Prospect Capital Corporation (PSEC) Q4 2012 Earnings Report, Transcript and Summary

Good day and welcome to the Prospect Capital Fiscal Year Earnings Release and Conference Call. (Operator instructions.) Please note this event is being recorded. I would now like to turn the conference over to Mr. John F. Barry III, Chairman and CEO. Mr. Barry, the floor is yours, sir.

Well 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?

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 a 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 previously. Now, I’ll turn the call back over to John.

Thanks, Brian. Over the past year your management delivered record Prospect net investment income and record Prospect year-over-year growth in the June 2012 quarter as well as in the 2012 fiscal year. Your management also delivered $0.47 per share growth in net asset value per share over the course of the last year. Net investment income for 2012 was $187 million, up 98% from the prior year. On a per share basis, net investment income for the year was $1.63, up 48% from 2011. Net investment income for the quarter was $64 million, up 113% from the prior year. On a per share basis, net investment income for the quarter was $0.51, up 66% from the prior year. Your management delivered strong net investment income growth while keeping leverage low. Net of cash and equivalents, our debt to equity ratio was less than 36% in June. We have substantial unused debt capacity and liquidity to drive future earnings. We estimate our net investment income per share in the current September quarter will be $0.41 to $0.46. We just announced more shareholder distributions through October which will be Prospect’s 51st shareholder distribution and 28th consecutive per share monthly increase. Our net investment income has exceeded distributions, demonstrating substantial distribution coverage for the current tax year, the prior fiscal year, the last three quarters and the cumulative history of the company. That excess coverage is more than $50 million in the current tax year, demonstrating our conservative approach to distribution payouts and coverages. Prospect has now paid out more than $10 per share and more than $500 million in distributions since 2004. I will now turn the call over to Grier.

Thanks, John. Our business continues to grow at a prudent pace. As of today we’ve now reached more than $3 billion of assets and undrawn credit. Our team has increased to nearly 60 professionals, representing one of the largest dedicated middle-market credit groups in the industry. With our scale, longevity, experience and deep bench we continue to focus on a diversified investment strategy that includes third-party, private equity sponsor related lending, direct non-sponsor lending, Prospect-sponsored transactions, and structured credit. Our team typically originates thousands of opportunities per annum and invests in a disciplined manner in a single digit percentage of such opportunities. Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans. Our approach is one that generates attractive risk-adjusted yields and in our debt investments we’re generating an annualized yield of 13.6% as of June 30. We also hold equity positions and many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions. Originations in 2012 fiscal year were $1.12 billion, up 17% from the prior fiscal year. We also experienced $501 million of repayments as a nice validation of our capital preservation objective. As of June we are up to 82 portfolio companies, a 14% increase from the prior year and demonstrating both an increase in diversity as well as a migration towards both larger positions and larger portfolio companies. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. The June quarter was particularly active, with $573 million of originations and $146 million of repayments. Exits for SonicWall, Copernicus, C&J and Sports Helmets generated realized IRRs of 16%, 35%, 36%, and 41% respectively. We closed the First Tower acquisition in the June quarter and we are expecting to receive annualized yields in excess of 18% from this investment. ESHI paid us $33 million in dividends in the June quarter and was a significant income contributor. We don’t know precisely what dividends ESHI will pay us in the future but we hope to see solid dividends in the next two quarters. The current September quarter is off to a strong start with $400 million or originations and $45 million of repayments. Pinnacle and US Healthworks exited with realized IRRs of 15% each. Our credit quality continues to be robust. None of our loans originated in nearly five years has gone on nonaccrual status. Nonaccruals as a percentage of total assets stood at 1.9% in June, down from 3.5% the prior year. Our advanced investment pipeline aggregates more than $600 million of potential opportunities boding well for the coming months. Thank you. I’ll now turn the call over to Brian.

Thanks, Grier. As John discussed we’ve grown our business with low leverage. Net of cash and equivalents our debt to equity ratio stood at less than 36% in June. We believe our low leverage and diversified access to funding demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. We’re a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, conduct an ATM program, develop a retail notes program and acquire a competitor, as we did with Patriot Capital. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry that we have taken toward construction of the writing end of our balance sheet. As of June, we held approximately $1.5 billion of our nearly $2.3 billion in total assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding which has an AA-rated $507.5 million revolver with 15 banks and with a $650 million total size accordion feature at our option. The revolver is priced at LIBOR plus 275 basis points and revolves for three years followed by two years of amortization with interest distributions allowed. We started the June quarter with a $410 million revolver in ten banks so we’ve seen significant lender interest as we’ve grown the revolver. Outside of our revolver and benefitting from our unencumbered assets, we’ve issued at Prospect Capital Corporation multiple types of BBB-rated unsecured debt including convertible bonds, a baby bond, and retail notes programs. All of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver. We’ve now tapped the five-year, seven-year, ten-year and greater unsecured term debt market to extend our liability duration. We have no debt maturities until December, 2015, with debt maturities extending through 2022. With so many banks and debt investors across so many debt tranches we substantially reduced our counterparty risks over the years. As of today, we have issued four tranches of convertible bonds with staggered maturities that aggregate $647.5 million, have interest rates ranging from 5.375% to 6.25%, and have conversion prices ranging from $11.35 to $12.76 per share. We have issued a $100 million 6.95% baby bond due in 2022 and traded on the New York Stock Exchange with the ticker PRY. We have issued $59.1 million of retail notes with staggering maturities and a weighted average interest rate of 6.4%. From March 31 to today, in addition to our revolver expansion, retail notes program issuance and two convertible bond issuances – one in April and one recently in August – we have issued equity twice, both times at a premium to net asset value. In an ATM program in June and July we raised $59.2 million and in an underwritten offering in July we raised $269.3 million. We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver and that we are in compliance with all revolver terms, and taking into account our cash balances on hand we have over $600 million of new investment capacity. Now we’ll open up the call for questions.

Thank you. We will now begin the question-and-answer session. (Operator instructions.) And the first question comes from Arren Cyganovich with Evercore. Arren Cyganovich – Evercore Partners: Thanks. The thing that I guess is getting a little bit more difficult to model is the dividend income from Energy Solutions, and I guess the benefits that you’re continuing to have from the sale of Gas Solutions. I was wondering if you could talk a little bit about, I would assume that some of that is in your next quarter’s guidance of $0.41 to $0.46. Can you put any parameters about how much of the carryover – I know you had earn-outs of $28 million, how much of that has been already in that and how much of the remaining benefit is there from the sale of Gas Solutions that you said I guess is going to come over through the next couple of quarters?

Grier, can you ask the person to repeat the question, please? I lost my connection briefly. Arren Cyganovich – Evercore Partners: Sure, I was asking about the potential of the Gas Solutions dividend income that’s been high relative to the $33 million I guess from Energy Solutions overall this quarter. How much of that was from Gas Solutions and how much of that is remaining and how much should we expect over the next two quarters?

Okay, good. Before we do that question, this is John Barry back on the call – I did lose my connection. But as a substantial shareholder I have an important question for the team. One thing the team left out is that the total return in the last year is 29%. But with that said, this call to date seems quite retro to me. What is the team going to do for me as a substantial shareholder in the upcoming year, Grier?

Well, predictions about the future are just that but we think we’ve got a good pipeline and an attractive liquidity profile. Maybe we should migrate to answering the question. So the question was about Energy Solutions Holdings. There’s a $28 million earn out and that’s a longer-dated earn out, and we wouldn’t necessarily expect to receive any proceeds from that this year. It’s related to what a future realization looks like to the purchaser, which is done by a private equity-related institution. We did have I believe it was $10 million of escrowed funds and that is due to be released in two stages. We’ve got $5 million of that in July and the second and final tranche will be released in early January I believe. Related to the question about what future distribution dividends might look like, yes, some of that is included in our guidance for the September quarter. Our hope and expectation is that we will continue to reap substantial dividends as I said in my prepared remarks. We don’t know precisely how much but we expect at least for the next two quarters to have substantial dividends and then we’ll see about 2013. Energy Solutions today is a business focused on energy and energy-related services including the offshore supply vessel industry with an operating business called Freedom Marine Holdings where we continue to make additional investments to grow that business. So we’re looking to add on acquisitions, we’re looking at organic growth opportunities. And it’s difficult to predict especially where 2013 will play out but we expect 2012 to still have substantial distributions. Arren Cyganovich – Evercore Partners: Thanks, that’s helpful but maybe if you could maybe take a step back and let me understand the dividend contribution from the sold portion of I guess the midstream business, or is it that their remaining businesses I imagine can’t provide that level of dividend, $33 million that are part of Energy Solutions. I just want to get an idea of what is more kind of recurring and nonrecurring in that business.

Sure. Well we reaped a substantial gain on sale. The purchaser is a typical, and we talked a little bit about this last quarter – as is typical with especially energy-related transactions there’s a lot of partnership asset-related M&A that occurs especially in the MLP space and this is an MLP-able asset, it’s a midstream asset. So the buyers tend to want assets and not c-corps. So as a result we had a substantial gain on sale at the corp. level and as we bring back cash to Prospect Capital Corporation we reap significant dividends out of earnings and profits. We had somewhere around, what Brian - $160 million of cash a few months ago at ESHI? Today, post the distribution we made in June that’s down to more like a $125 million-ish level. And so that gives you a sense of how much cash we have that could be distributed. I suspect we wouldn’t distribute all of that by the end of 2012, and it really does depend upon what opportunities we see out of the business. Arren Cyganovich – Evercore Partners: Okay, that’s helpful. And then I guess following up on the First Tower acquisition, it’s relatively large relative to your portfolio, I think about 14% of the fair value of the portfolio. And so maybe if you could just talk about your comfort in that business and having such a large proportion of your portfolio in one company. And then the other question would be I guess on the solicited - debt facility, and it’s at L plus 18.5% which seems very high; so if you can just talk about the pricing on that yield of that investment.

Sure. So we’re very excited about the Tower acquisition. This is a transaction that we worked on for almost a year from inception to finality, building upon a multiyear experience in the consumer installment lending business, having previously been a lender to a company called Regional Management that actually went public in the spring time, around the time we announced the Tower acquisition actually. So we have many years of experience in this industry and built upon that for this deal. From a diversification standpoint, as we pro forma for recent issuance and deploying capital I think you see Tower decline to sub 10% of our asset mix. But it’s a highly, highly diversified business – diversified across multiple states, literally hundreds of thousands of loans and in itself running at a fairly low level of leverage for the multi-bank, multiyear facility. This is also a business that performed quite well during the last recession with very little of a downdraft that you might see in say industrial businesses that occurred in the last recession. You asked about pricing of our hold co debt and it seems like a higher rate. We’ve been able to achieve pretty attractive prices on debt instruments. We closed another deal in the space on a non-control sense called SMC and have an attractive rate as well. So we think it’s attractive not just on a return basis but on a risk-adjusted basis. Is there anything, John, you would add to that?

Thank you, Grier. Two things for me, if you remove the regulatory risk and you look at this company over the past decade and even decades, you observe a company that seems to be somewhat insulated from the economic cycle which maybe is counterintuitive but we can go into why at length, maybe at another time. What you see in economic downturns is a small, a modest uptick in non-payments and associated defaults but not anything significant that impairs the value of the investment. So the primary risk is regulatory, and people fear that there will be some regulatory interference which never seems to come because in the states where these types of businesses operate they are contributors to the community. And as a result, each time there’s a head of steam from some regulatory direction to try to restrict what these businesses do the steam peters out before anything happens. A third point is on the regulatory front, the business that we own is, as Grier says, there’s many fish between us and the shark swimming out there. Were regulators to interfere they would first interfere with so-called payday lending where people hand a blank check to the lender and the lender cashes the check the day the money is deposited from payroll into the person’s account; and similar, very expensive forms of what I would call super-subprime personal lending. Our loans are generally in the thousands of dollars and they’re made to more substantial credits, and as a result we have a much lower default rate and we are farther from the center of attention for regulators. So for those reasons we believe that this, in addition to the main point that Grier mentioned – that there are so many thousands of loans there – that we are buying a diversified portfolio in effect with very minimal, single variable risk. Arren Cyganovich – Evercore Partners: Thanks for the color, I appreciate it.

The next question we have comes from Mickey Schleien of Ladenburg. Mickey Schleien – Ladenburg Thalmann & Co.: Yes, good morning and thank you for taking my call. Just briefly on First Tower, you closed in the middle of June. Did you accrue any investment income in the quarter you just reported for First Tower?

Grier?

We did. We closed June 15th so about two weeks’ worth. Mickey Schleien – Ladenburg Thalmann & Co.: Okay. I wanted to talk a little bit about spillover income. I calculate about $0.43 of spillover income available for potential dividends. Any thoughts on whether you’re going to - are you more interested in retaining that for funding your business or perhaps declaring a special dividend to avoid the excise tax?

Sure, I’ll start with this one. So we view the excise tax as relatively cheap financing. It’s a 4% excise tax on undistributed capital that relates to not hitting a 98% distribution in a particular year. The more important payout requirement is the 90% related to preservation of RIC status which of courses is very important, and our intention is to continue being a non-tax paying RIC from that standpoint. And as you mentioned, spillover is something we can utilize where we can count distributions over the next several quarters towards the prior tax year distribution requirement. We’re actually in an August tax year, a slight offset from our fiscal, and which ends in about a week; and we would have to distribute I think it’s by May, somewhere in that timeframe, Brian – in order to meet our distribution requirement for the August tax year. So we have plenty of time to meet that requirement. We’re being very, very careful to make sure investors are seeing the dividend as a rock solid proposition. We’re not making guarantees about the future but by keeping our dividend adjustments in I think the modest increase category we think we’re enhancing our ability to do that for the long term. And I think in our industry we probably have the highest coverage by a country mile with any of our peers in the last twelve months of net investment income versus distribution payout. Mickey Schleien – Ladenburg Thalmann & Co.: Okay, fair enough. I just wanted to also understand the nature of the “other income” that you reported in F4Q.

I’m going to ask Brian to handle that one. Brian?

Yeah, it’s going to be substantially structuring fees and other fees that we charged on new loan origination. Mickey Schleien – Ladenburg Thalmann & Co.: Okay. And you reversed accruals for legal fees in the quarter. Can you explain that, please?

We actually didn’t reverse. We actually got reimbursements for some of our legal fees from our insurance carrier, and we applied the proceeds from that to reduce our legal fees. Mickey Schleien – Ladenburg Thalmann & Co.: Okay. And lastly, could you update us on the status of H&M and New Meat Company?

I’ll push that back to Grier.

Sure. H&M, what we’ve done there is we struck a deal with the current owner for that current owner to inject more capital into the business junior to our secured position to drill more wells. If you’ll recall this is a crude oil producer in West Texas, still an attractive economic proposition given where crude oil prices given the nature of how drilling has unfolded in the Permian Basin to drill wells. And a lot of the drilling in our country in the last year has been focused on liquids rich gases and liquids, crude oil itself. So that’s happening in real time and a number of wells are going to be drilled in the upcoming weeks and our hope is that continues to enhance value towards a future exit. John, is there anything you would add to that?

Yes, we’re really very happy that when we moved to foreclose, that the equity owner felt that taking the company to bankruptcy was a method of avoiding any obligations because what the equity owner discovered was that the property belonged to us unless he started writing checks, something he hadn’t done in years and years. So he’s now writing checks for millions of dollars; otherwise the asset goes to us. And we’re happy to see the drilling has revived and the asset values are being protected and enhanced. And for me, speaking to Chip Greenblatt who I’m sure is on the line, Scattered Corporation – look him up – I’m glad to see you’re finally writing checks, Chip. Mickey Schleien – Ladenburg Thalmann & Co.: And New Meatco?

John, do you want to take the one on Meatco?

Grier, why don’t you address that?

Sure. Meatco is a meat distribution business based on the West Coast that over the last six to twelve months has been in the course of transitioning to a much larger distribution facility; and they just now in real time have been expanding and opening up their new facility. Our hope and expectation along with the sponsor owner is that that should cause a meaningful uptick in profitability. We’ve been careful on the valuation there. As you’ve seen, there was a bad debt write off associated with one of their customers which we hope and think was a one-time event late last year. And so getting past that, as that rolls off of TTM profitability and having the new facility open up, we’re seeing liquidity improve with the company, we’re seeing profitability improve and our hope and expectation is that the company will continue to grow its profits in the coming quarters. Mickey Schleien – Ladenburg Thalmann & Co.: Thank you for your time this morning.

And next we have Robert Dodd of Raymond James. Please go ahead. Robert Dodd – Raymond James: Hi guys, a few questions; if I can go back to Energy Solutions real quick, the fair value at the end of last quarter was $166 million, now it’s gone to $126 million, down about $39 million. Obviously $33 million of that is the dividend. Can you give us some color on what the other $6 million markdown was? I assume that’s the other assets that are in that portfolio. And then tied to that obviously the common equity, which is by proxy for cash at Energy Solutions went from $122 million to $70 million, $80 million if we include the escrow on payable – that’s down about $40 million and that leaves you about $80 million in cash left to dividend up or buy other assets. You expect substantial dividends in the next couple quarters but how are you going to allocate that between bringing assets in to keep ESHI going long-term as a dividend to you versus up-streaming that dividend or that cash short term to boost NII?

Thanks, Robert. I’ll take the second part of the question and then refer the valuation one to Brian. On the second part of the question, the answer is we don’t know exactly how capital will be allocated between distributions and additional investments within ESHI related to acquisitions and related to organic growth. We do have some investments planned in the Freedom Marine business, the offshore supply vessel business; we acquired a new boat, a new vessel some months ago and we’re looking at updating the technology of some of the existing fleet with more modern, GPS-related technology. Those should not be large investments for the latter. Recall as we take capital up to Prospect Capital Corporation, and we think we’ve been prudent and conservative on our Prospect Capital Corporation dividends, that cash which was sitting in effectively a money market-type account earning very little we can now utilize in a productive capacity at Prospect Capital Corporation where we have a weighted average yield on debt instruments of 13.6% as of June. So let’s not forget that as well. On the valuation side I’ll ask Brian to tackle that. Brian?

Robert, the valuation, there’s several components to it but one of the components is that these escrow receivables and contingent payments need to be valued also. And there were some changes in the assumptions on the collectability of the contingent payment that drove the change in the fair value. Robert Dodd – Raymond James: Okay, got it. I appreciate that. Next one if I can, on First Tower, the comment you made about it shrinking as a percentage of the portfolio from the current size, that to me would tend to imply that you’re not looking to make substantial or at least add-on acquisitions in the installment lending space. Is that right? I mean are you expecting to keep First Tower, grow it modestly but kind of leave it as is, or are add-ons a likely mode to growth now?

Sure. Well I was doing calculations based on the existing business of Tower remaining reasonably stable in size or only growing modestly, and then the rest of the book growing. We do expect to be making organic investments to drive growth in Tower. There’s plans in place to expand to different geographies, which we think is great from a diversification standpoint and consumer demand continues to be robust across their businesses. In terms of add-on acquisitions, I mean we’re always looking at add-on acquisitions across all of our controlled book and we’re looking actively at new deals. As we look at the lifespan of our company and some of the most move-the-needle transactions you can point to, such as Patriot Capital or Gas Solutions or Energy, those were obviously all control in nature; and differentiating I think as Prospect Capital Corp. is as a BDC for shareholders since nearly all of our peers do not do control deals or choose to house those in separate funds that are only available to on a private basis institutional investors. So that’s available to folks here and we’re actively looking at other deals, but diversified by industry – not necessarily limited to specialty finance and consumer installment lending. But we do have a lot of expertise in this industry and we are looking at deals; it’s just hard to predict and model out because as I said earlier in my remarks we close a single digit percent of the deals that we look at. John, is there anything you’d add to that?

Nope, that’s pretty complete. Robert Dodd – Raymond James: If I can keep going then, the next question I’ve got is portfolio allocation. You’ve emphasized you want to move to senior secure and I understand that given the economic environment, etc., but it looks like the fastest growing portion of the portfolio right now is CLOs with the majority of that actually being residual interest. And post the end of the quarter with $400 million in deployment, $60 million of that in the [ING and Halcyon] [ph] CLOs, so I mean that’s continuing to grow modestly, maybe 13% of assets at this point. What’s your target if you have a target allocation for that, and how do you reconcile if I was going to put CLO residual interest on a risk profile it’d pretty much be at the opposite end from senior secured.

Sure. Well actually to correct one thing you said, we’re not really moving toward senior secured. We’ve been senior secured and we’ve had a majority of our assets in senior secured loans for quite some time. On a comparative basis we’ve had the highest mix I think of true first lien senior secured loans of almost all of our even larger peers you might comp ourselves to. By the way, I would point out that I’ve seen in the past some of our peers use the word “senior loan” and then they forget to leave out that if they last out first lien, which is in our definition junior debt or it’s a second lien. So there’s not really an easy way to do apples-to-apples comparisons without clear labeling. We try to be as crystal clear as we can be in our 10-K and break things out actually multiple ways. On your question about CLOs, well actually before answering that I just want to comment having a diversified book is very, very important to us, and we’re up now to 85-ish portfolio companies here today in the last week of August. Maybe we will be above 100 by this time next year, we’ll see; having a significant diversification by industry – we have 30 industries now in the company. So we think that builds a significant risk management for the future. CLOs are a modest percentage of our book at Prospect Capital Corporation and will always be a modest percentage, not just because of the diversification requirement but also because they fall into the so-called 30% basket for BDC so it picks up – and we talked a little bit about this last quarter but I think it’s helpful to understand in terms of natural caps on assets. It picks up on really most financials and which Tower is a part of as well, it picks up offshore entities and CLOs for tax purposes are almost entirely housed in the Caymans in that $300 billion marketplace even though these are US loans as the underlying. And it picks up public companies with a market cap of more than $250 million. That part is very little of our focus as we’re focused on the less efficient part of the marketplace. So that sort of 10% to 15%-ish range of assets is a place that’ll be difficult to go beyond given that 30% basket. But let me comment about risk and risk-adjusted; you used the term “opposite spectrum.” I would not use that language, Robert. We think the “leverage associated with CLOs” is arguably the best leverage you can get. It’s naturally match book funding. It’s multiyear funding. You have no real covenant that a bank can come, bulldoze over you and foreclose on your property-type risk that exists. We have zero defaults in our CLO book which now spans about a dozen or so deals and maybe 1000 loans. There’s extreme diversity across name and industry, and we think it’s very attractive risk adjusted yield. We’ve carved out a market leadership position in that marketplace; we’re very comfortable with that. We continue to see attractive flow from our investment partners, and they’ve continued to be an important part of our business but a minority part of our business as we have lots and lots of horses that pull the dividend wagon for our company. John, is there anything you’d add to that?

Well, Robert, just to link your questions – we obviously appreciate your excellent questions on FT and CLOs. We are bottoms-up investors, so we don’t start at the beginning of the year “Okay, we need to hit this allocation, that allocation, this percentage of our assets – let’s go look for things that will fill those buckets.” We look at everything that comes in and when we think we see an excellent risk/reward we’re going to go for it. That was true with Cash Solutions, which at the time was a significant percentage of our assets; it was true of Patriot, it was true of FT and it’s true with these CLOs. So when people ask “Well, what’s the grand scheme here?” and I have been asked that – “What’s the grand plan, what’s the total strategy?” The total strategy is to keep doing bottoms-up investing with a very sharp eye on risk, and we believe that that’s the reason why I think our IRR in our controlled book is above 60% from 2004 to date. We’ve seen nothing going on nonaccrual in over five years – the item that went on nonaccrual went on nonaccrual for a very specific - we made the investment and it went on nonaccrual years later for specific reasons, which we can go into. When you look at the CLOs for a variety of reasons we think that the market substantially overestimates the risk there. If you look at a portfolio, a risk portfolio like ours which is running at a high IRR – 13% and change current return in this environment, when Treasuries are yielding I don’t know what, 25 basis points – you have to ask yourself “How are these people doing this with no nonaccruals in five years?” We’re doing it by focusing very carefully on risk, and I submit that the number one risk in our business is single point of failure risk. So when you invest in one single company, what if they lose a contract? What if there’s a regulatory issue? What if a gigantic competitor decides to devote huge resources to taking market share? What if a unique CEO dies? So those are single point of failure risks that we have every time that we make an individual loan. We don’t have those in the CLO book. The main risk in the CLO book is the macro risk of a significant economic downturn. Now you might say yeah, well that’s what you were thinking about. Our CLO investments are structured so that the marked to market that occurs will not be a problem for us because none of ours are marked to market investments in the CLO book. Number two, we are investing only with managers on a fund to fund basis where we have various control or call rights and only with people that we have determined to be the best of the best by analyzing their track record, by analyzing their performance, by analyzing their systems – by analyzing the capacity of the teams that are there overseen by us. And in every case, I think the lowest IRR of any of our managers going through the credit crisis of ’07 and ’08 was I think 9.4%, meaning that when it was really ugly out there these managers managed right through it and made money for the equity with no defaults, as Grier said, no defaults in any of our sales book, and when you look at that you ask yourself, well why has this type of investment frightened so many people? Well, because there were other people that did not structure their deals so carefully. The result of their lack of care was that there were problems. I don’t know that there were any defaults or loss of capital with those marked to market – I just don’t have the data because we don’t invest in those – but the result of the mistakes that people made doing marked to market CLOs is that many people won’t look at them. Many people have this visceral view “CLO, whoa – alphabet soup, I’m not going near that,” and that’s great for us because the result is the entire market appears to be mispriced. I don’t know how long that will continue, and we are able to invest on a very risk-controlled basis; and our results to date have been above our base case. So the concern is some significant economic downturn, but we saw the same structures, the same managers, the same types of portfolios in ’07 and ’08 perform just fine. So that’s why we believe that we have identified and structured a way much, not all – you can’t structure it all the way – but much of the risk in no CLOs. Robert Dodd – Raymond James: Okay, I appreciate that, it’s very helpful. If I have one more, not on CLOs but just one last question, an easy one – if we take out the structuring fees from First Tower from other income it was about $5 million left over; $5 million on some $520 million in gross originations. Is that indicative that currently the origination income you’re generating is about 100 bps on originations?

Brian, do you want to take that? Grier?

Sure, that’s pretty accurate. It ranges between zero and 200 basis points, so yeah, I think that’s a pretty good estimate.

Just to add, in some cases, Robert, if we have a refinancing situation or a change of control situation where we’re in a credit and a new buyer for the equity is coming in, you have a built-in advantage as an incumbent having superior credit knowledge, having lived with the credit for a while, and we may offer more modest – 100 basis points in that situation. More typically on a new credit we’d be higher than that, more closer to 200 basis points; a little below that on some of our first lien stuff and a little bit above that typically on some of our junior debt. Robert Dodd – Raymond James: Okay, appreciate it. Thanks, guys.

Next we have a question from Greg Mason of Stifel Nicolaus. Greg Mason – Stifel Nicolaus: Great, thank you. A quick follow-up on Rob’s question on the CLOs, as we think about modeling purposes, what are you generating in terms of returns on your CLO equity income?

Grier?

Thanks for your question, Greg. I think we’re north of 18% right now, in the low-20%s in some of our deals. But that’s probably a good number to utilize for modeling purposes. Would you add anything to that, Brian?

Yeah, I’d say 18% to 22%. Greg Mason – Stifel Nicolaus: Okay, great. And then my next question is actually kind of a follow-up on John’s first question about shareholder returns. Is there a point where the growth in the equity base has diminishing returns for shareholders where you get to you’re too big and you’re competing in a much more competitive environment in the larger scale? Can you talk about your views on growth and returns for shareholders?

Greg, I would like to respond and Grier will have a lot to add I’m sure. That is a challenge, there’s no doubt about it. As you grow your ability at least theoretically your ability to put money to work at high returns diminishes. If you’re running a hedge fund and you go from small cap stocks to large caps and you enter more and more efficient markets, you have more difficulty – no doubt about it. Is that true here? Well, as a theoretical matter it is. How about as a practical matter? Well, as a practical matter having a very small asset base, which we had when we took the company public – we had $97.5 million to invest – what you find is that your ability to drive deals, your ability to get the terms you want, your ability to be flexible, your ability to do larger deals, your ability to move quickly, how attractive you are to sponsors, how attractive you are to sellers of business, being small is not helpful in any of those and many other categories. How about your ability to attract what we feel are the best people in the business doing this? Not that many people want to go work at a $97.5 million asset base company. So I would submit to you that as we have grown, our ability to earn better returns has increased. It is true that the average yield on the portfolio has dropped as we’ve grown, but of course it was very high. For years I think it was above 17% for a year or two, and then I think it dropped into the 16%’s and into the 15%’s. We were fortunate in making some very good investments with our small, little, tiny pile of cash for ’05 and ’06 when it was more what I would call venture/lending. And so we were able to earn high returns. Whether we can do that again or not I don’t know. I feel that our ability to earn high returns now with a substantial asset base is much better assured because we have reversed all the factors that I mentioned, including most importantly the desirability of working at Prospect. And I mean I’m sure you can well appreciate that if you’re a person with a long track record in sponsored finance you find coming to work at Prospect an attractive possibility that you might not have seen years ago. And if you look at our website and see the people that have recently joined – I’m not going to embarrass them by naming them – you will see their résumés and you will realize that attracting people of that extreme high caliber, really the best in the business was not so easy for us even eight years ago. So that’s the biggest thing for me, is the extreme high caliber and quality of the people that we have here because that’s the whole business, right? You take that out of the equation you don’t have any business. The second thing that I’d mention to you is that we find that with the capital base that we have now, I guess what I would say is we are able to do significant controlled transactions on terms that may not be a 60% IRR in every case, which is what I believe our cumulative IRR is above that, but where in each case we are able to earn a return above – not in every single case, but so far in every single case I think a return above what we can earn on our debt portfolio. The ability to put money to work in controlled transactions is much - let’s put it this way, our market share in that segment is significantly less than our market share in the debt and the sponsored finance and in the direct lending segment. So yes, if we were to continue to grow at 100% per year for the next five years we would start to wonder how big is the sponsored finance segment? And do we have to go into larger and larger deals, even into high-yield which we do some of them right now and earn lower returns? Well, there’s an aspect of that happening but there’s also an aspect of that being offset by our ability to do these significant controlled transactions where for example, we see companies that are presented to us, good companies – one we’re looking at now 5x recurring cash flow. Well, that’s a 20% current return, and if we buy at a point in the cycle where values are lower and we exit at a point in the cycle when values are higher, which we’ve fortunately been able to do in the past, then we should do better than 20%. So I look at our portfolio return of, I think it’s 13.8%. You would think all of the things being equal over long periods of time that would tend to decline and that would be my expectation, but we believe we are doing things to slow that decline and maybe even reverse it. Grier?

Thanks, John. Greg, putting aside the step down we think in risk of our business over the years, which is a substantial step down as we’ve increased the name count, the industry count – we have probably more diversified access to funding than just about any of our peers at this point, a lot of it unsecured funding. Your question was one of reward, and so a few things to build on what John was saying, first, because of our scale we have the ability to not just participate but lead and take down entire amounts of larger transactions, capturing fees along the way and the ongoing benefits of being in that sort of control-the-tranche seat. That’s a great driver of our business, and we saw that just in the last few weeks as we put $400 million on the books – we talked about the CLO portion which was a small piece of that; we didn’t talk about the other $340 million of originations that were available to us in significant part through our scale. We closed an $85 million deal, swallowed that all around; we closed a $110 million deal. And most of our peers are very small and do not have the ability to hold their sizes in one place. The other aspect, too, is – and I know, Greg, you’ve focused on and written about the theme of as BDCs get larger, is it better to be small than large. We like both. I mean we have not stopped working on $5 million to $15 million EBITDA-sized companies – we’re sort of hard pressed to go below that but that size is still very much in our strike zone as is $15 million to $50 million EBITDA companies. And we might have had a migration towards somewhat larger sizes of portfolio companies but that doesn’t mean we aren’t working on smaller deals, less-efficient markets, particularly on a controlled side of things. As John mentioned we’ve got some deals in the shop right now and at some pretty attractive multiples. So it’s not just a question of scale but what do you do with it, and what we’ve done is we’ve hired a lot of people. And we continue to hire a lot of people and talented people at that, as John was saying, and we’re not ten people sitting here picking off loans from a desk at price takers at ever reducing yields. I don’t think that’s a very good business for the long term. You may do a little bit of that as a portion of your book but be selective about it. We are the agent and/or anchor lender and/or controlling shareholder in the vast, vast bulk of our deals – probably 80% at least. So that’s very differentiating, and I know there’s a watch out, Greg, you’ve written about, associated with BDCs that do more of the pick loans off a syndicated desk routine and that’s 100% of their business. That’s not our business and that’s not going to be our business. Greg Mason – Stifel Nicolaus: Great, I appreciate the thoughts, guys.

Next we have a question from John Ellis, investor. John Ellis – Private Investor : Hello. John, if I may, I’m glad we’re on the same side of the table, finally – I’ve been wondering.

Well John, when I asked the question we’ve heard all these things that the company’s done in the last year – ho hum, ho hum. John Ellis – Private Investor : Exactly – it all sounds great but what’s in it for us?

“What are you going to do for me tomorrow?” right, John? John Ellis – Private Investor : I have a table of your dividend payments in front of me; there hasn’t been anything meaningful since really ’09. I mean you cut the dividend in summer of 2010; there’s been nothing meaningful since then. What are you going to do? What’s the company going to do for us? I hear all these statements about more NII, when I hear like you may pay the taxes on some of them and put them back in investments that chills my blood.

Okay, well John, I was thinking of you when I said “Okay, we heard all the great things that have happened in the last year – ho hum, what are you guys going to do for me tomorrow?” John Ellis – Private Investor : Remember, I supported you when you were criticized for paying high fees. I’m all for that – I think management should also get paid.

Well I appreciate that but I also remember on this call last year a very long discussion about why we were over-distributing, which I dissented from even the perception of that. John Ellis – Private Investor : I did, too – I was never a part of that. I didn’t agree with that. I’m a shareholder.

I know, I appreciate that. So let me try to address. Obviously we would like to increase the dividend. What we are doing right now, John, is we are increasing it by very tiny amounts every single- I know, you can’t buy that big house down in Palm Beach you want with those increases just yet. John Ellis – Private Investor : I can hardly buy dinner.

Okay, John. Well so John, what we’re doing is we want to be sure that - Grier will often say to me “John, I view the dividend as not so different from a liability, like an obligation to pay interest on a loan”; and we do not want to have to reduce the dividend. If you remember, in the “economic crisis,” the Great Recession whatever you want to call it – it was a downturn and it was really a financial downturn in ’07 and ’08. We wanted to be able to take advantage of opportunities in the marketplace and needed to be sure that we had the cash to do that, and also had the cash to repay our bank facility in full at any second because everybody was panicking in those days and the person without cash ends up disappearing from the field – which is what happened to Patriot. As a result we issued shares – it was not a great price to be issuing shares. It was dilutive to the NAV and it was dilutive to the dividend, and ultimately we thought we could catch up by making the good acquisitions. And finally we just said you know what, we can’t seem to catch up so we’re going to cut the dividend. We did; it was very painful for us as a management team to admit defeat there. It was really a tactical setback because frankly, buying Patriot, being able to pay our bank loan facility off at any single time – the latter was a risk control and the former was a great addition to the earnings capacity of the company. John Ellis – Private Investor : And I didn’t complain about it, either.

Oh, I know that, and so now here we are with our NAV back up substantially, with the stock price back up substantially – now looking at the dividend we are substantially under-distributing, but before we raise the dividend again we feel that we want to see more visibility with respect to 2014, ’15, and ’16. And we have things in the works with respect to those years, but we don’t yet have the comfort level we feel we would like to have to know that if and when we were to increase the dividend that we can sustain it all the way out through the end of 2016 and beyond. But let me tell you, John – everybody at Prospect, are hearing your comments here and being thankful for your support of management, is quite determined to find ways to increase the dividend and increase overall shareholder return. John Ellis – Private Investor : Should I feel special then?

You should feel special, as every shareholder should. John Ellis – Private Investor : Then pay me a special dividend.

Trust me – we will look at that. But bear in mind something… John Ellis – Private Investor : When I hear these dates, 2016, ’17 – it doesn’t give me a lot of confidence. Remember, I need my (inaudible).

Well, and you want the stock price to stay high too, I believe. John Ellis – Private Investor : I’m far less interested in that. But if you pay a higher dividend the stock price will follow, I guarantee it.

That’s true. But John, also bear in mind that between now and the end of the year we are expecting possibly a cornucopia of investment opportunities depending on taxes and whether people feel they need to get out of Dodge before tax rates go up hugely. And if that’s the case we may see lots of companies in filings bargain basement and being an excellent opportunity for us. So we don’t want to be sitting here unable to take advantage of that opportunity. But we are mindful of your focus on the dividend. You’re not the only person; I am, too. Grier?

I’m all set.

We have a question from [Steve Koloff] [ph], investor. Steve Koloff – Private Investor: Yes, hello. First of all, congratulations on the quarter. I met the management team back in December – it was my first annual meeting I ever attended and I got a very good presentation and I got a good feel of you guys. And I have a couple of questions. One of them was already asked by Mr. John Ellis; I just want to just reiterate that I feel the same way, that there’s a lot of great things being done with the company and being said with the company but at the end of the day, as an individual shareholder, the only way that I can tangibly receive those benefits is either with an increase in share price and/or a dividend increase. And as Mr. Barry had said, the dividend increases have been kind of incremental. So I would hope that the management team is constantly talking about perhaps at the very least some form of special dividend that would kind of keep us going and hold us off until 2016 or 2017 – this way you’re not committed and an investor isn’t necessarily spoiled so to speak in thinking they’re going to get a dividend increase substantially every month. But perhaps if we thought that at the end of the year there might be some type of bonus, if you will, that I know would alleviate my hesitation with regard to what’s going on with the company. But that’s the first thing I wanted to say. Second to that was getting back to the First Tower acquisition I wanted to know if, you said originally that your interest in the First Tower acquisition was that you had invested in another similar company that you had a very good experience with that subsequent to that had gone public. So my question is first of all how is that First Tower acquisition doing, how is the business? And then second to that, are you possibly contemplating down the road possibly spinning off First Tower if it continues to do well into its own separate IPO and a separate company from Prospect?

Okay, Grier, why don’t I take this? I appreciate your question and I did enjoy seeing you at the shareholder meeting. Number one, First Tower is doing at least as well as we expected. So it’s just been fine. We have a great manager there – Frank Lee. No company’s perfect every single second but I can’t think of anything there that’s been a disappointment to date. So we’re very happy with that acquisition, that’s number one. Number two, when it comes to spinning things off, separate IPOs – we do look at that. We do consider those options, structural possibilities. There are a number that we thought of not just relating to First Tower and we continue to refine our thoughts. Nothing is imminent. That is possible. The default always is, it’s like when you own a great piece of real estate – I don’t know how many people you know that bought a four-unit rental, four rental units in Dorchester, in Boston or someplace like that and they paid $100,000 for it twenty years ago and now it’s generating $100,000 per year. So that can happen with FT and if that’s the case that won’t be the worst thing. Now we have shown that when things tick up, when there’s a bubble, when everybody wants to buy Energy or everybody wants to buy Gas Solutions, we’re here to sell it – “Here you go. If you really want it that badly you can have it.” But our default generally is to keep these yield assets, because what they do is they generate a big yield that goes directly to the shareholder without intervening taxation. And if you invest in most other companies, the vast book of other companies that you can invest in that are publicly traded, before you get a dividend the company has already paid 36% of its income in taxes. So then you pay. Let’s say you’re in the 30% tax bracket, or let’s say you’re at the top margin already – in New York it’s 45%. So actually a dividend has been taxed at that point, what is it 45% plus 36%, I can’t even count… 81%? So that’s why there is an important benefit for us holding onto these assets as a default, and when it gets even better than that we’re happy to sell. Grier?

Sure. We reap, Steve, significant benefits in holding Tower as a partnership. It’s not a c-corp and so it’s very tax efficient to hold this partnership and then to have Prospect Capital Corporation as a registered investment company on top. So virtually no taxes downstairs, no taxes upstairs, and Prospect shareholders benefit. Were we to spin off Tower and take it public unless the tax rules were to change, which is not foreseen in this particular area, most likely you’d have to convert it into a c-corp, which is in fact what regional management is in companies like World Acceptance that are already public. Those companies have done very well over the years but there’s just one problem – they pay a ton in taxes, and it’s very hard to shield that. So there’s a few ideas we might have pertaining to a partnership and… Steve Koloff – Private Investor: Well, as an investor I’m not necessarily - I was thinking about that as a possibility, but the end result as an investor with Prospect and its relation to First Tower is the same, well, how is Prospect Capital going to monetize this ultimately for the individual investor? When I heard about this acquisition I was like “Wow, this looks like it’s going to make some serious yield,” as Mr. Barry said. I bet you we’re going to hopefully see some serious increase in either our dividend payment or a special dividend, something somewhere down the road with full understanding that which I highly respect from the management team that you’re constantly looking at risk before you’re looking at reward. And I really think that I believe that’s the way I run my practice and that’s really the way you have to go, because if you take care of the risk usually the reward will take care of itself down the road. But I think that as investors, we’ve been relatively patient. To make a press release that says that Prospect Capital has given out $10.40 in dividends since 2004 is great but how many of us, I know I’m not – how many of us have been investors with Prospect since 2004? It’s like Mr. Barry said – what have you done for me lately? I haven’t been an investor for just a month but I have been an investor since 2008, 2009, and as a result I would like to now hopefully receive a little bit more remuneration than I’ve been receiving with respect to either monthly dividend increases or a special dividend – something down the road where sooner rather than later I can really feel a little bit better about the company.

Well Steve, your points are being listened to carefully by this management team and the points made by the prior caller. I just want to set things into context. We’ve owned the Tower investment for barely 60 days. Give it some time to make sure that things do well and we can make our upstairs distributions, and then we’ll see in the future about what we’re thinking about as a Board for dividends. Steve Koloff – Private Investor: Right. And I just want to say, one thing before I go is that I don’t want to portray my call as being disgusted. On the contrary, I’m extremely happy with the company. I trust the management inherently. I can see that you’re definitely steering this company towards the long-term. I’m 50, I’ve got two kids – one in college, one on the way – and I’m in this for the long term myself. So I just want to leave the phone call with you guys knowing that all in all I’m extremely happy with the management team and with the company; I just would like to see a little bit more remuneration sooner rather than later.

Good, well we certainly got the message. Thanks. Steve Koloff – Private Investor: Thanks, and have a good day, and you guys have a good lunch, okay? Take care, bye-bye.

Next we have Lynn Cook, investor. Lynn Cook – Private Investor : Good morning. I’ve been listening to everything with a great deal of interest. My question regards all the variety of ways that you’ve been raising funds over this last year. I’m wondering if you can explain a little the difference between convertible bonds, retail notes and baby bonds.

Okay, Ms. Cook, this is John speaking. This would maybe require an all-day or all-week seminar. I can give you the very quick answer and I’m asking Brian to send you some information; if you call Brian he can give it to you. Ms. Cook, actually if you were to look in the 10-K it actually does explain everything but let me do a very quick explanation for you. Lynn Cook – Private Investor : Okay, let’s make it even briefer, the convertible bonds, can individuals buy those?

Here’s the answer. You need to speak to your broker, and you need to ask your broker who will explain these various securities. Do you have a broker? Lynn Cook – Private Investor : Yes, okay.

Actually John, let me add to that. The convertible bonds, when issued are issued under Rule 144 that only institutional investors with $100 million of assets can purchase. But after I believe one year they become free to purchase by any investor, including an individual. So in that case yes, you should talk to your broker and see about those. I would say that I’m not sure what the liquidity looks like for those types of vehicles and an individual investor might be better served to look at something like our retail notes program or our baby bond which trades like a stock as ticker PRY on the New York Stock Exchange. Lynn Cook – Private Investor : Yes, I’ve looked at that one.

But the main thing is your broker has an obligation to study these things, and he also has an obligation to provide suitable investments, right? He’s familiar with your financial situation and what’s suitable and what’s not, so I would start there and let’s see how that goes. If for some reason your broker is not giving you information that creates confidence for you, you can call Brian. He’s on our website and you can get his number there. Lynn Cook – Private Investor : Okay, thank you very much.

Well, it appears that we have no further questions at this time. We’ll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. John Barry for any closing remarks. Sir?

Okay, well I want to thank everybody and now we’re going to start working on what we’re going to try to do for our shareholders tomorrow and in the days and weeks and months and years ahead. Thank you all. Bye.

Thank you, Sir, and thank you to the rest of management for your time. The conference call is now concluded. We thank you all for attending today’s presentation. At this time you may disconnect.