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Summary

  • Prospect has made capital contributions to its wholly-owned holding companies equivalent in magnitude and coincident in timing to distributions received as dividends and structuring fees.
  • During its May 7th conference call, Prospect stated that it has recognized income from holding companies in line with cash flow, but in excess of net income.
  • The term "cash flow" is categorically broad enough to include "cash flow from financing".
  • We document multiple examples of such transactions.

Prospect Capital (NASDAQ:PSEC) asserts a restatement of its financials would "increase our historical net increase in net assets resulting from operations". [1]

A brief review of the historical exhibit raises uncertainty with respect to this claim.

Specifically: Prospect has made multiple capital contributions to its wholly-owned holding companies equivalent in magnitude and coincident in timing to distributions received as dividends and purported structuring fees.

Such receipts are then recognized as income for computation of incentive fees, Net Investment Income, and Net Increase in Net Assets from Operations.

Herewith, we document three recent transactions in company filings.

I) First Tower Holdings of Delaware LLC

On the very last business day of December, 2013, Prospect contributed $8.5mm in additional debt and $1.5mm in equity. During the same month [month, but not day disclosed], it received and recognized as income $8mm in structuring fees from same. [2]

II) Credit Central Holdings of Delaware LLC

During the month of March 2014, Prospect contributed $2.5mm in additional financing and received $2mm in dividends. Such dividends were immediately recognized as income. [3]

III) Nationwide Acceptance Holdings LLC

Again, during the month of March 2014, Prospect contributed $4mm in additional financing and received $5mm in return as a dividend. Again, proceeds were immediately booked as income. [4]

CASH FLOW versus INCOME

During its May 7th conference call, Prospect stated that it has recognized income from holding companies in line with cash flow, but in excess of net income. [5]

The term cash flow is categorically broad enough to include cash flow from financing.

This appears to be the case in each of the transactions above.

Prospect should now provide additional disclosure regarding the economic substance of these transactions with wholly-owned holding companies Nationwide, Credit Central, and First Tower, along with any others so referenced by Mr. Barry in the conference call.

ACKNOWLEDGEMENTS

Intellectual credit and gracious acknowledgement provided to Jordan Wathen and Prospect Capital Monitor who raised the accounting issues documented herein.

We also acknowledge our debt to Jon Bock of Wells Fargo for his exploration of the relation of cash flow and net income during May 7th's conference call. (see footnotes [5] and [6], infra.)

FOOTNOTES

[1] SEC Form 10-Q (Mar. 2014), p. 100.

[2] See both Footnote (40) to Consolidated Schedule of Investments, SEC Form 10-Q (Sep. 2013), p. 40 and Footnote (42) to Consolidated Schedule of Investments, SEC Form 10-Q (Dec. 2013), p. 39.

Also see SEC Form 10-Q (Dec. 2013), p. 97 "Included within this amount is an $8,000 fee from First Tower Delaware related to the renegotiation and expansion of First Tower's third party revolver for which a fee was received in December 2013."

And on p. 81 "On December 30, 2013, we made a $10,000 follow-on investment in First Tower to support seasonal demand. We invested $1,500 of equity and $8,500 of debt in First Tower. "

[3] See Footnote (45) to Consolidated Schedule of Investments, SEC Form 10-Q (Mar 2014), p. 38.

Also see p. 95 "The increase in dividend income is primarily attributed to dividends of $5,000 and $2,000 received from our investments in Nationwide and Credit Central. The dividends received include distributions as part of follow-on financings in March 2014 for which we provided an additional $6,500 of financing."

Finally, see Footnote (42) to Consolidated Schedule of Investments, SEC Form 10-Q (Dec. 2013), p. 39 for comparison to December quarter.

[4] See note [3], supra.

[5] Transcript, Prospect 2014 Third Fiscal Quarter 2014 Conference Call, May 7, 2014.

Jon Bock - Wells Fargo Securities

…please correct me if I am wrong but does that mean that you booked more income into NII or more income to you, than the actual amount of earnings and profits that were being generated by those individual businesses?

John Barry - Chairman and CEO

Jon, the answer there is yes and that's absolutely the case with almost every company we have whether it is wholly owned or it's a straight debt investment, the answer is that these companies are paying their interest cost out of cash flow, cash flow is the determining factor as to whether they can make their payments or not, so these payments were all made out of cash flow.

[6] Ibid.

Jon Bock - Wells Fargo Securities

[A]re you deemed effective by the SEC to issue such [equity] securities?

Grier Eliasek - President and COO

We don't know, no one said we're not effective, we just decided the last week that we didn't think it was a good idea.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Prospect Capital: Intra-Quarter Conversions From Capital Account To Income Through Wholly-Owned Holding Companies