      Fair Value  

Bank Debt/Senior Secured Loans

   $ 519,005       $ 511,107       $ 426,201       $ 412,396   

Subordinated Debt/Corporate Notes

     509,640         486,501         604,157         546,859   

Preferred Equity

     143,512         145,568         15,107         14,664   

Common Equity/Partnership Interests/Warrants

     90,854         50,426         107,108         71,124   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,263,011       $ 1,193,602       $ 1,152,573       $ 1,045,043   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2012 and December 31, 2011, the weighted average yield on income producing investments in our portfolio based on fair market value was approximately 13.9% and 14.2%, respectively. The weighted average yield on income producing investments in our portfolio based on cost was approximately 13.8% and 13.2%, respectively. We had two non-accrual assets with a total market value of $21.1 million and one asset with a market value of $5.9 million as of June 30, 2012 and December 31, 2011, respectively.

Results of Operations for the Quarter Ended June 30, 2012 compared to the Quarter Ended June 30, 2011

Revenue

 

     For the Three Months June 30,         
             2012                      2011              % Change  
     (in thousands)         

Investment income

   $ 34,833       $ 35,283         (1 %) 

Investment income for the second quarter of 2012 was comparable to the second quarter of 2011. For the second quarter of 2011 compared same period of 2012, interest income was earned on a larger earning asset balance, offset by a slightly lower weighted average yield.

Expenses

 

     For the Three Months
June 30,
        
     2012      2011      % Change  
     (in thousands)         

Investment advisory and management fees

   $ 5,673       $ 5,096         11

Performance-based incentive fee

     3,591         5,269         (32 %) 

Interest and other credit facility expenses

     9,051         1,895         378

Administrative service fee

     1,128         279         304

Other general and administrative expenses

     995         1,376         (28 %) 
  

 

 

    

 

 

    

Total operating expenses

   $ 20,438       $ 13,915         47
  

 

 

    

 

 

    

Investment advisory and management fees, which are calculated based on average gross assets, were higher during the three months ended June 30, 2012 due to larger average gross assets. The performance-based incentive fee, which is calculated as a percentage of net investment income above certain hurdle rates, was lower for the three months June 30, 2012 to the comparable period in 2011 due to lower net investment income. Interest and other credit facility expenses for the three months ended June 30, 2012 were higher than during the comparable period in 2011 mainly due to costs associated with the establishment of a credit facility and private notes and for expenses to retire a predecessor credit facility and term loan. Administrative service fees are higher for the three months ended June 30, 2012 due to higher operating costs. Other general and administrative expenses for the three months ended June 30, 2012 were lower compared to the same period in 2011 due to tax expenses incurred in 2011, which was presented within this expense item.

 

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Net Realized and Unrealized Gains and Losses

 

     For the Three Months
June 30,
 
     2012     2011  
     (in thousands)  

Net realized gain (loss) loss on investments

   $ (20,322   $ 2,304   

Net realized gain (loss) on forward contracts

     1,730        (4,872

Net realized loss on foreign currency exchange

     (563     (242

Net unrealized gain (loss) on investments

     19,286        (7,430

Net unrealized gain on forward contracts

     159        473   

Net unrealized gain on foreign currency exchange

     1,403        783   
  

 

 

   

 

 

 

Total realized and unrealized gain (loss)

   $ 1,693      $ (8,984
  

 

 

   

 

 

 

The combined net gain during the second quarter of 2012 was primarily due to an increase in the fair value of our portfolio during the period due to improved market trends. During the second quarter of 2011, total realized and unrealized loss of approximately $9.0 million was attributable to worsening conditions in the credit markets and the widening of spreads. We analyze this section on a combined basis because offsets may exist in the individual line items due to foreign exchange fluctuations and movements from unrealized to realized, which may have impacted income in prior periods.

Results of Operations for the Six Months Ended June 30, 2012 compared to the Six Months Ended June 30, 2011

Revenue

 

     For the Six Months Ended June 30,         
             2012                      2011              % Change  
     (in thousands)         

Investment income

   $ 71,142       $ 67,577         5

Investment income was higher during the first six months of 2012 primarily due to higher interest income earned on a larger earning asset balance and higher prepayment premiums and accelerated amortization of upfront fees related to early repayment of assets compared to the same period in 2011.

Expenses

 

     For the Six Months
Ended June 30,
        
     2012      2011      % Change  
     (in thousands)         

Investment advisory and management fees

   $ 10,951       $ 10,083         9

Performance-based incentive fee

     8,866         10,057         (12 %) 

Interest and other credit facility expenses

     11,746         3,932         199

Administrative service fee

     1,824