PSEC

Prospect Capital Corporation (PSEC)

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Prospect Capital Corporation (PSEC)

F2Q10 (Qtr End 12/31/09) Earnings Call

February 10, 2010 11:00 am ET

Executives

John Barry - Chairman & CEO

Brian Oswald - CFO

Grier Eliasek - President & COO

Analysts

Chris Harris - Wells Fargo Securities

Arren Cyganovich - Ladenburg Thalmann

Robert Dodd - Morgan Keegan

James Bellessa - D.A. Davidson & Co

Troy Ward - Stifel Nicolaus & Company

Dan Mazur - Harvest Capital

Tony Reiner - Dominick & Dominick

Jim Stone - PSK Advisor

Rob Schwartzberg - Compass Point

Greg Mason - Stifel Nicolaus

Mark Sunderhuse - Red Rocks Capital

Presentation

Operator

Good day, and welcome to the Earnings Call for Second Fiscal Quarter ended December 31, 2009 for Prospect Capital. All participants will be in a listen-only mode. After today's' presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. Now, I would like to turn the conference over to Mr. John Barry, Chairman and CEO. Mr. Barry, the floor is yours, sir.

John Barry

Thank you, Mike. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer and Brian Oswald, our Chief Financial Officer. Brian?

Brian Oswald

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 forecasted due to the impact of many factors. We do not undertake to update our forward-looking statements, unless required by law. This communication is not a proxy statement or a solicitation of proxies and does not constitute an offer to sell or a solicitation of an offer to buy any securities. For additional disclosure, see our earnings press release, form 10-Q and other documents filed previously with the SEC.

Now I will turn the call back over to John.

John Barry

Thank you, Brian. With the three months ended December 31, 2009, our net investment income was $16.9 million or $0.29 per weighted average share outstanding. For the six months ended December 31, 2009, our net investment income was $29.2 million or $0.54 per weighted average share outstanding.

Our net investment income increased 37% and our net investment income per share increased 19%. From the quarter ended September 30, 2009 to the quarter ended December 31, 2009.

We closed our acquisition of Patriot Capital Funding on December 2, while the full quarterly benefit to the Patriot acquisition are not expected to be reflected until the March 31, 2010 quarterly financial results. We did recognize a gain on the Patriot acquisition of $5.7 million.

We also recognized $7.5 million of interest income from the acquisition through the end of the quarter, including $4.6 million of interest income from the acceleration of purchase discounts upon early repayments of three loans, repayments of three revolving lines of credit and a sale of investment position.

These early repayments have been total PAR repayments comparing favorably to the discount on our purchase of the Patriot portfolio. 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 potential additional portfolio and individual investment opportunities that aggregate more than $3 billion of assets.

We estimate that our net investment income for the current third fiscal quarter ended March 31, 2010 will be $0.24 to $0.32 per share. If we have significant early repayments out of the Patriot portfolio, we have the potential to exceed this range as we continue to recognize the deferred value of the discount associated with our purchase of the Patriot portfolio.

We expect to announce our third fiscal quarter distribution in March. In December 31, 2009 quarter because of a desire to eliminate excise taxes for the 2009 calendar year included two, not just one record date, thereby causing a second dividend payable and a second associated deduction from our net asset value deduction during the quarter, absent such timing differences, net asset value per share on December 31, 2009 would have been $10.47.

Valuation changes virtually all on a mark-to-mark unrealized basis on our equity positions due to trailing 12-months EBITDA changes in the 2009 recession comprised approximately 56 per share this past quarter. So far in 2010, we have seen increases in backlog, increases in order bookings and increases in other leading business indicators in a number of our portfolio companies.

Thank you. I will now turn the call over to Grier,

Grier Eliasek

Thanks John. At December 31, 2009, our portfolio grew to 55 long-term investments with a fair value of approximately $648.1 million compared to 29 long-term investments with a fair value of $510.8 million at September 30, 2009. This increase in investments was driven by the acquisition of Patriot, net of post closing monitorizations from the Patriot portfolio.

On December 2, we acquired the outstanding shares of Patriot common stock for $201.1 million. Under the terms of the merger agreement, Patriot common shareholders received 0.363992 shares of our common stock for each share of Patriot common stock, resulting in 8,444,068 million shares of common stock being issued by us.

In connection with the transaction, we repaid all the outstanding borrowings of Patriot in compliance with the merger agreement. On December 2, Patriot made a final dividend equal to its undistributed net ordinary income and capital gains of $0.38 per share.

In accordance with the recent IRS revenue procedure, the dividend was paid 10% in cash and 90% in newly issued shares of Patriot's common stock. The exchange ratio was adjusted to give effect to the tax distribution so that our purchase consideration for Patriot was not effected by this distribution.

The merger has been accounted for as an acquisition of Patriot by Prospect in accordance with the acquisition method of accounting as detailed in ASC 805 business combinations. The fair value of the consideration paid was allocated to the assets acquired and liabilities assumed based on their fair values as of the date of acquisition.

As of the acquisition date, the fair value, the identifiable net assets acquired exceeded the fair value of the consideration transferred and we recognize the excess as a gain. A gain of $5.7 million was recorded by Prospect in the quarter ended December 31, related to the acquisition of Patriot.

During the quarter, from the acquisition of Patriot on December 2 through December 31, we recognized $7.5 million of interest income from the assets acquired from Patriot. Included in this amount is $4.6 million resulting from the acceleration of purchase discounts from the early repayments of three revolving lines of credit and the sale of one investment position.

During the quarter ended December 31, 2009, one additional investment scale products has repaid its outstanding debt to us. Earlier in the quarter, we had purchased additional debt in Resco at a 40% discount to PAR and subsequently received a full PAR repayment of all of our debt at the closing, generating a 16% cash on cash internal rate of return on our overall investment.

Gas Solutions continues to generate free cash flows with no third party debt. We are discussing opportunities for a potential monetization of our position and we recently hired a new senior executive to help drive further revenue and profit growth.

As we discussed earlier, we currently have an investment pipeline of potential opportunities which totals more than $3 billion. This pipeline includes investment opportunities across multiple strategies, including sponsor financings, direct loans, operating company buyouts and strategic financial portfolio acquisitions.

We generally announce specifics related to such transactions only upon successful consummation, if a particular transaction opportunity with the public company counterpart happens to become publicly known through counterparty communications which may be self-interested or distorted, one should not interpret that publicity to mean that we are solely or primarily working on such publicly disclosed opportunity to the detriment of other potential opportunities.

Primary investments opportunity in the marketplace is increased recently and we are currently evaluating a robust pipeline to potential investments some of which has the potential to close this quarter. These investments are primarily secured investments with double-digit coupons, sometimes coupled with equity upsides or co-investment or warrants and diversified by sector.

As compared to competition in 2006, before the credit dislocation began, we see far fewer competitors in our target middle market and are reaping the benefits from having significant access to capital in the current environment.

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