Prospect Capital Corp (PSEC) 2010 Q3 法說會逐字稿

Good morning and welcome to the Prospect Capital earnings call for the third fiscal quarter ending March 31st, 2010. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to John Barry, Chairman and CEO of Prospect Capital. Please go ahead, sir.

Thank you, Amy. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer, and Brian Oswald our Chief Financial Officer. 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 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-Q filed previously.

Now, I'll turn the call back over to John.

Thank you, Brian. For the three months ended March 31st, 2010, our net investment income was $19 million, or $0.30 per weighted average share outstanding. Our net investment income increased 12% and our net investment income per share increased 3% from the quarter ended December 31st, 2009 to the quarter ended March 31st, 2010. For the nine months ended March 31st, 2010, our net investment income was $48.2 million, or $0.85 per weighted average share outstanding.

We closed our acquisition of Patriot Capital on December 2, 2009. During the quarter ended March 31st, 2010, we recognized $15.6 million of interest income in connection with the assets acquired from Patriot, including $6.7 million of interest income from the acceleration of purchase discounts upon repricing of three loans.

We have additional liquidity available that can be deployed into other accretive investments beyond the Patriot acquisition, and are currently moving forward a pipeline of additional portfolio and individual investment opportunities.

We estimate that our net investment income for the current fourth fiscal quarter ended June 30th, 2010 will be $0.24 to $0.32 per share. We expect to announce our fourth fiscal quarter distribution in June.

Thank you. I'll now turn the call over to Grier.

Thanks, John. At March 31st our portfolio consisted of 55 long-term investments, with a fair value of approximately $697 million, compared to the same number of long-term investments with the fair value of $648 million at December 31st, 2009. This increase in invested capital resulted primarily from a follow on investment in Shearer's Foods, Inc. ("Shearer's"), on March 31st, 2010, as well as additional fundings to existing portfolio companies.

During the quarter ended March 31st, we completed a $36.3 million investment in Shearer's, a snack food company, for which we received $35 million of junior secured debt and $1.3 million of equity interests. Concurrent with this funding, Shearer's repaid its existing $18 million loan to us.

During the nine months ended March 31st we also made follow-on investments in portfolio companies and received principal payments of $15.7 million on loan.

During the three months ended March 31st we repriced our loans to AFI, Prince and ROM. The revised terms were more favorable than the original terms and increased the present value of the future cash flows. In accordance with ASE 320-20-35, the cost bases of the new loans were recorded at par value resulting in $6.7 million of accelerated original purchase discounts recognized as interest income.

Subsequent to March 31st we invested $12.3 million in secured debt in Seaton Corp., a leading vendor-on-premise staffing company.

Primary investment activity in the marketplace has increased recently and we are currently evaluating a growing pipeline of potential investments, some of which have the potential to close this quarter. These investments are primarily secured investments with double-digit coupons, sometimes coupled with equity upsides through co-investments or warrants, and diversified across multiple sectors.

Gas Solutions continues to generate meaningful free cash flows with no third-party debt. In February we hired Robert Bourne as President and CEO of Gas Solutions. Mr. Bourne has over 30 years of experience in the midstream sector. He is focusing on new business development and seeking new opportunities to help Gas Solutions grow beyond its existing footprint.

In April, Gas Solutions purchased a series of propane puts with a strike price of $1.00 per gallon for the period from May 1st, 2010 through April 30th, 2011, and $0.95 per gallon covering the period from May 1st, 2011 through April 30th, 2012.

Gas Solutions hedged approximately 85% of its current exposure to natural gas liquids based on current plant volumes. These hedges are expected to reduce the earnings volatility associated with lower prices of natural gas liquids, without limiting the upside from higher prices, helping protect significant cash flows from Gas Solutions for interest and dividend payments.

Thank you. I'll now turn the call over to Brian.

Thanks, Grier. On June 25th, 2009 we completed a first closing of an expanded syndicated revolving credit facility. The facility includes an accordion feature, which allows this facility to accept up to an aggregate total of $250 million of commitments. Since that initial closing with two lenders, we have added four additional lenders to the facility, and currently have commitments totaling $210 million.

The facility has an investment grade rating by Moody's of A2. We are working with our lenders to reduce the cost, grow the size, increase the advance rate, expand the collateral pool, and extend the duration of the Facility, with such amendment targeted for completion within the next 45 days.

As of March 31st, 2010, we had $54.2 million of borrowings under our facility. With the pledging of additional assets from the Patriot acquisition, we have significant additional credit availability of $62.5 million, not including further leveragability of additional collateral that we could add to the facility with additional transaction activity, and not including further availability increases targeted by our facility amendment.

Our virtually unlevered balance sheet is a source of significant strength in comparison with many overleveraged competitors. Our equitized balance sheet also gives us the potential for future earnings upside as we prudently grow our existing revolving credit facility, add additional secured facilities, and evaluate term debt solutions driven by our investment grade facilities ratings at both the corporate and facility levels.

We are pleased with the increase in desire of counterparties to provide us additional credit at significantly more attractive pricing as compared to what the capital markets offered a year ago.

Now, I'll turn the call back to John.

Thanks, Brian. We can now answer any questions.

(Operator Instructions.) Our first question comes from Jasper Birch at Macquarie.

Hey, good morning, guys. Thanks for the color on the financing that you're looking at. Could you give us a little more color on the size and timing of your pipeline and where you're seeing deals coming from?

Sure. And good morning, Jasper. We have a pipeline of about $2 billion in size right now. And what we're seeing is a significant uptick in activity in the marketplace, which should not be surprising to anyone given the improvement in the economy year-over-year, an increase in financing activity and M&A activity, really transaction activity of all types.

We don't, as you know, make precise predictions about when new transactions might close. They're not on a perfect conveyor belt, as you know. But we are working on a number of transactions which we hope and expect to close before quarter end and to drive earnings through both up-fronts and well as ongoing coupons associated with those new originations.

And we're ramping up significantly in terms of our infrastructure to handle that uptick in activity. We've made several new hires on the investment team, at senior levels, at junior levels, to make sure that we've got all the horses in the stable to handle that volume.

Great. And do have -- I mean, do you give a number on the term sheets that you have so far? And also, what's the time to completion in this sort of market environment?

I'll answer the second question while I look for the answer to the first. Time to completion really can vary. There are sort of shorter views of flow opportunities and larger deals, club deals, syndicated loan type deals that typically are more on a 30-day cycle.

And then, direct origination deals where we're the -- play a heavy role in structuring and that pertains to our bio business, our direct lending business. And our low or no market sponsor business tends to be in a longer gestation period that can really have a wide range from say 60 days to six months or even longer. Sometimes there can be a long gestation period indeed.

Right now, we have approximately 20 or so term sheets out to answer your first question.

Excellent. So, just to continue that. So, you're seeing more club and syndication deals coming through, coming to the market?

We're seeing all the above. We're seeing -- as you know, our business is balanced across sponsor finance, which is further divided into deals that we directly originate and structure. Tend to low and middle market from $5 million to $15 million, [probably] to $20 million EBITDA company, sometimes larger.

And then syndicated loans on the larger end. That's kind of vertical one, the sponsor business. Vertical two is the direct lending business, where we lend money to closely held companies. No institutional ownership. And vertical three is the bio business, where we take a controlling interest and put up the debt and the equity. And we're seeing activity robust across all three.

Okay. Thank you. And then just quickly, what's the remaining purchase discount on the PCAP portfolio?

The unamortized portion?

Yes.

Do you have that, Brian?

It's about $35 million. It's about $35 million.

Excellent. With that, I'll hop off for now and might come back on. Thank you.

Thank you, Jasper.

The next question comes from Arren Cyganovich from Ladenburg.

Good morning, guys.

Good morning.

Could you talk a little bit about the repricing of the three portfolio companies this quarter? And basically, we're curious as to how you convince existing portfolio companies to take the new pricing and what you're offering them in return. And then, also, are there more of these in the pipeline to come in the future?

Well, as you can imagine, when you increase terms with a counterparty, it's not always a walk in the park pleasant conversation. And the last couple of years have been a good reminder of that. The debt and the equity are adversarial to one another in a down case scenario.

I would say that adversarial stance came as a shock to the system to some in the latter part of 2008 and the first part of 2009. But then, counterparties became a lot more used to it and came to expect it.

And this is really where the importance of covenants comes into play, which allows us to have a seat at the table to reprice transactions. And what we do with covenants is set covenants based on counterparty -- often management projections. They're usually growing profits.

And we hold companies to those projections by taking the covenants off of those. And even a company that's performing well -- they might have increased its profitability, but not as much to hit its tightening covenants in the future -- might trip a covenant.

That gives us a seat at the table for strong performing companies, as well as for companies that are experiencing economic cyclicality to not just reprice on an economic sense, but also look for ways to reduce our risk. To ask the owner to put up additional equity, to pay us down, to provide some type of backstop, to have faster amortization. Really, each deal is a little bit different.

We've gone through a significant wave of such repricings. We expect there will continue to be some in the future as well. But over time, we'll cycle from legacy companies to new [vintages] where, in a growing economy, we would expect fewer covenant breaches. But, if you have a down GAAP for a particular company that experiences an issue then, yes, that's why we have covenants.

And we really stay away from almost completely the covenant-like, covenant not, take toggle types of structures that seem to start to permeate the large flow name business in late '06 and '07.

Thank you. And then also, with the new aftermarket issuance program, it looks like you've accessed that about $10 million this -- in the March quarter, and thus far $31 million through this quarter. I'm just trying to balance what -- why you're issuing the equity when you have such low leverage and why not take advantage of accessing some of your leverage, or is it just until you close this new facility that you're wanting to kind of reduce your refinancing risk related to that?

Yes. I think it's three reasons at least. One is we are in the midst of closing our extension. Because of the economic backdrop a year ago our extension was only a two-year deal, which is one year revolver and one year term. And we knew a year ago we'd be working on yet another extension this spring. We expect for this next extension to give us a longer runway than before, and not to be doing this again a year from now. So, that's one reason.

The second is the originations we do expect to go up and we are seeing increased activity. And expanding the equity base makes sense against that backdrop. And thirdly, it was accretive to shareholders given our recent trading activity.

Thank you.

The next question comes from Greg Mason at Stifel Nicolaus.

Yes, thanks. This is Jonathan stepping in for Greg. Just a quick question on dividend income. Noticed that it was a little light quarter-over-quarter. And could you walk us through the moving parts of that line? And also, what should we expect from Gas Solutions going forward with the new puts?

For a dividend income, Gas Solutions paid a lower distribution this quarter than it had in prior quarters. As the puts start to roll off in a business and we have puts at a lower strike now going forward close to the range of $1.00 per gallon compared to $1.40, $1.50 that we had been enjoying in the past.

It's difficult to predict an equity dividend distribution from a portfolio company, but the puts we expect do provide downside protection at that current level. And we're hoping that Bob Bourne, who we brought onboard as the new Chief Executive Officer of that company, can drive growth for future increases in distributions, but it would be premature to project that.

Okay. Okay. Thank you. And moving to the credit facility, as the facility is approaching the end of the revolving period, could you talk about maybe some color on how the discussions are going with your lenders to this point?

Very well.

Would you expect the size of the facility to shrink or a borrowing base to improve, or to allow mezzanine in the credit facility?

We are targeting an increase in the face amount of the facility, an increase in our advance rate. An addition of second-lien collateral back into the facility that had been limited to legacy deals a year ago. An improvement in our spread by upwards of a couple hundred basis points. And hope over time to attract additional lenders.

We accomplished a lot of things in 2009, buying Patriot Capital, expanding our business, closing on a facility during an extremely challenging time. And the thing that was probably the most challenging was to go from one lender to half a dozen last year in an environment where people had shrinking facilities, lenders pulling back, etc.

We're very pleased with the diversification of counterparty risk created by that, very mindful of counterparty risk. Want to have a lot of horses pulling the sled, so to speak. And we want to increase that diversity over time.

We may have a closing of extension with our existing group, and then an addition of new lenders thereafter in subsequent closings. Our job number one is to get the deal done, and we're already well on our way in documentation and commitment letters and term sheets and the like.

Great. And then talking about the market environment, I know you mentioned your pipeline previously. Could you talk about what you're seeing in the market in terms of yields and IRRs? I know that you just purchased -- or subsequent to quarter end, you purchased Seaton. Maybe talk about the yield on that investment and, really, where those opportunities are today.

Sure. Deal structure-wise, we can broadly categorize certain deals into senior secured, so-called unitranches where we'll extend more than a regional bank might extend on a cash flow basis. Sometimes collateralized as well which was the case with Seaton, by the way.

Senior secured unitranches in the range of 10.5% to 12.5%, give or take. Second lien secured in the range of 12% to 14%. And then unsecured mezzanine typically 14% plus. So, that's on a coupon basis, not including up-fronts, and that's really for more heavily equitized sponsor deals. And those deals have a lot more equity during this part of the cycle than a couple years back with a minimum 35%, 40% equity, and deals oftentimes more closer to 50%.

And that also does not include equity tickers that we might achieve in non-sponsor or direct lending. And of course, our own prospect-sponsored buyouts where the leverage being provided to the company is our own leverage.

Right. And also, could you speak to some of the opportunities in the structured finance or the CLO markets?

Well, we continue to look at that business as a potentially strategic addition to our business. We've examined and spent a fair amount of time in the last six to nine months about potential acquisitions of CLO type platforms both middle market and flow name. And potential, really asset management type businesses that would operate as controlled off balance sheet portfolio companies that we'd look to expand.

Folks who've spent time in that marketplace will tell you that in order -- as the CLO market comes back, sponsors will be expected to put up their own equity capital into deals. And there are a lot of CLO managers out there that lack the resources to put up that capital. And they're interested in talking to us about some type of partnership, a controlling interest in which we would provide that capital.

So, we're spending time on deals that are very people intensive, relationship intensive. We're very careful about who we might align ourselves with, if anybody. We've also not pulled the trigger in part because that marketplace for new issuance has been slow to reemerge, but we will continue to examine opportunities there.

Thanks a lot, guys.

Thank you.

Our next question comes from Chris Harris at Wells Fargo.

Hey, thank you. Good morning, everyone.

Good morning, Chris.

Grier, maybe if you can give us a little bit of commentary on how the portfolio has been performing here. Didn't know if you were beginning to see kind of revenue increases amongst your portfolio companies. I know your nonaccrual investments appear to be relatively flat on a sequential period basis. Maybe any commentary you can provide there would be helpful.

Sure, Chris. As you pointed out, we had no new loans on nonaccrual in the past quarter. We're seeing an uptick, really across the board.

We had a number of verticals which we had expanded diversity-wise, going back to '07 and '08, and adding healthcare verticals, food and beverage verticals, to pick a couple. They continue to grow both top and bottom line through the cycle. We're obviously very pleased with that.

A lot of our industrial legacy, energy-related book has started to cycle upward again. We've sold out of a lot of energy services companies and companies with exposure to the natural gas industry, which we're pleased with because prices have gone down significantly and there's been a lot of volatility there.

But other industrial-rated companies, a company like Ajax, for example, which tracks very much what's going on with say a Caterpillar would in the larger capitalization context. In the first part of 2009, that company had experienced significant drops in new orders and backlog, really along with the rest of the industrial economy. And it's been a mirror image of that in the first quarter of 2010, with a snap back to not quite peak -- call it 2007 levels, pre-recession, but getting very close to that.

So, we're pleased with how the portfolio is performing. We're pleased with the diversity that we added. We feel like we added the right diversity during the last cycle. We didn't load up on restaurants and auto parts and a large number of retailers and ad-driven media spending. Just to pick a few that really were harmed significantly during the last downtick.

Okay. Thank you. And then, can you remind us what portion of your portfolio is fixed versus floating? I think I recall the majority of it's fixed, but correct me if I'm wrong with that assumption.

That's right. The sort of the legacy prospect portfolio, virtually all of the pools are fixed or the greater fixed or floating. We were very mindful back in '06, '07 when LIBOR was 500 basis points that if and when the economy would cycle downward that we would want to have interest rate protection as the Fed would start chopping interest rates, which of course is what happened. As we've gone to 100 BIPs LIBOR had during the '01, '02, '03 cycle and here we've seen LIBOR skirt close to zero. So, we've benefited from that.

The Patriot book had been more floating rate in nature. Of course, when we bought Patriot LIBOR was close to zero, so we had a built-in protection there already. And a lot of those bonds have been repriced upwards with new floors in place. So, the vast -- or paid off at par, a book that we had paid in the aggregate at $0.63 on the dollar for. So, we're getting the benefit of those repricings for LIBOR floors as well.

So, a lot of these new investments you're looking at, are they floating rate loans, or they continue to be fixed?

We have greater fixed or floating. So, we have a floor in, I believe, all of our new deals.

Okay. And then a last question here related to Gas Solutions. I'm just curious, what happened to the last CEO that was there?

Well, we had a General Manager, Steve Kennedy, continues with the business. And Steve's done a wonderful job. He's been associated with this business for a couple of decades.

So, Bob really is assisting Steve with new business development. We felt Steve was stretched thin in his existing responsibilities. So, we didn't subtract from the management team, we really added to it.

I mean, the point is that Bob has a background in the midstream business and is well known to our major counterparties down in Texas. So, his coming aboard means that we have multiple discussions for joint ventures, for increases of volume through the plant. The last time I looked, I think it was 36% capacity. And so, we're looking for Bob to be additive to all the wonderful things that Steve Kennedy as Manager of the plant has done.

Okay. Thanks a lot, guys.

Thank you.

The next question comes from Jasper Birch at Macquarie.

Hey, again, gentlemen. I'm just hopping back on. I was wondering if you could give any commentary on how you -- on your dividend, how you're looking at it now? Especially, I mean, you guys have done a great job maintaining it. But just looking at your guidance for next quarter and this quarter what you're thinking about with the dividend.

Well, we don't give dividend guidance and make projections. We really never have as a company. But I would say, in general, how we're looking to drive earnings going forward to sustain the dividend, it really focuses on originations, growing the book, employing leverage. Our debt-to-equity ratio today is less than 0.05, or approximately 0.05.

So, we have significant, significant upside to our facility. And that's why we're focused on growing our access to credit, improving the cost of that facility as well, which will help to drive earnings.

We're also looking at move-the-needle transactions. When you think about some of those meaningful transactions versus the company, Gas Solutions obviously comes to mind. We've talked about that on this call. The acquisition of Patriot Capital last year comes to mind as well.

We're on the lookout for other move-the-needle types of transactions that give us upside. And we have that additional arrow in our quiver, if you will, as a Company, apart from others that just focus on sort of sponsor, debt oriented originations.

Great. So, it's really -- I mean, you guys are pretty confident with sort of a long-term outlook and it's really just a matter of getting levered up. Is that a good way to look at it?

We're very happy with the trajectory of our company and we have significant debt capacity. And when I say levering up, or when you say levering up, I want to be careful to emphasize that doesn't mean going close to 1-to-1 debt to equity. We've told folks and we've told counterparties that getting closer to 0.5 debt-to-equity, which gives us significant, significant cushion, is a better long-term target for us.

Okay. And then when you do look at the dividend sort of long term, I know that's how you guys evaluate it, are you more looking at core income or taxable? Because I know the purchase discount, a lot of that's not taxable.

We're looking at core as opposed to taxable. And you're right in that, because a lot of that purchase discount is not taxable, we're building a cushion for the future vis-a-vis distributions.

Okay. Thanks. Thank you guys a lot.

Thank you.

The next question comes from James Bellessa at D.A. Davidson.

Good morning.

Hi, Jim.

It's not an earnings call without Jim asking a question. Right, Jim?

That's right. Been around a long time.

I was getting worried, Jim.

Okay. You indicated that the natural gas business, industry[has slipped], yet the evaluation of Gas Solutions went up about $5 million during the quarter and last 90 days. Can you explain that?

Sure. Gas Solutions, all other things being equal, benefits when natural gas prices go down. And that's because the vast bulk of the business is driven by gas associated with casing-head gas, oil-rich gas. And basically, if crude oil prices stay level and natural gas prices go down, then Gas Solutions, which is a spread of those two, does better. And the best approximate for that spread is the price of propane. And that's why, when we look to hedge exposure, we look to hedge propane.

And propane has bounced back significantly and we were quite fortunate in our risk management policies in which we were proactive to hedge propane when we saw record high prices back in 2007, 2008 and we enjoy the benefits of that. Propane has come back from somewhere -- I believe bottomed out around $0.60 to $0.70 a gallon, upwards of over $1.00 per gallon. And we're hedged a little bit out of the money from that.

And do you recall that you've ever marked down Gas Solutions?

I can't recall precise quarter to quarter. We have made some slight adjustments along the way. And of course, when we say we, as you know, our process as a Company and as a Board of Directors, is to have an independent third party valuation done. And that third party takes into account discounted cash flow forecasts, purchase multiples and trading multiples of comparables.

Jim, I can't specifically remember, but I -- but if I had to guess, I think maybe there was maybe one quarter, maybe two, more likely one where it was marked down a little bit. The reason we don't have the intimate knowledge of that is that that's really outsourced.

The entire valuation program is conducted by Lincoln International working with a portfolio of companies, delivering a report to us which we then check to make sure things are spelled right and the arithmetic is correct, and give to our Board, typically, within 24 hours.

And BBO's position is that we cannot vary from the midpoint of the ranges that are set forth in that Lincoln report. And if there's no range, just one valuation number, we can't vary from that if we want BBO to sign off for our financials. So, as a result, the valuation process takes place largely in a universe that we don't spend a lot of time in.

Since making the Patriot Capital acquisition, you've issued -- and that was for about -- a little over 8 million shares that you purchased that for. You've issued almost 4 million shares additionally up through recent weeks. Can you go through the expansion and capital require -- that you've gone through? And why are you doing it when you are unleveraged?

Thank you, Jim. We addressed this a little bit, but I can expand upon that. We have been doing so at the market formats, which we've found to be quite efficient for capital access, about a 200 basis point cost of accessing that capital as opposed to trading dynamics and investor discounts and underwriter discounts that can stop in the range of 10% to 15% on a marketed deal. So, we like that efficiency. We think it's very protective of existing shareholders.

We're expanding because, quite simply, we expect for new originations to go up significantly. We like the accretion of such issuance. And we're doing so also in the midst of closing a facility, which we hope and expect to do over the next 45 days. And of course, it is not a "done deal" yet. We're optimistic. No guarantees, but we're optimistic we'll get it done. But in the interim, we want to make sure we can continue to fund the pipeline.

You said the issuance was accretive, but there really (inaudible) to earnings until you're actually able to deploy the capital. Is that right?

That's a fair point. And I can't comment on the precise timeline of deals, but we hope and expect to close in the next few weeks. But we're seeing dramatically ramped up activity across the board, which is why we have hired several new people in the last few weeks.

Thank you very much.

Thank you, Jim.

The next question comes from Henry Coffey at Sterne Agee.

Yes. I feel real old school since both Jim and I are the only guys who've been around the whole time. There's got to be a point, like maybe there isn't, where this equity issuance equation stops and the leverage process starts. But we actually don't really care about that.

What I really care about is you've got a $0.41 dividend and a $0.30 earnings stream. Can you give us a sense of what the numbers would have to look like to turn that into a, say, $0.40 or $0.45 earnings stream and how long that's going to take given your existing pipeline?

I mean, obviously, we don't want to tie you down to something too rigid, but you've got to know your pipeline. You obviously didn't issue equity at these price levels without some serious ambitions. So, short of giving us guidance, can you give us at least a profile of what the Company has to look like so that, at this share level, it can generate $0.45 to $0.45 a share in net investment income?

Right. So--.

And then I have a couple of other related questions.

Sure. So, Henry, focusing on that, the credit facility cost, I think is an important one. Candidly, we don't love the pricing of the existing facility that we have right now. We felt like we were a price taker, along with a few other people. And you know others that have the unfortunate timing of when they're doing their extensions in the first half of 2009.

When does that facility roll over?

It matures a year from now, but the revolving period ends in June 25th. And so, we're working on the extension right now.

But my point is that we have an L-plus 400, 200 floor facility. We think it's priced way too high relative to current market conditions. And that's why in our extension, and where we're focused on with our term sheet and commitment letters, is a significant reduction in floors, in spreads, improvement in advance rates, in addition of junior debt to back into the collateral.

All the things that we think are important to be able to, A, access our facility efficiently and, B, do so with reduced costs. We do not want to load up on an expensive inflexible facility, as I'm sure you can appreciate. So, we're focused on doing that and then utilizing it.

But first off, let's stop right there. What would that facility have to look like in general terms for you actually to stop issuing equity and start using the facility?

Well, our intention is to use the facility post-closing of this extension. And we're fine with where we are on--

Even under current rates and terms once you get your extension you'll stop issuing equity and start using debt?

Once we get our extension, we expect to significantly use the facility.

In terms of issuing equity, that will depend, Henry. I mean, it'll depend on if another Patriot comes along, for example, which is--

But Patriot hasn't generated or hasn't covered its share issuance. When you look at the shares issued, the eight plus the three, and divide that into the earnings of Patriot, it's not covering the dilution of the offering. So, if another Patriot came along and you weren't able to use leverage, using equity to buy it wouldn't, unless I'm missing something on the math, wouldn't add a lot. I mean, you gave us the numbers, which is very, very helpful. And if we disaggregate Patriot capital from your results, what's the earnings on the shares issued?

Well, I think we had given a prior guidance without accelerated accretion, we expect that Patriot to generate $0.09 to $0.10 of incremental net investment income to the business. And--

So, that would put your earnings at $0.40 and they aren't there. Because they were at 40 -- they were in the 30s before you started.

Well, to be fair and we also expanded the share count in the same time. So, we did have a higher bogey to shoot for.

Right.

But I think, really, the main aspect here is we have a balance sheet that has no leverage.

Right and that's the problem that you keep issuing shares. So, we're trying to figure out at what point are you going to stop the share issuance, start using leverage, and earn that $0.40 to $0.45 to cover your dividend. And if you could give us either a sense of timing or a sense of what the Company would look like under that scenario, that would be helpful. So we could at least sit down and kind of model around that expectation.

Right. I've given a sense of without precision on exactly what we expect our spread to be. You'll see that when we close the facility in the next 45 days, you know, the precision around that. But if you take that cost of leverage and grow the balance sheet at -- to a 0.5 debt-to-equity ratio, I think that'll get you into the comfortable zone, Henry.

Okay. Gladstone cut their dividend in half and their stock went up. Is there -- have you looked at that and given some -- any kind of consideration to it, or-- You don't need to keep bribing people to own your stock if you have a good investment opportunity.

Well, I don't know if we should be commenting on what other companies are doing, Henry. There may be other specifics going with that business. What I do know is we haven't made a specific projection on what we're doing with the dividend. The Board meets and deliberates on that on a quarterly basis so will do so again in June. It's not a forever decision. It's a point-in-time decision.

We do appreciate the market context. No one's trying to bribe anyone and I would take issue what that characterization.

Well, I mean, it's just -- I don't think you do. I mean, I don't think you need to keep paying out that high a dividend to get people to invest in your company given where the price-to-book ratio is.

But now, on your debt facility, right now my understanding is you basically have to have every new investment put into the facility approved by your lending group? Maybe that's too harsh an interpretation. Is that requirement likely to go away?

That is not an existing requirement.

Okay.

Nor do we expect that to be a requirement. You may be confusing that with other companies' facilities.

I think at one point that was the case with your -- maybe one generation ago or something.

No, that's never been the case. I think we're in our fifth generation of facilities and at no point in time have we had deal-by-deal lender approval. What we do have is in the borrowing base third-party input that's quantitative and mechanical in nature for calculations relating to specific collateral ratings, and pertaining to independent third-party valuations.

All right, I must have misunderstood.

There's no point at which lenders can say, oh, I don't feel like funding this so I'll stop. There's zero arbitrary capricious--

So, once the facility is set, it's available to be used as long as the collateral meets certain objective criteria.

Yes. That's exactly right. And we have significant utilization today, even if you put non-borrowing-base compliant assets in. And if you put borrowing-base compliant assets in, then you get an iterative effect to increase the borrowing base further.

If we were allocating overhead to the Patriot acquisition, should we just use your management ratios or should we look at it differently?

You should use the management ratios.

All right. Well, thank you. I appreciate your--

Hey, Henry, to correct one thing you said that I want to be sure is corrected. There's never been any -- not only can the banks not -- they don't have a veto or approval right. But also there's never been any requirement that each investment go into the facility. We can make investments and choose not to contribute them to the facility.

Oh, no, no. We understand that. I get that.

Okay.

Great. Thank you.

Thank you, Henry.

The next question comes from James Bellessa at D.A. Davidson & Co.

Thanks for the second question here. You've got a line item now called potential merger expenses and you attempted to do some type of proxy contestation with Allied Capital. And you spent over $900,000 in the most recent quarter. But for the nine months it's $1.1 million. Do I assume that it's all for the attempts around Allied Capital?

It's primarily for that. There were some other potential acquisitions that we looked at that we incurred small costs for, but the bulk of the costs are for the Allied investigation.

And those costs have stopped.

And you were talking about a pipeline of portfolio opportunities. Do you foresee yourself ever attempting to go back to try to take over another BDC, just like you did with Patriot, or is this unlikely to go in that direction?

Well, Jim, it depends what comes up, right? If there's another Patriot acquisition and we have a chance to bid for it on an attractive basis, we would certainly consider that.

Well, what's your sense of the market right now and opportunities out there for takeover of other BDCs?

Well, the market was at -- there were more opportunities at the end of '08 and through a good part of '09 than are apparent right this second. But, you never know. And we're prepared to take advantage of opportunities as they come up.

There are still opportunities that we're looking at. But, one of the things we've seen is that, in fact, with respect to a couple of opportunities we've spent significant time on, and I'm thinking of two in particular, we were overbid by a very large amount. And in each case we're wondering how the calculators work at the other companies and how they're going to make money on those acquisitions.

So, we've gotten into a little bit of a frothy market for the purchases of portfolios, and even to some extent individual loans. And it's our experience and when those things happen that trees do not grow to the sky and the market does right itself. So, we may be seeing more attractive opportunities a month from now than we see right at this second, which is fewer than what we saw mid-year 2009.

Thank you.

Thank you, Jim.

Our next question comes from Arren Cyganovich at Ladenburg.

Hi. I just have a quick question on Manx Energy. I guess you combined a couple of your troubled portfolios, Appalachian Energy and Coalbed, and then added about $2.8 million, which is on non-accrual but the marked at par. Kind of wondering what's going on there and the future prospects for them? And what the $2.8 million was actually used for?

Sure. So, recall that years ago we had a book of assets of very small loans to very small companies, many of which we subsequently concluded were subscale to be competitive. And that was the case with Conquest and AEH, where we determined combining operations, reducing overhead and G&A would be a very smart thing to do with a quality management team at the helm. And a team able to attract also third-party equity capital to the business such that Prospect would not be the sole institutional supporter of that company.

The additional capital has gone in to expand operations. Manx is looking at organic growth opportunities, as well as follow-on acquisitions. And there's a pretty ripe opportunity to purchase both smaller services companies, as well as smaller E&P companies given the -- in particular, the natural gas price volatility and depression that's occurred. Great time to be a buyer.

The way to think about it is the quality of management that you can attract to a company with $1 million or $2 million of EBITDA will not be the same as the quality of management that you can attract to run a company five times as big. And so, once we found a management company that was interested in rolling these up for us and managing them on a consolidated basis, we did the work and we're happy to have made the change.

Do you think that this is something that eventually will come off non-accrual status, or what's the end game for this--?

Well, the plan is for it to come off of non-accrual status. I'm sure you know that that's the plan.

And right now the Manx operation, it's a little slower out of the starting blocks than we expected, but it's nonetheless tracking what we were hoping. And I think really, Brian needs to explain why that is on non-accrual because not everybody here thought that that was appropriate, but there are accounting reasons for that. Brian?

Yes. The reason it's on non-accrual is that it's -- both of the assets prior to being consolidated were on non-accrual. And until they generate meaningful operating income and can show and demonstrate that that's sustainable, that loan will stay on non-accrual status.

So, once you go on non-accrual you can contribute two companies together into one company, roll it up, bring in new management. And even when that new management raises new equity capital, you still need to have a track record of performance with that new capital before you can put the company back on accrual. Nonetheless, you can hold it at par if the liquidation value of the assets is equal to or in excess of the debt. And so, that's the situation there.

Okay. That's helpful. Thank you.

Thank you.

Our next question comes from James Bellessa at D.A. Davidson.

On NRG is the question about that portfolio company. At one time you had indicated that it was possible that you might monetize that. Then it faded and then it's revived. I see that you mark it up in the most recent quarter. Can you tell us what the status is there and what you're seeing?

Jim, we actually marked NRG down a bit in the past quarter. NRG had had some exposure to the natural gas market through manufacture of lead tank equipment going to new drilling rigs and that market had slowed. Folks are projecting that market to pick up again in the future.

So, we had written down our equity position. Our debt continues to perform just fine and we're comfortable with our position there.

In terms of a sale process, we don't think exiting now would make a lot of economic sense. And as with any of our investments, if we see significant growth potential we're more likely to hold on. We don't have the particular pressure to exit at any given point in time, particularly as a company that runs in the macro sense with low leverage. But, if we got a nice compelling price and off of a growth uptick, we could potentially look at that again.

We also have there, Jim, a very good strong management team that is looking at other opportunities in a market that's a little depressed for them. We hope that they can close on some of those.

The other thing that we've noticed is that -- and which is a testament to the competence of the team, is when mud tanks were not in such demand as they had been before, the company diversified its backlog into other areas quickly, protecting the revenues and cash flows which, as you know, is not something that's so terribly easy to do.

So, we have I guess an optimistic view of the future of NRG, particular if this management team can buy one or two other additional operations.

Thank you.

Thank you, Jim.

This concludes our question and answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Well, I think we're all set. We don't have any closing remarks except we're hungry for lunch.

Thank you all.

Bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.