Terry Hart - CFO
Kevin McCarthy - President and CEO
James Shanahan - Wachovia
Kayne Anderson Energy (KED) Q4 2007 Earnings Call February 12, 2008 10:00 AM ET
Good day ladies and gentlemen, and welcome to the fourth quarter and year end 2007 Kayne Anderson Energy Development Company Earnings Call. My name is Francis and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions)
I would now like to turn the call over to, Mr. Terry Hart, Chief Financial Officer for the company. Please proceed.
Good morning, everyone, and welcome to the Kayne Anderson Energy Development Company conference call to discuss our results for the quarter and year ended November 30th, 2007. Before we begin this morning, I would like to remind you that our call will include statements reflecting assumptions, expectations, projections, intentions, or beliefs of our future events. These and other statements not relating strictly to historical or current facts are intended to be forward-looking. Generally, words such as believe, expect, intend, estimate, anticipate, project, will, and similar expressions identify forward-looking statements, which generally are not historical in nature.
Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ from the company's historical experience, its present expectations, or projections. For a description of the factors that may cause such a variance, I would direct you to the forward-looking statement discussion in our annual report on Form 10-K and our quarterly reports on Form 10-Q. These reports are available free of charge through our website at www.kaynefunds.com and at SEC.gov.
You should not place undue reliance on forward-looking statements. The company undertakes no obligation to update or revise any forward-looking statements. There is no assurance that the company's investment objectives will be attained. With that, I will now turn our conference over to our President and Chief Executive Officer, Kevin McCarthy.
Thanks, Terry and good morning everybody. Thank you for joining us today for our fourth-quarter conference call for Kayne Anderson Energy Development Company, or KED. With me in Houston today are Terry Hart and John Riley. Also dialed into the call from LA are J.C. Frey, David LaBonte, and David Shladovsky.
First we would like to start a review of our operational performance during the year, and the quarter ended November 30th, then we will review current market conditions for investments, and our recent announcement that we have elected to no longer be treated as an RIC for tax purposes. Next Terry will discuss our financial performance, and finally, we will discuss our guidance based on our portfolio at end of November 30th, and then open the phone lines for our Q&A session.
During the fourth quarter we had a total return of just under 1%, based on the change in NAV plus dividends paid during the quarter. This performance was achieved in spite of the volatility in the capital markets during the quarter. From the beginning of August to the end of the fiscal year, both the fixed income and MLP markets experienced substantial downward pressure.
During fiscal 2007, we had a total return of 6.3% based on the change in NAV, plus the reinvestment of dividends. As we'll discuss in more detail we believe the fundamentals for both public and private main stream energy companies remains quite strong.
As we review our operational performance for the year, we are very proud of what we accomplished. Fiscal 2007 was a year of executing other plans we outlined in our IPO. First we invested the proceeds from our IPO within nine months in line with our projected ramp up period.
Second we established our revolving credit facility, and invested $85 million of proceeds in portfolio securities.
Third we achieved our dividend target yield which was 6.5% of the IPO prize, one quarter ahead of plan. Dividends paid during fiscal '07 were approximately $1.35 per share, which exceeds our target distribution for the first full fiscal year of $1.30 per share.
Finally, KED paid a dividend of $0.41 per share in January 2008, which was attributable to the fourth quarter. This dividend is $0.13 per share higher than the dividend rate paid in January of 2007. As a result of our most recent dividend increase, we are now yielding approximately 6.8%.
As a result of our investing throughout the year, at November 30th, we owned $93 million of equity securities of MLPs and MLP affiliates, which represented approximately 28% of our total investments. $138 million of equity securities of private MLPs which is 43% of our total, and $96 million of debt securities and preferred stock of private energy companies, which is 29% of the total. As many of you know, it was a very tumultuous year for the MLP market, with the last five months of 2007 one of the most difficult markets in recent memory. In contrast with the first seven months of the year where we saw tremendous strength with the Citi index -- MLP index up over 20%. Volatility in the markets have continued during the first quarter of '08, largely the result of weak performance of the overall equity markets, the turbulence in the credit markets and fears of a recession.
When all the dust settled there was still a very strong gear for MLP sector. The Citi MLP index had total returns of 10.3%, largely driven by very strong distribution growth which was over 11% for the year. Our research is looking for distribution increases in 2008 which are consistent with the double digit growth rates we have seen in the past three years. We expect the MLP equity market to continue to face challenges during the first half of 2008 as concerns remain over the impact of the recession. The continued credit market was in the continued need of MLPs to access the market to fund growth. We believe in a third-party acquisition activity will continue to drive distribution growth in 2008, but the third-party acquisition activity will be in a lower level than 2007. After a short transition period, we believe M&A multiples will decline to reflect the higher cost of capital, so that the accretive nature of the acquisitions, remain intact.
Continued a trend we saw in 2007, we think distribution growth will be increasingly driven by drop down acquisitions in the total growth projects. We've seen a significant increase in the number of announced internal growth projects which is good because these opportunities typically have much higher returns in third party acquisitions. We believe that MLPs will spend more than $10 billion on dropdown, acquisitions, and internal growth projects in 2008. While the ability to finance these projects may be more of an issue in 2008 than 2007, we believe this provides a greater opportunity for us to provide privately negotiated financing. Our private MLPs investments continue to perform well as was outlined in the presentations in our Analyst Day, each of our four largest private MLPs is actively pursuing growth opportunities, both acquisition and internal growth projects. In fact Millennium Midstream and Crest Midstream have each completed large acquisitions within the past six months, and all five private MLPs are seeing very good deal flow. Despite the tumult in the capital markets, the operational backdrop from midstream companies continues to be strong, with strong oil and gas prices driving the need for additional infrastructure. We believe our business model of financing private midstream companies within the MLP structure would remain sound. We are pleased with the quality and quantity and the opportunities to invest capital in these private midstream companies. We respect KED's fixed income investments market conditions, as it is significantly more difficult since last August. Our flight to quality and risk aversion is negatively impacted in second lien bank loans and high yield markets. In general the operational results and assets coverage of KED's fixed income investments which are all energy related companies, is strong and any decrease in value of those investments is really being driven by market conditions as opposed to any company specific events. Only one of our fixed income investments has faced some operational problems, as unusually low gas prices in the Rockies has impacted our petrol investment. LIBOR fluctuated dramatically during the last six months, but our exposure to such changes is relatively minor, since we have appropriately $71 million in LIBOR-based investments, which offsets our $85 million of LIBOR-based bonds. As we reviewed at our Analyst Day on January 23rd, we have elected to no longer be treated as an RIC under the internal revenue code. The effect of this election is that we will become taxable as a corporation.
We will still be treated as a business development company or BDC under the 40 Act. As we explained in our press release and in the subsequent Analyst Conference, we changed our election for a variety of reasons. First and foremost was the fact that we were continuing to see attractive opportunities to invest in private MLPs, but we were effectively precluded from making any additional investments in private MLPs due to the requirements imposed by the RIC test.
Furthermore, result of the compliance of that RIC test was becoming increasingly difficult, and what has been very difficult to maintain to the extent that we were successful in taking public one or more of our private MLPs. We discussed this plan in our press release, but I think it's important to reiterate that this election is not expected to have an impact on our distributable cash flow in the short-term, as the tax deferred nature of partnership distributions both public and private coupled with our leverage in operating expenses is expected to result in no taxable income.
This election will have an impact on our NAV as we are required to book deferred taxes on all unrealized gains. As of January 10th, we had $11 million of unrealized gains and the impact on deferred taxes would have been $0.42 per share. As a result of this election, we anticipate increasing our allocation to private MLP investments, which we believe offer the highest risk adjusted return.
We also anticipate reducing our exposure to fixed income securities, which are less attractive in the taxable corporation, and it will also be less attractive as a LIBOR benchmark, and therefore the rate we get paid continues to decline.
So to summarize, we are pleased with the progress we have made since our IPO, and are excited about the outlook for our investments. By electing to be treated as a taxable corporation, we have the flexibility to take advantage of the market opportunities during 2008.
I’ll now turn the conference over to Terry Hart, our Chief Financial Officer who will discuss our financial performance.
Thanks Kevin. During the fourth quarter, we had a net increase in net assets that resulted from operations of $1.4 million, and our net asset value at the end of the quarter was $245.1 million or $24.39 per share. This compares to a net asset value as of August 31st, of $247.2 million, or $24.65 per share.
KED had a net investment loss for the fourth quarter of $400,000. Interest income earned from KED's fixed income investments and to a lesser extent the short-term investments were the primary components of its $2.9 million of investment income for the period. KED received $4 million in dividends and distributions, all of which was treated as return of capital resulting in no contribution to investment income for these investments.
Operating expenses for the period were $3.5 million including $1.4 million in base and incentive management fees, and $1.5 million of interest expense. The base management fee rate for the period was 1.6% of average total assets, which equates to an annual base fee rate of 1.75 % less a fee waiver of 0.5% through September 24th, which was the expiration date of the waiver.
There were no management fees on investments in the US Treasury bills associated with our treasury facility. Net realized gains from KED'S investments during the fourth quarter were $2 million and KED had net unrealized losses from its investments and net of income taxes of $200, 000 during the period.
For the year ended November 30, 2007, KED had net investment income of $3.6 million. Interest income earned was $11 million, and KED received $9.2 million in dividends and distributions, substantially all of which was treated as return of capital resulting in a $500,000 contribution to investment income for these investments.
Operating expenses for the year were $8.5 million, including $3.8 million in base and incentive management fees, and $2.5 million of interest expense. Net realized gains from KED's investments during the year were $5.5 million, and KED had net unrealized gains from its investments net of income taxes of $6.3 million during the year. On December 20th KED declared a dividend of $0.41 per common share or $4.1 million based on its fourth quarter results. This dividend represents an increase of 1.2% compared to the quarterly dividend of $0.45 per share for the quarter ended August 31st, 2007.
As of November 31, KED had $15 million of capacity under its Investment Facility, and had approximately $10.8 million of short-term investments in repurchase agreements. In conjunction with our announcement that we no longer intended to be treated as RIC we sold our investment in treasury bills and terminated the treasury facility on January 31, 2008.
At this point I'll turn the conference back over to Kevin to discuss our current guidance.
Thank you, Terry. As we've done for the last several quarters, we'll now review our most recent guidance. Let's start with dividends, distributions and interest income that we estimate can be earned from the portfolio as of November 30th. I'd like to emphasize that the portfolio composition in the average yields are as of November 30th, and they don't reflect any changes in portfolio allocation or yields that are expected to occur over the next several quarters. As always we will report those changes at the end of the quarter.
With that carryout in mind, our portfolio at year-end consisted of $93 million invested in public MLPs and MLP affiliates, with an average yield of 6.5%. $138 million invested in private MLPs with an average yield of 8.5%. $96 million invested in fixed income securities of private companies with an average yield of 11.3% and $11 million in investments in repos with an average yield of 3.1%.
These numbers are pro forma for the sale of our treasury securities on January 31st, and the termination of our treasury facility. Based on this portfolio we estimate dividends, distributions and interest income to be approximately $7.2 million per quarter.
Please note that this estimate does not include the impact of return on capital which will reduce the net investment income reported under GAAP. It does also not include any additional investments we've made subsequent to November 30th.
Let's turn now to our estimates of interest expense and operating expenses. Based on $85 million borrowed under our investment facility at November 30th, we estimate interest expense to be $1.4 million per quarter. This estimate is also based on the rates as of November 30th, when LIBOR was 5.24% versus current LIBOR of just slightly over 3%.
We estimate that our base management fees to be approximately $1.4 million per quarter, which reflect the expiration of the fee rebate in September. Other operating expenses are expected to be $600,000 per quarter.
We don't provide any guidance on realized gains or incentive management fee, but as previously mentioned we have $5.5 million of gains for fiscal 2007.
So to summarize, despite tough market conditions we are very pleased with our operational performance during fiscal 2007. We have met or exceeded the guidance provided at the time of our IPO, and we believe the fundamental supporting the public and private MLPs remain strong.
Finally, we believe that our election to become a taxable corporation allow us the flexibility to pursue many of the attractive opportunities in the private MLP space.
Operator, at this time we would like to begin the Q&A session.
(Operator Instructions). Your first question comes from the line of James Shanahan from Wachovia. Please proceed.
James Shanahan - Wachovia
Thank you and good morning I have to apologize in advance if you have touched on this, I was on other earnings call and dialed in a few minutes late. I'd like to get some thoughts on how the portfolio might be expected to change? Are there any public MLPs that you think make sense for long-term investment, or to say it differently, do you think that we should expect to see that portfolio decline over time to be replaced with private MLP opportunities, and how small could that portfolio be over the course in the next 12 or 24 months?
Yeah we do plan on reducing our exposure to the public MLPs, it will be a transition period as we see opportunities in the private MLP space. One is the constraints we had as a RIC was the requirement to have some small investments to meet our diversification test. So that's really the main reason why we were required to have the public MLPs, as we see opportunities to participate in pipe transactions in conjunction with our other funds. We may always have some slug of public MLPs but we would expect that to decline from the 28% that we are currently to sort of between zero and 10% of our portfolio a year from now.
James Shanahan - Wachovia
Great and one more question please I think you touched on this in your Investor Day which was very good by the way we appreciate that.
James Shanahan - Wachovia
What do you think about the market for, the IPO market for MLPs in 2008?
Well I think in the short-term it's continuing to be a difficult market. I think that the market now is distinguishing between the qualitative IPOs. It's our view that high quality IPOs can still get done, I think the O' Passa transaction in December is a good example of that. But the marginal deals will probably get pulled or postponed. We don't think it will have an impact on the plans for any of our portfolio companies, because we are not planning to take anything of those public within the first six months. Our long-term view of the MLP market, is that it will recover from some of the technical factors that they are impacting it currently, and we're pretty hopeful that the IPO receptivity will be much too better later in the year.
James Shanahan - Wachovia
Okay, thank you very much.
Well thank you operator. Given the fact that we had our Analyst Day just over three weeks ago I am not surprised, hopefully we've answered everybody's question, but happy to follow-up afterwards if people still have questions. Thank you everyone for taking your time this morning, and your continued interest in KED. Please refer to our website at kaynefunds.com for any future updates. And we look forward to future conference calls.
Thank you all for your participation in today's conference, this concludes the presentation, you may now disconnect and have a great day.