10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 31, 2009
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 814-00659
PROSPECT CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
     
     
Maryland
(State or other jurisdiction of incorporation or organization)
  43-2048643
(I.R.S. Employer Identification No.)
     
10 East 40th Street    
44th Floor    
New York, New York   10016
(Address of principal executive offices)   (Zip Code)
(212) 448-0702
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of February 9, 2010 was 63,586,731.
 
 

 

 


 

PROSPECT CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 2009
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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Table of Contents

PART I: FINANCIAL INFORMATION
Item 1.  
Financial Statements
PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
December 31, 2009 and June 30, 2009
(in thousands, except share and per share data)
                 
    December 31, 2009     June 30, 2009  
    (Unaudited)     (Audited)  
Assets (Note 10)
               
Investments at fair value (cost of $633,636 and $531,424, respectively, Note 3)
               
Control investments (cost of $165,867 and $187,105, respectively)
  $ 191,898     $ 206,332  
Affiliate investments (cost of $68,052 and $33,544, respectively)
    66,479       32,254  
Non-control/Non-affiliate investments (cost of $399,717 and $310,775, respectively)
    389,758       308,582  
 
           
Total investments at fair value
    648,135       547,168  
 
           
 
               
Investments in money market funds
    23,418       98,735  
Cash
    3,844       9,942  
Receivables for:
               
Interest, net
    5,723       3,562  
Dividends
    2       28  
Other
    359       571  
Prepaid expenses
    175       68  
Due from Prospect Administration (Note 8)
    998        
Deferred financing costs, net
    5,891       6,951  
Other assets
    535        
 
           
Total Assets
  $ 689,080     $ 667,025  
 
           
 
               
Liabilities
               
Credit facility payable (Note 10)
    10,000       124,800  
Dividend payable
    25,894        
Due to Prospect Administration (Note 8)
          842  
Due to Prospect Capital Management (Note 8)
    7,412       5,871  
Accrued expenses
    8,039       2,381  
Other liabilities
    258       535  
 
           
Total Liabilities
    51,603       134,429  
 
           
 
               
Net Assets
  $ 637,477     $ 532,596  
 
           
 
               
Components of Net Assets
               
Common stock, par value $0.001 per share (100,000,000 and 100,000,000 common shares authorized, respectively; 63,349,746 and 42,943,084 issued and outstanding, respectively)
  $ 63     $ 43  
Paid-in capital in excess of par
    741,520       545,707  
Under/(over) distributed net investment income
    (14,326 )     24,152  
Accumulated realized losses on investments
    (104,279 )     (53,050 )
Unrealized appreciation on investments
    14,499       15,744  
 
           
Net Assets
  $ 637,477     $ 532,596  
 
           
 
               
Net Asset Value Per Share
  $ 10.06     $ 12.40  
 
           
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For The Three and Six Months Ended December 31, 2009 and 2008

(in thousands, except share and per share data)
(Unaudited)
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31,     December 31,  
    2009     2008     2009     2008  
 
                               
Investment Income
                               
Interest Income
                               
Control investments (Net of foreign withholding tax of ($52), $62, ($19), and $109, respectively)
  $ 5,052     $ 5,075     $ 9,643     $ 11,797  
Affiliate investments (Net of foreign withholding tax of $0, $0, $0, and $0, respectively)
    1,539       1,075       2,388       1,635  
Non-control/non-affiliate investments
    11,948       11,091       21,343       21,365  
 
                       
Total interest income
    18,539       17,241       33,374       34,797  
 
                       
 
                               
Dividend income
                               
Control investments
    4,160       4,584       10,360       9,168  
Money market funds
    10       81       28       220  
 
                       
Total dividend income
    4,170       4,665       10,388       9,388  
 
                       
 
                               
Other income: (Note 5)
                               
Control/affiliate investments
    75       87       75       831  
Gain on Patriot acquisition (Note 2)
    5,714             5,714        
Non-control/non-affiliate investments
    385       220       849       12,996  
 
                       
Total other income
    6,174       307       6,638       13,827  
 
                       
 
                               
Total Investment Income
    28,883       22,213       50,400       58,012  
 
                       
 
                               
Operating Expenses
                               
Investment advisory fees:
                               
Base management fee (Note 8)
    3,176       2,940       6,385       5,763  
Income incentive fee (Note 8)
    4,231       2,990       7,311       8,865  
 
                       
Total investment advisory fees
    7,407       5,930       13,696       14,628  
 
                               
Interest and credit facility expenses
    1,995       1,965       3,369       3,483  
Sub-administration fees (Including former Chief Financial Officer and Chief Compliance Officer)
          217             467  
Legal fees
    390       184       390       483  
Valuation services
    153       110       273       422  
Audit, compliance and tax related fees
    239       306       501       629  
Allocation of overhead from Prospect Administration (Note 8)
    840       588       1,680       1,176  
Insurance expense
    63       63       126       124  
Directors’ fees
    64       62       128       143  
Other general and administrative expenses
    807       295       994       462  
Tax expense
          533             533  
 
                       
Total Operating Expenses
    11,958       10,253       21,157       22,550  
 
                       
 
                               
Net Investment Income
    16,925       11,960       29,243       35,462  
 
                       
 
                               
Net realized (loss) gain on investments
    (51,229 )     16       (51,229 )     1,661  
Net change in unrealized appreciation/depreciation on investments
    17,451       (5,452 )     (1,245 )     (16,601 )
 
                       
 
                               
Net (Decrease) Increase in Net Assets Resulting from Operations
  $ (16,853 )   $ 6,524     $ (23,231 )   $ 20,522  
 
                       
 
                               
Net (decrease) increase in net assets resulting from operations per share: (Note 7)
  $ (0.29 )   $ 0.22     $ (0.43 )   $ 0.69  
 
                       
Dividends/distributions declared per share:
  $ 0.41     $ 0.40     $ 0.82     $ 0.80  
 
                       
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
For The Six Months Ended December 31, 2009 and 2008
(in thousands, except share data)
(Unaudited)
                 
    For The Six Months Ended  
    December 31,     December 31,  
    2009     2008  
(Decrease) Increase in Net Assets from Operations:
               
Net investment income
  $ 29,243     $ 35,462  
Net realized (loss) gain on investments
    (51,229 )     1,661  
Net change in unrealized depreciation on investments
    (1,245 )     (16,601 )
 
           
Net (Decrease) Increase in Net Assets Resulting from Operations
    (23,231 )     20,522  
 
           
 
               
Dividends/Distributions to Shareholders:
    (67,721 )     (23,848 )
 
           
 
               
Capital Share Transactions:
               
Net proceeds from capital shares sold
    98,833        
Less: Offering costs of public share offerings
    (1,158 )      
Fair value of equity issued in conjunction with Patriot acquisition
    92,800        
Reinvestment of dividends/distributions
    5,358       1,506  
 
           
Net Increase in Net Assets Resulting from Capital Share Transactions
    195,833       1,506  
 
           
 
               
Total Increase in Net Assets:
    104,881       (1,820 )
Net assets at beginning of period
    532,596       429,623  
 
           
Net Assets at End of Period
  $ 637,477     $ 427,803  
 
           
 
               
Capital Share Activity:
               
Shares sold
    11,431,797        
Shares issued for Patriot acquisition
    8,444,068        
Shares issued through reinvestment of dividends/distributions
    530,797       117,549  
 
           
Net increase in capital share activity
    20,406,662       117,549  
Shares outstanding at beginning of period
    42,943,084       29,520,379  
 
           
 
               
Shares Outstanding at End of Period
    63,349,746       29,637,928  
 
           
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Six Months Ended December 31, 2009 and 2008
(in thousands, except share data)
(Unaudited)
                 
    For The Six Months Ended
December 31,
 
    2009     2008  
Cash Flows from Operating Activities:
               
Net (decrease) increase in net assets resulting from operations
  $ (23,231 )   $ 20,522  
Net realized loss (gain) on investments
    51,229       (1,661 )
Net change in unrealized depreciation on investments
    1,245       16,601  
Accretion of original issue discount on investments
    (6,670 )     (2,128 )
Amortization of deferred financing costs
    2,106       360  
Gain on settlement of net profits interest
          (12,576 )
Gain on Patriot acquisition
    (5,714 )      
 
               
Change in operating assets and liabilities:
               
Payments for purchases of investments
    (7,321 )     (70,513 )
Payment-in-kind interest
    (2,059 )     (931 )
Proceeds from sale of investments and collection of investment principal
    69,735       13,077  
Purchases of cash equivalents
    (199,997 )     (19,999 )
Sales of cash equivalents
    199,997       19,999  
Net decrease investments in money market funds
    75,317       10,394  
Decrease (increase) in interest receivable
    163       (336 )
Decrease in dividends receivable
    26       4,229  
Decrease in loan principal receivable
          71  
Increase in receivable for managerial assistance
          (25 )
Increase in receivable for potential deal expenses
          (86 )
Decrease (increase) in other receivables
    212       (17 )
Increase in prepaid expenses
    (72 )     (505 )
Decrease in due from Prospect Administration
    502        
Increase in other assets
    (535 )      
Decrease in due to Prospect Administration
    (842 )     (12 )
Increase (decrease) in due to Prospect Capital Management
    1,541       (317 )
(Decrease) increase in accrued expenses
    (227 )     997  
Decrease in other liabilities
    (277 )     (270 )
 
           
Net Cash Provided By (Used In) Operating Activities:
    155,128       (23,126 )
 
           
 
               
Cash Flows from Investing Activities:
               
Acquisition of Patriot, net of cash acquired (Note 2)
    (106,586 )      
 
           
Net Cash Used In Investing Activities:
    (106,586 )      
 
           
 
               
Cash Flows from Financing Activities:
               
Borrowings under credit facility
    60,000       54,500  
Payments under credit facility
    (174,800 )     (7,000 )
Financing costs paid and deferred
    (1,046 )     (270 )
Net proceeds from issuance of common stock
    98,833        
Offering costs from issuance of common stock
    (1,158 )      
Dividends/distributions paid
    (36,469 )     (22,221 )
 
           
Net Cash Provided By Financing Activities:
    54,640       25,009  
 
           
 
               
Total (Decrease) Increase in Cash
    (6,098 )     1,883  
Cash balance at beginning of period
    9,942       555  
 
           
Cash Balance at End of Period
  $ 3,844     $ 2,438  
 
           
 
               
Cash Paid For Interest
  $ 496     $ 2,862  
 
           
 
               
Non-Cash Financing Activity:
               
Amount of shares issued in connection with Patriot acquisition
  $ 92,800     $  
 
           
Amount of shares issued in connection with dividend reinvestment plan
  $ 5,358     $ 2,901  
 
           
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
     
 
                               
LEVEL 3 INVESTMENTS:                                
 
     
 
                               
Control Investments (25.00% or greater of voting control)                                
 
     
 
                               
Ajax Rolled Ring &
  South Carolina /  
Senior Secured Note – Tranche A (10.50%, due 4/01/2013)(3), (4)
  $ 21,266     $ 21,266     $ 21,266       3.3 %
Machine, Inc.
  Manufacturing  
Subordinated Secured Note – Tranche B (11.50% plus 6.00% PIK, due 4/01/2013)(3), (4)
    12,038       12,038       4,536       0.7 %
 
     
Subordinated Secured Note – Tranche B (15.00%, due 10/30/2010)
    500       500             0.0 %
 
     
Convertible Preferred Stock – Series A (6,143 shares)
            6,057             0.0 %
 
     
Unrestricted Common Stock (6 shares)
                        0.0 %
 
     
 
                         
 
     
 
            39,861       25,802       4.0 %
 
     
 
                         
 
     
 
                               
AWCNC, LLC(20)
  North Carolina /  
Members Units – Class A (1,800,000 units)
                        0.0 %
 
  Machinery  
Members Units – Class B-1 (1 unit)
                        0.0 %
 
     
Members Units – Class B-2 (7,999,999 units)
                        0.0 %
 
     
 
                         
 
     
 
                        0.0 %
 
     
 
                         
 
     
 
                               
C&J Cladding LLC
  Texas / Metal Services and Minerals  
Warrants (400 warrants, expiring 3/30/2014)
            580       3,095       0.5 %
 
     
 
                         
 
     
 
            580       3,095       0.5 %
 
     
 
                         
 
     
 
                               
Change Clean Energy Holdings, Inc. (“CCEHI”)(5)
  Maine / Biomass Power  
Common Stock (1,000 shares)
            2,825       1,976       0.3 %
 
     
 
                         
 
     
 
            2,825       1,976       0.3 %
 
     
 
                         
 
     
 
                               
Coalbed, Inc. / Coalbed, LLC(6)
  Tennessee / Oil & Gas Production  
Senior Secured Note (14.50%, in non-accrual status effective 10/21/2009, due 6/30/2010)
    10,441       10,441       3,686       0.6 %
 
     
Common Stock (1,000 shares)
                        0.0 %
 
     
 
                         
 
     
 
            10,441       3,686       0.6 %
 
     
 
                         
 
     
 
                               
Fischbein, LLC
  North Carolina / Machinery  
Senior Subordinated Debt (12.00% plus 6.50% PIK, due 5/01/2013)
    3,707       3,508       3,515       0.5 %
 
     
Membership Interest – Class A (2,800,000 units)
            1,877       1,876       0.3 %
 
     
 
                         
 
     
 
            5,385       5,391       0.8 %
 
     
 
                         
 
     
 
                               
Freedom Marine Services
  Louisiana /  
Subordinated Secured Note (16.00% PIK, due 12/31/2011)(3)
    7,960       7,899       6,181       1.0 %
LLC
  Shipping Vessels  
Net Profits Interest (22.50% payable on Equity distributions)(3), (7)
                        0.0 %
 
     
 
                         
 
     
 
            7,899       6,181       1.0 %
 
     
 
                         
 
     
 
                               
Gas Solutions Holdings,
  Texas / Gas  
Senior Secured Note (18.00%, due 12/22/2018)(3)
    25,000       25,000       25,000       3.9 %
Inc.(8)
  Gathering and  
Junior Secured Note (18.00%, due 12/23/2018)(3)
    5,000       5,000       5,000       0.8 %
 
  Processing  
Common Stock (100 shares)(3)
            5,003       55,187       8.7 %
 
     
 
                         
 
     
 
            35,003       85,187       13.4 %
 
     
 
                         
 
     
 
                               
Integrated Contract
  North Carolina /  
Senior Demand Note (15.00%, due 12/31/2009)(10)
    1,170       1,170       1,170       0.2 %
Services, Inc.(9)
  Contracting  
Senior Secured Note (7.00% plus 7.00% PIK plus 6.00% default interest, in non-accrual status effective 10/09/2007, past due)
    800       800       928       0.1 %
 
     
Junior Secured Note (7.00% plus 7.00% PIK plus 6.00% default interest, in non-accrual status effective 10/09/2007, past due)
    14,003       14,003       3,177       0.5 %
 
     
Preferred Stock – Series A (10 shares)
                        0.0 %
 
     
Common Stock (49 shares)
            679             0.0 %
 
     
 
                         
 
     
 
            16,652       5,275       0.8 %
 
     
 
                         
See notes to consolidated financial statements.

 

7


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
       
Control Investments (25.00% or greater of voting control)                                
 
       
Iron Horse Coiled Tubing, Inc.
  Alberta, Canada / Production Services  
Bridge Loan (15.00% plus 3.00% PIK, in non-accrual status effective 5/01/2009, due 12/31/2009)
  $ 11,418     $ 11,199     $ 10,440       1.6 %
 
     
Senior Secured Note (15.00%, in non-accrual status effective 5/01/2009, due 12/31/2009)
    9,250       9,250       1,878       0.3 %
 
     
Common Stock (1,781 shares)
            268             0.0 %
 
     
 
                         
 
     
 
            20,717       12,318       1.9 %
 
     
 
                         
NRG Manufacturing, Inc.
  Texas / Manufacturing  
Senior Secured Note (16.50%, due 8/31/2011)(3), (4)
    13,080       13,080       13,080       2.1 %
     
Common Stock (800 shares)
            2,317       13,610       2.1 %
     
 
                         
 
     
 
            15,397       26,690       4.2 %
 
     
 
                         
 
     
 
                               
Nupla Corporation
  California / Home & Office Furnishings,  
Revolving Line of Credit (0.50% – 7.25% plus 2.00% default interest, due 9/04/2012)(4)
    1,093       933       929       0.2 %
 
  Housewares & Durable  
Senior Secured Term Loan A (8.00% plus 2.00% default interest, due 9/04/2012)(4)
    5,139       1,503       1,503       0.2 %
 
     
Senior Subordinated Debt (10.00% plus 5.00% PIK, in non-accrual status effective 4/01/2009, due 3/04/2013)
    3,204                   0.0 %
 
     
Preferred Stock – Class A (475 shares)
                        0.0 %
 
     
Preferred Stock – Class B (1,045 shares)
                        0.0 %
 
     
Common Stock (1,140,584 shares)
                        0.0 %
 
     
 
                         
 
     
 
            2,436       2,432       0.4 %
 
     
 
                         
 
     
 
                               
R-V Industries, Inc.
  Pennsylvania / Manufacturing  
Warrants (200,000 warrants, expiring 6/30/2017)
            1,682       3,211       0.5 %
 
     
Common Stock (545,107 shares)
            5,086       8,751       1.4 %
 
     
 
                         
 
     
 
            6,768       11,962       1.9 %
 
     
 
                         
 
     
 
                               
Sidump’r Trailer Company, Inc.
  Nebraska / Automobile  
Revolving Line of Credit (0.50% – 7.25%, in non-accrual status effective 11/01/2008, due 1/10/2011)(4)
    950       404       404       0.0 %
 
     
Senior Secured Term Loan A (7.25%, in non-accrual status effective 11/01/2008, due 1/10/2011)(4)
    2,048       464       464       0.1 %
 
     
Senior Secured Term Loan B (8.75%, in-non-accrual status effective 11/01/2008, due 1/10/2011)(4)
    2,321                   0.0 %
 
     
Senior Secured Term Loan C (16.50% PIK, in non-accrual status effective 9/27/2008, due 7/10/2011)
    2,841                   0.0 %
 
     
Senior Secured Term Loan D (7.25%, in non-accrual status effective 11/01/2008, due 7/10/2011)(4)
    1,700                   0.0 %
 
     
Preferred Stock (49,635 shares)
                        0.0 %
 
     
Common Stock (64,050 shares)
                        0.0 %
 
     
 
                         
 
     
 
            868       868       0.1 %
 
     
 
                         
 
     
 
                               
Yatesville Coal Holdings, Inc.(11)
  Kentucky / Mining, Steel, Iron and Non-Precious Metals and Coal Production  
Senior Secured Note (15.77%, in non-accrual status effective 1/01/2009, due 12/31/2010)(4)
    10,000       1,035       1,035       0.2 %
     
Junior Secured Note (15.77%, in non-accrual status effective 1/01/2009, due 12/31/2010)(4)
    41,836                   0.0 %
     
Common Stock (1,000 shares)
                        0.0 %
 
     
 
                         
 
     
 
            1,035       1,035       0.2 %
 
     
 
                         
 
     
 
                               
Total Control Investments
    165,867       191,898       30.1 %
 
     
 
                         
See notes to consolidated financial statements.

 

8


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
     
 
                               
LEVEL 3 INVESTMENTS:                                
 
     
 
                               
Affiliate Investments (5.00% to 24.99% voting control)                                
 
     
 
                               
Appalachian Energy Holdings LLC(12)
  West Virginia / Construction Services  
Senior Secured Debt – Tranche A (14.00% plus 3.00% PIK plus 3.00% default interest, in non-accrual status effective 11/01/2008, due 1/31/2011)
  $ 2,066     $ 1,897     $ 1,165       0.2 %
   
Senior Secured Debt – Tranche B (14.00% plus 3.00% PIK plus 3.00% default interest, in non-accrual status effective 11/01/2008, past due)
    2,120       1,960             0.0 %
   
Preferred Stock – Series A (200 units)
            82             0.0 %
 
   
Preferred Stock – Series B (241 units)
            241             0.0 %
 
   
Preferred Stock – Series C (500 units)
            500             0.0 %
 
   
Warrants (6,065 warrants, expiring 2/13/2016)
            176             0.0 %
 
   
Warrants (6,025 warrants, expiring 6/17/2018)
            172             0.0 %
 
   
Warrants (25,000 warrants, expiring 11/30/2018)
                        0.0 %
 
     
 
                         
 
     
 
            5,028       1,165       0.2 %
 
     
 
                         
Biotronic NeuroNetwork(17)
  Michigan / Healthcare  
Senior Secured Note (11.50% plus 1.00% PIK, due 2/21/2013)(3), (4)
    26,227       26,227       27,014       4.2 %
   
Preferred Stock (9,925 shares)(13)
            2,300       3,497       0.6 %
   
 
                         
   
 
            28,527       30,511       4.8 %
 
     
 
                         
 
     
 
                               
Boxercraft Incorporated
  Georgia / Textiles & Leather  
Revolving Line of Credit (0.50%, due 9/16/2013)
                        0.0 %
   
Senior Secured Term Loan A (9.50% – 10.50%, due 9/16/2013)(4)
    4,049       3,412       3,140       0.5 %
   
Senior Secured Term Loan B (10.00% – 11.00%, due 9/16/2013)(4)
    4,835       3,750       3,788       0.5 %
   
Senior Secured Term Loan C (12.00% plus 6.50% PIK, due 3/16/2014)
    7,003       5,468       5,467       0.9 %
 
   
Preferred Stock (1,000,000 shares)
                        0.0 %
 
   
Common Stock (10,000 shares)
                        0.0 %
 
   
 
                         
 
   
 
            12,630       12,395       1.9 %
 
     
 
                         
KTPS Holdings, LLC
  Colorado / Textiles & Leather  
Revolving Line of Credit (0.50%, due 1/31/2012)
                        0.0 %
   
Senior Secured Term Loan A (10.50% – 11.25%, due 1/31/2012)(4)
    3,530       3,142       2,840       0.4 %
   
Senior Secured Term Loan B (12.00%, due 1/31/2012)
    445       372       372       0.1 %
   
Senior Secured Term Loan C (12.00% plus 6.00% PIK, due 3/31/2012)
    4,725       4,027       3,959       0.6 %
 
   
Membership Interest – Class A (730 units)
                        0.0 %
 
   
Membership Interest – Common (199,795 units)
                        0.0 %
 
   
 
                         
 
   
 
            7,541       7,171       1.1 %
 
     
 
                         
Miller Petroleum, Inc.
  Tennessee / Oil & Gas Production  
Warrants, Common Stock (2,117,689 warrants, expiring 5/04/2010 to 12/31/2014)(14)
            150       937       0.2 %
   
 
                         
   
 
            150       937       0.2 %
 
     
 
                         
Smart, LLC(15)
  New York / Diversified / Conglomerate Service  
Membership Interest – Class B (1,218 units)
                        0.0 %
   
Membership Interest – Class D (1 unit)
                        0.0 %
   
 
                         
   
 
                        0.0 %
See notes to consolidated financial statements.

 

9


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
     
 
                               
LEVEL 3 INVESTMENTS:                                
 
     
 
                               
Affiliate Investments (5.00% to 24.99% voting control)                                
 
 
Sport Helmets Holdings, LLC(15)
  New York / Personal & Nondurable Consumer Products  
Revolving Line of Credit (0.50%, due 12/14/2013)
          $     $       0.0 %
   
Senior Secured Term Loan A (4.26% – 6.00%, due 12/14/2013)(4)
  $ 3,975       2,302       2,329       0.3 %
 
   
Senior Secured Term Loan B (4.76% – 6.50%, due 12/14/2013)(4)
    7,425       4,963       5,072       0.8 %
 
   
Senior Subordinated Debt – Series A (12.00% plus 3.00% PIK, due 6/14/2014)
    7,215       5,655       5,646       0.9 %
 
   
Senior Subordinated Debt – Series B (10.00% plus 5.00% PIK, due 6/14/2014)
    1,324       898       895       0.1 %
 
   
Common Stock (20,000 shares)
            358       358       0.1 %
 
   
 
                         
 
   
 
            14,176       14,300       2.2 %
 
     
 
                         
Total Affiliate Investments
    68,052       66,479       10.4 %
 
     
 
                         
 
     
 
                               
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
     
 
                               
ADAPCO, Inc.
  Florida / Ecological  
Common Stock (5,000 shares)
            141       295       0.0 %
 
     
 
                         
 
     
 
            141       295       0.0 %
 
     
 
                         
Aircraft Fasteners International, LLC
  California / Machinery  
Revolving Line of Credit (0.50%, due 11/01/2012)
                        0.0 %
   
Senior Secured Term Loan (3.92% – 5.40%, due 11/01/2012)(4)
    5,188       3,653       3,675       0.6 %
   
Junior Secured Term Loan (12.00% plus 2.00% PIK, due 5/01/2013)
    5,433       4,555       4,613       0.7 %
 
     
Convertible Preferred Stock (32,500 units)
            396       396       0.1 %
 
     
 
                         
 
     
 
            8,604       8,684       1.4 %
 
     
 
                         
American Gilsonite Company
  Utah / Specialty Minerals  
Senior Subordinated Note (12.00% plus 3.00% PIK, due 3/14/2013)(3)
    14,783       14,783       15,078       2.4 %
 
   
Membership Interest Units in AGC/PEP, LLC (99.9999%)(16)
            1,031       2,728       0.4 %
 
     
 
                         
 
     
 
            15,814       17,806       2.8 %
 
     
 
                         
Arrowhead General Insurance Agency, Inc.(17)
  California / Insurance  
Junior Secured Term Loan (10.25% plus 2.50% PIK, due 2/8/2013)
    5,085       3,873       3,871       0.6 %
 
   
 
                         
 
   
 
            3,873       3,871       0.6 %
 
     
 
                         
Borga, Inc.
  California / Mining, Steel, Iron and Non-Precious Metals and Coal Production  
Revolving Line of Credit (0.50% – 5.00% plus 3.00% default interest, due 5/06/2010)(4)
    800       701       680       0.1 %
 
   
Senior Secured Term Loan B (8.50% plus 3.00% default interest, due 5/6/2010)(4)
    1,612       1,411       1,375       0.2 %
 
   
Senior Secured Term Loan C (12.00% plus 4.00% PIK plus 3.00% default interest, due 5/06/2010)
    8,453       651       622       0.1 %
 
     
Warrants (33,750 warrants)
                        0.0 %
 
     
 
                         
 
     
 
            2,763       2,677       0.4 %
See notes to consolidated financial statements.

 

10


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
 
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
 
 
Caleel + Hayden, LLC (15)
  Colorado / Personal & Nondurable  
Junior Secured Term Loan B (9.75% – 10.00%, due 11/10/2011)(4)
  $ 8,425     $ 8,399     $ 8,416       1.3 %
 
  Consumer Products  
Senior Subordinated Debt (12.00% plus 4.50% PIK, due 11/10/2012)
    6,250       5,779       5,778       0.9 %
 
     
Common Stock (7,500 shares)
            351       351       0.1 %
 
     
Options in Mineral Fusion Natural Brands, LLC (11,662 options)
                        0.0 %
 
     
 
                         
 
     
 
            14,529       14,545       2.3 %
 
     
 
                         
 
     
 
                               
Castro Cheese Company, Inc.
  Texas / Food Products  
Junior Secured Note (11.00% plus 2.00% PIK, due 2/28/2013)(3)
    7,615       7,505       7,655       1.2 %
 
     
 
                         
 
     
 
            7,505       7,655       1.2 %
 
     
 
                         
 
     
 
                               
Copernicus Group
  North Carolina / Healthcare  
Revolving Line of Credit (0.50% – 10.50%, due 10/08/2013)(4)
    150       3             0.0 %
 
     
Senior Secured Term Loan A (10.50% – 11.50%, due 10/08/2013)(4)
    6,250       5,272       5,205       0.8 %
 
     
Senior Subordinated Debt (12.00% plus 6.00% PIK – 10.00% plus 10.00% PIK, due 4/08/2014)
    12,741       10,661       11,948       1.9 %
 
     
Preferred Stock – Series A (1,000,000 shares)
            67             0.0 %
 
     
Preferred Stock – Series C (212,121 shares)
            212       140       0.0 %
 
     
 
                         
 
     
 
            16,215       17,293       2.7 %
 
     
 
                         
 
     
 
                               
Custom Direct, Inc. (17)
  Maryland / Printing &  
Senior Secured Term Loan (3.06%, due 12/31/2013)(4)
    1,651       1,204       1,219       0.2 %
 
  Publishing  
Junior Secured Term Loan (6.31%, due 12/31/2014)(4)
    2,000       1,243       1,278       0.2 %
 
     
 
                       
 
     
 
            2,447       2,497       0.4 %
 
     
 
                         
 
     
 
                               
Deb Shops, Inc.(17)
  Pennsylvania / Retail  
Second Lien Debt (1.00% plus 13.00% PIK, in non-accrual status effective 2/24/2009, due 10/23/2014)
    16,378       14,607       2,318       0.4 %
 
     
 
                         
 
     
 
            14,607       2,318       0.4 %
 
     
 
                         
 
     
 
                               
Diamondback Operating, LP
  Oklahoma / Oil & Gas Production  
Net Profits Interest (15.00% payable on Equity distributions)(7)
                  404       0.1 %
 
     
 
                         
 
     
 
                  404       0.1 %
 
     
 
                         
 
     
 
                               
EXL Acquisition Corp.
  South Carolina / Electronics  
Revolving Line of Credit (0.50%, due 3/15/2012)
                        0.0 %
 
     
Senior Secured Term Loan A (3.93% – 5.50%, due 3/15/2011)(4)
    1,790       1,494       1,473       0.2 %
 
     
Senior Secured Term Loan B (4.18% – 5.75%, due 3/15/2012)(4)
    4,053       3,680       3,714       0.6 %
 
     
Senior Secured Term Loan C (4.68% – 6.25%, due 3/15/2012)(4)
    2,500       2,294       2,316       0.4 %
 
     
Senior Secured Term Loan D (12.00% plus 3.00% PIK, due 3/15/2012)
    5,967       6,039       6,085       0.9 %
 
     
Common Stock – Class A (2,475 shares)
            509       509       0.1 %
 
     
Common Stock – Class B (25 shares)
            306       306       0.1 %
 
     
 
                         
 
     
 
            14,322       14,403       2.3 %
 
     
 
                         
 
     
 
                               
Fairchild Industrial Products, Co.(2)
  North Carolina / Electronics  
Preferred Stock – Class A (378 shares)
            377       380       0.1 %
     
Common Stock – Class B (28 shares)
            211       211       0.0 %
 
     
 
                         
 
     
 
            588       591       0.1 %
 
     
 
                         
 
     
 
                               
H&M Oil & Gas, LLC
  Texas / Oil & Gas Production  
Senior Secured Note (13.00%, due 6/30/2010)
    49,661       49,661       46,081       7.2 %
 
     
Net Profits Interest (8.00% payable on Equity distributions)(7)
                  1,047       0.2 %
 
     
 
                         
 
     
 
            49,661       47,128       7.4 %
 
     
 
                         
See notes to consolidated financial statements.

 

11


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
 
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
 
Hudson Products Holdings, Inc.(17)
  Texas / Mining, Steel, Iron and Non-Precious Metals and Coal Production  
Senior Secured Term Loan (8.00%, due 8/24/2015)(4)
  $ 7,406     $ 6,729     $ 6,993       1.1 %
 
     
 
                       
 
     
 
            6,729       6,993       1.1 %
 
     
 
                         
 
     
 
                               
IEC Systems LP (“IEC”) /Advanced Rig Services LLC (“ARS”)
  Texas / Oilfield Fabrication  
IEC Senior Secured Note (12.00% plus 3.00% PIK, due 11/20/2012)(3), (4)
    20,209       20,209       20,209       3.2 %
     
ARS Senior Secured Note (12.00% plus 3.00% PIK, due 11/20/2012)(3), (4)
    12,128       12,128       12,128       1.9 %
     
 
                       
 
     
 
            32,337       32,337       5.1 %
 
     
 
                         
 
     
 
                               
Impact Products, LLC
  Ohio / Machinery  
Junior Secured Term Loan (6.25% – 8.25%, due 9/09/2012)(4)
    8,835       7,704       7,753       1.2 %
 
     
Senior Subordinated Debt (10.00% plus 5.00%, due 9/09/2012)
    5,548       5,259       5,260       0.8 %
 
     
 
                       
 
     
 
            12,963       13,013       2.0 %
 
     
 
                         
 
     
 
                               
Label Corp Holdings, Inc.
  Nebraska / Printing & Publishing  
Senior Secured Term Loan (8.50%, due 8/08/2014)(4)
    5,823       5,193       5,306       0.8 %
 
     
 
                       
 
     
 
            5,193       5,306       0.8 %
 
     
 
                         
 
     
 
                               
LHC Holdings Corp.(17)
  Florida / Healthcare  
Revolving Line of Credit (0.50%, due 11/30/2012)
                        0.0 %
 
     
Senior Secured Term Loan A (4.31% – 5.75%, due 11/30/2012)(4)
    2,918       2,114       2,177       0.3 %
 
     
Senior Subordinated Debt (12.00% plus 2.50% PIK, due 5/31/2013)
    4,565       4,157       4,156       0.7 %
 
     
Membership Interest (125 units)
            216       216       0.0 %
 
     
 
                         
 
     
 
            6,487       6,549       1.0 %
 
     
 
                         
 
     
 
                               
Mac & Massey Holdings, LLC
  Georgia / Food Products  
Senior Subordinated Debt (10.00% plus 5.75% PIK, due 2/10/2013)
    8,426       6,960       6,940       1.1 %
 
     
Common Stock (250 shares)
            169       170       0.0 %
 
     
 
                       
 
     
 
            7,129       7,110       1.1 %
 
     
 
                         
 
     
 
                               
Maverick Healthcare, LLC
  Arizona / Healthcare  
Second Lien Debt (12.50% plus 3.50% PIK, due 4/30/2014)(3)
    12,894       12,894       12,894       2.0 %
 
     
Preferred Units (1,250,000 units)
            1,252       1,693       0.3 %
 
     
Common Units (1,250,000 units)
                        0.0 %
 
     
 
                       
 
     
 
            14,146       14,587       2.3 %
 
     
 
                         
 
     
 
                               
Northwestern Management Services, LLC
  Florida / Healthcare  
Revolving Line of Credit (0.50%, due 12/13/2012)
                        0.0 %
 
     
Senior Secured Term Loan A (4.24% – 5.75%, due 12/13/2012)(4)
    5,050       4,050       3,936       0.6 %
 
     
Senior Secured Term Loan B (4.74% – 6.25%, due 12/13/2012)(4)
    1,228       864       865       0.1 %
 
     
Junior Secured Term Loan (12.00% plus 3.00%, due 6/13/2013)
    2,927       2,372       2,370       0.4 %
 
     
Common Stock (50 shares)
            371       371       0.1 %
 
     
 
                       
 
     
 
            7,657       7,542       1.2 %
 
     
 
                       
See notes to consolidated financial statements.

 

12


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
 
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
 
Prince Mineral Company, Inc.
  New York / Metal  
Junior Secured Term Loan (5.29% – 7.00%, due 12/21/2012)(4)
  $ 11,175     $ 7,633     $ 7,816       1.2 %
  Services and Minerals  
Senior Subordinated Debt (13.00% plus 1.00%, due 7/21/2013)
    12,168       1,279       1,269       0.2 %
     
 
                       
 
     
 
            8,912       9,085       1.4 %
 
     
 
                         
 
     
 
                               
Qualitest Pharmaceuticals, Inc.(17)
  Alabama / Pharmaceuticals  
Second Lien Debt (7.78%, due 4/30/2015)(3), (4)
    12,000       11,952       12,000       1.9 %
 
     
 
                       
 
     
 
            11,952       12,000       1.9 %
 
     
 
                         
 
     
 
                               
Regional Management Corp.
  South Carolina / Financial Services  
Second Lien Debt (13.00% plus 2.00% PIK, due 6/29/2012)(3)
    25,685       25,685       24,511       3.8 %
 
     
 
                       
 
     
 
            25,685       24,511       3.8 %
 
     
 
                         
 
     
 
                               
R-O-M Corporation
  Missouri / Manufacturing  
Revolving Line of Credit (0.50%, due 2/08/2013)
                        0.0 %
 
   
Senior Secured Term Loan A (3.00% – 4.75%, due 2/08/2013)(4)
    5,440       4,600       4,456       0.7 %
 
     
Senior Secured Term Loan B (4.50% – 6.25%, due 5/8/2013)(4)
    8,294       7,035       7,263       1.1 %
 
     
Senior Subordinated Debt (12.00% plus 3.00% due 8/08/2013)
    7,282       6,929       6,939       1.1 %
 
     
 
                       
 
     
 
            18,564       18,658       2.9 %
 
     
 
                         
 
     
 
                               
Shearer’s Foods, Inc.
  Ohio / Food Products  
Second Lien Debt (15.00%, due 10/31/2013)(3)
    18,000       18,000       18,180       2.8 %
 
 
 
 
Membership Interest Units in Mistral Chip Holdings, LLC (2,000 units)(18)
            2,000       4,467       0.7 %
 
     
 
                       
 
     
 
            20,000       22,647       3.5 %
 
     
 
                         
 
     
 
                               
Stryker Energy, LLC
  Ohio / Oil & Gas Production  
Subordinated Secured Revolving Credit Facility (12.00%, due 12/01/2011)(3), (4)
    29,500       29,217       28,360       4.5 %
 
     
Overriding Royalty Interests(19)
                  2,762       0.4 %
 
     
 
                         
 
     
 
            29,217       31,122       4.9 %
 
     
 
                         
 
     
 
                               
TriZetto Group(17)
  California / Healthcare  
Subordinated Unsecured Note (12.00% plus 1.50% PIK, due 10/01/2016)(3)
    15,319       15,185       15,771       2.5 %
 
     
 
                       
 
     
 
            15,185       15,771       2.5 %
 
     
 
                         
 
     
 
                               
Unitek(17)
  Pennsylvania / Technical Services  
Second Lien Debt (13.08%, due 12/31/2013)(3), (4)
    11,500       11,373       11,615       1.8 %
 
 
   
 
                       
 
 
   
 
            11,373       11,615       1.8 %
 
     
 
                         
 
     
 
                               
Wind River Resources Corp. and Wind River II Corp.
  Utah / Oil & Gas Production  
Senior Secured Note (13.00% plus 3.00% default interest, in non-accrual status effective 12/01/2008, due 7/31/2010)(4)
    15,000       15,000       10,627       1.7 %
 
     
Net Profits Interest (5.00% payable on Equity distributions)(7)
                        0.0 %
 
     
 
                         
 
     
 
            15,000       10,627       1.7 %
 
     
 
                         
 
     
 
                               
Total Non-Control/Non-Affiliate Investments (Level 3 Investments)
    399,598       389,640       61.1 %
 
     
 
                         
 
Total Level 3 Portfolio Investments
    633,517       648,017       101.6 %
 
     
 
                         
See notes to consolidated financial statements.

 

13


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            December 31, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
     
 
                               
LEVEL 1 INVESTMENTS:                                
 
     
 
                               
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
     
 
                               
Allied Defense Group, Inc.
  Virginia / Aerospace & Defense  
Common Stock (10,000 shares)
          $ 56     $ 48       0.0 %
 
     
 
                         
 
     
 
            56       48       0.0 %
 
     
 
                         
 
     
 
                               
Dover Saddlery, Inc.
  Massachusetts / Retail  
Common Stock (30,974 shares)
            63       70       0.0 %
 
     
 
                         
 
     
 
            63       70       0.0 %
 
     
 
                         
 
     
 
                               
Total Non-Control/Non-Affiliate Investments (Level 1 Investments)
    119       118       101.6 %
 
     
 
                         
 
     
 
                               
Total Portfolio Investments
    633,636       648,135       101.6 %
 
     
 
                         
 
     
 
                               
LEVEL 2 INVESTMENTS:                                
 
     
 
                               
Money Market Funds                                
 
     
 
                               
Fidelity Institutional Money Market Funds — Government Portfolio (Class I)             16,070       16,070       2.5 %
Fidelity Institutional Money Market Funds — Government Portfolio (Class I)(3)             3,347       3,347       0.5 %
Victory Government Money Market Funds             4,001       4,001       0.7 %
 
     
 
                         
Total Money Market Funds (Level 2 Investments)
    23,418       23,418       3.7 %
 
     
 
                         
 
     
 
                               
Total Investments
    657,054       671,553       105.3 %
 
     
 
                         
See notes to consolidated financial statements.

 

14


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            June 30, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
       
Control Investments (25.00% or greater of voting control)                                
 
       
Ajax Rolled Ring & Machine, Inc.
  South Carolina / Manufacturing  
Senior Secured Note – Tranche A (10.50%, due 4/01/2013)(3), (4)
  $ 21,487     $ 21,487     $ 21,487       4.0 %
 
     
Subordinated Secured Note – Tranche B (11.50% plus 6.00% PIK, due 4/01/2013)(3), (4)
    11,675       11,675       10,151       1.9 %
 
     
Convertible Preferred Stock – Series A (6,143 shares)
            6,057             0.0 %
 
     
Unrestricted Common Stock (6 shares)
                        0.0 %
 
     
 
                         
 
     
 
            39,219       31,638       5.9 %
 
     
 
                         
 
     
 
                               
C&J Cladding LLC
  Texas / Metal Services and Minerals  
Senior Secured Note (14.00%, due 3/30/2012)(3), (4)
    3,150       2,722       3,308       0.6 %
 
     
Warrants (400 warrants, expiring 3/30/2014)
            580       3,825       0.7 %
 
     
 
                         
 
     
 
            3,302       7,133       1.3 %
 
     
 
                         
 
     
 
                               
Change Clean Energy Holdings, Inc.
  Maine / Biomass Power  
Common Stock (1,000 shares)
            2,530       2,530       0.5 %
(“CCEHI”)(5)
     
 
                         
 
     
 
            2,530       2,530       0.5 %
 
     
 
                         
 
     
 
                               
Gas Solutions Holdings, Inc.(8)
  Texas / Gas Gathering and Processing  
Senior Secured Note (18.00%, due 12/22/2018)(3)
    25,000       25,000       25,000       4.7 %
     
Junior Secured Note (18.00%, due 12/23/2018)(3)
    5,000       5,000       5,000       0.9 %
 
     
Common Stock (100 shares)(3)
            5,003       55,187       10.4 %
 
     
 
                         
 
     
 
            35,003       85,187       16.0 %
 
     
 
                         
 
     
 
                               
Integrated Contract Services, Inc.(9)
  North Carolina / Contracting  
Senior Demand Note (15.00%, due 6/30/2009)(10)
    1,170       1,170       1,170       0.2 %
     
Senior Secured Note (7.00% plus 7.00% PIK plus 6.00% default interest, in non-accrual status effective 10/09/2007, past due)
    800       800       800       0.1 %
 
     
Junior Secured Note (7.00% plus 7.00% PIK plus 6.00% default interest, in non-accrual status effective 10/09/2007, past due)
    14,003       14,003       3,030       0.6 %
 
     
Preferred Stock – Series A (10 shares)
                        0.0 %
 
     
Common Stock (49 shares)
            679             0.0 %
 
     
 
                         
 
     
 
            16,652       5,000       0.9 %
 
     
 
                         
 
     
 
                               
Iron Horse Coiled Tubing, Inc.
  Alberta, Canada / Production Services  
Bridge Loan (15.00% plus 3.00% PIK, due 12/31/2009)
    9,826       9,826       9,602       1.8 %
 
     
Senior Secured Note (15.00%, due 12/31/2009)
    9,250       9,250       3,004       0.6 %
 
     
Common Stock (1,781 shares)
            268             0.0 %
 
     
 
                         
 
     
 
            19,344       12,606       2.4 %
 
     
 
                         
 
     
 
                               
NRG Manufacturing, Inc.
  Texas / Manufacturing  
Senior Secured Note (16.50%, due 8/31/2011)(3), (4)
    13,080       13,080       13,080       2.5 %
 
     
Common Stock (800 shares)
            2,317       19,294       3.6 %
 
     
 
                         
 
     
 
            15,397       32,374       6.1 %
 
     
 
                         
 
     
 
                               
R-V Industries, Inc.
  Pennsylvania / Manufacturing  
Warrants (200,000 warrants, expiring 6/30/2017)
            1,682       4,500       0.8 %
 
     
Common Stock (545,107 shares)
            5,086       12,267       2.3 %
 
     
 
                         
 
     
 
            6,768       16,767       3.1 %
 
     
 
                         
 
     
 
                               
Yatesville Coal Holdings, Inc.(11)
  Kentucky / Mining, Steel, Iron and Non-  
Senior Secured Note (15.72%, in non-accrual status effective 1/01/2009, due 12/31/2010)(4)
    10,000       10,000       10,000       1.9 %
 
   Precious Metals and Coal Production  
Junior Secured Note (15.72%, in non-accrual status effective 1/01/2009, due 12/31/2010)(4)
    38,463       38,463       3,097       0.6 %
 
     
Common Stock (1,000 shares)
            427             0.0 %
 
     
 
                         
 
     
 
            48,890       13,097       2.5 %
 
     
 
                         
 
     
 
                               
Total Control Investments
    187,105       206,332       38.7 %
 
     
 
                         
See notes to consolidated financial statements.

 

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PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            June 30, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
       
Affiliate Investments (5.00% to 24.99% voting control)                                
 
       
Appalachian Energy Holdings LLC(12)
  West Virginia / Construction Services  
Senior Secured Debt – Tranche A (14.00% plus 3.00% PIK plus 3.00% default interest, in non-accrual status effective 11/01/2008, due 1/31/2011)
  $ 1,997     $ 1,891     $ 2,052       0.4 %
 
     
Senior Secured Debt – Tranche B (14.00% plus 3.00% PIK plus 3.00% default interest, in non-accrual status effective 11/01/2008, past due)
    2,050       1,955       356       0.1 %
 
     
Preferred Stock – Series A (200 units)
            82             0.0 %
 
     
Preferred Stock – Series B (241 units)
            241             0.0 %
 
     
Preferred Stock – Series C (500 units)
            500             0.0 %
 
     
Warrants (6,065 warrants, expiring 2/13/2016)
            176             0.0 %
 
     
Warrants (6,025 warrants, expiring 6/17/2018)
            172             0.0 %
 
     
Warrants (25,000 warrants, expiring 11/30/2018)
                        0.0 %
 
     
 
                         
 
     
 
            5,017       2,408       0.5 %
 
     
 
                         
 
     
 
                               
Biotronic NeuroNetwork(17)
  Michigan / Healthcare  
Senior Secured Note (11.50% plus 1.00% PIK, due 2/21/2013)(3), (4)
    26,227       26,227       27,007       5.1 %
 
     
Preferred Stock (9,925 shares)(13)
            2,300       2,839       0.5 %
 
     
 
                         
 
     
 
            28,527       29,846       5.6 %
 
     
 
                         
 
     
 
                               
Total Affiliate Investments
    33,544       32,254       6.1 %
 
     
 
                         
 
     
 
                               
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
 
American Gilsonite Company
  Utah / Specialty Minerals  
Senior Subordinated Note (12.00% plus 3.00% PIK, due 3/14/2013)(3)
    14,783       14,783       15,073       2.8 %
 
     
Membership Interest Units in AGC/PEP, LLC (99.9999%)(16)
            1,031       3,851       0.7 %
 
     
 
                         
 
     
 
            15,814       18,924       3.5 %
 
     
 
                         
 
     
 
                               
Castro Cheese Company, Inc.
  Texas / Food Products  
Junior Secured Note (11.00% plus 2.00% PIK, due 2/28/2013)(3)
    7,538       7,413       7,637       1.4 %
 
     
 
                       
 
     
 
            7,413       7,637       1.4 %
 
     
 
                         
 
     
 
                               
Conquest Cherokee, LLC(6)
  Tennessee / Oil & Gas Production  
Senior Secured Note (13.00% plus 4.00% default interest, in non-accrual status effective 4/01/2009, past due)(4)
    10,200       10,191       6,855       1.3 %
 
     
Overriding Royalty Interests(19)
                  565       0.1 %
 
     
 
                         
 
     
 
            10,191       7,420       1.4 %
 
     
 
                         
 
     
 
                               
Deb Shops, Inc.(17)
  Pennsylvania / Retail  
Second Lien Debt (8.67%, due 10/23/2014)
    15,000       14,623       6,272       1.2 %
 
     
 
                         
 
     
 
            14,623       6,272       1.2 %
 
     
 
                         
 
     
 
                               
Diamondback Operating, LP
  Oklahoma / Oil & Gas Production  
Net Profits Interest (15.00% payable on Equity distributions) (7)
                  458       0.1 %
 
     
 
                         
 
     
 
                  458       0.1 %
 
     
 
                         
 
     
 
                               
Freedom Marine Services LLC
  Louisiana / Shipping Vessels  
Subordinated Secured Note (12.00% plus 4.00% PIK, due 12/31/2011)(3)
    7,234       7,160       7,152       1.4 %
 
     
Net Profits Interest (22.50% payable on Equity distributions)(3), (7)
                  229       0.0 %
 
     
 
                         
 
     
 
            7,160       7,381       1.4 %
 
     
 
                         
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            June 30, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
 
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
     
 
                               
H&M Oil & Gas, LLC(3)
  Texas / Oil & Gas  
Senior Secured Note (13.00%, due 6/30/2010)(3)
  $ 49,688     $ 49,688     $ 49,697       9.3 %
 
  Production  
Net Profits Interest (8.00% payable on Equity distributions)(3), (7)
                  1,682       0.3 %
 
     
 
                         
 
     
 
            49,688       51,379       9.6 %
 
     
 
                         
 
     
 
                               
IEC Systems LP (“IEC”) /Advanced Rig
  Texas / Oilfield Fabrication  
IEC Senior Secured Note (12.00% plus 3.00% PIK, due 11/20/2012)(3), (4)
    21,411       21,411       21,839       4.1 %
 Services LLC (“ARS”)
     
ARS Senior Secured Note (12.00% plus 3.00% PIK, due 11/20/2012)(3), (4)
    12,836       12,836       13,092       2.5 %
 
     
 
                       
 
     
 
            34,247       34,931       6.6 %
 
     
 
                         
 
     
 
                               
Maverick Healthcare, LLC
  Arizona / Healthcare  
Second Lien Debt (12.00% plus 1.50% PIK, due 4/30/2014)(3)
    12,691       12,691       12,816       2.4 %
 
     
Preferred Units (1,250,000 units)
            1,252       1,300       0.2 %
 
     
Common Units (1,250,000 units)
                        0.0 %
 
     
 
                         
 
     
 
            13,943       14,116       2.6 %
 
     
 
                         
 
     
 
                               
Miller Petroleum, Inc.
  Tennessee / Oil & Gas Production  
Warrants, Common Stock (1,935,523 warrants, expiring 5/04/2010 to 6/30/2014)(14)
            150       241       0.1 %
 
     
 
                         
 
     
 
            150       241       0.1 %
 
     
 
                         
 
     
 
                               
Peerless Manufacturing
  Texas / Manufacturing  
Subordinated Secured Note (11.50% plus 3.50% PIK, due 4/29/2013)(3)
    20,000       20,000       20,400       3.8 %
 
     
 
                       
 
     
 
            20,000       20,400       3.8 %
 
     
 
                         
 
     
 
                               
Qualitest Pharmaceuticals, Inc.(17)
  Alabama / Pharmaceuticals  
Second Lien Debt (8.10%, due 4/30/2015)(3), (4)
    12,000       11,949       11,452       2.2 %
 
     
 
                       
 
     
 
            11,949       11,452       2.2 %
 
     
 
                         
 
     
 
                               
Regional Management Corp.
  South Carolina / Financial Services  
Second Lien Debt (12.00% plus 2.00% PIK, due 6/29/2012)(3)
    25,424       25,424       23,073       4.3 %
 
     
 
                       
 
     
 
            25,424       23,073       4.3 %
 
     
 
                         
 
     
 
                               
Resco Products, Inc.
  Pennsylvania / Manufacturing  
Second Lien Debt (8.67%, due 6/22/2014)(3), (4)
    9,750       9,594       9,750       1.8 %
 
     
 
                       
 
     
 
            9,594       9,750       1.8 %
 
     
 
                         
 
     
 
                               
Shearer’s Foods, Inc.
  Ohio / Food Products  
Second Lien Debt (14.00%, due 10/31/2013)(3)
    18,000       18,000       18,360       3.5 %
 
     
Membership Interest Units in Mistral Chip Holdings, LLC (2,000 units)(18)
            2,000       3,419       0.6 %
 
     
 
                         
 
     
 
            20,000       21,779       4.1 %
 
     
 
                         
 
     
 
                               
Stryker Energy, LLC
  Ohio / Oil & Gas Production  
Subordinated Secured Revolving Credit Facility (12.00%, due 12/01/2011)(3), (4)
    29,500       29,154       29,554       5.5 %
 
     
Overriding Royalty Interests(19)
                  2,918       0.6 %
 
     
 
                         
 
     
 
            29,154       32,472       6.1 %
 
     
 
                         
 
     
 
                               
TriZetto Group(17)
  California / Healthcare  
Subordinated Unsecured Note (12.00% plus 1.50% PIK, due 10/01/2016)(3)
    15,205       15,065       16,331       3.1 %
 
     
 
                       
 
     
 
            15,065       16,331       3.1 %
 
     
 
                         
 
     
 
                               
Unitek(17)
  Pennsylvania / Technical Services  
Second Lien Debt (13.08%, due 12/31/2013)(3), (4)
    11,500       11,360       11,730       2.2 %
 
     
 
                       
 
     
 
            11,360       11,730       2.2 %
 
     
 
                         
See notes to consolidated financial statements.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
                                         
            June 30, 2009  
                                    % of  
            Principal             Fair     Net  
Portfolio Company   Locale / Industry   Investments(1)   Value     Cost     Value(2)     Assets  
 
 
LEVEL 3 INVESTMENTS:                                
 
 
Non-control/Non-affiliate Investments (less than 5.00% of voting control)                                
 
 
Wind River Resources Corp. and Wind River II Corp.
  Utah / Oil & Gas Production  
Senior Secured Note (13.00% plus 3.00% default interest, in non-accrual status effective 12/01/2008, due 7/31/2010)(4)
  $ 15,000     $ 15,000     $ 12,644       2.4 %
 
     
Net Profits Interest (5.00% payable on Equity distributions)(7)
                  192       0.0 %
 
     
 
                         
 
     
 
            15,000       12,836       2.4 %
 
     
 
                         
 
     
 
                               
Total Non-Control/Non-Affiliate Investments
    310,775       308,582       57.9 %
 
     
 
                         
 
     
 
                               
 
Total Level 3 Portfolio Investments
    531,424       547,168       102.7 %
 
     
 
                         
 
     
 
                               
 
 
LEVEL 2 INVESTMENTS:                                
 
     
 
                               
Money Market Funds                                
 
Fidelity Institutional Money Market Funds — Government Portfolio (Class I)             94,753       94,753       17.8 %
Fidelity Institutional Money Market Funds — Government Portfolio (Class I)(3)             3,982       3,982       0.7 %
 
     
 
                         
Total Money Market Funds (Level 2 Investments)
    98,735       98,735       18.5 %
 
     
 
                         
 
 
     
 
                               
Total Investments
    630,159       645,903       121.2 %
 
     
 
                         
See notes to consolidated financial statements.

 

18


Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
Endnote Explanations for the Consolidated Schedule of Investments as of December 31, 2009 and June 30, 2009
     
(1)  
The securities in which Prospect Capital Corporation (“we”, “us” or “our”) has invested were acquired in transactions that were exempt from registration under the Securities Act of 1933, as amended, or the “Securities Act.” These securities may be resold only in transactions that are exempt from registration under the Securities Act.
   
 
(2)  
Fair value is determined by or under the direction of our Board of Directors. As of December 31, 2009, two of our portfolio investments, Allied Defense Group, Inc. and Dover Saddlery, Inc., were publically traded and classified as Level 1 within the valuation hierarchy established by Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC 820”). As of December 31, 2009 and June 30, 2009, the fair value of our remaining portfolio investments was determined using significant unobservable inputs. ASC 820 classifies such inputs used to measure fair value as Level 3 within the valuation hierarchy. Our investments in money market funds are classified as Level 2. See Note 3 and Note 4 within the accompanying consolidated financial statements for further discussion.
   
 
(3)  
Security, or portion thereof, is held as collateral for the revolving credit facility (see Note 10). The market values of these investments at December 31, 2009 and June 30, 2009 were $339,012 and $434,069, respectively; they represent 50.5% and 67.2% of total investments at fair value, respectively.
   
 
(4)  
Floating rate loan. Stated interest rate was in effect at December 31, 2009 and June 30, 2009.
   
 
(5)  
There are several entities involved in the Biomass investment. We own 100 shares of common stock in Worcester Energy Holdings, Inc. (“WEHI”), representing 100% of the issued and outstanding common stock. WEHI, in turn, owns 51 membership certificates in Biochips LLC (“Biochips”), which represents a 51% ownership stake.
   
 
   
We own 282 shares of common stock in Worcester Energy Co., Inc. (“WECO”), which represents 51% of the issued and outstanding common stock. We own directly 1,665 shares of common stock in Change Clean Energy Inc. (“CCEI”), f/k/a Worcester Energy Partners, Inc., which represents 51% of the issued and outstanding common stock and the remaining 49% is owned by WECO. CCEI owns 100 shares of common stock in Precision Logging and Landclearing, Inc. (“Precision”), which represents 100% of the issued and outstanding common stock.
   
 
   
During the quarter ended March 31, 2009, we created two new entities in anticipation of the foreclosure proceedings against the co-borrowers (WECO, CCEI and Biochips) Change Clean Energy Holdings, Inc. (“CCEHI”) and DownEast Power Company, LLC (“DEPC”). We own 1,000 shares of CCEHI, representing 100% of the issued and outstanding stock, which in turn, owns a 100% of the membership interests in DEPC.
   
 
   
On March 11, 2009, we foreclosed on the assets formerly held by CCEI and Biochips with a successful credit bid of $6,000 to acquire the assets. The assets were subsequently assigned to DEPC. WECO, CCEI and Biochips are joint borrowers on the term note issued to Prospect Capital. Effective July 1, 2008, this loan was placed on non-accrual status.
   
 
   
Biochips, WECO, CCEI, Precision and WEHI currently have no material operations and no significant assets. As of June 30, 2009, our Board of Directors assessed a fair value of $0 for all of these equity positions and the loan position. We determined that the impairment of both CCEI and CCEHI as of June 30, 2009 was other than temporary and recorded a realized loss for the amount that the amortized cost exceeds the fair value at June 30, 2009. Our Board of Directors set the value of the remaining CCEHI investment at $1,976 and $2,530 as of December 31, 2009 and June 30, 2009, respectively.
   
 
(6)  
During the three months ended December 31, 2009, we created two new entities, Coalbed Inc. and Coalbed LLC, to foreclose on the outstanding senior secured loan and assigned rights and interests of Conquest Cherokee, LLC (“Conquest”), as a result of the deterioration of Conquest’s financial performance and inability to service debt payments. We own 1,000 shares of common stock in Coalbed Inc., representing 100% of the issued and outstanding common stock. Coalbed Inc., in turn owns 100% of the membership interest in Coalbed LLC.
   
 
   
On October 21, 2009, Coalbed LLC foreclosed on the loan formerly made to Conquest. As of December 31, 2009, our Board of Directors assessed a fair value of $3,686 for the equity and the loan position in Coalbed LLC.
   
 
(7)  
In addition to the stated returns, the net profits interest held will be realized upon sale of the borrower or a sale of the interests.
   
 
(8)  
Gas Solutions Holdings, Inc. is a wholly-owned investment of us.
   
 
(9)  
Entity was formed as a result of the debt restructuring of ESA Environmental Specialist, Inc. In early 2009, we foreclosed on the two loans on non-accrual status and purchased the underlying personal and real property. We own 1,000 shares of common stock in The Healing Staff (“THS”), f/k/a Lisamarie Fallon, Inc. representing 100% ownership. We own 1,500 shares of Vets Securing America, Inc. (“VSA”), representing 100% ownership. VSA is a holding company for the real property of Integrated Contract Services, Inc. (“ICS”) purchased during the foreclosure process.

 

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Table of Contents

PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS — (CONTINUED)
December 31, 2009 and June 30, 2009
(in thousands, except share data)
Endnote Explanations for the Consolidated Schedule of Investments as of December 31, 2009 and June 30, 2009 (Continued)
     
(10)  
Loan is with THS an affiliate of ICS.
   
 
(11)  
On June 30, 2008, we consolidated our holdings in four coal companies into Yatesville Coal Holdings, Inc. (“Yatesville”), and consolidated the operations under one management team. As part of the transaction, the debt that we held of C&A Construction, Inc. (“C&A”), Genesis Coal Corp. (“Genesis”), North Fork Collieries LLC (“North Fork”) and Unity Virginia Holdings LLC (“Unity”) were exchanged for newly issued debt from Yatesville, and our ownership interests in C&A, E&L Construction, Inc. (“E&L”), Whymore Coal Company Inc. (“Whymore”), Genesis and North Fork were exchanged for 100% of the equity of Yatesville. This reorganization allows for a better utilization of the assets in the consolidated group. Genesis Coal Corp. (“Genesis”), was not part of the transaction.
   
 
   
At December 31, 2009 and at June 30, 2009, Yatesville owned 100% of the membership interest of North Fork. In addition, Yatesville held a $9,325 and $8,062, respectively, note receivable from North Fork as of those two respective dates.
   
 
   
At December 31, 2009 and at June 30, 2009, Yatesville owned 90% and 87%, respectively, of the common stock of Genesis and held a note receivable of $20,897 and $20,802, respectively, as of those two respective dates.
   
 
   
Yatesville held a note receivable of $4,261 from Unity at December 31, 2009 and at June 30, 2009.
   
 
   
There are several entities involved in Yatesville’s investment in Whymore at June 30, 2009. As of June 30, 2009, Yatesville owned 10,000 shares of common stock or 100% of the equity and held a $14,973 senior secured debt receivable from C&A, which owns the equipment. Yatesville owned 10,000 shares of common stock or 100% of the equity of E&L, which leases the equipment from C&A, employs the workers, is listed as the operator with the Commonwealth of Kentucky, mines the coal, receives revenues and pays all operating expenses. Yatesville owned 4,900 shares of common stock or 49% of the equity of Whymore, which applies for and holds permits on behalf of E&L. Yatesville also owned 4,285 Series A convertible preferred shares in each of C&A, E&L and Whymore. Whymore and E&L are guarantors under the C&A credit agreement with Yatesville.
   
 
   
In August 2009, Yatesville sold its 49% ownership interest in the common shares of Whymore to the 51% holder of the Whymore common shares (“Whymore Purchaser”). All reclamation liability was transferred to the Whymore Purchaser. In September 2009, Yatesville completed an auction for all of its equipment.
   
 
   
Yatesville currently has no material operations. As of December 31, 2009, our Board of Directors determined that the impairment of Yatesville was other than temporary and we recorded a realized loss for the amount that the amortized cost exceeds the fair value. Our Board of Directors set the value of the remaining Yatesville investment at $1,035 as of December 31, 2009.
   
 
(12)  
There are several entities involved in the Appalachian Energy Holdings LLC (“AEH”) investment. We own warrants, the exercise of which will permit us to purchase 37,090 Class A common units of AEH at a nominal cost and in near-immediate fashion. We own 200 units of Series A preferred equity, 241 units of Series B preferred equity, and 500 units of Series C preferred equity of AEH. The senior secured notes are with C&S Operating LLC and East Cumberland L.L.C., both operating companies owned by AEH.
   
 
(13)  
On a fully diluted basis represents, 11.677% of voting common shares.
   
 
(14)  
Total common shares outstanding of 19,310,956 as of December 9, 2009 from Miller Petroleum, Inc.’s Quarterly Report on Form 10-Q filed on December 21, 2009 as applicable to our December 31, 2009 reporting date. Total common shares outstanding of 15,811,856 as of March 11, 2009 from Miller’s Quarterly Report on Form 10-Q filed on March 16, 2009.
   
 
(15)  
A portion of the positions listed were issued by an affiliate of the portfolio company.
   
 
(16)  
We own 99.9999% of AGC/PEP, LLC. AGC/PEP, LLC owns 2,038 out of a total of 83,639 shares (including 4,932 vested an unvested management options) of American Gilsonite Holding Company which owns 100% of American Gilsonite Company.
   
 
(17)  
Syndicated investment which had been originated by another financial institution and broadly distributed.
   
 
(18)  
Mistral Chip Holdings, LLC owns 44,800 shares out of 50,650 total shares outstanding of Chip Holdings, Inc., the parent company of Shearer’s Foods, Inc., before adjusting for management options.
   
 
(19)  
The overriding royalty interests held receive payments at the stated rates based upon operations of the borrower.
   
 
(20)  
On December 31, 2009, we sold our investment in Aylward Enterprises, LLC. AWCNC, LLC is the remaining holding company with zero assets and our remaining outstanding debt has no value of December 31, 2009.

 

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PROSPECT CAPITAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
(Unaudited)
(In thousands, except share and per share data)
Note 1. Organization
References herein to “we”, “us” or “our” refer to Prospect Capital Corporation (“Prospect”) and its subsidiary unless the context specifically requires otherwise.
We were formerly known as Prospect Energy Corporation, a Maryland corporation. We were organized on April 13, 2004 and were funded in an initial public offering (“IPO”), completed on July 27, 2004. We are a closed-end investment company that has filed an election to be treated as a Business Development Company (“BDC”), under the Investment Company Act of 1940 (the “1940 Act”). As a BDC, we have qualified and have elected to be treated as a regulated investment company (“RIC”), under Subchapter M of the Internal Revenue Code. We invest primarily in senior and subordinated debt and equity of companies in need of capital for acquisitions, divestitures, growth, development, project financings, recapitalizations, and other purposes.
On May 15, 2007, we formed a wholly-owned subsidiary, Prospect Capital Funding, LLC, a Delaware limited liability company, for the purpose of holding certain of our loan investments in the portfolio which are used as collateral for our credit facility.
Note 2. Patriot Acquisition
On December 2, 2009, we acquired the outstanding shares of Patriot Capital Funding, Inc. (“Patriot”) common stock for $201,083. 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 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, 2009, Patriot made a final dividend payment equal to its undistributed net ordinary income and capital gains of $0.38 per share. In accordance with a 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 final income distribution.
The merger has been accounted for as an acquisition of Patriot by Prospect in accordance with acquisition method of accounting as detailed in ASC 805, Business Combinations (“ASC 805”). 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 described in more detail in ASC 805, goodwill, if any, would have been recognized as of the acquisition date, if the consideration transferred exceeded the fair value of identifiable net assets acquired. As of the acquisition date, the fair value of the identifiable net assets acquired exceeded the fair value of the consideration transferred, and we recognized the excess as a gain. A gain of $5,714 was recorded by Prospect in the quarter ended December 31, 2009 related to the acquisition of Patriot. The acquisition of Patriot was negotiated in July 2009 with the purchase agreement being signed on August 3, 2009. Between July 2009 and December 2, 2009, our valuation of certain of the investments acquired from Patriot increased due to market improvement, which resulted in the recognition of the gain at closing.

 

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Preliminary Purchase Price Allocation
The purchase price has been allocated to the assets acquired and the liabilities assumed based on their estimated fair values as summarized in the following table:
         
Cash (to repay Patriot debt)
  $ 107,313  
Cash (to fund purchase of restricted stock from former Patriot employees)
    970  
Common stock issued (1)
    92,800  
 
     
Total purchase price
    201,083  
 
     
Assets acquired:
       
Investments (2)
    207,126  
Cash and cash equivalents
    1,697  
Other assets
    3,859  
 
     
Assets acquired
    212,682  
Other liabilities assumed
    (5,885 )
 
     
Net assets acquired
    206,797  
 
     
Preliminary gain on Patriot acquisition (3)
  $ 5,714  
 
     
     
(1)  
The value of the shares of common stock exchanged with the Patriot common shareholders was based upon the closing price of our common stock on December 2, 2009, the price immediately prior to the closing of the transaction.
 
(2)  
The fair value of Patriot’s investments were determined by the Board of Directors in conjunction with an independent valuation agent. This valuation resulted in a purchase price which was $98,150 below the amortized cost of such investments. For those assets which are performing, Prospect will record the accretion to par value in interest income over the remaining term of the investment.
 
(3)  
The preliminary gain has been determined based upon the estimated value of certain liabilities which are not yet settled. Any changes to such accruals will be recoded in future periods as an adjustment to such gain. We do not believe such adjustments will be material.
Preliminary Condensed Statement of Net Assets Acquired
The following condensed statement of net assets acquired reflects the preliminary values assigned to Patriot’s net assets as of the acquisition date, December 2, 2009.
         
Investment securities
  $ 207,126  
Cash and cash equivalents
    1,697  
Other assets
    3,859  
 
     
Total assets
    212,682  
 
       
Other liabilities
    (5,885 )
 
     
Preliminary fair value of net assets acquired
  $ 206,797  
 
     

 

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The following unaudited pro forma condensed combined financial information does not purport to be indicative of actual financial position or results of our operations had the Patriot acquisition actually been consummated at the beginning of each period presented. Certain one-time charges have been eliminated. The pro forma adjustments reflecting the allocation of the purchase price of Patriot and the gain of $5,714 recognized on the Patriot Acquisition have been eliminated from all periods presented. Management expects to realize net operating synergies from this transaction. The pro forma condensed combined financial information does not reflect the potential impact of these synergies and does not reflect any impact of additional accretion which would have been recognized on the transaction, except for that which was recorded after the transaction was consummated on December 2, 2009.
                                 
    Three months ended     Six months ended  
    December 31,     December 31,  
    2009     2008     2009     2008  
Total Investment Income
  $ 30,730     $ 32,384     $ 60,298     $ 78,412  
Net Investment Income
    18,098       16,392       31,812       44,953  
Net Increase (Decrease) in Net Assets Resulting from Operations
    (15,901 )     (11,944 )     (26,766 )     239  
Net Increase (Decrease) in Net Assets Resulting from Operations per share
    (0.25 )     (0.23 )     (0.44 )     0.00  
Note 3. Significant Accounting Policies
The following are significant accounting policies consistently applied by us:
Basis of Presentation
The accompanying interim financial statements, which are not audited, have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 6 and 10 of Regulation S-X, as appropriate.
Use of Estimates
The preparation of GAAP financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reported period. Changes in the economic environment, financial markets, creditworthiness of our portfolio companies and any other parameters used in determining these estimates could cause actual results to differ, and these differences could be material.
Basis of Consolidation
Under the 1940 Act rules, the regulations pursuant to Article 6 of Regulation S-X and the American Institute of Certified Public Accountants’ Audit and Accounting Guide for Investment Companies, we are precluded from consolidating any entity other than another investment company or an operating company which provides substantially all of its services and benefits to us. Our financial statements include our accounts and the accounts of Prospect Capital Funding, LLC, our only wholly-owned, closely-managed subsidiary that is also an investment company. All intercompany balances and transactions have been eliminated in consolidation.
Investment Classification
We are a non-diversified company within the meaning of the 1940 Act. We classify our investments by level of control. As defined in the 1940 Act, control investments are those where there is the ability or power to exercise a controlling influence over the management or policies of a company. Control is generally deemed to exist when a company or individual possesses or has the right to acquire within 60 days or less, a beneficial ownership of 25% or more of the voting securities of an investee company. Affiliated investments and affiliated companies are defined by a lesser degree of influence and are deemed to exist through the possession outright or via the right to acquire within 60 days or less, beneficial ownership of 5% or more of the outstanding voting securities of another person.

 

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Investments are recognized when we assume an obligation to acquire a financial instrument and assume the risks for gains or losses related to that instrument. Investments are derecognized when we assume an obligation to sell a financial instrument and forego the risks for gains or losses related to that instrument. Specifically, we record all security transactions on a trade date basis. Investments in other, non-security financial instruments are recorded on the basis of subscription date or redemption date, as applicable. Amounts for investments recognized or derecognized but not yet settled are reported as receivables for investments sold and payables for investments purchased, respectively, in the Consolidated Statements of Assets and Liabilities.
Investment Risks
The Company’s investments are subject to a variety of risks. Those risks include the following:
Market Risk
Market risk represents the potential loss that can be caused by a change in the fair value of the financial instrument.
Credit Risk
Credit risk represents the risk that the Partnership would incur if the counterparties failed to perform pursuant to the terms of their agreements with the Partnership.
Liquidity Risk
Liquidity risk represents the possibility that the Partnership may not be able to rapidly adjust the size of its positions in times of high volatility and financial stress at a reasonable price.
Interest Rate Risk
Interest rate risk represents a change in interest rates, which could result in an adverse change in the fair value of an interest-bearing financial instrument.
Prepayment Risk
Most of the Company’s debt investments allow for prepayment of principal without penalty. Downward changes in interest rates may cause prepayments to occur at a faster than expected rate, thereby effectively shortening the maturity of the security and making the security less likely to be an income producing instrument.
Investment Valuation
Our Board of Directors has established procedures for the valuation of our investment portfolio. These procedures are detailed below.
Investments for which market quotations are readily available are valued at such market quotations.
For most of our investments, market quotations are not available. With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, our Board of Directors has approved a multi-step valuation process each quarter, as described below:
         
  1 )  
Each portfolio company or investment is reviewed by our investment professionals with the independent valuation firm;
       
 
  2 )  
the independent valuation firm engaged by our Board of Directors conducts independent appraisals and makes their own independent assessment;
       
 
  3 )  
the audit committee of our Board of Directors reviews and discusses the preliminary valuation of our Investment Adviser and that of the independent valuation firm; and
       
 
  4 )  
the Board of Directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of our Investment Adviser, the respective independent valuation firm and the audit committee.

 

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Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. We adopted ASC 820 on a prospective basis beginning in the quarter ended September 30, 2008.
ASC 820 classifies the inputs used to measure these fair values into the following hierarchy:
Level 1: Quoted prices in active markets for identical assets or liabilities, accessible by us at the measurement date.
Level 2: Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.
Level 3: Unobservable inputs for the asset or liability.
In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to each investment. The changes to GAAP from the application of ASC 820 relate to the definition of fair value, framework for measuring fair value, and the expanded disclosures about fair value measurements. ASC 820 applies to fair value measurements already required or permitted by other standards. In accordance with ASC 820, the fair value of our investments is defined as the price that we would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market in which that investment is transacted.
In April 2009, the FASB issued ASC Subtopic 820-10-65, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“ASC 820-10”). This update provides further clarification for ASC 820 in markets that are not active and provides additional guidance for determining when the volume of trading level of activity for an asset or liability has significantly decreased and for identifying circumstances that indicate a transaction is not orderly. ASC 820-10-65 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of ASC 820-10-65 for the three and six months ended December 31, 2009, did not have any effect on our net asset value, financial position or results of operations as there was no change to the fair value measurement principles set forth in ASC 820.
Valuation of Other Financial Assets and Financial Liabilities
In February 2007, FASB issued ASC Subtopic 820-10-05-1, The Fair Value Option for Financial Assets and Financial Liabilities (“ASC 820-10-05-1”). ASC 820-10-05-1 permits an entity to elect fair value as the initial and subsequent measurement attribute for many of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. We adopted this statement on July 1, 2008 and have elected not to value other assets and liabilities at fair value as would be permitted by ASC 820-10-05-1.
Revenue Recognition
Realized gains or losses on the sale of investments are calculated using the specific identification method.
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Accretion of such purchase discounts or premiums is calculated by the effective interest method as of the purchase date and adjusted only for material amendments or prepayments. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as interest income. The purchase discount for portfolio investments acquired from Patriot was determined based on the difference between par value and fair market value as of December 2, 2009, and will continue to accrete until maturity or repayment of the respective loans.

 

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Dividend income is recorded on the ex-dividend date.
Structuring fees and similar fees are recognized as income as earned, usually when paid. Structuring fees, excess deal deposits, net profits interests and overriding royalty interests are included in other income.
Loans are placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Non-accrual loans are restored to accrual status when past due principal and interest is paid and in management’s judgment, are likely to remain current.
Federal and State Income Taxes
We have elected to be treated as a regulated investment company and intend to continue to comply with the requirements of the Internal Revenue Code of 1986 (the “Code”), applicable to regulated investment companies. We are required to distribute at least 90% of our investment company taxable income and intend to distribute (or retain through a deemed distribution) all of our investment company taxable income and net capital gain to stockholders; therefore, we have made no provision for income taxes. The character of income and gains that we will distribute is determined in accordance with income tax regulations that may differ from GAAP. Book and tax basis differences relating to stockholder dividends and distributions and other permanent book and tax differences are reclassified to paid-in capital.
If we do not distribute (or are not deemed to have distributed) at least 98% of our annual taxable income in the calendar year it is earned, we will generally be required to pay an excise tax equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such taxable income for the year. To the extent that we determine that our estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, we accrue excise taxes, if any, on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.
We adopted FASB ASC 740, Income Taxes (“ASC 740”). ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax benefit or expense in the current year. Adoption of ASC 740 was applied to all open tax years as of July 1, 2007. The adoption of ASC 740 did not have an effect on our net asset value, financial condition or results of operations as there was no liability for unrecognized tax benefits and no change to our beginning net asset value. As of December 31, 2009 and for the three and six months then ended, we did not have a liability for any unrecognized tax benefits. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof.
Dividends and Distributions
Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount, if any, to be paid as a dividend or distribution is approved by our Board of Directors each quarter and is generally based upon our management’s estimate of our earnings for the quarter. Net realized capital gains, if any, are distributed at least annually.
Financing Costs
We record origination expenses related to our credit facility as deferred financing costs. These expenses are deferred and amortized as part of interest expense using the effective interest method over the stated life of the facility.
We record registration expenses related to shelf filings as prepaid assets. These expenses consist principally of Securities and Exchange Commission (“SEC”) registration fees, legal fees and accounting fees incurred. These prepaid assets will be charged to capital upon the receipt of an equity offering proceeds or charged to expense if no offering completed.
Guarantees and Indemnification Agreements
We follow FASB ASC 460, Guarantees (“ASC 460”). ASC 460 elaborates on the disclosure requirements of a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires a guarantor to recognize, at the inception of a guarantee, for those guarantees that are covered by ASC 460, the fair value of the obligation undertaken in issuing certain guarantees. ASC 460 did not have a material effect on the financial statements. Refer to Note 4, Note 8 and Note 11 for further discussion of guarantees and indemnification agreements.

 

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Per Share Information
Net increase or decrease in net assets resulting from operations per common share are calculated using the weighted average number of common shares outstanding for the period presented. Diluted net increase or decrease in net assets resulting from operations per share are not presented as there are no potentially dilutive securities outstanding.
Subsequent Events
In May 2009, the FASB issued ASC 855, Subsequent Events (“ASC 855”). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The standard, which includes a new required disclosure of the date through which an entity has evaluated subsequent events, is effective for interim or annual periods ending after June 15, 2009. We evaluated all events or transactions that occurred after December 31, 2009 up through February 9, 2009, the date we issued the accompanying financial statements. During this period, we did not have any material recognizable subsequent events other than those disclosed in our financial statements.
Recent Accounting Pronouncements
In June 2009, the FASB issued ASC 105, Generally Accepted Accounting Principles (“ASC 105”), which establishes the FASB Codification which supersedes all existing accounting standard documents and will become the single source of authoritative non-governmental U.S. GAAP. All other accounting literature not included in the Codification will be considered non-authoritative. The Codification did not change GAAP but reorganizes the literature. ASC 105 is effective for interim and annual periods ending after September 15, 2009. We have conformed our financial statements and related Notes to the new Codification for the quarter ended December 31, 2009.
In June 2009, the FASB issued ASC 860, Accounting for Transfers of Financial Assets — an amendment to FAS 140 (“ASC 860”). ASC 860 improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets: the effects of a transfer on its financial position, financial performance, and cash flows: and a transferor’s continuing involvement, if any, in transferred financial assets. ASC 860 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Our management does not believe that the adoption of the amended guidance in ASC 860 will have a significant effect on our financial statements.
In June 2009, the FASB issued ASC 810, Amendments to FASB Interpretation No. 46(R) (“ASC 810”). ASC 810 is intended to (1) address the effects on certain provisions of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, as a result of the elimination of the qualifying special-purpose entity concept in ASC 860, and (2) constituent concerns about the application of certain key provisions of Interpretation 46(R), including those in which the accounting and disclosures under the Interpretation do not always provided timely and useful information about an enterprise’s involvement in a variable interest entity. ASC 810 is effective as of the beginning of our first annual reporting period that begins after November 15, 2009. Our management does not believe that the adoption of the amended guidance in ASC 860 will have a significant effect on our financial statements.
In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, Measuring Liabilities at Fair Value, to amend FASB Accounting Standards Codification ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), to clarify how entities should estimate the fair value of liabilities. ASC 820, as amended, includes clarifying guidance for circumstances in which a quoted price in an active market is not available, the effect of the existence of liability transfer restrictions, and the effect of quoted prices for the identical liability, including when the identical liability is traded as an asset. We adopted ASU 2009-05 effective October 1, 2009. The amended guidance in ASC 820 does not have a significant effect on our financial statements for the quarter ended December 31, 2009.
In September 2009, the FASB issued ASU 2009-12, Measuring Fair Value of Certain Investments (“ASU 2009-12”). This update provides further amendments to ASC 820 to offer investors a practical expedient for measuring the fair value of investments in certain entities that calculate net asset value per share. Specifically, measurement using net asset value per share is reasonable for investments within the scope of ASU 2009-12. We adopted ASU 2009-12 effective October 1, 2009. The amended guidance in ASC 820 does not have a significant effect on our financial statements for the quarter ended December 31, 2009.

 

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In January 2010, the FASB issued Accounting Standards Update 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASC 2010-06”). ASU 2010-06 amends ASC 820-10 and clarifies and provides additional disclosure requirements related to recurring and non-recurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009. Our management does not believe that the adoption of the amended guidance in ASC 820-10 will have a significant effect on our financial statements.
Note 4. Portfolio Investments
At December 31, 2009, we had invested in 55 long-term portfolio investments, which had an amortized cost of $633,636 and a fair value of $648,135. At June 30, 2009, we had invested in 30 long-term portfolio investments, which had an amortized cost of $531,424 and a fair value of $547,168.
As of December 31, 2009, we own controlling interests in Ajax Rolled Ring & Machine (“Ajax”), AWCNC, LLC, C&J Cladding, LLC (“C&J”), Change Clean Energy Holdings, Inc. (“CCEHI”), Coalbed, Inc./Coalbed, LLC (formerly Conquest Cherokee, LLC) (“Coalbed”), Fischbein, LLC (“Fischbein”), Freedom Marine Services LLC (“Freedom Marine”), Gas Solutions Holdings, Inc. (“GSHI”), Integrated Contract Services, Inc. (“ICS”), Iron Horse Coiled Tubing, Inc. (“Iron Horse”), NRG Manufacturing, Inc. (“NRG”), Nupla Corporation (“Nupla”), R-V Industries, Inc. (“R-V”), Sidump’r Trailer Company, Inc. (“Sidump’r”) and Yatesville Coal Holdings, Inc. (“Yatesville”). We also own an affiliated interest in Appalachian Energy Holdings, LLC (“AEH”), Biotronic NeuroNetwork (“Biotronic”), Boxercraft Incorporated (“Boxercraft”), KTPS Holdings, LLC (“KTPS”), Miller Petroleum, Inc. (“Miller”), Smart, LLC (“Smart”) and Sport Helmets Holdings, LLC (“Sport Helmets”).
The fair values of our portfolio investments as of December 31, 2009 disaggregated into the three levels of the ASC 820 valuation hierarchy are as follows:
                                 
            Significant              
    Quoted Prices in     Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Securities     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
Investments at fair value
                               
Control investments
  $     $     $ 191,898     $ 191,898  
Affiliate investments
                66,479       66,479  
Non-control/non-affiliate investments
    118             389,640       389,758  
 
                       
 
    118             648,017       648,135  
Investments in money market funds
          23,418             23,418  
 
                       
Total assets reported at fair value
  $ 118     $ 23,418     $ 648,017     $ 671,553  
 
                       

 

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The aggregate values of Level 3 portfolio investments changed during the six months ended December 31, 2009 as follows:
                                 
    Fair Value Measurements Using Unobservable Inputs (Level 3)  
                    Non-Control/        
    Control     Affiliate     Non-Affiliate        
    Investments     Investments     Investments     Total  
Fair value as of June 30, 2009
  $ 206,332     $ 32,254     $ 308,582     $ 547,168  
Total realized losses
    (51,229 )                 (51,229 )
Change in unrealized appreciation (depreciation)
    7,390       (283 )     (7,209 )     (102 )(1)
Assets acquired in the Patriot acquisition
    10,534       36,400       160,073       207,007  
Purchases of portfolio investments
    5,854             1,467       7,321  
Payment-in-kind interest
    725       193       1,141       2,059  
Accretion of original issue discount
    3,343       281       3,046       6,670  
Dispositions of portfolio investments
    (8,733 )     (2,516 )     (59,628 )     (70,877 )
Transfers within Level 3
    17,682       150       (17,832 )      
Transfers in (out) of Level 3
                       
 
                       
Fair value as of December 31, 2009
  $ 191,898     $ 66,479     $ 389,640     $ 648,017  
 
                       
     
(1)  
Relates to assets held at December 31, 2009.
As of December 31, 2009, the valuation methodology for Ajax changed from a discounted cash flow analysis to an enterprise and equity valuation. The independent valuation agent proposed this adjustment due to our controlling equity interest in Ajax. As a result, and combined with declining financial results, the fair market value of Ajax decreased from $31,638 to $25,802 as of June 30, 2009 and December 31, 2009, respectively. There were no other material changes to our valuation methodology.
At December 31, 2009, nine loan investments were on non-accrual status: AEH, Coalbed, Deb Shops, ICS, Iron Horse, Nupla, Sidump’r, Wind River Resources Corp. and Wind River II Corp. (“Wind River”), and Yatesville. At June 30, 2009, five loan investments were on non-accrual status: AEH, Coalbed, ICS, Wind River and Yatesville. The loan principal of these loans amounted to $146,376 and $92,513 as of December 31, 2009 and June 30, 2009, respectively. The fair values of these investments represent approximately 5.7% and 7.3% of our net assets as of December 31, 2009 and June 30, 2009, respectively. For the three months ended December 31, 2009 and December 31, 2008, the income foregone as a result of not accruing interest on non-accrual debt investments amounted to $8,052 and $2,528, respectively. For the six months ended December 31, 2009 and December 31, 2008, the income foregone as a result of not accruing interest on non-accrual debt investments amounted to $12,510 and $4,983, respectively. At December 31, 2009, we held one asset on which payment of interest was past-due more than 90 days for which we continue to accrue interest, H&M Oil and Gas, LLC. The principal balance of this loan is $49,661 and the accrued interest receivable is $2,744 at December 31, 2009. We expect full repayment of principal and interest on this loan.
During the three months ended December 31, 2009, we discontinued operations at Yatesville. As of December 31, 2009, consistent with the decision to discontinue operations, we determined that the impairment of Yatesville was other-than-temporary and recorded a realized loss of $51,228 for the amount that the amortized cost exceeded the fair market value. As of December 31, 2009 and June 30, 2009, Yatesville is valued at $1,035 and $13,097, respectively.
GSHI has indemnified us against any legal action arising from its investment in Gas Solutions, LP. We have incurred approximately $2,093 from the inception of the investment in GSHI through December 31, 2009 for fees associated with a legal action, and GSHI has reimbursed us for the entire amount. Of the $2,093 reimbursement, $41 and $182 was reflected as dividend income: control investments in the Consolidated Statements of Operations for the three and six months ended December 31, 2008, respectively. There were no such legal fees incurred or reimbursed for the three and six months ended December 31, 2009. Additionally, certain other expenses incurred by us which are attributable to GSHI have been reimbursed by GSHI and are reflected as dividend income: control investments in the Consolidated Statements of Operations. For the three months ended December 31, 2009 and December 31, 2008, such reimbursements totaled as $800 and $1,895, respectively. For the six months ended December 31, 2009 and December 31, 2008, such reimbursements totaled as $2,031and $3,515, respectively.
The original cost basis of debt placements and equity securities acquired (including purchases of portfolio investments, follow-on investments and payment-in-kind interest) totaled to approximately $210,438 and $13,564 during the three months ended December 31, 2009 and December 31, 2008, respectively. These placements and acquisitions totaled to approximately $216,506 and $84,020 during the six months ended December 31, 2009 and December 31, 2008, respectively. The $210,438 and $216,506 for the three and six months ended December 31, 2009, respectively, include $207,126 of portfolio investments acquired from Patriot. Debt repayments and sales of equity securities with a cost basis of approximately $45,494 and $2,112 were received during the three months ended December 31, 2009 and December 31, 2008, respectively. These repayments and sales amounted to $69,735 and $11,416 during the six months ended December 31, 2009 and December 31, 2008, respectively.

 

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Note 5. Other Investment Income
Other investment income consists of the gain on our acquisition of Patriot, structuring and amendment fees, overriding royalty interests, settlement of net profit interests, deal deposits, administrative agent fee, and other miscellaneous and sundry cash receipts. Income from such sources for the three and six months ended December 31, 2009 and December 31, 2008 were as follows:
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31,     December 31,  
Income Source   2009     2008     2009     2008  
 
                               
Gain on Patriot acquisition
  $ 5,714     $     $ 5,714     $  
Structuring and amendment fees
    398       87       803       774  
Overriding royalty interests
    44       173       88       331  
Settlement of net profits interests
    10             10       12,576  
Miscellaneous
    8       47       23       146  
 
                       
Other Investment Income
  $ 6,174     $ 307     $ 6,638     $ 13,827  
 
                       
Note 6. Equity Offerings and Related Expenses
We issued 11,437,797 shares of our common stock in public and private offerings during the six months ended December, 2009. We did not issue any common stock during the six months ended December 31, 2008. The proceeds raised, the related underwriting fees, the offering expenses and the prices at which these shares were issued are as follows:
                                         
                    Gross              
    Number of     Offering     Proceeds     Underwriting     Offering  
Issuances of Common Stock   Shares Issued     Price     Raised     Fees     Expenses  
 
                                       
July 7, 2009
    5,175,000     $ 9.000     $ 46,575     $ 2,329     $ 200  
 
                                       
August 20, 2009 (1)
    3,449,686     $ 8.500     $ 29,322           $ 117  
 
                                       
September 24, 2009 (1)
    2,807,111     $ 9.000     $ 25,264           $ 840  
     
(1)  
Concurrent with the sale of these shares, we entered into a registration rights agreement in which we granted the purchasers certain registration rights with respect to the shares. We have filed with the SEC a post-effective amendment to the registration statement on Form N-2 which has been declared effective by the SEC.
Our shareholders’ equity accounts at December 31, 2009 and June 30, 2009 reflect cumulative shares issued as of those respective dates. Our common stock has been issued through public offerings, a registered direct offering, private offerings, the exercise of over-allotment options on the part of the underwriters, our dividend reinvestment plan and business combinations. When our common stock is issued, the related offering expenses have been charged against paid-in capital in excess of par. All underwriting fees and offering expenses were borne by us.
On December 2, 2009, we issued 8,444,068 shares of common stock to acquire Patriot. This transaction is described in further detail in Note 2.
On July 20, 2009 and October 19, 2009, we issued shares of our common stock in connection with the dividend reinvestment plan of 297,274 and 233,523, respectively.

 

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On October 9, 2008, our Board of Directors approved a share repurchase plan under which we may repurchase up to $20,000 of our common stock at prices below our net asset value as reported in our financial statements published for the year ended June 30, 2008. We have not made any purchases of our common stock during the period from October 9, 2008 to December 31, 2009 pursuant to this plan.
Note 7. Net Decrease (Increase) in Net Assets per Common Share
The following information sets forth the computation of net (decrease) increase in net assets resulting from operations per common share for the three and six months ended December 31, 2009 and December 31, 2008, respectively.
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31,     December 31,  
    2009     2008     2009     2008  
Net (decrease) increase in net assets resulting from operations
  $ (16,853 )   $ 6,524     $ (23,231 )   $ 20,522  
Weighted average common shares outstanding
    57,613,489       29,618,762       53,709,197       29,569,571  
 
                       
Net (decrease) increase in net assets resulting from operations per common share
  $ (0.29 )   $ 0.22     $ (0.43 )   $ 0.69  
 
                       
Note 8. Related Party Agreements and Transactions
Investment Advisory Agreement
We have entered into an investment advisory and management agreement with Prospect Capital Management (the “Investment Advisory Agreement”) under which the Investment Adviser, subject to the overall supervision of our Board of Directors, manages the day-to-day operations of, and provides investment advisory services to us. Under the terms of the Investment Advisory Agreement, our Investment Adviser: (i) determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes, (ii) identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio companies); and (iii) closes and monitors investments we make.
Prospect Capital Management’s services under the Investment Advisory Agreement are not exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired. For providing these services the Investment Adviser receives a fee from us, consisting of two components: a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 2.00% on our gross assets (including amounts borrowed). For services currently rendered under the Investment Advisory Agreement, the base management fee is payable quarterly in arrears. The base management fee is calculated based on the average value of our gross assets at the end of the two most recently completed calendar quarters and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.
The total base management fees incurred to the favor of the Investment Adviser for the three months ended December 31, 2009 and December 31, 2008 were $3,176, and $2,940, respectively. The fees incurred for the six months ended December 31, 2009 and December 31, 2008 were $6,385, and $5,763, respectively.
The incentive fee has two parts. The first part, the income incentive fee, is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees and other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the Administration Agreement described below, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment in kind interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding calendar quarter, is compared to a “hurdle rate” of 1.75% per quarter (7.00% annualized).

 

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The net investment income used to calculate this part of the incentive fee is also included in the amount of the gross assets used to calculate the 2.00% base management fee. We pay the Investment Adviser an income incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:
   
no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle rate;
 
   
100.00% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 125.00% of the quarterly hurdle rate in any calendar quarter (8.75% annualized assuming a 7.00% annualized hurdle rate); and
 
   
20.00% of the amount of our pre-incentive fee net investment income, if any, that exceeds 125.00% of the quarterly hurdle rate in any calendar quarter (8.75% annualized assuming a 7.00% annualized hurdle rate).
These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.
The second part of the incentive fee, the capital gains incentive fee, is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date), and equals 20.00% of our realized capital gains for the calendar year, if any, computed net of all realized capital losses and unrealized capital depreciation at the end of such year. In determining the capital gains incentive fee payable to the Investment Adviser, we calculate the aggregate realized capital gains, aggregate realized capital losses and aggregate unrealized capital depreciation, as applicable, with respect to each investment that has been in its portfolio. For the purpose of this calculation, an “investment” is defined as the total of all rights and claims which maybe asserted against a portfolio company arising from our participation in the debt, equity, and other financial instruments issued by that company. Aggregate realized capital gains, if any, equals the sum of the differences between the aggregate net sales price of each investment and the aggregate cost basis of such investment when sold or otherwise disposed. Aggregate realized capital losses equal the sum of the amounts by which the aggregate net sales price of each investment is less than the aggregate cost basis of such investment when sold or otherwise disposed. Aggregate unrealized capital depreciation equals the sum of the differences, if negative, between the aggregate valuation of each investment and the aggregate cost basis of such investment as of the applicable calendar year-end . At the end of the applicable calendar year, the amount of capital gains that serves as the basis for our calculation of the capital gains incentive fee involves netting aggregate realized capital gains against aggregate realized capital losses on a since-inception basis and then reducing this amount by the aggregate unrealized capital depreciation. If this number is positive, then the capital gains incentive fee payable is equal to 20.00% of such amount, less the aggregate amount of any capital gains incentive fees paid since inception.
For the three months ended December 31, 2009 and December 31, 2008, income incentive fees of $4,231 and $2,990, respectively, were incurred. For the six months ended December 31, 2009 and December 31, 2008, income incentive fees of $7,311 and $8,865, respectively, were incurred. No capital gains incentive fees were incurred for the three or six months ended December 31, 2009 and December 31, 2008.
Administration Agreement
We have also entered into an Administration Agreement with Prospect Administration, LLC (“Prospect Administration”) under which Prospect Administration, among other things, provides (or arranges for the provision of) administrative services and facilities for us. For providing these services, we reimburse Prospect Administration for our allocable portion of overhead incurred by Prospect Administration in performing its obligations under the Administration Agreement, including rent and our allocable portion of the costs of our chief compliance officer and chief financial officer and their respective staffs. For the three months ended December 31, 2009 and 2008, the reimbursement was approximately $840 and $588, respectively. For the six months ended December 31, 2009 and 2008, the reimbursement was approximately $1,680 and $1,176, respectively. Under this agreement, Prospect Administration furnishes us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Prospect Administration also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records that we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, Prospect Administration assists us in determining and publishing our net asset value, overseeing the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the Administration Agreement, Prospect Administration also provides on our behalf managerial assistance to those portfolio companies to which we are required to provide such assistance. The Administration Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. Prospect Administration is a wholly owned subsidiary of our Investment Adviser.

 

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The Administration Agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, Prospect Administration and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Prospect Administration’s services under the Administration Agreement or otherwise as administrator for us.
Prospect Administration, pursuant to the approval of our Board of Directors, engaged Vastardis Fund Services LLC (“Vastardis”) to serve as our sub-administrator to perform certain services required of Prospect Administration. Under the sub-administration agreement, Vastardis provided us with office facilities, equipment, clerical, bookkeeping and record keeping services at such facilities. Vastardis also conducted relations with custodians, depositories, transfer agents, dividend disbursing agents, other stockholder servicing agents, accountants, attorneys, underwriters, brokers and dealers, corporate fiduciaries, insurers, banks and such other persons in any such other capacity deemed to be necessary or desirable. Vastardis provided reports to the Administrator and the Directors of its performance of obligations and furnished advice and recommendations with respect to such other aspects of our business and affairs as it shall determine to be desirable. Under the sub-administration agreement, Vastardis also provided the service of William E. Vastardis as our Chief Financial Officer (“CFO”). We compensated Vastardis for providing us these services by the payment of an asset-based fee with a $400 annual minimum, payable monthly. Our service agreement was amended on September 28, 2008 so that Mr. Vastardis no longer served as our CFO effective as of November 11, 2008. At that time, Brian H. Oswald, a managing director at Prospect Administration, assumed the role of CFO.
We terminated our agreement with Vastardis to provide sub-administration services effective June 30, 2009. We entered into a new consulting services agreement for the period from July 1, 2009 until the filing of our Form 10-K for the year ended June 30, 2009. We paid Vastardis a total of $30 for services rendered in conjunction with preparation of Form 10-K under the new agreement. All services previously provided by Vastardis were assumed by Prospect Administration beginning on July 1, 2009 for the fiscal year ending June 30, 2010 and thereafter.
Managerial Assistance
As a business development company, we offer, and must provide upon request, managerial assistance to certain of our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. We billed $260 and $215 of managerial assistance fees for the three months ended December 31, 2009 and June 30, 2009, respectively, of which $135 and $60 remains on the consolidated statement of assets and liabilities as of December 31, 2009, and June 30, 2009, respectively. We billed $461 and $431 of managerial assistance fees for the six months ended December 31, 2009 and June 30, 2009, respectively. These fees are paid to the Administrator when received. We simultaneously accrue a payable to the Administrator for the same amounts, which remain on the consolidated statements of assets and liabilities.

 

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Note 9. Financial Highlights
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31, 2009     December 31, 2008     December 31, 2009     December 31, 2008  
Per Share Data(1):
                               
Net asset value at beginning of period
  $ 11.11     $ 14.63     $ 12.40     $ 14.55  
Net investment income
    0.29       0.40       0.54       1.20  
Net realized gain (loss)
    (0.89 )           (0.95 )     0.06  
Net unrealized appreciation (depreciation)
    0.30       (0.18 )     (0.02 )     (0.56 )
Net decrease in net assets as a result of public offerings and DRIP issuance
    (0.01 )           (0.79 )      
Net increase in net assets as a result of shares issued for Patriot acquisition
    0.08             0.14        
Dividends declared and paid
    (0.82 )     (0.42 )     (1.26 )     (0.82 )
 
                       
Net asset value at end of period
  $ 10.06     $ 14.43     $ 10.06     $ 14.43  
 
                       
 
                               
Per share market value at end of period
  $ 11.81     $ 11.97     $ 11.81     $ 11.97  
Total return based on market value(2)
    14.09 %     (3.41 %)     37.87 %     (3.17 %)
Total return based on net asset value(2)
    (6.32 %)     1.96 %     (12.87 %)     5.74 %
Shares outstanding at end of period
    63,349,746       29,637,928       63,349,746       29,637,928  
Average weighted shares outstanding for period
    57,613,489       29,618,762       53,709,197       29,569,571  
 
                               
Ratio / Supplemental Data:
                               
Net assets at end of period (in thousands)
  $ 637,477     $ 427,803     $ 637,477     $ 427,803  
Annualized ratio of operating expenses to average net assets
    7.65 %     9.34 %     7.24 %     10.14 %
Annualized ratio of net operating income to average net assets
    10.91 %     11.33 %     9.77 %     16.86 %

 

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Note 9. Financial Highlights (continued)
                                         
    Year     Year     Year     Year     Year  
    Ended     Ended     Ended     Ended     Ended  
    June 30,     June 30,     June 30,     June 30,     June 30,  
    2009     2008     2007     2006     2005  
Per Share Data(1):
                                       
Net asset value at beginning of period
  $ 14.55     $ 15.04     $ 15.31     $ 14.59     $ (0.01 )
Costs related to the initial public offering
                      0.01       (0.21 )
Costs related to the secondary public offering
          (0.07 )     (0.06 )            
Net investment income
    1.87       1.91       1.47       1.21       0.34  
Realized (loss) gain
    (1.24 )     (0.69 )     0.12       0.04        
Net unrealized appreciation (depreciation)
    0.48       (0.05 )     (0.52 )     0.58       0.90  
Net (decrease) increase in net assets as a result of public offering
    (2.11 )           0.26             13.95  
Dividends declared and paid
    (1.15 )     (1.59 )     (1.54 )     (1.12 )     (0.38 )
 
                             
Net asset value at end of period
  $ 12.40     $ 14.55     $ 15.04     $ 15.31     $ 14.59  
 
                             
 
                                       
Per share market value at end of period
  $ 9.20     $ 13.18     $ 17.47     $ 16.99     $ 12.60  
Total return based on market value(2)
    (22.04 %)     (15.90 %)     12.65 %     44.90 %     (13.46 %)
Total return based on net asset value(2)
    (4.81 %)     7.84 %     7.62 %     12.76 %     7.40 %
Shares outstanding at end of period
    42,943,084       29,520,379       19,949,065       7,069,873       7,055,100  
Average weighted shares outstanding for period
    31,559,905       23,626,642       15,724,095       7,056,846       7,055,100  
 
                                       
Ratio / Supplemental Data:
                                       
Net assets at end of period
  $ 532,596     $ 429,623     $ 300,048     $ 108,270     $ 102,967  
Annualized ratio of operating expenses to average net assets
    9.03 %     9.62 %     7.36 %     8.19 %     5.52 %
Annualized ratio of net investment income to average net assets
    13.14 %     12.66 %     9.71 %     7.90 %     8.50 %
     
(1)  
Financial highlights are based on weighted average shares.
 
(2)  
Total return based on market value is based on the change in market price per share between the opening and ending market prices per share in each period and assumes that dividends are reinvested in accordance with our dividend reinvestment plan. Total return based on net asset value is based upon the change in net asset value per share between the opening and ending net asset values per share in each period and assumes that dividends are reinvested in accordance with our dividend reinvestment plan.
Note 10. Revolving Credit Agreements
On June 6, 2007, we closed on a $200,000 three-year revolving credit facility (as amended on December 31, 2007) with Rabobank Nederland (“Rabobank”) as administrative agent and sole lead arranger (the “Rabobank Facility”). Until November 14, 2008, interest on the Rabobank Facility was charged at LIBOR plus 175 basis points; thereafter, under the terms of a commitment letter with Rabobank to arrange and structure a new rated credit facility, we agreed to an immediate increase in the current borrowing rate on the Rabobank Facility to LIBOR plus 250 basis points. Additionally, Rabobank charged a fee on the unused portion of the facility. This fee is assessed at the rate of 37.5 basis points per annum of the amount of that unused portion.
On June 25, 2009, we completed a first closing on an expanded $250,000 revolving credit facility (the “Syndicated Facility”). The new Syndicated Facility, which had $195,000 and $175,000 total commitments as of December 31, 2009 and June 30, 2009, respectively, includes an accordion feature which allows the Syndicated Facility to accept up to an aggregate total of $250,000 of commitments for which we continue to solicit additional commitments from other lenders for the additional $55,000 as of December 31, 2009. The revolving period extends through June 24, 2010. If not renewed or extended by the participant banks, a one year amortization period would commence whereby we may not borrow additional funds. Thereafter for ten years, all principal, interest and fee payments received in conjunction with collateral pledged to the Syndicated Facility, less a monthly servicing fee payable to us, are required to be used to repay outstanding borrowings under the Syndicated Facility. Any remaining outstanding borrowings would be due and payable on the commitment termination date, which is currently June 24, 2011.

 

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The Syndicated Facility contains restrictions pertaining to the geographic and industry concentrations of funded loans, maximum size of funded loans, interest rate payment frequency of funded loans, maturity dates of funded loans and minimum equity requirements. The Syndicated Facility also contains certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early termination of the Syndicated Facility. The Syndicated Facility also requires the maintenance of a minimum liquidity requirement. At December 31, 2009 and June 30, 2009, we were in compliance with the applicable covenants.
Interest on borrowings under the credit facility is one-month LIBOR plus 400 basis points, subject to a minimum Libor floor of 200 basis points. Additionally, the banks charge a fee on the unused portion of the credit facility equal to 100 basis points. As of December 31, 2009 and June 30, 2009, we had $10,000 and $124,800 outstanding under our credit facility, respectively. As of December 31, 2009 and June 30, 2009, $62,914 and $946 was available to us for additional borrowing under our credit facility, respectively. As we make additional investments which are eligible to be pledged under the credit facility, we will generate additional availability to the extent such investments are eligible to be placed into the borrowing base. At December 31, 2009 and June 30, 2009, the investments used as collateral for the Syndicated Facility had an aggregate market value of $339,012 and $434,069, which represents 53.2% and 81.5% of net assets, respectively.
In connection with the origination and amendment of the Syndicated Facility, we incurred approximately $9,472 of fees which are being amortized over the term of the facility.
Note 11. Commitments and Off-Balance Sheet Risks
From time to time, we provide guarantees for portfolio companies for payments to counterparties, usually as an alternative to investing additional capital. We provide indemnifications to Prospect Administration in accordance with our respective agreements with that service provider. These indemnifications are described in further detail in Note 8. As of December 31, 2009, no other material contingency agreements exist.
Note 12. Litigation
From time to time, we may become involved in various investigations, claims and legal proceedings that arise in the ordinary course of our business. These matters may relate to intellectual property, employment, tax, regulation, contract or other matters. The resolution of these matters as they arise will be subject to various uncertainties and, even if such claims are without merit, could result in the expenditure of significant financial and managerial resources.
On December 6, 2004, Dallas Gas Partners, L.P. (“DGP”) served us with a complaint filed November 30, 2004 in the U.S. District for the Southern District of Texas, Galveston Division. DGP alleges that DGP was defrauded and that we breached our fiduciary duty to DGP and tortiously interfered with DGP’s contract to purchase Gas Solutions, Ltd. (a subsidiary of our portfolio company, GSHI) in connection with our alleged agreement in September 2004 to loan DGP funds with which DGP intended to buy Gas Solutions, Ltd. for approximately $26,000. The complaint sought relief not limited to $100,000. On November 30, 2005, U.S. Magistrate Judge John R. Froeschner of the U.S. District Court for the Southern District of Texas, Galveston Division, issued a recommendation that the court grant our Motion for Summary Judgment dismissing all claims by DGP. On February 21, 2006, U.S. District Judge Samuel Kent of the U.S. District Court for the Southern District of Texas, Galveston Division issued an order granting our Motion for Summary Judgment dismissing all claims by DGP, against us. On May 16, 2007, the Court also granted us summary judgment on DGP’s liability to us on our counterclaim for DGP’s breach of a release and covenant not to sue. On January 4, 2008, the Court, Judge Melinda Harmon presiding, granted our motion to dismiss all DGP’s claims asserted against certain of our officers and affiliates. On August 20, 2008, Judge Harmon entered a Final Judgment dismissing all of DGP’s claims. DGP appealed to the U.S. Court of Appeals for the Fifth Circuit, which affirmed the Final Judgment on June 24, 2009. DGP then moved for rehearing on July 8, 2009, which the Fifth Circuit denied on August 6, 2009. Our damage claims against DGP remain pending.

 

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In May 2006, based in part on unfavorable due diligence and the absence of investment committee approval, we declined to extend a loan for $10,000 to a potential borrower (“plaintiff”). Plaintiff was subsequently sued by its own attorney in a local Texas court for plaintiff’s failure to pay fees owed to its attorney. In December 2006, plaintiff filed a cross-action against us and certain affiliates (the “defendants”) in the same local Texas court, alleging, among other things, tortuous interference with contract and fraud. We petitioned the United States District Court for the Southern District of New York (the “District Court”) to compel arbitration and to enjoin the Texas action. In February 2007, our motions were granted. Plaintiff appealed that decision. On July 24, 2008, the Second Circuit Court of Appeals affirmed the judgment of the District Court. The arbitration commenced in July 2007 and concluded in late November 2007. Post-hearing briefings were completed in February 2008. On April 14, 2008, the arbitrator rendered an award in our favor, rejecting all of plaintiff’s claims. On April 18, 2008, we filed a petition before the District Court to confirm the award. On October 8, 2008, the District Court granted the Company’s petition to confirm the award, confirmed the awards and subsequently entered judgment thereon in favor of the Company in the amount of $2,288. After filing a defective notice of appeal to the United States Court of Appeals for the Second Circuit on November 5, 2008, plaintiff’s counsel resubmitted a new notice of appeal on January 9, 2009. The plaintiff subsequently requested that the Company agree to stipulate to the withdrawal of plaintiff’s appeal to the Second Circuit. Such a stipulation was filed with the Second Circuit on or about April 14, 2009. Based on this stipulation, the Second Circuit issued a mandate terminating the appeal, which was transmitted to the District Court on April 23, 2009. Post-judgment discovery against plaintiff is continuing and we have filed a motion for sanctions against plaintiff’s counsel. Argument for the motion for sanctions was held on November 19, 2009 and a decision from the court is pending.
Note 13. Selected Quarterly Financial Data (Unaudited)
                                                                 
                                    Net Realized and     Net Increase (Decrease)  
                                    Unrealized     in Net Assets from  
    Investment Income     Net Investment Income     Gains (Losses)     Operations  
Quarter Ended   Total     Per Share (1)     Total     Per Share (1)     Total     Per Share (1)     Total     Per Share (1)  
September 30, 2006
  $ 6,432     $ 0.65     $ 3,274     $ 0.33     $ 690     $ 0.07     $ 3,964     $ 0.40  
December 31, 2006
    8,171       0.60       4,493       0.33       (1,553 )     (0.11 )     2,940       0.22  
March 31, 2007
    12,069       0.61       7,015       0.36       (2,039 )     (0.10 )     4,976       0.26  
June 30, 2007
    14,009       0.70       8,349       0.42       (3,501 )     (0.18 )     4,848       0.24  
 
                                                               
September 30, 2007
    15,391       0.77       7,865       0.39       685       0.04       8,550       0.43  
December 31, 2007
    18,563       0.80       10,660       0.46       (14,346 )     (0.62 )     (3,686 )     (0.16 )
March 31, 2008
    22,000       0.92       12,919       0.54       (14,178 )     (0.59 )     (1,259 )     (0.05 )
June 30, 2008
    23,448       0.85       13,669       0.50       10,317       0.38       23,986       0.88  
 
                                                               
September 30, 2008(2)
    35,799       1.21       23,502       0.80       (9,504 )     (0.33 )     13,998       0.47  
December 31, 2008
    22,213       0.75       11,960       0.40       (5,436 )     (0.18 )     6,524       0.22  
March 31, 2009
    20,669       0.69       11,720       0.39       3,611       0.12       15,331       0.51  
June 30, 2009
    21,800       0.59       11,981       0.32       (12,730 )     (0.34 )     (749 )     (0.02 )
 
                                                               
September 30, 2009
    21,517       0.43       12,318       0.25       (18,696 )     (0.38 )     (6,378 )     (0.13 )
December 31, 2009
    28,883       0.50       16,925       0.29       (33,778 )     (0.59 )     (16,853 )     (0.29 )
 
     
(1)  
Per share amounts are calculated using weighted average shares during period.
 
(2)  
Additional income for this quarter was driven by other investment income from the settlement of net profits interests on IEC Systems LP and Advanced Rig Services LLC.

 

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Note 14. Subsequent Events
On January 25, 2010, we issued 236,985 shares of our common stock in connection with the dividend reinvestment plan.
On January 4, 2010, we completed a closing for an additional $15,000 commitment to the Syndicated Facility, increasing total commitments to $210,000.
Merger Discussions with Allied Capital Corporation
On January 14, 2010, Prospect Capital delivered a proposal letter to the Allied Capital Board (the “First Prospect Capital Merger Offer Letter”) containing an offer to acquire each outstanding Allied Capital Corporation (“Allied Capital”) Share in exchange for 0.385 of a share of Prospect Capital Common Stock (the “First Prospect Capital Merger Offer”).
On January 19, 2010, Allied Capital filed a Form 8-K stating that the Allied Capital Board determined that the First Prospect Capital Merger Offer did not constitute a “Superior Proposal” as such term is defined in the Ares Capital Merger Agreement.
On January 20, 2010, Prospect Capital issued a press release containing a copy of a letter it subsequently sent to the Allied Capital Board in connection with the First Prospect Capital Merger Offer.
On January 26, 2010, Prospect Capital announced that it delivered another letter to the Allied Capital Board, raising its offer to acquire Allied Capital (the “Second Prospect Capital Merger Offer Letter”).
On February 3, 2010, Allied Capital informed us and filed a Form 8-K stating that the Allied Capital Board determined that the Second Prospect Capital Merger Offer did not constitute a “Superior Proposal” as such term is defined in the Ares Capital Merger Agreement.
On February 9, 2010, Prospect Capital announced that it delivered another letter to the Allied Capital Board, raising its offer to acquire Allied Capital (the “Third Prospect Capital Merger Offer Letter”).

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(All figures in this item are in thousands except share, per share and other data)
References herein to “we,” “us” or “our” refer to Prospect Capital Corporation and its subsidiary unless the context specifically requires otherwise.
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this quarterly report on Form 10-Q. Historical results set forth are not necessarily indicative of our future financial position and results of operations.
Note on Forward Looking Statements
Some of the statements in this report constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained herein involve risks and uncertainties, including statements as to:
   
our future operating results;
 
   
our business prospects and the prospects of our portfolio companies;
 
   
the impact of investments that we expect to make;
 
   
our contractual arrangements and relationships with third parties;
 
   
the dependence of our future success on the general economy and its impact on the industries in which we invest;
 
   
the ability of our portfolio companies to achieve their objectives;
 
   
our expected financings and investments;
 
   
the adequacy of our cash resources and working capital; and
 
   
the timing of cash flows, if any, from the operations of our portfolio companies.
We generally use words such as “anticipates,” “believes,” “expects,” “intends” and similar expressions to identify forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements for any reason, including the factors set forth in “Risk Factors” and elsewhere in this report.
We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the Securities and Exchange Commission (“SEC”), including any annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
General
We are a financial services company that primarily lends to and invests in middle market privately-held companies. We are a closed-end investment company that has filed an election to be treated as a business development company under the Investment Company Act of 1940, or the 1940 Act. We invest primarily in senior and subordinated debt and equity of companies in need of capital for acquisitions, divestitures, growth, development, project financing and recapitalization. We work with the management teams or financial sponsors to seek investments with historical cash flows, asset collateral or contracted pro-forma cash flows.
We seek to be a long-term investor with our portfolio companies. Since the fiscal year ended June 30, 2007, we have invested primarily in industries related to the industrial/energy economy. Since then, we have widened our strategy to focus in other sectors of the economy and continue to diversify our portfolio holdings.

 

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Patriot Acquisition
On December 2, 2009, we acquired the outstanding shares of Patriot Capital Funding, Inc. (“Patriot”) common stock for $201,083. 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 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, 2009, Patriot made a final dividend equal to its undistributed net ordinary income and capital gains of $0.38 per share. In accordance with a 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.
The merger has been accounted for as an acquisition of Patriot by Prospect Capital Corporation (“Prospect”) in accordance with acquisition method of accounting as detailed in ASC 805, Business Combinations (“ASC 805”). The fair value of the consideration paid was allocated to the assets acquired and liabilities assumed based on their fair values as the date of acquisition. As described in more detail in ASC 805, goodwill, if any, would have been recognized as of the acquisition date, if the consideration transferred exceeded the fair value of identifiable net assets acquired. As of the acquisition date, the fair value of the identifiable net assets acquired exceeded the fair value of the consideration transferred, and we recognized the excess as a gain. A gain of $5,714 was recorded by Prospect in the quarter ended December 31, 2009 related to the acquisition of Patriot. The acquisition of Patriot was negotiated in July 2009 with the purchase agreement being signed on August 3, 2009. Between July 2009 and December 2, 2009, our valuation of certain of the investments acquired from Patriot increased due to market improvement, which resulted in the recognition of the gain at closing.
The purchase price has been allocated to the assets acquired and the liabilities assumed based on their estimated fair values as summarized in the following table:
         
Cash (to repay Patriot debt)
  $ 107,313  
Cash (to fund purchase of restricted stock from former Patriot employees)
    970  
Common stock issued (1)
    92,800  
 
     
Total purchase price
    201,083  
 
     
Assets acquired:
       
Investments (2)
    207,126  
Cash and cash equivalents
    1,697  
Other assets
    3,859  
 
     
Assets acquired
    212,682  
Other liabilities assumed
    (5,885 )
 
     
Net assets acquired
    206,797  
 
     
Preliminary gain on Patriot acquisition (3)
  $ 5,714  
 
     
     
(1)  
The value of the shares of common stock exchanged with the Patriot common shareholders was based upon the closing price of our common stock on December 2, 2009, the price immediately prior to the closing of the transaction.
 
(2)  
The fair value of Patriot’s investments were determined by the Board of Directors in conjunction with an independent valuation agent. This valuation resulted in a purchase price which was $98,150 below the amortized cost of such investments. For those assets which are performing, Prospect will record the accretion to par value in interest income over the remaining term of the investment.
 
(3)  
The preliminary gain has been determined based upon the estimated value of certain liabilities which are not yet settled. Any changes to such accruals will be recoded in future periods as an adjustment to such gain. We do not believe such adjustments will be material.
During the period from the acquisition of Patriot on December 2, 2009 to December 31, 2009, we recognized $7,495 of interest income from the assets acquired from Patriot. Included in this amount is $4,560 resulting from the acceleration of purchase discounts from the early repayments of three loans, three revolving lines of credit and the sale of one investment position.
Market Conditions
In 2008 and 2009, the financial services industry has been negatively affected by turmoil in the global capital markets. What began in 2007 as a deterioration of credit quality in subprime residential mortgages has spread rapidly to other credit markets. Market liquidity and credit quality conditions continue to remain weaker today than two years ago.

 

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We believe that Prospect Capital is well positioned to navigate through these adverse market conditions. As a business development company, we are limited to a maximum 1 to 1 debt to equity ratio, and as of December 31, 2009, we had $62,914 available under our credit facility, of which $10,000 was outstanding. In addition, we had $105,050 of eligible assets from the Patriot acquisition in the process of being pledged to the facility which will generate an additional $67,086 of availability. Further, as we make additional investments that are eligible to be pledged under the credit facility, we will generate additional availability. The revolving period for the extended credit facility continues until June 25, 2010, with an amortization running to June 25, 2011.
We also continue to generate liquidity through public and private stock offerings. On July 7, 2009 we completed a public stock offering for 5,175,000 shares of our common stock at $9.00 per share, raising $46,575 of gross proceeds. On August 20, 2009 and September 24, 2009, we issued 3,449,686 shares and 2,807,111 shares, respectively, of our common stock at $8.50 and $9.00 per share, respectively, in private stock offerings, raising $29,322, and $25,264 of gross proceeds, respectively. Concurrent with the sale of these shares, we entered into a registration rights agreement in which we granted the purchasers certain registration rights with respect to the shares. Under the terms and conditions of the registration rights agreement, we filed with the SEC a post-effective amendment to the registration statement on Form N-2 on November 6, 2009. Such amendment was declared effective by the SEC on November 9, 2009.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reported period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ materially. In addition to the discussion below, our critical accounting policies are further described in the notes to the financial statements.
Basis of Consolidation
Under the 1940 Act rules, the regulations pursuant to Article 6 of Regulation S-X, and the American Institute of Certified Public Accountants’ Audit and Accounting Guide for Investment Companies, we are precluded from consolidating any entity other than another investment company or an operating company which provides substantially all of its services and benefits to us. Our December 31, 2009 and June 30, 2009 financial statements include our accounts and the accounts of Prospect Capital Funding, LLC, our only wholly-owned, closely-managed subsidiary that is also an investment company. All intercompany balances and transactions have been eliminated in consolidation.
Investment Classification
We are a non-diversified company within the meaning of the 1940 Act. We classify our investments by level of control. As defined in the 1940 Act, control investments are those where there is the ability or power to exercise a controlling influence over the management or policies of a company. Control is generally deemed to exist when a company or individual possesses or has the right to acquire within 60 days or less, a beneficial ownership of 25% or more of the voting securities of an investee company. Affiliated investments and affiliated companies are defined by a lesser degree of influence and are deemed to exist through the possession outright or via the right to acquire within 60 days or less, beneficial ownership of 5% or more of the outstanding voting securities of another person.
Investments are recognized when we assume an obligation to acquire a financial instrument and assume the risks for gains or losses related to that instrument. Investments are derecognized when we assume an obligation to sell a financial instrument and forego the risks for gains or losses related to that instrument. Specifically, we record all security transactions on a trade date basis. Investments in other, non-security financial instruments are recorded on the basis of subscription date or redemption date, as applicable. Amounts for investments recognized or derecognized but not yet settled are reported as Receivables for investments sold and Payables for investments purchased, respectively, in the Consolidated Statements of Assets and Liabilities.

 

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Investment Valuation
Our Board of Directors has established procedures for the valuation of our investment portfolio. These procedures are detailed below.
Investments for which market quotations are readily available are valued at such market quotations.
For most of our investments, market quotations are not available. With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, our Board of Directors has approved a multi-step valuation process each quarter, as described below:
1) Each portfolio company or investment is reviewed by our investment professionals with the independent valuation firm engaged by our Board of Directors;
2) the independent valuation firm conducts independent appraisals and makes their own independent assessment;
3) the audit committee of our Board of Directors reviews and discusses the preliminary valuation of our Investment Adviser and that of the independent valuation firm; and
4) the Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith based on the input of our Investment Adviser, the independent valuation firm and the audit committee.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC” or “Codification”) 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. We adopted ASC 820 on a prospective basis beginning in the quarter ended September 30, 2008.
ASC 820 classifies the inputs used to measure these fair values into the following hierarchy:
Level 1: Quoted prices in active markets for identical assets or liabilities, accessible by the Company at the measurement date.
Level 2: Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.
Level 3: Unobservable inputs for the asset or liability.
In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to each investment.
The changes to generally accepted accounting principles from the application of ASC 820 relate to the definition of fair value, framework for measuring fair value, and the expanded disclosures about fair value measurements. ASC 820 applies to fair value measurements already required or permitted by other standards.
In accordance with ASC 820, the fair value of our investments is defined as the price that we would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market in which that investment is transacted.
In April 2009, the FASB issued ASC 820-10-65, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“ASC 820-10-65”). This update provides further clarification for ASC 820 in markets that are not active and provides additional guidance for determining when the volume of trading level of activity for an asset or liability has significantly decreased and for identifying circumstances that indicate a transaction is not orderly. ASC 820-10-65 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of ASC 820-10-65 for the three and six months ended December 31, 2009, did not have any effect on our net asset value, financial position or results of operations as there was no change to the fair value measurement principles set forth in ASC 820.
In January 2010, the FASB issued Accounting Standards Update 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASC 2010-06”). ASU 2010-06 amends ASC 820-10 and clarifies and provides additional disclosure requirements related to recurring and non-recurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009. Our management does not believe that the adoption of the amended guidance in ASC 820-10 will have a significant effect on our financial statements.

 

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Federal and State Income Taxes
We have elected to be treated as a regulated investment company and intend to continue to comply with the requirements of the Internal Revenue Code of 1986 (the “Code”), applicable to regulated investment companies. We are required to distribute at least 90% of our investment company taxable income and intend to distribute (or retain through a deemed distribution) all of our investment company taxable income and net capital gain to stockholders; therefore, we have made no provision for income taxes. The character of income and gains that we will distribute is determined in accordance with income tax regulations that may differ from GAAP. Book and tax basis differences relating to stockholder dividends and distributions and other permanent book and tax differences are reclassified to paid-in capital.
If we do not distribute (or are not deemed to have distributed) at least 98% of our annual taxable income in the calendar year earned, we will generally be required to pay an excise tax equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such taxable income for the year. To the extent that we determine that our estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, we accrue excise taxes, if any, on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.
We adopted FASB ASC 740, Income Taxes (“ASC 740”). ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax benefit or expense in the current year. Adoption of ASC 740 was applied to all open tax years as of July 1, 2007. The adoption of ASC 740 did not have an effect on our net asset value, financial condition or results of operations as there was no liability for unrecognized tax benefits and no change to our beginning net asset value. As of December 31, 2009 and for the three and six months then ended, we did not have a liability for any unrecognized tax benefits. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof.
Revenue Recognition
Realized gains or losses on the sale of investments are calculated using the specific identification method.
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as interest income.
Loans are placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected. Unpaid accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Non-accrual loans are restored to accrual status when past due principal and interest is paid and in management’s judgment, are likely to remain current. As of December 31, 2009, approximately 5.7% of our net assets are in non-accrual status.
Dividend income is recorded on the ex-dividend date.
Structuring fees and similar fees are recognized as income as earned, usually when paid. Structuring fees, excess deal deposits, net profits interests and overriding royalty interests are included in other income.
Statement of Assets and Liabilities Overview
During the six months ended December 31, 2009, net assets have increased by $104,881 from $532,596 as of June 30, 2009 to $637,477 as of December 31, 2009. This net increase in assets primarily resulted from $195,833 of capital share transactions including 8,444,068 of shares issued in conjunction with the Patriot Acquisition, offset by $67,721 in dividends declared to our stockholders. During this six month period we recognized net investment income of $29,243, a decrease in net assets due to realized losses of $51,229 and a decrease in net assets due to changes in unrealized depreciation of investments of $1,245.

 

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The aggregate fair value of our portfolio investments was $648,135 and $547,168 as of December 31, 2009 and June 30, 2009, respectively. During the six months ended December 31, 2009, our net cost of investments increased by $102,212, or 19.2%, primarily from the acquisition of Patriot. At December 31, 2009, we were invested in 55 long-term portfolio investments.
Investment Activity
During the six months ended December 31, 2009, we acquired $207,126 of investments from Patriot, completed follow-on investments in existing portfolio companies totaling approximately $7,321, and recorded PIK interest of $2,059, resulting in gross investment originations with a cost basis of $216,506. The more significant of these investments are described briefly in the following:
During the six months ended December 31, 2009, we made follow-on secured debt investments of $1,423 in Iron Horse Coiled Tubing, Inc. (“Iron Horse”) in support of the build out of additional equipment and to fund working capital requirements.
During the six months ended December 31, 2009, we provided additional fundings of $3,376 to Yatesville Coal Holdings, Inc. (“Yatesville”) to fund ongoing operations.
On October 5, 2009 we purchased an additional secured debt investment of $1,675 in Resco Products, Inc. (“Resco”) at a discount of $670, increasing our cost basis by $1,005 in this investment.
On October 30, 2009, we made a follow-on secured subordinated debt investment of $500 in Ajax Rolled Ring & Machine (“Ajax”),
On December 2, 2009, we acquired portfolio investments with a face amount of $289,030 for $207,126 from Patriot.
During the six months ended December 31, 2009, we closed-out six positions which are briefly described below.
On August 31, 2009, C&J Cladding, LLC (“C&J”) repaid the $3,150 loan receivable to us and we received an additional 5% prepayment penalty totaling $158. We continue to hold warrants for common units in this investment.
On September 4, 2009, Peerless Manufacturing Co. repaid the $20,000 loan receivable to us.
On December 4, 2009, CS Operating, LLC repaid the $4,460 loan receivable to us.
On December 10, 2009, Resco repaid the $11,425 loan receivable to us.
On December 17, 2009, ADAPCO, Inc. (“ADAPCO”) repaid the $7,466 loan receivable to us. We continue to hold warrants for common stock in this investment.
On December 18, 2009, Quartermaster, Inc. (“Quartermaster”) repaid the $11,274 loan receivable to us.
On December 31, 2009, we sold our investment in Aylward Enterprises, LLC (“Aylward”) for net amount of $4,775.
During the six months ended December 31, 2009, we also received principal amortization payments of $7,184 on several loans.
On September 30, 2008, we settled our net profits interests (“NPIs”) in IEC Systems LP (“IEC”) and Advanced Rig Services LLC (“ARS”) with the companies for a combined $12,576. IEC and ARS originally issued the NPIs to us when we loaned a combined $25,600 to IEC and ARS on November 20, 2007. In conjunction with the NPI realization, we recognized other income of $12,576 simultaneously reinvested the $12,576 as incremental senior secured debt in IEC and ARS. The incremental debt will amortize over the period ending November 20, 2010.

 

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The following is a quarter-by-quarter summary of our investment activity:
                 
Quarter-End   Acquisitions(1)     Dispositions(2)  
December 31, 2009
  $ 210,438     $ 45,494  
September 30, 2009
    6,066       24,241  
June 30, 2009
    7,929       3,148  
March 31, 2009
    6,356       10,782  
December 31, 2008
    13,564       2,128  
September 30, 2008
    70,456       10,949  
June 30, 2008
    118,913       61,148  
March 31, 2008
    31,794       28,891  
December 31, 2007
    120,846       19,223  
September 30, 2007
    40,394       17,949  
June 30, 2007
    130,345       9,857  
March 31, 2007
    19,701       7,731  
December 31, 2006
    62,679       17,796  
September 30, 2006
    24,677       2,781  
June 30, 2006
    42,783       5,752  
March 31, 2006
    15,732       901  
December 31, 2005
          3,523  
September 30, 2005
    25,342        
June 30, 2005
    17,544        
March 31, 2005
    7,332        
December 31, 2004
    23,771       32,083  
September 30, 2004
    30,371        
 
           
Since inception
  $ 1,027,033     $ 304,377  
 
           
 
     
(1)  
Includes new deals, additional fundings, refinancings and PIK interest.
 
(2)  
Includes scheduled principal payments, prepayments and refinancings.
Investment Holdings
As of December 31, 2009, we continue to pursue our investment strategy. Despite our name change to “Prospect Capital Corporation” and the termination of our policy to invest at least 80% of our net assets in energy companies in May 2007, we currently have a concentration of investments in companies in the energy and energy related industries. This concentration continues to decrease as we make investments outside of the energy and energy related industries. Some of the companies in which we invest have relatively short or no operating histories. These companies are and will be subject to all of the business risk and uncertainties associated with any new business enterprise, including the risk that these companies may not reach their investment objective or the value of our investment in them may decline substantially or fall to zero.
Our portfolio had an annualized current yield of 15.6% and 16.0% across all our long-term debt and certain equity investments as of December 31, 2009 and December 31, 2008, respectively. At December 31, 2009, this yield includes interest from all of our long-term investments as well as dividends from Gas Solutions Holdings, Inc. (“GSHI”) and NRG Manufacturing, Inc. (“NRG”). We expect the current yield to decline over time as add to the portfolio. Monetization of other equity positions that we hold is not included in this yield calculation. In each of our portfolio companies, we hold equity positions, ranging from minority interests to majority stakes, which we expect over time to contribute to our investment returns. Some of these equity positions include features such as contractual minimum internal rates of returns, preferred distributions, flip structures and other features expected to generate additional investment returns, as well as contractual protections and preferences over junior equity, in addition to the yield and security offered by our cash flow and collateral debt protections.
We classify our investments by level of control. As defined in the 1940 Act, control investments are those where there is the ability or power to exercise a controlling influence over the management or policies of a company. Control is generally deemed to exist when a company or individual possesses or has the right to acquire within 60 days or less, a beneficial ownership of 25% or more of the voting securities of an investee company. Affiliated investments and affiliated companies are defined by a lesser degree of influence and are deemed to exist through the possession outright or via the right to acquire within 60 days or less, beneficial ownership of 5% or more of the outstanding voting securities of another person.

 

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As of December 31, 2009, we own controlling interests in Ajax, AWCNC, LLC, C&J, Change Clean Energy Holdings, Inc. (“CCEHI”), Coalbed, Inc./Coalbed, LLC (formerly Conquest Cherokee, LLC) (“Coalbed”), Fischbein, LLC (“Fischbein”), Freedom Marine Services LLC (“Freedom Marine”), GSHI, Integrated Contract Services, Inc. (“ICS”), Iron Horse, NRG, Nupla Corporation (“Nupla”), R-V Industries, Inc. (“R-V”), Sidump’r Trailer Company, Inc. (“Sidump’r”) and Yatesville. We also own an affiliated interest in Appalachian Energy Holdings, LLC (“AEH”), Biotronic NeuroNetwork (“Biotronic”), Boxercraft Incorporated (“Boxercraft”), KTPS Holdings, LLC (“KTPS”), Miller Petroleum, Inc. (“Miller”), Smart, LLC (“Smart”) and Sport Helmets Holdings, LLC (“Sport Helmets”).
The following is a summary of our investment portfolio by level of control:
                                                                 
    December 31, 2009     June 30, 2009  
            Percent     Fair     Percent             Percent     Fair     Percent  
Level of Control   Cost     of Portfolio     Value     of Portfolio     Cost     of Portfolio     Value     of Portfolio  
Control
  $ 165,867       25.2 %   $ 191,898       28.6 %   $ 187,105       29.7 %   $ 206,332       31.9 %
Affiliate
    68,052       10.4 %     66,479       9.9 %     33,544       5.3 %     32,254       5.0 %
Non-control/Non-affiliate
    399,717       60.8 %     389,758       58.0 %     310,775       49.3 %     308,582       47.8 %
Money Market Funds
    23,418       3.6 %     23,418       3.5 %     98,735       15.7 %     98,735       15.3 %
 
                                               
 
                                                               
Total Portfolio
  $ 657,054       100.0 %   $ 671,553       100.0 %   $ 630,159       100.0 %   $ 645,903       100.0 %
 
                                               
The following is our investment portfolio presented by type of investment at December 31, 2009 and June 30, 2009, respectively:
                                                                 
    December 31, 2009     June 30, 2009  
            Percent     Fair     Percent             Percent     Fair     Percent  
Level of Control   Cost     of Portfolio     Value     of Portfolio     Cost     of Portfolio     Value     of Portfolio  
Money Market Funds
  $ 23,418       3.6 %     23,418       3.5 %   $ 98,735       15.7 %   $ 98,735       15.3 %
Revolving Line of Credit
    2,041       0.3 %     2,013       0.3 %           %           %
Senior Secured Debt
    306,009       46.6 %     281,321       41.9 %     232,534       36.9 %     220,993       34.2 %
Subordinated Secured Debt
    272,320       41.4 %     239,968       35.7 %     251,292       39.9 %     194,547       30.1 %
Subordinated Unsecured Debt
    15,185       2.3 %     15,771       2.4 %     15,065       2.4 %     16,331       2.5 %
Preferred Stock
    11,484       1.7 %     6,106       0.9 %     10,432       1.6 %     4,139       0.7 %
Common Stock
    18,713       2.9 %     82,213       12.2 %     16,310       2.6 %     89,278       13.8 %
Membership Interests
    5,124       0.8 %     9,287       1.4 %     3,031       0.5 %     7,270       1.1 %
Overriding Royalty Interests
          %     2,762       0.4 %           %     3,483       0.5 %
Net Profit Interests
          %     1,451       0.2 %           %     2,561       0.4 %
Warrants
    2,760       0.4 %     7,243       1.1 %     2,760       0.4 %     8,566       1.4 %
 
                                               
 
                                                               
Total Portfolio
  $ 657,054       100.0 %   $ 671,553       100.0 %   $ 630,159       100.0 %   $ 645,903       100.0 %
 
                                               

 

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The following is our investment portfolio presented by geographic location of the investment at December 31, 2009 and June 30, 2009, respectively:
                                                                 
    December 31, 2009     June 30, 2009  
            Percent     Fair     Percent             Percent     Fair     Percent  
Level of Control   Cost     of Portfolio     Value     of Portfolio     Cost     of Portfolio     Value     of Portfolio  
Canada
  $ 20,717       3.1 %   $ 12,318       1.8 %   $ 19,344       3.1 %   $ 12,606       2.0 %
Midwest US
    115,332       17.6 %     122,125       18.2 %     77,681       12.3 %     84,097       13.0 %
Northeast US
    61,171       9.3 %     53,823       8.0 %     44,875       7.1 %     47,049       7.3 %
Southeast US
    189,313       28.8 %     152,209       22.7 %     164,652       26.1 %     101,710       15.7 %
Southwest US
    183,428       27.9 %     245,792       36.6 %     178,993       28.4 %     253,615       39.3 %
Western US
    63,675       9.7 %     61,868       9.2 %     45,879       7.3 %     48,091       7.4 %
Money Market Funds
    23,418       3.6 %     23,418       3.5 %     98,735       15.7 %     98,735       15.3 %
 
                                               
Total Portfolio
  $ 657,054       100.0 %   $ 671,553       100.0 %   $ 630,159       100.0 %   $ 645,903       100.0 %
 
                                               

 

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The following is our investment portfolio presented by industry sector of the investment at December 31, 2009 and June 30, 2009, respectively:
                                                                 
    December 31, 2009     June 30, 2009  
            Percent     Fair     Percent             Percent     Fair     Percent  
Level of Control   Cost     of Portfolio     Value     of Portfolio     Cost     of Portfolio     Value     of Portfolio  
Aerospace and Defense
  $ 56       %   $ 48       %   $       %   $       %
Automobile
    868       0.1 %     868       0.1 %           %           %
Biomass Power
    2,825       0.4 %     1,976       0.3 %     2,530       0.4 %     2,530       0.4 %
Construction Services
    5,028       0.8 %     1,165       0.2 %     5,017       0.8 %     2,408       0.4 %
Contracting
    16,652       2.5 %     5,275       0.8 %     16,652       2.6 %     5,000       0.8 %
Ecological
    141       %     295       %             %           %
Electronics
    14,910       2.3 %     14,994       2.2 %             %           %
Financial Services
    25,685       3.9 %     24,511       3.6 %     25,424       4.0 %     23,073       3.6 %
Food Products
    34,634       5.3 %     37,412       5.6 %     27,413       4.4 %     29,416       4.6 %
Gas Gathering and Processing
    35,003       5.3 %     85,187       12.7 %     35,003       5.6 %     85,187       13.2 %
Healthcare
    88,217       13.4 %     92,253       13.7 %     57,535       9.1 %     60,293       9.3 %
Home and Office Furnishings, Housewares and Durable
    2,436       0.4 %     2,432       0.4 %           %           %
Insurance
    3,873       0.6 %     3,871       0.6 %           %           %
Machinery
    26,952       4.1 %     27,088       4.0 %           %           %
Manufacturing
    80,590       12.3 %     83,112       12.4 %     90,978       14.4 %     110,929       17.2 %
Metal Services and Minerals
    9,492       1.4 %     12,180       1.8 %     3,302       0.5 %     7,133       1.1 %
Mining, Steel, Iron and Non-Precious Metals and Coal Production
    10,527       1.6 %     10,705       1.6 %     48,890       7.8 %     13,097       2.0 %
Oil and Gas Production
    104,469       15.9 %     93,904       14.0 %     104,183       16.5 %     104,806       16.2 %
Oilfield Fabrication
    32,337       4.9 %     32,337       4.8 %     34,247       5.4 %     34,931       5.4 %
Personal and Nondurable Consumer Products
    28,705       4.4 %     28,845       4.3 %           %           %
Pharmaceuticals
    11,952       1.8 %     12,000       1.8 %     11,949       2.0 %     11,452       1.8 %
Printing and Publishing
    7,640       1.2 %     7,803       1.2 %           %           %
Production Services
    20,717       3.2 %     12,318       1.8 %     19,344       3.1 %     12,606       1.9 %
Retail
    14,670       2.2 %     2,388       0.4 %     14,623       2.3 %     6,272       1.0 %
Shipping Vessels
    7,899       1.2 %     6,181       0.9 %     7,160       1.1 %     7,381       1.1 %
Specialty Minerals
    15,814       2.4 %     17,806       2.7 %     15,814       2.5 %     18,924       2.9 %
Technical Services
    11,373       1.7 %     11,615       1.7 %     11,360       1.8 %     11,730       1.8 %
Textiles and Leather
    20,171       3.1 %     19,566       2.9 %           %           %
Money Market Funds
    23,418       3.6 %     23,418       3.5 %     98,735       15.7 %     98,735       15.3 %
 
                                               
 
                                                               
Total Portfolio
  $ 657,054       100.0 %   $ 671,553       100.0 %   $ 630,159       100.0 %   $ 645,903       100.0 %
 
                                               
Investment Valuation
In determining the fair value of our portfolio investments at December 31, 2009, the Audit Committee considered valuations from the independent valuation firm and from management having an aggregate range of $604,614 to $680,622, excluding money market investments.
In determining the range of value for debt instruments, management and the independent valuation firm generally shadow rated the investment and then based upon the range of ratings, determined appropriate yields to maturity for a loan rated as such. A discounted cash flow analysis was then prepared using the appropriate yield to maturity as the discount rate, yielding the ranges. For equity investments, the enterprise value was determined by applying EBITDA multiples for similar recent investment sales. For stressed equity investments, a liquidation analysis was prepared.

 

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The Board of Directors looked at several factors in determining where within the range to value the asset including: recent operating and financial trends for the asset, independent ratings obtained from third parties and comparable multiples for recent sales of companies within the industry. The composite of all these analysis, applied to each investment, was a total valuation of $648,135, excluding money market investments.
Our investments are generally lower middle market companies, outside of the financial sector, with less than $30,000 of annual EBITDA. We believe our market has experienced less volatility than others because we believe there are more buy and hold investors who own these less liquid investments.
During the six months ended December 31, 2009, there has been a general improvement in the markets in which we operate and market rates of interest demanded for middle market loans have decreased. The fair value is limited on the high side to the loans par value, plus any prepayment penalties that would be imposed. Many of the debt investments in this category have not seen a significant change in value as they were previously valued at or near par value. In comparison to assets held as of June 30, 2009, these assets include: American Gilsonite Company, Biotronic, Castro Cheese Company, Inc., IEC/ARS, Maverick Healthcare, LLC, Qualitest Pharmaceuticals, Inc., Regional Management Corp., Shearer’s Foods, Inc., Stryker Energy, LLC, TriZetto Group and Unitek. Such assets acquired from Patriot include: Aircraft Fasteners International, LLC, Boxercraft, Copernicus Group, EXL Acquisition Corp., Fairchild Industrial Products Co., Hudson Products Holdings, Inc., KTPS, Label Corp Holdings, Inc., LHC Holdings Corp., Northwestern Management Services LLC, R-O-M Corporation and Sport Helmets.
Nine debt investments were made to companies that are not performing in line with budget expectations as of December 31, 2009 and have seen a diminution of value since June 30, 2009 (Ajax, Coalbed, Deb Shops, Inc., H&M Oil & Gas, LLC, Iron Horse, NRG, R-V, Wind River Resources Corp. and Wind River II Corp. and Yatesville). The valuation of these assets is further stressed by declining market demand within their respective industries, primarily retail, industrial and energy-related. For these assets, we have increased the market interest rates to take into account the increased credit risk, illiquidity and general changes in current interest rates for similar assets to determine their fair value.
Five portfolio companies (ADAPCO, C&J, Diamondback, Miller and R-V) are equity investments for which the previously outstanding debt has been repaid.
Control investments offer increased risk and reward over straight debt investments. Operating results and changes in market multiples can result in dramatic changes in values from quarter to quarter. Significant downturns in operations can further result in our looking to recoveries on sales of assets rather than the enterprise value of the investment. Several control investments in our portfolio are under enhanced scrutiny by our senior management and our Board of Directors and are discussed below.
Ajax Rolled Ring & Machine, Inc.
We acquired a controlling equity interest in Ajax in a recapitalization of the company that was closed on April 4, 2008. We funded $22,000 of senior secured term debt, $11,500 of subordinated term debt and $6,300 of equity as of that closing. As of December 31, 2009, we control 78.1% of the fully-diluted common and preferred equity.
Ajax forges seamless steel rings sold to various customers. The rings are used in a range of industrial applications, including in construction equipment and wind power turbines. Ajax’s business is cyclical, and the business suffered in light of the global macroeconomic crisis of the past several quarters. 2008 was relatively strong for Ajax, but in the first half of 2009, Ajax experienced massive cuts in ordering of steel rings by its key customers. The second half of 2009 showed steady improvement versus very weak performance in the first half of the year and despite improvement in the second half of the year, Ajax’s overall performance in 2009 was well below that of 2008. At December 31, 2009, Ajax had a backlog of new business that would indicate continued improvement through 2010.
The Board of Directors wrote-down the fair value of our investment in Ajax to $25,802 as of December 31, 2009, a reduction of $14,059 from its amortized cost, compared to the $7,581 unrealized loss recorded at June 30, 2009.

 

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Change Clean Energy Holdings Inc. and Change Clean Energy, Inc., f/k/a Worcester Energy Partners, Inc.
Change Clean Energy, Inc. (“CCEI”) is an investment that we originated in September 2005 which owns and operated a bio-mass energy plant. In March 2009 CCEI ceased operations temporarily as it was not economically feasible to make a profit based on the cost of materials and the price being paid for electricity. During that quarter, we determined that it was appropriate to institute foreclosure proceedings against the co-borrowers of our debt to take full control of the assets. In anticipation of such proceedings CCEHI was established and on March 11, 2009, the foreclosure was completed and the assets were assigned to a wholly owned subsidiary of CCEHI. During the six months ended December 31, 2009, we provided additional funding of $296 to CCEHI to fund ongoing operations. CCEI currently has no material operations. At June 30, 2009 we determined that the impairment at both CCEI and CCEHI was other than temporary and recognized a realized loss of $41,134, which was the amount by which the amortized cost exceeded the fair value. At December 31, 2009, our Board of Directors, under recommendation from senior management, has set the value of the CCEHI investment at $1,976, a reduction of $849 from its amortized cost.
Gas Solutions Holdings, Inc.
GSHI is an investment that we made in September 2004 in which we own 100% of the equity. GSHI is a midstream gathering and processing business located in East Texas. GSHI has improved its operations and we have experienced an increase in revenue, gross margin, and EBITDA (the later two metrics on both an absolute and a percentage of revenues basis) over the past five years.
During the past two years, we have been in discussions with multiple interested purchasers for Gas Solutions. While we wish to unlock the value in Gas Solutions, we do not wish to enter into any agreement at any time that does not recognize the long term value we see in Gas Solutions. As a well hedged midstream asset, which will generate predictable and consistent cash flows to us, Gas Solutions is a valuable asset that we wish to sell at a value-maximizing price, or not at all. We continue discussions with interested parties, but have a patient approach toward the process. In addition, a sale of the assets, rather than the stock of GSHI, might result in a significant tax liability at the GSHI level which will need to be paid prior to any distribution to us.
In early May 2008, Gas Solutions II Ltd purchased a series of propane puts at $0.10 out of the money and at prices of $1.53 per gallon and $1.394 per gallon covering the periods May 1, 2008, through April 30, 2009, and May 1, 2009, through April 30, 2010, respectively. These hedges were executed at close to the highest market propane prices ever achieved on an historical basis; such hedges preserve the upside of Gas Solutions II Ltd to benefit from potential future increases in commodity prices. GSHI generated approximately $26,172 of EBITDA for the fiscal year ending December 31, 2008, an increase of 67% from 2007 results. Despite the volatility in commodity prices over the last year, GSHI generated approximately $25,816 of EBITDA for the fiscal year ending December 31, 2009.
In determining the value of GSHI, we have utilized several valuation techniques to determine the value of the investment. These techniques offer a wide range of values. Our Board of Directors has determined the value to be $85,187 for our debt and equity positions at December 31, 2009 based upon a combination of a discounted cash flow analysis and a public comparables analysis. At December 31, 2009 and June 30, 2009, GSHI was valued $50,184 above its amortized cost.
Integrated Contract Services, Inc.
ICS is an investment that we made in April 2007. Prior to January 2009, ICS owned the assets of ESA Environmental Specialists, Inc. (“ESA”) and 100% of the stock of The Healing Staff (“THS”). ESA originally defaulted under our contract governing our investment in ESA, prompting us to commence foreclosure actions with respect to certain ESA assets in respect of which we have a priority lien. In response to our actions, ESA filed voluntarily for reorganization under the bankruptcy code on August 1, 2007. On September 20, 2007, the U.S. Bankruptcy Court approved a Section 363 Asset Sale from ESA to us. To complete this transaction, we contributed our ESA debt to a newly-formed entity, ICS, and provided funds for working capital on October 9, 2007. In return for the ESA debt, we received senior secured debt in ICS of equal amount to our ESA debt, preferred stock of ICS, and 49% of the ICS common stock. ICS subsequently ceased operations and assigned the collateral back to us. ICS is in default of both payment and financial covenants. During September and October 2007, we provided $1,170 to THS for working capital.
In January 2009, we foreclosed on the real and personal property of ICS. Through this foreclosure process, we gained 100% ownership of THS and certain ESA assets. Based upon an analysis of the liquidation value of the ESA assets and the enterprise value of THS, our Board of Directors affirmed the fair value of our investment in ICS at $5,275 at December 31, 2009, a reduction of $11,377 from its amortized cost, compared to the $11,652 unrealized loss recorded at June 30, 2009.

 

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Iron Horse Coiled Tubing, Inc.
Iron Horse is an investment that we made in April 2006. Iron Horse had been a provider of coiled tubing subcontractor services prior to making a strategic decision in late 2007 to directly service natural gas and oil producers in the Western Canadian Sedimentary Basin (“WCSB”) as a fracturing services provider. As a result of the business transition, the Company’s 2008 financial performance declined significantly from 2007 levels. Iron Horse completed its transition from a subcontractor to a direct service provider in 2009, but natural gas prices fell to trough levels due to the recession and heightened natural gas inventory levels. Since November 2009, Iron Horse has seen increased activity in the WCSB and is now completing wells for several large producers in the WCSB.
Prior to December 31, 2007, we owned 8.5% of the common stock in Iron Horse. On December 31, 2007, we received an additional 50.3% of the common stock in Iron Horse, which increased our total ownership to 58.8%. Through a series of subsequent loans that were used to construct equipment and facilitate the transition from a subcontractor to a direct service provider, we secured an additional 21.0% of the common stock in Iron Horse in September 2008, which increased our total ownership to 79.8% of the common stock in Iron Horse.
The Board of Directors wrote-down the fair value of our investment in Iron Horse to $12,318 as of December 31, 2009, a reduction of $8,399 from its amortized cost, compared to the $6,738 unrealized loss recorded at June 30, 2009.
Yatesville Coal Holdings, Inc.
All of our coal holdings have been consolidated under common management in Yatesville. Yatesville began to show improvement after the consolidation of the coal holdings, but the company exhausted its permitted reserves in December 2008 and has not had any meaningful revenue stream since. We continue to evaluate strategies for Yatesville such as soliciting indications of interest regarding a transaction involving part or all of recoverable reserves. During the six months ended December 31, 2009, we provided additional funding of $3,376 to Yatesville to fund ongoing operations including new permitting. During the quarter, we discontinued operations at Yatesville. As of December 31, 2009, our Board of Directors determined that consistent with the decision to discontinue operations, the impairment of Yatesville was other than temporary and we recorded a realized loss of $51,228 which was the amount that the amortized cost exceeded the fair value at December 31, 2009. Our Board of Directors set the value of the remaining Yatesville investment at $1,035, which represents the residual value of recoverable reserves, as of December 31, 2009, a reduction of $12,062 from its value as of June 30, 2009.
Capitalization
Our investment activities are capital intensive and the availability and cost of capital is a critical component of our business. We capitalize our business with a combination of debt and equity. Our debt is currently consists of a revolving credit facility availing us of the ability to borrow debt subject to borrowing base determinations and our equity capital is currently comprised entirely of common equity.
On June 25, 2009, we completed a first closing on an expanded $250,000 syndicated revolving credit facility (the “Facility”). The new Facility, for which six lenders have closed on $210,000 to date, includes an accordion feature which allows the Facility to accept up to an aggregate total of $250,000 of commitments for which we continue to solicit additional commitments from other lenders for the additional $40,000. The revolving period of the Facility extends through June 2010, with an additional one year amortization period after the completion of the revolving period. As of December 31, 2009 and June 30, 2009, we had $10,000 and $124,800 of borrowings outstanding under our credit facility, respectively.

 

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Interest on borrowings under the credit facility is one-month Libor plus 400 basis points, subject to a minimum Libor floor of 200 basis points after that date. The maintenance of this facility requires us to pay a fee for the amount not drawn upon. This fee assessed at the rate of 100 basis points per annum. The following table shows the facility amounts and outstanding borrowings at December 31, 2009 and June 30, 2009:
                                 
    As of December 31, 2009     As of June 30, 2009  
    Facility     Amount     Facility     Amount  
    Amount     Outstanding     Amount     Outstanding  
Revolving Credit Facility
  $ 195,000     $ 10,000     $ 175,000     $ 124,800  
The following table shows the contractual maturity of our revolving credit facility at December 31, 2009:
                         
    Payments Due By Period  
    Less Than             More Than  
    1 Year     1 - 3 Years     3 Years  
Credit Facility Payable
  $ 10,000     $     $  
 
                 
During the six months ended December 31, 2009, we completed public and private offerings and raised $97,675 of additional equity by issuing 11,431,797 shares of our common stock below net asset value diluting shareholder value by $0.75 per share. We also issued 8,444,068 shares to acquire Patriot increasing net asset value to shareholders by $0.03 per share. The following table shows the calculation of net asset value per share as of December 31, 2009 and June 30, 2009:
                 
    As of December 31, 2009     As of June 30, 2009  
Net Assets
  $ 637,477     $ 532,596  
Shares of common stock outstanding
    63,349,746       42,943,084  
 
           
Net asset value per share
  $ 10.06     $ 12.40  
 
           
At December 31, 2009, we had 63,349,746 of our common stock issued and outstanding.
Results of Operations
For the three months ended December 31, 2009 and December 31, 2008, the net (decrease) increase in net assets resulting from operations was ($16,853) and $6,524, respectively, representing ($0.29) and $0.22 per share, respectively. We experienced a net realized and unrealized loss of $33,778 or approximately $0.59 per share in the three months ended December 31, 2009. This compares with the net realized and unrealized loss of $5,436 during the three months ended December 31, 2008 or approximately $0.18 per share.
For the six months ended December 31, 2009 and December 31, 2008, the net (decrease) increase in net assets resulting from operations was ($23,231) and $20,522, respectively, representing ($0.43) and $0.69 per share, respectively. We experienced a net realized and unrealized loss of $52,474 or approximately $0.98 per share in the six months ended December 31, 2009. This compares with the net realized and unrealized loss of $14,940 during the six months ended December 31, 2008 or approximately $0.51 per share.
While we seek to maximize gains and minimize losses, our investments in portfolio companies can expose our capital to risks greater than those we may anticipate as these companies are typically not issuing securities rated investment grade, have limited resources, have limited operating history, are generally private companies with limited operating information available and are likely to depend on a small core of management talents. Changes in any of these factors can have a significant impact on the value of the portfolio company.
Investment Income
We generate revenue in the form of interest income on the debt securities that we own, dividend income on any common or preferred stock that we own, and amortized loan origination fees on the structuring of new deals. Our investments, if in the form of debt securities, will typically have a term of one to ten years and bear interest at a fixed or floating rate. To the extent achievable, we will seek to collateralize our investments by obtaining security interests in our portfolio companies’ assets. We also may acquire minority or majority equity interests in our portfolio companies, which may pay cash or in-kind dividends on a recurring or otherwise negotiated basis. In addition, we may generate revenue in other forms including prepayment penalties and possibly consulting fees. Any such fees generated in connection with our investments are recognized as earned.

 

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Investment income consists of interest income, including accretion of loan origination fees and prepayment penalty fees, dividend income and other income, including net profits interest, overriding royalties interest and structuring fees. The following table details the various components of investment income and the related levels of debt investments for the three months ended December 31, 2009 and December 31, 2008:
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31,     December 31,  
    2009     2008     2009     2008  
 
                               
Interest income
  $ 18,539     $ 17,241     $ 33,374     $ 34,797  
Dividend income
    4,170       4,665       10,388       9,388  
Other income
    6,174       307       6,638       13,827  
 
                       
Total investment income
  $ 28,883     $ 22,213     $ 50,400     $ 58,012  
 
                       
 
                               
Average debt principal of investments
  $ 571,809     $ 537,101     $ 535,069     $ 517,421  
 
                       
Weighted-average interest rate earned
    12.86 %     12.74 %     12.37 %     13.34 %
 
                       
Total investment income increased significantly from $22,213 for the three months ended December 31, 2008 to $28,883 for the six months ended December 31, 2009. This $6,670 increase is primarily due to the Patriot acquisition, for which we recognized a gain from the acquisition of $5,714 and purchase discount accretion of $5,320 during the three months ended December 31, 2009. The discount accretion includes $4,560 of accelerated accretion from early repayments of ADAPCO, Quartermaster and Aylward. Total investment income has decreased for the six months ended December 31, 2009 from the amount reported for the six months ended December 31, 2008 primarily due to a decrease in other income. This $7,189 decrease in other income is primarily due to the settlement of our net profit interests in IEC/ARS for $12,576 during the six months ended December 31, 2008, partially offset but gain from the acquisition of Patriot.
Average principal balances of debt investments have increased from $537,101 for the three months ended December 31, 2008 to $571,809 for the three months ended December 31, 2009. For the six months ended December 31, 2008 and 2009, average principal balances of debt investments increased from $517,421 to $535,069, respectively. These increases are primarily due to the Patriot acquisition which resulted in an additional $289,030 of debt principal to our portfolio.
The weighted-average interest rate earned increased from 12.74% for the three months ended December 31, 2008 to 12.86% for the three months ended December 31, 2009. This increase is primarily the result of purchase discount accretion of $5,320 from the Patriot acquisition. For the six months ended December 31, 2008 and 2009, weighted-average interest rate earned decreased from 13.34% to 12.37%, respectively. This decrease is primarily the result of Patriot acquisition purchase discount accretion, offset by foregone interest on non-accrual loans. During the six month period ended December 31, 2009, interest of $12,510 was foregone on non-accrual debt investments compared to $4,983 of forgone interest for the three months ended December 31, 2008. Without adjustments for foregone interest and purchase discount accretion from the Patriot acquisition, the weighted average interest rates earned on debt investments would have been 15.0% and 15.3% for the three months ended December 31, 2009 and 2008, respectively.
Operating Expenses
Our primary operating expenses consist of investment advisory fees (base management and income incentive fees), credit facility costs, legal and professional fees and other operating and overhead-related expenses. These expenses include our allocable portion of overhead under the Administration Agreement with Prospect Administration under which Prospect Administration provides administrative services and facilities for us. Our investment advisory fees compensate our Investment Adviser for its work in identifying, evaluating, negotiating, closing and monitoring our investments. We bear all other costs and expenses of our operations and transactions in accordance with our Administration Agreement with Prospect Administration. Operating expenses were $11,958 and $10,253 for the three months ended December 31, 2009 and December 31, 2008, respectively. Operating expenses were $21,157 and $22,550 for the six months ended December 31, 2009 and December 31, 2008, respectively.

 

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The base management fee was $3,176 and $2,940 for the three months ended December 31, 2009 and December 31, 2008, respectively. The base management fee was $6,385 and $5,763 for the six months ended December 31, 2009 and December 31, 2008, respectively. The increase in this expense for the three and six months ended December 31, 2009 is directly related to our growth in total assets.
For the three months ended December 31, 2009 and December 31, 2008, we incurred $4,231 and $2,990, respectively, of income incentive fees. The $1,241 increase in the income incentive fee for the respective three-month period is driven by an increase in pre-incentive fee net investment income from $14,950 for the three months ended December 31, 2008 to $21,156 for the three months ended December 31, 2009, primarily the result of additional investment income from the Patriot acquisition. For the six months ended December 31, 2009 and December 31, 2008, we incurred $7,311 and $8,865, respectively, of income incentive fees. The $1,554 decrease in the income incentive fee for the respective six-month period is driven by a decrease in pre-incentive fee net investment income from $44,327 for the six months ended December 31, 2008 to $36,554 for the six months ended December 31, 2009, primarily the result of the settlement of net profits interest in IEC/ARS in the 2008 period offset by the income from the Patriot acquisition. No capital gains incentive fee has yet been incurred pursuant to the Investment Advisory Agreement.
During the three and six months ended December 31, 2009, we incurred $1,995 and $3,369 of expenses related to our credit facility. This compares with expenses of $1,965 and $3,483 incurred during the three and six months ended December 31, 2008. These expenses are related directly to the leveraging capacity put into place for each of those periods and the levels of indebtedness actually undertaken during those quarters. The table below describes the various credit facility expenses and the related indicators of leveraging capacity and indebtedness during these periods.
                                 
    For The Three Months Ended     For The Six Months Ended  
    December 31,     December 31,  
    2009     2008     2009     2008  
 
                               
Interest on borrowings
  $ 266     $ 1,712     $ 393     $ 2,942  
Amortization of deferred financing costs
    1,282       180       2,106       360  
Commitment and other fees
    447       73       870       181