Apollo Investment Corp. (NASDAQ:AINV)
F4Q08 Earnings Call
May 29, 2008 11:00 am ET
Jim Zelter – President, Chief Operating Officer
Richard Peteka – Chief Financial Officer
Patrick Dalton – Executive Vice President, Chief Investment Officer Apollo Investment Management
Carl Drake – Suntrust Robinson Humphrey
Sanjay Sakhrani – KBW
Vernon Plack – BB&T Capital Markets
Greg Mason – Stifel Nicolaus
James Shanahan – Wachovia
Jon Arfstrom – RBC Capital Markets
Jackson Turner – Argus Research Company
Good morning and welcome to the Apollo Investment Corporation’s fourth quarter and fiscal year 2008 earnings conference call. (Operator instructions) It is now my pleasure to turn the call over to Mr. Jim Zelter, President and Chief Operating Officer of Apollo Investment Corporation. Mr. Zelter, you may begin your conference.
Thank you and good morning everyone. I’d like to welcome you to our fourth quarter and fiscal year 2008 earnings conference call. I am joined today by Patrick Dalton, Apollo Investment Corporations Executive VP and Chief Investment Officer at Apollo Investment Management and Richard Peteka, our Chief Financial Officer. Rich, before we begin would you start off by disclosing some general conference call information and include the comments about forward-looking statements.
Sure, thanks Jim. I’d like to remind everyone that today’s call and webcast is being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Audio replay information is available in our earnings press release.
I’d also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today’s conference call and web cast may include forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections.
We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit our website at www.ApolloIC.com or call us at 212-515-3450. At this time I’d like to turn the call back to our President and Chief Operating Officer Jim Zelter.
Thank you Rich. As we entered 2008 the overall credit market remained significantly dislocated and in January and February we saw continued volatility and further depreciation in the global capital markets. As in 2007, these dynamics were mostly due to the further technical pressure and the lack of liquidity in the overall credit marketplace.
However, beginning in mid March and post the Bear Stearns bailout, the market began a technical rally that has continued through today. Both the bank loan and high yield market indices are up over 500 basis points from the March 17 trough. And it would be reasonable for you to assume that our quoted portfolio which represents a majority of our assets today has also appreciated since the quarter end.
With ongoing Federal Reserve actions and the market’s confidences returning, we have also seen a significant action by the large commercial and investment banks to aggressively work off the overhang of LBO loans and bonds that have plagued their balance sheets for the last year.
We believe that the overhand of loans and bonds have been reduced from approximately $375 billion at its peak to under $100 billion today. In summary, we see the last nine months as a period of re-pricing of systematic risk combined with a large technical overhand in credit.
For the quarter ended March 31, we were highly selective and we saw lower volume of high quality primary market opportunities for the larger credits that we generally focus on. As we expected, the most high quality companies can afford to be a bit patient and wait until the more favorable market conditions to access the market for financing or for M&A.
So, we continued our strategy of investing our capital where we saw the best relative value. During the quarter that remained in the secondary market where we made a handful of select investments. Approximately two weeks ago, Apollo Investment Corporation completed a strategic and opportunistic follow-on common equity offering where we had significant demand for our stock from both current and new investors.
This strong demand afforded us the added advantage of allocating and placing stock with those we believe to be long term buy and hold investors as are we. Ultimately we announced the closing of our overnight deal that raised $382 million in gross proceeds.
This positive news then flowed into the secondary market and was supported by additional demand. During the transaction we were pleased to hear how our investors understood and valued our differentiated, consistent and unwavering business and investment strategy.
We were also pleased to hear how our overall transparency has generated significant credibility in an inconsistent marketplace. Lastly, we were excited to hear about how investors have come to understand and distinguish Apollo Investment Corporation’s portfolio composition, including our investments in larger companies.
We believe our continued focus on investing in larger companies offers many superior benefits, especially the significantly more experienced portfolio management teams that better understand managing a leveraged company across and through credit cycles.
Also inherent with investing in larger companies is the added benefit of valuation transparency and liquidity. But those benefits come with a need to understand the current market’s volatility and the temporary day to day effects on our NAV from marking to market.
As a reminder, and as we have since our IPO, when market quotes are available, we use them. It is therefore important for all investors of our company to understand the difference between marks affected by the volatility that permeates today’s marketplace and marks reflecting expected or actual credit impairment.
Let me add a few other reminders while I’m at it. The investment portfolio of Apollo Investment Corporation is invested primarily in senior secured and subordinated corporate loans. We then compliment this fixed income portfolio of investments with a modest amount of select private equity and expect to generate sufficient capital gains to strategically offset the inevitable losses one has in a fixed income portfolio.
Since our IPO and to date, I’m pleased to say that this overall portfolio strategy continues to work well. Since we began making investments in April 2004, we have made investments in 112 companies and have had two defaults. We have also generated approximately $200 million in realized gains that has more than offset any such losses and has provided a significant harvest of taxable income in support of our objective of delivering a steady stable and growing dividend stream to shareholders.
Our portfolio does not contain direct investments in mortgage related securities, nor does it contain debt or equity investments in any portfolio companies controlled by Apollo Global Management. At March 31, 2008, our portfolio contained investments in 71 different portfolio companies and was invested 22% in senior secured loans, 57% in subordinated debt, 6% in preferred equity and 15% in common equity and warrants measured at fair value.
Before I turn the call over to our CFO Richard Peteka, let me express that we are encouraged with the investment opportunities we see ahead and with Apollo’s fully integrated sourcing and investment platform, Apollo Investment Corporation is well positioned to utilize its substantial liquidity and strong conservative balance sheet to capitalize on these opportunities.
We look forward to continuing our efforts to preserve your capital while generating sufficient earnings to support our objective of delivering a steady stable and growing dividend stream to you. With that I’ll ask Rich to provide us with some details on the fourth fiscal quarter results. Rich.
Thanks Jim. We closed our fourth fiscal quarter and year end on March 31, 2008 with a net asset value of $15.83 per share, down $1.88 per share from our NAV at December 31, 2007 which was $17.71.
Year over year, our NAV decreased by $2.04. Considering reinvested dividends of $2.07 per share for the year, the total return based on NAV was essentially flat. That said, these changes to NAV for the quarter and one year period ended were driven primarily in changes in the market quotes of our assets that Jim described earlier.
As a reminder, a majority of our investments have market quotes available and we use them. Also keep in mind that given the overall volatility in the market, our reported NAV largely represents a snapshot, just one point in time, where the markets were pricing assets that day.
That said, let me turn to some performance numbers which include reinvested dividends. Since our IPO on April 8, 2004 and through March 31, 2008, the cumulative and average annual total returns based on NAV was 63.8% and 13.2% respectively. The cumulative and average annual total return on shares of AINV since our IPO is 45% cumulatively and 9.8% average annual respectively.
And moving to some operating results. Gross investment income for the quarter totaled $90 million. This compared to $92.9 million for the quarter ended December 31, 2007 and $75.3 million for the comparable quarter a year earlier. Accordingly, our gross investment income decreased by 3% for the quarter and was up 20% higher than the comparable quarter a year earlier.
Net operating expenses for the quarter totaled $46.1 million of which $27 million was management and net performance based incentive fees, $17 million was interest expense and $2.1 million was SG&A. This compares to the December quarter of $49.7 million in net operating expenses of which $32 million was management and net performance based incentive fees, $15 million was interest expense and $1.7 million was SG&A.
For the comparable March quarter a year earlier, net operating expenses totaled $53.1 million of which $43.6 million was management and net performance based incentive fees, $7.7 million was interest expense and $1.8 million was SG&A.
The decrease in expenses from December quarter was driven primarily by the absence of a net realized capital gains based incentive fee for the March quarter offset by growth interest expense stemming from an increase in investment activity during the quarter. On a comparative basis, net operating expenses totaled $154.4 million versus $139.7 million respectively for the full fiscal year as ended March 2008 and March 2007.
Of these amounts, $90.3 million represents management and performance based incentive fees for the 2008 fiscal year and $98.5 million for the 2007 fiscal year. Interest expense totaled $55.8 million for the year ended March 31, 2008 and $34.4 million for the year ended March 31, 2007.
SG&A totaled $8.3 million for the fiscal 2008 period and $6.8 million for fiscal 2007. In addition, excise tax of $1.9 million were paid during the fiscal year ended March 31, 2008 as compared to $1.1 million for the previous fiscal year.
The increase in expenses year over year is primarily due to the increase in interest expense offset by a decrease in the accruals for net realized capital gains based incentive fees. Accordingly, net investment income was $43.7 million or $0.37 per share during the quarter as compared to $41.5 million or $0.35 per share for the quarter ended December 31, 2007 and $21.7 million or $0.22 per share for the comparable March quarter a year earlier.
As a reminder, net investment income can vary quarter to quarter based on many factors, including the timing of investments made by us as well as when investments are sold or prepaid. Apollo Investment Corporation’s GAAP net investment income also continues to represent only a portion of our taxable earnings included in quarterly dividends.
Taxable earnings also include net realized capital gains, structuring fees and commitment fees and other upfront fees received from investments among others. Investment sales and prepayments sold $103 million during the quarter. Net realized losses totaled $4.6 million for the quarter as compared to net realized gains of $80.5 million for the previous quarter ended December 31, 2007 and net realized gains of $106.6 million for the comparable quarter ended March 31, 2007.
Also during the quarter we experienced a net decrease in unrealized appreciation of $201.5 million. As was also mentioned earlier in the call, this change in unrealized appreciation was primarily due to our continued use of marking to market our quoted portfolio.
That said, this compared to a net decrease in appreciation of $147.6 million for the quarter ended December 31, 2007 and a net decrease of $25.6 million for the comparable March quarter a year earlier. At December 31, our overall portfolio had net unrealized depreciation of $197 million versus net unrealized appreciation of $4.4 million and $92.2 million respectively at December 31 and March 31, 2007.
All totaled, our quarterly operating results decreased net assets by $162.4 million or $1.36 per share verse a decrease of $25.6 million or $0.21 per share for the quarter ended December 31, 2007 and an increase of $102.8 million or $1.04 per share for the quarter ended March 31, 2007.
Now let me turn the call over to our Chief Investment Officer, Patrick Dalton who will take us through our investment activity for the quarter as well as discuss our portfolio in more detail. Patrick.
Thanks Rich. From day one we have followed our consistent strategy of building an investment portfolio that is focused on a few key principles. Number one, maintaining a proper asset liability match. Number two, building a high quality portfolio of investments primarily in subordinated debt of larger companies.
Number three, making only a select amount of private equity investments to help build a cushion for our dividend and to offset the inevitable losses from the fixed income portfolio. And, number four, using only a prudent amount of leverage and keeping dry powder available at all times.
This simple strategy has allowed us to be patient when we should be patient and active when we should be active, both on the investing side as well as with our own capital raising activities.
During the quarter ended March 31, we chose to continue to be a patient investor, as a long term relative value investor, we took stock in the markets and continued to review a wide range of opportunities from a variety of different sources. However, we saw the prolonged material weakness and the technical drivers of the credit markets continue during the beginning of the quarter and chose only to make one follow on investment in January.
Towards the back half of the quarter, the markets began to trough and we were able to make a handful of select investments at attractive prices. We are pleased with these investments that we have made during the quarter. We closed our third quarter having invested $203 million across two new and six existing portfolio companies.
The quarter also saw prepayments and other exits totaling $103 million. Since our IPO in 2004 our total invested capital now exceeds $5.2 billion across 112 portfolio companies. Now let me take you through a few of our investments made during the quarter. We invested approximately $118 million in debt securities of First Data Corporation in the secondary market.
First Data in which we previously held a $65 million investment in the common equity is a dominant global transaction processing franchise providing payment processing services and electronic commerce to merchants and card issuers. First Data is owned by KKR.
We also invested $25 million in high yield securities to support the buyout of Goodman Global Inc. by Hellman and Friedman. Goodman Global, a former Apollo Management portfolio company is the second largest domestic manufacturer of heating, ventilation and the air condition products.
US Investigation Services Inc, a leading provider of security clearance, background investigation and employment screening services to government agencies and commercial customers in the United States. We invested $6.1 million in senior notes in the secondary market at attractive prices. US Investigation is owned by Providence Equity Partners.
We selectively added to our position in the bridge loans of Laureate Education Inc, investing an additional $16.5 million at a discount to original issue price. Laureate Education is a leading provider of international higher education through campus based and online universities. Laureate’s bridge loans have since converted into fixed rate high yield notes with five years of call protection.
Lastly, we further invested approximately $13 million in the secondary market in the names of companies that we currently own including Car Holdings and Dresser Inc at substantial discounts to original issue prices.
Ultimately, our investment portfolio at March 31 consisted of 71 companies with a market value of $3.2 billion. And while we experienced a decrease in net unrealized appreciation during the quarter due to various mark to market quotes as the overall bank and bond markets traded off, we are comfortable with the overall fundamentals in credit quality of our portfolio.
At the quarter end, the weighted average yield on our debt portfolio was 12% as compared to 12.6% at the end of the previous quarter. The weighted average yield on our subordinated debt and senior loan portfolios were 12.8% and 10% respectively, down from 13% and 11.6% respectively in the prior quarter.
The impact to our debt portfolio yield during the quarter was derived primarily from prepayments of higher yielding assets and a declining market and benchmark rates. However, given that we roughly match our floating rate assets or floating rate liabilities, this reduction in yield which is based on our original cost does not necessarily reflect a one to one reduction in net interest margin on our portfolio.
Our portfolio remains diversified by issuer and by the industry. As of March 31, our weighted average risk rating in the total portfolio remained a rating of a 2. And our weighted average cash interest coverage was over 2 times. There were also no new non-accruals during the quarter.
Of the 112 portfolio companies invested in since the IPO, we have only had two investments place on non-accrual and we believe that the additions to the portfolio since the market dislocation began have also been advantageous and we expect these opportunities will continue on a selective basis.
We also expect the primary market will increase over the next several quarters. As seasoned credit investors, even with the recent rally in the bank and bond markets, we are not yet ready to state that we are fully out of the woods with respect to the economy at large.
We are extremely focused on the underlying fundamentals of the economic climate that we are in and expect that it will continue at least through 2008. So, we remain steadfast in our focus on our existing portfolio as well as pursuing only the highest quality investments in larger companies with strong free cash flow.
Accordingly, our average portfolio company investment continues to exceed $45 million at March 31. More importantly, the weight average EBITDA for our total portfolio is now well in excess of $200 million per company. We continue to believe that our focus on larger companies, especially during this current economic climate is a more prudent less competitive and ultimately more attractive investment strategy.
We continue to believe that larger companies are better able to manage through less robust economic climates. The dislocation in the credit markets which began last summer is now almost a year old and there are some signs that there is some stability returning to the bank and bond markets.
We believe that this is a positive for Apollo Investment Corporation. Financial sponsors with several hundred billions of dollars of capital have been inactive for almost a year as well. Financial sponsors generally only have five years to invest the capital or they are required to return it and we do not expect that they will return it un-invested.
A rally in the secondary market generally leads to an increase in primary market activity. We believe that we continue to be well positioned to take advantage of opportunities wherever the best relative value lies.
We are encouraged by the dialogues that we are currently having with financial sponsors and their overwhelming desire to be closer to their debt capital providers. In addition, we are also encouraged by the discussions that we continue to have with banks that are also looking to underwrite new business and are in the later stages of cleaning up their own balance sheets.
Additionally, the pricing, terms and conditions of these investments are better than we have seen in quite some time. It is worth mentioning that a high quality pipeline does take some time to build but we are very encouraged by both the volume and the quality of deal flow that we are seeing emerge in our market.
And with our opportunistic capital raise, we’re well positioned to take advantage of it. We continued to benefit from the overall Apollo Global Management platform by working closely with all of our investment professionals, operating executives, lawyers and accountants across the entire Apollo platform.
We are experienced and prepared to work closely with all of our portfolio companies should there be any further stress from the current economic environment and we have focused on creating and preserving value for our shareholders.
Before I open up the call to questions, I would like to thank our dedicated and growing investment team. We all remain committed to our consistent business model and are convinced that our access to long term capital continues to be a strategic tool that we expect will benefit our shareholders in the long term.
Going forward, we will continue to navigate ahead with our investment discipline and our focus on preserving your capital. With that, moderator, can you please open up the line for questions? Thank you.
(Operator instructions) Your first question comes from Carl Drake – Suntrust Robinson Humphrey.
Carl Drake – Suntrust Robinson Humphrey
Maybe we could start off with some updates on the portfolio, what you’re seeing out there with respect to cash flow growth in the aggregate and then maybe touch on a few companies that have some significant marks, Arbonne, Eurofresh perhaps and then maybe also, I know you don’t control the timing of exits on portfolio companies but if there’s any visibility on realizations on the equity side perhaps, Exco, MEG or Prysmian.
First on the overall portfolio, as we mentioned in the call, we’re very encouraged that the cash interest coverage is over two times on the portfolio at a weighted average basis. That’s a very fundamental part of our investment strategy going into investments that there is significant cushion on cash flow as well as significant cushion in the equity behind our securities.
We are seeing in this market as we’ve been talking about since last June that the economy is not growing as fast. If you listen to the economic reports, we’re growing at less than 1% GDP, but not quite ready to state that we’re in a recession, but we are managing our portfolio as if we are.
The management teams that we are fortunate to invest in are managing their businesses as if cash flow is going to be tighter. They’re taking very aggressive actions to cut costs. The last few years have been a robust environment for them so there is some opportunity that we’re seeing across the portfolio where companies are taking aggressive action and some which companies aren’t even seeing a decline yet in top line.
So we’re encouraged, it’s really on a case by case, investment by investment basis which leads me to your second question. A couple of the names in particular. Arbonne is a company we’ve invested in for quite some time. The business had fast growth and then it slowed down dramatically. We are encouraged that we’re now looking at several quarters of stability in cash flow and EBITDA for that company.
Where we are today on a leveraged basis is lower than where we invested in. If the company was even to maintain its current level of EBITDA, we will see cash flow deleveraging and we’re encouraged by that.
Eurofresh, we may have mentioned last call that the company was quoted down significantly given some challenges that the company had to manage on the operating side. We are encouraged that it was refinanced, the senior debt, ahead of securities, was refinanced giving the company additional capital, an additional cushion on its covenants.
We expect to get our interest payments in July or next time. We’re also very encouraged by the operations of the company, cleaning out which was a virus in this company, produces tomatoes. The clean outs are working, the company has time. The quotes have been increasing. So we’re very happy to hear that.
The last part of your question, would you mind just reminding me?
Carl Drake – Suntrust Robinson Humphrey
It was about visibility on any gains like, I know you don’t control the timing but Exco, MEG Energy, Prysmian, anything that that might be looking at in the near term.
Sure, we are very happy to see, and these are publicly quoted securities, Exco and Prysmian, since quarter end which folks it’s available to look at, the prices of our common equity that we have in Prysmian as well as the common equity price of Exco, even though we own a convert, so obviously related.
We are always looking at what the right time for liquidity is. It comes down to the fundamentals of the company. Right now in Prysmian we still are subject to a lockup. It’s coming close to a period where we’ll be able to get out of that lockup. But the fundamentals of the company, if you listen to the outlook and the publicly stated conference calls, they’re seeing a very, very strong year. It’s an international global company.
So we’re encouraged by that and the run up in their stock price reflects that. We’ve gotten significant gains from that investment to date and at the right time the management team will sit down, we’ll go through exiting of both of those securities. We are also encouraged that the larger companies in our portfolio do get sold. [Sigma Caylon] was sold early in the quarter where we refinanced from that investment.
We had another company that did an acquisition, we were able to refinance, we chose to go back into the company at a better price and structure. So we’re happy with that. And another company in our portfolio that was publicly announced was acquired, Norcross was acquired by Honeywell. We had a $50 million whole co pick security that was refinanced at a premium.
So we’re not seeing the refinancings happen which have been frustrating for us over the last couple of years. But good companies can still be bought and sold in this market.
Carl Drake – Suntrust Robinson Humphrey
One last question on the financing side, with the recent offering you’ve got about $1 billion of potential leverage capacity and I think your revolver commitments would limit you to about half of that. What are your plans for increasing debt capacity and what kind of cost might you see there and are there any plans to look at off balance sheet arrangements as well?
Let me focus on that, we certainly, we would concur with some of your numbers. We have, one of the benefits of being part of Apollo is having a great dialogue with a variety of financial institutions and lenders and we have a variety of strategies that we’re working on right now.
It would be premature for us to get into detail with those but we’re certainly broadening out our debt capacity, is one of the options that we are, we don’t feel like we have any pressure to do it tomorrow but yet we are doing it in the time, it’s always better to raise debt capital when you have equity in place rather than the converse of that.
And so we feel, that’s certainly one of the strategic objectives of our company over the next coming quarters, very, very focused on it. And we believe that we have a couple of ideas that we’ll do something that is consistent with our conservative structure of our balance sheet but will allow us greater flexibility.
Your next question comes from Sanjay Sakhrani – KBW.
Sanjay Sakhrani – KBW
If I’m doing to the math correctly there is some amount of dilution related to this past equity offering. I was just hoping if you could help us think about how you’re going to manage through that. Are there opportunities to deploy the capital in a pretty efficient manner? And maybe related to that, where are the dollars expected to go, primary versus secondary, smaller type companies versus larger type companies.
We feel that with our capital raise it was very opportunistic, it was at the right price and the right time and we’re encouraged that the market was receptive to that offering. We were patient and prudent in when we chose to raise the capital like we are when we raise debt capital or even do investments. For us, $350 million of net proceeds, that could be three deals, it could be two deals it could be ten deals.
We’re seeing the emergence of primary market activity, there has been some press on a deal that we were involved in. It’s a top story in Bloomberg today about the change in financing markets and a company called Angelica that we work with, Lehman Brothers, Merchant Banking as they acquired the company. It was a large investment for us, we’ve committed to it, it will take time to close, it’s not on our pipeline because it will close when it closes.
It will show up in our investments and our assets. But that is a terrific call to get from a relationship we’ve known for years. It’s primary market, its certainty, it’s our ability to move quickly and martial our resources to have a view. And the pricing and terms of that structure are better. It was a direct deal.
We did receive fees for that direct deal. We think that’s a market we’d like to be in, we want to be in going forward and we think the market opportunity given that Wall Street is still not really back in this business and we’re hearing that this will change for at least several quarters if not years, how Wall Street behaves.
That’s good for us, we’d like the primary market to come back. It usually comes back when secondary markets rallied and secondary markets rallied and so you’ve seen us be more patient last quarter in the secondary market. If the secondary market has another leg down, we can invest more there. It’s really the relative value, where it’s best is where we’ll spend our time. But the capital we raised, if the market opportunities are there to invest it all in one or two quarters, we’ll do that. If not there, we’ll be patient.
Sanjay Sakhrani – KBW
On that Angelica deal, is there a size that’s out there in the public?
It hasn’t been disclosed yet but it is sizable.
Sanjay Sakhrani – KBW
I also saw that First Data, the stake obviously went up a lot you mentioned that in your prepared remarks, I mean how should we think about the strategy there? Is that a hold to maturity type paper or would you consider trading out of that if the bids were covered on that paper?
That for us, we’re yield to maturity investors. What pays the dividend is the cash we receive off the investment portfolio. If we feel that First Data will continue to pay us the cash and it’s the right thing to do, we will continue to hold that. We going in to every investment soon we’re going to be in it until maturity.
If there is a reason for us to believe that there’s more downside coming based upon fundamentals in the company and we can either take our money off the table and preserve our capital or preserve a gain, we’ll do that. But it’s not a trading business. Short term IRR doesn’t pay the dividend for us, so we’re going to be patient and prudent about that.
Sanjay Sakhrani – KBW
What are the estimated IRRs on that paper that you invested in?
They are in the mid teens on the yield to maturity, if you get yield to call you can assume that they’re higher than that.
Your next question comes from Vernon Plack – BB&T Capital Markets.
Vernon Plack – BB&T Capital Markets
I just wanted a little clarification in terms of changes that we saw on the balance sheet. Cash equivalents decreased $421 million while the credit facility increased to $519 and the payables for investments and cash equivalents actually decreased $776 million I believe. So I’m just trying to get a sense for what sort of dictated those balance sheet movements during the quarter?
A couple of changes, I think Patrick mentioned on another call, I think Jim with regards to the Bear Stearns bailout, there was a lot of uncertainty in the market in the middle of March. We saw being Apollo with our dialogue with banks and what we see in the market, our broad views, we thought it prudent in the middle of March prior to the Bear Stearns announcement that we draw down on our revolver.
We wanted to preserve our debt capital, we didn’t want it to be, if there was any run on any banks, being the last guy to ask for the money that was due us and then it not being there.
So in mid March we strategically in advance of the announcement, drew down on our revolver to that level that you see on our balance sheet and invested those in very short term treasury bills to preserve capital and have that capital available to us so we can continue on in our day to day business without having to worry about drawing down on our revolver on a bank that may have some strain or issues or even panic in the market that shuts those legally committed dollars off.
So again, we were prudent, protecting our debt capacity, drew down on it and added T-bill to our portfolio of investments in mid March. We held that for roughly a month until the market stabilized. We then sold those treasury bills at a slight realized gain but nothing material. That wasn’t the reason for it again, it was preservation of our debt capacity and our ability to operate day to day without any problems.
So that had a slight maybe $0.01 impact to our top line net investment income, there was a cost of preserving that capital but there was not managering fees paid on those dollars that was drawn down for the quarter and again it was just to preserve that capital. So some of that swing you’re seeing.
I think the other swing you need to consider is the payable for investments and cash equivalents purchased. So I could take you through the numbers at any time but, at any given quarter end there’s always open trades because as a BDC we record things on a pay date basis and they get funded subsequent to the quarter end.
So it’s essentially your prior quarter’s balance. There was liabilities there that needed to be funded post-December 31. And then there was the treasury bill transaction that we did in March and then subsequently got out of.
Vernon Plack – BB&T Capital Markets
The portfolio turnover ratio as you define it, in 08 it was 24%, in 07 it was 44%. 39% in 06, I would imagine that for 09 that ratio will be lower than 24%?
Yes, what I described in the past, today and in the past conference calls and what Patrick has described, you have, in a credit cycles we’re going right now, we would expect to hold some of our key positions a little bit longer as the M&A activity is at a slower pace in the aggregate.
And we’ve always talked about in a more buoyant market the average life being 2.5 years and then in an environment like we’re in today, stretching out to 3-4 years. So we think that’s very typical, we’re actually happy, names that we like that we are very comfortable that are clipping the coupon, we have no problem owning them for a period of time.
But you’re right, we would expect that number to go down as we see the engine of an M&A cycle starting to show some signs and then developing over the next number of quarters.
Your next question comes from Greg Mason – Stifel Nicolaus.
Greg Mason – Stifel Nicolaus
You said it was important for us to differentiate between industry volatility and credit issues. I was wondering if you could help shed some light on that this quarter, what you guys consider credit issues versus industry volatility marks.
I think we’ve been historically have really talked about, we have a lot transparency in our underlying names in our portfolio and certainly we have been very, very clear and consistent in the disclosure on this and again as Rich said in his comments and I said in my comments is we have a fair amount of names that are quoted. And certainly by no means we always believe we outperform the index and our numbers over the last four years would prove that out dramatically.
But in terms of getting into individual line items, that’s not something we’re prepared to do right now. But suffice to say that with the quote portfolio like more and more of our names are and the transparency that comes along with that, there was quite a bit of volatility. If you look at the indexes where they began January and where the troughed down to in March 17, and then where they ended up, they were down 6-8% over that period of time, between the high yield and the loan indexes.
If you look between January 1 and March 31, they rallied that last two weeks in the credit markets and then subsequent to that, today, they certainly rallied as well. Those indexes were up 500 basis points at least, if not higher. So we think that’s the kind of direction I’d like to give you. We’re very comfortable with that and certainly I think if you look where we are today, that would be a good baseline.
We disclosed our average rating, still is a 2. And that’s the same as last quarter and same as the quarter after that. Quite frankly it’s been pretty steady and stable. Because we’re so transparent by using the quotes, not everyone does that, but we have that transparency. Many analysts can go into the Bloomberg machine or pull up the LPC and get their quotes.
So again we feel very good about the transparency and liquidity in our portfolio. Underlying fundamentals, that’s what our investment team focuses on, that’s been looking at the monthly financials, going out and visiting the tours and touring the factories, meeting with management, the sponsor etc.
So if you take the points of hey we use the quotes but the credit rating is a 2 and there are no new non-accruals, the last non-accrual we had was last September on Lexicon and that’s posted in our schedule of investments with nothing else in. Again I think you can tell in the tone of those data points where the credit marks are versus where the mark to market technical and liquidity drivers are that are driving these quotes.
Greg Mason – Stifel Nicolaus
So would you, if we kind of took a look at the portfolio and looked at debt investments that were down say 20% marks from last quarter like an Arbonne, [Coronas], WDAC, Advanstar, would it be appropriate to say anything kind of over those 20% type of marks are probably more credit related than mark to market volatility issues?
No that wouldn’t. Not necessarily I mean there was a tremendous amount of volatility in the credits markets in the first quarter. You know liquidity had a major price on it in terms of variety of vehicles and you know so I think that, I feel we’ve given a lot of transparency and color but there’s examples across the board where very good performing companies got marked down to the mark to market and we don’t think that’s a reliance of what’s going on in the underlying credit.
Sometimes it’s just news that comes out or a rumor and that trades these things off. And again these marks are just for that day, for that moment, so whatever it was, if there was a news event on the 31st or the 30th that somebody grabbed on, any panic in the market will drive these things. Or any, quite frankly, it goes both ways, any euphoria works the same way up or down.
So for us, if you want to, one of the bigger impacts is in our NAV on March with Prysmian. This is a company that’s paid us many, many dollars of capital gains over the last year or two and it was quoted, it was marked down substantially, that’s a quote security. You know the ticker is easily looked up.
Where it was in December versus where it was in March, anybody can pull it up in Yahoo that this was a substantial impairment to our NAV. That thing is daily traded, you can see where it is today, it’s significantly different today than where it was on March 31.
So again these are just quotes for us. Fundamentals are being focused on everyday by the investment team and as Patrick alluded to, if there’s a fundamental problem with the company, those are the ones you’re going to see selling. We’re trying to get ahead of that, we’re trying to monitor that to make sure we’re ahead of it.
Your next question comes from James Shanahan – Wachovia.
James Shanahan – Wachovia
What is the dollar value of undistributed income that can be used to support the dividend near term?
That’s something we haven’t discussed. In our press release in one of the pages underneath the dividend section, we disclose that number, its $137 million.
James Shanahan – Wachovia
That’s roughly about $1.00 per share right. And what is the timing for more importantly, the timing for paying out that distribution to shareholders and what sort of flexibility do would you have to accelerate or extend those payments?
Kind of tying into the strategy discussion that Patrick described earlier in the call in his prepared remarks, our strategy as a private equity mezzanine investor is you know you’re not going to get capital gains year in and year out in the private equity business.
And what we’re trying to do is best match our assets which are subordinated debt, doing the work up front, investing in a core asset class that’s earning 12-16%, just the debt. And we’ve always kept our leverage very low. That leverage is generally taking care of all the fees and expenses of the public company.
And then that little bit of equity which has had as we’ve described earlier, over $200 million in realized gains, realized gains, not talking about what’s still unrealized to Carl Drake’s question earlier, but that strategy is to harvest those realized gains because you know one day you’re going to have losses.
You know, we’re not perfect, we’re investors, it’s a humbling business. But we think we have a strategy that makes a lot of sense. That equity continues to build a cushion as you see, that number of $137 million is increased from our prior 10-K, March 07 number of $100 million.
So for the fiscal year ended March 31, 2008, our dividend cushion, what protects our dividend, the dollars have grown from $100 million to $137 million. So that’s a cushion to keep, to conserve and to use to protect the dividend. And to the extent one day we do have losses, we have some protection there.
I wouldn’t expect today that our Board or management here is going to promote doing special dividends. Those are typically done at the end of the calendar year, at least that’s when they’re considered based on the regulated investment company tax rules.
James Shanahan – Wachovia
The other part of the question was what kind of flexibility do you have for paying out that dividend? Is there some point in time where that $137 million must be paid out or can you extend that and just sort of putting some bookends around that?
As a BDC we’re a regulated investment company for tax or all BDCs is my understanding. But the way the rules work is because those were earnings generated in the fiscal year ended March 31, 2008, you have to pay out 90% to maintain your RIC status.
The timing is really your question and that means you have to pay those earnings out prior to when you file your tax return in order to claim the dividend paid deduction. That dividend paid deduction satisfied to the extent that dividends paid subsequent to your March 31 fiscal year end or designated as dividends from prior year’s earnings. So for example, the June dividend will likely be designated from earnings from the prior year to satisfy that accumulated tax rule reserve.
Your next question comes from Jon Arfstrom – RBC Capital Markets.
Jon Arfstrom – RBC Capital Markets
Patrick can you talk a little bit about the fundamental performance of the three and four rated credits. Are there any general themes or anything positive or negative we can get from that?
I think stresses began about a year ago on the consumer side and housing and those have continued. We have now started to see that kind of durables and deferrables which is anything that costs a lot of money for a company to purchase and or something a company can defer.
I think if you look at the durable orders were a little bit better in April than people had expected them to be. But they’re still down. And I think if you look at IT spending or spending where it makes a great ROE, actually to make that spending, but people are hording cash and hording capital. That will sort of play through, even with very good products and good companies.
The key for us is to then focus on companies that have significant cushion on cash flow knowing that they will cycle, people will defer purchases if they can or they may not have the capital to invest in expensive durable goods. And we’ve seen that sort of at the beginning of the year start to take hold and we’re watching that very closely.
The consumer and consumer confidence remains low. Anything building products related is a challenge. I think we’re also focusing our time looking at commodities, raw material price increases. You know people saw the news from Dow this morning about 20% in their products because they have to.
Energy prices are expensive. People are understanding that you have to pass them through now. Food costs are tough. Gas prices at $4.00 a gallon is causing an issue. So really inflation is on the radar for us and we’re seeing companies really hording cash but the companies in our portfolio, the larger ones, and they’re global, many of them, are still performing very well on a relative basis.
But more importantly for us, on an absolute basis, and the cushion we’ve built into these companies going in is definitely something that we’re, where we’re happy that we have.
Jon Arfstrom – RBC Capital Markets
In terms of the NAV, we obviously obsess about the NAV and I’m just curious, other than the capital raising issue, how important is NAV to you from quarter to quarter given the fact that it seems like more and more of your portfolio is becoming quoted over time.
We obsess about a lot of things here, we obsess about free cash flow, we obsess about the dividend. The NAV is a result of all these things, a good successful investment strategy. We are not, we have always talked about as Patrick really laid out today, we believe if we invest in these great companies, the marketplace does vote everyday on some quotes, we’re not going to let that get in the way of our long term strategy.
And while we understand it, we are very, we see it, we’re not going to change our core investment strategy by day to day volatility. That’s how we’ve made money for many, many years here at Apollo.
We’re going to continue doing that and there’s good opportunities out there that people are not distinguishing good credits from bad, large versus small, ones that will be able to be very robust participants in this credit cycle versus those that are not. And we’re focused on it to the degree that we want to make sure our investors feel good about their investment, but we have a broader investment strategy that’s all part and parcel with the dividend and long term growth.
Your last question comes from Jackson Turner – Argus Research Company.
Jackson Turner – Argus Research Company
Looking at the balance sheet I noticed there was a substantial change in receivables. Just curious if you can give a little bit of color on why that change occurred over the last year and then also I estimate that you’ve got about $0.5 billion in dry powder, just wanted to make sure that’s correct.
The receivables, they’re really not up. It’s just a timing issue of when are, we have no, directly, there are no past due receivables for dividends or interest as of March 31. So we’re clear on that. The size of the receivables is really more of a function of our growing portfolio and the timing of when these things pay. So there’s nothing there to read into.
The dry powder, we disclosed in the March K and in our press release that it was roughly $415 million available to us at the end of March based on the current commitments on our current revolver. You know that’s kind of a number that we report because we should. Again there’s obviously more capacity for debt capital above that amount up to our net assets, up to that 1:1.
That’s kind of theoretical, we’ve never really levered our book up to that as others might have moved closer. So that’s theoretically there to the extent we wanted to access that debt capital. And then we’ve just on our equity raise and then there’s some net portfolio growth that you should assume. So the number is more than the $500 million that you said if you were to add those things together, taken those publicly disclosed numbers.
This concludes the question and answer session.
It’s an imaginative team, we want to thank you for all joining our fiscal year end 2008 conference call and we look forward to speaking with you again through the next year as well and continued success from all parties. So thank you for your time and your help.
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