MidCap Financial Investment Corp (MFIC) 2010 Q3 法說會逐字稿

Good morning, and welcome to Apollo Investment Corporation's Third Fiscal Quarter 2010 Earnings Conference Call.

At this time, all participants have been placed in listen-only mode. The call will be opened for a question-and-answer session following the speakers' remarks. (Operator instructions)

It is now my pleasure to turn the call over to Mr. Jim Zelter, Chief Executive Officer of Apollo Investment Corporation. Mr. Zelter, you may begin your conference.

Thank you, and good morning. I'm joined today by Patrick Dalton, Apollo Investment Corporation's President and Chief Operating Officer, and Richard Peteka, our Chief Financial Officer.

Rich, before we begin, would you start off by disclosing some general conference call information and include the comments about forward-looking statements.

Certainly. Thanks, Jim.

I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information.

Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections.

We do not undertake to update our forward-looking statements or projections unless required by law.

To obtain copies of our latest SEC filings, please visit our website at www.ApolloIC.com or call us at 212-515-3450.

At this time I'd like to turn the call back to our Chief Executive Officer, Jim Zelter.

Thank you, Rich.

Activity in the credit markets was especially strong during the fourth quarter of 2009. Demand was driven by continued institutional and retail inflows and an improving economic backdrop.

As a result, increased two-[wave] trading flow developed in the loan and high-yield bond markets, ultimately tightening yield spreads further and improving overall liquidity.

Such improved market conditions also created a spillover into the high-quality larger end of the mezzanine market, where more issuers saw an additional alternative to the traditional high-yield market.

Overall, the fourth quarter ended with significant market liquidity, a tighter high-yield index, and more investors searching for primary and secondary paper.

Certainly, many commercial and investment banks, among other financial institutions, benefited from these improving conditions, and with certain banks dealing significantly better, we recognized an opportunity for Apollo Investment Corporation to proactively seek an extension of our own credit facility. We believe this important benefit was open only to a select group of borrowers with broad-based platforms and proven track records of transparency, liquidity, and overall credit quality.

Accordingly, we believe that our performance and behavior through the cycle led to our ability to successfully and proactively amend and extend our multi-currency revolving credit facility out to April 2013, well after its scheduled maturity in April 2011.

With this extension, we believe Apollo Investment Corporation retains the largest and most flexible revolving credit facility in the sector, affording us the ability to continue to grow our business as we further move into this recovery.

Complementing our amended bank facility was another successful capital markets issuance during the quarter, raising $108 million of additional equity capital. With this raise and at December 31, 2009, Apollo Investment Corporation had more than $600 million of available capital to invest. We believe this places us in a position of strength for our current pipeline of investment opportunities.

Therefore, we believe that by proactively extending our revolving credit facility with our banks and growing and fortifying again our equity capital base, we have accomplished two significant strategic initiatives that will afford Apollo Investment Corporation the opportunity to continue to move forward into 2010 and beyond.

Other December quarterly activity included realizing some of our pipeline late in the quarter, investing $212 million for the three months. In the end, we closed the calendar year with a $2.8 billion portfolio measured at fair market value, which represents 70 different companies in 33 different industries.

Other quarterly highlights include a continuation of our stable net investment income and our low leveraged level of 0.52 to 1 debt to equity.

Furthermore, and even after considering our two recent new share issuances which affect per-share results, both net investment income and earnings per share each remained strong, totaling $0.30 per share and $0.48 per share, respectively.

We are pleased with these results, and with our portfolio again beginning to build, we believe we can further grow our harvest of undistributed taxable income that provides significant visibility and cushion to our quarterly dividends to shareholders.

Before I turn the call over to Rich, I'd like to again reiterate that we take our leadership role within the sector very seriously and remain committed to our investment discipline as we seek to grow our business during 2010. That said, we will continue to look at all available investment opportunities and execute only when we believe it makes economic and investment sense.

At this time, I'll turn the call over to Rich to take you through some detailed financial highlights for the quarter. Rich?

Thanks, Jim.

Let me start off with some December 31 balance sheet highlights.

Our total investment portfolio had a fair market value of $2.8 billion as compared to $2.6 billion at September 30.

Our net assets totaled $1.83 billion at December 31 with a net asset value per share of $10.40. This compares to net assets totaling $1.68 billion at September 30 and a net asset value per share of $10.29.

The $0.11 net income in NAV per share for the quarter was driven primarily by net unrealized appreciation on our investment portfolio, as well as from earnings in excess of our distributions to shareholders.

In addition, we had outstanding debt of approximately $948 million on our revolving credit facility at December 31. This compares to $902 million at September 30, and we maintain a modest debt-to-equity ratio of 0.52 to 1 measured at fair value.

Accordingly, we continue to be well in compliance with our credit facility financial covenants.

As indicated on our schedule of investments, we placed certain investments in three portfolio companies on non-accrual status during the quarter, while at the same time, one investment came off non-accrual status.

The investments placed on non-accrual status for the quarter were issued by Oriental Trading Company, Pacific Crane Maintenance Company, and Quality Home Brands Holdings. Accordingly, they did not contribute any income for the quarter.

Our investment coming off non-accrual status was issued by Associated Materials.

With these additions and subtractions, our portfolio of 70 companies has five companies with investments on non-accrual status at December 31, 2009, and they represent 1.5% of the fair value of our investment portfolio. On a cost basis, they total 8.6% of our investment portfolio.

As for operating results, gross investment income for the quarter totaled $85.6 million. This compares to $84.4 million for the quarter ended September 2009 and $97.5 million for the comparable December 2008 quarter.

Net operating expenses for the quarter totaled $34.2 million. This compares to $33 million for the September 30 quarter and $43.9 million for the comparable December 2008 quarter.

Ultimately, net investment income totaled $50.2 million, or $0.30 per average share. This compares to $51.4 million, or $0.34 per average share, for the September 2009 quarter and $52.8 million, or $0.37 per share, for the comparable December 2008 quarter.

Also during the quarter, we received proceeds from investment sales and prepayments totaling $67 million. In addition, the Company received a $36 million US-equivalent distribution from our GS Prysmian portfolio company during the quarter.

These transactions reversed previously recognized unrealized appreciation and depreciation and generated net realized losses of $152 million. This compares to net realized loss of $3.1 million for the September 2009 quarter and $3.6 million for the December 2008 quarter.

The Company also recognized net unrealized appreciation of $181.4 million for the quarter ended December 31, 2009. This considers the noted realized losses and compares to recognizing net unrealized appreciation of $60.9 million for the September 2009 quarter and net unrealized depreciation of $524.8 million for the comparable post-Lehman December 2008 quarter.

In total, our quarterly operating results increased net assets by approximately $80 million, or $0.48 per average share, versus an increase of $109.2 million, or $0.71 per average share, for the September 2009 quarter and a decrease of $475.5 million, or $3.34 per average share, for the December 2008 quarter.

Now, let me turn the call over to our President and Chief Operating Officer, Patrick Dalton. Patrick?

Thank you, Rich.

The quarter ended December 31, 2009 demonstrated our success in completing a number of important strategic initiatives for Apollo Investment Corporation.

As Jim noted earlier in the call, obtaining extension from our cost-effective credit facility was critically important and evidenced our own bank lenders' long-term confidence in Apollo Investment Corporation.

Our behavior prior to and throughout the cycle was further rewarded by the financial sponsored community, which is back to the table once again asking us to partner with them on new investment opportunities. This is significant as we believe the primary market will be an important driver to our net growth over the next 24 months. In addition, these sponsors care more than ever about who they have as lenders to their portfolio companies.

Lastly, our track record of consistency, transparency, and responsibility continues to reward us with ongoing equity capital market access at an attractive cost to capital.

Accordingly, we believe we have turned the corner on the cycle and are looking ahead with many lessons learned. That said, expect us to maintain our strategy of managing our cost of capital and investing in larger companies at an attractive and accretive risk-adjusted return.

Now, getting into our December quarterly portfolio activity. We invested $212 million across two new and several existing portfolio companies, and when we mention investing in existing portfolio companies, our investments are typically added through secondary market purchases, not additional direct investments.

Let me take you through some specific information on the portfolio activity during the quarter.

First, we made investments in two new portfolio companies during the quarter, ATI Acquisition Company, a for-profit post-secondary education company, and Datatel, Incorporated, a provider of enterprise resource planning software solutions to the higher-education industry. We invested $56 million in the senior and subordinated debt of ATI and $20 million in the second lien debt of Datatel.

We also acquired additional investments in current portfolio companies. For example, we purchased an additional $44 million of the bank debt of Ranpak from a third-party seller. Ranpak is a manufacturer and marketer of packaging systems.

We also purchased an additional $19.5 million of mezzanine securities of BNY Convergex. BNY Convergex is an institutional agency-only broker and financial technology provider.

We also made a $20.6 million investment in the senior notes of Cengage Learning. Cengage delivers highly customized learning solutions for colleges and universities to specialized content, applications, and services.

We also added $25 million of high-yield notes of General Nutrition Centers, a retailer of health and wellness products.

In addition, we made smaller secondary market add-on investments to several other [inaudible] portfolio companies, including Catalina Marketing, Sheridan Holdings, and Fox Co., among others.

Lastly, we made an additional $11 million Canadian dollar investment in the common equity of MEG Energy Corporation, a company focused on oil sands development in Canada.

We also received $67 million in proceeds from select asset sales and prepayments. Two of our portfolio companies made prepayments during the quarter.

We tendered our $31.4 million positions in KAR Holdings, Incorporated, a vehicle auction provider, at 108% of par, as KAR Holdings completed its IPO. This demonstrates the importance and added returns provided by well-structured call protection.

In addition, our $12 million investment in the subordinated debt of Associated Materials, a manufacturer and distributor of building products, was made by the Company at 101% of par during the quarter.

These companies made significant strides through the cycle, allowing them to refinance under attractive terms in an improved marketplace.

Additionally, and consistent with our objective of cleansing and optimizing our portfolio for the future, we exited select under-performing names out of the portfolio, including our remaining exposure in Eurofresh, the greenhouse tomato producer, World Directories, a publisher of white and yellow page directories, and Latham Manufacturing, a swimming pool manufacturer.

We also turned our position in the bank debt of American Safety Razor, a razor and razor blade manufacturer, at a small gain.

Lastly, we are pleased to have received another $36 million US dollar-equivalent distribution from GS Prysmian during the quarter, representing approximately 46% of our remaining and direct ownership.

Ultimately, our investment portfolio at December 31 remained diversified by issuer and industry, consisting of 70 companies in 33 different industries.

The total investment portfolio at fair market value was $2.8 billion, which was distributed 28% in senior secured loans, 58% in subordinated debt, 3% in preferred equity, and 11% in common equity and warrants, again measured at fair value.

The weighted average yield on our overall debt portfolio at our original cost at December 31, 2009 was 11.6% versus 11.5% at September 30. The weighted average yields on our subordinated debt and senior loan portfolios was 13.4% and 8.2%, respectively, at December 31, 2009 versus 13.2% and 7.9%, respectively, at September 30.

Please note that Apollo Investment Corporation's floating rate asset portfolio remains closely matched with the Company's average floating rate credit exposure.

Furthermore, at December 31, the weighted averaged EBITDA of our portfolio of companies continues to exceed $250 million, and the weighted average cash interest coverage of the portfolio remains over two times.

The weighted average risk rating of our total portfolio improved slightly during the quarter to 2.6 measured at cost and 2.1 measured at fair market value at December 31, 2009.

Lastly, Apollo Investment Corporation's leverage ratio stood at a conservative 0.52 to 1 debt to equity, as compared to 0.54 to 1 at September 30, 2009.

Before I open up the call to questions, I'd like to reiterate what was said earlier in the call with regard to our strategic proactive positioning and the strength of our invigorated balance sheet.

As we head into this recovery, there will be many opportunities available for us to invest your significant capital. That said, we will remain disciplined and selective and continue to employ all the lessons learned from those that have made it through the cycle, as well as from those that have not made it through.

Currently, we expect to continue our investment focus on the larger end of the middle market, seeking more debt-like yields rather than deploy your capital into certain smaller companies that are seemingly willing to accept any cost of debt capital to survive the cycle.

We believe those companies and the yields they're willing to pay, as compared to the sustainable margins of their businesses, to be more equity-like investments with equity-like risks.

Again, our single and double debt investments -- investing focus will remain with the larger companies that we believe offer better risk-adjusted returns, and given our objective of protecting your capital, we believe our strategy remains prudent.

In closing, I'd like to thank our dedicated team of professionals and our shareholders for your continued long-term support and confidence in Apollo Investment Corporation.

With that, Operator, please open up the call to questions.

(Operator instructions)

And your first question comes from Sanjay Sakhrani of KBW.

Looks like you guys had a pretty active quarter in terms of gross originations. Could you talk about kind of how the pipeline looks at this point in time and what you're thinking about near-term growth?

Hey, Sanjay, it's Patrick. Thanks for the question.

You know, we're very happy that the fourth quarter provided us some opportunities on the primary side, as you saw, a couple of new investments, but also, there were some other folks that were cleaning up and winding down some portfolios we were able to execute on making some attractive secondary market purchases as people were getting ready for their year-ends. That does provide us with some sort of a seasonal opportunity.

Going into this year, the credit markets were pretty hot starting in January and February. They've come back a little bit the last week or so. We're going to be very selective on what we do there. We're not going to chase yields down or leverage up because the credit markets are hot.

We think with the pullback in the last couple of weeks, there will be some more opportunities we think will fit our strike zone. The primary market of new opportunities, we really expect that to be more of a second half to -- second quarter to a second-half opportunity for us because once you have a credit market that shows that it's there and available, then sponsors will bring companies that they own out to the market for sale, and we're seeing books hit our pipeline today.

Those do take a quarter or two to sort of get to the finish line, and new books are hitting our pipeline each week, but they will take time to develop, to do the due diligence for us to not chase the market if it becomes too hot. We're not going to sacrifice our capital. So we're optimistic, but we are going to be selective and prudent.

Okay. And just to be clear, on some of the investments you made to existing companies, they weren't for distress situations; they were just some opportunistic secondary market buys?

Yes, we are not a distressed market buyer. We're looking for opportunities that are accretive to our business. Maybe the seller is more distressed or stressed, but these are what we look at as par loans that we expect to get a full recovery or full repayment at maturity or sooner, and if it's accretive to our business, we'll take advantage of that. But it's really, as you mentioned, an opportunistic par loan investment versus a distressed investment.

Okay. And just maybe, Patrick, you guys could go through the non-accruals this quarter and kind of what happened for each specific item?

Yes, sure. We have to be a little bit careful about what we say because these are private company situations, and we're under NDAs, but these names should not surprise anybody. They're names we've talked about in the past. They've been on our watch list for some time. The companies had either -- have a covenant amendment that may be coming up. The companies -- their performance has not improved to a point where we thought that those restructurings would be in the favor of us to put them back on to continue to accrue the interest.

We're also taking the opportunity in a couple situations where we think that we can restructure our debt perhaps in the form of equity in converting.

Generation Brands did file for bankruptcy, which is Quality Home Brands. It's now emerged from bankruptcy. We have restructured our holdings into more equity-like holdings of that company. We knew that going into the end of last year that that would be the likely outcome, but it had not yet happened, so we didn't want to put it in -- a new security into our portfolio that had not -- doesn't exist yet. So we kind of knew that we had -- expectations did come through.

We now own equity in that company. We're optimistic that the company's capital structure will allow the company to sustain itself and hopefully improve into a recovery, and perhaps there will be a nice recovery on the equity, but time will tell.

So each situation is different. It's unique. It's fluid. But if we sit together as the investment committee and with our board of directors at the end of the quarter going through the performance of underlying companies and we feel that we're not going -- we ought not to be accruing any more and/or we're not being paid current interest, then they'll just automatically go on non-accrual.

Okay. And then, finally, Jim, you mentioned that banks are starting to lend again, as evidenced by you guys securing the revolver renewal. I mean are we seeing that spread through to the middle market so that you guys have someone on the senior debt side?

You know, I guess my view, Sanjay, is we saw a year-and-a-half of really a frozen lending environment, and now we're seeing the thaw open up. I think you'll see periods over the next year-and-a-half where there will be some volatility, but yes, people are looking to be a bit more active in the primary markets on the senior side, as well as on the subordinated side, so I think that there is some capital out there to put behind higher-quality issuers. And, certainly, there's a lot of lessons learned by a lot of lenders and their process -- and their underwriting process is extremely rigorous now, but yes, there is an opening, and I think that a lot of companies that had had access in the past may not necessarily have it in the future, and we were very happy to be the first one to come out in this space in what we believe is the largest and most flexible facility to get ours done first.

Okay, great. Thank you.

No problem.

Your next question comes from Faye Elliott of Bank of America Merrill Lynch.

Hi. Good morning. On the NPAs, I guess the level stayed flat at 8.6, but that was net of the investments that were sold off, and if we grossed it up, it would look like NPAs were a bit higher.

And so any guidance you could give that would kind of impart some confidence that we are nearing kind of the peak of the credit cycle with regard to your particular portfolio?

Faye, thank you for the question. I think from a qualitative perspective, our watch list is shrinking. That's a good thing. We're not adding new names to that watch list. We've definitely seen since the March quarter sequential quarter-over-quarter growth in both revenue and EBITDA for the portfolio in aggregate. Those are encouraging signs.

There will be, as there are, surprises that come. Unfortunately, some are negative. Some are positive. But we think we've done a good job of marketing the portfolio appropriately, that there should not be any surprises. Therefore, you see the risk rating at fair value at or around the two, which is as we expected the investments to perform.

We've seen an improvement, slight improvement, in the ratings at cost. We're going to cleanse the portfolio. We're focused on the future. We've got access to capital [inaudible - technical difficulty] the opportunities that should be attractive, but we do think that the recovery -- as a team, the recovery will be choppy. We're not expecting that we're going to be in a violent, sustainable up trend. There may be quarters that the economy gets a little choppy, but we've now cleansed our portfolio enough and optimized it and fortified the balance sheet that we can take advantage of opportunities. If we can learn lessons and we'll be more selective as we go through into the early parts of the recovery and be able to sort of focus on the larger end of the market, there's a little less competition there. Over time as the credit markets come back, then we should see more M&A flow, and we could be relevant investor of our capital.

Okay. And so I take it you'll continue to cleanse the portfolio, but should we expect that maybe going forward that that would result in a lower NPA at cost, as opposed to this quarter, where it was kind of just a replacement?

Yes, I think that's a fair statement. Obviously, we don't know what the next quarter will bring in the surprise front. If we're not surprised by any information that comes to the company that we're not aware of, then that statement you've made is not an unreasonable statement.

So, basically, as you look at it now, then it's a reasonable statement, as you just said. Thank you very much.

Correct.

Thank you.

Your next question comes from Vernon Plack of BB&T Capital Markets.

Thanks very much. Patrick, at the end of the quarter, the portfolio was 28% senior secured, 58% sub debt, and 14% equity. I was curious; should we expect a shift in the mix going forward?

When we look at senior debt and we look at mezzanine or subordinated debt, senior debt is predominantly second lien, which was a replacement, and in the last cycle, the secondary market was built, which really replaced mezzanine securities or subordinated debt securities. The risk-adjusted returns, we'd look to match. Maybe with the lien, you get a little bit more security and a little bit lower yields. Also, floating rate is mostly in the second lien versus the subordinated, which is mostly a fixed rate.

We were seeing less activity in second lien, but that could -- market may come back, and we're going to be looking at both markets as opportunities. So if the markets are there and the issuers want second-lien securities, then we'll look [while] you could do more there. If the issuers want more fixed-rate securities, then we'll do something there. So it's really -- we look at it on a credit-adjusted basis not being that dissimilar from each other.

Right.

But they have just certainly different attributes, and it depends upon the marketplace for second lien versus subordinated debt. And as a relative investor, we fortunately can do either.

Okay, thanks. And like to get current thoughts on the refinancings that will likely take place in the portfolio. Obviously, lots of debt coming due here over the next several years. Are you looking at that as an opportunity or perhaps a challenge?

In our portfolio, we certainly try to model out what we expect to happen, and the good and bad of having a high-quality portfolio is our companies do have options.

KAR Holdings was a terrific investment for us. We ultimately bought it down when the markets corrected and bought at a discount, and we got back 108% of par. That's nice to get that back. Unfortunately, we no longer hold the investment in that company, which is a good company. So it's a bit bittersweet.

There are a number of companies in our portfolio that fit that same profile. If we have an opportunity to stay involved using our call protection perhaps as a currency, if it's a sale to somebody else or if it's a refinancing, what we've always done is if the refinancing is at a higher leverage level or at a lower price than we're willing to accept, then we're going to let it go, and we'll find other opportunities out there. So that's within our portfolio.

Outside of our portfolio, we do expect that the refinancing window that's going to require in 2012 and 2013 for some bank, it should provide us with opportunities where stretch senior loans will no longer be stretch senior loans; it'll be a pocket between the senior debt that's refinanceable and the junior capital that currently exists in the capital structure, we -- may be a nice opportunity for us to come in the middle of that and invest at a good yield with good credit quality and good, good solid credit protection.

Okay, thanks.

Your next question comes from [Matthew Hallad] of Macquarie Securities.

Great. Thanks for taking my question. Just a clarification on new investments going forward. There's about 10 billion, I think, ready to price on the forward calendar and leverage on space. Are you saying that you're really not going to participate meaningfully in that primary market over the next month?

No, I mean I think what you're hearing us saying is we do watch the leverage loan market, we watch the high-yield market, and certainly, our primary market is the mezzanine market, and as you probably know, the average high-yield deal last year and last couple years has been approaching $500 million.

So those were important barometers for us, what gets done in those markets. We continue to look at every deal that comes forth. Some of the absolute pricing on the forward leverage loan marketplace, the back of the calendar just does not have the right return characteristics for us -- good companies, not very levered, but the actual return of the asset does not meet our requirements.

So we look at all those -- we look at that backlog, I think the theme that Patrick was alluding to earlier is a vigorous new issue leverage loan and high-yield market, we believe that incents and creates a lot of sponsors to then review their companies and say, okay, now what can we put up for sale? What would be able to be financed? And, therefore, we believe there will be some very good primary product for us to purchase as the second quarter and the year goes on.

So it's going to be an environment where we believe the defaults have peaked. We believe we're going to go through a elongated two or three years of periods of 4% to 6% high yield defaults, and we're going to have periods of volatility, where the high-yield market opens and closes.

That's more of a normal credit cycle, and we expect that, and that's why we really wanted to be proactive with cleansing our portfolio and getting our balance sheet in order so we can be opportunistic from our vantage point during that environment.

Got you. Thank you for the clarification.

And then just remind us again where you see sort of the optimal leverage or debt to equity sort of in this -- at this point in the cycle.

And, Patrick, you spent some time on the Hill last year. I mean any major structural changes you think for the BDCs in the near term, as well?

Matthew, your question about leverage levels for our business, our portfolio or the leverage levels of the portfolio companies?

Your level, your financial leverage.

Yes, I think, as we've always said, is we're operating around 0.52 to 1 today, which is obviously very healthy. We're very comfortable moving that up. Once we've approached 0.7, 0.75, we've historically chosen to access equity cap and deleverage further, so we want to always have cushion between what our covenant limits and regulatory limits are, and so we're not going to try to take leverage up too high. It does give us dry powder if we had to or needed to, but we've historically accessed the markets when the leverage levels get that high. Expect the same strategy from the management team here.

As far as regulatory changes, we did spend some time individually and as an industry in Washington. I think that there's a lot of other priorities ahead of us. Unfortunately, many of those priorities remain. I think at the right time, once the industry has sort of cleansed itself and we've got an opportunity to have a dialog that's constructive, that makes sense, we certainly approach it, but we're running our company assuming that there will not be any changes.

I think that's the right decision. It's been prudent for us historically to the extent that there's around the edges a way for us to help the small and middle market and the US financial [self], and there is less folks focused on providing capital debt market. We read about that every day. If that resonates in Washington, we can be a provider of that capital, but at the moment, we're going to stand ready to have that conversation, but let's not expect any changes.

Great. Thanks, guys.

Your next question comes from Chris Harris of Wells Fargo.

Great. Thanks a lot. Guys, I'm looking at your investment portfolio here on a sequential basis, and it appears that your investment in Innkeepers increased slightly on a cost basis. I'm curious, I guess, did you provide additional capital into that investment, number one?

And then, number two, I guess I know you guys are always asked about this every single quarter, but maybe if you can just give us a little update on what's happening with Innkeepers and whether you think the rebound in the economy here is going to potentially help out that position?

I'll let Rich answer the question on the cost basis, and I'll take the question on the company.

Hi, Chris. The increase in the cost basis was just on the pref, and that's the capitalized deferred interest for the quarter. That's all that is.

Okay.

Okay? And as far as the company goes, obviously, you can imagine a lot going on. In the industry, where we are seeing sequential improvement quarter to quarter, the industry is still down year over year. Last year was a very tough year. It remains a challenged market.

Visibility remains low, which really is a function of folks waiting till the last minute to book travel. We are seeing corporate travel increase quarter over quarter, but we are not projecting another violent recovery there. It's going to be a tough, tough road here.

Our management team has done a tremendous job of rightsizing the cost structure. We've got great partner relationships with our franchise or partners and management company. We continue to work very diligently on our capital structure.

The nice thing about having this marked appropriately, which is obviously or unfortunately low versus our cost basis, but it gives us the flexibility to be aggressive and assertive when it makes sense to be assertive with the capital structure.

We're watching the industry closely. You read about many, many companies in the commercial real estate space working on restructurings, working on proactive changes to capital structure. We seek every opportunity given the breadth of Apollo and what we can do as a sponsor, as well as the company's management team working closely with all of our lending relationships there, and we're going to be aggressive when we need to be aggressive.

Fortunately, the company is performing relatively well versus the competition. We try to maintain very good healthy relationships with our franchise or partners and invest in capital when it makes sense to invest capital. The company invests in capital and its properties, not necessarily Apollo, but we stand ready to be supportive in any way that we can. Again, too early to tell you what the outcome's going to be.

That's very helpful, Patrick. Thank you. And then, Rich, maybe you can remind me here, the non-extending lenders on your credit line, is that credit -- is that an amortized-only line, or are you able to revolve up until the maturity date there?

I'm sorry, Chris, on that $380 million --

Correct.

-- of non-extending, what was your question?

Yes, whether you're able to revolve on that portion --

Yes.

-- of the line?

You are?

Yes, absolutely, through April 2011 at that cost of [LIBOR] plus 100.

Okay, great. Thanks, guys.

Your next question comes from Greg Mason of Stifel Nicolaus.

Great. Good morning, gentlemen.

Rich, I wanted a little bit of discussion or color on the other income line that had been running about $1 million on average over the last four quarters. It was $5.8 million this quarter. I know a lot goes into that number, but could you give us a little bit of color on the cause for the jump this quarter?

You know, there was probably about 10 different items that contributed to that number, and they really are all over the place. There were some fees on the upfront fees that we took. There were some consent fees, some amendment fees, and so there was a whole host of fees going on. Patrick mentioned some restructurings.

So it's really a compilation of about 10 different fees that went into it. From a modeling perspective, they're generally nonrecurring, although in this environment, you're always prone to get some money in there, and it was a couple million dollar higher than usual. So I wouldn't model that in going forward, but you never know. Each quarter brings a different potential market for fees, and whether -- as we started money to work now, moving forward with our low leverage and our balance sheet and our liquidity, we -- in the primary market if and when you do close deals, there will be fees available. We just don't know when and we don't know whether coupon or full protection is more valuable; it's a case-by-case basis.

So it's very lumpy for you to model, and we apologize for that, but it's really just one component of the overall investment.

Okay, great. And you had the tax expense this quarter. Do you have your final dividends spill over from a taxable income perspective for the end of the year?

I do not because we have a March 31 fiscal year-end, and taxable E&P is measured on that date, so March 31, 2010, we'll actually have that number.

But if you wanted to ballpark it, Greg, one of the things you can do is if you look at our P&L, our statement of operations, you'll see that we brought approximately $86 million of spillover into the fiscal year beginning April 1 of 2009, and if you just took on a relative basis, if you look at our P&L, you'll see that our net investment income less our distributions for the fiscal year to date for those three quarters, you'll have about another $19 million or so that we're going to add to that 68 -- I'm sorry, add to that $86 million.

So we've grown our harvest in dollar terms, but given the fact that we've raised equity and issued shares in August and December, there is an impact on a per-share basis, but clearly, for the three quarters, we've grown our dollars of harvest to support the dividend and give investors good visibility in the future.

Great. And then one last question. Fed fund futures are projecting that at some point this year, we're going to start seeing a rise in interest rates. How well are you guys matched from a rising interest rate perspective, and what do you want to do to either protect or take advantage of a potential rising rate environment?

Hey, Greg, it's Patrick. One thing that we've always -- advice as I have done is really tried to match our floating rate liabilities with our floating rate assets, so we're agnostic from a profitability perspective. It has had an impact on NAV. As you'd mark to market your portfolio, generally, you're mark to marking [inversely] fixed-rate market, so we have the really well-performing assets where LIBOR decreased the marks we're taking on those assets, even though are spread in profitability was the same and the collectibility was still so very, very good.

So, yes, you may have some volatility in NAV. It may reverse itself out if rates do rise. But we're not really prone to speculate on rates. We like the matching of our business. The profitability's what generates our earnings, which generates our dividends.

If you had to, on balance, invest in a security, fixed or floating, what we have done is when you look at the swap curve, you may have a lower yield on a floating-rate instrument versus a fixed-rate instrument because the swap was sort of two, 300-basis-point swap because the market does expect rising rates. If we didn't use our revolver to hedge, we'd probably look to use some other instruments to hedge that out. So we don't speculate on rates.

Great. Thank you, gentlemen.

Thank you, Greg.

Your next question comes from Scott Valentin of FBR Capital Markets.

Good morning. Thanks for taking my question. We've heard from some of your peers there's been a bit of a bifurcation in the market, that the large liquid investment market is seeing some signs of maybe some covenant weakness or term weakness. I mean nothing what it was a couple years ago but some weakness from maybe where it was six months ago versus the middle market, which still remains pretty constrained.

Any thoughts? I know you guys preferred a large liquid market, but any thoughts of maybe moving down to smaller investment sizes?

I think that's a great question. We've always maintained -- I think what happened [inaudible] some challenges in our portfolio have been really when we were a smaller company, and we're investing in smaller companies themselves.

What you see is there is a -- more folks are attracted to the larger end of the market, especially coming out of the cycle, because the resilience in those companies has proven so, and folks always think they're going to reenter the market, banks and/or other institutions, reentering the lending market. They're going to reenter where they believe there's resilience and liquidity, and that is the upper end of the market.

That resilience and that liquidity in our portfolio has really afforded us the pathway to get through the cycle and emerge as a leader. There is a dearth of capital that was in the small/middle market, and you can extract value in the form of yield but ultimately end up squeezing liquidity out of these companies, and that's really not our model.

There are folks that have exited that market. There are many, especially finance companies, whether it's Capital Source or CHE and others, who have had challenges in that marketplace working on their own restructurings to improve their companies coming out, but the funding of those businesses is challenged.

We look at that opportunity. We think what we're good at is really focusing on what we do and we've done is to focus on the larger end of the market, being a relevant investor, being early, getting -- working very closely with the sponsors of high quality who invest in that space, and there is market opportunity for others in the small end of the market. That's not something that we're currently designing our business around.

Okay.

And, Scott, let me add that we've managed our cost of capital from day one in our business so there'll be no need to chase yield. Those yields, I think, as mentioned earlier on our call, were more equity-like risks in some of those yields, especially in the middle markets.

So they may sound good today; we're concerned about tomorrow, and again, as we've noted, there have been a lot of issues in the space with some of those players, those commercial lenders.

So right now, we think that there is some yield tightening in the large end of the middle market given all those attributes that Patrick mentioned -- the liquidity and the performance and the resiliency through the cycle -- but again, we've managed our cost of capital since our IPO. Those transactions we could still find very accretive and, quite frankly, on a risk-adjusted basis, we think, are more compelling.

Okay. Just one follow-up question. In terms of targeted industries, any shift there? Sounds like you maybe have a brighter outlook for the economy. Wondering if maybe you're shifting towards more cyclical industries away from more defensive industries?

You know, we don't really instigate which deals come to the primary market. It's really a function of the companies that performed because companies that perform can be sold. Companies that have not performed recently, [inaudible] tough time to find themselves.

We've seen in our business in the attractive investments we've made have been in those defensive industries because they've proven themselves through this very, very difficult time. Education and healthcare, government have been just some common industry groups. We've done some of those investments not because they're in those industries per se but because they've performed, and they perform at a very, very difficult environment, and we expect them to continue to perform.

We expect to see that some of the companies away from defensive, not the deep cyclicals because that's not an attractive industry group for us, but for companies that have -- a lot of companies have some reliance on GDP growth that will broaden that universe out for us, and those companies that have performed maybe relatively better than others -- and as a debt provider, we don't necessarily need growth in those companies. We just need sustainability. Maybe sustainability at trough levels will be how those companies are capitalized, and we'll be a provider of capital in that. If it grows, that's just added benefit to us. If they troughed out and there's cash flow there and capital structures are over-equitized versus historical measures and we can get our capital in there at a good place, the business was -- continued to go sideways, we're going to get free cash flow generation and deleveraging. Those are very attractive for us.

So you probably would expect to see, as we do, a broadening out but not an intentional broadening away. But if we're at 10.1% in education today, which is about where we are, you're probably not going to see too much more education assets coming to our portfolio because we do like diversity.

Okay. Thanks very much.

Thank you.

Your next question comes from [Greg Robinson] of SunTrust.

Good morning. Actually, this is John Stilmar. Guys, thank you for allowing me to ask my question. I had three of them.

Patrick or Jim, maybe starting with -- you mentioned, I believe, in your remarks, talking about both revenue and EBITDA, trends up. Can you provide something a little more quantitative or a little bit more precision to that and generically what you're seeing, at least in terms of revenue and EBITDA trends, at least in terms of the slope or pace of the recovery that you're seeing in some of your portfolio companies?

And then with that, is there a bifurcation between some of those portfolio companies that may have been more cyclical versus non-cyclical? Where are you seeing the bulk of your revenue and EBITDA growth as you've [sort of] talked about earlier on the call?

John, great question. We have a portfolio of 70 companies. It's a dynamic portfolio, so it's hard to measure over time, sort of give specifics around that. What we do is we watch as best we can the generalities more specifically than the details because companies can come in and out of the portfolio and they may be meaningful investment -- may have a meaningful impact, but we do -- we look at quarterly trends in our business of what the current portfolio is today and what it looked like historically, and what we're seeing is sequential growth still a little bit down over last year. You know, you can look at the full-year basis, but sequential growth and quarter-over-quarter improvements getting the right direction.

So directionally, it'd be very hard unless you had a static portfolio that was in the kind of run-off that you could measure that over time, and our portfolio is dynamic.

We're in a growth mode, so some of our best-performing investments we expect in the future will be the ones that we've just made.

So it's hard to really sort of trend those back over time because we were not involved in those companies, they didn't have the capital structure they currently have, etcetera.

So going to be cautioned about giving specifics on that, but since the March '09 quarter, we are very happy that as the current environment looks like across the board -- you read about it in the paper -- things getting a little bit better. They're not getting meaningfully better yet. They're getting better. Stabilization first now getting a little bit better quarter over quarter.

We may have a negative surprise on one company next quarter. That's a large company. May be down 5% on top line but up 10% on EBITDA. We've seen a little bit better performance on the EBITDA line because the company has gone in and been aggressive about their cost structures, as we hoped and expected that would have done and they have done that.

We are optimistic that a little top-line improvement going forward will have a nice flow-through given the revised cost structures of many of our companies.

So I'm sorry I can't give you more detail than that, John, but that's kind of what we're overseeing. We're pleased with that kind of dynamic, but again, we may be in a choppy environment for the next 12 months. We're not economists who are predicting that it's a stable and sustainable, aggressive growth.

That's actually really helpful.

And then, Patrick, to follow up, we've often talked about Apollo's relevance in the primary market, both in proprietary looks at deal volume, as well as being relevant in providing structural leadership. Can you talk to me about how both of those themes may have played out in your new primary investments this past quarter?

On both those two investments that were primary in the December quarter, HEI Acquisition Corp. and Datatel, we were very much engaged with both the sponsor and in the banks who are lending on the capital structure, as well.

I think without getting to specifics, these are private companies, so the situation is that both sponsors [inaudible] would, I think, say some very positive things about us.

Datatel was Hellman and Friedman. We invested in it three or four times in the past. We have investments with them today and a few companies that have performed very, very well. We like them as a sponsor. Hopefully, as you can see, that they're coming back to us, we remained wide open in our dialog with them. We'd love to be helpful to them going forward.

[HEIDT] Partners, we're invested with them in Brenntag. We're now investing with them here. We're in dialogs about hopefully helping them on many opportunities. We have a very active, direct dialog with them, as well as Wall Street.

With the markets improving in this first part of the year, mostly technically driven because of cash flow -- cash coming into these markets, the last couple of days have been a little bit choppy. Banks are going to want to know that they can de-risk their originations pipelines by finding [and providing] the capital that are there, are relevant, can help structure, and where an active dialogue and discussion with those opportunities [we are today].

Going forward, as Jim mentioned, that if the markets get overly hot, we've seen them, we've looked at them. We will stand out. If the market's window closes for more syndicated financings, we can come into a meaningful investment.

And you look at the size of our investments in ATI as a -- relevant to the size of that tranche, we were very significant. I think that that was helpful to both the sponsor and to the banks who were working on that financing.

So we'll work on every day both on a sponsor coverage basis, direct with the sponsors, as well as with all the Wall Street firms to our capital markets team that's here talking to Wall Street every day.

Perfect. Thank you for your time.

Thanks, John.

Your next question comes from [Aaron Saganavich] of Ladenburg Thalmann.

Hi. Maybe I missed this in the call earlier, but were most of the new investments this quarter, were they made towards the end of the December quarter?

Yes, that's right, Aaron.

Okay, so generally, the average investments should kind of produce a higher net interest income in the coming quarter?

Yes, there was not a lot of contribution to earnings from those investments. Maybe the sponsors or sellers in the market came to us in the latter half of December and, therefore, we'll see those accrete to earnings in the March quarter.

Yes, just one comment on that. It wasn't we were looking to make investments in December, but it's natural -- it happened in the year before and the year before -- that a lot of folks like to get things done by year-end, so there is -- and that's good for us as a buyer because we can extract some value for that because we spend a lot of time on these companies. We've either known them. Some of them in the secondary market were already in our portfolio, and folks had a desire and a need to clean up their portfolios and sell assets, and that accrues to value to us because we can come in there and we can be patient and use that to our advantage.

Great. And then, also, on your exits of your non-accruing companies, what's your strategy in terms -- or do you have a specific process in terms of exiting these companies that are kind of just hanging around on the balance sheet?

You know, there's a few things that go on there, and every situation is very different. We are not in the business of exiting something that we think ultimately will have higher value for our shareholders.

These names we exited, we've been in these names for a long, long time as they've been stressed, and with either cushion or relief and/or restructuring.

Well, Eurofresh did emerge from bankruptcy, and we had a restructured instrument in the form of equity, and we had a view. We had folks who were interested in acquiring those securities to us either come to us and/or we could seat that market -- go in the marketplace giving our platform of relationships we have with other folks who may be more in the distressed option opportunities that they want to buy a portfolio of these.

So they're all fluid. They're all very different. We're not trying to give it away. We will do -- exhaust all of our resources if we think there's more value to be had. If there's not, then we're not going to sit there and watch further value deteriorate.

Okay, thank you.

And our final question is from Faye Elliott with Bank of America Merrill Lynch.

Hi. Thanks again. Is it possible to give a breakdown of the [inaudible] of your portfolio, particularly since you are investing more heavily now?

You know, again, it's a dynamic portfolio. We've done a fair amount of investments each of the years. I think that we've seen as our -- the average hold period in our business is generally three to five years. Our portfolio is a little bit shorter than that because there was investments made in 2005 and '6 that came out pretty quick. It's not a disparate between years. I think that what we're pleased to see is some of those vintages that others may consider a risky vintage, '07/'06, have performed very, very well for us, amongst the best performing.

As we continue to grow the size of the companies we're investing in, the resilience of those companies has proven so, and so we've been very pleased with that.

So I wouldn't say it's a big disparity on the numbers of investments. As we've gotten bigger, our dollars of capital have gotten bigger. We invest in bigger companies. So the trend may look each year getting a little bit bigger in the vintages, but there's nothing I would say that's meaningful from a statistical point of view.

Okay.

Faye, we don't really track it that way, and that's why we don't have the numbers for you. It's really a bottoms up, one investment at a time. And, again, it's trending, as Patrick said, as we grew our capital base and we sought bigger companies and [inaudible - technical difficulty] relevant and control documentation, etcetera or have liquidity. Those were some of the primary drivers, not necessarily -- it's not really a portfolio approach; it's really bottoms up one at a time.

Okay, thank you.

Thanks, Faye.

Thanks, Faye.

Well, with that, I'd like to thank everybody for joining our call today. We appreciate your continued support, and we look forward to giving you the update at the end of next quarter. Take care.

Thank you.

And, ladies and gentlemen, that concludes our conference for this morning. We appreciate your time and attention. You may now disconnect.