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ACAS > SEC Filings for ACAS > Form 10-Q on 11-Aug-2014All Recent SEC Filings

Show all filings for AMERICAN CAPITAL, LTD

Form 10-Q for AMERICAN CAPITAL, LTD


11-Aug-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (in millions, except per share data)

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of American Capital's financial statements with a narrative from the perspective of management. Our MD&A is presented in four sections:

•Executive Overview

•Results of Operations

•Financial Condition, Liquidity and Capital Resources

•Forward-Looking Statements

EXECUTIVE OVERVIEW

American Capital, Ltd. (which is referred to throughout this report as "American Capital", "we", "our" and "us") is a publicly traded global asset manager and private equity firm. We invest in private equity, private debt, private real estate securities, technology investments, special situation investments and funds managed by us. We provide investors the opportunity to participate in the asset management and private equity industry through an investment in our publicly traded stock. Our primary business objectives are to increase our funds under management and our net earnings and net asset value ("NAV") by making investments with attractive current yields and/or potential for equity appreciation and realized gains.
We primarily invest in senior and mezzanine debt and equity in buyouts of private companies sponsored by us ("American Capital One Stop Buyouts®") or sponsored by other private equity funds and provide capital directly to early stage and mature private and small public companies ("Sponsor Finance Investments"). We also invest in first and second lien floating rate loans to large-market U.S. based companies ("Senior Floating Rate Loans") and structured finance investments ("Structured Products"), including collateralized loan obligation ("CLO") securities and commercial mortgages and commercial mortgage backed securities ("CMBS").
We are also a fund manager with $83 billion of total assets under management (including levered assets) as of June 30, 2014, which includes $6 billion of total assets on our balance sheet and $77 billion of third-party assets under management, $13 billion of which are third-party earning assets under management for which we are paid a management fee. Our fund management is conducted through our wholly-owned portfolio company, American Capital Asset Management, LLC ("ACAM"). ACAM manages the following funds:
• European Capital Limited ("European Capital")

• American Capital Agency Corp. ("AGNC")

• American Capital Mortgage Investment Corp. ("MTGE")

• American Capital Senior Floating, Ltd. ("ACSF")

• American Capital Equity I, LLC ("ACE I")

• American Capital Equity II, LP ("ACE II")

• ACAS CLO 2007-1, Ltd. ("ACAS CLO 2007-1")

• ACAS CLO 2012-1, Ltd. ("ACAS CLO 2012-1")

• ACAS CLO 2013-1, Ltd. ("ACAS CLO 2013-1")

• ACAS CLO 2013-2, Ltd. ("ACAS CLO 2013-2")

• ACAS CLO 2014-1, Ltd. ("ACAS CLO 2014-1")

ACAM will also manage American Capital Equity III, LP ("ACE III"), a $1.1 billion U.S. lower middle market private equity fund that entered into definitive agreements with a group of investors on April 28, 2014 and is expected to close in the third quarter of 2014.
As a business development company ("BDC"), we are required by law to make significant managerial assistance available to most of our portfolio companies. Such assistance typically involves providing guidance and counsel concerning the management, operations and business objectives and policies of the portfolio company to its management and board of directors, including participating on the company's board of directors. We have an operations team with significant turnaround and bankruptcy


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experience that assists our investment professionals in providing intensive operational and managerial assistance to our portfolio companies. As of June 30, 2014, we had board seats at 47 companies in our investment portfolio and had board observation rights at certain other companies. Providing assistance to the companies in our investment portfolio serves as an opportunity for us to maximize their value.
American Capital Investment Portfolio
Portfolio Composition

Our investments can be divided into the following six business lines:
(i) American Capital One Stop Buyouts®, (ii) Sponsor Finance Investments, (iii) European Capital, (iv) Asset Management, (v) Structured Products and (vi) Senior Floating Rate Loans. As of June 30, 2014, we had investments totaling $5.6 billion and $5.5 billion at cost basis and fair value, respectively. As of June 30, 2014, our ten largest investments had a cost basis and fair value totaling $2.6 billion and $3.0 billion, respectively, or 46% of total assets at fair value, and are as follows (in millions):

Company                Business Line             Industry                 Cost Basis       Fair Value
American Capital       Asset Management          Capital Markets        $        189     $        925
Asset Management,
LLC
European Capital       European Capital          Diversified                     959              827
Limited                                          Financial Services
CML Pharmaceuticals,   American Capital One      Life Sciences Tools             443              343
Inc.                   Stop Buyouts®             & Services
Mirion Technologies,   American Capital One      Electrical Equipment             92              155
Inc.(1)                Stop Buyouts®
The Tensar             Sponsor Finance           Construction &                  159              154
Corporation(2)         Investments               Engineering
Affordable Care        American Capital One      Health Care                      90              154
Holding Corp.(1)       Stop Buyouts®             Providers & Services
SMG Holdings,          American Capital One      Hotels, Restaurants             152              115
Inc.(1)                Stop Buyouts®             & Leisure
WRH, Inc.(1)           American Capital One      Life Sciences Tools             344              111
                       Stop Buyouts®             & Services
Soil Safe Holdings,    Sponsor Finance           Professional                    101               98
LLC                    Investments               Services
Unwired Holdings,      American Capital One      Electronic
Inc.                   Stop Buyouts®             Equipment,
                                                 Instruments &
                                                 Components                       57               82
Total                                                                   $      2,586     $      2,964


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(1) Potential exits as part of the ACE III transaction. See Note 12 to our interim consolidated financial statements in this Form 10-Q.

(2) The Tensar Corporation was exited on July 9, 2014.


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The composition of our investment portfolio as of June 30, 2014, at fair value, as a percentage of total investments based on these different business lines, is shown below:

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The following tables set forth the aggregate dollar amount of new investments by security type, use and business line (in millions). The amounts of our new investments include both funded and unfunded commitments as of the investment date:

                                 Three Months Ended               Six Months Ended
                                      June 30,                        June 30,
Security Type                       2014             2013          2014           2013
Senior Debt                $       674              $  28    $       938         $ 108
Structured Products                 73                 13            112            13
Common Equity                       63                  4             76             6
Mezzanine Debt                       2                  -              6             -
Preferred Equity                     1                  5              2            21
    Total by security type $       813              $  50    $     1,134         $ 148


                                                          Three Months Ended             Six Months Ended
                                                               June 30,                      June 30,
Use                                                        2014          2013            2014            2013
Senior Floating Rate Loans                             $       579     $     -     $       778         $    -
Sponsor Finance Investments                                     99           2             161             31
Structured Products                                             73          13              92             13
Investments in ACAM and Fund Development                        50          12              84             12
American Capital One Stop Buyouts®                               -           -               -             27
Add-on financing for working capital in distressed
situations                                                       9           5              12              8
Add-on financing for growth and working capital                  3           6               7              9
Add-on financing for recapitalizations, not including
distressed investments                                           -           -               -             36
Add-on financing for purchase of debt of a portfolio
company                                                          -          12               -             12
    Total by use                                       $       813     $    50     $     1,134         $  148


                                                          Three Months Ended             Six Months Ended
                                                               June 30,                      June 30,
Business Line                                              2014          2013            2014            2013
Senior Floating Rate Loans                             $       579     $     -     $       778         $    -
Sponsor Finance Investments                                    108          14             172             75
Structured Products                                             73          13              92             13
Asset Management                                                50          12              84             12
American Capital One Stop Buyouts®                               3          11               8             48
    Total by business line                             $       813     $    50     $     1,134         $  148


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We received cash proceeds from realizations and repayments of portfolio investments by source and business line as follows (in millions):

                                                             Three Months Ended        Six Months Ended
                                                                  June 30,                 June 30,
Source                                                        2014         2013        2014         2013
Principal prepayments                                      $     185     $  115     $     201     $  263
Equity investments                                               142         18           466         78
Payment of accrued PIK notes and dividend and accreted OID        61          7           124         67
Scheduled principal amortization                                  19         10            38         19
Loan syndications and sales                                        1          -            21          4
Total by source                                            $     408     $  150     $     850     $  431



                                        Three Months Ended             Six Months Ended
                                             June 30,                      June 30,
Business Line                             2014            2013          2014           2013
American Capital One Stop Buyouts® $     282             $  85    $     348           $ 254
Structured Products                       42                 6           59              11
Sponsor Finance Investments               41                56           98             155
European Capital                          34                 -          138               -
Senior Floating Rate Loans                 8                 -            8               -
Asset Management                           1                 3          199              11
Total by business line             $     408             $ 150    $     850           $ 431

American Capital One Stop Buyouts®
In an American Capital One Stop Buyout®, we lend senior and mezzanine debt and make majority equity investments to finance our acquisition of an operating company through a change in control. A change in control transaction could be the result of a corporate divestiture, a sale by a private equity firm, a sale by a family-owned closely held business, going private transactions or ownership transitions. In addition, we may make additional add-on investments in our American Capital One Stop Buyouts® to finance strategic acquisitions, growth or for working capital.
Our ability to fund the entire capital structure is a competitive advantage in completing many middle market transactions. We sponsor American Capital One Stop Buyouts® in which we provide most, if not all, of the senior and mezzanine debt and equity financing in the transaction. For our American Capital One Stop Buyouts®, we typically fund all of the senior debt at closing. Currently, we intend to hold the senior debt of these controlled portfolio companies which will allow these controlled portfolio companies to pay cash dividends to their shareholders, including us. Generally, third-party senior debt limits the ability of our controlled portfolio companies to pay cash dividends to us. We will generally invest up to $750 million in a single American Capital One Stop Buyout®.
As of June 30, 2014, there were 35 companies in our American Capital One Stop Buyout® portfolio with a fair value and cost basis of $1.8 billion and $2.3 billion, respectively, with an average investment size of $53 million at fair value. As of June 30, 2014, our American Capital One Stop Buyout® portfolio consisted of $879 million and $961 million of debt and equity investments at fair value. As of June 30, 2014, the weighted average effective interest rate on the debt investments in this portfolio was 9.8%, which includes the impact of non-accruing loans, and our fully-diluted weighted average ownership interest in the equity investments in this portfolio was 63%. During the three and six months ended June 30, 2014, we recognized operating revenues from our American Capital One Stop Buyouts® portfolio totaling $51 million and $101 million, respectively.
There is generally no publicly available information about these companies and a primary or secondary market for the trading of these privately issued loans and equity securities generally does not exist. These investments have been historically exited through normal repayment, a change in control transaction or recapitalization of the portfolio company. Sponsor Finance Investments
The majority of the investments in our Sponsor Finance Investments portfolio were originated either to assist in the funding of change of control buyouts of privately held middle market companies sponsored by other private equity firms or to support the growth or recapitalization of an existing portfolio company. A change of control transaction could be the result of a corporate


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divestiture, a sale of a family-owned or closely-held business, a going private transaction, the sale by a private equity fund of a portfolio company or an ownership transition. In these transactions, we generally lend senior, mezzanine and unitranche debt and make minority equity co-investments in privately-held middle market companies. We will generally invest between $10 million and $150 million in a single Sponsor Finance Investment transaction. Generally, we make investments in companies that have a minimum earnings before interest, taxes, depreciation and amortization ("EBITDA") of $10 million.
Our senior loans may consist of first lien secured revolving credit facilities, first lien secured term loans, second lien secured term loans and unitranche loans. Our mezzanine loans may consist of secured and unsecured loans. Our loans typically mature in five to ten years and require monthly or quarterly interest payments at fixed rates or variable rates generally based on London Interbank Offered Rate ("LIBOR"), plus a margin. Certain of our loans permit the interest to be paid-in-kind by adding it to the outstanding loan balance and paid at maturity.
As of June 30, 2014, there were 44 companies in our Sponsor Finance Investment portfolio with a fair value and cost basis of $813 million and $906 million, respectively, with an average investment size of $18 million at fair value. As of June 30, 2014, our Sponsor Finance Investment portfolio consisted of $609 million and $204 million of debt and equity investments at fair value. As of June 30, 2014, the weighted average effective interest rate on the debt investments in this portfolio was 8.9%, which includes the impact of non-accruing loans, and our fully-diluted weighted average ownership interest in the equity investments in this portfolio was 37%. During the three and six months ended June 30, 2014, we recognized operating revenues from our Sponsor Finance Investment portfolio totaling $(1) million and $(2) million, respectively, primarily due to the net negative impact from non-accrual investments in 2014.
There is generally no publicly available information about these companies and a primary or secondary market for the trading of these privately issued loans and equity securities generally does not exist. These investments have been historically exited through normal repayment, a change in control transaction or recapitalization of the portfolio company. However, we may also sell our loans or equity investments in non-change of control transactions. Asset Management
Our fund management business is conducted through our wholly-owned portfolio company, ACAM and its consolidated subsidiaries. In general, subsidiaries of ACAM will enter into management agreements with each of its managed funds. As of June 30, 2014, our investment in ACAM was $189 million and $925 million at cost basis and fair value, respectively, or 17% of our total investments at fair value. As of June 30, 2014, ACAM's earning assets under management totaled $13 billion. As of June 30, 2014, ACAM had $77 billion of total assets under management (including levered assets), including $67 billion of total assets under management for AGNC and $7 billion of total assets under management for MTGE, which are publicly traded mortgage real estate investment trusts ("REITs"), and $0.3 billion of total assets under management for ACSF. We believe that having capital to incubate new funds to be managed by ACAM is a competitive advantage for our asset management business.
ACAM had over 115 employees as of June 30, 2014, including six investment teams with 55 investment professionals located in Bethesda (Maryland), New York, Annapolis (Maryland), London and Paris. We have entered into service agreements with ACAM to provide it with additional asset management and administrative services support. Through these agreements, we provide investment advisory and oversight services to ACAM, as well as access to our employees, infrastructure, business relationships, management expertise and capital raising capabilities. ACAM generally earns base management fees based on the shareholders' equity, total assets or the net cost basis of the funds under management and may earn incentive income, or a carried interest, based on the performance of the funds. In addition, American Capital or ACAM may invest directly into these funds and earn investment income from its investments in those funds. During the three and six months ended June 30, 2014, we recognized operating revenues from our investment in ACAM of $26 million and $49 million, respectively.


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The following table sets forth certain information with respect to ACAM's funds under management as of June 30, 2014:

                                                       Assets
                                                        under
       Fund             Fund type      Established   management    Investment types   Capital type
 European Capital    Private Equity       2005          $1.2          Senior and       Permanent
                          Fund                         Billion     Mezzanine Debt,
                                                                       Equity,
                                                                      Structured
                                                                       Products
       AGNC          Publicly Traded      2008          $66.9           Agency         Permanent
                      REIT - NASDAQ                    Billion        Securities
                         (AGNC)
       MTGE          Publicly Traded      2011          $7.0           Mortgage        Permanent
                      REIT - NASDAQ                    Billion       Investments
                         (MTGE)
       ACSF          Publicly Traded      2014          $0.3       Senior Floating     Permanent
                      BDC - NASDAQ                     Billion        Rate Loans
                         (ACSF)
      ACE I          Private Equity       2006          $0.4            Equity        Finite Life
                          Fund                         Billion
      ACE II         Private Equity       2007          $0.2            Equity        Finite Life
                          Fund                         Billion
    ACE III(1)       Private Equity       2014          $0.9            Equity        Finite Life
                          Fund                         Billion
 ACAS CLO 2007-1           CLO            2006          $0.4         Senior Debt      Finite Life
                                                       Billion
 ACAS CLO 2012-1           CLO            2012          $0.4         Senior Debt      Finite Life
                                                       Billion
 ACAS CLO 2013-1           CLO            2013          $0.4         Senior Debt      Finite Life
                                                       Billion
 ACAS CLO 2013-2           CLO            2013          $0.4         Senior Debt      Finite Life
                                                       Billion
ACAS CLO 2014-1(2)         CLO            2014          $0.6         Senior Debt      Finite Life
                                                       Billion


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(1) ACE III's closing is subject to regulatory approvals and other standard conditions that are expected to occur in the third quarter of 2014.

(2) ACAS CLO 2014-1 closed on the sale of $619 million of CLO bonds on July 9, 2014.

Recent Fund Development
ACSF is a BDC that invests primarily in first lien and second lien floating rate loans to large market, U.S. based companies and invests opportunistically in equity tranches of CLOs collateralized primarily by Senior Floating Rate Loans. On January 15, 2014, ACSF successfully completed its Initial Public Offering ("IPO") of ten million shares of common stock for proceeds of $150 million. Its shares are traded on The NASDAQ Global Select Market under the symbol "ACSF." ACAM earns a base management fee of 0.80% of ACSF's assets, as defined in ACSF's management agreement. In addition, ACAM also purchased 3% of the common stock of ACSF for $4.5 million.
ACAS CLO 2014-1 completed a $619 million securitization in July 2014 that invests in broadly syndicated commercial senior secured loans purchased in the primary and secondary markets. ACAM manages ACAS CLO 2014-1 in exchange for a base management fee of 0.50% of ACAS CLO 2014-1's assets and a 20% Carried Interest, subject to certain hurdles. A subsidiary of ACAM also purchased 60% of the non-rated equity tranche of subordinated notes in ACAS CLO 2014-1 for $31 million.
ACE III is a $1.1 billion U.S. lower middle market private equity fund that entered into definitive agreements with a group of investors on April 28, 2014 and is expected to close in the third quarter of 2014. ACAM will manage ACE III upon closing.
European Capital

European Capital is a wholly-owned investment fund incorporated in Guernsey and is managed by ACAM. European Capital invests in senior and mezzanine debt and equity in buyouts of private companies sponsored by European Capital ("European Capital One Stop Buyouts®"), Sponsor Finance Investments and provides capital directly to early stage and mature private and small public companies primarily in Europe. It primarily invests in senior and mezzanine debt and equity. As of June 30, 2014, European Capital had investments in 29 portfolio companies totaling $1,037 million at fair value, with an average investment size of $36 million, or 3.1% of its total assets. As of June 30, 2014, European Capital's five largest investments at fair value were $676 million, or 57% of its total assets.


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The composition of European Capital's investment portfolio by business line as of June 30, 2014, at fair value, as a percentage of its total investments, is shown below:

Business Line                       June 30, 2014
European Capital One Stop Buyouts®        51.4 %
Sponsor Finance Investments               46.7 %
Structured Products                        1.9 %
Total by business line                   100.0 %

As of June 30, 2014, all of European Capital's assets are invested in portfolio companies headquartered in countries with AA+ rating or better based on Standard & Poor's ratings. As of June 30, 2014, European Capital's NAV at fair value was $949 million and our investment in European Capital consisted of an equity investment with a cost basis and fair value of $959 million and $827 million, respectively. We valued our equity investment in European Capital below its NAV as a result of applying several discounts to its NAV in computing the fair value. See Note 3 to our interim consolidated financial statements in this Form 10-Q for further discussion of our valuation of European Capital. Structured Products
Our Structured Products portfolio is composed of investments in CLO and CMBS securities. As of June 30, 2014, over 90% of the fair value of this portfolio is invested in debt and equity tranches of CLOs that are generally collateralized by first and second lien floating rate loans.
As of June 30, 2014, there were 54 investments in our Structured Products portfolio with a fair value and cost basis of $338 million and $411 million, . . .

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