Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion is designed to provide a better understanding of our financial statements, including a brief discussion of our business, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the Unaudited Financial Statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q, and the Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended
December 31, 2012
. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Forward-Looking Statements
Some of the statements in this Quarterly Report constitute forward-looking statements because they relate to future events or our future performance or financial condition. Forward-looking statements may include, among other things, statements as to our future operating results, our business prospects and the prospects of our portfolio companies, the impact of the investments that we expect to make, the ability of our portfolio companies to achieve their objectives, our expected financings and investments, the adequacy of our cash resources and working capital, and the timing of cash flows, if any, from the operations of our portfolio companies. Words such as “expect,” “anticipate,” “target,” “goals,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “continue,” “forecast,” “may,” “should,” “potential,” variations of such words, and similar expressions indicate a forward-looking statement, although not all forward-looking statements include these words. Readers are cautioned that the forward-looking statements contained in this Quarterly Report are only predictions, are not guarantees of future performance, and are subject to risks, events, uncertainties and assumptions that are difficult to predict. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors discussed herein and in Item 1A entitled “Risk Factors” in Part I of our Annual Report on Form 10-K for the year ended
December 31, 2012
. Other factors that could cause actual results to differ materially include changes in the economy, risks associated with possible disruption due to terrorism in our operations or the economy generally, and future changes in laws or regulations and conditions in our operating areas. These statements are based on our current expectations, estimates, forecasts, information and projections about the industry in which we operate and the beliefs and assumptions of our management as of the date of this Quarterly Report. We assume no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless we are required to do so by law. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Overview of Our Business
We are a Maryland corporation which has elected to be treated and operates as an internally managed business development company, or BDC, under the Investment Company Act of 1940, or 1940 Act. Our wholly-owned subsidiaries, Triangle Mezzanine Fund LLLP, or Triangle SBIC, and Triangle Mezzanine Fund II LP, or Triangle SBIC II, are licensed as small business investment companies, or SBICs, by the United States Small Business Administration, or SBA. In addition, Triangle SBIC has also elected to be treated as a BDC under the 1940 Act. We, Triangle SBIC and Triangle SBIC II invest primarily in debt instruments, equity investments, warrants and other securities of lower middle market privately-held companies located in the United States.
Our business is to provide capital to lower middle market companies in the United States. We focus on investments in companies with a history of generating revenues and positive cash flows, an established market position and a proven management team with a strong operating discipline. Our target portfolio company has annual revenues between $20.0 million and $200.0 million and annual earnings before interest, taxes, depreciation and amortization, or EBITDA, between $3.0 million and $25.0 million.
We invest primarily in subordinated debt securities secured by second lien security interests in portfolio company assets, coupled with equity interests. On a more limited basis, we also invest in senior debt securities secured by first lien security interests in portfolio companies. Our investments generally range from $5.0 million to $30.0 million per portfolio company. In certain situations, we have partnered with other funds to provide larger financing commitments.
We generate revenues in the form of interest income, primarily from our investments in debt securities, loan origination and other fees and dividend income. Fees generated in connection with our debt investments are recognized over the life of the loan using the effective interest method or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our debt investments generally have a term of between three and seven years and typically bear interest at fixed rates between 12.0% and 17.0% per annum. Certain of our debt investments have a form of interest, referred to as payment-in-kind, or PIK, interest, that is not paid currently but is instead accrued and added to the loan balance and paid at the end of the term. In our negotiations with potential portfolio companies, we generally seek to minimize PIK interest. Cash interest on our debt investments is generally payable monthly; however, some of our debt investments pay cash interest on a quarterly basis. As of
March 31, 2013
and
December 31, 2012
, the weighted average yield on our outstanding debt investments other than non-accrual debt investments was approximately
14.8%
and 14.6%, respectively. The weighted average yield on all of our outstanding investments (including equity and equity-linked investments but excluding non-accrual debt investments) was approximately
13.4%
as of both
March 31, 2013
and
December 31, 2012
. The weighted average yield on all of our outstanding
investments (including equity and equity-linked investments and non-accrual debt investments) was approximately
12.8%
and 12.9% as of
March 31, 2013
and
December 31, 2012
, respectively.
Triangle SBIC and Triangle SBIC II are eligible to issue debentures to the SBA, which pools these with debentures of other SBICs and sells them in the capital markets at favorable interest rates, in part as a result of the guarantee of payment from the SBA. Triangle SBIC and Triangle SBIC II invest these funds in portfolio companies. We intend to continue to operate Triangle SBIC and Triangle SBIC II as SBICs, subject to SBA approval, and to utilize the proceeds from the issuance of SBA-guaranteed debentures, referred to herein as SBA leverage, to enhance returns to our stockholders.
Portfolio Investment Composition
The total value of our investment portfolio was
$715.5 million
as of
March 31, 2013
, as compared to
$706.8 million
as of
December 31, 2012
. As of
March 31, 2013
, we had investments in 81 portfolio companies with an aggregate cost of
$707.6 million
. As of
December 31, 2012
, we had investments in 82 portfolio companies with an aggregate cost of
$700.2 million
. As of both
March 31, 2013
and
December 31, 2012
, none of our portfolio investments represented greater than 10% of the total fair value of our investment portfolio.
As of
March 31, 2013
and
December 31, 2012
, our investment portfolio consisted of the following investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
|
|
Percentage of
Total
Portfolio
|
|
Fair Value
|
|
Percentage of
Total
Portfolio
|
March 31, 2013:
|
|
|
|
|
|
|
|
Subordinated debt and 2nd lien notes
|
$
|
604,000,832
|
|
|
85
|
%
|
|
$
|
581,372,402
|
|
|
81
|
%
|
Senior debt and 1st lien notes
|
29,672,384
|
|
|
4
|
|
|
29,513,125
|
|
|
4
|
|
Equity shares
|
61,848,229
|
|
|
9
|
|
|
80,808,396
|
|
|
11
|
|
Equity warrants
|
12,107,097
|
|
|
2
|
|
|
23,723,994
|
|
|
4
|
|
Royalty rights
|
—
|
|
|
—
|
|
|
108,000
|
|
|
—
|
|
|
$
|
707,628,542
|
|
|
100
|
%
|
|
$
|
715,525,917
|
|
|
100
|
%
|
December 31, 2012:
|
|
|
|
|
|
|
|
Subordinated debt and 2nd lien notes
|
$
|
582,365,584
|
|
|
83
|
%
|
|
$
|
559,355,550
|
|
|
79
|
%
|
Senior debt and 1st lien notes
|
46,955,594
|
|
|
7
|
|
|
46,576,994
|
|
|
7
|
|
Equity shares
|
60,948,229
|
|
|
9
|
|
|
78,979,179
|
|
|
11
|
|
Equity warrants
|
9,961,097
|
|
|
1
|
|
|
21,759,000
|
|
|
3
|
|
Royalty rights
|
—
|
|
|
—
|
|
|
132,000
|
|
|
—
|
|
|
$
|
700,230,504
|
|
|
100
|
%
|
|
$
|
706,802,723
|
|
|
100
|
%
|
Investment Activity
During the
three
months ended
March 31, 2013
, the Company made debt investments in six existing portfolio companies totaling approximately $8.5 million and equity investments in two existing portfolio companies totaling approximately $1.8 million. We had one portfolio company loan repaid at par of approximately $5.8 million and received normal principal repayments and partial loan prepayments totaling approximately $2.0 million in the
three
months ended
March 31, 2013
. In addition, we received proceeds related to the sales of certain equity securities totaling $1.5 million and realized gains totaling approximately $1.3 million in the
three
months ended
March 31, 2013
.
During the
three
months ended
March 31, 2012
, we made four new investments totaling approximately $41.0 million, debt investments in two existing portfolio companies totaling approximately $0.8 million and one equity investment in an existing portfolio company of approximately $0.2 million. We had two portfolio company loans repaid at par totaling approximately $6.7 million and received normal principal repayments and partial loan prepayments totaling approximately $1.6 million in the
three
months ended
March 31, 2012
.
Total portfolio investment activity for the
three
months ended
March 31, 2013
and
2012
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31, 2013:
|
Subordinated
Debt and 2
nd
Lien Notes
|
|
Senior Debt
and 1
st
Lien
Notes
|
|
Equity
Shares
|
|
Equity
Warrants
|
|
Royalty
Rights
|
|
Total
|
Fair value, beginning of period
|
$
|
559,355,550
|
|
|
$
|
46,576,994
|
|
|
$
|
78,979,179
|
|
|
$
|
21,759,000
|
|
|
$
|
132,000
|
|
|
$
|
706,802,723
|
|
New investments
|
5,513,545
|
|
|
1,500,000
|
|
|
1,100,000
|
|
|
2,146,000
|
|
|
—
|
|
|
10,259,545
|
|
Reclassifications
|
18,570,523
|
|
|
(18,570,523
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Proceeds from sales of investments
|
—
|
|
|
—
|
|
|
(1,437,000
|
)
|
|
(37,000
|
)
|
|
—
|
|
|
(1,474,000
|
)
|
Loan origination fees received
|
(255,159
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(255,159
|
)
|
Principal repayments received
|
(7,577,746
|
)
|
|
(223,200
|
)
|
|
|
|
|
|
|
|
|
|
|
(7,800,946
|
)
|
PIK interest earned
|
4,017,911
|
|
|
196,883
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
4,214,794
|
|
PIK interest payments received
|
(529,733
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(529,733
|
)
|
Accretion of loan discounts
|
396,661
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
396,661
|
|
Accretion of deferred loan origination revenue
|
706,745
|
|
|
27,349
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
734,094
|
|
Realized gain
|
578,782
|
|
|
—
|
|
|
1,237,000
|
|
|
37,000
|
|
|
—
|
|
|
1,852,782
|
|
Unrealized gain (loss)
|
595,323
|
|
|
5,622
|
|
|
929,217
|
|
|
(181,006
|
)
|
|
(24,000
|
)
|
|
1,325,156
|
|
Fair value, end of period
|
$
|
581,372,402
|
|
|
$
|
29,513,125
|
|
|
$
|
80,808,396
|
|
|
$
|
23,723,994
|
|
|
$
|
108,000
|
|
|
$
|
715,525,917
|
|
Weighted average yield on debt investments at end of period(1)
|
|
|
|
|
|
14.8
|
%
|
Weighted average yield on total investments at end of period(1)
|
|
|
|
|
|
13.4
|
%
|
Weighted average yield on total investments at end of period
|
|
|
|
|
|
12.8
|
%
|
|
|
(1)
|
Excludes non-accrual debt investments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31, 2012:
|
Subordinated
Debt and 2
nd
Lien Notes
|
|
Senior Debt
and 1
st
Lien
Notes
|
|
Equity
Shares
|
|
Equity
Warrants
|
|
Royalty
Rights
|
|
Total
|
Fair value, beginning of period
|
$
|
387,169,056
|
|
|
$
|
59,974,195
|
|
|
$
|
43,972,024
|
|
|
$
|
15,043,300
|
|
|
$
|
920,000
|
|
|
$
|
507,078,575
|
|
New investments
|
27,726,000
|
|
|
9,161,883
|
|
|
4,206,989
|
|
|
858,117
|
|
|
—
|
|
|
41,952,989
|
|
Loan origination fees received
|
(466,420
|
)
|
|
(200,000
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(666,420
|
)
|
Principal repayments received
|
(7,048,039
|
)
|
|
(1,205,805
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(8,253,844
|
)
|
PIK interest earned
|
2,837,384
|
|
|
424,087
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3,261,471
|
|
PIK interest payments received
|
(260,426
|
)
|
|
(296,683
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(557,109
|
)
|
Accretion of loan discounts
|
316,068
|
|
|
58,273
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
374,341
|
|
Accretion of deferred loan origination revenue
|
416,175
|
|
|
60,337
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
476,512
|
|
Unrealized gain (loss)
|
(2,209,952
|
)
|
|
464,934
|
|
|
1,325,000
|
|
|
1,276,700
|
|
|
(88,000
|
)
|
|
768,682
|
|
Fair value, end of period
|
$
|
408,479,846
|
|
|
$
|
68,441,221
|
|
|
$
|
49,504,013
|
|
|
$
|
17,178,117
|
|
|
$
|
832,000
|
|
|
$
|
544,435,197
|
|
Weighted average yield on debt investments at end of period(1)
|
|
|
|
|
|
15.1
|
%
|
Weighted average yield on total investments at end of period(1)
|
|
|
|
|
|
14.0
|
%
|
Weighted average yield on total investments at end of period
|
|
|
|
|
|
13.8
|
%
|
|
|
(1)
|
Excludes non-accrual debt investments.
|
Non-Accrual Assets
Generally, when interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. As of
March 31, 2013
, the fair value of our non-accrual assets was approximately
$2.6 million
, which comprised
0.4%
of the total fair value of
our portfolio, and the cost of our non-accrual assets was approximately
$21.1 million
, which comprised
3.0%
of the total cost of our portfolio. As of
December 31, 2012
, the fair value of our non-accrual assets was approximately
$2.4 million
, which comprised
0.3%
of the total fair value of our portfolio, and the cost of our non-accrual assets was approximately
$14.9 million
, which comprised
2.1%
of the total cost of our portfolio.
Our non-accrual assets as of
March 31, 2013
were as follows:
Gerli and Company
In November 2008, we placed our debt investment in Gerli and Company, or Gerli, on non-accrual status. As a result, under generally accepted accounting principles in the United States, or U.S. GAAP, we no longer recognize interest income on our debt investment in Gerli for financial reporting purposes. During the first quarter of 2011, we restructured our investment in Gerli. As a result of the restructuring, we received a new note from Gerli with a face amount of $3.0 million and a fair value of approximately $2.3 million and preferred stock with a liquidation preference of $0.4 million. In addition, we invested $375,000 in a Gerli senior subordinated note. Under the terms of the notes, interest on the notes is payable only if Gerli meets certain covenants, which they were not compliant with as of
March 31, 2013
. In the
three
months ended
March 31, 2013
, we recognized unrealized depreciation on our debt investments in Gerli of approximately
$0.1 million
. As of
March 31, 2013
, the cost of our debt investments in Gerli was
$3.4 million
and the fair value was
$0.7 million
.
Fire Sprinkler Systems, Inc.
In October 2008, we placed our debt investment in Fire Sprinkler Systems, Inc., or Fire Sprinkler Systems, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in Fire Sprinkler Systems for financial reporting purposes. In the
three
months ended,
March 31, 2013
, we recorded unrealized appreciation of
$0.1 million
on our debt investment in Fire Sprinkler Systems. As of
March 31, 2013
, the cost of our debt investment in Fire Sprinkler Systems was
$3.0 million
and the fair value of such investment was
$0.3 million
.
Equisales, LLC
In May 2012, we placed our debt investment in Equisales, LLC, or Equisales, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in Equisales for financial reporting purposes. In the
three
months ended
March 31, 2013
, we recorded unrealized depreciation of
$0.1 million
on our debt investment in Equisales. As of
March 31, 2013
, the cost of our debt investment in Equisales was
$3.2 million
and the fair value of such investment was
$0.1 million
.
Venture Technology Groups, Inc.
In November 2012, we placed our debt investment in Venture Technology Groups, Inc. or VTG, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in VTG for financial reporting purposes. During the
three
months ended
March 31, 2013
, we recorded unrealized depreciation of
$0.8 million
on our debt investment in VTG. As of
March 31, 2013
, the cost of our debt investment in VTG was
$5.7 million
and the fair value of such investment was
$0.7 million
.
Xchange Technology Groups, LLC
In March 2013, we placed our debt investment in Xchange Technology Groups, LLC or XTG, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in XTG for financial reporting purposes. During the
three
months ended
March 31, 2013
, we recorded unrealized depreciation of
$0.8 million
on our debt investment in XTG. As of
March 31, 2013
, the cost of our debt investment in XTG was
$5.9 million
and the fair value of such investment was
$0.8 million
.
PIK Non-Accrual Assets
In addition to our non-accrual assets, as of
March 31, 2013
, we had debt investments in two portfolio companies (our subordinated notes to Minco Technology Labs, LLC and FCL Holding SPV, LLC) that were on non-accrual only with respect to the PIK interest component of the loans. As of
March 31, 2013
, the fair value of these debt investments was approximately
$3.4 million
, or
0.5%
of the total fair value of our portfolio and the cost of these assets was approximately
$6.5 million
, or
0.9%
of the total cost of our portfolio.
In addition, as of
March 31, 2013
, our subordinated notes to Home Physicians were on non-accrual only with respect to the PIK interest component of the loans. As of
March 31, 2013
, the fair value of our subordinated debt investments in Home Physicians was approximately
$10.4 million
, or
1.5%
of the total fair value of our portfolio and the cost of our subordinated debt investments in Home Physicians was approximately
$11.9 million
, or
1.7%
of the total cost of our portfolio. Since December 31, 2012, the operating and financial outlook for Home Physicians has improved, and as a result we recorded unrealized appreciation of $4.2 million on our subordinated debt investments in Home Physicians in the
three
months ended
March 31, 2013
. If the outlook for Home Physicians continues to improve in the near term, we anticipate we will resume the accrual of PIK interest.
Results of Operations
Comparison of
three
months ended
March 31, 2013
and
March 31, 2012
Investment Income
For the
three
months ended
March 31, 2013
, total investment income was
$24.5 million
, a
28%
increase from
$19.1 million
of total investment income for the
three
months ended
March 31, 2012
. This increase was primarily attributable to a $5.4 million increase in total loan interest, fee and dividend income, as well as an increase in PIK interest income. The increase in total loan interest, fee and dividend income was due to (i) a net increase in our portfolio investments from
March 31, 2012
to
March 31, 2013
and (ii) an increase in non-recurring fee income of approximately $0.1 million. Non-recurring fee income was $0.5 million for the
three
months ended
March 31, 2013
as compared to $0.4 million for the
three
months ended
March 31, 2012
.
Expenses
For the
three
months ended
March 31, 2013
, expenses increased by
33%
to
$9.2 million
from
$6.9 million
for the
three
months ended
March 31, 2012
. The increase in expenses was attributable to a
$1.8 million
increase in interest and other financing fees and a
$0.5 million
increase in general and administrative expenses. The increase in interest and other financing fees is related to (i) an increase in interest expense on our 2019 Notes of approximately $0.8 million due to the 2019 Notes only being outstanding for a portion of the three months ended March 31, 2012, (ii) interest on our 2022 Notes, which were issued in October 2012, of approximately $1.3 million for the quarter ended
March 31, 2013
, and (iii) an increase of $0.2 million in amortization of deferred financing fees related to costs associated with the 2019 and 2022 Notes, partially offset by lower interest expense related to SBA-guaranteed debentures in the quarter ended March 31, 2013 versus the quarter ended March 31, 2012. The decrease in interest expense on SBA-guaranteed debentures relates to lower SBA loan balances and lower weighted average rates on outstanding SBA-guaranteed debentures for the quarter ended
March 31, 2013
as compared to loan balances and weighted average rates on outstanding SBA-guaranteed debentures for the quarter ended
March 31, 2012
. The increase in general and administrative expenses in the quarter ended
March 31, 2013
was primarily related to increased salary and incentive compensation costs, as well as increased non-cash compensation expenses.
Net Investment Income
As a result of the
$5.4 million
increase in total investment income and the
$2.3 million
increase in expenses, net investment income increased by
25%
to
$15.2 million
for the
three
months ended
March 31, 2013
as compared to
$12.2 million
for the
three
months ended
March 31, 2012
.
Net Increase in Net Assets Resulting from Operations
In the
three
months ended
March 31, 2013
we realized a gain on the sale of one affiliate investment of approximately $1.3 million and a gain on the refinancing of one non-control/non-affiliate investment totaling approximately $0.6 million. In addition, during the
three
months ended
March 31, 2013
, we recorded unrealized appreciation on 32 investments totaling approximately $11.4 million, unrealized depreciation on 27 investments totaling approximately $8.4 million and unrealized depreciation reclassification adjustments related to the realized gains noted above totaling $1.3 million.
In the
three
months ended
March 31, 2012
, we recorded net unrealized appreciation of investments totaling approximately
$0.6 million
comprised of unrealized appreciation on 33 investments totaling approximately $5.7 million and unrealized depreciation on 12 investments totaling approximately $5.1 million.
In the
three
months ended
March 31, 2013
and
March 31, 2012
, we recognized a non-cash loss on the extinguishment of debt of approximately
$0.4 million
and
$0.2 million
, respectively, related to prepayments of SBA-guaranteed debentures.
As a result of these events, our net increase in net assets from operations was
$18.4 million
for the
three
months ended
March 31, 2013
as compared to a net increase in net assets from operations of
$12.6 million
for the
three
months ended
March 31, 2012
.
Liquidity and Capital Resources
We believe that our current cash and cash equivalents on hand, our available leverage under our Credit Facility and our anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations for at least the next twelve months.
In the future, depending on the valuation of Triangle SBIC’s assets and Triangle SBIC II’s assets pursuant to SBA guidelines, Triangle SBIC and Triangle SBIC II may be limited by provisions of the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to Triangle Capital Corporation that may be necessary to enable Triangle Capital Corporation to make the minimum required distributions to its stockholders and qualify as a RIC.
Cash Flows
For the
three
months ended
March 31, 2013
, we experienced a net decrease in cash and cash equivalents in the amount of
$35.3 million
. During that period, our operating activities used
$0.7 million
in cash, consisting primarily of portfolio investments of
$10.3 million
, partially offset by repayments received from portfolio companies of approximately
$9.3 million
. In addition, financing activities reduced cash by
$34.6 million
, consisting primarily of cash dividends paid in the amount of
$14.1 million
and voluntary repayments of SBA-guaranteed debentures of
$20.5 million
. At
March 31, 2013
, we had
$37.0 million
of cash and cash equivalents on hand.
For the
three
months ended
March 31, 2012
, we experienced a net increase in cash and cash equivalents in the amount of
$75.6 million
. During that period, our operating activities used
$30.3 million
in cash, consisting primarily of new portfolio investments of
$42.0 million
, partially offset by repayments received from portfolio companies totaling
$8.3 million
. In addition, financing activities provided
$105.9 million
of cash, consisting primarily of proceeds from public common stock offerings of
$77.2 million
and net proceeds from a public offering of Notes of
$66.8 million
, partially offset by cash dividends paid in the amount of
$11.8 million
, voluntary repayments of SBA-guaranteed debentures of
$10.4 million
and a repayment of borrowings under the Credit Facility of
$15.0 million
. At
March 31, 2012
, we had
$142.5 million
of cash and cash equivalents on hand.
Financing Transactions
Due to Triangle SBIC’s and Triangle SBIC II’s status as licensed SBICs, Triangle SBIC and Triangle SBIC II have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the Small Business Investment Act and the SBA rules applicable to SBICs, an SBIC (or group of SBICs under common control) can have outstanding at any time debentures guaranteed by the SBA up to two times (and in certain cases, up to three times) the amount of its regulatory capital, which generally is the amount raised from private investors. The maximum statutory limit on the dollar amount of outstanding debentures guaranteed by the SBA issued by a single SBIC is currently $150.0 million and by a group of SBICs under common control is $225.0 million. Debentures guaranteed by the SBA have a maturity of ten years, with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity but may be pre-paid at any time, without penalty.
As of
March 31, 2013
, Triangle SBIC had issued $118.7 million of SBA-guaranteed debentures and had the current capacity to issue up to the statutory maximum of $150.0 million, subject to SBA approval. As of
March 31, 2013
, Triangle SBIC II had issued $75.0 million in face amount of SBA-guaranteed debentures. In addition to the one-time 1.0% fee on the total commitment from the SBA, the Company also pays a one-time 2.425% fee on the amount of each debenture issued (2.0% for SBA LMI debentures). These fees are capitalized as deferred financing costs and are amortized over the term of the debt agreements using the effective interest method. The weighted average interest rate for all SBA-guaranteed debentures as of
March 31, 2013
was 4.07%. As of
March 31, 2013
, all SBA debentures were pooled. In the
three
months ended
March 31, 2013
, the Company prepaid approximately
$20.5 million
of SBA-guaranteed debentures and recognized a loss on extinguishment of debt of approximately
$0.4 million
.
In September 2012, we entered into a four-year senior secured credit facility to provide additional liquidity in support of our investment and operational activities. The Credit Facility, which has an initial commitment of $165.0 million supported by nine financial institutions, replaced our $75.0 million senior secured credit facility, or the Prior Facility. We entered into the Prior Facility in May 2011 with an initial commitment of $50.0 million, which was increased to $75.0 million in November 2011.
The Credit Facility has an accordion feature that allows for an increase in the total commitment size up to $215.0 million, subject to certain conditions, and also contains two one-year extension options, bringing the total potential borrowing term to six years from closing. The Credit Facility, which is structured to operate like a revolving credit facility, is secured primarily by our assets, excluding the assets of Triangle SBIC and Triangle SBIC II.
Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) the applicable base rate plus 1.95% or (ii) the applicable LIBOR rate plus 2.95%. The applicable base rate is equal to the greater of (i) prime rate, (ii) the federal funds rate plus 0.5% or (iii) the adjusted one-month LIBOR plus 2.0%. We pay a commitment fee of 0.375% per annum on undrawn amounts, which is included with interest and other financing fees on our Consolidated Statement of Operations. Borrowings under the Credit Facility are also limited to a borrowing base, which includes certain cash and a portion of eligible debt investments. As of
March 31, 2013
and
December 31, 2012
, we had no borrowings outstanding under the Credit Facility.
As with the Prior Facility, the Credit Facility contains certain affirmative and negative covenants, including but not limited to (i) maintaining a minimum interest coverage ratio, (ii) maintaining minimum consolidated tangible net worth and (iii) maintaining its status as a regulated investment company and as a BDC. As of
March 31, 2013
, we were in compliance with all covenants of the Credit Facility.
In March 2012, we issued $69.0 million of 2019 Notes. The 2019 Notes mature on March 15, 2019, and may be redeemed in whole or in part at any time or from time to time at our option on or after March 15, 2015. The 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning June 15, 2012. The net proceeds from the sale of the 2019 Notes, after underwriting discounts and offering expenses, were approximately $66.7 million.
In October 2012, we issued $70.0 million of 2022 Notes and in November 2012, we issued $10.5 million of 2022 Notes pursuant to the exercise of an over-allotment option. The 2022 Notes mature on December 15, 2022, and may be redeemed in whole or in part at any time or from time to time at our option on or after December 15, 2015. The 2022 Notes bear interest at a rate of 6.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning December 15, 2012. The net proceeds from the sale of the 2022 Notes, after underwriting discounts and offering expenses, were approximately $77.8 million.
The indentures relating to the 2019 Notes and the 2022 Notes contain certain covenants, including but not limited to (i) a requirement that we comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement that we provide financial information to the holders of the notes and the trustee under the indenture if we should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934.
Distributions to Stockholders
We elected to be treated as a RIC under the Code, commencing with our taxable year ended December 31, 2007. In order to maintain our qualification as a RIC and to obtain RIC tax benefits, we must meet certain minimum distribution, source-of-income and asset diversification requirements. If such requirements are met, then we are generally required to pay income taxes only on the portion of our taxable income and gains we do not distribute (actually or constructively) and certain built-in gains. We have historically met our minimum distribution requirements and continually monitor our distribution requirements with the goal of ensuring compliance with the Code. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act.
The minimum distribution requirements applicable to RICs require us to distribute to our stockholders each year at least 90% of our investment company taxable income, or ICTI, as defined by the Code. Depending on the level of ICTI earned in a tax year, we may choose to carry forward ICTI in excess of current year distributions into the next tax year and pay a 4% excise tax on such excess. Any such carryover ICTI must be distributed before the end of the next tax year through a dividend declared prior to filing the final tax return related to the year which generated such ICTI.
ICTI generally differs from net investment income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. We may be required to recognize ICTI in certain circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments issued with warrants), we must include in ICTI each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in ICTI other amounts that we have not yet received in cash, such as (i) PIK interest income and (ii) interest income from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is
recognized in ICTI. Because any original issue discount or other amounts accrued will be included in our ICTI for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements, even though we will not have received and may not ever receive any corresponding cash amount. ICTI also excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.
Current Market Conditions
We were able to secure access to additional liquidity in 2012, including public offerings of common stock and debt securities, new leverage through SBA-guaranteed debentures and entering into an expanded credit facility. There can be no assurances, however, that the current market conditions will continue and that debt or equity capital will be available to us in the future on favorable terms, if it all. In 2008, the debt and equity capital markets in the United States were severely impacted by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated bank loan market, among other factors. These events, along with the deterioration of the housing market, led to an economic recession in the U.S. and abroad. Banks, investment companies and others in the financial services industry reported significant write-downs in the fair value of their assets, which led to the failure of a number of banks and investment companies, a number of distressed mergers and acquisitions and the government take-over of the nation's two largest government-sponsored mortgage companies. These events significantly impacted the financial and credit markets and reduced the availability of debt and equity capital for the market as a whole, and for financial firms in particular. Notwithstanding recent gains across both the equity and debt markets, recent U.S. budget deficit concerns and uncertainty regarding potential federal spending cuts and the federal debt ceiling, together with continued signs of deteriorating sovereign debt conditions in Europe, have increased the possibility that these unfavorable conditions in the debt and equity capital markets may reoccur in the future and could then continue for a prolonged period of time.
Recent Developments
In May 2013, we invested $7.6 million in subordinated debt and equity of Dyno Parent LLC ("Dyno”), a supplier of sewing products and seasonal decorative products. Under the terms of the investment, Dyno will pay interest on the subordinated debt at a rate of 14% per annum.
Critical Accounting Policies and Use of Estimates
The preparation of our unaudited financial statements in accordance with U.S. GAAP requires management to make certain 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 for the periods covered by such financial statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. On an on-going basis, we evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.
Investment Valuation
The most significant estimate inherent in the preparation of our financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded. We have established and documented processes and methodologies for determining the fair values of portfolio company investments on a recurring (quarterly) basis in accordance with FASB ASC Topic 820,
Fair Value Measurements and Disclosures,
or ASC Topic 820. Under ASC Topic 820, a financial instrument is categorized within the ASC Topic 820 valuation hierarchy based upon the lowest level of input to the valuation process that is significant to the fair value measurement. The three levels of valuation inputs established by ASC Topic 820 are as follows:
Level 1 Inputs
– include quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 Inputs
– include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 Inputs
– include inputs that are unobservable and significant to the fair value measurement.
Our investment portfolio is comprised of debt and equity instruments of privately held companies for which quoted prices or other inputs falling within the categories of Level 1 and Level 2 are not available. Therefore, we determine the fair value of our investments in good faith using Level 3 inputs, pursuant to a valuation policy and process that is established by our
management with the assistance of certain third-party advisors and subsequently approved by our Board of Directors. There is no single standard for determining fair value in good faith, as fair value depends upon the specific circumstances of each individual investment. The recorded fair values of our investments may differ significantly from fair values that would have been used had an active market for the securities existed. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.
Our valuation process is led by our executive officers and managing directors. The valuation process begins with a quarterly review of each investment in our investment portfolio by our executive officers and our investment committee. Valuations of each portfolio security are then prepared by our investment professionals, who have direct responsibility for the origination, management and monitoring of each investment. Under our valuation policy, each investment valuation is subject to (i) a review by the lead investment officer responsible for the portfolio company investment and (ii) a peer review by a second investment officer or executive officer. Generally, any investment that is valued below cost is subjected to review by one of our executive officers. After the peer review is complete, we engage two independent valuation firms, Duff & Phelps, LLC and Lincoln Partners Advisors LLC (collectively, the “Valuation Firms”), to provide third-party reviews of certain investments, as described further below. Finally, the Board of Directors has the responsibility for reviewing and approving, in good faith, the fair value of our investments in accordance with the 1940 Act.
The Valuation Firms provide third party valuation consulting services to us which consist of certain limited procedures that we identified and requested the Valuation Firms to perform (hereinafter referred to as the “Procedures”). The Procedures are performed with respect to each portfolio company at least once in every calendar year and for new portfolio companies, at least once in the twelve-month period subsequent to the initial investment. In addition, the Procedures are generally performed with respect to a portfolio company when there has been a significant change in the fair value of the investment. In certain instances, we may determine that it is not cost-effective, and as a result is not in our stockholders’ best interest, to request the Valuation Firms to perform the Procedures on one or more portfolio companies. Such instances include, but are not limited to, situations where the fair value of the investment in the portfolio company is determined to be insignificant relative to the total investment portfolio.
The total number of investments and the percentage of our portfolio on which the Procedures were performed are summarized below by period:
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|
|
|
|
For the quarter ended:
|
Total
companies
|
|
Percent of total
investments at
fair value
(1)
|
March 31, 2012
|
10
|
|
19%
|
June 30, 2012
|
14
|
|
21%
|
September 30, 2012
|
16
|
|
33%
|
December 31, 2012
|
17
|
|
30%
|
March 31, 2013
|
17
|
|
23%
|
|
|
(1)
|
Exclusive of the fair value of new investments made during the quarter.
|
Upon completion of the Procedures, the Valuation Firms concluded that, with respect to each investment reviewed by each Valuation Firm, the fair value of those investments subjected to the Procedures appeared reasonable. Our Board of Directors is ultimately responsible for determining the fair value of our investments in good faith.
Investment Valuation Inputs
Under ASC Topic 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between a willing buyer and a willing seller at the measurement date. For our portfolio securities, fair value is generally the amount that we might reasonably expect to receive upon the current sale of the security. Under ASC Topic 820, the fair value measurement assumes that the sale occurs in the principal market for the security, or in the absence of a principal market, in the most advantageous market for the security. Under ASC Topic 820, if no market for the security exists or if we do not have access to the principal market, the security should be valued based on the sale occurring in a hypothetical market. The securities in which we invest are generally only purchased and sold in merger and acquisition transactions, in which case the entire portfolio company is sold to a third-party purchaser. As a result, unless we have the ability to control such a transaction, the assumed principal market for our securities is a hypothetical secondary market. The Level 3 inputs to our valuation process reflect management’s best estimate of the assumptions that would be used by market participants in pricing the investment in a transaction in a hypothetical secondary market.
Enterprise Value Waterfall Approach
In valuing equity securities (including warrants), we estimate fair value using an “Enterprise Value Waterfall” valuation model. We estimate the enterprise value of a portfolio company and then allocate the enterprise value to the portfolio company’s securities in order of their relative liquidation preference. In addition, the model assumes that any outstanding debt or other securities that are senior to our equity securities are required to be repaid at par. Additionally, we estimate the fair value of a limited number of its debt securities using the Enterprise Value Waterfall approach in cases where we do not expect to receive full repayment.
To estimate the enterprise value of the portfolio company, we primarily use a valuation model based on a transaction multiple, which generally is the original transaction multiple, and measures of the portfolio company’s financial performance. In addition, we consider other factors, including but not limited to (i) offers from third-parties to purchase the portfolio company, (ii) the implied value of recent investments in the equity securities of the portfolio company, (iii) publicly available information regarding recent sales of private companies in comparable transactions and, (iv) when management believes there are comparable companies that are publicly traded, we perform a review of these publicly traded companies and the market multiple of their equity securities.
The significant Level 3 inputs to the Enterprise Value Waterfall model are (i) an appropriate transaction multiple and (ii) a measure of the portfolio company’s financial performance, which generally is either earnings before interest, taxes, depreciation and amortization, as adjusted, or Adjusted EBITDA, or revenues. Such inputs can be based on historical operating results, projections of future operating results, or a combination thereof. The operating results of a portfolio company may be unaudited, projected or pro forma financial information and may require adjustments for certain non-recurring items. In determining the operating results input, we utilize the most recent portfolio company financial statements and forecasts available as of the valuation date. Management also consults with the portfolio company’s senior management to obtain updates on the portfolio company’s performance, including information such as industry trends, new product development, loss of customers and other operational issues. Additionally, we consider some or all of the following factors:
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•
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financial standing of the issuer of the security;
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|
•
|
comparison of the business and financial plan of the issuer with actual results;
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|
|
•
|
the size of the security held;
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|
|
•
|
pending reorganization activity affecting the issuer, such as merger or debt restructuring;
|
|
|
•
|
ability of the issuer to obtain needed financing;
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|
•
|
changes in the economy affecting the issuer;
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•
|
financial statements and reports from portfolio company senior management and ownership;
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|
|
•
|
the type of security, the security’s cost at the date of purchase and any contractual restrictions on the disposition of the security;
|
|
|
•
|
information as to any transactions or offers with respect to the security and/or sales to third parties of similar securities;
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|
•
|
the issuer’s ability to make payments and the type of collateral;
|
|
|
•
|
the current and forecasted earnings of the issuer;
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|
|
•
|
statistical ratios compared to lending standards and to other similar securities;
|
|
|
•
|
pending public offering of common stock by the issuer of the security;
|
|
|
•
|
special reports prepared by analysts; and
|
|
|
•
|
other pertinent factors.
|
Fair value measurements using the Enterprise Value Waterfall model can be sensitive to significant changes in one or more of the inputs. A significant increase in either the transaction multiple, Adjusted EBITDA or revenues for a particular equity security would result in a higher fair value for that security.
Income Approach
In valuing debt securities, we utilize an “Income Approach” model that considers factors including, but not limited to, (i) the stated yield on the debt security, (ii) the portfolio company’s current trailing twelve months, or TTM Adjusted EBITDA as compared to the portfolio company’s historical or projected Adjusted EBITDA as of the date the investment was made and
the portfolio company’s anticipated Adjusted EBITDA for the next twelve months of operations, (iii) the portfolio company’s current Leverage Ratio (defined as the portfolio company’s total indebtedness divided by Adjusted EBITDA) as compared to its Leverage Ratio as of the date the investment was made, (iv) publicly available information regarding current pricing and credit metrics for similar proposed and executed investment transactions of private companies and (v) when management believes a relevant comparison exists, current pricing and credit metrics for similar proposed and executed investment transactions of publicly traded debt. In addition, we use a risk rating system to estimate the probability of default on the debt securities and the probability of loss if there is a default. This risk rating system covers both qualitative and quantitative aspects of the business and the securities held.
We consider the factors above, particularly any significant changes in the portfolio company’s results of operations and leverage, and develop an expectation of the yield that a hypothetical market participant would require when purchasing the debt investment (the “Required Rate of Return”). The Required Rate of Return, along with the Leverage Ratio and Adjusted EBITDA are the significant Level 3 inputs to the Income Approach model. For investments where the Leverage Ratio and Adjusted EBITDA have not fluctuated significantly from the date the investment was made or have not fluctuated significantly from management’s expectations as of the date the investment was made, and where there have been no significant fluctuations in the market pricing for such investments, we may conclude that the Required Rate of Return is equal to the stated rate on the investment and therefore, the debt security is appropriately priced. In instances where we determine that the Required Rate of Return is different from the stated rate on the investment, we discount the contractual cash flows on the debt instrument using the Required Rate of Return in order to estimate the fair value of the debt security.
Fair value measurements using the Income Approach model can be sensitive to significant changes in one or more of the inputs. A significant increase (decrease) in the Required Rate of Return or Leverage Ratio inputs for a particular debt security may result in a lower (higher) fair value for that security. A significant increase (decrease) in the Adjusted EBITDA input for a particular debt security may result in a higher (lower) fair value for that security.
The fair value of our royalty rights are calculated based on specific provisions contained in the pertinent operating or royalty agreements. The determination of the fair value of such royalty rights is not a significant component of our valuation process.
Revenue Recognition
Interest and Dividend Income
Interest income, adjusted for amortization of premium and accretion of original issue discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. The cessation of recognition of such interest will negatively impact the reported fair value of the investment. We write off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. Dividend income is recorded on the ex-dividend date.
We may have to include in our ICTI, interest income, including OID income, from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is recognized in ICTI. As a result, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements to maintain our RIC status, even though we will not have received and may not ever receive any corresponding cash amount. Additionally, any loss recognized by us for federal income tax purposes on previously accrued interest income will be treated as a capital loss.
Fee Income
Origination, facility, commitment, consent and other advance fees received in connection with the origination of a loan, or Loan Origination Fees, are recorded as deferred income and recognized as investment income over the term of the loan. Upon prepayment of a loan, any unamortized loan origination fees are recorded as investment income. In the general course of our business, we receive certain fees from portfolio companies, which are non-recurring in nature. Such fees include loan prepayment penalties, certain investment banking and structuring fees and loan waiver and amendment fees, and are recorded as investment income when received.
Payment-in-Kind (PIK) Interest Income
We currently hold, and we expect to hold in the future, some loans in our portfolio that contain a PIK interest provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is periodically added to the principal balance of the loan, rather than being paid to us in cash, and is recorded as interest income. Thus, the actual collection of PIK interest may be deferred until the time of debt principal repayment.
PIK interest, which is a non-cash source of income, is included in our taxable income and therefore affects the amount we are required to distribute to our stockholders to maintain our qualification as a RIC for federal income tax purposes, even though we have not yet collected the cash. Generally, when current cash interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing PIK interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. We write off any previously accrued and uncollected PIK interest when it is determined that the PIK interest is no longer collectible.
We may have to include in our ICTI, PIK interest income from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is recognized in ICTI. As a result, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements, even though we will not have received and may not ever receive any corresponding cash amount.
Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements.