Prospect Capital Corp (PSEC) 2009 Q4 法說會逐字稿

Hello and welcome to the fiscal year earnings release conference call. (Operator Instructions). Please note this conference is being recorded. Now I would like to turn the conference over to Mr. John Barry, Chairman and CEO of Prospect Capital Corporation. Mr. Barry, the floor is yours, sir.

Thank you, Mike. Joining me on the call today are Grier Eliasek, our President and COO, and Brian Oswald, our CFO. Brian?

Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be Safe Harbor -- be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release and our 10-K filed yesterday.

Now I will turn the call back to John.

Thanks, Brian. For the year ended June 30, 2009, our net investment income was $59.2 million or $1.87 per weighted average number of shares for the year, an increase of 31% from the prior year on a dollars basis and comparable to the prior year weighted average share amount of $1.91. Our net asset value per share on June 30 stood at $12.40 per share.

For the quarter ended June 30, our net investment income was $12 million or $0.32 per weighted average number of shares for the quarter. We estimate that our net investment income for the current first fiscal quarter ended September 30 will be $0.25 to $0.30 per share. These temporary per share changes from prior quarters are primarily due to the raising of additional capital to fund the acquisition of Patriot Capital, the benefits of which will be reflected in our future financial results after the Patriot closing projected in the fourth quarter. We expect the Patriot acquisition to be significantly accretive to net investment income per quarter in an amount approximating at least $0.09 to $0.10 per share, which could be greater with early repayments before scheduled maturity dates as has occurred with multiple prior Patriot transactions.

In addition, we are currently evaluating a pipeline of potential additional portfolio and individual investment opportunities, aggregating more than $1 billion for which we have significant cash and credit facility availability on hand. We expect to announce our first fiscal quarter dividend later this month.

Now Grier Eliasek will comment on our investment activity.

Thanks, John. During the year ended June 30, 2009, we completed three new investments in Castro Cheese, TriZetto and Biotronic, as well as several follow-on investments in existing portfolio companies, totaling approximately $96.3 million. For the year ended June 30, we fully exited our investments in Deep Down and Charlevoix and partially exited our investments in RV and Diamondback, including full repayment of the Diamondback loan.

As of June 30, we held 30 portfolio company investments, aggregating approximately $547.2 million. Since June 30, two additional investments, Peerless and C&J, have been repaid, generating a 19% cash on cash and total rate of return in each case, not including a 40% equity stake, which we continued to hold in C&J.

On August 3 we announced our entering into a definitive agreement to acquire Patriot, including assets with an amortized cost of approximately $311 million for a purchase price of approximately $197 million or 63% of amortized cost. We are purchasing Patriot with our common stock plus cash to repay all Patriot debt anticipated to be approximately $110.5 million when the acquisition closes. Our common shares will be exchanged at a ratio of approximately 0.3992 for each Patriot share or approximately 8.6 million shares of our common stock for approximately 21.6 million Patriot shares with such exchange ratio decreased for any tax distributions Patriot may declare before closing. We expect significant accretion of this discount on a quarterly basis and anticipate a majority of this accretion to be income not subject to Prospect's shareholder taxation. We are basing our net investment income accretion assumptions assuming no early repayments. Early repayments would accelerate the recognition of such accretion income.

The Patriot acquisition reflects our previously articulated strategy of identifying and closing on opportunities created by the marketplace credit dislocation, including opportunities to acquire financial companies and portfolios with attractive assets but with liquidity issues created by lenders seeking immediate payments. We are currently evaluating a number of other portfolios both public and private where our ability to provide liquidity has the potential for significant rewards.

In addition, the Patriot acquisition will approximately double our number of portfolio companies to approximately 60 companies, thereby expanding our diversification by company, by industry, by geography and by business owner. Approximately 70% of the acquired asset value is in companies where Patriot has a senior secured position. Our gross assets will also expand by more than 30%, providing anticipated scaling benefits as a consolidator in the industry.

Thank you. I will now turn the call over to Brian.

Thanks, Grier. On June 25 we completed a first closing on our expanded $250 million syndicated revolving credit facility. The new facility for which lenders have closed on $175 million to date includes an accordion feature which allows the facility to accept up to an aggregate total of $250 million of commitments for which we continue to solicit additional commitments from other lenders for the additional $75 million.

The revolving period of the facility extends through June 2010 with an additional one year amortization period after the completion of the revolving period. The maturity date of the facility is June 2020. Interest on borrowings under the credit facility is one month LIBOR plus 400 basis points subject to a minimum LIBOR floor of 200 basis points.

The facility has an investment grade Moody's rating of A2. We expect to close on an additional lender commitment for which lender committee approval has already occurred, but for which signed documentation has not yet been received in the next 30 days, bringing our facility size to $195 million and our number of lenders to five providing counterparty diversification benefits.

As of June 30, we had $124.8 million outstanding under our credit facility. We currently have zero outstanding borrowings in our facility and have cash equivalent instruments of approximately $60 million on hand. Our unlevered balance sheet is a source of significant strength in comparison with many over-leverage competitors. Our equitized balance sheet also gives us the potential for future earnings upside as we prudently grow our revolving credit facility and evaluate term debt solutions driven by our facility's investment grade facility rating.

We also continue to generate liquidity through stock offerings and the realization of portfolio investments. On March 19, April 27, May 26, July 7 and August 20, we completed stock offerings aggregating approximately 21.6 million shares of our common stock, raising approximately $180.7 million in gross proceeds.

In the second quarter of the fiscal year ended June 30, 2009, we announced the authorization by our Board of Directors to repurchase up to $20 million of our outstanding stock. To date we have not made any such repurchases, but we continue to maintain the flexibility to do so should we deem such purchases to be in the best interests of our shareholders.

On April 30 we gave 60-day notice to Vastardis Fund Services regarding termination of effective June 30, 2009 of the agreement with Vastardis to provide sub-administration services. The prior cost of this agreement had been approximately $700,000 per year based on approximately $600 million of assets. With our having expanding our finance and administration teams in recent months, we no longer require services from Vastardis.

Now I will turn the call back to John.

Thanks, Brian. We can now take 10 seconds to answer questions.

(Operator Instructions). Jasper Birch, Fox-Pitt Kelton.

Good morning and good job on the quarter. Just a couple of quick questions. First, I noticed that your interest income was down by about $4 million and dividends increased by about $4.5 million. What were the moving parts in there?

Sure. The dividend increase was related to a recapitalization done involving Gas Solutions. Given the performance of that Company, it's a very under-leveraged company at only about 1.5 times debt to EBITDA.

On the income side, we put our mining-related investments at Yatesville on non-accrual as the main component.

Excellent. Thank you. And then just in terms of how you guys -- in terms of capital raising, obviously with market yields at your current stock price really, any capital raise would probably be accretive to NOI. How are you weighing that versus allowing your stock to run up and break through the next level and wait to raise capital up above book value?

We appreciate the question. Let's start by noting that we as a management team at one point were the largest shareholder in the company, larger than any institution. I believe Wellington is larger than we are now.

So each time we do an offering we are very conscious of the effect on the offering price, the effect on the dividend and the effect on the future of the Company in terms of share price and our ability to take advantage of the opportunity-rich environment in which we are currently doing business.

We do that on a case-by-case basis. So on one hand at any time, we are looking at an opportunity set of opportunities that can offer us rates of return in the high teens and low 20s on a -- after adjusting for defaults and recoveries and also the opportunity to sell stock.

Now, as time goes on, we believe those opportunities will become scarcer as the market and other competitors compete those away as those loans pay off. And, as a result, the opportunities to sell stock at these prices -- we don't like selling stock at these prices -- but the opportunity to sell stock at these prices and make money by reinvesting it will become scarcer and scarcer, we believe. But I think the point is that each stock offering is looked at on a case-by-case basis.

I would also add, Jasper, that the timing associated with potential acquisitions moves independent of our desires, the stock price movement, etc. And if we had waited, given, for example, the auction nature of Patriot, we would have lost out on this opportunity if we did not have sufficient capital to meet the needs for a full lender paydown.

You know one last point I think people should be aware of, a company like ours cannot issue stock on a dime. We cannot issue stock during a week or even a month just because a great opportunity comes along. Business development companies are very highly regulated. The SEC has to, in effect, give us permission each time we sell stock, and they don't just look at the disclosure. They look at the substance of the offering and are fairly intrusive in my opinion with respect to our ability to run our business as we see fit.

So, as a result, there is because of the regulatory regime under which we work, there is a reason to maintain liquidity, maintain access cash, and, in effect, sell stock at good prices when you think you can and not just wait for the last second to do so.

Thank you, guys. That is very helpful. I would also thank you this quarter for breaking out your MPIs and overriding revenue and interest. I found that helpful, and I guess I will hop off now.

Robert Dodd, Morgan Keegan.

Just three questions, one about Gas Solutions. You said you have recapped. In the K it still notes that you are looking essentially to monetize that investment. Could you give us your thoughts on how active -- how actively you are shopping it or what your other plans are for that piece of business right now?

Yes. We have had it on the market since last year. We have had three very interested parties. We are not desperately urgently looking to liquidate this company, and so we are able to take out time negotiating the type of transaction that we would like to see occur. Meanwhile we are collecting significant dividends. Meanwhile we are looking at possibly growing the Company by having the Company itself make acquisitions itself at managers who will be focused more on new business than liquidating the Company.

So, as with any part of our balance sheet, any liability or any asset, we are looking at all times to optimize. It may be worthwhile to sell it on Tuesday, and then maybe on Wednesday we may have a business opportunity for Gas Solutions that we want to pursue.

What I would tell you, Robert, is that as of now and really continuously since we first put it up for sale, we have at each -- virtually each moment -- not every single second but most of the time been in an active discussion with one or more acquirers, and that is the case now.

Now can I predict the future? Will we sell it? Will we buy something else? Will we inject more capital to grow it? Will we accept the minority investment?

We like to look at our portfolio as something that we would like to optimize at all times, and so when we make a final decision and (inaudible) some contract, at that point a decision would be final as to that deal.

Got it. On the debt side, if I heard correctly, you said you paid it off essentially relatively recently. Obviously the end of June you still had debt outstanding on the other facility. You paid off this current one. Can you tell us how you view utilizing that? Is it going to be a policy to carry a minimum of $30 million in cash, no debt if you can, or do you intend to kind of just keep a continuously revolving balance on that facility? What is your view on how to manage that piece of the capital structure?

Sure, Robert. Well, we view having cash availability on hand as a good thing as a protective measure. But, in addition to that, our intention is to utilize our facility to grow the business, and we have, in fact, are growing that facility as we announced we have an additional lender coming in increasing the lender diversity and taking our facility up to $195 million. We expect for that to occur this month. And then there are other lenders which would take us up to our target 250 which continue.

Longer-term this is a benefit that arises not only out of our investment grade rating on the new facility, but also in terms of having more scale and diversity associated with our asset mix. We are exploring potential term debt solutions that would give us more confidence to grow our debt to equity mix over a long period of time.

One of the things we have been mindful of in running our Company is not to get caught in the borrow short, lend long, have your liquid assets squeeze that has defined so many companies out there unable to meet obligations when they come due. And keeping your debt at a manageable level is one way to handle that; running a matchbook is another. And we think the market continues to get better on the latter side of things, and we are exploring potential structures in the marketplace to avail ourselves of that, both term debt solutions, as well as longer-term revolving debt solutions.

I have two more if I can. Obviously I realize you cannot predict the future, but potentially a lot of gains locked up in the Patriot acquisition. Do you have any color you can give us on kind of what kind of timeline you would expect those gains? Obviously we have got a maturity schedule from their documentation, but any color you can give us on scale and timeline there?

Well, we would accrete those gains in accordance with the maturity schedule with each performing asset and, as a testament to their management team, which has done a good job of managing those assets. Their portfolio is holding up very well, and so we would expect significant accretion. The upside comes when there are potential early repayments after closing, unscheduled early repayments in which case the recognition of that discount would come earlier than the levelized recognition associated with the maturity schedule.

Got it and just one more if I can. On Yatesville obviously your coal investments have been kind of struggling for a while given various difficulties going all the way back to Genesis, etc. Has something -- now it is on non-accrual -- has something incrementally deteriorated there, or is it just the price of coal?

Well, there are several things. And before I go into that Robert, I wanted to add to what Grier had to tell you.

It would be nice if people I know, that some of the research people would like to have models showing that we always have so much debt or so much cash. And I know it is easier to model, but we want to share with you that the way in which we go about it is we want to minimize the amount of cash sitting on our balance sheet that we borrow because if we have a negative spread, that is not good for us, right?

On the other hand, we need flexibility; we need liquidity. So what tends to happen is these things end up being very much on a bottoms up basis, not a top-down basis. So I wanted you to know that. So you may see, for example, if we are looking at a significant opportunity, you may see us running more cash than we would in quiet times, whereas we complete the end of the year and we don't expect to be closing things.

Alright. With that said, let me go over to my favorite topic --

Real quick, Robert, to give you another number on the accretion, as we disclosed actually in our joint proxy, we expect year one accretion to be approximately $17 million, and that would increase in accordance with levelized yield much like the recognition of income for an original issue discount analysis.

Got it. Thank you.

Alright. And as to a lot of these decisions, we have a vigorous debate, and yet at one point in time one proposition is prevailing, and that could change the next day or the day after.

Alright. So let's talk about Yatesville. In these coal companies, what we have discovered is sometimes you get involved in an investment and the terms of trade continuously and repeatedly and it appears on a secular basis and in unpredictable ways run against you, and that has happened in the coal companies.

First, when we invested, coal prices were high. They went higher. That was good while we were developing the coal mines. Then coal prices have steadily declined. Producers who had production in greater amounts than we did were able to hedge in ways that we were not able to do at high prices. I think it is Massey or someone I was looking at the other day has a lot of coal sold forward for the next couple of years at $110 a ton. We don't. We did not have the production; we could not lock that in.

What then happens is because of those hedges there is overproduction. The utilities don't need it. The Chinese are not buying the met coal like they were, and so what you have is a significant decline in coal prices, and that was beyond what we had predicted.

Then we have the Obama administration is not terribly friendly to coal. The permitting, which our Company is a permitting company -- is not moving forward on the basis and with the speed that we had projected. And one of the problems we then have is you have a business in which the revenue numbers are not providing sufficient profit to be running your business full-time, yet you have significant fixed overhead in equipment, in people, in minimum lease payments.

So what happens in the coal business is that people can make a lot of money in a short amount of time, but they better be prepared to also lose a lot of money in a typically longer period of time. And what we have concluded we would like to do is gradually and step-by-step, inch by inch, sale by sale reduce our overhead there and reduce our exposure to that business, but still maintain a foothold so that when the business turns around, which it always does eventually, we are still there. Putting the business on nonaccrual was related to the fact that we felt that the value of the reserves that we have under lease and our desire to keep making minimum lease payments had both decreased to the point where we felt it was more appropriate to put it on non-accrual than to accrue the interest.

Chris Harris, Wells Fargo Securities.

John, perhaps I did not catch in your prepared remarks, did you say the Patriot acquisition is expected to close in the December quarter? Is that right?

Well, you know what, it was not in my prepared remarks, and I guess I would say when we first signed the agreement, I could not imagine why it would take any longer than 60 days. And people kept telling me, well, you know these things do take longer. And so we thought it would be 60 days when we first signed it. It then took 32 days to get our proxy filed, which was 30 days longer than I thought would be required for that.

And so it seems to be somewhat like running as fast as you can underwater, and it has left no shortage of frustration for us because we like the Patriot people quite a lot. We like what they have been doing. We would like to be working hand in hand with them to be going after what Grier likes to call the opportunity-rich environment, and we are still waiting now for the SEC to clear our proxy, which was filed what a week ago, right, Brian? So what can you do? You just have to wait for the regulators to give you permission to go ahead and consummate this transaction, which I think is really good for both companies, both sets of shareholders and important to meet the people that work at both companies.

Chris, once we get cleared and mailed, 60 days is not a bad estimate. So if that were to happen this week, then we would hope to close by, say, mid-November.

Okay. And then --

Just one second. Brian, do you have a forecast of when we think we can mail?

We have not heard back from investors. So it will be -- I expect that we will be closing in the fourth quarter.

Okay. And then, Grier, on the year one accretion number that you just talked about, the $17 million, is that number 12 months following the date of the acquisition closing, or is it some other year one that you are referring to?

It is following the date of closing, correct.

Okay. All right, what is the -- do you happen to have or know the weighted average maturity of the Patriot portfolio off-hand?

It is about four years.

Four years, okay.

Leaving up to four years.

William Mansfield, Berkley Asset Management.

Maybe if you would allow me, I was hoping to ask you sort of a bigger picture question about the Patriot acquisition. Is their portfolio as you have looked through it, sort of how is it similar and how is it different from your existing portfolio?

Well, it is similar in that the company sizes are in the lower middle market range and that we probably have a few more there in the larger core middle-market.

It is different -- it is similar in that these are profitable companies. It is different in that the pool of assets tend to be smaller positions. They tend to be more diversified industry-wise, which matches up very well. With our mix they have been a little bit heavier in energy and industrials historically based on how we have built the business and built the book over time.

And their focus origination-wise has been squarely on the sponsor private equity owner marketplace, while we have had a balanced mix here of sponsor business, directly lending in closely held companies and Prospect controlled buyouts. Sort of those three lines of business. So it's a very good balanced mix that builds scale, builds diversity like I had discussed in the prepared remarks, and just as importantly, it comes with a team that we think very highly of.

Okay. That is great. And then my next question was really a follow-up question I think one of the prior gentlemen asked about your share sale philosophy. In particular, the share sale you did in August a couple of weeks ago, was that share sale done in connection with the Patriot acquisition and that you have certain requirements on paying down their loan, or was that share sale done to raise more money for potentially other acquisitions?

More for the latter. We have had sufficient liquidity to close the Patriot transaction. We, as John mentioned in his remarks, are pursuing a potential pipeline that is more than $1 billion in scale right now. At least a dozen portfolios we are looking at right now, and we would need additional capital, and that is really what would justified that raise to tackle some of the larger opportunities in front of us.

Okay. And as you look forward if -- I heard your comments that you don't anticipate the environment to stay the same as it does in terms of opportunities for lending and opportunities for buying companies. But were the environment to stay the same, we should be anticipating future share sales because you want to keep making more and more of these acquisitions or making more and more of these loans. Is that --

Well, it depends on the scale of the opportunity. I mean if a several hundred million dollar portfolio becomes available and the economics justify it, then that could justify a raise. Recall the Patriot deal we are buying at $0.63 on the dollar on an asset basis, and to use some leverage, obviously you get significant benefits beyond that.

But bear in mind, we do have a credit facility. We are growing that facility, and, as I mentioned, we are exploring other longer-term solutions. So our intention is not to run a zero leverage company but rather a prudent leveraged one. We are limited to 1:1 as a max for leverage. We don't think that given our conservative bent running at the max or close to 1:1 as others have done with negative adverse consequences with covenant breaches, with regulatory issues, tax issues that emerge from that is very prudent that, but you could see us building towards 0.5 debt to equity as a long-term target. Scale and diversity helps for us to achieve that.

And bear in mind, we can also use built-in leverage on deals as well. There is using our own facility. In the Patriot case, we are doing a full paydown of the lenders, but there's other portfolios we are looking at where the attachment points of debt are higher as the mix of the assets and where we can work out of deal with the existing lender to offer them a partial paydown but an extension as well. Anything to add to that, John?

William, bear in mind that considering how many shares that we own, our first preference would be to issue no additional shares ever again and just have the dividend climb and climb and climb and be able to make acquisitions with recycled cash. I don't know how possible that is going to be, but that would be our first preference because we would like to see the price and value of the shares that we own increase and the dividend increase without issuing any new ones.

Now when we depart from our first preference, it is usually because there is a very good reason to do so. And I think in the year of the past raising capital via share issuances was very important in enabling us to break out from the pack of all the other BDCs that first could not raise capital on any terms, and secondly ran into trouble with their banks, and thirdly, lost confidence in the investment community because it was apparent that they were not masters of their own fate.

So we have gone through a year during which there was good reason to be issuing shares. I would expect that there would be fewer reasons in the future and that we would perhaps be able to see more share price appreciation. But, as I think everyone on this phone call knows, the future moment to moment is highly unpredictable, and what we do want to do is provide long-term performance for our shareholders both on a price and dividend basis.

Terrific. That is all of my questions. Thank you for taking them.

Gentlemen, we are showing no further questions at this time.

Well, thank you all. Have a wonderful lunch.

Thank you, sir. The conference has now concluded. We thank you for attending today's presentation. You may now disconnect.