MidCap Financial Investment Corp (MFIC) 2011 Q3 法說會逐字稿

Good morning, and welcome to Apollo Investment Corp.'s earnings conference call for its third fiscal quarter ended December 31, 2010. (Operator Instructions). It is now my pleasure to turn the call over to Mr. Jim Zelter, Chief Executive Officer of Apollo Investment Corp.. Mr. Zelter, you may begin your conference.

Thank you, and good morning, everyone. I'm joined today by Patrick Dalton, Apollo Investment Corp.'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?

Sure. Thanks, Jim. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corp. 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.

Thanks, Rich. I'll start off with a brief description of the market conditions during the December quarter, and then move to some of our more strategic initiatives before touching on some portfolio highlights of the business.

The strong credit markets during the December 2010 quarter continued to offer enhanced liquidity for primary issuers and secondary paper. For the full year ended December 2010, high yield has a strong record issuance of north of $300 billion, as compared to $180 billion for 2009.

Concerns over double-dip recession and sovereign issuer defaults also waned significantly during the quarter, improving the economic outlook and contributing to a tightening of yield spreads across the spectrum. This dynamic only further increased demand for secondary paper, driving bond prices higher, lowering yields, and finishing a year of strong returns for investors and credit.

Investors in the public stock of Apollo Investment Corp., ticker AINV, achieved a total return of 28.5% for the 12 months ended 2010 -- December 31, 2010, including reinvested dividends.

Strategically, we set out to accomplish three goals during the December quarter. One was to complete the necessary steps to add additional long-term fixed-rate debt to our balance sheet. Two was to finalize our due diligence on the credits we liked and were about to add in our portfolio and have been working on. And three, we wanted to further optimize and improve the quality of our portfolio.

That said, Apollo Investment Corp. recently completed its debt-raising and capital structure initiatives announced last call. This January, we were pleased to again issue in the strength of the credit markets and issue $200 million senior unsecured five-year convertible notes with what we believe are attractive terms, a 5 3/4 coupon with a conversion premium of 17.5%. We anticipate this access to the unsecured credit markets will generate long-term benefits to AIC and introduce us to a new investor base.

Furthermore, and also in January, we were pleased to add another new relationship bank to our revolving credit facility, which added a $50 million commitment to our growing syndicate of revolver lenders.

Accordingly, and with the significant reach and expansion of our debt capacity, we have deliberately accumulated our liquidity and capital resources as we look ahead and prepare for what may be a long period of M&A activity and related investment opportunity for Apollo Investment Corp.. With our new January debt capital raises, our total debt capacity currently exceeds $2 billion. Pro forma for our 2011 debt maturities later this year, Apollo Investment Corp. will have approximately $680 million available for new investment. At December 31, 2010, our outstanding leverage stood at 0.53 to 1, measured as a ratio to stockholders' equity.

Now let me briefly go over some portfolio highlights for the quarter ended December 31, 2010. It was an active quarter for us. In total, we invested $382 million in eight new and three existing portfolio companies. We also received prepayments totaling $326 million and sold select assets totaling $155 million. At December 31, 2010, our portfolio of investments totaled $2.92 billion, measured at fair value, and was represented by 69 distinct portfolio companies diversified amongst 30 different industries.

Now with that, I'll ask Rich to take you through some detailed financial highlights for the quarter. Rich?

Thanks, Jim. I'll start off with some December 31, 2010, balance sheet highlights.

As Jim noted earlier, our total investment portfolio had a fair-market value of $2.92 billion. Our December 31 net assets totaled $1.9 billion with a net asset value per share of $9.73. This compares to net assets totaling $1.86 billion at September 30 and a net asset value per share of $9.58. The increase in NAV for the quarter was driven primarily from net unrealized appreciation on our investment portfolio.

Positive contributors to performance for the quarter included our investments in AIC Credit Opportunity Fund and Ceridian Corporation. The positive impact was primarily due to improving valuations.

Partially offsetting the Company's unrealized appreciation during the quarter was unrealized depreciation from PlayPower Holdings and Generation Brands.

On the liability side of our balance sheet, we had total debt outstanding of $1.0 billion at December 31, as compared to $1.1 billion at September 30. This left our debt-to-equity leverage ratio at 0.53 to 1 at December 31, as compared to 0.59 to 1 at September 30.

Our 2004 vintage investment in PlayPower Holdings was placed on non-accrual status during the quarter. However, we did exit completely from our investment in Pacific Crane Maintenance Company, as well as restructure our investment in LVI Services, both of which were previously on non-accrual status.

Our portfolio of 69 companies now has two companies with investments on non-accrual status at December 31, 2010, versus three companies at September 30, 2010. These investments represent 2.0% of the fair value of our investment portfolio at December 31, versus 0.2% at September 30. On a cost basis, they represent 6.6% of our investment portfolio at December 31, versus 5.7% at September 30.

As for operating results, gross investment income for the December 2010 quarter totaled $94.3 million, an increase from $91.5 million for the quarter ended September 30 and up from $85.6 million for the comparable December 2009 quarter.

Expenses for the December 2010 quarter totaled $44.2 million. This compares to $41.3 million for the quarter ended September 30 and $34.2 million for the comparable December 2009 quarter.

Ultimately, net investment income totaled $50.1 million, or $0.26 per average share. This compares to $50.2 million, or $0.26 per average share, for the September 2010 quarter, and $50.2 million, or $0.30 per average share, for the comparable December 2009 quarter.

Also during the December quarter, we received proceeds from investment sales and prepayments totaling $481 million. Net realized losses totaled $64.9 million. These were primarily related to the realization of previously-recognized unrealized losses on Pacific Crane Maintenance Company, as well as LVI Services and increased structuring, all partially offset by the realized gains we received from MEG Energy.

These results compare to net realized losses of $89.4 million for the September 2010 quarter and the net realized losses of $152 million for the December 2009 quarter.

The Company's investment portfolio also had net unrealized appreciation of $99.3 million for the quarter ended December 31, 2010. This compares to net unrealized appreciation of $107.4 million for the September 2010 quarter and net unrealized appreciation of $181.4 million for the comparable December 2009 quarter.

In total, our quarterly operating results increased net assets by $84.5 million, or $0.43 per average share, versus an increase of $68.2 million, or $0.35 per average share, for the September 2010 quarter, and an increase of $79.5 million, or $0.48 per average share, to the comparable December 2009 quarter.

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

Thank you, Rich. As we highlighted earlier in the call, it was an extremely active quarter for Apollo Investment Corp..

Strategically and on the back of the Company's private note issuance that we announced last call, we continued our efforts to obtain additional cost-effective debt capital. These efforts culminated in the issuance of our inaugural unsecured convertible note in January, and in addition, we also added another new revolving letter to our Company, one that has the capabilities and the scale to partner with us for the long term. Ultimately, we believe our continued access to diversified funding sources to an expanding population of investors is a significant competitive advantage for Apollo, one that is strategic to the future growth of our business.

We also believe that this year's successful fundraising initiatives have solidified our balance sheet for new investment opportunities over the long term.

We were also active with our portfolio during the quarter, investing in eight new and three existing portfolio companies. We continued our process of selective portfolio optimization with the intention of generating incremental yield and improving our risk-adjusted returns.

Lastly, we received significant proceeds back from several of our successful investments, generating attractive internal rates of return.

Let me take you through some of the portfolio-specific changes. Portfolio company investments totaled $382 million. Our subordinated debt investment to new portfolio companies were in Univar, Inc., Renal Advantage, and Exova.

Our investment in Univar consisted of $79 million in mezzanine notes and $9 million in a common-equity co-investment. Univar is a global chemical distributor, and a CVC Capital Partners and Clayton, Dublier & Rice portfolio company. Renal Advantage, a dialysis services provider, received an investment from us of $32 million in their mezzanine notes. At Exova, a laboratory-based testing provider, we invested GBP18 million in the senior unsecured notes.

Other new portfolio company investments were in Vertafore Inc., a TPG portfolio company, where we invested $74 million in their second-lien senior-secured debt. Vertafore is a leading provider of software solutions to the insurance industry. We also invested $26 million in the second-lien senior-secured debt of Applied Systems, another provider of software solutions for the insurance industry.

In addition, we invested $15 million in the first-lien senior-secured debt of Brickman Group, a provider of landscape maintenance services. Other senior-secured debt investments and new portfolio companies included small investments in Leslie's Poolmart, a provider of swimming pool supplies; and Global Auto Care, the producer of auto care products such as Armor All and STP.

Our investments in existing portfolio companies included $49 million in the second-lien senior-secured debt of Advantage Sales & Marketing, a leading sales and marketing agency. This investment followed the refinancing of Advantage Sales & Marketing's previously-existing 2006 and 2010 vintage second-lien secured debt, which we supported. This successful investment was repaid at a premium to par.

Our additions include $24 million in the discount notes of Catalina Marketing, a leading media and marketing services company, and a small investment in the first-lien senior-secured debt of PlayPower Inc., a playground systems provider.

Other highlights of significant portfolio changes during the quarter include the successful monetization of our 2010 vintage common-equity investment in MEG Energy, an oilsands developer in Canada. We realized gains in excess of $32 million on our $55 million investment.

In addition, our successful investment in BNY Convergex, a leading institutional agency-only broker and financial technology provider, which we initially invested in 2006, also came back to us at a premium to par. Additionally, we fully repaid our 2007 vintage investment in Gray Wireline, a leading independent provider and operator of measurement and maintenance tools used to service oil and natural gas wells.

On the restructuring side, we are pleased to complete the recapitalization of LVI Services, giving it more runway to succeed over the long term.

Our activity in December quarter is certainly reflective of our scaled pipeline of investment opportunities and our large global platform. And we continue to stand ready to deploy our substantial available capital and grow our business. That said, we will continue to be disciplined with regard to any individual quarterly deployment, especially during any overzealous periods where, in our opinion, risk is usually mispriced or terms such as rights and remedies are unacceptable. We believe this is prudent investment approach in seeking the most attractive risk-adjusted returns, and will accrue to our shareholders' best interest over the long term.

At this point, let me go over some portfolio highlights at December 31, 2010. We continue to be well diversified by issuer and industry, 69 portfolio companies invested in 30 different industries. The Company's total investment portfolio had a fair-market value of $2.92 billion, which was comprised of 29% in senior secured loans, 62% in subordinated debt, 1% in preferred equity, and 8% in common equity and warrants. Again, measured at fair value.

The weighted average yield on our overall debt portfolio at our cost at December 31, 2010, was 11.5%, versus 11.7% at September 30. The weighted average yields on our subordinated debt and senior loan portfolios were 12.9% and 8.7%, respectively, at December 31, 2010, versus 13.3% and 8.9%, respectively, at September 30, 2010.

Also at December 31, the weighted average EBITDA of our portfolio 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 was 2.3 at December 31, unchanged from September 30, measured at cost, and continues to be rated 1.9 times measured at fair value at December 31, 2010, which is also unchanged from the prior quarter.

Before I open up the call to questions, I'd like to reiterate that we continue to be pleased with how our current overall investment portfolio is performing and how the underlying companies are progressing even in this uneven economic recovery. We also believe that 2011 and 2012 will be an active period for M&A activity, which should provide us with an array of investment opportunities, given our substantial available capital and relationships with high-quality financial sponsors.

In closing, we'd like to thank all the dedicated and long-term investors in Apollo Investment Corp. for your continued support and confidence in us. Now with that, operator, please open up the call to questions.

(Operator Instructions). Sanjay Sakhrani, KBW.

Thank you. My first question is for Jim and Patrick. I guess what I find striking at this point is some of the larger BDCs have had a little bit of a tough time posting net growth, despite having a ton of liquidity and great access to the public markets. I was wondering to what do you ascribe this, and could you just talk about how that dynamic changes from here on out? Thanks.

Sure, let me start out, Sanjay, and then Patrick will add, but we have been in business for a number of years now. We've obviously reached critical mass, and when you have a portfolio as large as ours where you made a lot of investments in 2006 and 2007, it's natural, as the markets rebound d and rally, that companies that can refinance, do refinance. So that's expected.

Certainly in the last 30 to 90 days, we've been in a very robust period. A lot of search for yield, and candidly, as we look at not only our company but all the whole BDC marketplace, we look at the returns, and the yield is pretty compelling on a lot of people's stocks versus the alternatives out there. But I'll remind people that last February and March, we had the same period, and then all of a sudden in April you had a market selloff.

So, what you're hearing me say is there's no doubt there's a lot of euphoria out there right now, and when you look back to the last cycle, periods of euphoria aren't always the best times to invest. But there is inevitably windows. There is inevitably volatility.

Last April, when the market fell down, that's when we really had an opportunity to do a very interesting transaction that resulted in our investment in Altegrity, which took a few months. But the windows open and close pretty quickly. And while certainly we see a lot of wins in the economic backdrop right now, it's just -- it's proven to us over time that there will be volatility.

Now, do I expect volatility like 2007 and 2008 with the credit crisis? I don't. But I've been in the high-yield market for plus 23, 24 years, and there's always windows that open and close. And that's why we want to be poised to have those things right now.

So, what you're really hearing me say is, yes, we have the luxury of having a big portfolio. Some really good investments rolled off. We made some good investments in the December quarter, and we're going to be prudent, but inevitably there will be opportunities for us to find areas for growth.

And the only thing I would add to Jim's comments, Sanjay, is the markets do change. The only thing we can do is stay true to our strategic initiatives and our investment prudence, so that we can build a portfolio for the long run, and we are confident that we'll see -- those opportunities will be here.

Then maybe just a couple of more questions. What is the average duration of the portfolio today relative to where it was maybe a year ago? And then, just in terms of pricing, what's the pricing like in the sweet spot of where the opportunities are available to you? Thanks.

On the duration, I'll just give you some off-the-cuff numbers, and Patrick can talk about the pricing.

But certainly, you know the size of our overall portfolio, $3 billion. You saw what we lost in the fourth quarter in terms of just repayments, not sales, but repayments, and on that characterization, our portfolio on a December pace would have an average life around three years. Now we've always said in this business that it's going to vacillate between three years and 4.5 to five years. During 2007 and 2008, it was closer to that 4.5 and five years because we were getting very few repayments.

So, right now, I think it would be our view that our portfolio has a duration of 3.5, maybe four years, 3.5 years on average, and with our proportion of some senior bank debt and second liens and mezzanines, that may accelerate, because you're getting prepayments in the loan market right now in excess of 25% in aggregate. That's what I would say on that.

And then on the pricing side, there is no doubt that the credit markets have continued to tighten into this quarter. It is competitive out there.

We are looking for the best risk-adjusted returns. We have had a bias towards more floating-rate on the asset side as we fixed some of our debt on -- fixed-rate on our own debt to take advantage of a rising rate environment to recruit more income into our Company. But pricing really -- it's total yield. It's total return. It doesn't move around as much as you see the high yield of the bank loan market when you deal with mezzanine.

But it is competitive, and we just need to make sure it's accretive. We need to make sure it's the right risk-adjusted returns, or we may not play, which is -- we're not going to -- if you force investments into the portfolio at the wrong price and terms, it will come back to hurt you later on either through your NAV or lack of repayment or credit issues down the road.

So, we're going to be opportunistic. We're using our scale and our competitive advantages that we have to find -- that's why we're able to do last quarter $380 million in a marketplace that was several billion. We're going to be selective, but we're going to be prudent, and if it means we need to be a little patient, we're going to be patient.

And I would just say one more thing, again. I want to make sure people understand our perspective on this.

If you look at the industry in total, not just with our Company, but the yield on the dividends, if you look at those in aggregate versus a variety of other credit products right now, it was a pretty substantial gap. Our companies were pretty -- as an industry, we are fairly low leveraged right now, probably prudent to be. But when you see the indexes on single-Bs going through 7% in the mid-sixes, and the dividend yields of our companies in aggregate and our Company in particular, we believe it's a pretty healthy dividend and a pretty appropriate yield for the opportunity that exists.

Rick Shane, JPMorgan Chase & Co..

When we look at what's going on in the high-yield markets and what's going on in sort of the more traditional middle-market BDC environment, there's a pretty significant differential. Middle-market yields are still extremely high. High-yield spreads have come way in, and I think that's a function both of fundamentals and technicals.

Your strategy is to bridge the gap between those two markets. Do you think that the pressure of tighter spreads in the high-yield market is one of the things that's actually really driving the higher repayment activity within your portfolio?

Rick, it's Patrick. Absolutely. When you have -- an issuer has an opportunity to refinance their capital structure at a much lower rate or much higher leverage and take a dividend, that's something a sponsor is going to look at closely.

We have fought that for many years and have more duration than one would expect, given some call protection that we fight for going into a transaction. So, as we talked with some of those prepayments, we got some nice call premiums, and that we would like to continue to exist in our business.

We play across all markets where there is best relative value. We were able to acquire a lot of good assets of large companies in 2007, 2008, and 2009 in the secondary market, so we're -- now we're seeing some of those pay us back. That's great. It's a successful investment.

If right now the middle market has the right risk-adjusted returns, I think that -- but quite candidly, if you look at the yields across the space, the middle market is not as big of a gap as one may think it is, where deals are getting priced or the risk you're taking for those prices, either on leverage or on terms or unstructured.

So, we're open to all opportunities where it makes sense for us. If it means we end up doing more primary issuance in the middle market today, and maybe the market dislocates more in the secondary market, that's the benefit of our model is we're relative value. In the global platform, we see opportunities across all markets.

Got it. So realistically, what you're suggesting is that over the next 12 months or 24 months or whatever the horizon is, that there's probably a greater opportunity for you to move down a little bit in terms of enterprise values, transactions, and look at some of those deals.

Look, I think maybe is the answer. The high-yield market, as Jim mentioned, last year when that gapped up, we were able to do Altegrity Kroll transaction, which is a $327 million EBITDA company. Several billion dollars of value there.

And so we're going to stand ready and look at everything across all marketplaces, and when the best relative-value opportunity comes to us, be it from large cap, mid cap, up and down the capital structure, as long as it's complementary to our core skills and we can make it accretive to our business, we'll selectively take advantage of those opportunities. So, we don't want to promise which market, but we're going to look at all markets.

Jason Shum, Bank of America Merrill Lynch.

This is Jason. I'm filling in for [Faye]. Thank you for taking my question. Just a couple ones. Were you guys surprised about PlayPower going on to non-accrual status? It seems a little late in this part of the cycle for a new MPA. And my second question is, can you guys comment on where you guys are seeing the yields right now?

I'm sorry, the last question -- or last part of the question, please?

The second question I have, can you guys comment on where you guys are seeing yields right now?

Right, okay. On PlayPower, this is a business that we've been involved in since 2004. They're one of the only manufacturers of playground equipment in the U.S. and the UK and in the Netherlands.

It's performed very, very well for many years. Some of the buyers of this playground equipment are municipalities. You're seeing a current dislocation in what's happening at local and state governments and the municipal bond market, so that's obviously something that's had more of a lagging effect on the performance of this company. The business has continued to cash flow.

The issue that the company faced was a covenant step-down. A business that has a covenant issue has to deal with a covenant issue, and generally it requires restructuring or reorganization or recapitalization. We're very actively involved there, prospectively looking at what an outcome perhaps may be, and we'll have more to report with that, hopefully, by the end of our next quarter.

But it was not a surprise for us. The company just missed its covenant, and so when you find out where you are, but it had been appropriately, in our view, valued and put on nonaccrual when the catalyst of that nonaccrual happened.

And then, on the yield, I think we talked a little bit about where the yields are. It depends on which market you're looking at. I think yields are a little tighter in this market than they have been historically, but the bands of the yields we're searching for -- between our markets, say, we always call it somewhere between 10% and 16% market, depending upon the risk you're willing to take and the opportunity and what value you're are providing to your sponsor client, be it certainty or structure or long-term commitment, you can get paid a premium for that.

We are total return focused. So we're looking at coupon, we're looking at upfront fees and we're looking at call protection on the back end, and we'll manage each of those different parts of the deal to get us where we expect to be a yield over the long run. So, we're not believing we're going to see a significant deterioration in that, especially if we enter into a rising-rate economy.

That's fair. That's all I have. Thank you.

Greg Mason, Stifel Nicolaus.

First, I wanted to talk a little bit, if you can, about the convertible debt you issued in January. What is the likelihood that that can convert, if your stock trades above the conversion price, or are there things to protect that? And then, number two, as we understand it, there's kind of two methods, and if convert or net share settlement, can you talk about how you're thinking about potentially accounting for that?

I'll address the first part. This is Patrick. And I'll have Rich address the accounting.

We were very, very focused on that exact question. There was a comparable done in our industry in December, which had, I think, more flexibility. We look at this as -- our approach for this was we're a replacement for debt capital. We really focus on the price of debt and the structure and the early conversion being very unlikely.

We put in some protections. I think -- the note agreements are private documents, so I can't go through in detail, but there are significant protections where, i.e., the stock has to be such a high level, well above the conversion premium in there that we would -- it would have protections against someone's ability to early convert. So, without it having major changes in the market environment, whether on the up or down, we think that there is significant protection and we look at this as a debt replacement.

Now let me ask Rich to answer the question on the accounting.

Yes, there are a number of accounting structures or structures that require different accounting. I can't really speak to the others in the industry that have issued, but for us, this is a traditional if converted structure.

Again, it's really a debt substitute for us. It is debt unsecured, our first entree into the unsecured market, and we're going to accrue interest at the coupon, assuming it's debt, and I think that we're required to show on a fully-diluted basis, even though we won't be paying dividends for those additional shares, and if it is outstanding for the five-year tenor that we hope when we issued this thing.

Again, no dividends will be paid on those shares, even though we'll report either on our income statement or in the notes to the financial statements what the fully-diluted impact would be to EPS, but again, keeping our interest expense down and concentrating on net investment income and how that relates to our dividend is really our focus.

Great. And then, I know historically you guys haven't broken out kind of lumpy fees in the quarter, but you talked about you had $325 million of repayments and you guys have talked in the past that you've fought for call protection, so it would seemed like that heightened repayment activity would've led to some prepayment fees in the quarter. Can you just give us some guidance about how we should be thinking about that this quarter and going forward?

Sure, Greg. I think consensus was 24 for the quarter. We beat consensus by a couple of pennies and we did have an active quarter with a significant amount of repayments.

So it's very -- I think Patrick took you through some of the vintages. Some of these things were 2006. Some were 2007. Some were more recent. I think it's reasonable to think that some of the older ones, some of that core protection, you either run off or was very low. But some of the other stuff, the BNY Convergex is, if you track to our public filings, you can see we added -- it was an initial 2006 investment, but we continued to add in 2007, 2008, so the more recent vintage investments in BNY, it would be reasonable to think that there is call premium.

So it's really a mixed bag, depending on the vintage. It absolutely kept us on some of these big credits that had delevered, kept those credits in our portfolio longer. We are duration-focused, and again, we think that that matches up to a dividend liability that we have to pay every quarter.

We haven't broken it out, but again, I think the fact that we beat consensus by a couple of pennies, we did some upfront fees, we had some write-downs -- write-offs with PlayPower, and then we had some backended fees from call premiums. That all kind of gets you back to that net $0.02 over consensus.

Great. Then one final question, given that you have all of this debt capacity, what are your thoughts about equity issuance here in the next two, three quarters?

I think, right now, Greg, that we feel like our balance sheet and our capital structure is the way we'd like it right now. We don't find any -- certainly, we have a view that if we can opportunistically fix rates -- unsecured debt at rates that make sense for us long term, we will do so. But I don't think that -- we feel we've got a pretty nice balance sheet right now. We're not in a rush to make any kind of urgent changes.

And then, having dialogue with our investors, I think -- our hope is that they continue to appreciate our discipline when it comes to raising equity.

Right, and to the extent that our pipeline changes and we're closing significant transactions, not many, but if you close a few large ones like we did in the Altegrity, if that happens -- you know, a deal is not done until it's done, but if that was to come, would be a good problem, and then we would revisit that.

James Ballan, Lazard Capital.

I wanted to follow up on one of the previous questions. If you just look at the top line, just at the income, taking the other income out of it, you compare that to the portfolio at cost -- the performing portfolio at cost, it seems like there's a big step up in the -- so the weighted average yield across the portfolio, and when I look through some of the -- what came in and what went out in the portfolio in the quarter, it was kind of hard for me to come up with a reason why that would've come up. Could you give me a little color on what drove that?

Sure, Jim. It's really just geography. Under GAAP, call premiums are foregone interest, and they belong in the interest income line item, so that's really where you're seeing that. Where for our new business, you see a structuring fee, that may be fee for service, that would be in other income.

So we had net deployment of $382 million out the door, so that would be -- to the extent there was fees involved in that that were for services rendered, those would be in the other income line. To the extent we have call premiums back on the 326 that were prepaid, those would appear on the interest income line.

Got it. Can you give me a little bit of a feel of maybe the recurring portion of the interest income line?

I think my best guidance is for you -- because we report our weighted average yields on a cost basis, you can probably look at that times our portfolio, and we break that down by asset class -- senior, subordinated, and pref and equity. So take a look -- and the total. So, you should be able to budget pretty easily that way. We're pretty transparent with that.

I'll take a look at that. Rich, also, could you give us an update on the -- just where you are from an undistributed taxable income basis on a dollar amount or a per-share basis, and maybe talk about what that means for the sustainability of the dividend?

Yes, sure. Technically, E&P for tax is not measured until your fiscal tax year end, which for us is March 31. We're getting closer to that, and we're really further away from the tax numbers that we were required to report last March 31 that we reported at the end of May.

But I would say if you were to take our last reported tax number and kind of roll it from a GAAP perspective, I think that, assuming no significant deviation between GAAP and tax, and there always are some, but I'm not sure how material that would be because there is not a full GAAP to tax reconciliation because you can't do that inter-year. But I would say that if you were to just roll it forward, we'd probably have -- my estimate would be $0.28 to $0.30 just rolling the GAAP numbers relative to the last tax number reported. That's remaining in a spillover there to support our discipline, quite frankly, in being prudent and investing our money in the best risk reward.

So, that's there to cover that. It was really put in place there for this reason, whether it be a temporary decline in per-share amounts when you raise equity in the bull -- in the robust times or whether you're having prepayments. Again, it's part of our overall strategy and has been since we launched our IPO in 2004.

Great. That's helpful. Thanks, Rich. One more question, if I can. Can you maybe give us some of your thoughts on the Credit Opportunity Fund? When you're putting new assets into the portfolio, are there thoughts of expanding that, or is it -- just about -- or at this point you're thinking about it's all going on the balance sheet?

No. I would say that that's an attractive vehicle for us. We are finding some interesting opportunities right now as we source opportunities. Some are on the subordinated level. Some are on the senior basis, and if we -- and that's something that if we found the right opportunities, you should not be surprised if we expand that over the course of the year.

Jason Arnold, RBC Capital Markets.

Nice job this quarter. Just one quick question. In discussions internally at Apollo and with your other private equity sponsors that you work with, what are the thoughts on deploying capital in the deals over the next 12 months? Would you say that sponsors are looking for more, less, or similar activity ahead, versus perhaps what the view was last quarter?

That's a very good question about the environment. We have had dialogues with all of our sponsors we cover and down at the partner level.

There's a tremendous amount of optimism that we're seeing and hearing from the sponsors, and their desire and their comfort and their ability to deploy capital into an active M&A pipeline. We haven't quite seen that develop in closing transactions, but we're seeing it significantly develop in our pipeline of new opportunities that are coming. And the economy has been sort of a question mark over the last couple of years. That's given people more comfort, so they can underwrite business performance over the long term and be able to get their returns that they need for their private equity funds.

So there's optimism, there's opportunity, we're seeing our pipeline develop. Those take three, six months to close those transactions, but we're encouraged by what we're hearing that it should be an active year and it should be -- it should last for at least a couple of years.

John Stilmar, SunTrust. (Operator Instructions).

Joel Houck, Wells Fargo Securities.

I'm looking at the book value per share number of 973, and it grew modestly from last quarter, but just given the strength in the high-yield market and even the equity market in the December quarter, can you maybe articulate why perhaps we didn't see as much NAV growth as your underlying market dynamics? Was there something unique with your portfolio that would account for about 1.5% NAV growth?

Yes, Joel, it's Patrick. September was a pretty good credit market as well. There was improvement between September and December, for sure. And we saw, in general, the portfolio appreciate, given it's marked by third parties and where the credit markets are, and yield-based approach is generally the methodology used.

We did have a couple of offsets in the quarter. We mentioned in our script. Between Generation Brands and PlayPower, you had a couple of fundamental items that were depreciated, and net net, only came to that certain position of 973. But in general, the portfolio, but for those couple of situations, we were pleased to see net appreciation.

And Patrick, just to kind of follow up on that, what do you guys think of in terms of where you have written things down, both -- I know you can't obviously predict precisely what's going to happen with potential problem credits, but given what you see in the portfolio today and the underlying metrics, are you guys comfortable that the marks are kind of behind you, if you will, in terms of the sub debt and equity portions of your portfolio?

We could never predict, as you had mentioned on the call. I think we're feeling -- we feel very comfortable with the marks that are done by third parties each quarter, given the information that we have at that measurement period.

We have seen a lot fewer names on our watch list, so that's an encouraging fact pattern for us. PlayPower is something that we were hoping to avoid an item -- an issue, but the continued challenges in the municipal bond market have -- the EBITDA was a little less than we expected, and you trip a covenant and you're in a different place on that credit.

So, we would like to not see that happen again. We don't see much in our portfolio that would continue to go in that direction. Net net, we believe it's hopefully a better environment.

But we also -- if you point to Gray Wireline, or MEG Energy even, these are assets that are volatile, and Gray was going through a restructuring just over a year ago, and now the company was sold at a nice premium and we got some equity there. We got a nice upside. We got a nice return. So, if businesses have the time and the good management to get through a difficult period of time, we see appreciation even in some of the ones where there was historic significant depreciation.

So it's really a long way of saying we don't really know for sure the specifics, but we're feeling pretty darn good about the overall portfolio.

John Stilmar, SunTrust.

Apologize for my phone issue earlier. Patrick or Jim, this is the first question for you. With regards to the investments that you've made this quarter and with the investments that you passed on this quarter, can you take me through, obviously on a no-names basis, but maybe the term structures of the investments that you found compelling? And then, inside of those, how those fit inside the capital structure of the businesses that you were funding? So, it's the term structure and then the capital structure that you're financing for investments that you have purchased or you have put on the portfolio, versus ones that you might've passed. I'm looking for the relative opportunity that you speak of.

One theme that I'll just start out with, John, it's a good question. It's insightful about our business. But we're obviously very cautious about HoldCo dividends.

A lot of the companies we're familiar with, we've seen, they've done well, companies are refinancing and they're able to take a dividend out, I think we've been quite cautious on those as a concept, and there's been a variety that have gone done very successfully. So that's one theme I'm thinking about.

The other one, I would say, is some of the middle-market debt -- senior debt is at a fairly aggressive yield. So, we're trying to focus more on the subordinated nature of opportunities, and as the questioner said before, we took an approach in 2007 and 2008 to be in larger cap companies. There's a broader spectrum of companies that are coming in to our radar screen, if you would, that pass muster that we're finding interesting opportunities, large-cap and middle-market. So, those are just a couple that I would point out off the top.

Yes, I think, you know, John, if you look at Bloomberg today, there's an article just about how robust the bank loan market is. People are -- do a bank deal two months ago, and now they are redoing them with the same price but getting rid of all the covenants. It's just a supply-and-demand imbalance.

A lot of cash in both loans and high yields, and the publicly-known credit markets, and that's just foreseeing a lot of activity for people who are current issuers because there isn't that M&A pipeline hitting the market yet. But what that does, it sops up some of that excess cash flow. We should see some more standard -- or standardized capital structure that we're more comfortable, because that's a perfect example of -- in my comments about us looking at an overzealous market, being as prudent as we can be to avoid those. These may become interesting secondary market opportunities for us in the future when we look at all of them, but terms and structure is as important as price and leverage.

Perfect. If I was to kind of reiterate what I heard from you, Patrick, it seems like today the market itself is sopping up some liquidity, and you hope that the primary -- the return of a much more fervent primary market would provide a little bit more opportunities to normalize the supply/demand imbalance.

Yes, you know, we've had -- there's still a significant inflow each week into credit funds, both high-yield and bank loans. So we are still seeing additional cash coming in, but there hasn't been the other side of it, which is the primary market issuance to support new M&A transactions, which -- that's what we had back in 2007. You had a very robust market, but you had a ton of issuance. Here we have a robust market, and not a ton of issuance.

So when that comes, we think that will just normalize the market to a level that we hope will be attractive and should be attractive to us, and in and around that, we are finding ways to use our competitive advantage in relationships and structure and size and scale and certainty to still find those unique opportunities to put into the portfolio that we will feel comfortable -- that we're a buy-and-hold investor, that we should be buying and holding these investments.

Thank you, and then my one last question, you kind of prefaced the range earlier of 10% to 16% as sort of the targeted return, and that's obviously scales for opportunities. But as we look at your portfolio today of 11.5%, and I would assume, just given that the yields came down a little bit, that maybe the marginal investment is a little bit lower than that. Is it fair for us, then, to, using that 10% to 16% range as a spectrum for risk, to sort of view the opportunity as much less on the risk side of the spectrum today, or is it more of something else like floating rate versus fixed? You had spoken to that a little bit, which kind of can have an artificial risk return relative to yield. So, I was wondering if I'm missing something here, or if there's a little more color that you can add to that, relative to your previous comments. Thank you.

John, look, you're right on spot about -- given the bias towards credit quality and getting repaid, if the markets are robust and we have to go on the lower end to get a higher-quality asset, as long as, net net, it becomes accretive, we'll do that.

And also, some of those have more call protection on the back end, which we don't factor into the coupon. So sometimes, we will actually negotiate where you're willing to give up a little of the coupon to get three or four years of call protection and premiums thereafter. We won't know what that ultimate investment is going to achieve in a total return until we get called out, but as we've just seen now, a lot of those calls we're getting to pay us back, we're getting premiums on the back end. So, that's definitely an important point.

Second is we have had a bias towards floating rate, and right now we're willing to maybe be a lower end of total return because LIBOR is so low. We're getting some LIBOR floors in there, but if rates do increase, we've now moved our liabilities to a more fixed rate in our business where floating-rate assets are being higher level than our fixed rate -- floating-rate debt. We hope that, over time -- you look at the swap curves, that those investments themselves will continue to tick up as rates tick up and accrue to the benefit of our Company.

Jasper Burch, Macquarie.

Just starting off quickly, just some clarity on the diluted share count calculation. Does that only -- do you only have -- does the share count only increase from the dilution on the converts when your stock is above the strike price? Or the convert price of 1375?

I'm sorry, Jasper. Can you repeat that?

Yes. Rich talked a little earlier about the diluted share count calculation, and it sounded like he was saying that you're going to have -- that the diluted share count's going to be higher than actual share count now, just because of the convert. I was wondering for a little more color on that calculation. Does the diluted share count only -- does the increase in diluted shares only start when your stock is actually trading above the convert price on your convertible debt?

No, Jasper. That would be on the other, the net share settlements that someone mentioned earlier. So for us, again, we don't have to paid a dividend on those shares, but we have to report fully diluted as if we were paying that dividend, but we're not.

Okay, so it's fully diluted, okay, thank you. And then, Patrick a couple of times now on the call has mentioned shifting into floating-rate assets and also the benefit of locking in the fixed-rate liabilities. I was wondering if you could give us a little more color on what your outlook is on interest rates, on timing of interest rates rising, and also if you've considered swapping out some of your interest-rate exposure on the liability side.

You know, I mean, I don't -- I'm not -- you guys didn't call in to hear my interest-rate forecasts today, and other than saying that we have a general view that probably we're going to see higher rates at some point in the future.

So, with that view, we had a very simple capital structure a year ago to 1.5 years ago. We've become more of critical mass. We've accessed these other avenues, which are really important to us. And not only are they important from an owner shareholder base, but for us to lock in some of these liabilities we think makes sense for us. So that's all we've done so far. We've not taken an aggressive view on swapping. But certainly by our secured debt and our convert debt, having a little bit of fixed-rate and debt in this environment, we feel that's the right path to go down.

Yes, we've now got about $425 million of fixed-rate debt, which is about $1 billion of borrowings. We think that is a hedge itself. Over and above that entry into a swap agreement is not necessarily necessary for us. But we don't know when. But we don't think rates are going to go much lower. We think they are going to go higher, but we don't know exactly when that is going to be. But we've just positioned ourselves to certainly not get hurt and maybe benefit on the upside.

Good, thank you. That's helpful. And then, just lastly, looking at your dividend, I was wondering what sort of assumptions does the Board bake in in terms of looking at when you will be fully deployed and sort of the sustainability of the dividend?

In terms of declaring our dividend or --

Well, no, I mean, in terms of -- I mean, looking at your dividend rate and the dividend run rate, obviously it's based on a little bit more leveraged capital structure. And I was just wondering, sort of how far in the future is the Board looking and what sort of assumptions are they baking in in terms of the full earnings power of the Company?

We've been public and consistent in saying that we're comfortable operating our Company between 0.5 and 0.7 times leverage. Right now, we're on the lower side of that, so we have a little bit of room to operate a little bit more leverage.

We feel comfortable declaring our dividend this quarter. We've not been on the track of pointing to a lot of future on that, but we understand the importance of that and are very, very in focus on constantly increasing and maintaining our NII. So the Board really is driven by that.

Thank you, and nice job on the quarter.

Arren Cyganovich, Evercore Partners.

Just a point of clarification. Can you -- I think I heard you say that the leverage level today was at 0.5 [three to one]. Did I hear that correct?

Yes, at December 31.

What was driving the reduction in the leverage?

Smaller portfolio, given the repayments versus our net deployment.

Okay, and then, also you have mentioned a couple of times that the market is a little bit overzealous. Can you kind of maybe just clarify this? We're not really seeing a level of overzealous market like we did in 2007, but are you thinking this is more familiar to how it was last year, so it's -- we're not really seeing crazy pricing and leverage levels out there, it's just a little bit more active. Is that fair?

I would say you've seen a couple of -- not particularly this business, but you've seen a few bank deals be what's called covenant-lite. As Patrick mentioned, there were a few transactions done in the fall, new buyouts that already have refinanced their bank deals or announcing to refinance their bank deals within three to six months. That would be -- that's not what you've seen in a normal market. That's signs of a little bit of an aggressive or overzealous market.

The thirst for yield from a wide variety of investors, and what's happening in the muni market, is forcing a lot of investors, institutional and retail, into credit products. That brings money into the bank loan market. Brings money into the high-yield market. And when that occurs, certainly investors come into credit.

So, we're by no means seeing the -- some of the excess that you saw in 2007 and 2008, but it's a pretty robust calendar right now, and transactions are being subscribed to in a very short period of time. So, listen, momentum can change, and if the equity market takes off and there's a big sector rotation out of fixed income into equities, that may have a bit of a negative impact on where fund flows go, but certainly it's -- next to 2007, 2008, it's very robust out there right now.

Okay, that's helpful. And then, just lastly, you talked a little bit about seeing opportunities on the radar screen in the large cap and middle market. How do you define the large cap for your segment?

We've always really used the term upper end of middle market. We're not necessarily focused on supporting new transactions in the primary market of a large cap. Generally, those are going to get done at levels that are not necessarily accretive to our business.

Or the high-yield market.

The high-yield market. But those opportunities do end up coming towards us when those markets dislocate. So, those become more secondary market opportunities to us.

You know, our sweet spot and our average EBITDA, as I mentioned, is over $250 million. And that's a mixture of primary and some of the secondary opportunistic transactions we made post-2007, 2008, and 2009. But really, our sweet spot is between $50 million of EBITDA up to $200 million of EBITDA size companies. That's kind of the larger end of middle market, and we are able to buy and hold and structure and commit to solutions for sponsors in all of those -- across that range of EBITDA.

Martin Ji, ClearBridge Advisors.

Just want to follow up on the asset liability match. Just wonder as you term out your loans to do some more unsecured debt offerings, are you also trying to tweak on the investment side, maybe, say, for example, just expand the duration for a little while to kind of maintain the spread, other things equal?

We have always tried to -- for a good asset, we like to have the asset for a long time, so we're always fighting for call protection. I think Jim gave you some kind of bands of where, when markets are robust, the durations are shorter.

If, for example, we were called out on a couple of investments at a premium, it was still net net cheaper for the sponsor to call us out, even paying us a premium, to access credit today that's much cheaper than when we did some of those deals. So, we're going to fight for that stickiness, and at least if we do get taken out, we'll get taken out at a premium and make some earnings for our shareholders.

But we're always looking to get the longer side of duration. But because we focus mostly on supporting financial sponsors, their hold periods have generally been, on average, three to five years. So, we're going to fight for call protection, but without refinancing, usually they'll sell their company and will get paid back when they sell their company.

Greg Mason, Stifel Nicolaus.

Patrick, I wanted to follow up on something you said about M&A activity still not being that robust. Can you talk about what it's going to take for that to really pick up? Some of the things that were hindering it in the past were a lack of senior debt availability. That seems to be fully in place now. What's it going to take for the M&A activity to really pick up?

You know, one clarification, Greg, it hasn't close -- these transactions haven't closed yet. They take a long time to gestate, and then come out the back end and actually close.

But what -- I think we have seasonal slowdown into the latter part of last year and early part of this year. That's just seasonal. Then you add on top of that companies wanting to see a sustainable economic recovery, and you look at the job reports today. You look at what's going on in the U.S.. People are feeling more comfortable, so you -- they can sell their company and get a value that they want and a buyer willing to, with conviction, put that out there. So, there is a natural decision at the Board level of portfolio companies to sell themselves, and we think that those decisions have generally been made or are being made as we speak.

Then there is a period of due diligence and putting the documentation together to sell a company, and then there is a three- to six-month timeframe for those companies to actually get sold and close. So we, by having the dialogue we have and the pipeline that we have today, we are in the middle of a lot of the stuff that's happening that we may not see in our business close until the second part of the year.

Great. And then, one final, just small modeling question, Rich, the last couple of years, you've had an income tax expense in the December quarter and nothing this year. Can you talk about where the moving factors that impacted that this year?

It's really just timing, Greg. That's all it is. It's a timing of income recognition and short-term gains on losses.

Okay, well, on behalf of Apollo Investment Corp. and my partners, we appreciate your longstanding support and great questions and participation on this call. We look forward to talking to you at the end of next quarter. Thank you very much.

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