Prospect Capital Corporation
Q2 2008 Earnings Call Transcript

Published: 12 Feb 2008

[Operator:]

Hello and welcome to the Prospect Capital Second Fiscal Quarter Earnings Release. All participants will be in Listen Only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions)

[John F. Barry III:]

Joining me in the call today are Grier Eliasek, our President and COO, Bill Vastardis our CFO, and Robert Kleinman, our SVP of Finance, making his maiden. Rob, thank you. Before we begin, Bill will review a few legal matters.

[Bill Vastardis:]

Forward-looking statement within the meaning of the securities Law. All such statements are intended to be subject to Safe Harbor Protection. Actual outcomes and results could differ materially from those forecasts due to the impact of many factors. We do not undertake to update our forward-looking unless required by law. For additional disclosure, VR earnings press release and our 10-Q filed previously. Now, I will turn the call back over to John.

[John F. Barry III:]

Our net investment income for the second fiscal quarter adjusted for nonrecurring items was $11.1 million or 48 cents per weighted average number of shares for the quarter, an increase of approximately 146% and 45% from the prior year-over-year quarter on dollars and per share basis respectively. We estimated our net investment income for the current Third Fiscal Quarter, ended March 31, will be $0.45 to $0.53 per share. We expect to announce our Third Fiscal Quarter dividend in March. Now, Grier Eliasek comment on our investment activity.

[Grier Eliasek:]

On December 31, the fair value of our portfolio was approximately $440 million and 32 long-term portfolio companies. As of December 31, our portfolio generated current yield of 15.3% across all of our long-term debt and equity including dividend, net profit interest, and realty income. Last quarter, we completed seven new investments which consisted of Resco, Unitech, Maverick, Shears, Qualitest, Deb Shops, IEC, and ARS, as well as follow on investments and existing portfolios totaling approximately $121 million. This was the record investment quarter for us. Additionally, we monetized two positions, CIE and Advantage for a higher grade of $9.1 million in principal proceeds, not including interest payments. As of today, we now have 32 portfolio companies aggregating approximately $440 million of assets calculated as of December 31 investment portfolio, plus additional investments in every payment. On December, we announced that we engage RBC’s Financial Adviser to explore strategic alternative including a potential sale of our largest 100% control investment Gas Solutions, a midstream gathering and processing business in East Texas. Gas solutions is currently generating approximately $26.5 million of adjusted EBITDA as an annualize run rate. We expect to conclude that process over the next few months and hope to see a significant growth in shareholder value. Currently, we are pleased with the reward to risk characteristics of potential transactions under evaluation. With the retreat of credit providers in the marketplace, even with the drop in LIBOR, we are seeing diminished competition and attractive spreads across all of our direct corporate lending, sponsor and finance, and single-stock buyout investment strategies. The vast bulk of our portfolio is at a fixed-rate loan or flowing rate loans with a fixed flow as a protection against LIBOR reductions. We expect an active calendar year 2008 after a calendar year 2007, with approximately twice the investment pays over the prior year.

[Bill Vastardis:]

On December 31, borrowings under our credit facility stood at approximately $107 million. We are currently in discussion to increase the size of our $200 million facility to at least $400 million in Size. On October 17, we priced a secondary offering of 3.5 million shares of common stock at $16.34 per share, raising $57.2 million in gross proceeds. On November 13, the underwriters exercised the over-allotment option raising an additional $3.3 million in gross proceeds when 0.2 million shares of common stock were issued.

[John F. Barry III:]

We can now answer any questions.

[Operator:]

Our fist question, I believe, comes from Robert Dodd at Morgan, Keegan & Company, Inc.

[Robert Dodd:]

Could you go over the nonrecurring expenses that you talked about? I assume that it is with the legal side. Then, could you tell us what happened with CIE last quarter is carried at a cost and there did not seem to be any issues with. In this quarter, it was written down and sold. Thirdly, on Gas Solutions, could you give us any more color about what is going on there in terms of the number of, if you can disclose that, indication of indications of interest etc?

[John F. Barry III:]

I will start with the two items that I will cover and Bill Vastardis will cover the expense items. In the case of CIE, that is an ethanol facility in Southern Illinois that has been under construction for some time. We were not fully aware of the difficulties that were being generated there, and the fundamental problem being that Lergy which is the contractor, was that odds with the management. Once they started fighting, it created pressure elsewhere in the system including, with respect to the farmers’ willingness to live up to their subordination obligations under the corn delivery agreements. What we discovered was the situation rapidly unraveled and so, we were part of the process of trying to get everybody back to the table and in our view, act reasonably and complete the plant, which did not work. And, when that did not work, we put our position up for sale. Even though it was after the bankruptcy, we were able to get, I think, 65 cents on the dollar, right, Grier?

[Mr. M. Grier Eliasek:]

Correct.

[John F. Barry III:]

So, that is the story there. We seem to have gotten out ahead of bunch of other people who took even bigger loses. With respect to gas solutions and the sale of energy, we can not comment in detail on exactly where those processes stand because, of course, they are fluid. People are looking at gas solutions at the facility. They are reviewing materials. We do not have any bids yet. We do not expect any for a while. We expect that to proceed over the next few weeks and possibly maybe a month or two. We are not able to predict exactly how quickly these things go. In the case of energy, it is moving along more slowly than gas solutions in part because the company just purchased and merged with Dynafab. Therefore, they have had to take some time to get their numbers in order. Is that adequate on those two questions, Robert?

[Robert Dodd:]

Just on gas solutions, would you be expecting anything to be done before the end of this quarter or will we be looking at next quarter?

[John F. Barry III:]

Well, it is hard to predict the future particularly when it is in the hands of other actors. Looking at this quarter, we are halfway through February. We are talking 45 days. I think it is reasonable to expect that we will know an often lot more by the end of March. I do not think it is a reasonable expectation to think that we would have closed on the transaction. Typically, as I am sure, everybody in this phone call knows that you go out with materials. People come back with indicative bits. Then, there are some back and forth with the top X, Y, Z percent of those indicative bids. They come back again. The flock is thinned. You get down to four or five people that you are interested in talking to, and the process does take time. I just do not know. I am not seeing any processes conclude in 60 days. I have seen them, it takes six months. Now, Bill will comment on expenses.

[Bill Vastardis:]

With respect to the nonrecurring items for this quarter, as we mentioned in the previous quarter, there is a case being handled through the arbitration process and there were some additional cost to this quarter related to that back at the large majority of the nonrecurring that relates to that. And of course, we adjusted that expense for the performance of the impact and the net is what we lift in our earnings release.

[John F. Barry III:]

Thanks Robert, did that answered your question? Robert, we hope we answered your question adequately, did we?

[Operator:]

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

[James Bellessa:]

I am looking at these losses that you realized, and if I heard you right, you took that 65 cents on the dollar for CIE. Is that $2.8 million loss than if you have a cost basis of $8 million, is that how you calculate that?

[John F. Barry III:]

That is very close. It is about $2.9 million.

[James Bellessa:]

On Advantage Oil Field Group, you said that had $18.6 million of total realized losses in the quarter and so, the bulk of the losses evidently came from AOG.

[John F. Barry III:]

Correct.

[James Bellessa:]

But, I can not track down the numbers precisely and so, just see if you have any help there.

[John F. Barry III:]

Yes, let me help you with that. We had that on our books for about $10.6, 930, and we took a further, deducted realization of $6.7 million in the past quarter.

[James Bellessa:]

How do you get to the total of $18.6 million?

[John F. Barry III:]

That is the original cost.

[James Bellessa:]

And so, you have gone from unrealized losses to realized losses, does that abolish to the other, your report unrealized losses and gains during the period? Does that get reduced, the amount of unrealized losses get reduced during the quarter when you take the loss, actually, realize the losses, what happens?

[Bill Vastardis:]

That is correct. The AOG unrealized loss from the previous quarter or the accumulative unrealized loss was converted to realize loss. Therefore, while we had approximately $15 million in realized losses for the quarter on AOG, there was an increase of unrealized appreciation of approximately $8 million which was how we helped, so far, we had written it down. That $8 million helped us during the quarter with our positive unrealized appreciation.

[James Bellessa:]

And that turned out to be just about $5 million so you must have had depreciations occurring.

[Bill Vastardis:]

On other security, that is correct.

[James Bellessa:]

And you identified those in the queue by saying those were in Genesis, Whymore, and WECO.

[Bill Vastardis:]

Correct.

[James Bellessa:]

And you want to comment on any of those or…

[Bill Vastardis:]

Sure, I am happy to comment on those since I spend a fair amount of time on them. They are my “babies” now. In the case of Genesis, Genesis is profitable more days than that which is an improvement from where we were, and that is just based off of 2007 pricing going to early 2008 pricing which is yet to reflect the significant run up in coal prices. Whymore has been more profitable more often than Genesis. Whymore also has yet to reprise its coal supply agreements and we are looking at what we can do to get something more like the $70.00 a ton that people are now quite suddenly paying. The coal prices have gone up to 50% over what time period?

[James Bellessa:]

Over the last three months.

[Bill Vastardis:]

So, we have struggled with these two companies and we have struggled on a fundamental basis to get them to be profitable with the old pricing we have encountered every conceivable surprise and difficulty, including engineering reports overstating how much coal, how much ash is there, the size of the partings. Honestly, every conceivable thing. If you want a training in fixing companies, this is where you would be sent. So, we have maintained these companies cash flow breakeven to now positive, and we have told them we are not giving them any more money. We hope that will stick, and we are looking to see the improved situation and at the way it continue to improve. Also, we continue to look at other properties and we have other opportunities that are potentially synergistic with those two. We are not giving up and we still have them on the books although severely written down. And, every time we give them any more money, that is immediately written off as well. Hopefully that is behind us. In the case of WECO, WECO also has been at test of patience in that all of the predictions by then engineers and by the consultants, how quickly that would be amortizing debt and paying dividends have not come to past. But, we have ***** approached the point where we can see exactly what we need to do instead of having a punch list of 100 things to do. We are now down two, three, or four and what they are is, this weekend, the boiler pre-feed water heater is being changed over so that we will more often be above 20 megawatts than below 20 megawatts. That is important. Number two, while we have in front of us expenditure for the condensers, we need to modernize the condensers there. And if we do that, we think we will be exceeding 21 megawatts, maybe not every second everyday, basis has been on a fairly consistent basis. The third thing we need to do is have our average price of wood be $34.00 per green pan. It is currently in the market at $34.00 per green pan but we need to have our own in-house wood supply operation so that we are not perceived as being vulnerable to all the wood suppliers up there that we can actually harvest our own wood and the problem we have had to date is that our own wood operation has not been as efficient as the people in the marketplace. The pros have been doing this for years and years, which is not that surprising. We revamp the wood operation in the last month and we have gotten our prices down. I think last, it was 44 bucks right, Grier?

[Mr. M. Grier Eliasek:]

Yes.

[Bill Vastardis:]

If it is a significant decrease from where we were. So, when we look at the grids that we have received our engineer, they show 21 megawatts, $34 fuel, and a significant EBITDA, a few of the exact number is. That is where we are trying to get. It has taken at least a year longer that we were led to believe but every month, we make this turn of progress. Is that responsive, Jim?

[James Bellessa:]

Thank you very much. On the queue, you have a weighted average borrowings, I had not noticed it before. Is this the first time I am showing up and if it is the first time, is there a historical chart or table that can be provided to see what the average weighted borrowings were per quarter?

[Bill Vastardis:]

Yes, we did this at this new for the first time and we will in the future queues put a table in for comparison purposes.

[James Bellessa:]

Is there something for us to help and know what the average weighted borrowings were before the past quarters or do we have to wait for them to be reported in the future?

[Bill Vastardis:]

I do not have that information here with me today. Unfortunately, you will have to wait. We do show a comparison from Q2 of ’08 versus Q2 of ’07.

[John F. Barry III:]

As you know, we have run our business with almost no leverage historically or diminished leverage as a bridging to build the equity-based of the company and we are only now reaching a critical size and mass allowing us to have long-term leverage outstanding as a means of driving the dividend and we are just now entering that positive pace of our business which we hope and believe will be a significant dividend driver going forward. So, we wanted to have this weighted average number to be helpful in a going-forward basis.

[James Bellessa:]

In that regard, you talked about having about $100 million line of credit to see if the credit facility is $107 million in the balance sheet, and your cash position was a little over $26 million. Why did you not have any cash?

[John F. Barry III:]

Well, we maintain cash liquidity at all times, of course it is a balancing act between appropriate liquidity to run the business on a day to day basis and not excess liquidity a drag on yield. There will be some timing differences which might make that cash number move up or down based on where we are in a particular month. For example, we take money out of the special purpose vehicle where our credit facility are non-recourse secured credit facility for Prospect Capital, LLC - Prospect Capital Corporation which is the borrower for the - Bank facility. We take distributions out of that once per month. So, there will be timing differences which might have a slightly larger cash number depending upon what part of the month we are in. But in general, our goal is to strike the right balance between appropriate short short-term liquidity in longer term. Of course, just liquidity in general, we have plenty of liquidity as a company, both to make new investments, as well as to run the business on a day by day basis. We also have that capital to, at the end of that quarter, of course, in part to pay the dividend that was paid something like a week later.

[James Bellessa:]

Okay. I have not heard of any new investments that you made in this quarter, the March quarter yet. So, after paying that dividend that you paid down some of your credit facility or did you keep the facility where it was and maintain your cash position?

[John F. Barry III:]

Again, we used some of that for the dividend which I think it is under $10 million keeper take, so we maintained some cash for other uses. We have not made a significant number of long-term investments in the last 30 or so days but that is not at all indicative of the opportunity set that we have in front of us right now which were very happy with. We are looking at array of opportunities for sorting through them at the buyer’s market in a number of ways and we are making sure we a high-grading this opportunities to select the absolute best and of course, new closings in this business can be monthly rehab. No closings in a particular period and then you will have three or five closed at ounce. So, we have a very active pipeline and expect this to be inactive over the year in general.

[John F. Barry III:]

The sense that we have on some of the transactions that we are being sold is the price gets better the slower we move and we have seen continued reprising in this indicative loan market, we have seen continued reprising in the sponsor market, and we have seen continuing reprising in the market in which we invest. So, as we track our feed on some of these deals, what we find is the pricing improves and frankly, our time to look at them improves also. What we do not want to be doing is investing in front of a reprising and so far, we have been able to avoid the brunt of that.

[Bill Vastardis:]

We have also made an investment, to follow investment deep down on one of our existing portfolio companies for the last day of the quarter of approximately $6 billion, some of the cash receives for that as well.

[James Bellessa:]

Okay. Thank on that. [Audio Break] the pace of investment this year will be twice perhaps the last year’s. Are you talking about calendar year there when you say years?

[Bill Vastardis:]

Yes. I was quoting calendar years. We put out about $150 approximately in calendar year 2006 and in calendar year 2007. It was approximately twice closer to $300 million in aggregate. If you annualize the $120 million that was invested in the last quarter, that points towards about $500 million pays which is an uptake. We are not promising that exact pays to be some deviations because - opportunity driven in all cases, but I think that is a reflection of broadening our reach. It is a reflection of having a larger team to capitalize in opportunities. It is a reflection of the opportunities that we are seeing in the marketplace.

[James Bellessa:]

Let us just suppose you are able to find half of that amount, $250 million, did you say that you are trying to get your credit facility expanded? Is that what I heard?

[Bill Vastardis:]

We are currently working on at least doubling the sides of our existing facility from $200 million to $400 million. We will have additional disclosure if that progresses. Those are immediate processes. They take time and effort to achieve, but we are happy to have a supportive lender and look forward to growing our facility. That is an - 75 facility which at today’s LIBOR is approximately 5% money. We are interested in prudently maximizing that, we are limited to not more than 1

[John F. Barry III:]

As you know, Jim, Ravo is either the only or one of the only financial institutions out there that triple-A-rated and we view our relationship with the people there as a very valuable asset for the company.

[Operator:]

Our next question comes from Henry Coffey at Ferris, Baker Watts, Inc.

[Henry Coffey:]

In going through this, I certainly understand how the numbers work but I want to get them tied down. With Avantage, what was the original carrying value of that loan and how much did you write down and of course, the same question for Central.

[John F. Barry III:]

18.6 original costs carried in our books, 930…

[Henry Coffey:]

No, 18.6 was the original cost, not the value.

[John F. Barry III:]

Correct, carried on our books, 930 at 10.6, written down by approximately 6.7.

[Henry Coffey:]

Central Illinois is the same?

[John F. Barry III:]

Central Illinois’ original cost, eight on our books for 8 to 930, written down 2.9.

[Henry Coffey:]

Okay, and then we asked you about the rest of the realized losses, you started talking about Genesis and WECO, filling in the remaining of almost $10 million of realized losses.

[John F. Barry III:]

Henry, there were no other realize losses, 2.9.

[Henry Coffey:]

Net realized losses all at investments of $18.6 million, is that figure correct?

[John F. Barry III:]

That is correct.

[Henry Coffey:]

So, you wrote AOG down by 6.7? This is what I am trying to get to. I am trying to allocate that 18.6 and obviously 6.7, 2.9 do not equal 18.

[John F. Barry III:]

Well, if we go through the accounting.

[Henry Coffey:]

Okay. What does this focus on the realized losses from?

[John F. Barry III:]

The realized losses were entirely those two, $2.9 million of it was CIE, and the rest was AOG.

[Bill Vastardis:]

[Audio Break] Henry is that there has been a reversal where you add back prior unrealized depreciation that has already been taken in prior quarter and had shown ****it is just a movement of categories from what it has already been written.

[Henry Coffey:]

In the realized loss column, you had previous realized losses? I am just looking at the 18.6.

[Bill Vastardis:]

Henry, they moved from unrealized to the realized category. So, you are seeing kind of accumulative number there on the realized side. It includes prior quarters and then unrealized has to compensate for something that we had already taken a mark in prior…

[Henry Coffey:]

I understand the unrealized portion, I am just trying to figure out, so you lost $3 million on CIE and then the other $50 million was written down on Advantage, is that the way to understand it?

[Bill Vastardis:]

On accumulative basis which is approximately six to seven of it, we had already taken…

[Henry Coffey:]

I am not paying attention to that. Okay, I got it done. The next question is of course, you talked a little bit about what is going with Gas Solutions, I assume it is the same process with NRG.

[Bill Vastardis:]

Yes, it is. As I said, Henry, the energy process is moving more slowly because NRG purchased and merged Dynafab into NRG which requires…

[Henry Coffey:]

Was Dynafab one of your companies or one of a new company?

[Bill Vastardis:]

It was a new company.

[Henry Coffey:]

In the past, you sort of given us LTM EBITDA information on both, can you give us that and update that and to include the Dynafab number.

[Bill Vastardis:]

For Gas Solutions, the run rate which is approximately in the last quarter annualized is about 26.5.

[Henry Coffey:]

What is that in an LTM basis?

[Bill Vastardis:]

ATMI, I believe, is approximately closer to about $20 million. The 26 - run rate is up from just under 25 a couple of months ago.

[Henry Coffey:]

Right, I remember that.

[Bill Vastardis:]

Energy, I do not have at my fingertips, Henry. That one is a step slower because of the integration of the acquisition that had been done.

[Henry Coffey:]

And Dynafab was added at the EBITDA?

[Bill Vastardis:]

Yes.

[Henry Coffey:]

On a historical basis not on a…

[Bill Vastardis:]

Yes, it was a follow on acquisition done, something like a three times multiple.

[Henry Coffey:]

When was that done?

[Bill Vastardis:]

We had a press release about that last quarter. I believe it was on October if I am not mistaken.

[Henry Coffey:]

Obviously, you can not sit down and show us your pitch book and give us full list of all the people that you have talked to, and company notes and the like. Can you give us some expectation, sense of what your expectations are in terms of how these businesses should be valued? At what point would you just walk away from the sales process?

[Bill Vastardis:]

Henry, I think I had answered the question but I will try again. We do not have an opinion that is any different from what is in our financials and in the evaluations that we go through each quarter. We are going through a process that will possibly lead to a realization with either none of those businesses, both of those businesses, more than both of those businesses, one of them.

[Henry Coffey:]

So, do you think that when you sell it, the combined value for Gas Solutions or the total enterprise value would be $47.5 million plus whatever bank that is out there?

[Bill Vastardis:]

I am not making any prediction. Where is the $47.5 million coming from?

[Henry Coffey:]

It is on page 8 of your 10 queue.

[Bill Vastardis:]

Look, we go through it, we discuss at length in prior quarters…

[Henry Coffey:]

Right, I know. I am just trying to get that.

[Bill Vastardis:]

Henry, we can not be making predictions about the future. We are very careful running a full process here. We may have potential interested buyers on this phone call. Suffice to say, we are looking to maximize shareholder value. I would not necessarily say where the asset happens to be, in particular on our books, is a reflection of where we would or we are not.

[Henry Coffey:]

I am just trying to get your sense of how large a potential there between what is on the books and what you are likely to get. Is it really a business that is worth 10 or 12 times EBITDA? You are obviously valuing it at four or five, or is it a business that you are valuing at four of five, but it is really worth five or six times EBITDA.

[Bill Vastardis:]

We are not making any predictions.

[Henry Coffey:]

Okay. Finally, my favorite company, Regional, your consumer finance company that was a pretty devastating article in the Wall Street Journal today about lenders in the sort of a Mississippi, Florida, Georgia area, had there been any developments at that company in terms of its loan products and its relationships on the compliance side with people? Can you give us a sense of how that company is holding up in the face of all these other issues that we are facing in the sub-prime market and lots of regulatory noise?

[Henry Coffey:]

But I mean it is a great company and so they are continuing to kind of hold up in the midst of all these as what you are telling me, you are right.

[Bill Vastardis:]

We are not getting any news that there is any problem there and as you know, they are not lending against homes.

[Henry Coffey:]

Yes, I know what they do with it, but you are seeing any spill down into those subnets of lending then holding up nicely.

[Bill Vastardis:]

We are not and we have I think 40% equity underneath this and that deal which would bear any lumps should that happen, which is not happening. Well, I think also as you know, if you take the numbers back, these companies do somewhat better in recessions relative to the rest of financial services.

[Operator:]

Our next question comes from Robert Dodd at Morgan, Keegan.

[Robert Dodd:]

Hi guys, turning back to the credit facility, are we talking about a true revolving credit facility this time or another, I lack of a better term, a bucket list where you have to carefully allocate and restricts your ability to deploy capital in some cases?

[Operator:]

(Operator Instructions)

[Operator:]

Our next question comes from Robert Dodd at Morgan, Keegan.

[Robert Dodd:]

Just one more, in the dividend income in the quarter, can you give us some column where that came from and particularly how much did came from gas solutions?

[Operator:]

(Operator Instructions)