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NGP Capital Resources Company (NASDAQ:NGPC)

Q2 2012 Earnings Call

August 7, 2012 11:00 am ET

Executives

Stephen K. Gardner – President and Chief Executive Officer

L. Scott Biar – Chief Financial Officer, Chief Compliance Officer, Treasurer and Secretary

R. Kelly Plato – Senior Vice President

Analysts

Greg Mason – Stifel, Nicolaus & Co., Inc.

Pavel Molchanov – Raymond James & Associates

Operator

Ladies and gentlemen, welcome to your NGP Capital Resources Company’s Second Quarter 2012 Earnings Call. At this time, all lines are in listen-only mode with the Q&A session to follow. (Operator Instructions) As a reminder, this conversation is being recorded.

Now, I would like to turn the call over to your host, NGPC President and CEO, Steve Gardner. Sir, you may begin.

Stephen K. Gardner

Thank you, Latiff, and thank you all for joining us on today’s conference call. With me on today’s call are Kelly Plato, our Senior Vice President and Chief Investment Officer; and Scott Biar, our Chief Financial Officer.

I’ll make some opening remarks, after which Scott will provide some details regarding the financial results for the second quarter. Kelly will then discuss our portfolio activity and prospects for new investment, and then I’ll wrap up with some summary comments, and we’ll open it up for questions.

First a bit of housekeeping, I want to remind everyone that our remarks today include comments which could be considered forward-looking statements. And such statements are subject to many factors that can cause actual results to differ materially from our expectations as expressed in those forward looking statements. Those factors are described in more details in our SEC filings, and I refer you to our website or to the SEC’s website to review those filings. We undertake no obligation to publicly update or revise any forward-looking statements, which speak only as of today’s date, okay.

For the second quarter of 2012, we have reported total investment income of $5.3 million and net investment income of $2.6 million or $0.12 per share. Our net asset value declined slightly to $9.29 per share, and our weighted average yield on portfolio investments remained strong at an annualized rate of 11.4%.

During the second quarter, we funded $28 million of new investments, most notably the $25 million participation in a $2 billion senior note offering by Everest Acquisition, LLC, which recently acquired what had been El Paso Corporation’s U.S. oil and gas exploration and production assets. Everest is owned by a group of investors led by Apollo Global Management, LLC, Riverstone Holdings, LLC and others.

In early July, just after the end of the quarter, we entered into two new investments totaling $75 million bringing our year to date new investment activity to over $110 million or $75 million net of redemptions and repayments, and our current investment portfolio is valued at roughly $225 million. That’s the highest aggregate value of our investment portfolio since the first quarter of 2009. Kelly will provide more details on the new investments later in the call.

At June 30, 2012, our targeted investment portfolio consisted of 18 portfolio companies with an aggregate value of $149.4 million. We had net cash on our balance sheet of $50 million as of June 30. Factoring in the $75 million of new investments made after quarter end, we currently have approximately $27.5 million outstanding on our investment credit facility leaving us with $45 million available for new investment.

Also during the second quarter, we repurchased 250,029 shares of our common stock or roughly 1.2% of our shares outstanding at an average price of $6.51 per share for a total cost of $1.6 million. These repurchases added $0.04 per share to our net asset value during the quarter. We have remaining authorization under the plan to repurchase up to an additional $8.4 million of stock subject to applicable securities laws and regulations that set certain restrictions on the method, timing, price and volume of stock purchases.

Now, I’ll turn the call over to Scott Biar, our Chief Financial Office, and he will discuss the details of our quarterly performance. Scott?

L. Scott Biar

Thank you, Steve. For the quarter ended June 30, 2012, total investment income was $5.3 million or $0.25 per share compared to $5.6 million or $0.26 per share in the first quarter of 2012, and $9.1 million or $0.42 per share in the second quarter of 2012.

The year-over-year decline is attributable to $3.9 million of unusual interest income activity in the second quarter of 2011 including the recognition of $4.5 million of previously unrecognized PIK interest income on Tranche B of a Term Loan with Alden Resources, which we sold in July of 2011. And the reserve is 600,000 of previously recognized interest income on BioEnergy and Bionol Clearfield. The small sequential decline is primarily a function of slightly lower average investment portfolio balance due to the timing of principal pay downs and new investments during the first half of 2012.

Operating expenses for the second quarter of 2012 totaled $2.7 million, increasing less than 1% compared to the first quarter of 2012, and decreasing $700,000 or 21% compared to the second quarter of 2011.

The year-over-year decrease was primarily attributable to lower management fees to our investment advisor as a result of lower total asset balances, and because the second quarter of 2011 included $300,000 of investment income incentive fees that did not reoccur in 2012.

Our net investment income for the first quarter totaled $2.6 million or $0.12 per share compared to $3.0 million or $0.14 per share in the first quarter of 2012, and $5.7 million or $0.26 per share in the second quarter of 2011.

We had net realized and unrealized losses totaling $1.5 million or $0.07 per share in the second quarter of 2012 compared to net gains of $1.2 million or $0.06 per share in the first quarter of 2012, and net losses of $22.1 million or $1.02 per share in the second quarter of 2011.

Key components in the second quarter of 2012 net unrealized loss included the $2.0 million reduction in the fair value of our Black Pool term loan, which Kelly will discuss in a moment, and another $1000 reduction in the estimated fair value of our earn-out from Globe related to our sale of Alden last year. Partially offsetting these losses were $1.1 million increase in the fair value of our Castex Energy Development Fund, LP units due to successful development work and increased production of that project, and a $900,000 mark-to-market adjustment on our Everest Senior notes which were trading around $103.6 as of the end of the quarter.

Primary drivers of the loss in the second quarter of 2011 were the reduction to zero in the fair value of our investments in BioEnergy and Bionol and the reductions in value on our overriding royalty interest and equity investment in Alden to reflect the actual value and allocation of proceeds from the sale of Alden investments which occurred in July of 2011.

So our net increase in net assets resulting from operations during the second quarter of 2012 was $1.1 million or $0.05 per share. Our common stock repurchases increased net asset value by $0.04 per share, and we declared dividends of $0.13 per share bringing our net asset value as of June 30, 2012 to $9.29 per share, a slight decrease for the quarter, but still $0.03 per share higher than our December 31 net asset value of $9.26 per share.

At June 30, 2012 we had cash and cash equivalents of $121.4 million. We had $71.3 million outstanding, and no additional amount available for borrowing under our investment facility.

As the end of the quarter approached, we anticipated that we would fund on the last day of the quarter one or both of the investments totaling $75 million, but ultimately funded in July. So our cash balance at the end of the quarter is higher than it otherwise would have been.

Our debt-to-capitalization ratio at the end of June was 29%, and our net debt-to-capitalization ratio was a negative 25%. In July, after funding the two new investments, we repaid $44 million of the amount outstanding under the investment facility, and we’re currently at $27.5 million of debt outstanding under the investment facility, and approximately $45 million available for borrowing.

With that, I’ll turn the call over to Kelly Plato, our Chief Investment Officer.

R. Kelly Plato

Thank you, Scott. I’d first like to discuss the two new investments we made in July and then I’ll discuss some recent developments with a couple of our investments in the portfolio.

On July 3, we advanced an additional $25 million to ATP Oil & Gas Corporation or ATP under our limited term overriding royalty interest in certain producing oil and gas properties that are operated by ATP in the Gulf of Mexico. It brings our net balance outstanding under this arrangement to approximately $43 million.

As consideration for the additional investment with ATP, we obtained a 5% limited term overriding royalty interest in ATP’s Telemark properties to supplement our 10.8% overriding royalty interest in ATP’s Gomez field properties. This investment is structured as a real property interest, and the underlying Gomez and Telemark oil and gas properties which are operated by ATP, which currently contain nine producing wells.

Payments received under this royalty arrangement are first applied to interest at an annual rate of 13.2% with any excess being applied to principle. The limited term override expires after we have received all of our investment back with the interest of 13.2% per annum.

There’s been a fair amount of discussion in the market recently concerning ATP's financial condition and liquidity, and how our investment will be affected if ATP files bankruptcy. Needless to say, we contemplated the same question before we entered into the July transaction, and our investment is structured as a real property interest, which we believe is entitled to receive payments, based on the revenues generated from the producing wells at these properties.

While there might be some delays or temporary suspensions of our monthly payments as this situation plays out, the revenue stream that supports our investment should remain outside the bankruptcy estate if there is a borrowing, and we believe that the value of the pre-developed producing reserves in these properties is more than adequate for us to recover our invested capitals, and realize the rate of return on our investment through future production.

On July 10, 2012, we acquired $50.0 million of redeemable Preferred Units in Castex Energy 2005 LP, a private oil and gas limited partnership engaged in the acquisition, exploration and development of oil and gas properties in South Louisiana, and the shallow waters of the Gulf of Mexico. This is the same management team involved in our existing Castex Energy Development Fund investment, but Castex 2005 involves a much broader and more diversified set of assets.

The Preferred Units earned 8% cumulative cash dividends, which are payable quarterly. And upon redemption, holders of Preferred Units have the option to elect, to receive the outstanding face amount, plus either a cash payment, which results in a total 12% internal rate of return, inclusive of the cash dividend or a limited partnership interest, which our share would be approximately two thirds of 1% of the outstanding limited partnership interest.

The Preferred Units are callable by Castex ‘05 at anytime after one year subject to the redemption rights described earlier. Each holder of the Preferred Units has the right to put its Preferred Units to Castex ‘05 on the redemption term described on or after the earlier of July 1, 2016, a change of control or any liquidation. The way this investment is structured, I’m assuming no unforeseen developments impacting the fair value determination of near term.

We anticipate that we will record dividend income currently at 8% and evaluate the fair value of the total investment including the redemption features described earlier on a quarter-to-quarter basis. This is our third investment with the management team at Castex, and we feel very strongly about the credit quality and prospects for this new investment.

With regard to the existing portfolio, there have been a couple of developments recently. As we have previously disclosed, Pallas Contour, a specialized contract coal mining company violated a financial covenant and was noticed of the default on its term loan of January of this year. Pallas Contour’s performance was negatively affected by the downturn in the coal industry, and earlier this year had several months in which only one of its four minors was under contract to mine for third parties.

In July, Pallas Contour sold an highwall mining machine for $5 million, and repaid $3.6 million of our principal on our senior secured term loan. They reduced our outstanding balance to $7.6 million.

After the sale, Contour has three remaining highwall mining machines that secure our term loan, and all three are currently under contract with third parties. The results of this asset sale and subsequent repayment certainly improve our position, and the lower debt level and new work areas will help Contour sustain its operations through challenging conditions in the coal mining industry.

Secondly, we reduced the value of our Black Pool term loan by $2 million in the second quarter, primarily based on the impact of an updated engineering review and recent production data.

On July 31, subsequent to these valuations, Black Pool was merged into a new private oil and gas company, which is comprised of six portfolio companies owned by a private equity client. The new company is being managed by the management team from Black Pool, this consolidation has been in process for several months, and it's an important first step to our restructuring and resolution with Black Pool, and we see it as a very positive development. We continue to negotiate with management towards a potential restructuring of our Black Pool investment, and that’s really all we can say about it at this time.

As you are aware, we rate all of our investments from 1 to 7 with 1 being the highest credit quality. At the end of the second quarter, our average portfolio rating on a dollar weighted fair market value basis was 4.5, which compared to 4.2 at March 31. This reduction in credit quality rating reflects a downgrading risk for certain of our investments, primarily those that have been in a covenant default for several quarters.

Of the 19 rated investments we held as of June 30, 2012, 10 retained the same rating, six investments declined in rating, one improved and two new investments were added in the first six months of 2012. No investments have been placed on that rule in 2012.

Deal flow and manager space has continued to be relatively strong. At present, we are working on a number of E&P development deals and energy service opportunities that look interesting, although the timing and likelihood of closing is hard to project at this point.

Additionally, we are currently working on several potential middle market investments that look promising. And through July we have recorded $111 million of new investments this year towards our goal of targeting the $150 million to $200 million of new energy focused investments, and we hope to see some new middle market originations later this year.

With that, I’ll turn the call back over to Steve.

Stephen K. Gardner

Thanks, Kelly. In summary, I’ll say that I’m pleased with the quarterly results for the second quarter of this year. Our investment income was solid given the size of our investment portfolio, and our weighted average yield of portfolio investments has remained strong at 11.4%.

We increased our dividend from $0.12 per share to $0.13 per share this quarter, and through the six months we’ve declared dividends totaling $0.25 per share. Our net investment income per share has been $0.26 per share through the first six months of 2012.

I’m pleased to have a fair value of our investment portfolio at it highest level and over three years, and I believe we are well positioned to grow our earnings over the second half of the year as we continue to expand our investment portfolio.

Now, I’ll turn the call back to Latiff to take your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from Greg Mason of Stifel, Nicolaus. Your line is open.

Greg Mason – Stifel, Nicolaus & Co., Inc.

All right good morning, gentlemen.

Stephen K. Gardner

Good morning, Greg.

L. Scott Biar

Good morning, Greg.

Greg Mason – Stifel, Nicolaus & Co., Inc.

Congrats on putting the capital work, that’s been the key to this story. As we look at your current credit facility, $72 million of kind of maximum capacity, as you get close to using all of that, that will put you at, call it 0.35 debt-to-equity. What kind of leverage do you want on these assets, and what alternatives are you guys are exploring for additional debt capacity as you’ve now deployed a lot of your excess capacity?

Stephen K. Gardner

Sure Greg, this is Steve. I don’t think we would get much further north of 0.35, probably to 0.5 will be the higher end of the range. We are currently in discussions with our banks about adding some new banks to the facility and increasing our capacity there. And with early stages of having some conversations with folks about issuing a baby bond so to speak. But all add, I think 0.5 or slightly above that would be the high end of where we want to leverage these assets.

Greg Mason – Stifel, Nicolaus & Co., Inc.

All right, great. And then, the write down in Black Pool at June 31, does that take into account any of the July events that occurred?

Stephen K. Gardner

No. No, it really hasn’t and our current position is unchanged, obviously the merger and the continuing negotiations are positive developments. But as of June 30, the merger has not occurred, and that’s just a number as of that day.

Greg Mason – Stifel, Nicolaus & Co., Inc.

Great. And then with the size of a couple of these investments, it would seem to me that diversification test that BDC has to manage could become problematic. Can you talk about how you manage the diversification tests, and is the large bucket essentially full at this point and can that impact the investments that you need to make going forward to manage that?

Stephen K. Gardner

Sure, Greg. Yes, the large bucket so to speak is full. And it is something we have to focus on. The way we’ll manage it and going forward is, there are some issues that we may sell down that we own to basically push the large investments into the, large bucket investments into the smaller bucket. We’ll also look for ways to deliver the balance sheet to increase total assets. But I think principally, as we put new investments on the books, we may well lighten the load in some of the larger investments.

R. Kelly Plato

And I think you also see us closing some of the bigger deals as well.

Stephen K. Gardner

The newer deals that we’re looking at as Kelly mentioned, that are up in the large bucket variety, we’re in conversations with folks to where we put pool group of financings or capital sources together.

Greg Mason – Stifel, Nicolaus & Co., Inc.

Okay, great. And then one last question, we like the share repurchases at a discount, and congrats this quarter, what’s your view on repurchases given the stock is $1 higher almost from where you repurchased last quarter?

Stephen K. Gardner

Obviously we’re still trading at a discount, and we think it’s accretive to continue to acquire shares. Our ability to acquire shares is subject to the insight of trading rules that all the insiders are subject to as well. So if there are developments out there that are not public yet, that may keep us out of the market, additionally the other primary consideration in reacquiring shares, is the diversification test that you mentioned earlier Greg. When we are bumping up against the diversification test requirements to shrink the balance sheet, the share repurchases can be problematic.

So at this point we have facility or the program approved, it’s available to us, it will continue to be a day-to-day decision, and that’s as far we’ll go right now, is that right Scott?

L. Scott Biar

Yeah.

Greg Mason – Stifel, Nicolaus & Co., Inc.

Great, thank you gentlemen.

Stephen K. Gardner

Thank you, Greg.

Operator

(Operator Instructions) Our next question comes from Pavel Molchanov of Raymond James. Your line is open.

Pavel Molchanov – Raymond James & Associates

Hey, guys.

Stephen K. Gardner

Hi, Pavel.

Pavel Molchanov – Raymond James & Associates

I think that since the last time we had this call, natural gas is up close to 50%, and I’m curious how the recent dynamics in the gas market, the recent rebound has been influencing your thinking in particularly about the E&P side of things?

R. Kelly Plato

It hasn’t really changed our thinking a whole lot, it’s in line with what we’ve been expecting in the market, it has made the Castex investment a little easier to get it wrapped around, and allowed us to do some hedging there, but we might not been able to do earlier this year. We are seeing a handful of gas deals, but we’re really not seeing that many gas deals.

We continue to look form, we like the long-term fundamentals of natural gas, it is difficult, and the short term with these low prices, but we still think although we haven’t really seen it, we still believe that we saw gas prices are going to provide us some opportunity, where people are going to need the capital. But other than that, our thoughts on the gas market has stayed fairly consistent.

Pavel Molchanov – Raymond James & Associates

And I guess, on a slightly different topic compared to let’s say 12 months ago, what’s the competitive landscape looking like, I mean in other words has it gotten, tougher, easier or unchanged?

R. Kelly Plato

It’s become tougher, the handful of guys who stayed in the space some have become a little more aggressive and are willing to step a little further on the risk spectrum than we’ve been willing to do, and then there are also some new people coming in, but especially for the better quality deals, competition is pretty still.

Pavel Molchanov – Raymond James & Associates

Okay, that’s all from me, I appreciate it guys.

R. Kelly Plato

Thank you, Pavel.

Operator

Thank you. And as there are no further questions in queue, I’d like to turn the call back over to Mr. Gardner for any closing remarks.

Stephen K. Gardner

Thank you, Latiff. We appreciate your answers this morning, and participation on the call. You should hear from us in middle of September on our next dividend announcement, and then we’ll have convenient other teleconference after the third quarter. Thanks a lot for your time.

Operator

Thank you, sir. And thank you ladies and gentlemen for your participation. That does conclude your program. You may disconnect your lines at this time. Have an excellent day.

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