UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 814-00757
FS Investment Corporation
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code:(215) 495-1150
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☐ No ☐.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
There were 239,154,069 shares of the registrant’s common stock outstanding as of November 7, 2018.
TABLE OF CONTENTS
PART I—FINANCIAL INFORMATION
ITEM 1.
Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017
Unaudited Consolidated Statements of Changes in Net Assets for the nine months ended September 30, 2018 and 2017
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.
ITEM 4.
PART II—OTHER INFORMATION
ITEM 1A.
ITEM 5.
ITEM 6.
Statements.
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
Assets
Investments, at fair value
Non-controlled/unaffiliated investments (amortized cost—$3,352,266 and $3,532,517, respectively)
Non-controlled/affiliated investments (amortized cost—$200,981 and $197,468, respectively)
Controlled/affiliated investments (amortized cost—$108,778 and $86,861, respectively)
Total investments, at fair value (amortized cost—$3,662,025 and $3,816,846, respectively)
Cash
Foreign currency, at fair value (cost—$1,411 and $3,685, respectively)
Receivable for investments sold and repaid
Income receivable
Deferred financing costs
Deferred merger costs
Prepaid expenses and other assets
Total assets
Liabilities
Payable for investments purchased
Credit facilities payable (net of deferred financing costs of $2,341 and $3,179, respectively)(1)
Unsecured notes payable (net of deferred financing costs of $925 and $1,402, respectively)(1)
Stockholder distributions payable
Management fees payable
Subordinated income incentive fees payable(2)
Administrative services expense payable
Interest payable
Directors’ fees payable
Other accrued expenses and liabilities
Total liabilities
Commitments and contingencies(3)
Stockholders’ equity
Preferred stock, $0.001 par value, 50,000,000 shares authorized, none issued and outstanding
Common stock, $0.001 par value, 450,000,000 shares authorized, 239,154,069 and 245,725,416 shares issued and outstanding, respectively
Capital in excess of par value
Accumulated earnings (loss)
Total stockholders’ equity
Total liabilities and stockholders’ equity
Net asset value per share of common stock at period end
See Note 8 for a discussion of the Company’s financing arrangements.
See Note 2 for a discussion of the methodology employed by the Company in calculating the subordinated income incentive fees.
See Note 9 for a discussion of the Company’s commitments and contingencies.
See notes to unaudited consolidated financial statements.
1
Unaudited Consolidated Statements of Operations
Investment income
Interest income
Paid-in-kindinterest income
Fee income
Dividend income
From non-controlled/affiliated investments:
From controlled/affiliated investments:
Total investment income
Operating expenses
Management fees(1)
Subordinated income incentive fees(2)
Administrative services expenses
Accounting and administrative fees
Interest expense(3)
Directors’ fees
Other general and administrative expenses
Total operating expenses
Management fee waiver(1)
Net expenses
Net investment income
Realized and unrealized gain/loss
Net realized gain (loss) on investments:
Non-controlled/unaffiliated investments
Non-controlled/affiliated investments
Controlled/affiliated investments
Net realized gain (loss) on foreign currency
Net change in unrealized appreciation (depreciation) on investments:
Net change in unrealized appreciation (depreciation) on secured borrowing(3)
Net change in unrealized gain (loss) on foreign currency
Total net realized and unrealized gain (loss)
Net increase (decrease) in net assets resulting from operations
Per share information—basic and diluted
Net increase (decrease) in net assets resulting from operations (Earnings per Share)
Weighted average shares outstanding
See Note 4 for a discussion of the waiver by FB Income Advisor, LLC, the Company’s former investment adviser, of certain management fees to which it was otherwise entitled during the applicable period.
See Note 2 for a discussion of the methodology employed by the Company in calculating the subordinated income incentive fee.
2
Unaudited Consolidated Statements of Changes in Net Assets
(in thousands)
Operations
Net investment income (loss)
Net realized gain (loss) on investments and foreign currency
Net change in unrealized appreciation (depreciation) on investments and secured borrowing(1)
Stockholder distributions(2)
Distributions to stockholders
Net decrease in net assets resulting from stockholder distributions
Capital share transactions(3)
Reinvestment of stockholder distributions
Repurchases of common stock
Net increase (decrease) in net assets resulting from capital share transactions
Total increase (decrease) in net assets
Net assets at beginning of period
Net assets at end of period
See Note 5 for a discussion of the sources of distributions paid by the Company.
See Note 3 for a discussion of the Company’s capital share transactions.
3
Unaudited Consolidated Statements of Cash Flows
Cash flows from operating activities
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities:
Purchases of investments
Paid-in-kindinterest
Proceeds from sales and repayments of investments
Net realized (gain) loss on investments and secured borrowing
Net change in unrealized (appreciation) depreciation on investments and secured borrowing(1)
Accretion of discount
Amortization of deferred financing costs and discount
Unrealized (gain)/loss on borrowings in foreign currency
(Increase) decrease in receivable for investments sold and repaid
(Increase) decrease in income receivable
(Increase) decrease in deferred merger costs
(Increase) decrease in prepaid expenses and other assets
Increase (decrease) in payable for investments purchased
Increase (decrease) in management fees payable
Increase (decrease) in subordinated income incentive fees payable
Increase (decrease) in administrative services expense payable
Increase (decrease) in interest payable
Increase (decrease) in directors’ fees payable
Increase (decrease) in other accrued expenses and liabilities
Net cash provided by (used in) operating activities
Cash flows from financing activities
Stockholder distributions
Borrowings under credit facilities(1)
Repayments of credit facilities(1)
Deferred financing costs paid
Net cash provided by (used in) financing activities
Total increase (decrease) in cash
Cash and foreign currency at beginning of period
Cash and foreign currency at end of period
Supplemental disclosure
Local and excise taxes paid
See Note 8 for a discussion of the Company’s financing arrangements. During the nine months ended September 30, 2017, the Company paid $121 in interest expense on its secured borrowing. During the nine months ended September 30, 2018 and 2017, the Company paid $61,793 and $57,590, respectively, in interest expense on the credit facilities and unsecured notes.
4
Unaudited Consolidated Schedule of Investments
As of September 30, 2018
(in thousands, except share amounts)
Portfolio Company(a)
Industry
Senior Secured Loans—First Lien—119.0%
5 Arch Income Fund 2, LLC
A.P. Plasman Inc.
Advanced Lighting Technologies, Inc.
AG Group Merger Sub, Inc.
All Systems Holding LLC
Altus Power America, Inc.
Aspect Software, Inc.
Atlas Aerospace LLC
AVF Parent, LLC
Borden Dairy Co.
ConnectiveRx, LLC
CSafe Acquisition Co., Inc.
Dade Paper & Bag, LLC
Eagle Family Foods Group LLC
Empire Today, LLC
Evergreen AcqCo 1 LP
GC Agile Intermediate Holdings Ltd.
Greystone Equity Member Corp.
H.M. Dunn Co., Inc.
Harrison Gypsum, LLC
Hudson Technologies Co.
Icynene U.S. Acquisition Corp.
Imagine Communications Corp.
Industrial Group Intermediate Holdings, LLC
5
Unaudited Consolidated Schedule of Investments (continued)
Industry City TI Lessor, L.P.
International Aerospace Coatings, Inc.
JAKKS Pacific, Inc.
JMC Acquisition Merger Corp.
JSS Holdings, Inc.
Kodiak BP, LLC
Latham Pool Products, Inc.
LEAS Acquisition Co Ltd.
Logan’s Roadhouse, Inc.
MB Precision Holdings LLC
Micronics Filtration Holdings, Inc.
Murray Energy Corp.
North Haven Cadence Buyer, Inc.
Nova Wildcat Amerock, LLC
PHRC License, LLC
Power Distribution, Inc.
Reliant Acquisitions Holdings, Inc.
Roadrunner Intermediate Acquisition Co., LLC
Rogue Wave Software, Inc.
Safariland, LLC
Sequel Youth and Family Services, LLC
Sequential Brands Group, Inc.
SGS Cayman, L.P.
Sorenson Communications, Inc.
SSC (Lux) Limited S.Ã r.l.
Staples Canada, ULC
SunGard Availability Services Capital, Inc.
6
Sutherland Global Services Inc.
ThermaSys Corp.
Trace3, LLC
VP Parent Holdings, Inc.
VPG Metals Group LLC
Warren Resources, Inc.
Westbridge Technologies, Inc.
Zeta Interactive Holdings Corp.
Total Senior Secured Loans—First Lien
Unfunded Loan Commitments
Net Senior Secured Loans—First Lien
Senior Secured Loans—Second Lien—6.7%
Ammeraal Beltech Holding BV
Arena Energy, LP
Bellatrix Exploration Ltd.
Byrider Finance, LLC
Chisholm Oil and Gas Operating, LLC
Gruden Acquisition, Inc.
LBM Borrower, LLC
One Call Corp.
Spencer Gifts LLC
Ultimate Baked Goods Midco LLC
Total Senior Secured Loans—Second Lien
Net Senior Secured Loans—Second Lien
Senior Secured Bonds—8.9%
Black Swan Energy Ltd.
FourPoint Energy, LLC
JW Aluminum Co.
Mood Media Corp.
7
Sunnova Energy Corp.
Velvet Energy Ltd.
Total Senior Secured Bonds
Subordinated Debt—16.2%
Aurora Diagnostics, LLC
Byrider Holding Corp.
CEC Entertainment, Inc.
DEI Sales, Inc.
Global Jet Capital Inc.
Greystone Mezzanine Equity Member Corp.
P.F. Chang’s China Bistro, Inc.
Quorum Health Corp.
S1 Blocker Buyer Inc.
8
Total Subordinated Debt
Unfunded Debt Commitments
Net Subordinated Debt
Collateralized Securities—2.4%
MP4 2013-2A Class Subord. B
NewStar Clarendon 2014-1A Class D
NewStar Clarendon 2014-1A Class Subord. B
Rampart CLO 2007 1A Class Subord.
Wind River CLO Ltd. 2012 1A Class Subord. B
Total Collateralized Securities
9
Equity/Other—17.9%(k)
5 Arches, LLC, Common Equity
Advanced Lighting Technologies, Inc., Common Equity
Advanced Lighting Technologies, Inc., Warrants
Altus Power America Holdings, LLC, Common Equity
Altus Power America Holdings, LLC, Preferred Equity
APP Holdings, LP, Warrants
Ascent Resources Utica Holdings, LLC, Common Equity
ASG Everglades Holdings, Inc., Common Equity
ASG Everglades Holdings, Inc., Warrants
Aspect Software Parent, Inc., Common Equity
Aurora Diagnostics Holdings, LLC, Warrants
Byrider Holding Corp., Common Equity
Chisholm Oil and Gas, LLC, Series A Units
CSF Group Holdings, Inc., Common Equity
Eastman Kodak Co., Common Equity
Escape Velocity Holdings, Inc., Common Equity
FourPoint Energy, LLC, Common Equity, Class C-II-A Units
FourPoint Energy, LLC, Common Equity, Class D Units
FourPoint Energy, LLC, Common Equity, Class E-IIUnits
FourPoint Energy, LLC, Common Equity, Class E-IIIUnits
Fronton Investor Holdings, LLC, Class B Units
Global Jet Capital Holdings, LP, Preferred Equity
H.I.G. Empire Holdco, Inc., Common Equity
Harvest Oil & Gas Corp., Common Equity
Harvey Holdings, LLC, Common Equity
HM Dunn Aerosystems, Inc., Preferred Equity, Series A
HM Dunn Aerosystems, Inc., Preferred Equity, Series B
Imagine Communications Corp., Common Equity, Class A Units
Industrial Group Intermediate Holdings, LLC, Common Equity
International Aerospace Coatings, Inc., Common Equity
International Aerospace Coatings, Inc., Preferred Equity
JMC Acquisition Holdings, LLC, Common Equity
JSS Holdco, LLC, Net Profits Interest
JW Aluminum Co., Common Equity
JW Aluminum Co., Preferred Equity
MB Precision Investment Holdings LLC, Class A-2Units
Micronics Filtration Holdings, Inc., Common Equity
Micronics Filtration Holdings, Inc., Preferred Equity, Series A
Capital Goods
Micronics Filtration Holdings, Inc., Preferred Equity, Series B
Mood Media Corp., Common Equity
Media
North Haven Cadence TopCo, LLC, Common Equity
Consumer Services
10
PDI Parent LLC, Common Equity
Ridgeback Resources Inc., Common Equity
Energy
Roadhouse Holding Inc., Common Equity
S1 Blocker Buyer Inc., Common Equity
Commercial & Professional Services
Safariland, LLC, Common Equity
Safariland, LLC, Warrants
Sequential Brands Group, Inc., Common Equity
Consumer Durables & Apparel
Sorenson Communications, Inc., Common Equity
Telecommunication Services
SSC Holdco Limited, Common Equity
Health Care Equipment & Services
Sunnova Energy Corp., Common Equity
Sunnova Energy Corp., Preferred Equity
The Brock Group, Inc., Common Equity
ThermaSys Corp., Common Equity
ThermaSys Corp., Preferred Equity
Viper Holdings, LLC, Series I Units
Viper Holdings, LLC, Series II Units
Viper Parallel Holdings LLC, Class A Units
VPG Metals Group LLC, Class A-2 Units
Materials
Warren Resources, Inc., Common Equity
Zeta Interactive Holdings Corp., Preferred Equity,Series E-1
Software & Services
Zeta Interactive Holdings Corp., Preferred Equity, Series F
Zeta Interactive Holdings Corp., Warrants
Total Equity/Other
TOTAL INVESTMENTS—171.1%
LIABILITIES IN EXCESS OF OTHER ASSETS—(71.1%)
NET ASSETS—100%
Security may be an obligation of one or more entities affiliated with the named company.
Certain variable rate securities in the Company’s portfolio bear interest at a rate determined by a publicly disclosed base rate plus a basis point spread. As of September 30, 2018, the three-month London Interbank Offered Rate, or LIBOR or “L”, was 2.40%, the Euro Interbank Offered Rate, or EURIBOR, was (0.32)%, Canadian Dollar Offer Rate, or CDOR, was 2.02% and the U.S. Prime Lending Rate, or Prime, was 5.25%. PIK means paid-in-kind. PIK income accruals may be adjusted based on the fair value of the underlying investment.
Denominated in U.S. dollars unless otherwise noted.
Fair value determined by the Company’s board of directors (see Note 7).
Security or portion thereof held within Locust Street Funding LLC and is pledged as collateral supporting the amounts outstanding under the term loan facility with JPMorgan Chase Bank, N.A. (see Note 8).
Security or portion thereof held within Race Street Funding LLC. Security is available as collateral to support the amounts outstanding under the Senior Secured Revolving Credit Facility (see Note 8).
Security or portion thereof is pledged as collateral supporting the amounts outstanding under the Senior Secured Revolving Credit Facility (see Note 8).
11
Security or portion thereof held within Hamilton Street Funding LLC. Security is available as collateral to support the amounts outstanding under the Senior Secured Revolving Credit Facility (see Note 8).
Position or portion thereof unsettled as of September 30, 2018.
The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. A business development company may not acquire any asset other than qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. As of September 30, 2018, 80.9% of the Company’s total assets represented qualifying assets.
Listed investments may be treated as debt for GAAP or tax purposes.
Security is non-income producing.
Security held within IC American Energy Investments, Inc., a wholly-owned subsidiary of the Company.
Security held within FSIC Investments, Inc., a wholly-owned subsidiary of the Company.
Security held within IC Arches Investments, LLC, a wholly-owned subsidiary of the Company.
Security held within IC Altus Investments, LLC, a wholly-owned subsidiary of the Company.
Security is an unfunded commitment. The stated rate reflects the spread disclosed at the time of commitment and may not indicate the actual rate received upon funding.
Asset is on non-accrual status.
(s) Security is classified as Level 1 or Level 2 in the Company’s fair value hierarchy (see Note 7).
12
Under the Investment Company Act of 1940, as amended, the Company generally is deemed to be an “affiliated person” of a portfolio company if it owns 5% or more of the portfolio company’s voting securities and generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of September 30, 2018, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person for the nine months ended September 30, 2018:
Portfolio Company
Senior Secured Loans—First Lien
H.M. Dunn Co., Inc.(2)
Logan’s Roadhouse, Inc.(3)
Senior Secured Loans—Second Lien
Senior Secured Bonds
Equity/Other
Total
Interest, PIK and fee income presented for the full nine months ended September 30, 2018.
The Company held this investment as of December 31, 2017 but it was not deemed to be an “affiliated person” of the portfolio company or deemed to “control” the portfolio company as of December 31, 2017. Transfers in or out have been presented at amortized cost.
13
Security includes a partially unfunded commitment with an amortized cost of $1,218 and a fair value of $1,218.
Under the Investment Company Act of 1940, as amended, the Company generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of September 30, 2018, the Company held investments in one portfolio company of which it is deemed to be an “affiliated person” and deemed to “control”. During the nine months ended September 30, 2018, the Company disposed of investments in one portfolio company of which it was deemed to be an “affiliated person” and deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person and deemed to control for the nine months ended September 30, 2018:
Interest and PIK income presented for the full nine months ended September 30, 2018.
14
Consolidated Schedule of Investments
As of December 31, 2017
Footnotes
Senior Secured Loans—First Lien—110.3%
Actian Corp.
ConnectiveRX, LLC
Crestwood Holdings LLC
Eastman Kodak Co.
15
Consolidated Schedule of Investments (continued)
Micronics Filtration, LLC
MORSCO, Inc.
Nobel Learning Communities, Inc.
Polymer Additives, Inc.
SSC (Lux) Limited S.à r.l.
16
U.S. Xpress Enterprises, Inc.
USI Senior Holdings, Inc.
Waste Pro USA, Inc.
Senior Secured Loans—Second Lien—8.6%
American Bath Group, LLC
Compuware Corp.
LTI Holdings, Inc.
Stadium Management Corp.
Senior Secured Bonds—7.1%
Global A&T Electronics Ltd.
Ridgeback Resources Inc.
17
Subordinated Debt—21.4%
Ascent Resources Utica Holdings, LLC
Brooklyn Basketball Holdings, LLC
Ceridian HCM Holding, Inc.
EV Energy Partners, L.P.
18
Jupiter Resources Inc.
PriSo Acquisition Corp.
19
Equity/Other—22.0%(k)
Advanced Lighting Technologies, Inc., Warrants, 10/4/2027
AP Exhaust Holdings, LLC, Class A1 Common Units
AP Exhaust Holdings, LLC, Class A1 Preferred Units
APP Holdings, LP, Warrants, 5/25/2026
ASG Everglades Holdings, Inc., Warrants, 6/27/2022
Aurora Diagnostics Holdings, LLC, Warrants, 5/25/2027
Burleigh Point, Ltd., Warrants, 7/16/2020
20
PSAV Holdings LLC, Common Equity
Safariland, LLC, Warrants, 7/27/2018
Safariland, LLC, Warrants, 9/20/2019
SandRidge Energy, Inc., Common Equity
Sequel Industrial Products Holdings, LLC, Common Equity
Sequel Industrial Products Holdings, LLC, Preferred Equity
Sequel Industrial Products Holdings, LLC, Warrants, 9/28/2022
Sequel Industrial Products Holdings, LLC, Warrants, 5/10/2022
The Stars Group Inc., Warrants, 5/15/2024
Zeta Interactive Holdings Corp., Preferred Equity, SeriesE-1
Zeta Interactive Holdings Corp., Warrants, 4/20/2027
TOTAL INVESTMENTS—171.8%
LIABILITIES IN EXCESS OF OTHER ASSETS—(71.8%)
Certain variable rate securities in the Company’s portfolio bear interest at a rate determined by a publicly disclosed base rate plus a basis point spread. As of December 31, 2017, the three-month London Interbank Offered Rate, or LIBOR or “L”, was 1.69%, the Euro Interbank Offered Rate, or EURIBOR, was (0.33)% and the U.S. Prime Lending Rate, or Prime, was 4.50%. PIK means paid-in-kind.
21
Security or portion thereof held within Race Street Funding LLC and is pledged as collateral supporting the amounts outstanding under the revolving credit facility with ING Capital LLC (see Note 8).
Security or portion thereof is pledged as collateral supporting the amounts outstanding under the revolving credit facility with ING Capital LLC (see Note 8).
Security or portion thereof held within Hamilton Street Funding LLC and is pledged as collateral supporting the amounts outstanding under the revolving credit facility with HSBC Bank USA, N.A. (see Note 8).
Position or portion thereof unsettled as of December 31, 2017.
The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. A business development company may not acquire any asset other than qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. As of December 31, 2017, 82.0% of the Company’s total assets represented qualifying assets.
Security held within IC Arches Investments LLC, a wholly-owned subsidiary of the Company.
Security is an unfunded commitment. Reflects the stated spread at the time of commitment, but may not be the actual rate received upon funding.
(s) Security is classified as Level 1 in the Company’s fair value hierarchy (see Note 7).
22
Under the Investment Company Act of 1940, as amended, the Company generally is deemed to be an “affiliated person” of a portfolio company if it owns 5% or more of the portfolio company’s voting securities and generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2017, the Company held investments in portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person for the year ended December 31, 2017:
ASG Technologies Group, Inc.
Aspect Software, Inc.(1)(2)
Aspect Software, Inc.(2)
Aspect Software, Inc.(3)
Logan’s Roadhouse, Inc.(4)
Subordinated Debt
Mood Media Corp.(2)
Advanced Lighting Technologies, Inc., Preferred Equity
Security includes a partially unfunded commitment with an amortized cost of $25 and a fair value of $25.
The Company held this investment as of December 31, 2016 but it was not deemed to be an “affiliated person” of the portfolio company or deemed to “control” the portfolio company as of December 31, 2016. Transfers in or out have been presented at amortized cost.
23
Security is an unfunded commitment with an amortized cost of $361 and a fair value of $0.
Security includes a partially unfunded commitment with an amortized cost of $1,131 and a fair value of $1,120.
Interest, PIK, fee and dividend income presented for the full year ended December 31, 2017.
Under the Investment Company Act of 1940, as amended, the Company generally is deemed to “control” a portfolio company if it owns more than 25% of the portfolio company’s voting securities or it has the power to exercise control over the management or policies of such portfolio company. As of December 31, 2017, the Company held investments in one portfolio company of which it is deemed to be an “affiliated person” and deemed to “control”. During the year ended December 31, 2017, the Company disposed of investments in one portfolio of which it was deemed to be an “affiliated person” and deemed to “control”. The following table presents certain information with respect to investments in portfolio companies of which the Company was deemed to be an affiliated person and deemed to control for the year ended December 31, 2017:
Swiss Watch International, Inc.(1)
SWI Holdco LLC, Common Equity(1)
24
Notes to Unaudited Consolidated Financial Statements
Note 1. Principal Business and Organization
FS Investment Corporation (NYSE: FSIC), or the Company, was incorporated under the general corporation laws of the State of Maryland on December 21, 2007 and formally commenced investment operations on January 2, 2009. The Company is an externally managed, non-diversified, closed-endmanagement investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, the Company has elected to be treated for U.S. federal income tax purposes, and intends to qualify annually, as a regulated investment company, or RIC, as defined under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. As of September 30, 2018, the Company had two wholly-owned financing subsidiaries and five wholly-owned subsidiaries through which it holds interests in portfolio companies. The unaudited consolidated financial statements include both the Company’s accounts and the accounts of its wholly-owned subsidiaries as of September 30, 2018. All significant intercompany transactions have been eliminated in consolidation. Certain of the Company’s consolidated subsidiaries are subject to U.S. federal and state income taxes.
The Company’s investment objectives are to generate current income and, to a lesser extent, long-term capital appreciation by investing primarily in senior secured loans and second lien secured loans of private U.S. companies. The Company seeks to generate superior risk-adjusted returns by focusing on debt investments in a broad array of private U.S. companies, including middle market companies, which the Company defines as companies with annual revenues of $50 million to $2.5 billion at the time of investment. The Company may purchase interests in loans or make other debt investments, including investments in senior secured bonds, through secondary market transactions in the “over-the-counter” market or directly from the Company’s target companies as primary market or directly originated investments. In connection with the Company’s debt investments, the Company may on occasion receive equity interests such as warrants or options as additional consideration. The Company may also purchase or otherwise acquire interests in the form of common or preferred equity or equity-related securities, such as rights and warrants that may be converted into or exchanged for common stock or other equity or the cash value of common stock or other equity, in the Company’s target companies, generally in conjunction with one of the Company’s debt investments, including through the restructuring of such investments, or through aco-investment with a financial sponsor, such as an institutional investor or private equity firm. In addition, a portion of the Company’s portfolio may be comprised of corporate bonds, collateralized loan obligations, or CLOs, other debt securities and derivatives, including total return swaps and credit default swaps. The Company’s investment adviser will seek to tailor the Company’s investment focus as market conditions evolve. Depending on market conditions, the Company may increase or decrease its exposure to less senior portions of the capital structure or otherwise make opportunistic investments.
As the Company previously announced on April 9, 2018, GSO / Blackstone Debt Funds Management LLC, or GDFM, resigned as the investment sub-adviser to the Company and terminated the investment sub-advisory agreement, or the investment sub-advisory agreement, between FB Income Advisor, LLC, or FB Advisor, and GDFM, effective April 9, 2018. In connection with GDFM’s resignation as the investment sub-adviser to the Company, on April 9, 2018, the Company entered into an investment advisory agreement, or the FS/KKR Advisor investment advisory agreement, with FS/KKR Advisor, LLC, or FS/KKR Advisor, a newly-formed investment adviser jointly operated by an affiliate of Franklin Square Holdings, L.P. (which does business as FS Investments) and by KKR Credit Advisors (US), LLC, or KKR Credit, pursuant to which FS/KKR Advisor acts as investment adviser to the Company. The FS/KKR Advisor investment advisory agreement replaced the amended and restated investment advisory agreement, dated July 17, 2014, or the FB Advisor investment advisory agreement, by and between the Company and FB Advisor.
On July 22, 2018, the Company entered into an Agreement and Plan of Merger, or the Merger Agreement, with Corporate Capital Trust, Inc., a Maryland corporation, or CCT, IC Acquisition, Inc., a Maryland corporation and wholly-owned subsidiary of the Company, or the Merger Sub, and FS/KKR Advisor. The Merger Agreement provides that, subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into CCT, with CCT continuing as the surviving company and as a wholly-owned subsidiary of the Company, or the Merger, and, immediately thereafter, CCT will merge with and into the Company, with the Company continuing as the surviving company, or together with the Merger, the Transaction. See Note 11 for additional information.
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Notes to Unaudited Consolidated Financial Statements (continued)
Note 2. Summary of Significant Accounting Policies
Basis of Presentation: The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For a more complete discussion of significant accounting policies and certain other information, the Company’s interim unaudited consolidated financial statements should be read in conjunction with its audited consolidated financial statements as of and for the year ended December 31, 2017 included in the Company’s annual report on Form 10-K for the year ended December 31, 2017. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The December 31, 2017 consolidated balance sheet and consolidated schedule of investments are derived from the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017. The Company is considered an investment company under GAAP and follows the accounting and reporting guidance applicable to investment companies under Accounting Standards Codification Topic 946, Financial Services—Investment Companies. The Company has evaluated the impact of subsequent events through the date the consolidated financial statements were issued and filed with the U.S. Securities and Exchange Commission, or the SEC.
Use of Estimates: The preparation of the unaudited consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Many of the amounts have been rounded, and all amounts are in thousands, except share and per share amounts.
Capital Gains Incentive Fee: Pursuant to the terms of the FS/KKR Advisor investment advisory agreement, the incentive fee on capital gains is determined and payable in arrears as of the end of each calendar year (or upon termination of the FS/KKR Advisor investment advisory agreement). This fee equals 20.0% of the Company’s incentive fee capital gains, which equals the Company’s realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. The Company accrues for the capital gains incentive fee, which, if earned, is paid annually. The Company accrues the incentive fee on capital gains based on net realized and unrealized gains; however, the fee payable to FS/KKR Advisor is based on realized gains and no such fee is payable with respect to unrealized gains unless and until such gains are actually realized. The terms of the incentive fee on capital gains were substantially similar under the FB Advisor investment advisory agreement.
Subordinated Income Incentive Fee: Pursuant to the terms of the FS/KKR Advisor investment advisory agreement, FS/KKR Advisor may also be entitled to receive a subordinated incentive fee on income. The subordinated incentive fee on income under the FS/KKR Advisor investment advisory agreement is calculated and payable quarterly in arrears, and equals 20.0% of the Company’s “pre-incentive fee net investment income” for the immediately preceding quarter subject to a hurdle rate, expressed as a rate of return on the value of the Company’s net assets, equal to 1.75% per quarter (1.875% under the FB Advisor investment advisory agreement), or an annualized hurdle rate of 7.0% (7.5% under the FB Advisor investment advisory agreement). As a result, FS/KKR Advisor will not earn this incentive fee for any quarter until the Company’s pre-incentive fee net investment income for such quarter exceeds the hurdle rate of 1.75% (1.875% under the FB Advisor investment advisory agreement). Once the Company’s pre-incentive fee net investment income in any quarter exceeds the hurdle rate, FS/KKR Advisor will be entitled to a “catch-up” fee equal to the amount of the Company’s pre-incentive fee net investment income in excess of the hurdle rate, until the Company’s pre-incentive fee net investment income for such quarter equals 2.1875%, or 8.75% annually (2.34375%, or 9.375% annually under the FB Advisor investment advisory agreement), of the value of the Company’s net assets. Thereafter, FS/KKR Advisor will be entitled to receive 20.0% of the Company’s pre-incentive fee net investment income.
The subordinated incentive fee on income is subject to a cap equal to (i) 20.0% of the pershare pre-incentive fee return for the then-current and eleven preceding calendar quarters minus the cumulative per share incentive fees accrued and/or payable for the eleven preceding calendar quarters multiplied by (ii) the weighted average number of shares outstanding during the calendar quarter for which the subordinated incentive fee on income is being calculated. For the foregoing purpose, the “per share
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Note 2. Summary of Significant Accounting Policies (continued)
pre-incentive fee return” for any calendar quarter is equal to (i) the sum of theCompany’s pre-incentive fee net investment income for the calendar quarter, realized gains and losses for the calendar quarter and unrealized appreciation and depreciation of the Company’s investments for the calendar quarter and, for any calendar quarter ending prior to January 1, 2018, base management fees for the calendar quarter, divided by (ii) the weighted average number of shares outstanding during such calendar quarter. In addition, the “per share incentive fee” for any calendar quarter is equal to (i) the incentive fee accrued and/or payable for such calendar quarter divided by (ii) the weighted average number of shares outstanding during such calendar quarter.
Partial Loan Sales: The Company follows the guidance in Accounting Standards Codification Topic 860, Transfers and
Servicing, or ASC Topic 860, when accounting for loan participations and other partial loan sales. This guidance requires a participation or other partial loan sale to meet the definition of a participating interest, as defined in the guidance, in order for sale treatment to be allowed. Participations or other partial loan sales which do not meet the definition of a participating interest remain on the Company’s consolidated balance sheets and the proceeds are recorded as a secured borrowing until the participation or other partial loan sale meets the definition. Secured borrowings are carried at fair value to correspond with the related investments, which are carried at fair value. See Note 8 for additional information.
Reclassifications: Certain amounts in the unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2017 and the audited consolidated financial statements as of and for the year ended December 31, 2017 may have been reclassified to conform to the classifications used to prepare the unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2018. These reclassifications had no material impact on the Company’s consolidated financial position, results of operations or cash flows as previously reported.
Revenue Recognition: Security transactions are accounted for on the trade date. The Company records interest income on an accrual basis to the extent that it expects to collect such amounts. The Company records dividend income on the ex-dividend date. The Company does not accrue as a receivable interest or dividends on loans and securities if it has reason to doubt its ability to collect such income. The Company’s policy is to place investments on non-accrual status when there is reasonable doubt that interest income will be collected. The Company considers many factors relevant to an investment when placing it on or removing it from non-accrual status including, but not limited to, the delinquency status of the investment, economic and business conditions, the overall financial condition of the underlying investment, the value of the underlying collateral, bankruptcy status, if any, and any other facts or circumstances relevant to the investment. If there is reasonable doubt that the Company will receive any previously accrued interest, then the interest income will be written-off. Payments received on non-accrual investments may be recognized as income or applied to principal depending upon the collectability of the remaining principal and interest. Non-accrual investments may be restored to accrual status when principal and interest become current and are likely to remain current based on the Company’s judgment.
Loan origination fees, original issue discount and market discount are capitalized and the Company amortizes such amounts as interest income over the respective term of the loan or security. Upon the prepayment of a loan or security, any unamortized loan origination fees and original issue discount are recorded as interest income. The Company records prepayment premiums on loans and securities as fee income when it receives such amounts.
Effective January 1, 2018, the Company adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, using the cumulative effect method applied to in-scope contracts with customers that have not been completed as of the date of adoption. The Company did not identify any in-scope contracts that had not been completed as of the date of adoption and, as a result, the Company did not recognize a cumulative effect on stockholders’ equity in connection with the adoption of the new revenue recognition guidance.
The new revenue recognition guidance applies to all entities and all contracts with customers to provide goods or services in the ordinary course of business, excluding, among other things, financial instruments as well as certain other contractual rights and obligations. Under the new revenue recognition guidance, which the Company has applied to all newin-scope contracts as of the date of adoption, structuring and other upfront fees are recognized as revenue based on the transaction price as the performance obligation is fulfilled. The related performance obligation consists of structuring activities and is satisfied over time as such activities are performed. Consideration is variable and is constrained from being included in the transaction price until the
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uncertainty associated with the variable consideration is resolved, typically as of the trade date of the related transaction. Payment is typically due on the settlement date of the related transaction.
For the nine months ended September 30, 2018, the Company recognized $4,352 in structuring fee revenue under the new revenue recognition guidance and included such revenue in the fee income line item on its consolidated statement of operations. Comparative periods are presented in accordance with revenue recognition guidance effective prior to January 1, 2018, under which the Company recorded structuring and other non-recurring upfront fees as income when earned. The Company has determined that the adoption of the new revenue recognition guidance did not have a material impact on the amount of revenue recognized for the nine months ended September 30, 2018.
Note 3. Share Transactions
Below is a summary of transactions with respect to shares of the Company’s common stock during the nine months ended September 30, 2018 and 2017:
Reinvestment of Distributions
Share Repurchase Program
Net Proceeds from Share Transactions
During the nine months ended September 30, 2018, the administrator for the Company’s distribution reinvestment plan, or DRP, purchased 1,550,162 shares of common stock in the open market at an average price per share of $7.64 (totaling $11,850) pursuant to the DRP, and distributed such shares to participants in the DRP. During the period from October 1, 2018 to November 7, 2018, the administrator for the DRP purchased 421,423 shares of common stock in the open market at an average price per share of $7.02 (totaling $2,957) pursuant to the DRP, and distributed such shares to participants in the DRP. For additional information regarding the terms of the DRP, see Note 5.
In February 2018, the Company’s board of directors authorized a stock repurchase program. Under the program, the Company was permitted to repurchase up to $50 million in the aggregate of its outstanding common stock in the open market at prices below the then-current net asset value per share. During the nine months ended September 30, 2018, the Company repurchased 6,571,347 shares of common stock pursuant to the share repurchase program at an average price per share of $7.61 (totaling $50,000).
The program has terminated since the aggregate repurchase amount that was approved by the Company’s board of directors has been expended.
Note 4. Related Party Transactions
Compensation of the Investment Adviser
Pursuant to the FS/KKR Advisor investment advisory agreement, FS/KKR Advisor is entitled to an annual base management fee based on the average weekly value of the Company’s gross assets (gross assets equal the total assets of the Company as set forth on the Company’s consolidated balance sheets) and an incentive fee based on the Company’s performance. The base management fee is payable quarterly in arrears, and is calculated at an annual rate of 1.50% of the average weekly value of the Company’s gross assets. See Note 2 for a discussion of the capital gains and subordinated income incentive fees that FS/KKR Advisor may be entitled to under the FS/KKR Advisor investment advisory agreement.
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Note 4. Related Party Transactions (continued)
Pursuant to the FB Advisor investment advisory agreement, FB Advisor was entitled to an annual base management fee equal to 1.75% of the average value of the Company’s gross assets (gross assets equal the total assets of the Company as set forth on the Company’s consolidated balance sheets) and an incentive fee based on the Company’s performance. FB Advisor had agreed, effective October 1, 2017, to (a) waive a portion of the base management fee to which it was entitled under the FB Advisor investment advisory agreement so that the fee received equaled 1.50% of the average value of the Company’s gross assets and (b) continue to calculate the subordinated incentive fee on income to which it was entitled under the FB Advisor investment advisory agreement as if the base management fee was 1.75% of the average value of the Company’s gross assets. Pursuant to the investment sub-advisory agreement, GDFM was entitled to receive 50% of all management and incentive fees payable to FB Advisor under the FB Advisor investment advisory agreement with respect to each year.
On April 9, 2018, the Company entered into a new administration agreement with FS/KKR Advisor, or the FS/KKR Advisor administration agreement, which replaced an administration agreement with FB Advisor, or the FB Advisor administration agreement. Pursuant to the FS/KKR Advisor administration agreement, FS/KKR Advisor oversees the Company’s day-to-day operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities, and other administrative services. FS/KKR Advisor also performs, or oversees the performance of, the Company’s corporate operations and required administrative services, which includes being responsible for the financial records that the Company is required to maintain and preparing reports for the Company’s stockholders and reports filed with the SEC. In addition, FS/KKR Advisor assists the Company in calculating its net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to the Company’s stockholders, and generally overseeing the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others.
Pursuant to the FS/KKR Advisor administration agreement, the Company reimburses FS/KKR Advisor for expenses necessary to perform services related to its administration and operations, including FS/KKR Advisor’s allocable portion of the compensation and related expenses of certain personnel of FS Investments and KKR Credit providing administrative services to the Company on behalf of FS/KKR Advisor. The Company reimburses FS/KKR Advisor no less than quarterly for all costs and expenses incurred by FS/KKR Advisor in performing its obligations and providing personnel and facilities under the FS/KKR Advisor administration agreement. FS/KKR Advisor allocates the cost of such services to the Company based on factors such as total assets, revenues, time allocations and/or other reasonable metrics. The Company’s board of directors reviews the methodology employed in determining how the expenses are allocated to the Company and the proposed allocation of administrative expenses among the Company and certain affiliates of FS/KKR Advisor. The Company’s board of directors then assesses the reasonableness of such reimbursements for expenses allocated to it based on the breadth, depth and quality of such services as compared to the estimated cost to the Company of obtaining similar services from third-party service providers known to be available. In addition, the Company’s board of directors considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, the Company’s board of directors compares the total amount paid to FS/KKR Advisor for such services as a percentage of the Company’s net assets to the same ratio as reported by other comparable BDCs. The FB Advisor administration agreement was substantially similar to the FS/KKR Advisor administration agreement.
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The following table describes the fees and expenses accrued under the FB Advisor investment advisory agreement, the FB Advisor administration agreement, the FS/KKR Advisor investment advisory agreement, and the FS/KKR Advisor administration agreement, as applicable, during the three and nine months ended September 30, 2018 and 2017:
Related Party
Source Agreement
Description
FB Advisor and FS/KKR Advisor
FB Advisor agreed, effective October 1, 2017, to waive a portion of the base management fee to which it was entitled under the FB Advisor investment advisory agreement so that the fee received equaled 1.50% of the average value of the Company’s gross assets. For the nine months ended September 30, 2018, the amount shown is net of waivers of $2,776. During the nine months ended September 30, 2018 and 2017, $45,841 and $54,756, respectively, in base management fees were paid to FS/KKR Advisory and/or FB Advisor. As of September 30, 2018, $14,259 in base management fees were payable to FS/KKR Advisor.
During the nine months ended September 30, 2018 and 2017, $35,776 and $37,649, respectively, of subordinated incentive fees on income were paid to FS/KKR Advisor and/or FB Advisor.
During the nine months ended September 30, 2018 and 2017, $2,235 and $2,017, respectively, of administrative services expenses related to the allocation of costs of administrative personnel for services rendered to the Company by FB Advisor and FS/KKR Advisor and the remainder related to other reimbursable expenses. The Company paid $2,078 and $2,247, respectively, in administrative services expenses to FB Advisor and FS/KKR Advisor during the nine months ended September 30, 2018 and 2017.
Potential Conflicts of Interest
The members of the senior management and investment teams of FS/KKR Advisor serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as the Company does, or of investment vehicles managed by the same personnel. For example, FS/KKR Advisor is the investment adviser to FS Investment Corporation II, FS Investment Corporation III, FS Investment Corporation IV, Corporate Capital Trust, Inc. and Corporate Capital Trust II, and the officers, managers and other personnel of FS/KKR Advisor may serve in similar or other capacities for the investment advisers to future investment vehicles affiliated with FS Investments or KKR Credit. In serving in these multiple and other capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the Company’s best interests or in the best interest of the Company’s stockholders. The Company’s investment objectives may overlap with the investment objectives of such investment funds, accounts or other investment vehicles. For additional information regarding potential conflicts of interest, see the Company’s annual report on Form 10-K for the year ended December 31, 2017.
Exemptive Relief
As a BDC, the Company is subject to certain regulatory restrictions in making its investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term.
In an order dated June 4, 2013, or the FS Order, the SEC granted exemptive relief permitting the Company, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with certain affiliates of FB
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Advisor, including FS Energy and Power Fund, FS Investment Corporation II, FS Investment Corporation III, FS Investment Corporation IV and any future BDCs that are advised by FB Advisor or its affiliated investment advisers. However, in connection with the investment advisory relationship with FS/KKR Advisor, and in an effort to mitigate potential future conflicts of interest, the Company’s board of directors authorized and directed that the Company (i) withdraw from the FS Order, except with respect to any transaction in which the Company participated in reliance on the FS Order prior to April 9, 2018, and (ii) rely on an exemptive relief order, dated April 3, 2018, that permits the Company, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions, including investments originated and directly negotiated by FS/KKR Advisor or KKR Credit, with certain affiliates of FS/KKR Advisor.
Note 5. Distributions
The following table reflects the cash distributions per share that the Company has declared on its common stock during the nine months ended September 30, 2018 and 2017:
For the Three Months Ended
Fiscal 2017
March 31, 2017
June 30, 2017
September 30, 2017
Fiscal 2018
March 31, 2018
June 30, 2018
September 30, 2018
On November 1, 2018, the Company’s board of directors declared a regular quarterly cash distribution of $0.19 per share, which will be paid on or about January 2, 2019 to stockholders of record as of the close of business on December 12, 2018. On October 12, 2018, the Company’s board of directors declared a special distribution of $0.09 per share, which will be paid on or about December 3, 2018 to stockholders of record as of the close of business on November 19, 2018. This special distribution equates to the cumulative amount of net investment income earned during the twelve months following October 1, 2017 that was in excess of $0.76 per share. The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of the Company’s board of directors.
Pursuant to the Company’s DRP, the Company will reinvest all cash dividends or distributions declared by the Company’s board of directors on behalf of stockholders who do not elect to receive their distributions in cash. As a result, if the Company’s board of directors declares a distribution, then stockholders who have not elected to “opt out” of the DRP will have their distributions automatically reinvested in additional shares of the Company’s common stock.
With respect to each distribution pursuant to the DRP, the Company reserves the right to either issue new shares of common stock or purchase shares of common stock in the open market in connection with implementation of the DRP. Unless the Company, in its sole discretion, otherwise directs the plan administrator, (A) if the per share market price (as defined in the DRP) is equal to or greater than the estimated net asset value per share (rounded up to the nearest whole cent) of the Company’s common stock on the payment date for the distribution, then the Company will issue shares of common stock at the greater of (i) net asset value per share of common stock or (ii) 95% of the market price; or (B) if the market price is less than the net asset value per share, then, in the sole discretion of the Company, (i) shares of common stock will be purchased in open market transactions for the accounts of participants to the extent practicable, or (ii) the Company will issue shares of common stock at net asset value per share. Pursuant to the terms of the DRP, the number of shares of common stock to be issued to a participant
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Note 5. Distributions (continued)
will be determined by dividing the total dollar amount of the distribution payable to a participant by the price per share at which the Company issues such shares; provided, however, that shares purchased in open market transactions by the plan administrator will be allocated to a participant based on the average purchase price, excluding any brokerage charges or other charges, of all shares of common stock purchased in the open market.
If a stockholder receives distributions in the form of common stock pursuant to the DRP, such stockholder generally will be subject to the same federal, state and local tax consequences as if it elected to receive distributions in cash. If the Company’s common stock is trading at or below net asset value, a stockholder receiving distributions in the form of additional common stock will be treated as receiving a distribution in the amount of cash that they would have received if they had elected to receive the distribution in cash. If the Company’s common stock is trading above net asset value, a stockholder receiving distributions in the form of additional common stock will be treated as receiving a distribution in the amount of the fair market value of the Company’s common stock. The stockholder’s basis for determining gain or loss upon the sale of common stock received in a distribution will be equal to the total dollar amount of the distribution payable to the stockholder. Any stock received in a distribution will have a holding period for tax purposes commencing on the day following the day on which the shares of common stock are credited to the stockholder’s account.
The Company may fund its cash distributions to stockholders from any sources of funds legally available to it, including proceeds from the sale of shares of the Company’s common stock, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to the Company on account of preferred and common equity investments in portfolio companies. The Company has not established limits on the amount of funds it may use from available sources to make distributions. During certain periods, the Company’s distributions may exceed its earnings. As a result, it is possible that a portion of the distributions the Company makes may represent a return of capital. A return of capital generally is a return of a stockholder’s investment rather than a return of earnings or gains derived from the Company’s investment activities. Each year a statement on Form 1099-DIV identifying the sources of the distributions (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of capital, which is a nontaxable distribution) will be mailed to the Company’s stockholders. There can be no assurance that the Company will be able to pay distributions at a specific rate or at all.
The following table reflects the sources of the cash distributions on a tax basis that the Company has paid on its common stock during the nine months ended September 30, 2018 and 2017:
Source of Distribution
Offering proceeds
Borrowings
Net investment income(1)
Short-term capital gains proceeds from the sale of assets
Long-term capital gains proceeds from the sale of assets
Non-capital gains proceeds from the sale of assets
Distributions on account of preferred and common equity
During the nine months ended September 30, 2018 and 2017, 85.1% and 89.4%, respectively, of the Company’s gross investment income was attributable to cash income earned, 1.4% and 1.2%, respectively, was attributable to non-cash accretion of discount and 13.5% and 9.4%, respectively, was attributable to PIK interest.
The Company’s net investment income on a tax basis for the nine months ended September 30, 2018 and 2017 was $159,142 and $146,571, respectively. As of September 30, 2018 and December 31, 2017, the Company had $171,450 and
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$150,413 of undistributed net investment income, respectively, and $140,920 and $197,855, respectively, of accumulated capital losses on a tax basis.
The difference between the Company’s GAAP-basis net investment income and its tax-basis net investment income is primarily due to the reclassification of unamortized original issue discount and prepayment fees recognized upon prepayment of loans from income for GAAP purposes to realized gains or deferred to future periods for tax purposes, the impact of consolidating certain subsidiaries for purposes of computing GAAP-basis net investment income but not for purposes of computing tax-basis net investment income and income recognized for tax purposes on certain transactions but not recognized for GAAP purposes.
The following table sets forth a reconciliation between GAAP-basis net investment income and tax-basis net investment income during the nine months ended September 30, 2018 and 2017:
GAAP-basis net investment income
Income subject to tax not recorded for GAAP
GAAP versus tax-basis impact of consolidation of certain subsidiaries
Reclassification or deferral of unamortized original issue discount, prepayment fees and other income
Other miscellaneous differences
Tax-basis net investment income
The determination of the tax attributes of the Company’s distributions is made annually as of the end of the Company’s fiscal year based upon the Company’s taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full year. The actual tax characteristics of distributions to stockholders are reported to stockholders annually on Form 1099-DIV.
As of September 30, 2018 and December 31, 2017, the components of accumulated earnings on a tax basis were as follows:
Distributable ordinary income
Distributable realized gains (accumulated capital losses)(1)
Other temporary differences
Net unrealized appreciation (depreciation) on investments and secured borrowing and gain/loss on foreign currency(2)
Net capital losses may be carried forward indefinitely, and their character is retained as short-term or long-term losses. As of September 30, 2018, the Company had short-term and long-term capital loss carryforwards available to offset future realized capital gains of $2,799 and $138,121, respectively.
As of September 30, 2018 and December 31, 2017, the gross unrealized appreciation on the Company’s investments and secured borrowing and gain on foreign currency was $189,359 and $257,940, respectively. As of September 30, 2018 and December 31, 2017, the gross unrealized depreciation on the Company’s investments and secured borrowing and loss on foreign currency was $367,480 and $198,067, respectively.
The aggregate cost of the Company’s investments for U.S. federal income tax purposes totaled $3,714,613 and $3,870,085 as of September 30, 2018 and December 31, 2017, respectively. The aggregate net unrealized appreciation (depreciation) on investments on a tax basis was $(177,361) and $56,149 as of September 30, 2018 and December 31, 2017, respectively.
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As of September 30, 2018, the Company had a deferred tax liability of $12,839 resulting from unrealized appreciation on investments held by the Company’s wholly-owned taxable subsidiaries and a deferred tax asset of $20,077 resulting from net operating losses of the Company’s wholly-owned taxable subsidiaries. As of September 30, 2018, certain wholly-owned taxable subsidiaries anticipated that they would be unable to fully utilize their generated net operating losses and capital losses, therefore the deferred tax asset was offset by a valuation allowance of $7,238. For the nine months ended September 30, 2018, the Company did not record a provision for taxes related to its wholly-owned taxable subsidiaries.
Note 6. Investment Portfolio
The following table summarizes the composition of the Company’s investment portfolio at cost and fair value as of September 30, 2018 and December 31, 2017:
Collateralized Securities
Amortized cost represents the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on investments.
In general, under the 1940 Act, the Company would be presumed to “control” a portfolio company if it owned more than 25% of its voting securities or it had the power to exercise control over the management or policies of such portfolio company, and would be an “affiliated person” of a portfolio company if it owned 5% or more of its voting securities.
As of September 30, 2018, the Company held investments in one portfolio company of which it is deemed to “control.” As of September 30, 2018, the Company held investments in seven portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control.” For additional information with respect to such portfolio companies, see footnotes (t) and (u) to the unaudited consolidated schedule of investments as of September 30, 2018 in this quarterly report on Form 10-Q.
As of December 31, 2017, the Company held investments in one portfolio company of which it is deemed to “control.” As of December 31, 2017, the Company held investments in six portfolio companies of which it is deemed to be an “affiliated person” but is not deemed to “control.” For additional information with respect to such portfolio companies, see footnotes (t) and (u) to the consolidated schedule of investments as of December 31, 2017 in this quarterly report on Form 10-Q.
The Company’s investment portfolio may contain loans and other unfunded arrangements that are in the form of lines of credit, revolving credit facilities, delayed draw credit facilities or other investments, pursuant to which the Company may be required to provide funding when requested by portfolio companies in accordance with the terms of the underlying agreements. As of September 30, 2018, the Company had seventeen unfunded debt investments with aggregate unfunded commitments of $178,424 and one unfunded commitment to purchase up to $71 in shares of preferred stock of Altus Power America Holdings, LLC. As of December 31, 2017, the Company had twenty unfunded debt investments with aggregate unfunded commitments of $154,074, one unfunded commitment to purchase up to $295 in shares of preferred stock of Altus Power America Holdings, LLC and one unfunded commitment to purchase up to $4 in shares of common stock of Chisholm Oil and Gas, LLC. The Company maintains sufficient cash on hand, available borrowings and liquid securities to fund such unfunded commitments should the need arise. For additional details regarding the Company’s unfunded debt investments, see the Company’s unaudited consolidated
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Note 6. Investment Portfolio (continued)
schedule of investments as of September 30, 2018 and the Company’s audited consolidated schedule of investments as of December 31, 2017.
The table below describes investments by industry classification and enumerates the percentage, by fair value, of the total portfolio assets in such industries as of September 30, 2018 and December 31, 2017:
Industry Classification
Automobiles & Components
Diversified Financials
Food & Staples Retailing
Food, Beverage & Tobacco
Retailing
Semiconductors & Semiconductor Equipment
Technology Hardware & Equipment
Transportation
Note 7. Fair Value of Financial Instruments
Under existing accounting guidance, fair value is defined as the price that the Company would receive upon selling an investment or pay to transfer a liability in an orderly transaction to a market participant in the principal or most advantageous market for the investment. This accounting guidance emphasizes valuation techniques that maximize the use of observable market inputs and minimize the use of unobservable inputs. Inputs refer broadly to the assumptions that market participants would use in pricing an asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on the best information available in the circumstances. The Company classifies the inputs used to measure these fair values into the following hierarchy as defined by current accounting guidance:
Level 1: Inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Inputs that are quoted prices for similar assets or liabilities in active markets.
Level 3: Inputs that are unobservable for an asset or liability.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
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Note 7. Fair Value of Financial Instruments (continued)
As of September 30, 2018 and December 31, 2017, the Company’s investments were categorized as follows in the fair value hierarchy:
Valuation Inputs
Level 1—Price quotations in active markets
Level 2—Significant other observable inputs
Level 3—Significant unobservable inputs
The Company has elected the fair value option under ASC Topic 825, Financial Instruments, relating to accounting for debt obligations at their fair value for its secured borrowing which arose due to partial loan sales which did not meet the criteria for sale treatment under ASC Topic 860. The Company reports changes in the fair value of its secured borrowing as a component of the net change in unrealized appreciation (depreciation) on secured borrowing in the consolidated statements of operations. The net gain or loss reflects the difference between the fair value and the principal amount due on maturity.
The Company’s investments consist primarily of debt investments that were acquired directly from the issuer. Debt investments, for which broker quotes are not available, are valued by independent valuation firms, which determine the fair value of such investments by considering, among other factors, the borrower’s ability to adequately service its debt, prevailing interest rates for like investments, expected cash flows, call features, anticipated prepayments and other relevant terms of the investments. Except as described below, all of the Company’s equity/other investments are also valued by independent valuation firms, which determine the fair value of such investments by considering, among other factors, contractual rights ascribed to such investments, as well as various income scenarios and multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. An investment that is newly issued and purchased near the date of the financial statements is valued at cost if the Company’s board of directors determines that the cost of such investment is the best indication of its fair value. Such investments described above are typically classified as Level 3 within the fair value hierarchy. Investments that are traded on an active public market are valued at their closing price as of the date of the financial statements and are classified as Level 1 within the fair value hierarchy. Except as described above, the Company values its other investments by using the midpoint of the prevailing bid and ask prices from dealers on the date of the relevant period end, which are provided by independent third-party pricing services and screened for validity by such services and are typically classified as Level 2 within the fair value hierarchy.
The Company periodically benchmarks the bid and ask prices it receives from the third-party pricing services and/or dealers and independent valuation firms as applicable, against the actual prices at which the Company purchases and sells its investments. Based on the results of the benchmark analysis and the experience of the Company’s management in purchasing and selling these investments, the Company believes that these prices are reliable indicators of fair value. The valuation committee of the Company’s board of directors, or the valuation committee, and the board of directors reviewed and approved the valuation determinations made with respect to these investments in a manner consistent with the Company’s valuation policy.
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The following is a reconciliation for the nine months ended September 30, 2018 and 2017 of investments for which significant unobservable inputs (Level 3) were used in determining fair value:
Fair value at beginning of period
Accretion of discount (amortization of premium)
Net realized gain (loss)
Net change in unrealized appreciation (depreciation)
Purchases
Sales and repayments
Net transfers in or out of Level 3(1)
Fair value at end of period
The amount of total gains or losses for the period included in changes in net assets attributable to the change in unrealized gains or losses relating to investments still held at the reporting date
Net transfers in or out of Level 3
As of June 30, 2018, the Company determined to classify investments whose valuations were obtained from independent third-party pricing services as Level 2 in the fair value hierarchy as the Company identified significant other observable inputs in these market quotations. It is the Company’s policy to recognize transfers between levels at the beginning of the reporting period.
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The following is a reconciliation for the nine months ended September 30, 2017 of a secured borrowing for which significant unobservable inputs (Level 3) were used in determining market value:
Amortization of premium (accretion of discount)
Repayments on secured borrowing
Proceeds from secured borrowing
The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements as of September 30, 2018 and December 31, 2017 were as follows:
Type of Investment
Valuation
Technique(1)
Unobservable
Input
Range
Investments using a market quotes valuation technique were valued by using the midpoint of the prevailing bid and ask prices from dealers on the date of the relevant period end, which were provided by independent third-party pricing services and screened for validity by such services. For investments utilizing a market comparables valuation technique, a significant increase (decrease) in the market yield, in isolation, would result in a significantly lower (higher) fair value measurement, and a significant increase (decrease) in any of the valuation multiples, in isolation, would result in a significantly higher (lower) fair value measurement. For investments utilizing a discounted cash flow valuation technique, a significant increase (decrease) in the discount rate, in isolation, would result in a significantly lower (higher) fair value measurement. For investments utilizing an option valuation model valuation technique, a significant increase (decrease) in the volatility, in isolation, would result in a significantly higher (lower) fair value measurement.
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Fair value based on expected outcome of proposed corporate transactions and/or other factors.
ValuationTechnique(1)
UnobservableInput
Senior Secured Loans— Second Lien
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Note 8. Financing Arrangements
The following tables present summary information with respect to the Company’s outstanding financing arrangements as of September 30, 2018 and December 31, 2017. For additional information regarding these financing arrangements, see the notes to the Company’s audited consolidated financial statements contained in its annual report on Form 10-K for the year ended December 31, 2017. Any significant changes to the Company’s financing arrangements during the three months ended September 30, 2018 are discussed below.
Arrangement
Rate
Locust Street Credit Facility(1)
Senior Secured Revolving Credit Facility(1)
L+1.75% –
2.00%(2)
4.000% Notes due 2019(4)
4.250% Notes due 2020(5)
4.750% Notes due 2022(6)
The carrying amount outstanding under the facility approximates its fair value.
The spread over LIBOR is determined by reference to the ratio of the value of the borrowing base to a combined debt amount calculation.
Amount includes borrowing in Euros and Canadian dollars. Euro balance outstanding of €26,000 has been converted to U.S. dollars at an exchange rate of €1.00 to $1.16 as of September 30, 2018 to reflect total amount outstanding in U.S. dollars. Canadian dollar balance outstanding of CAD $28,200 has been converted to U.S dollars at an exchange rate of CAD $1.00 to $0.77 as of September 30, 2018 to reflect total amount outstanding in U.S. dollars.
As of September 30, 2018, the fair value of the 4.000% notes was approximately $402,082.
As of September 30, 2018, the fair value of the 4.250% notes was approximately $407,152.
As of September 30, 2018, the fair value of the 4.750% notes was approximately $275,235.
Hamilton Street Credit Facility(1)
ING Credit Facility(1)
4.000% Notes due 2019(3)
4.250% Notes due 2020(4)
4.750% Notes due 2022(5)
Borrowings in Euros and Canadian dollars. Euro balance outstanding of €41,576 has been converted to U.S. dollars at an exchange rate of €1.00 to $1.20 as of December 31, 2017 to reflect total amount outstanding in U.S. dollars. Canadian dollar balance outstanding of CAD $20,987 has been converted to U.S. dollars at an exchange rate of CAD $1.00 to $0.80 as of December 31, 2017 to reflect total amount outstanding in U.S. dollars.
As of December 31, 2017, the fair value of the 4.000% notes was approximately $406,966.
As of December 31, 2017, the fair value of the 4.250% notes was approximately $414,828.
As of December 31, 2017, the fair value of the 4.750% notes was approximately $283,895.
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Note 8. Financing Arrangements (continued)
For the three and nine months ended September 30, 2018 and 2017, the components of total interest expense for the Company’s financing arrangements were as follows:
Arrangement(1)
Hamilton Street Credit Facility(2)
ING Credit Facility(2)
Locust Street Credit Facility
Senior Secured Revolving Credit Facility
4.000% Notes due 2019
4.250% Notes due 2020
4.750% Notes due 2022
Partial Loan Sale(3)
Borrowings of each of the Company’s wholly-owned, special-purpose financing subsidiaries are considered borrowings of the Company for purposes of complying with the asset coverage requirements applicable to BDCs under the 1940 Act.
Direct interest expense includes the effect of non-usage fees.
Total interest expense for the secured borrowing includes the effect of amortization of discount.
The Company’s average borrowings and weighted average interest rate, including the effect of non-usage fees, for the nine months ended September 30, 2018 were $1,685,283 and 4.43%, respectively. As of September 30, 2018, the Company’s weighted average effective interest rate on borrowings, including the effect of non-usage fees, was 4.59%.
The Company’s average borrowings and weighted average interest rate, including the effect of non-usage fees, for the nine months ended September 30, 2017 were $1,770,279 and 4.10%, respectively. As of September 30, 2017, the Company’s weighted average effective interest rate on borrowings, including the effect of non-usage fees, was 4.21%.
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On August 9, 2018, or the Effective Date, the Company entered into a senior secured revolving credit facility, or the Senior Secured Revolving Credit Facility, with CCT, FS Investment Corporation II, or FSIC II, FS Investment Corporation III, or FSIC III, JPMorgan Chase Bank, N.A., or JPMorgan, as administrative agent, ING Capital LLC, or ING, as collateral agent and the lenders party thereto. The Senior Secured Revolving Credit Facility provides for borrowings in U.S. dollars and certain agreed upon foreign currencies in an initial aggregate amount of up to $3,435,000, with an option for the Company to request, at one or more times after the Effective Date, that existing or new lenders, at their election, provide up to $1,717,500 of additional commitments. As of the Effective Date, the Senior Secured Revolving Credit Facility provides for a sublimit available for the Company to borrow up to $685,000 of the total facility amount, which sublimit may be reduced or increased from time to time pursuant to the terms of the Senior Secured Revolving Credit Facility and subject to the oversight and approval of the Company’s board of directors. A sublimit of the total facility amount also is available to each of CCT, FSIC II and FSIC III, as additional borrowers, and the obligations of the other borrowers under the Senior Secured Revolving Credit Facility are several (and not joint) in all respects. The Senior Secured Revolving Credit Facility provides for the issuance of letters of credit on behalf of the Company in an aggregate face amount not to exceed $25,000. The Company’s obligations under the Senior Secured Revolving Credit Facility are guaranteed by certain of the Company’s subsidiaries, including Race Street Funding LLC, IC American Energy Investments, Inc., FSIC Investments, Inc., IC Altus Investments, LLC, IC Arches Investments, LLC and Hamilton Street Funding LLC. The Company’s obligations under the Senior Secured Revolving Credit Facility are secured by a first priority security interest in substantially all of the assets of the Company and the subsidiary guarantors thereunder.
Availability under the Senior Secured Revolving Credit Facility will terminate on August 9, 2022, or the Revolver Termination Date, and the outstanding loans under the Senior Secured Revolving Credit Facility will mature on August 9, 2023. The Senior Secured Revolving Credit Facility also requires mandatory prepayment of interest and principal upon certain events during the term-out period commencing on the Revolver Termination Date.
The proceeds of the Senior Secured Revolving Credit Facility drawn by the Company on the Effective Date were used in part to prepay in full all loans outstanding on the Effective Date under (i) the Senior Secured Revolving Credit Agreement, dated as of April 3, 2014, by and among the Company, the lenders party thereto and ING as administrative agent (as amended, restated, amended and restated and otherwise modified on or prior to the Effective Date), or the ING Credit Facility, and (ii) the Loan and Security Agreement, dated as of December 15, 2016, by and among Hamilton Street Funding LLC, the lenders party thereto, HSBC Bank USA, National Association, as administrative agent, and U.S. Bank National Association, as collateral agent, account bank and custodian (as amended, restated, amended and restated and otherwise modified on or prior to the Effective Date), or the Hamilton Street Credit Facility.
Borrowings under the Senior Secured Revolving Credit Facility are subject to compliance with a borrowing base test. Interest under the Senior Secured Revolving Credit Facility for (i) loans for which the Company elects the base rate option, (A) if the total value of the borrowing base is equal to or greater than 1.85 times the combined debt amount, is payable at an “alternate base rate” (which is the greatest of (a) the prime rate as publicly announced by JPMorgan, (b) the sum of (x) the greater of (I) the federal funds effective rate and (II) the overnight bank funding rate plus (y) 0.5%, and (c) the one month LIBOR plus 1% per annum) plus 0.75% and, (B) if the value of the borrowing base is less than 1.85 times the combined debt amount, the alternate base rate plus 1.00%; and (ii) loans for which the Company elects the Eurocurrency option (A) if the value of the borrowing base is equal to or greater than 1.85 times the combined debt amount, is payable at a rate equal to LIBOR plus 1.75% and (B) if the value of the borrowing base is less than 1.85 times the combined debt amount, is payable at a rate equal to LIBOR plus 2.00%. The Company will pay a non-usage fee of at least 0.375% and up to 0.50% per annum (based on the immediately preceding quarter’s average usage) on the unused portion of its sublimit under the Senior Secured Revolving Credit Facility during the revolving period. The Company also will be required to pay letter of credit participation fees and a fronting fee on the average daily amount of any lender’s exposure with respect to any letters of credit issued under the Senior Secured Revolving Credit Facility.
In connection with the Senior Secured Revolving Credit Facility, the Company has made certain representations and warranties and must comply with various covenants and reporting requirements customary for facilities of this type. In addition,
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the Company must comply with the following financial covenants: (a) the Company must maintain a minimum shareholders’ equity, measured as of each fiscal quarter end; and (b) the Company must maintain at all times a 200% asset coverage ratio.
The Senior Secured Revolving Credit Facility contains events of default customary for facilities of this type. Upon the occurrence of an event of default, JPMorgan, at the instruction of the lenders, may terminate the commitments and declare the outstanding advances and all other obligations under the Senior Secured Revolving Credit Facility immediately due and payable.
The Company incurred costs in connection with obtaining the Senior Secured Revolving Credit Facility, which the Company has recorded as deferred financing costs, along with $1,756 of unamortized fees from the ING Credit Facility, on its consolidated balance sheets and which the Company amortizes to interest expense over the life of the facility. As of September 30, 2018, $6,213 of such deferred financing costs had yet to be amortized to interest expense.
Hamilton Street Credit Facility
In connection with entering into the Senior Secured Revolving Credit Facility, the Company repaid and terminated the Hamilton Street Credit Facility. The $1,297 of remaining unamortized deferred financing costs for the Hamilton Street Credit Facility were charged to interest expense.
ING Credit Facility
In connection with entering into the Senior Secured Revolving Credit Facility, the Company repaid and terminated the ING Credit Facility. The Company incurred costs in connection with obtaining the ING Credit Facility, which the Company had recorded as deferred financing costs on its consolidated balance sheets and amortized to interest expense over the life of the facility. As of August 9, 2018, $1,756 of such deferred financing costs had yet to be amortized to interest expense. Pursuant to the terms of the Senior Secured Revolving Credit Facility, the remaining unamortized deferred financing costs of $1,756 will be amortized over the contractual term of the Senior Secured Revolving Credit Facility.
Note 9. Commitments and Contingencies
The Company enters into contracts that contain a variety of indemnification provisions. The Company’s maximum exposure under these arrangements is unknown; however, the Company has not had prior claims or losses pursuant to these contracts. Management of FS/KKR Advisor has reviewed the Company’s existing contracts and expects the risk of loss to the Company to be remote.
The Company is not currently subject to any material legal proceedings and, to the Company’s knowledge, no material legal proceedings are threatened against the Company. From time to time, the Company may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of the Company’s rights under contracts with its portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, the Company does not expect that any such proceedings will have a material effect upon its financial condition or results of operations.
See Note 6 for a discussion of the Company’s unfunded commitments.
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Note 10. Financial Highlights
The following is a schedule of financial highlights of the Company for the nine months ended September 30, 2018 and the year ended December 31, 2017:
Per Share Data:(1)
Net asset value, beginning of period
Results of operations(2)
Net realized and unrealized appreciation (depreciation) on investments and secured borrowing and gain/loss on foreign currency
Stockholder distributions(3)
Distributions from net investment income
Distributions from net realized gain on investments
Capital share transactions
Issuance of common stock(4)
Repurchases of common stock(5)
Net asset value, end of period
Per share market value, end of period
Shares outstanding, end of period
Total return based on net asset value(6)
Total return based on market value(7)
Ratio/Supplemental Data:
Net assets, end of period
Ratio of net investment income to average net assets(8)
Ratio of total operating expenses to average net assets(8)
Ratio of net operating expenses to average net assets(8)
Portfolio turnover(9)
Total amount of senior securities outstanding, exclusive of treasury securities
Asset coverage per unit(10)
Per share data may be rounded in order to recompute the ending net asset value per share.
The per share data was derived by using the weighted average shares outstanding during the applicable period.
The per share data for distributions reflect the actual amount of distributions paid per share during the applicable period.
The issuance of common stock on a per share basis reflects the incremental net asset value changes as a result of the issuance of shares of common stock pursuant to the Company’s DRP. The issuance of common stock at a price that is greater than the net asset value per share results in an increase in net asset value per share. The per share impact of the Company’s DRP is an increase to the net asset value of less than $0.01 per share during the year ended December 31, 2017.
Represents the incremental impact of the Company’s share repurchase program by buying shares in the open market at a price lower than NAV.
The total return based on net asset value for each period presented was calculated by taking the net asset value per share as of the end of the applicable period, adding the cash distributions per share that were declared during the period and dividing the total by the net asset value per share at the beginning of the period. Total return based on net asset value does not consider the effect of any sales commissions
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Note 10. Financial Highlights (continued)
The total return based on market value for each period presented was calculated based on the change in market price during the applicable period, including the impact of distributions reinvested in accordance with the Company’s DRP. Total return based on market value does not consider the effect of any sales commissions or charges that may be incurred in connection with the sale of shares of the Company’s common stock. The historical calculation of total return based on market value in the table should not be considered a representation of the Company’s future total return based on market value, which may be greater or less than the return shown in the table due to a number of factors, including the Company’s ability or inability to make investments in companies that meet its investment criteria, the interest rates payable on the debt securities the Company acquires, the level of the Company’s expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which the Company encounters competition in its markets, general economic conditions and fluctuations in per share market value. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.
Weighted average net assets during the applicable period are used for this calculation. Ratios for the nine months ended September 30, 2018 are annualized. Annualized ratios for the nine months ended September 30, 2018 are not necessarily indicative of the ratios that may be expected for the year ending December 31, 2018. The following is a schedule of supplemental ratios for the nine months ended September 30, 2018 and year ended December 31, 2017:
(Unaudited)
Ratio of subordinated income incentive fees to average net assets
Ratio of interest expense to average net assets
Ratio of excise taxes to average net assets
Portfolio turnover for the nine months ended September 30, 2018 is not annualized.
Asset coverage per unit is the ratio of the carrying value of the Company’s total consolidated assets, less liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness.
Note 11. CCT Acquisition
On July 22, 2018, the Company entered into the Merger Agreement with CCT, Merger Sub and FS/KKR Advisor. The Merger Agreement provides that, subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into CCT, with CCT continuing as the surviving company and as a wholly-owned subsidiary of the Company and, immediately thereafter, CCT will merge with and into the Company, with the Company continuing as the surviving company. The parties to the Merger Agreement intend the Transaction to be treated as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended.
In the Merger, each share of CCT common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into a number of shares of the Company’s common stock equal to an exchange ratio to be determined in connection with the closing of the Merger, or the Exchange Ratio. The Exchange Ratio will equal the net asset value per share of CCT common stock (determined no earlier than two business days prior to the closing date of the Merger), divided by the net asset value per share of the Company’s common stock (determined no earlier than two business days prior to the closing date of the Merger). No fractional shares of the Company’s common stock will be issued, and holders of CCT common stock will receive cash in lieu of fractional shares.
Consummation of the Merger, which is currently anticipated to occur during the fourth quarter of 2018, is subject to certain closing conditions, including (1) requisite approvals of the Company’s stockholders and CCT stockholders, (2) the absence of
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Note 11. CCT Acquisition (continued)
certain legal impediments to the consummation of the Merger, (3) effectiveness of the registration statement for the Company’s common stock to be issued as consideration in the Merger, (4) subject to certain exceptions, the accuracy of the representations and warranties and compliance with the covenants of each party to the Merger Agreement and (5) required regulatory approvals (including expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended).
The Merger is expected to be accounted for as an asset acquisition in accordance with the asset acquisition method of accounting as detailed in ASC 805-50, Business Combinations—Related Issues. Generally, under asset acquisition accounting, acquiring assets in groups not only requires ascertaining the cost of the asset (or net assets), but also allocating that cost to the individual assets (or individual assets and liabilities) that make up the group. The cost of the group of assets acquired in an asset acquisition is allocated to the individual assets acquired or liabilities assumed based on their relative fair values of net identifiable assets acquired other than certain“non-qualifying” assets (for example cash) and does not give rise to goodwill. The final allocation of the purchase price will be determined after the Merger is completed and after completion of a final analysis to determine the estimated relative fair values of CCT’s assets and liabilities.
In connection with the Merger, the Company is seeking stockholder approval to amend the FS/KKR Advisor investment advisory agreement to (a) exclude cash and cash equivalents from the gross assets on which the annual base management fee is calculated, (b) revise the calculation of the cap on the subordinated incentive fee on income to take into account the historic per share pre-incentive fee return of both the Company and CCT, together with the historic per share incentive fees paid by both the Company and CCT, and (c) revise the calculation of incentive fees on capital gains to include historical net realized losses and unrealized depreciation of both the Company and CCT.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our unaudited consolidated financial statements and related notes thereto appearing elsewhere in this quarterly report on Form 10-Q. In this report, “we,” “us,” “our” and the “Company” refer to FS Investment Corporation.
Forward-Looking Statements
Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q may include statements as to:
our future operating results;
our business prospects and the prospects of the companies in which we may invest;
the impact of the investments that we expect to make;
the ability of our portfolio companies to achieve their objectives;
our current and expected financings and investments;
receiving and maintaining corporate credit ratings and changes in the general interest rate environment;
the adequacy of our cash resources, financing sources and working capital;
the timing and amount of cash flows, distributions and dividends, if any, from our portfolio companies;
our contractual arrangements and relationships with third parties;
actual and potential conflicts of interest with FS/KKR Advisor, FS Investments, KKR Credit or any of their respective affiliates;
the dependence of our future success on the general economy and its effect on the industries in which we may invest;
our use of financial leverage;
the ability of FS/KKR Advisor to locate suitable investments for us and to monitor and administer our investments;
the ability of FS/KKR Advisor or its affiliates to attract and retain highly talented professionals;
our ability to maintain our qualification as a RIC and as a BDC;
the impact on our business of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended, and the rules and regulations issued thereunder;
the effect of changes to tax legislation on us and the portfolio companies in which we may invest and our and their tax position;
the tax status of the enterprises in which we may invest; and
the Merger, the likelihood the Merger is completed and the anticipated timing of its completion.
In addition, words such as “anticipate,” “believe,” “expect” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason. Factors that could cause actual results to differ materially include:
changes in the economy;
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risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters;
future changes in laws or regulations and conditions in our operating areas; and
the price at which shares of our common stock may trade on the New York Stock Exchange, or NYSE.
We have based the forward-looking statements included in this quarterly report on Form10-Q on information available to us on the date of this quarterly report on Form 10-Q. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Stockholders are advised to consult any additional disclosures that we may make directly to stockholders or through reports that we may file in the future with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking statements and projections contained in this quarterly report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Exchange Act.
Overview
We were incorporated under the general corporation laws of the State of Maryland on December 21, 2007 and formally commenced investment operations on January 2, 2009. We are an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act and has elected to be treated for U.S. federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code.
On April 16, 2014, shares of our common stock began trading on the NYSE under the ticker symbol “FSIC”. This listing accomplished our goal of providing our stockholders with greatly enhanced liquidity.
Our investment activities are managed by FS/KKR Advisor and supervised by our board of directors, a majority of whom are independent. Under the FS/KKR Advisor investment advisory agreement, we have agreed to pay FS/KKR Advisor an annual base management fee based on the average weekly value of our gross assets and an incentive fee based on our performance.
Our investment activities were managed by FB Advisor until April 9, 2018 and thereafter have been managed by FS/KKR Advisor. FB Advisor previously engaged GDFM to act as our investment sub-adviser. GDFM resigned as our investment sub-adviserand terminated the investment sub-advisory agreement on April 9, 2018.
Our investment objectives are to generate current income and, to a lesser extent, long-term capital appreciation. We have identified and intend to focus on the following investment categories, which we believe will allow us to generate an attractive total return with an acceptable level of risk.
Direct Originations: We intend to directly source investment opportunities. Such investments are originated or structured for us or made by us and are not generally available to the broader market. These investments may include both debt and equity components, although we do not generally make equity investments independent of having an existing credit relationship. We believe directly originated investments may offer higher returns and more favorable protections than broadly syndicated transactions.
Opportunistic: We intend to seek to capitalize on market price inefficiencies by investing in loans, bonds and other securities where the market price of such investment reflects a lower value than deemed warranted by our fundamental analysis. We believe that market price inefficiencies may occur due to, among other things, general dislocations in the markets, a misunderstanding by the market of a particular company or an industry being out of favor with the broader investment community. We seek to allocate capital to these securities that have been misunderstood or mispriced by the market and where we believe there is an opportunity to earn an attractive return on our investment. Such opportunities may include event driven investments, anchor orders (i.e., opportunities that are originated and then syndicated by a commercial or investment bank but where we provide a capital commitment significantly above the average syndicate participant) and CLOs.
In the case of event driven investments, we intend to take advantage of dislocations that arise in the markets due to an impending event and where the market’s apparent expectation of value differs substantially from our fundamental analysis. Such events may include a looming debt maturity or default, a merger, spin-off or other corporate reorganization, an adverse regulatory or legal ruling, or a material contract expiration, any of which may significantly improve or impair a company’s financial position. Compared to other investment strategies, event driven investing depends more heavily on our ability to successfully predict the outcome of an individual event rather than on underlying macroeconomic fundamentals. As a result, successful event driven strategies may offer both substantial diversification benefits and the ability to generate performance in uncertain market environments.
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We may also invest in anchor orders. In these types of investments, we may receive fees, preferential pricing or other benefits not available to other lenders in return for our significant capital commitment. Our decision to provide an anchor order to a syndicated transaction is predicated on a rigorous credit analysis, our familiarity with a particular company, industry or financial sponsor, and the broader investment experiences of our investment adviser.
In addition, we opportunistically invest in CLOs. CLOs are a form of securitization where the cash flow from a pooled basket of syndicated loans is used to support distribution payments made to different tranches of securities. While collectively CLOs represent nearly fifty percent of the broadly syndicated loan universe, investing in individual CLO tranches requires a high degree of investor sophistication due to their structural complexity and the illiquid nature of their securities.
Broadly Syndicated/Other: Although our primary focus is to invest in directly originated transactions and opportunistic investments, in certain circumstances we will also invest in the broadly syndicated loan and high yield markets. Broadly syndicated loans and bonds are generally more liquid than our directly originated investments and provide a complement to our less liquid strategies. In addition, and because we typically receive more attractive financing terms on these positions than we do on our less liquid assets, we are able to leverage the broadly syndicated portion of our portfolio in such a way that maximizes the levered return potential of our portfolio.
Our portfolio is comprised primarily of investments in senior secured loans and second lien secured loans of private middle market U.S. companies and, to a lesser extent, subordinated loans of private U.S. companies. Although we do not expect a significant portion of our portfolio to be comprised of subordinated loans, there is no limit on the amount of such loans in which we may invest. We may purchase interests in loans or make other debt investments, including investments in senior secured bonds, through secondary market transactions in the “over-the-counter” market or directly from our target companies as primary market or directly originated investments. In connection with our debt investments, we may on occasion receive equity interests such as warrants or options as additional consideration. We may also purchase or otherwise acquire interests in the form of common or preferred equity or equity-related securities, such as rights and warrants that may be converted into or exchanged for common stock or other equity or the cash value of common stock or other equity, in our target companies, generally in conjunction with one of our debt investments, including through the restructuring of such investments, or through a co-investment with a financial sponsor, such as an institutional investor or private equity firm. In addition, a portion of our portfolio may be comprised of corporate bonds, CLOs, other debt securities and derivatives, including total return swaps and credit default swaps. FS/KKR Advisor will seek to tailor our investment focus as market conditions evolve. Depending on market conditions, we may increase or decrease our exposure to less senior portions of the capital structure or otherwise make opportunistic investments. The senior secured loans, second lien secured loans and senior secured bonds in which we invest generally have stated terms of three to seven years and subordinated debt investments that we make generally have stated terms of up to ten years, but the expected average life of such securities is generally between three and seven years. However, there is no limit on the maturity or duration of any security in our portfolio. Our debt investments may be rated by a NRSRO and, in such case, generally will carry a rating below investment grade.
Revenues
The principal measure of our financial performance is net increase in net assets resulting from operations, which includes net investment income, net realized gain or loss on investments, net realized gain or loss on foreign currency, net unrealized appreciation or depreciation on investments and net unrealized gain or loss on foreign currency. Net investment income is the difference between our income from interest, dividends, fees and other investment income and our operating and other expenses. Net realized gain or loss on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost, including the respective realized gain or loss on foreign currency for those foreign denominated investment transactions. Net realized gain or loss on foreign currency is the portion of realized gain or loss attributable to foreign currency fluctuations. Net unrealized appreciation or depreciation on investments is the net change in the fair value of our investment portfolio, including the respective unrealized gain or loss on foreign currency for those foreign denominated investments. Net unrealized gain or loss on foreign currency is the net change in the value of receivables or accruals due to the impact of foreign currency fluctuations.
We principally generate revenues in the form of interest income on the debt investments we hold. In addition, we generate revenues in the form of non-recurring commitment, closing, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance, consulting fees, prepayment fees and performance-based fees. We may also generate revenues in the form of dividends and other distributions on the equity or other securities we hold.
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Expenses
Our primary operating expenses include the payment of management and incentive fees and other expenses under the FS/KKR investment advisory agreement and the FS/KKR Advisor administration agreement, interest expense from financing arrangements and other indebtedness, and other expenses necessary for our operations. The management and incentive fees compensate FS/KKR Advisor for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments.
FS/KKR Advisor oversees our day-to-day operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities, and other administrative services. FS/KKR Advisor also performs, or oversees the performance of, our corporate operations and required administrative services, which includes being responsible for the financial records that we are required to maintain and preparing reports for our stockholders and reports filed with the SEC. In addition, FS/KKR Advisor assists us in calculating our net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others.
Pursuant to the FS/KKR Advisor administration agreement, we reimburse FS/KKR Advisor for expenses necessary to perform services related to our administration and operations, including FS/KKR Advisor’s allocable portion of the compensation and related expenses of certain personnel of FS Investments and KKR Credit providing administrative services to us on behalf of FS/KKR Advisor. We reimburse FS/KKR Advisor no less than quarterly for all costs and expenses incurred by FS/KKR Advisor in performing its obligations and providing personnel and facilities under the FS/KKR administration agreement. FS/KKR Advisor allocates the cost of such services to us based on factors such as total assets, revenues, time allocations and/or other reasonable metrics. Our board of directors reviews the methodology employed in determining how the expenses are allocated to us and the proposed allocation of administrative expenses among us and certain affiliates of FS/KKR Advisor. Our board of directors then assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared to the estimated cost to us of obtaining similar services from third-party service providers known to be available. In addition, our board of directors considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, our board of directors compares the total amount paid to FS/KKR Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs.
We bear all other expenses of our operations and transactions, including all other expenses incurred by FS/KKR Advisor in performing services for us and administrative personnel paid by FS Investments and KKR Credit.
In addition, we have contracted with State Street Bank and Trust Company to provide various accounting and administrative services, including, but not limited to, preparing preliminary financial information for review by FS/KKR Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
Pending Merger with CCT
On July 22, 2018, the Company, CCT, Merger Sub and FS/KKR Advisor entered into the Merger Agreement. The Merger Agreement provides that, subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into CCT, with CCT continuing as the surviving company and as a wholly-owned subsidiary of the Company and, immediately thereafter, CCT will merge with and into the Company, with the Company continuing as the surviving company. The parties to the Merger Agreement intend the Transaction to be treated as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended.
In the Merger, each share of CCT common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into a number of shares of the Company’s common stock equal to the Exchange Ratio. The Exchange Ratio will equal the net asset value per share of CCT common stock (determined no earlier than two business days prior to the closing date of the Merger), divided by the net asset value per share of the Company’s common stock (determined no earlier than two business days prior to the closing date of the Merger). No fractional shares of the Company’s common stock will be issued, and holders of CCT common stock will receive cash in lieu of fractional shares.
The Merger Agreement contains representations, warranties and covenants, including, among others, covenants relating to the operation of each of the Company’s and CCT’s businesses during the period prior to the closing of the Merger. The Company and CCT have agreed to convene and hold meetings of their stockholders for the purpose of obtaining the required approvals of the Company’s and CCT’s stockholders, respectively, and have agreed to recommend that their stockholders approve their respective proposals.
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The Merger Agreement provides that each of the Company and CCT may not solicit proposals relating to alternative transactions, or, subject to certain exceptions, enter into discussions or negotiations or provide information in connection with any proposal for an alternative transaction. However, each of the Company’s board of directors and the CCT board of directors may, subject to certain conditions and in some instances payment of a termination fee of approximately $75,200, change its recommendation to their respective stockholders, terminate the Merger Agreement and enter into an agreement with respect to a superior alternative proposal if it determines in its reasonable good faith judgment, after consultation with its outside legal counsel, that the failure to take such action would be reasonably likely to breach its standard of conduct under applicable law (taking into account any changes to the Merger Agreement proposed by CCT or the Company, as applicable).
Consummation of the Merger, which is currently anticipated to occur during the fourth quarter of 2018, is subject to certain closing conditions, including (1) requisite approvals of the Company’s stockholders and CCT stockholders, (2) the absence of certain legal impediments to the consummation of the Merger, (3) effectiveness of the registration statement for the Company’s common stock to be issued as consideration in the Merger, (4) subject to certain exceptions, the accuracy of the representations and warranties and compliance with the covenants of each party to the Merger Agreement and (5) required regulatory approvals (including expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended).
The Merger Agreement also contains certain termination rights in favor of the Company and CCT, including if the Merger is not completed on or before July 22, 2019 or if the requisite approvals of the Company’s stockholders or CCT stockholders are not obtained. The Merger Agreement also provides that, upon the termination of the Merger Agreement under certain circumstances, the Company may be required to pay CCT, or CCT may be required to pay the Company, a termination fee of approximately $75,200.
Portfolio Investment Activity for the Three and Nine Months Ended September 30, 2018 and for the Year Ended December 31, 2017
Total Portfolio Activity
The following tables present certain selected information regarding our portfolio investment activity for the three and nine months ended September 30, 2018:
Net Investment Activity
Sales and Repayments
Net Portfolio Activity
New Investment Activity by Asset Class
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The following table summarizes the composition of our investment portfolio at cost and fair value as of September 30, 2018 and December 31, 2017:
The following table presents certain selected information regarding the composition of our investment portfolio as of September 30, 2018 and December 31, 2017:
Number of Portfolio Companies
% Variable Rate (based on fair value)
% Fixed Rate (based on fair value)
% Income Producing Equity/Other Investments (based on fair value)
% Non-Income Producing Equity/Other Investments (based on fair value)
Average Annual EBITDA of Portfolio Companies
Weighted Average Purchase Price of Debt Investments (as a % of par)
% of Investments on Non-Accrual (based on fair value)
Gross Portfolio Yield Prior to Leverage (based on amortized cost)
Gross Portfolio Yield Prior to Leverage (based on amortized cost)—Excluding Non-Income Producing Assets
For the nine months ended September 30, 2018, our total return based on net asset value was (0.97)% and our total return based on market value was 3.47%. For the year ended December 31, 2017, our total return based on net asset value was 7.97% and our total return based on market value was (21.39)%.
Our estimated gross portfolio yield may be higher than an investor’s yield on an investment in shares of our common stock. Our estimated gross portfolio yield does not reflect operating expenses that may be incurred by us. In addition, our estimated gross portfolio yield and total return figures disclosed above do not consider the effect of any sales commissions or charges that may be incurred in connection with the sale of shares of our common stock. Our estimated gross portfolio yield and total return based on net asset value do not represent actual investment returns to stockholders. Our estimated gross portfolio yield and total return figures are subject to change and, in the future, may be greater or less than the rates set forth above. See the section entitled “Item 1A. Risk Factors” in our annual report on Form10-K for the year ended December 31, 2017 for a discussion of the uncertainties, risks and assumptions associated with these statements. See footnotes 6 and 7 to the table included in Note 10 to our unaudited consolidated financial statements included herein for information regarding the calculation of our total return based on net asset value and total return based on market value, respectively.
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Direct Originations
The following tables present certain selected information regarding our direct originations for the three and nine months ended September 30, 2018:
New Direct Originations
Total Commitments (including unfunded commitments)
Exited Investments (including partial paydowns)
Net Direct Originations
New Direct Originations by Asset Class
(including unfunded commitments)
Average New Direct Origination Commitment Amount
Weighted Average Maturity for New Direct Originations
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of New Direct Originations Funded during Period
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of New Direct Originations Funded during Period—Excluding Non-Income Producing Assets
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Direct Originations Exited during Period
The following table presents certain selected information regarding our direct originations as of September 30, 2018 and December 31, 2017:
Characteristics of All Direct Originations held in Portfolio
Average Leverage Through Tranche of Portfolio Companies—Excluding Equity/Other and Collateralized Securities
% of Investments on Non-Accrual
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations—Excluding Non-Income Producing Assets
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Portfolio Composition by Strategy
The table below summarizes the composition of our investment portfolio by strategy and enumerates the percentage, by fair value, of the total portfolio assets in such strategies as of September 30, 2018 and December 31, 2017:
Opportunistic
Broadly Syndicated/Other
See Note 6 to our unaudited consolidated financial statements included herein for additional information regarding the composition of our investment portfolio by industry classification.
Portfolio Asset Quality
In addition to various risk management and monitoring tools, FS/KKR Advisor uses, and FB Advisor historically used, an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. FS/KKR Advisor uses, and FB Advisor historically used, an investment rating scale of 1 to 5. The following is a description of the conditions associated with each investment rating:
Summary Description
The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of September 30, 2018 and December 31, 2017:
Investment Rating
The amount of the portfolio in each grading category may vary substantially from period to period resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment and exit activities. In addition, changes in the grade of investments may be made to reflect our expectation of performance and changes in investment values.
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Results of Operations
Comparison of the Three and Nine Months Ended September 30, 2018 and September 30, 2017
Our investment income for the three and nine months ended September 30, 2018 and 2017 was as follows:
Total investment income(1)
Such revenues represent $78,328 and $91,979 of cash income earned as well as $16,191 and $11,712 in non-cash portions relating to accretion of discount and PIK interest for the three months ended September 30, 2018 and 2017, respectively, and represent $247,710 and $275,583 of cash income earned as well as $43,402 and $32,867 in non-cash portions relating to accretion of discount and PIK interest for the nine months ended September 30, 2018 and 2017, respectively. Cash flows related to such non-cash revenues may not occur for a number of reporting periods or years after such revenues are recognized.
The level of interest income we receive is generally related to the balance of income-producing investments, multiplied by the weighted average yield of our investments. Fee income is transaction based, and typically consists of amendment and consent fees, prepayment fees, structuring fees and other non-recurring fees. As such, fee income is generally dependent on new direct origination investments and the occurrence of events at existing portfolio companies resulting in such fees.
The decrease in interest and fee income during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 can be primarily attributed to the placement of certain assets onnon-accrual and net sales and repayment activity during the three months ended September 30, 2018. The increase in PIK interest income during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 was primarily due to an increase in LIBOR.
The decrease in interest and fee income during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 can be primarily attributed to the placement of certain assets on non-accrual and net sales and repayment activity during the nine months ended September 30, 2018 and the repayment of certain large investments during the nine months ended September 30, 2017. The increase in PIK interest income during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to the restructuring of certain assets into assets with a higher PIK interest rate and an increase in LIBOR.
The increase in dividend income during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to a one-time dividend paid in respect of one of our investments during the nine months ended September 30, 2018.
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Our operating expenses for the three and nine months ended September 30, 2018 and 2017 were as follows:
Management fees
Subordinated income incentive fees
Interest expense
Expenses associated with our independent audit and related fees
Legal fees
Printing fees
Stock transfer agent fees
Other
Management fee waiver
Total net expenses
The following table reflects selected expense ratios as a percent of average net assets for the three and nine months ended September 30, 2018 and 2017:
Ratio of operating expenses to average net assets
Ratio of management fee waiver to average net assets(1)
Ratio of net operating expenses to average net assets
Ratio of incentive fees and interest expense to average net assets(1)
Ratio of net operating expenses, excluding certain expenses, to average net assets
Ratio data may be rounded in order to recompute the ending ratio of net operating expenses to average net assets or net operating expenses, excluding certain expenses, to average net assets.
Incentive fees and interest expense, among other things, may increase or decrease our expense ratios relative to comparative periods depending on portfolio performance and changes in amounts outstanding under our financing arrangements and benchmark interest rates such as LIBOR, among other factors.
Net Investment Income
Our net investment income totaled $56,082 ($0.23 per share) and $50,648 ($0.21 per share) for the three months ended September 30, 2018 and 2017, respectively. The increase in net investment income can be attributed primarily to the reduction of the subordinated income incentive fee and management fee, which was partially offset by lower interest income during the three months ended September 30, 2018 as discussed above.
Our net investment income totaled $152,584 ($0.63 per share) and $149,698 ($0.61 per share) for the nine months ended September 30, 2018 and 2017, respectively. The increase in net investment income can be attributed primarily to the reduction of the management fee and subordinated income incentive fee, which was partially offset by lower interest and fee income during the nine months ended September 30, 2018 as discussed above.
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Net Realized Gains or Losses
Our net realized gains (losses) on investments and foreign currency for the three and nine months ended September 30, 2018 and 2017 were as follows:
Net realized gain (loss) on investments(1)
Total net realized gain (loss)
We sold investments and received principal repayments, respectively, of $133,214 and $90,205 during the three months ended September 30, 2018 and $41,655 and $183,828 during the three months ended September 30, 2017. We sold investments and received principal repayments, respectively, of $301,975 and $487,642 during the nine months ended September 30, 2018 and $259,525 and $640,835 during the nine months ended September 30, 2017.
Net Change in Unrealized Appreciation (Depreciation)
Our net change in unrealized appreciation (depreciation) on investments, secured borrowing and unrealized gain (loss) on foreign currency for the three and nine months ended September 30, 2018 and 2017 were as follows:
Net change in unrealized appreciation (depreciation) on investments
Net change in unrealized appreciation (depreciation) on secured borrowing
Total net change in unrealized appreciation (depreciation)
During the three and nine months ended September 30, 2018, the net change in unrealized appreciation (depreciation) was driven primarily by lower valuations in a few select investments.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the three months ended September 30, 2018, the net decrease in net assets resulting from operations was $11,340 ($0.05 per share) compared to a net increase in net assets resulting from operations of $85,398 ($0.35 per share) during the three months ended September 30, 2017.
For the nine months ended September 30, 2018, the net decrease in net assets resulting from operations was $29,753 ($0.12 per share) compared to a net increase in net assets resulting from operations of $167,233 ($0.68 per share) during the nine months ended September 30, 2017.
Financial Condition, Liquidity and Capital Resources
As of September 30, 2018, we had $99,965 in cash and foreign currency, which we or our wholly-owned financing subsidiaries held in custodial accounts, and $632,959 in borrowings available under our financing arrangements, subject to borrowing base and other limitations. As of September 30, 2018, we also had broadly syndicated investments and opportunistic investments that could be sold to create additional liquidity. As of September 30, 2018, we had seventeen unfunded debt investments with aggregate unfunded commitments of $178,424 and one unfunded commitment to purchase up to $71 in shares of preferred stock. We maintain sufficient cash on hand, available borrowings and liquid securities to fund such unfunded commitments should the need arise.
We currently generate cash primarily from cash flows from fees, interest and dividends earned from our investments, as well as principal repayments and proceeds from sales of our investments. To seek to enhance our returns, we also employ
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leverage as market conditions permit and at the discretion of FS/KKR Advisor, but in no event will leverage employed exceed 50% of the value of our assets, as required by the 1940 Act. See “ —Financing Arrangements.”
Prior to investing in securities of portfolio companies, we invest the cash received from fees, interest and dividends earned from our investments and principal repayments and proceeds from sales of our investments primarily in cash, cash equivalents, including money market funds, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, consistent with our BDC election and our election to be taxed as a RIC.
Financing Arrangements
The following table presents summary information with respect to our outstanding financing arrangements as of September 30, 2018:
Type of Arrangement
See Note 8 to our unaudited consolidated financial statements included herein for additional information regarding our financing arrangements.
RIC Status and Distributions
We have elected to be subject to tax as a RIC under Subchapter M of the Code. In order to qualify for RIC tax treatment, we must, among other things, make distributions of an amount at least equal to 90% of our investment company taxable income, determined without regard to any deduction for distributions paid, each tax year. As long as the distributions are declared by the later of the fifteenth day of the ninth month following the close of a tax year or the due date of the tax return for such tax year, including extensions, distributions paid up to twelve months after the current tax year can be carried back to the prior tax year for determining the distributions paid in such tax year. We intend to make sufficient distributions to our stockholders to qualify for and maintain our RIC tax status each tax year. We are also subject to a 4% nondeductible federal excise taxes on certain undistributed income unless we make distributions in a timely manner to our stockholders generally of an amount at least equal to the sum of (1) 98% of our net ordinary income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains in excess of capital losses, or “capital gain net income” (adjusted for certain ordinary losses), for the one-year period ending October 31 of that calendar year and (3) any net ordinary income and capital gain net income for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax. Any distribution declared by us during October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. stockholders, on December 31 of the calendar year in which the distribution was declared. We can offer no assurance that we will achieve results that will permit us to pay any cash distributions. If we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings.
Subject to applicable legal restrictions and the sole discretion of our board of directors, we intend to authorize, declare and pay regular cash distributions on a quarterly basis. We will calculate each stockholder’s specific distribution amount for the period using record and declaration dates and each stockholder’s distributions will begin to accrue on the date that shares of our
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common stock are issued to such stockholder. From time to time, we may also pay special interim distributions in the form of cash or shares of our common stock at the discretion of our board of directors. On November 1, 2018, the Company’s board of directors declared a regular quarterly cash distribution of $0.19 per share, which will be paid on or about January 2, 2019 to stockholders of record as of the close of business on December 12, 2018. On October 12, 2018, the Company’s board of directors declared a special distribution of $0.09 per share, which will be paid on or about December 3, 2018 to stockholders of record as of the close of business on November 19, 2018. This special distribution equates to the cumulative amount of net investment income earned during the twelve months following October 1, 2017 that was in excess of $0.76 per share. The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of our board of directors.
During certain periods, our distributions may exceed our earnings. As a result, it is possible that a portion of the distributions we make may represent a return of capital. A return of capital generally is a return of a stockholder’s investment rather than a return of earnings or gains derived from our investment activities. Each year a statement on Form 1099-DIV identifying the sources of the distributions will be mailed to our stockholders. No portion of the distributions paid during the nine months ended September 30, 2018 or 2017 represented a return of capital.
We intend to continue to make our regular distributions in the form of cash, out of assets legally available for distribution, except for those stockholders who receive their distributions in the form of shares of our common stock under the DRP. Any distributions reinvested under the plan will nevertheless remain taxable to a U.S. stockholder.
The following table reflects the cash distributions per share that we have declared on our common stock during the nine months ended September 30, 2018 and 2017:
See Note 5 to our unaudited consolidated financial statements included herein for additional information regarding our distributions, including a reconciliation of our GAAP-basis net investment income to our tax-basis net investment income for the nine months ended September 30, 2018 and 2017.
Critical Accounting Policies
Our financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the financial statements, management has utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our operating plans, we will describe additional critical accounting policies in the notes to our future financial statements in addition to those discussed below.
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Valuation of Portfolio Investments
We determine the net asset value of our investment portfolio each quarter. Securities are valued at fair value as determined in good faith by our board of directors. In connection with that determination, FS/KKR Advisor provides our board of directors with portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party valuation services.
Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure, or ASC Topic 820, issued by the FASB, clarifies the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. ASC Topic 820 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
With respect to investments for which market quotations are not readily available, we undertake a multi-step valuation process each quarter, as described below:
our quarterly fair valuation process begins with FS/KKR Advisor’s management team reviewing and documenting valuations of each portfolio company or investment, which valuations may be obtained from an independent third-party valuation service, if applicable;
FS/KKR Advisor’s management team then provides the valuation committee with the preliminary valuations for each portfolio company or investment;
preliminary valuations are then discussed with the valuation committee;
our valuation committee reviews the preliminary valuations and FS/KKR Advisor’s management team, together with our independent third-party valuation services, if applicable, supplement the preliminary valuations to reflect any comments provided by the valuation committee;
following its review, the valuation committee will recommend that our board of directors approve our fair valuations; and
our board of directors discusses the valuations and determines the fair value of each such investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of FS/KKR Advisor, the valuation committee and any independent third-party valuation services, if applicable.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on our consolidated financial statements. In making its determination of fair value, our board of directors may use any approved independent third-party pricing or valuation services. However, our board of directors is not required to determine fair value in accordance with the valuation provided by any single source, and may use any relevant data, including information obtained from FS/KKR Advisor or any approved independent third-party valuation or pricing service that our board of directors deems to be reliable in determining fair value under the circumstances. Below is a description of factors that FS/KKR Advisor’s management team, any approved independent third-party valuation services and our board of directors may consider when determining the fair value of our investments.
Valuation of fixed income investments, such as loans and debt securities, depends upon a number of factors, including prevailing interest rates for like securities, expected volatility in future interest rates, call features, put features and other relevant terms of the debt. For investments without readily available market prices, we may incorporate these factors into discounted cash flow models to arrive at fair value. Other factors that may be considered include the borrower’s ability to adequately service its debt, the fair market value of the borrower in relation to the face amount of its outstanding debt and the quality of collateral securing our debt investments.
For convertible debt securities, fair value generally approximates the fair value of the debt plus the fair value of an option to purchase the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
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Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Our board of directors, in its determination of fair value, may consider various factors, such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. All of these factors may be subject to adjustments based upon the particular circumstances of a portfolio company or our actual investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, restructuring or other related items.
FS/KKR Advisor’s management team, any approved independent third-party valuation services and our board of directors may also consider private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio companies or industry practices in determining fair value. FS/KKR Advisor’s management team, any approved independent third-party valuation services and our board of directors may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, and may apply discounts or premiums, where and as appropriate, due to the higher (or lower) financial risk and/or the smaller size of portfolio companies relative to comparable firms, as well as such other factors as our board of directors, in consultation with FS/KKR Advisor’s management team and any approved independent third-party valuation services, if applicable, may consider relevant in assessing fair value. Generally, the value of our equity interests in public companies for which market quotations are readily available is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.
When we receive warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security, the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity securities received at the time of origination. Our board of directors subsequently values these warrants or other equity securities received at their fair value.
The fair values of our investments are determined in good faith by our board of directors. Our board of directors is responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and consistently applied valuation process. Our board of directors has delegated day-to-day responsibility for implementing our valuation policy to FS/KKR Advisor’s management team, and has authorized FS/KKR Advisor’s management team to utilize independent third-party valuation and pricing services that have been approved by our board of directors. The valuation committee is responsible for overseeing FS/KKR Advisor’s implementation of the valuation process.
See Note 7 to our unaudited consolidated financial statements included herein for additional information regarding the fair value of our financial instruments.
Revenue Recognition
Security transactions are accounted for on the trade date. We record interest income on an accrual basis to the extent that we expect to collect such amounts. We record dividend income on the ex-dividend date. We do not accrue as a receivable interest or dividends on loans and securities if we have reason to doubt our ability to collect such income. Our policy is to place investments on non-accrual status when there is reasonable doubt that interest income will be collected. We consider many factors relevant to an investment when placing it on or removing it from non-accrual status including, but not limited to, the delinquency status of the investment, economic and business conditions, the overall financial condition of the underlying investment, the value of the underlying collateral, bankruptcy status, if any, and any other facts or circumstances relevant to the investment. If there is reasonable doubt that we will receive any previously accrued interest, then the interest income will be written-off. Payments received on non-accrual investments may be recognized as income or applied to principal depending upon the collectability of the remaining principal and interest. Non-accrual investments may be restored to accrual status when principal and interest become current and are likely to remain current based on our judgment.
Loan origination fees, original issue discount and market discount are capitalized and we amortize such amounts as interest income over the respective term of the loan or security. Upon the prepayment of a loan or security, any unamortized loan origination fees and original issue discount are recorded as interest income. We record prepayment premiums on loans and securities as fee income when we receive such amounts.
Effective January 1, 2018, we adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, using the cumulative effect method applied to in-scope contracts with customers that have not been completed as of the date of adoption. We did not identify any in-scope contracts that had not been completed as of the date of adoption and, as a result, we did not recognize a cumulative effect on stockholders’ equity in connection with the adoption of the new revenue recognition guidance.
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The new revenue recognition guidance applies to all entities and all contracts with customers to provide goods or services in the ordinary course of business, excluding, among other things, financial instruments as well as certain other contractual rights and obligations. Under the new revenue recognition guidance, which we have applied to all new in-scope contracts as of the date of adoption, structuring and other upfront fees are recognized as revenue based on the transaction price as the performance obligation is fulfilled. The related performance obligation consists of structuring activities and is satisfied over time as such activities are performed. Consideration is variable and is constrained from being included in the transaction price until the uncertainty associated with the variable consideration is resolved, typically as of the trade date of the related transaction. Payment is typically due on the settlement date of the related transaction.
For the nine months ended September 30, 2018, we recognized $4,352 in structuring fee revenue under the new revenue recognition guidance and included such revenue in the fee income line item on our consolidated statement of operations. Comparative periods are presented in accordance with revenue recognition guidance effective prior to January 1, 2018, under which we recorded structuring and other non-recurring upfront fees as income when earned. We have determined that the adoption of the new revenue recognition guidance did not have a material impact on the amount of revenue recognized for the nine months ended September 30, 2018.
Net Realized Gains or Losses, Net Change in Unrealized Appreciation or Depreciation and Net Change in Unrealized Gains or Losses on Foreign Currency
Gains or losses on the sale of investments are calculated by using the specific identification method. We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized fees. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized gains or losses when gains or losses are realized. Net change in unrealized gains or losses on foreign currency reflects the change in the value of receivables or accruals during the reporting period due to the impact of foreign currency fluctuations.
We follow the guidance in ASC Topic 860 when accounting for loan participations and other partial loan sales. This guidance requires a participation or other partial loan sale to meet the definition of a participating interest, as defined in the guidance, in order for sale treatment to be allowed. Participations or other partial loan sales which do not meet the definition of a participating interest remain on our consolidated balance sheets and the proceeds are recorded as a secured borrowing until the participation or other partial loan sale meets the definition. Secured borrowings are carried at fair value to correspond with the related investments, which are carried at fair value.
Uncertainty in Income Taxes
We evaluate our tax positions to determine if the tax positions taken meet the minimum recognition threshold in connection with accounting for uncertainties in income tax positions taken or expected to be taken for the purposes of measuring and recognizing tax benefits or liabilities in our consolidated financial statements. Recognition of a tax benefit or liability with respect to an uncertain tax position is required only when the position is “more likely than not” to be sustained assuming examination by taxing authorities. We recognize interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in our consolidated statements of operations. During the nine months ended September 30, 2018 and 2017, we did not incur any interest or penalties.
See Note 2 to our unaudited consolidated financial statements included herein for additional information regarding our significant accounting policies.
Contractual Obligations
We have entered into an agreement with FS/KKR Advisor to provide us with investment advisory and administrative services. Payments for investment advisory services under the FS/KKR Advisor investment advisory agreement are equal to (a) an annual base management fee based on the average weekly value of our gross assets and (b) an incentive fee based on our performance. FS/KKR Advisor is reimbursed for administrative expenses incurred on our behalf. See Note 4 to our unaudited consolidated financial statements included herein and “—Related Party Transactions—Compensation of the Investment Adviser” for a discussion of these agreements and for the amount of fees and expenses accrued under similar agreements with FB Advisor during the nine months ended September 30, 2018 and 2017.
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A summary of our significant contractual payment obligations for the repayment of outstanding indebtedness at September 30, 2018 is as follows:
Locust Street Credit Facility(2)
Senior Secured Revolving Credit Facility(3)
Amounts outstanding under the financing arrangements will mature, and all accrued and unpaid interest thereunder will be due and payable, on the maturity date.
At September 30, 2018, no amounts remained unused under the financing arrangement.
At September 30, 2018, $632,959 remained unused under the Senior Secured Revolving Credit Facility. Amounts outstanding under the Senior Secured Revolving Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on August 9, 2023. Amount includes borrowing in Euros and Canadian dollars. Euro balance outstanding of €26,000 has been converted to U.S. dollars at an exchange rate of €1.00 to $1.16 as of September 30, 2018 to reflect total amount outstanding in U.S. dollars. Canadian dollar balance outstanding of CAD $28,200 has been converted to U.S dollars at an exchange rate of CAD $1.00 to $0.77 as of September 30, 2018 to reflect total amount outstanding in U.S. dollars.
Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.
Quantitative and Qualitative Disclosures About Market Risk.
We are subject to financial market risks, including changes in interest rates. As of September 30, 2018, 72.2% of our portfolio investments (based on fair value) paid variable interest rates, 17.3% paid fixed interest rates, 2.5% were income producing equity or other investments, and the remaining 8.0% consisted of non-incomeproducing equity or other investments. A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to any variable rate investments we hold and to declines in the value of any fixed rate investments we hold. To the extent that a substantial portion of our investments may be in variable rate investments, an increase in interest rates beyond this threshold would make it easier for us to meet or exceed the hurdle rate applicable to the subordinated incentive fee on income, and may result in a substantial increase in our net investment income and to the amount of incentive fees payable to FS/KKR Advisor with respect to our increased pre-incentive fee net investment income.
Pursuant to the terms of the Locust Street credit facility and the Senior Secured Revolving credit facility, we borrow at a floating rate based on a benchmark interest rate. Under the indenture governing the 4.000% notes, the 4.250% notes and the 4.750% notes, we pay interest to the holders of such notes at a fixed rate. To the extent that any present or future credit facilities or other financing arrangements that we or any of our subsidiaries enter into are based on a floating interest rate, we will be subject to risks relating to changes in market interest rates. In periods of rising interest rates when we or our subsidiaries have such debt outstanding, or financing arrangements in effect, our interest expense would increase, which could reduce our net investment income, especially to the extent we hold fixed rate investments.
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The following table shows the effect over a twelve month period of changes in interest rates on our interest income, interest expense and net interest income, assuming no changes in the composition of our investment portfolio, including the accrual status of our investments, and our financing arrangements in effect as of September 30, 2018 (dollar amounts are presented in thousands):
Basis Point Change in Interest Rates
Down 100 basis points
No change
Up 100 basis points
Up 300 basis points
Up 500 basis points
Assumes no defaults or prepayments by portfolio companies over the next twelve months.
We expect that our long-term investments will be financed primarily with equity and debt. If deemed prudent, we may use interest rate risk management techniques in an effort to minimize our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. During the nine months ended September 30, 2018 and 2017, we did not engage in interest rate hedging activities.
In addition, we may have risk regarding portfolio valuation. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Valuation of Portfolio Investments.”
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2018.
Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the three month period ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Legal Proceedings.
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of any legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material adverse effect upon our financial condition or results of operations.
Risk Factors.
You should carefully consider the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2017, as supplemented by our quarterly report on Form 10-Q for the quarter ended March 31, 2018, and in the joint proxy statement/prospectus for the Merger (filed on September 27, 2018).
Unregistered Sales of Equity Securities and Use of Proceeds.
In February 2018, our board of directors authorized a stock repurchase program. Under the program, we were permitted to repurchase up to $50 million in the aggregate of our outstanding common stock in the open market at prices below the then-current net asset value per share. We repurchased a total of 6,571,347 shares our common stock at an average price per share (inclusive of commissions paid) of $7.61 (totaling $50 million). The program has terminated since the aggregate repurchase amount that was approved by our board of directors has been expended.
Repurchases of our common stock under our stock repurchase program for the periods below were as follows (dollar amounts in the table below are presented in thousands, except for share and per share amounts).
Period
July 1, 2018 through July 31, 2018
August 1, 2018 through August 31, 2018
September 1, 2018 through September 30, 2018
Amount includes commissions paid.
Defaults upon Senior Securities.
Not applicable.
Mine Safety Disclosures.
Other Information.
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Exhibits
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Filed herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this quarterly report to be signed on its behalf by the undersigned, thereunto duly authorized on November 7, 2018.
/s/ Michael C. Forman
/s/ William Goebel
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