ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Exact Name of Registrant As Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
1221 McKinney Street, Suite 2975
|(Address of Principal Executive Offices)||(Zip Code)|
(Registrants Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
|Common Stock, Par Value $.001 per share||The NASDAQ Stock Market LLC|
|(Title of Class)||(Name of Exchange on Which Registered)|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
|Large accelerated filer o||Accelerated filer x||
(Do not check if a smaller reporting company)
|Smaller reporting company o|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of June 30, 2008, the aggregate market value of the registrants common stock held by non-affiliates of the registrant was $324,147,894 based on the closing sale price on the NASDAQ Global Select Market.
As of March 11, 2009, there were 21,628,202 shares of the registrants common stock outstanding.
The registrants definitive proxy statement for the 2009 Annual Meeting of Stockholders is incorporated by reference into certain sections of Part III herein.
Certain exhibits previously filed with the Securities and Exchange Commission are incorporated by reference into Part IV of this report.
Unresolved Staff Comments
Submission of Matters to a Vote of Security Holders
Market for Registrants Common Equity and Related Stockholder Matters
Selected Financial Data
Managements Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Directors, Executive Officers and Corporate Governance
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions
Principal Accountant Fees and Services
Exhibits, Financial Statement Schedules
We are a financial services company organized in July 2004 as a Maryland corporation to invest primarily in debt securities of small and mid-size private energy companies, which until July 21, 2008, we generally defined as companies that have net asset values or annual revenues of less than $500 million and are not issuers of publicly traded securities. Our investment objective is to generate both current income and capital appreciation primarily through debt investments with certain equity components. We are a closed-end, non-diversified management investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940 (the 1940 Act). In addition, for federal income tax purposes we operate so as to be treated as a regulated investment company, or RIC, under the Internal Revenue Code of 1986, as amended (the Code).
A key focus area for our targeted investments in the energy industry is domestic upstream businesses that produce, develop, acquire and explore for oil and natural gas. We also evaluate investment opportunities in such businesses as coal, power, electricity, energy services and alternative energy. Our investments generally range in size from $10 million to $50 million. However, we may invest more or less depending on market conditions and our managers view of a particular investment opportunity. Our targeted investments primarily consist of debt instruments, including senior and subordinated loans combined in one facility, sometimes with an equity or property component, and subordinated loans, sometimes with equity components. We may also invest in preferred stock and other equity securities on a stand-alone basis.
Our operations are conducted by our external manager, NGP Investment Advisor, LP, (the Manager), pursuant to an investment advisory agreement between us. Our Manager is owned by NGP Energy Capital Management, L.L.C. (NGP) and NGP Administration, LLC, (our Administrator). NGP manages the Natural Gas Partners private equity funds (NGP Funds), which have specialized in providing equity capital to the energy industry since November 1988. Kenneth A. Hersh and David R. Albin, who serve on our Board of Directors, have directed the investment of the NGP Funds during the twenty-year period since the inception of the initial fund in 1988.
Our Managers day-to-day operations are directed by our executive officers: John H. Homier, President and Chief Executive Officer; Stephen K. Gardner, Chief Financial Officer, Secretary and Treasurer; and R. Kelly Plato, Senior Vice President, who have more than 50 years combined experience in the energy and finance industries. Prior to founding NGP Capital Resources Company, Mr. Homier had more than 28 years of industry experience including two separate major financial institutions where he was responsible for building and managing successful energy finance businesses. Mr. Gardner has over 15 years of experience in financial and transactional management in the oil and gas industry and has served as a Chief Financial Officer of both public and private energy companies. Mr. Plato began his career as a petroleum engineer for an independent exploration, production and refining company, after which he has spent more than 10 years in the energy finance business.
Our Managers investment decisions are reviewed and approved (by majority determination) by its investment committee, consisting of Mr. Homier, our Chief Investment Officer, Mr. Hersh, our Board Chairman, and Richard L. Covington and William J. Quinn, each of whom is a senior NGP investment professional. The investment committee is supported by NGP Investment Advisor, LPs team of nine investment professionals.
Our executive offices are located at 1221 McKinney Street, Suite 2975, Houston, Texas 77010 and our telephone number is (713) 752-0062.
Our corporate website is www.ngpcrc.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Our website address is included in this document as an inactive textual reference only and the information contained on our website is not incorporated into this Form 10-K.
We focus our investments in the energy industry in companies that have an existing asset base or that will acquire assets that are expected to provide security for most of our investments. The energy industry broadly includes three sectors, generally categorized as follows:
|||Upstream businesses that find, develop and extract energy resources, including natural gas, crude oil and coal from onshore and offshore geological reservoirs and companies that provide services to those businesses.|
|||Midstream businesses that gather, process, store and transmit energy resources and their byproducts in a form that is usable by wholesale power generation, utility, petrochemical, industrial and gasoline customers, including businesses that own pipelines, gas processing plants, liquefied natural gas facilities and other energy infrastructure.|
|||Downstream businesses that refine, market and distribute refined energy resources, such as customer-ready natural gas, propane and gasoline, to end-user customers; businesses engaged in the generation, transmission and distribution of power and electricity and businesses engaged in the production of alternative energy.|
Within these broad sectors, our key area of focus is small and mid-size energy companies in the upstream and midstream sectors. In addition, we seek investment opportunities in the downstream sector.
Our targeted investments primarily consist of:
|||debt instruments including senior and subordinated loans combined in one facility sometimes with an equity component, which we refer to as vertical loans;|
|||subordinated loans; and|
|||subordinated loans with equity components, which we refer to as mezzanine investments.|
In many cases, we arrange to receive an equity participation interest in the properties, projects and/or companies that we finance as a part of our compensation for extending credit. These equity components may take a variety of forms. In many of our investments, we anticipate that we will receive a property-based equity interest. In addition, in certain investments, we may also receive a right to acquire equity securities of the borrowing company, such as a warrant or option, or we may receive a direct preferred equity interest or other similar participating interest in the companys equity.
We also may invest a portion of our assets in loans to, or securities of, foreign companies. We will limit any such investments to less than 10% of our assets.
Since commencing investment operations in November 2004 through December 31, 2008, we have invested $613.6 million in twenty-eight portfolio companies, all energy-related, and received principal repayments and realizations of $317.6 million. Most of our portfolio companies are exploration and production (E&P) businesses engaged in the acquisition, development and production of oil and natural gas properties in and along the Gulf Coast, in the state and federal waters of the Gulf of Mexico, Permian Basin, Mid-continent and Rocky Mountain areas. We also have investments in an oilfield service company with operations in Arkansas, Louisiana
and Texas; a Kentucky-based specialty coal company with mining and processing operations in the Central Appalachian region of the United States and an alternative fuels and specialty chemicals company based in Quincy, Massachusetts.
Our investment approach seeks attractive returns while attempting to limit the risk of potential losses. In the process of screening and evaluating potential investment opportunities our Manager considers the following general criteria. However, not all of these criteria may be met by each prospective investment.
|||Strong Management. We recognize the importance of strong, committed management teams to the success of an investment and seek to invest in companies with management teams that generally have strong technical, financial, managerial, and operational capabilities and a competitive edge in certain aspects of their businesses, which may come from extensive experience and knowledge in certain geographical areas and/or superior technological or transactional capabilities.|
|||Identified Properties with Development-Oriented Risk. Our investment philosophy places a premium on investments having strong underlying asset values established by engineering and technical analysis, rather than investments that rely solely on rising energy commodity prices, exploratory drilling success, or factors beyond the control of a portfolio company. We focus on companies that have strong potential for enhancing asset value through factors within their control. Examples of these types of factors include operating cost reductions and revenue increases driven by improved operations of previously under-performing or under-exploited assets. These factors involve implementing engineering and operational plans to increase cash flow through such means as development drilling of upstream assets or optimizing the performance of midstream or downstream assets like pipelines, processing plants or power plants that have been underutilized.|
|||Collateral Security. Most of our targeted investments are secured by the same assets that would secure traditional senior bank debt, in either a first or second lien position. However, in certain instances, we may make investments in our portfolio companies on an unsecured basis. In instances where we are providing subordinated debt only and there is senior debt provided by another party, we generally seek to obtain a second lien on the borrowing companys assets behind that of the senior lender.|
|||Capacity to Return Investment Principal. We perform financial sensitivity analyses when evaluating and structuring investments to analyze the effect of a confluence of unfavorable events on the investments ability to return investment principal. For an upstream transaction, these might include poor reserve development coupled with falling commodity prices or higher than expected costs. We seek to make and be compensated for investments in which the return on, and the timing of the return of, our investment capital may be at risk, but not the return of our capital.|
|||Exit Strategy. We seek to invest in companies that have multiple means of repayment of our investment, including: a steady stream of cash flow; the completion of asset development activities that allow a company to be able to refinance our facility, often with senior debt; or the sale of the portfolio companys assets or the entire company.|
Our Manager generally structures investments that have collateral coverage from the value of the underlying assets and from the cash flows of those assets. We perform extensive due diligence, exercise discipline with respect to company valuations and institute appropriate structural protections in our investment agreements. We believe that our management teams experience in utilizing fundamental engineering and technical analysis on energy assets and in dealing with the fundamental dynamics of the energy finance market allows us to:
|||assess the engineering and technical aspects of the identified assets;|
|||value the assets and associated cash flows that support our investments;|
|||structure investments to increase the likelihood of full principal repayment and realization of yield and upside potential; and|
|||have our portfolio companies implement financial hedging strategies to mitigate the effects of events such as declines in energy commodity prices.|
We believe that this approach enables our Manager to identify investment opportunities throughout the economic cycles.
Once we have determined that a prospective portfolio company is suitable for investment, we work with the management of that company and its other capital providers, including other senior, junior and equity capital providers, if any, to structure an investment. We negotiate among these parties to agree on how our investment is expected to perform relative to the other capital in the portfolio companys capital structure. Our primary consideration when structuring an investment is that the total return on our investments (including interest income, equity or other similar income and potential equity appreciation) appropriately compensates us for our risk. The targeted investments that comprise the substantial majority of our portfolio generally fall within one of the following categories:
|||Vertical Loans Combining Senior Secured Loans and Subordinated Loans with Equity Enhancements|
These investments consist of a senior secured loan tranche and a subordinated loan tranche. The senior tranche produces a current cash yield and typically is secured by a first lien on cash flow producing assets. The subordinated loan tranche typically includes a current cash yield component coupled with a property based equity participation right. In some cases, a warrant or option in the company may be obtained in addition to, or in lieu of, a property based equity participation right. The subordinated tranche generally is secured by a second lien on the companys assets. Additionally, these loans may have indirect asset coverage through a series of covenants that prohibit additional liens on the companys assets, limit additional debt or require maintenance of minimum asset coverage ratios. Generally, these loans have a term of three to five years, but in many cases will be repaid before maturity. Additionally, in a number of these loans, there may be amortization of principal during the entire life of the loan.
These loans will likely be made to energy companies with assets that provide cash flow that is sufficient to support a typical senior secured debt facility but not sufficient to support the extra debt needed to acquire or develop non-cash flowing assets.
|||Stand-Alone Subordinated Loans|
These investments typically consist of subordinated loans with relatively high, fixed interest rates. Generally, these loans are collateralized by a subordinated lien on some or all of the assets of the portfolio company, or in some cases, a first priority lien on assets not otherwise securing senior debt of the borrower. Additionally, these loans may have indirect asset coverage through a series of covenants that prohibit additional liens senior to ours on the companys assets, limit additional debt senior to ours or require maintenance of minimum asset coverage ratios.
These loans will likely be made to energy companies possessing assets that produce sufficient current cash flow and that have sufficient asset value to avoid the issuance of any equity rights that would be dilutive to the equity owners. For example, such loans could be made to a company that needs to access capital to develop non-producing oil and natural gas reserves but that has sufficient cash flow from its other assets to provide for the payment of the higher recurring cash payments required by this type of instrument. However, in some instances these loans may have a lower interest rate and an equity participation to compensate us for the lower current income. Generally, these loans have a term of five to seven years, but in many cases will be repaid before maturity. Additionally, amortization of principal may be deferred to the later years of these loans or the loans may be structured as non-amortizing.
These investments should generally provide us with the highest amount of current income, but the least amount of capital gains, of any of the targeted investment structures.
These investments are generally in the form of combined senior and subordinated loans, subordinated loans, partnership or limited liability company investments or preferred equity, with a meaningful property based equity participation right.
These investments will likely be made in energy companies that possess assets that do not produce sufficient current cash flow to amortize the principal throughout the life of a loan, but have sufficient collateral to support the investment. For example, such an investment could be made in a company that owns proved non-producing oil and natural gas reserves and requires capital to finance development drilling to initiate the production of the reserves and generate cash flow. Generally, these investments will have a term of three to seven years, but in many instances will be repaid before maturity. Additionally, amortization of principal is generally deferred to the later years of these investments or the investments may be structured as non-amortizing.
These investments should generally provide us with the least amount of current income, but the highest amount of capital gains, of any of the targeted investment structures.
|||Other Targeted Investments|
We may also make investments in high grade bonds, high yield bonds, other securities of public energy companies that are not thinly traded, bridge loans, asset backed securities, financial guarantees, distressed debt, lease assets, commercial loans or private equity. In general, these investments will have character and structure similar to the other categories of targeted investments.
We seek to negotiate or otherwise participate in structures that protect our rights and manage our risk, while creating incentives for our portfolio companies to achieve their business plans and enhance their profitability. The typical structural elements that we seek to negotiate in connection with our investments are covenants that afford portfolio companies as much flexibility in managing their businesses as possible, while also seeking to preserve our invested capital. Such restrictions may include affirmative and negative covenants, collateral value covenants, default penalties, lien protection, change of control provisions and governance rights, including either board seats or observation rights.
While we may from time to time elect to offer co-investment opportunities to third parties, we expect to hold most of our investments to maturity or repayment. We will sell our investments earlier if circumstances warrant or if a liquidity event, such as the sale or recapitalization of a portfolio company, occurs.
We believe we have the following competitive strengths:
Because of the history, market presence, and long-term relationships that our investment team and NGP have developed with energy company management teams, we believe that we have established ourselves as a consistent and reliable capital provider to the energy industry. We focus on originating a substantial number of our investment opportunities, rather than investing as a participant in transactions originated by other firms, although we may do so from time to time.
We are not subject to many of the regulatory limitations that govern traditional lending institutions. As a result, we can provide speed of execution and flexibility in structuring investments and selecting the types of securities in which we invest. The members of our management team have substantial experience in seeking investments that balance the needs of energy company entrepreneurs with appropriate risk control.
We operate our business so as to qualify as a regulated investment company for federal tax purposes, so that we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders as dividends. Thus, our stockholders will not be subject to double taxation
on dividends, unlike investors in typical corporations. Furthermore, investors in our stock generally are not required to recognize unrelated business taxable income (UBTI), unlike investors in public master limited partnerships.
On a quarterly basis, the investment team of our Manager prepares valuations for all of the assets in our portfolio and presents the valuations to our Valuation Committee and our Board of Directors. Investments for which market quotations are readily available are recorded in our financial statements at such market quotations adjusted for appropriate liquidity discounts, if applicable. However, few of our investments have market quotations, in which case our Board of Directors undertakes a multi-step valuation process each quarter for our investments that are not publicly traded, as described below:
|||Investment Team Valuation. The investment professionals of our Manager initially value each portfolio company or investment.|
|||Investment Team Valuation Documentation. The investment team documents and discusses its preliminary valuation conclusions with senior management of our Manager.|
|||Presentation to Valuation Committee. Senior management presents the valuation analyses and conclusions to the Valuation Committee of our Board of Directors.|
|||Third Party Valuation Activity. The Valuation Committee and our Board of Directors may retain an independent valuation firm to review on a selective basis the valuation analysis provided by the investment team of our Manager.|
|||Board of Directors and Valuation Committee. The Board of Directors and Valuation Committee reviews and discusses the preliminary valuations provided by the investment team of our Manager and the analysis of the independent valuation firm, if applicable.|
|||Final Valuation Determination. Our Board of Directors discusses the valuations recommended by the Valuation Committee and determines the fair value of each investment in our portfolio, in good faith, based on the input of the investment team of our Manager, our Valuation Committee and the independent valuation firm, if any.|
The types of factors that we may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral; the portfolio companys enterprise value, historical and projected financial results, ability to make payments, net income, revenue, discounted cash flow and book value; the markets in which the portfolio company does business; comparison to a peer group of publicly traded securities; the size and scope of the portfolio company and its specific strengths and weaknesses; recent purchases or sales of securities by the portfolio company; recent offers to purchase the portfolio company; the estimated value of comparable securities; and other relevant factors.
Historically, our primary competitors in this market have consisted of public and private funds, commercial and investment banks, and commercial finance companies. Although these competitors regularly provide finance products to energy companies similar to our targeted investments, a number of them focus on different aspects of this market. We also have faced competition from other firms that do not specialize in energy finance but which are substantially larger and have considerably greater financial and marketing resources than we do. Some of our competitors have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors have higher risk tolerances or different risk assessments, which allow them to consider a wider variety of investments and establish more portfolio relationships than we can. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company; nor are they subject to the requirements imposed on RICs by the Code. Nevertheless, we believe that the relationships of the senior professionals of our Manager and of the senior partners of NGP enable us to learn about, and compete effectively for, attractive investment opportunities. Additionally, we believe that the recent dislocation in the credit markets and decline in energy commodity prices should favorably impact the competitive environment, in that it is reducing the debt capital available to energy companies from other sources.
The Company has no employees. John H. Homier, our President and Chief Executive Officer, Stephen K. Gardner, our Chief Financial Officer, Secretary and Treasurer and R. Kelly Plato, our Senior Vice President comprise our senior management. Each of our officers also serves as an officer of our Manager and our Administrator. Our day-to-day investment operations are conducted by our Manager and our Administrator, which currently has a staff of sixteen individuals, including nine investment professionals.
We have elected to be regulated as a business development company under the 1940 Act. By electing to be treated as a business development company, we are subject to various provisions of the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than interested persons, as that term is defined in the 1940 Act. We may not change the nature of our business so as to cease to be, or withdraw our election to be treated as, a business development company without first obtaining the approval of a majority of our outstanding voting securities.
The Investment Advisers Act of 1940 (the Advisers Act) generally permits the payment of compensation based on capital gains in an investment advisory contract between an investment adviser and a business development company. We have elected to be regulated as a business development company in order to provide incentive compensation to our Manager based on the capital appreciation of our portfolio.
The following is a brief description of the requirements of the 1940 Act, and is qualified in its entirety by reference to the full text of the 1940 Act and the rules thereunder.
To maintain our status as a business development company, generally, at least 70 percent of our total assets must be invested in securities of certain specified types of companies (70 percent basket). Among other things, the 70 percent basket may include securities of eligible portfolio companies.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an underwriter as that term is defined in the Securities Act of 1933, as amended (the Securities Act). Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except (a) that we may enter into hedging transactions to manage the risks associated with commodity price and interest rate fluctuations, (b) to the extent we purchase or receive warrants to purchase the common stock of our portfolio companies or conversion privileges in connection with acquisition financing or other investments, and (c) in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances.
We do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally are prohibited from (a) acquiring more than 3% of the voting stock of any investment company, (b) investing more than 5% of the value of our total assets in the securities of one investment company, or (c) investing more than 10% of the value of our total assets in the securities of investment companies in the aggregate. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses. We also do not intend to (a) purchase or sell real estate or interests in real estate or real estate investments trusts (except to the extent that oil or natural gas royalty, net profits, or leasehold interests may be considered interests in real estate), (b) sell securities short (except with respect to managing risks associated with publicly traded securities issued by portfolio companies), or (c) purchase securities on margin (except to the extent that we purchase securities with borrowed money or we grant a security interest in our assets (including our portfolio securities) to a lender). None of these policies is fundamental and all may be changed without stockholder approval.
As a business development company, we may not acquire any asset other than qualifying assets unless at the time of acquisition the value of our qualifying assets comprise at least 70% of the value of our total assets. The principal categories of qualifying assets relevant to our business are:
|||securities of an eligible portfolio company that are purchased in transactions not involving any public offering. An eligible portfolio company is defined under the 1940 Act to include any issuer that:|
|||is organized and has its principal place of business in the U.S.;|
|||is not an investment company or a company operating pursuant to certain exemptions under the 1940 Act, other than a small business investment company wholly owned by a business development company; and|
|||does not have any class of publicly traded securities with respect to which a broker may extend margin credit;|
|||does not have a class of securities listed on a national securities exchange or has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million;|
|||is controlled by the business development company and has an affiliate of a business development company on its board of directors; or|
|||meets such other criteria as may be established by the SEC.|
|||securities received in exchange for or distributed with respect to securities described in the bullet above or pursuant to the exercise of options, warrants, or rights relating to those securities; and|
|||cash, cash items, government securities, or high quality debt securities (as defined in the 1940 Act), maturing in one year or less from the time of investment.|
Control, as defined by the 1940 Act, is presumed to exist where a business development company beneficially owns more than 25% of the outstanding voting securities of the portfolio company.
We may invest up to 30% of our total assets in assets that are not qualifying assets and are not subject to the limitations referenced above. These investments would generally include securities of companies that are listed on a national securities exchange with a market capitalization of more than $250 million, securities of companies not organized under the laws of, or having their principal places of business in, the United States of America, or securities that are otherwise qualifying assets purchased in the secondary market.
If the value of non-qualifying assets should at any time exceed 30% of our total assets, we will be precluded from acquiring any additional non-qualifying assets until such time as the value of our qualifying assets again equals at least 70% of our total assets.
In order to count portfolio securities as qualifying assets for the purpose of the 70% Test, as a BDC, we must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than certain small and solvent companies described above) significant managerial assistance. Making available significant managerial assistance means, among other things, (1) any arrangement whereby we, through our directors, officers or employees, offer to provide, and, if accepted, do so provide, significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company, (2) the exercise of a controlling influence over the management or policies of a portfolio company by us acting individually or as part of a group acting together to control such company, or (3) with respect to SBICs, the making of loans to a portfolio company. We may satisfy the requirements of clause (1) with respect to a portfolio company by purchasing securities of such company as part of a group of investors acting together if one person in such group provides the type of assistance described in such clause. However, we will not satisfy the general requirement of making available significant managerial assistance if we only provide such assistance indirectly
through an investor group. We need only extend significant managerial assistance with respect to portfolio companies that are treated as qualifying assets for the purpose of satisfying the 70% Test.
Pending investment in other types of qualifying assets, as described above, our investments generally consist of cash, cash equivalents, U.S. government securities or high-quality debt maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments. Typically, we invest in commercial paper, U.S. Treasury Bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. Government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the asset diversification requirements in order to qualify as a RIC for federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Our Manager will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
We are permitted, under specified conditions, to issue multiple classes of senior indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we are required to make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We are also permitted to borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage.
We may sell shares of our common stock at a price below our prevailing net asset value per share only upon the approval of the policy by security holders holding a majority of the shares we have issued, including a majority of shares held by nonaffiliated security holders except in connection with an offering to our existing stockholders (including a rights offering), upon conversion of a convertible security, or upon exercise of certain warrants. We may repurchase our shares subject to the restrictions of the 1940 Act.
We operated our business in calendar year 2008 so as to be taxed as a regulated investment company under Subchapter M of the Code. As long as we qualify as a regulated investment company, we are not taxed on our investment company taxable income (which generally consists of ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses), or realized net capital gains, to the extent that such investment company taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expense, and generally excludes net unrealized appreciation or depreciation, as such gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which results in the deferral of gains for tax purposes until notes received as consideration from the sale of investments are collected in cash. Dividends declared and paid by the Company in a year generally differ from taxable income for that year as such dividends may include the distribution of current year taxable income, the distribution of prior year taxable income carried forward into and distributed in the current year, or returns of capital.
We are generally required to distribute 98% of our taxable income during the year the income is earned, and 100% of any income realized, but not distributed or deemed distributed, in preceding years, to avoid paying an excise tax. If this requirement is not met, the Code imposes a nondeductible excise tax generally equal to 4% of
the amount by which the required distribution exceeds the distribution for the year. The taxable income on which an excise tax is paid is generally carried forward and distributed to stockholders in the next tax year. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income.
In order to maintain our status as a regulated investment company, we must, in general, (1) continue to qualify as a business development company; (2) derive at least 90% of our gross income from dividends, interest, gains from the sale of securities and other specified types of income; (3) meet asset diversification requirements as defined in the Code; and (4) timely distribute to stockholders at least 90% of our annual investment company taxable income as defined in the Code.
The Manager manages our investments and business pursuant to an investment advisory agreement. Subject to the overall supervision of our Board of Directors, the Manager acts as investment adviser to us and manages the investment and reinvestment of our assets in accordance with our investment objectives and policies. Under the terms of the investment advisory agreement, the Manager provides any and all investment advisory services necessary for the operation and conduct of our business and:
|||determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;|
|||identifies, evaluates and negotiates the structure of our investments;|
|||monitors the performance of, and manages our investments;|
|||determines the securities and other assets that we purchase, retain or sell and the terms on which any such securities are purchased and sold;|
|||arranges for the disposition of our investments;|
|||recommends to our Board of Directors the fair value of our investments that are not publicly traded debt or equity securities based on our valuation guidelines;|
|||votes proxies in accordance with the proxy voting policy and procedures adopted by our Manager; and|
|||provides us with such other investment advice, research and related services as our Board of Directors may, from time to time, reasonably require for the investment of our assets.|
The Managers services under the investment advisory agreement are not required to be exclusive, and it is free to furnish the same or similar services to other entities, including businesses that may directly or indirectly compete with us for particular investments, so long as its services to us are not impaired by the provision of such services to others. Under the investment advisory agreement and to the extent permitted by the 1940 Act, the Manager will also provide on our behalf significant managerial assistance to those portfolio companies to which we are required to provide such assistance under the 1940 Act and who require such assistance from us.
Pursuant to the investment advisory agreement, we pay the Manager a fee for management services consisting of two components a base management fee and an incentive fee.
Under the investment advisory agreement, the base management fee is calculated quarterly as 0.45% of the average of our total assets as of the end of the two previous quarters and is payable quarterly in arrears. The Manager has agreed to waive permanently, subsequent to September 30, 2007, that portion of the management fee attributable to U.S. Treasury securities acquired with borrowings under our credit facilities to the extent the amount of such securities exceeds $100 million. All of the $2,016,214 management and incentive fee payable to the Manager as of December 31, 2008 was the base management fee for the quarter ended December 31, 2008.
The incentive fee under the investment advisory agreement consists of two parts. The first part, which is calculated and payable quarterly in arrears, equals 20% of the excess, if any, of our net investment income for the quarter that exceeds a quarterly hurdle rate equal to 2% (8% annualized) of our net assets. Our incentive fee does not have a catch-up feature component.
For this purpose, net investment income means interest income, dividend income, and any other income (including any other fees, such as commitment, origination, syndication, structuring, diligence, monitoring, and consulting fees or other fees that we receive from portfolio companies) accrued during the fiscal quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement, interest expense and dividends paid on issued and outstanding preferred stock, if any, but excluding the incentive fee). Accordingly, we may pay an incentive fee based partly on accrued interest, the collection of which is uncertain or deferred. Net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued income that we have not yet received in cash. Net investment income does not include any realized capital gains, realized capital losses, or unrealized capital appreciation or depreciation.
No investment income incentive fee was earned during the calendar year 2008 compared to $88,060 earned during the calendar year 2007. The incentive fees due in any fiscal quarter are calculated as follows:
|||no incentive fee in any fiscal quarter in which our net investment income does not exceed the hurdle rate.|
|||20% of the amount of our net investment income, if any, that exceeds the hurdle rate in any fiscal quarter.|
The second part of the incentive fee (the Capital Gains Fee) is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date), and equals (1) 20% of (a) our net realized capital gains (realized capital gains less realized capital losses) on a cumulative basis from the closing date of our initial public offering to the end of such fiscal year, less (b) any unrealized capital depreciation at the end of such fiscal year, less (2) the aggregate amount of all Capital Gains Fees paid to the Manager in prior fiscal years. There was no capital gains fee earned for the year 2008 compared to $348,515 for the year 2007.
Realized capital gains on a security are calculated as the excess of the net amount realized from the sale or other disposition of such security over the amortized cost for the security. Realized capital losses on a security are calculated as the amount by which the net amount realized from the sale or other disposition of such security is less than the amortized cost of such security. Unrealized capital depreciation on a security is calculated as the amount by which the original cost of such security exceeds the fair value of such security at the end of a fiscal year. All period-end valuations are determined by us in accordance with GAAP and the 1940 Act.
The Manager has agreed that, to the extent permissible under federal securities laws and regulations, including Regulation M, it will utilize 30% of the fees it receives from the capital gains portion of the incentive fee (up to a maximum of $5 million of fees in the aggregate) to purchase shares of our common stock in open market purchases through an independent trustee or agent. Any sales of such stock will comply with any applicable six-month holding period under Section 16(b) of the Securities Act and all other restrictions contained in any law or regulation, to the fullest extent applicable to any such sale. Any change in this voluntary agreement will not be implemented without at least 90 days prior notice to stockholders and compliance with all applicable laws and regulations.
The investment advisory agreement was originally approved by our Board of Directors on November 9, 2004. The investment advisory agreement provides that unless terminated earlier as described below, the agreement shall remain in effect from year-to-year after November 9, 2006, provided continuation is approved at least annually by our Board of Directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case, approval by a majority of our directors who are not interested persons. On October 30, 2008, our Board of Directors, including a majority of the independent directors, approved an extension of the investment advisory agreement through November 9, 2009.
The investment advisory agreement may be terminated at any time, without the payment of any penalty, by a vote of our Board of Directors or the holders of a majority of our shares on 60 days written notice to the Manager, and will automatically terminate in the event of its assignment (as defined in the 1940 Act). The agreement may be terminated by either party without penalty upon not more than 60 days written notice to the other.
The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, the Manager,
its partners and the Managers and its partners respective officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys fees and amounts reasonably paid in settlement) arising from the rendering of the Managers services or obligations under the investment advisory agreement or otherwise as our investment adviser.
Pursuant to the investment advisory agreement, the compensation and routine overhead expenses of the investment professionals of our management team and their respective staffs, when and to the extent engaged in providing management and investment advisory services to us, will be paid for by the Manager. We will bear all other costs and expenses of our operations and transactions.
The Manager, NGP Investment Advisor, LP, was formed in 2004 and maintains an office at 1221 McKinney Street, Suite 2975, Houston, Texas 77010. The Managers sole activity is to perform management and investment advisory services for us. The Manager is a registered investment adviser under the Investment Advisers Act of 1940.
The foregoing description of the investment advisory agreement is qualified in its entirety by reference to the full text of the document, a copy of which was filed as Exhibit 10.1 to our Form 10-K for the year ended December 31, 2004, and is incorporated herein by reference.
Pursuant to a separate administration agreement, our Administrator furnishes us with office facilities, equipment, and clerical, bookkeeping, and record keeping services at such facilities. Under the administration agreement, the Administrator also performs, or oversees the performance by third parties of, our required administrative services, which include responsibility for the financial records that we are required to maintain and preparation of reports to our stockholders and reports filed with the SEC. In addition, the Administrator assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns, and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. To the extent permitted under the 1940 Act, the Administrator may also provide, on our behalf, significant managerial assistance to our portfolio companies. Payments under the administration agreement will be equal to the costs and expenses incurred by the Administrator in connection with administering our business. The administration agreement may be terminated at any time, without the payment of any penalty, by a vote of our Board of Directors or by the Administrator upon 60 days written notice to the other party, and will automatically terminate in the event of its assignment (as defined in the 1940 Act).
Of the $512,926 in accounts payable as of December 31, 2008, $203,080 is due to the Administrator for expenses incurred on our behalf for the month of December 2008.
The administration agreement was originally approved by our Board of Directors on November 9, 2004. The administration agreement provides that unless terminated earlier as described below, the agreement will continue in effect from year-to-year thereafter, provided continuation is approved at least annually by (i) our Board of Directors and (ii) a majority of our directors who are not parties to the administration agreement or interested persons of any such party. On October 30, 2008, the Board of Directors, including a majority of the independent directors, approved an extension of the administration agreement through November 9, 2009.
The administration agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, the Manager, its partners and the Managers and its partners respective officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys fees and amounts reasonably paid in settlement) arising from the rendering of the Administrators services under the administration agreement or otherwise as our administrator.
The foregoing description of the administration agreement is qualified in its entirety by reference to the full text of the document, a copy of which was filed as Exhibit 10.2 to our Form 10-K for the year ended December 31, 2004, and is incorporated herein by reference.
Our portfolio companies will generally be affected by the conditions and overall strength of the national, regional and international economies, including interest rate fluctuations, changes in capital markets and changes in the prices of their primary commodities and products. These factors could adversely impact the results of operations of our portfolio companies.
Our portfolio companies may be susceptible to economic downturns and may be unable to repay our loans during these periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic downturns could lead to financial losses in our portfolio and decreases in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in decisions by lenders not to extend credit to us. Additionally, oil and natural gas prices are volatile, and a decline in oil and natural gas prices could significantly affect the business, financial condition and results of operations of our portfolio companies and their ability to meet financial commitments. These events could prevent us from making additional investments and harm our operating results.
A portfolio companys failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on the assets securing such loans, which could trigger cross-defaults under other agreements and jeopardize our portfolio companys ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if one of our portfolio companies were to go bankrupt, even though we may have structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt holding and subordinate all or a portion of our claim to that of other creditors. This could negatively affect our ability to pay dividends and cause the loss of all or part of your investment.
Our business and results of operations are affected by conditions in the capital markets and the economy generally. The stress experienced by capital markets that began in the second half of 2007 continued and substantially increased during 2008. Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the United States (U.S.) mortgage market and a declining real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil and gas prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown. Many economists are now predicting that the U.S. economy, and possibly the global economy, may enter into a prolonged recession or depression as a result of the deterioration in the credit markets and the related financial crisis, as well as a variety of other factors. Both expected and, to a greater extent, actual downturns in the U.S. or global economy could hurt our business in a number of ways, including by decreasing the prices our portfolio companies receive for oil and natural gas production, increasing their various counterparty risks, increasing the likelihood of non-cash asset writedowns and goodwill impairments, and reducing our ability to comply with financial and restrictive covenants related to our indebtedness. Furthermore, a prolonged tightening of the credit market could adversely impact our access to capital, which would reduce our ability to make additional investments. Any of these effects could have a material adverse effect on our revenues, financial condition and results of operations.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, then-President Bush signed the Emergency Economic Stabilization Act of 2008, or the EESA, into law. Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets. Subsequently, on February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009, or the ARRA, a $787 billion stimulus bill for the purpose of stabilizing the economy by, among other things, creating jobs. The U.S. federal government and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We are unable to predict the effect that any such governmental actions will have on the financial markets generally or on the Companys competitive position, business and financial condition in particular.
During periods of higher oil and natural gas prices, energy companies may have less financial need for borrowing than in a lower commodity price environment. At higher commodity price levels, borrowers may use the additional cash flow to reduce outstanding debt under senior secured facilities, which typically makes future borrowing capacity available to such borrowers. In addition, to the extent senior lenders base borrowing capacity on reserve value calculations, higher commodity prices typically increase reserve values, thereby creating additional borrowing capacity. Because interest rates under senior secured facilities will generally be lower than the interest rates of our targeted investments, demand for our targeted investments may be reduced if energy companies have the ability to borrow additional amounts under their senior debt facilities. As a result, high commodity prices may have the effect of reducing the number of energy companies seeking financing similar to our targeted investments or causing us to achieve lower total returns on our targeted investments.
Periodically, we will need to access the capital markets to raise cash to fund new investments. Unfavorable economic conditions could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. An inability to successfully access the capital markets could limit our ability to grow our business and fully execute our business strategy and could decrease our earnings, if any. With certain limited exceptions, we are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. The amount of leverage that we employ will depend on our investment advisers and our Board of Directors assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that we will be able to maintain our current Facilities or obtain another line of credit at all or on terms acceptable to us.
In addition to issuing securities to raise capital as described above, we may in the future seek to securitize our loans to generate cash for funding new investments. To securitize loans, we may create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. This could include the sale of interests in the subsidiary on a non-recourse basis (except for customary repurchase obligations for breach of representations and warranties) to purchasers whom we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools, and we would expect that we would retain a subordinated interest in the assets and participate (most likely on a first loss basis) in losses related to the securitized assets to the extent of that interest. However, the exact structure and provisions of any securitization will be based upon then-current market conditions and may vary from the description in this prospectus. An inability to securitize our loan portfolio successfully could limit our ability to grow our business, fully execute our business strategy and decrease our earnings, if any. Moreover, the successful securitization of our loan portfolio might expose us to losses, as the residual loans in which we do not sell interests will tend to be those that are riskier and more apt to generate losses.
A large number of entities compete with us to make the types of investments that we make in energy companies. We compete with public and private funds, commercial and investment banks, commercial financing
companies, and, to the extent they provide an alternative form of financing, private equity funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company. The competitive pressures that we face may have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we may not be able to identify and make investments that are consistent with our investment objectives.
We do not seek to compete solely based on the interest rates we offer to prospective portfolio companies. However, some of our competitors may make loans with interest rates comparable to or lower than the rates we offer. We may lose investment opportunities if we do not match our competitors pricing, terms and structures. If we match our competitors pricing, terms and structures, we may experience decreased net interest income or capital gains and increased risk of credit loss, and the value of our shares or the amount of dividends paid may decline.
We were incorporated in July 2004 and commenced investment operations in November 2004. We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of your investment could decline substantially.
We invest primarily in privately-held companies, which may be subject to higher risk than investments in publicly-traded companies. Generally, little public information exists about these companies, and we are required to rely on the ability of our management team to obtain adequate information to evaluate the potential risks and returns involved in investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose some or all of the money we invest in these companies. These factors could subject us to greater risk than investments in publicly-traded companies and negatively affect our investment returns, which could negatively affect our ability to pay dividends and cause the loss of all or part of your investment.
A large percentage of our portfolio investments (other than our short-term cash investments) are, and will continue to be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. We value these securities quarterly at fair value in accordance with procedures as determined in good faith by our Board of Directors. However, we may be required on a more frequent basis to value our securities to reflect significant events affecting the value of our securities. The types of factors that may be considered in fair value pricing of an investment include the nature and realizable value of any collateral, the portfolio companys earnings and ability to make payments, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate during short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. As a result, we may not be able to dispose of our holdings at a price equal to or greater than our determined fair value. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments are materially higher than the values that we ultimately realize upon the disposal of such securities. In addition, the subjective nature of such valuations may cause the shares of our common stock to trade at a discount to our net asset value.
The equity interests in which we invest may not appreciate or may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. As a result, our equity interests may decline in value, causing us to lose all or part of our equity investment in those companies, and may negatively affect our ability to pay dividends and cause the loss of all or part of your investment.
We concentrate our investments in the energy industry. The revenues, income (or losses) and valuations of energy companies can fluctuate suddenly and dramatically due to any one or more of the following factors:
Commodity Pricing Risk. Energy companies in general are directly affected by energy commodity prices, such as the market prices of crude oil, natural gas, coal and wholesale electricity, especially for those who own the underlying energy commodity. In addition, the volatility of commodity prices can affect other energy companies due to the impact of prices on the volume of commodities produced, transported, processed, stored or distributed and on the cost of fuel for power generation companies. The volatility of commodity prices can also affect energy companies ability to access the capital markets in light of market perception that their performance may be directly tied to commodity prices. Historically, energy commodity prices have been cyclical and exhibited significant volatility. Some of our portfolio companies may not engage in hedging transactions to minimize their exposure to commodity price risk. Those companies that engage in such hedging transactions remain subject to market risks, including market liquidity and counterparty creditworthiness.
Regulatory Risk. The profitability of energy companies could be adversely affected by changes in the regulatory environment. The businesses of energy companies are heavily regulated by federal, state and local governments in diverse matters, such as the way in which energy assets are constructed, maintained and operated and the prices energy companies may charge for their products and services. Such regulation can change over time in scope and intensity. For example, a particular by-product of an energy process may be declared hazardous by a regulatory agency, which can unexpectedly increase production costs. Moreover, many state and federal environmental laws provide for civil penalties as well as regulatory remediation, thus adding to the potential liability an energy company may face.
Production Risk. The profitability of energy companies may be materially impacted by the volume of crude oil, natural gas or other energy commodities available for producing, transporting, processing, storing, distributing or generating power. A significant decrease in the production of natural gas, crude oil, coal or other energy commodities, due to the decline of production from existing facilities, import supply disruption, depressed commodity prices, political events, OPEC actions or otherwise, could reduce revenue and operating income or increase operating costs of energy companies and, therefore, their ability to pay debt or dividends.
Demand Risk. A sustained decline in demand for crude oil, natural gas, refined petroleum products and electricity could materially affect revenues and cash flows of energy companies. Factors that could lead to a decrease in market demand include a recession or other adverse economic conditions, increases in the market price of the underlying commodity, higher taxes or other regulatory actions that increase costs, or shifts in consumer demand for such products.
Depletion and Exploration Risk. A portion of an energy companys assets may consist of natural gas, crude oil and/or coal reserves and other commodities that naturally deplete over time. Depletion could have a material adverse impact on such companys ability to maintain its revenue. Further, estimates of energy reserves may not be accurate and, even if accurate, reserves may not be produced profitably. In addition, exploration of energy resources, especially of oil and natural gas, is inherently risky and requires large amounts of capital.
Weather Risk. Unseasonable extreme weather patterns could result in significant volatility in demand for energy and power or may directly affect the operations of individual companies. This weather-related risk may create fluctuations in earnings of energy companies.
Operational Risk. Energy companies are subject to various operational risks, such as failed drilling or well development, unscheduled outages, underestimated cost projections, unanticipated operation and maintenance
expenses, failure to obtain the necessary permits to operate and failure of third-party contractors, such as energy producers and shippers, to perform their contractual obligations. In addition, energy companies employ a variety of means of increasing cash flow, including increasing utilization of existing facilities, expanding operations through new construction, expanding operations through acquisitions, or securing additional long-term contracts. Thus, some energy companies may be subject to construction risk, acquisition risk or other risks arising from their specific business strategies.
Competition Risk . The energy companies in which we may invest will face substantial competition in acquiring properties, enhancing and developing their assets, marketing their commodities, securing trained personnel and operating their properties. Many of their competitors, including major oil companies, natural gas utilities, independent power producers and other private independent energy companies, may have financial and other resources that substantially exceed their resources. The businesses in which we may invest face greater competition in the production, marketing and selling of power and energy products brought about in part from the deregulation of the energy markets.
Valuation Risk. The targeted investments made by us are based upon valuations of our portfolio companies assets that are subject to uncertainties inherent in estimating quantities of reserves of oil, natural gas and coal and in projecting future rates of production and the timing of development expenditures, which are dependent upon many factors beyond our control. The estimates rely on various assumptions, including, for example, commodity prices, operating expenses, capital expenditures and the availability of funds, and are therefore inherently imprecise indications of future net cash flows. Actual future production, cash flows, taxes, operating expenses, development expenditures and quantities of recoverable reserves may vary substantially from those assumed in the estimates. Any significant variance in these assumptions could materially affect the value of our investments.
Financing Risk. Some of the portfolio companies in which we invest may rely on capital markets to raise money to pay their existing obligations. Their ability to access the capital markets on attractive terms or at all may be affected by any of the risk factors associated with energy companies described above, by general economic and market conditions or by other factors. This may in turn affect their ability to satisfy their obligations with us.
We generally make debt and minority equity investments, and are therefore subject to the risks that a portfolio company may make business decisions with which we disagree. Further, the stockholders and management of such company may take risks or otherwise act in ways that do not serve our interests. Due to the lack of liquidity in the markets for our investments in privately-held companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.
We generally make investments in private companies. Substantially all of these investments will be subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we have material non-public information regarding such portfolio company.
We could experience fluctuations in our quarterly operating results due to a number of factors, including changes in the fair values of our portfolio investments, the interest rate payable on the debt securities we acquire, the default rate on such securities, the level of our expenses, variations in, and the timing of, the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. Because of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Our investments are generally in the form of debt instruments, including senior and subordinated loans, combined in one facility, sometimes with an equity component, and subordinated loans, sometimes with equity components. We may also invest in preferred stock and other equity securities. These investments will likely be made in energy companies that possess assets that do not produce sufficient current cash flow at inception of our investment to amortize the principal throughout the life of a loan. For example, such an investment could be made in a company that owns proved non-producing oil and natural gas reserves and requires capital to finance development drilling to initiate the production of the reserves and generate cash flow. Some of these investments may be of a highly speculative nature and may lose some or all of their value, which could negatively affect our ability to pay dividends and cause the loss of part of your investment.
We are exposed to increased risk of loss due to our use of debt to make investments. A decrease in the value of our investments will have a greater negative impact on the value of our common stock than if we did not use debt. Our ability to pay dividends will be restricted if our asset coverage ratio falls below at least 200% and any amounts that we use to service our indebtedness are not available for dividends to our common stockholders.
Our current and future debt securities are and may be governed by an indenture or other instrument containing covenants restricting our operating flexibility. We, and indirectly our stockholders, bear the cost of issuing and servicing such securities. Any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock.
Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Our lenders have fixed dollar claims on our consolidated assets that are superior to the claims of our common stockholders or any preferred stockholders. If the value of our consolidated assets increases, then leveraging would cause the net asset value to increase more sharply than it would have had we not leveraged. Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our consolidated income in excess of consolidated interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our consolidated income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock dividend payments. Leverage is generally considered a speculative investment technique.
General interest rate fluctuations may have a negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on investment objectives and our rate of return on invested capital. Because we may borrow money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. As of December 31, 2008, approximately 15% of the investments at fair value in our portfolio were at fixed rates, while approximately 85% were at variable rates. Trading prices for debt that pays a fixed rate of return tend to fall as interest rates rise. Trading prices tend to fluctuate more for fixed-rate securities that have longer maturities. Although we have no policy governing the maturities of our investments, under current market conditions we expect that we will invest in a portfolio of debt generally having maturities of three to seven years, but may have longer maturities. This means that, to the extent we fund longer term fixed rate investments with shorter term floating rate borrowings, we will be subject to greater risk (other things being equal) than a fund invested solely in shorter term securities. A decline in the prices of the debt we own could adversely affect the trading price of our shares.
After our initial investment in a portfolio company, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment in a successful situation, for example, the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decision we make not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio company in need of such an investment or may result in a missed opportunity for us to increase our participation in a successful operation and may dilute our equity interest or otherwise reduce the expected yield on our investment.
We may issue debt securities or preferred stock, and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities, up to the maximum amount permitted by the 1940 Act. We may issue senior securities to make new or follow-on investments, to maintain our RIC status or to pay contingencies and expenses. We are permitted under the 1940 Act to issue senior securities if, immediately after the borrowing or issuance, we will have an asset coverage of at least 200%. That is, we may borrow funds in an amount up to 50% of the value of our assets (including investments made with borrowed funds). As of December 31, 2008, given our total assets of $401 million and total debt of $120 million, our asset coverage for senior securities was 334%.
The amount and nature of any borrowings will depend on a number of factors over which we have no control, including general economic conditions and conditions in the financial markets. We may also need to borrow funds to make qualifying investments to maintain our RIC status. Therefore, we may need to raise additional capital, which we may elect to finance in part through a credit facility. We may not be able to obtain a credit facility on terms that we find acceptable, if at all. The unavailability of funds from commercial banks or other sources on favorable terms could inhibit the growth of our business and have a material adverse effect on our performance.
Our Board of Directors has the authority to modify or waive most of our current operating policies and our strategies without prior notice and without stockholder approval. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our stock. However, the effects might be adverse, which could negatively affect our ability to pay you dividends and cause you to lose all or part of your investment. In the event that our Board of Directors determines that we cannot economically pursue our investment objective under the 1940 Act, they may at some future date decide to withdraw our election to be treated as a business development company and convert us to a management investment company or an operating company not subject to regulation under the 1940 Act, or cause us to liquidate. These changes may not be effected without approval of a requisite percentage of our Board of Directors and the holders of a majority of our shares.
We generally structure the debt investments in our portfolio companies to include customary business and financial covenants placing affirmative and negative obligations on the operation of each companys business and its financial condition. However, from time to time we may elect to waive breaches of these covenants, including our right to payment, or waive or defer enforcement of remedies, such as acceleration of obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company. These actions may reduce the likelihood of us receiving the full amount of future payments of interest or principal and be accompanied by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources, may be unable to meet future obligations and may go bankrupt. This could negatively affect our ability to pay dividends and cause the loss of all or part of your investment.
We are classified as a closed-end, non-diversified management investment company under the 1940 Act, which means we are not limited by the 1940 Act in the proportion of our assets that may be invested in the securities of a single issuer. A consequence of this concentration is that the aggregate returns we initially realize may be adversely affected if a small number of our investments perform poorly or if we need to write down the value of any one such investment. Beyond the applicable federal income tax diversification requirements, we do not have fixed guidelines for diversification, and our investments could be concentrated in relatively few portfolio companies. Financial difficulty on the part of any single portfolio company will expose us to a greater risk of loss than would be the case if we were a diversified company holding numerous investments. To the extent that we take large positions in the securities of a small number of portfolio companies, our net asset value and the market price of our common stock may fluctuate as a result of changes in the financial condition or in the markets assessment of such portfolio companies to a greater extent than that of a diversified investment company. These factors could negatively affect our ability to pay dividends and cause the loss of all or part of your investment.
In addition, our investments are concentrated in the energy industry. Consequently, we are exposed to the risks of adverse developments affecting the energy industry to a greater extent than if our investments were dispersed over a variety of industries. See The energy industry is subject to many risks.
A substantial amount of our assets is invested in subordinated debt securities and mezzanine investments issued by our portfolio companies. The portfolio companies usually will have, or may be permitted to incur, other debt that ranks equally with, or senior to, the securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such securities in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company. As a result, we may be prevented from obtaining the full value of our investment in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Managements assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 identified a material weakness in our internal controls in our financial reporting process due mainly to our failure to perform a sufficiently precise review to ensure the completeness and accuracy of the calculation of our income tax provision and deferred income tax assets and liabilities. As a result of this material weakness, management determined that our disclosure controls and procedures were not effective as of December 31, 2008. The material weakness and our plan to remediate that material weakness are described in Item 9A. entitled CONTROLS AND PROCEDURES of this Annual Report on Form 10-K.
The initiatives we have taken to improve the reliability of our internal controls and to remediate the material weakness are ongoing. However, we might be unable to design a control adequate to remediate the material weakness. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial reporting processes and that we will remediate the material weakness described in this Annual Report on Form 10-K. Any failure to implement required new or improved controls or to remediate the material
weakness, or difficulties encountered in their implementation could prevent us from accurately reporting our financial results, result in material misstatements in our financial statements or cause us to fail to meet our reporting obligations. In addition, we cannot assure you that we will not in the future identify further material weaknesses in our internal control over financial reporting that we have not discovered to date, which may impact the reliability of our financial reporting and financial statements. Insufficient internal controls could also cause investors to lose confidence in our reported financial information.
If we fail to invest any new capital effectively our return on equity may be negatively impacted, which could reduce the price of the shares of our common stock.
Foreign securities may be issued and traded in foreign currencies. As a result, their values may be affected by changes in exchange rates between foreign currencies and the U.S. dollar. For example, if the value of the U.S. dollar goes up compared to a foreign currency, a loan payable in that foreign currency will go down in value because it will be worth fewer U.S. dollars.
The political, economic, and social structure of some foreign countries may be less stable and more volatile than those in the U.S. Investments in these countries may be subject to the risks of internal and external conflicts, currency devaluations, foreign ownership limitations and tax increases. It is possible that a government may take over assets or operations of a company or impose restrictions on the exchange or export of currency or other assets. Some countries also may have different legal systems that may make it difficult for us to vote proxies, exercise stockholder rights, and pursue legal remedies with respect to foreign investments. Diplomatic and political developments, including rapid and adverse political changes, social instability, regional conflicts, terrorism and war, could affect the economies, industries and securities and currency markets, and the value of our investments, in non-U.S. countries. These factors are extremely difficult, if not impossible, to predict and to take into account with respect to our investments in foreign securities.
Brokerage commissions and other fees generally are higher for foreign securities. Government supervision and regulation of foreign stock exchanges, currency markets, trading systems and brokers may be less than in the U.S. The procedures and rules governing foreign transactions and custody (holding of our assets) may involve delays in payment, delivery or recovery of money or investments.
Foreign companies may not be subject to the same disclosure, accounting, auditing and financial reporting standards and practices as U.S. companies. Thus, there may be less information publicly available about foreign companies than about most U.S. companies.
Certain foreign securities may be less liquid (harder to sell) and more volatile than many U.S. securities. This means we may at times be unable to sell foreign securities at favorable prices.
Dividend and interest income from foreign securities may be subject to withholding taxes by the country in which the issuer is located, and we may not be able to pass through to our stockholders foreign tax credits or deductions with respect to these taxes.
The ethanol industry is subject to many risks which may adversely affect the market price of ethanol. For example, overcapacity in the ethanol industry may result in a decrease in the market price of ethanol if the demand for ethanol does not grow at the same pace as increases in supply. In addition, the ethanol industry is highly competitive, and other companies presently in the market, or that are about to enter the market, could adversely affect the market price of ethanol. Moreover, because corn is the principal raw material used to produce ethanol, ethanol companies in general are directly affected by the cost and supply of corn. Changes in the price and supply of corn are subject to and determined by market forces over which we have no or little control, including overall supply and demand, government programs and policies, weather, and other factors. Furthermore, because growth and demand for ethanol may be driven primarily by federal and state government policies, a change in government
policies favorable to ethanol may cause demand for ethanol to decline. These favorable government policies include the national renewable fuels standard, and various federal ethanol tax incentives that assist the ethanol industry. The continuation of these policies is uncertain, which means that demand for ethanol may decline if these policies change or are discontinued. A decline in the demand of ethanol is likely to cause lower ethanol prices. In addition, tariffs on imported ethanol, which currently effectively limit imported ethanol into the United States, could be reduced or eliminated, which may in turn negatively affect the demand for domestic ethanol and the price at which domestic ethanol is sold.
The 1940 Act imposes numerous complex constraints on the operations of BDCs. In order to maintain our status as a BDC, the 1940 Act prohibits us from acquiring any assets other than qualifying assets unless, after giving effect to the acquisition, at least 70% of our total assets are qualifying assets. We refer to this requirement as the 70% Test. Qualifying assets include securities of private U.S. companies, cash, cash equivalents, U.S. government securities and high quality debt instruments that mature in one year or less. The failure to comply with these provisions in a timely manner could prevent us from qualifying as a BDC or could force us to pay unexpected taxes and penalties, which could be material. Additionally, the RIC rules imposed by the Code require us to meet certain source-of-income, asset diversification and annual distribution requirements. The limited experience of our management team in managing a portfolio of assets under such regulatory constraints may hinder its ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objectives.
Our investment advisory agreement does not restrict the right of our Manager, NGP, or any persons working on our behalf, to carry on their respective businesses, including providing advice to others with respect to the purchase of securities that would meet our investment objectives. Although the officers of our Manager devote full time to the management of our business, our investment advisory agreement does not specify a minimum time period that representatives of NGP who are serving as directors or members of our Managers investment committee must devote to managing our investments. Each of Messrs. Hersh and Albin (who serve as members of our Board of Directors), and Messrs. Quinn and Covington (who serve as members of our Managers investment committee) continue to have substantial responsibilities in connection with their roles managing other NGP-affiliated funds. Our Manager and its management team may also be called upon to provide managerial assistance to our portfolio companies. The ability of these parties to engage in these other business activities, including managing assets for third parties, could reduce the time and effort they spend managing our portfolio, which could negatively affect our performance.
We depend on the diligence, experience, skill and network of business contacts of our management team. We also depend, to a significant extent, on our Managers investment professionals and the information and deal flow generated by them in the course of their investment and portfolio management activities. Our management team evaluates, negotiates, structures, closes and monitors our investments. Our future success will depend on the continued service of our management team. The departure of any of the senior members of our management team, or of a significant number of the investment professionals of our Manager, could have a material adverse effect on our ability to achieve our investment objectives. We have not entered into employment agreements, nor do we have an employment relationship, with any of these individuals. There is competition for qualified professionals in our Managers industry. If our Manager is unable to hire and retain qualified personnel, we may be unable to successfully implement our investment strategy and the value of your investment could decline. In addition, we can offer no assurance that our Manager will remain our Manager or that we will continue to have access to the investment professionals of our Manager or their information and deal flow. The loss of any member of our management team could detrimentally affect our operations.
In the course of our investing activities, we pay management and incentive fees to our Manager. Also, we reimburse our Manager and our Administrator for certain expenses they incur, such as those payable to third parties in monitoring our financial and legal affairs and investments and performing due diligence on our prospective investments. As a result, investors in our common stock will invest on a gross basis and receive distributions on a net basis after expenses, resulting in, among other things, a lower rate of return than one might achieve through direct investments. Due to this arrangement, there may be times when our Manager has interests that differ from those of our stockholders, giving rise to a conflict that could negatively affect our investment returns and the value of your investment.
We will pay our Manager a quarterly base management fee based on the value of our total assets (including assets acquired with borrowed funds). Accordingly, our Manager has an enhanced economic incentive to increase our leverage. If our leverage is increased, we will be exposed to increased risk of loss, bear the increased cost of issuing and servicing such senior indebtedness, and will be subject to any additional covenant restrictions imposed in an indenture or by the applicable lender, which could negatively affect our business and results of operation.
In addition to its base management fee, our Manager earns incentive compensation in two parts. The first part is payable quarterly and is equal to a specified percentage of the amount by which our net investment income exceeds a hurdle rate. The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year and equals (1) 20% of (a) our net realized capital gain (realized capital gains less realized capital losses) on a cumulative basis from the closing date of our initial public offering to the end of such fiscal year, less (b) any unrealized capital depreciation at the end of such fiscal year, less (2) the aggregate amount of all capital gains fees paid to our Manager in prior years.
The way in which the incentive fee payable to our Manager is determined may encourage our Manager to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would adversely affect our stockholders because their interests would be subordinate to those of debtholders. In addition, our Manager receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. As a result, our Manager may have a tendency to invest more in investments that are likely to result in capital gains as compared to income-producing securities. Other key criteria related to determining appropriate investments and investment strategies, including the preservation of capital, might be under-weighted if our Manager focuses exclusively or disproportionately on maximizing its income. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses.
Our Manager receives a quarterly incentive fee based, in part, on our net investment income, if any, for the immediately preceding fiscal quarter. To the extent our Manager exerts influence over our portfolio companies, the quarterly incentive fee may provide our Manager with an incentive to induce our portfolio companies to accelerate or defer payments for interest or other obligations owed to us from one fiscal quarter to another. This could result in greater fluctuations in the timing and amount of dividends that we pay.
Pursuant to the investment advisory agreement, our Manager is entitled to receive incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our net investment income for that quarter above a hurdle rate. In addition, the investment advisory agreement further provides that our net investment
income for incentive compensation purposes excludes unrealized capital losses that we may incur in the fiscal quarter, even if such capital losses result in a net loss on our statement of operations for that quarter. The calculation of the incentive fee includes any deferred interest accrued, but not yet received. As a result, we may be paying an incentive fee on interest, the collection of which may be uncertain or deferred. Thus, we may be required to pay our Manager incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter.
Our management team does not currently provide advisory services to other investment vehicles with common investment objectives to ours. However, they are not prohibited from doing so. In addition, the NGP-affiliated funds are not precluded from making investments in securities like our targeted investments, although they have not traditionally focused on such types of investments in the past. If our management team does provide such services to other investment vehicles in the future, or if the focus of the NGP-affiliated funds were to change to include securities like our targeted investments, our management team might allocate investment opportunities to other entities, and thus might divert attractive investment opportunities away from us. In addition, our executive officers and directors, and the members of our management team, serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. These multiple responsibilities might create conflicts of interest for our management team and NGP if they are presented with opportunities that might benefit us and their other clients, investors or stockholders.
Our Manager has not assumed any responsibility to us other than to provide the services described in the investment advisory agreement, and it is not responsible for any action of our Board of Directors in declining to follow our Managers advice or recommendations. Pursuant to the investment advisory agreement, our Manager, its partners and, among others, their respective partners, officers and employees are not liable to us for their acts under the investment advisory agreement, absent willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties. We have agreed to indemnify, defend and protect our Manager and its managing members, officers and employees with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our Manager not constituting willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties. These protections may lead our Manager to act in a riskier manner when acting on our behalf than it would when acting for its own account.
Our investment strategies differ from those of other funds (including any NGP-affiliated fund) that are, or have been, managed by NGP or its affiliates. Investors in NGP Capital Resources Company do not own any interest in NGP or in any other NGP-affiliated fund. The historical performance of NGP is not indicative of the results that our company will achieve, and you should not rely upon such historical performance in purchasing our common stock. The rate of return we target on investments is lower than that of NGPs private equity funds, and as a result, our expected rate of return is lower than returns sought by NGPs private equity funds. We can provide no assurance that we will replicate the historical or future performance of NGP or its affiliated funds, and we caution you that our investment returns may be substantially lower than the returns achieved by those funds.
If we do not continue to qualify as a business development company, we might be regulated as a closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility.
To qualify as a RIC under the Code, we must meet certain source-of-income, asset diversification and annual distribution requirements. The annual distribution requirement for a RIC is satisfied if we distribute at least 90% of our investment company taxable income (which generally consists of ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses) and net tax-exempt interest to our stockholders on an annual basis. Because we use debt financing, we are subject to certain asset coverage ratio requirements under the 1940 Act as a BDC, and financial covenants under our existing loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to qualify as a RIC. If we are unable to obtain cash from other sources, we may fail to qualify as a RIC and, thus, may be subject to corporate-level income tax. To qualify as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we fail to qualify as a RIC for any reason at any time in the future and we remain or become subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. In addition, our distributions would be taxable to our stockhholders as ordinary dividends. Such a failure would likely have a material adverse effect on our stockholders and us. For example, we failed to qualify as a RIC for our first taxable year ended on December 31, 2004.
For federal income tax purposes, we are required to include in income certain amounts that we have not yet received in cash, such as original issue discount, which arises, for example, when we receive warrants, property-based equity participation rights or loan discount points in connection with the purchase of a loan or payment-in-kind interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount or increases in loan balances as a result of payment-in-kind arrangements, which could be significant relative to our companys overall investment activities, are included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we do not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the tax requirement to distribute at least 90% of the sum of our investment company taxable income (which generally consists of ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses) and net tax-exempt interest, if any, to our stockholders on an annual basis, to maintain our status as a RIC. Accordingly, we may have to sell some of our investments at times we would not consider advantageous, raise additional debt or equity capital, borrow funds or reduce new investment originations to meet these distribution requirements. If we are not able to obtain cash from other sources, we may fail to qualify as a RIC and thus be subject to corporate-level income tax.
We have elected to be treated as a BDC under the 1940 Act. The 1940 Act imposes numerous restrictions on our activities, including restrictions on the nature of our investments, our use of borrowed funds, our issuance of securities, options, warrants, or rights. Such restrictions may prohibit the purchase of certain investments that would otherwise be suitable for investment or render such purchases inadvisable.
Under the provisions of the 1940 Act, as a BDC, we are permitted to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous and result in unfavorable prices.
We generally cannot issue and sell our common stock at a price below net asset value per share. However, we may sell our common stock, or warrants, options or rights to acquire our common stock, at prices below the current net asset value of the common stock if our Board of Directors determines that such sale is in the best interests of our company and its stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount).
Because there are no judicial and few administrative interpretations of the provisions of the 1940 Act pertaining to business development companies, there is no assurance that such provisions will be interpreted or administratively implemented in a manner consistent with our investment objectives and intended manner of operation. In the event that our Board of Directors determines that we cannot economically pursue our investment objective under the 1940 Act, they may at some future date decide to withdraw our election to be regulated as a BDC and convert us to a management investment company or an operating company not subject to regulation under the 1940 Act, or cause us to liquidate. These changes may not be effected without approval of a requisite percentage of our Board of Directors and the holders of a majority of our shares.
We, our portfolio companies, and our Manager and its affiliates are subject to regulation by laws and regulations at the local, state and federal level. New legislation may be enacted into law or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make, any of which could harm us, our Manager and our stockholders, with retroactive effect. Such changes could result in material changes to our strategies and plans and may result in our investment focus shifting from the areas of expertise of our Manager to other types of investments in which our Manager may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.
For example, under current federal tax laws, our portfolio companies are entitled to certain deductions relating to their operations, including deductions for intangible drilling costs, manufacturing tax deductions and depletion deductions. The Presidents budget for the fiscal year 2010 outlines proposals to eliminate several oil and gas federal income tax incentives, including the repeal of the manufacturing tax deduction, percentage depletion allowance and expensing of intangible drilling costs for oil and natural gas. It is not possible at this time to predict how legislation or new regulations that may be adopted to address these proposals would impact our business or the business of our portfolio companies, but any such future laws and regulations could adversely affect our results of operations and the value of your investment.
We are prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our independent directors and, in certain cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act, and we are generally prohibited from buying or selling any security from or to such affiliate, absent the prior approval of our independent directors and, in certain cases, the SEC. The 1940 Act also prohibits joint transactions with an affiliate, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in certain cases, the SEC. If a person acquires more than 25% of our voting securities, we are prohibited from buying or selling any security from or to such person, or entering into joint transactions with such person, absent the prior approval of the SEC.
We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located in Houston, Texas, where we occupy office space pursuant to our administration agreement with our Administrator. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us.
No matters were submitted to a vote of stockholders through the solicitation of proxies or otherwise during the fourth quarter of the fiscal year ended December 31, 2008.
Our common stock is traded on the NASDAQ Global Select Market under the symbol NGPC. On March 11, 2009, there were approximately 15,026 record holders and beneficial owners (held in street name) of our common stock, according to our transfer agent. The following table sets forth the range of high and low sales prices of our common stock as reported on the NASDAQ Stock Market and our dividends declared for the periods indicated.
per Share (2)
|Fourth quarter (3)||14.03||16.15||14.20||115||%||101||%|||
|(1)||Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low closing sales prices. The net values per share shown are based on outstanding shares at the end of each period.|
|(2)||Represents the dividend declared in the specified quarter.|
|(3)||Beginning November 10, 2004.|
Since the first full quarter following our IPO, we have distributed, and currently intend to continue to distribute in the form of dividends, a minimum of 90% of our investment company taxable income on a quarterly basis to our stockholders. We may retain long-term capital gains and treat them as deemed distributions for tax purposes. We report the estimated tax characteristics of each dividend when declared, while the actual tax characteristics of dividends are reported annually to each stockholder on Form 1099-DIV, prepared by our stock transfer agent. For income tax purposes, all of our dividends declared through December 31, 2006 were distributions of ordinary income for tax purposes and all dividends were classified as non-qualifying dividends. Our dividends declared for the year ended December 31, 2007 were 77.67% ordinary income and 22.33% capital gains for tax purposes and all dividends were classified as non-qualifying dividends. Our dividends declared for the year ended December 31, 2008 were 81.49% ordinary income and 18.51% capital gains for tax purposes. Of the 2008 ordinary dividends, 76.65% were classified as non-qualifying dividends and 23.35% were classified as qualifying dividends. Qualified dividend income is generally taxed to stockholders at the rates that apply to net capital gains. There is no assurance that we will achieve investment results or maintain a tax status that will permit any specified level of cash distributions or year-to-year increases in cash distributions. We have not purchased any of our shares of common stock, nor have we sold any equity securities.
Our stock transfer agent, registrar and dividend reinvestment plan administrator is American Stock Transfer & Trust Company. Information requests for American Stock Transfer & Trust Company can be sent to 59 Maiden Lane, Plaza Level, New York, NY 10038. Their telephone number for shareholder services is 1-800-937-5449 and for dividend reinvestment services the phone number is 1-800-278-4353.
The Company has established an opt out dividend reinvestment plan for its common stockholders. As a result, if the Company declares a cash dividend, a stockholders cash dividend will be automatically reinvested in additional shares of the Companys common stock unless the stockholder, or his or her broker, specifically opts out of the dividend reinvestment plan and elects to receive cash dividends. It is customary practice for many brokers to opt out of dividend reinvestment plans on behalf of their clients unless specifically instructed otherwise.
The Companys plan provides for the plan agent to purchase shares in the open market for credit to the accounts of plan participants unless the average of the closing sales prices for the shares for the five days immediately preceding the payment date exceeds 110% of the most recently reported net asset value per share.
The following Performance Graph is not soliciting material, is not deemed filed with the SEC, and is not to be incorporated by reference into any of our filings under the Securities Act or the Securities Exchange Act of 1934, as amended (the Exchange Act), respectively.
The following line graph compares the cumulative total return* on an investment in our common stock against the cumulative total return of the NASDAQ U.S. Stock Market Total Return Index and an index of peer companies (selected by us) for the period beginning June 30, 2004 and ending December 31, 2008 (we began trading on November 11, 2004). The peer group consists of the following fifteen business development companies: Allied Capital Corporation, American Capital, Ltd., Apollo Investment Corporation, Ares Capital Corporation, Gladstone Capital Corporation, Hercules Technology Growth Capital, Inc., Kohlberg Capital Corporation, Kayne Anderson Energy Development Company, Main Street Capital Corporation, MCG Capital Corporation, Patriot Capital Funding, Inc., PennantPark Investment Corporation, Prospect Capital Corporation, TICC Capital Corporation and Triangle Capital Corporation.
This Performance Graph and the related textual information are based on historical data and are not necessarily indicative of future performance.
|*||Assumes that an investment in our common stock and each index was $100 on 11/10/2004. Cumulative total return is based on share price appreciation plus reinvestment of dividends.|
The following table sets forth our selected historical financial and operating data, as of and for the dates and period indicated. The selected historical financial data are derived from our audited financial statements and should be read in conjunction with our financial statements and notes thereto and together with Managements Discussion and Analysis of Financial Condition and Results of Operations.
|Year Ended December 31, 2008||Year Ended December 31, 2007||Year Ended December 31, 2006||Year Ended December 31, 2005||
Period August 6,
(Commencement of Operations) Through
December 31, 2004
|Total investment income||$||37,460,916||$||37,499,360||$||27,517,093||$||17,306,794||$||853,038|
|Total operating expenses||18,814,380||18,238,203||10,970,889||6,898,885||1,443,255|
|Net investment income (loss) before income taxes||18,646,536||19,261,157||16,546,204||10,407,909||(590,217||)|
|Net realized capital gain (loss) on portfolio securities, corporate notes and commodity derivative instruments||19,251,090||6,721,176||(245,859||)||1,338,351|||
|Net increase (decrease) in unrealized appreciation (depreciation) on portfolio securities, corporate notes and commodity derivative instruments||(51,605,789||)||5,008,291||(1,299,127||)||(394,933||)||290,789|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||$||(13,276,222||)||$||30,867,816||$||15,001,218||$||11,351,327||$||(299,428||)|
Per Share Data
|Net investment income (loss)||$||1.09||$||1.09||$||0.95||$||0.60||$||(0.03||)|
|Net realized and unrealized gain (loss) on portfolio securities, corporate notes and commodity derivative instruments||$||(1.71||)||$||0.69||$||(0.09||)||$||0.05||$||0.01|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||$||(0.62||)||$||1.78||$||0.86||$||0.65||$||(0.02||)|
|Net asset value per share||$||12.29||$||14.30||$||13.96||$||14.02||$||14.03|
Balance Sheet Data
|Total stockholders equity (net assets)||$||265,822,646||$||250,259,337||$||243,258,256||$||243,898,485||$||244,038,830|
The following analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the notes thereto contained elsewhere in this report.
Certain statements in this report that relate to estimates or expectations of our future performance or financial condition may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various risks and uncertainties, which could cause actual results and conditions to differ materially from those projected, including, but not limited to,
|||uncertainties associated with the timing of transaction closings;|
|||changes in the prospects of our portfolio companies;|
|||changes in interest rates;|
|||changes in regional, national or international economic conditions and their impact on the industries in which we invest; continued disruption of credit and capital markets, such as the events that occurred during the third and fourth quarters of 2008;|
|||the future operating results of our portfolio companies and their ability to achieve their objectives;|
|||changes in the conditions of the industries in which we invest;|
|||the adequacy of our cash resources and working capital;|
|||the timing of cash flows, if any, from the operations of our portfolio companies;|
|||the ability of our Manager to locate suitable investments for us and to monitor and administer the investments; and|
|||other factors enumerated in our filings with the Securities and Exchange Commission.|
We may use words such as anticipates, believes, expects, intends, will, should, may and similar expressions to identify forward-looking statements. Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties that could cause actual results to differ materially from our historical experience and present expectations. Undue reliance should not be placed on such forward-looking statements, as such statements speak only as of the date on which they are made. Additional information regarding these and other risks and uncertainties is contained in our periodic filings with the SEC.
We are a financial services company created to invest primarily in debt securities of small and mid-size private energy companies, which, until July 21, 2008, were generally defined as companies that have net asset values or annual revenues of less than $500 million and are not issuers of publicly traded securities. On July 21, 2008, the Securities and Exchange Commission expanded the definition of eligible portfolio companies to include domestic operating companies with securities listed on a national securities exchange so long as the company has a market capitalization of less than $250 million. We have elected to be regulated as a BDC under the 1940 Act and, as such, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in qualifying assets, which are securities of private or thinly traded public U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less. In addition, for federal income tax purposes we operate so as to be treated as a RIC under the Code. Pursuant to these elections, we generally will not have to pay corporate-level taxes on any income and capital gains we distribute to our stockholders. The Company has several subsidiaries that are single member limited liability companies and wholly-owned limited partnerships established to hold certain portfolio investments or provide services to the Company in accordance with specific rules prescribed for a company operating as a RIC. These subsidiaries are: NGPC Funding GP, LLC, a Texas limited liability company; NGPC Nevada, LLC, a Nevada limited liability company; NGPC Funding, LP, a Texas limited partnership; NGPC Asset Holdings GP, LLC, a Texas limited liability company; NGPC Asset Holdings, LP, a Texas limited partnership;
NGPC Asset Holdings II, LP, a Texas limited partnership (NGPC II); NGPC Asset Holdings III, LP, a Texas limited partnership, NGPC Asset Holdings IV, LP, a Texas limited partnership and NGPC Asset Holdings V, LP, a Texas limited partnership. Effective May 28, 2008, NGPC Asset Holdings IV, LP merged with and into NGPC II. The Company consolidates the results of its subsidiaries for financial reporting purposes. The Company does not consolidate the financial results of its portfolio companies.
Our investment objective is to generate both current income and capital appreciation primarily through debt investments with certain equity components. A key focus area for our targeted investments in the energy industry is domestic upstream businesses that produce, develop, acquire and explore for oil and natural gas. We also evaluate investment opportunities in such businesses as coal, power, electricity, energy services and alternative energy. Our investments generally range in size from $10 million to $50 million, however, we may invest more or less depending on market conditions and our Managers view of a particular investment opportunity. Our targeted investments primarily consist of debt instruments, including senior and subordinated loans combined in one facility, sometimes with an equity component, and subordinated loans, sometimes with equity components. We may also invest in preferred stock and other equity securities on a stand-alone basis.
We generate revenue in the form of interest income on the debt securities that we own, dividend income on any common or preferred stock that we own, and capital gains or losses on any debt or equity securities that we acquire in portfolio companies and subsequently sell. Our investments, if in the form of debt securities, typically have a term of three to seven years and bear interest at a fixed or floating rate. To the extent achievable, we seek to collateralize our investments by obtaining security interests in our portfolio companies assets. We also may acquire minority or majority equity interests in our portfolio companies, which may pay cash or in-kind dividends on a recurring or otherwise negotiated basis. In addition, we may generate revenue in other forms including commitment, origination, structuring, administration or due diligence fees; fees for providing managerial assistance; and possibly consultation fees. Any such fees generated in connection with our investments are recognized as earned.
Our level of investment activity can and does vary substantially from period to period depending on many factors, including the amount of debt and equity capital available to energy companies, the level of acquisition and divestiture activity for such companies, the level and volatility of energy commodity prices, the general economic and competitive environment for the types of investments we make, and our own ability to raise capital, both through issuance of debt and equity securities, to fund our investments. We believe that the recent dislocation in the credit markets and decline in energy commodity prices should favorably impact the competitive environment, in that it is reducing the debt capital available to energy companies from other sources. Though the same macro economic factors also make our access to new debt and equity capital less certain, in September 2008 we extended the maturity of our Investment Facility to August 2010. While we currently have capital available to invest, it is not unlimited. We remain committed to our underwriting and investment disciplines in selectively investing in appropriate risk-reward opportunities within the energy sector.
The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and income and expenses during the periods reported. Actual results could materially differ from those estimates. We have identified the following as critical accounting policies.
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States, and include the accounts of the Company and its wholly owned subsidiaries. The consolidated financial statements reflect all adjustments and reclassifications which, in the opinion of management, are necessary for the fair presentation of the results of the operations and financial condition for the periods presented. All significant intercompany balances and transactions have been eliminated. Unless otherwise specified or the context otherwise requires, all references in these notes to the Company, we, us or our are to NGP Capital Resources Company and its consolidated subsidiaries.
Cash and cash equivalents include short-term, liquid investments in accounts such as demand deposit accounts, money market accounts, certain overnight investment sweep accounts and money market fund accounts. Cash and cash equivalents are carried at cost, which approximates fair value.
Prepaid assets consist of premiums paid for directors and officers insurance and fidelity bonds with policy terms of one year, fees associated with the establishment of the credit facility and registration expenses related to the Companys shelf filing. Such premiums and fees are amortized monthly on a straight line basis over the term of the policy or credit facility. Registration expenses, if any, are deferred and will be charged as a reduction of capital upon the sale of shares.
We place our cash and cash equivalents with financial institutions and, at times, cash held in checking or money market accounts may exceed the Federal Deposit Insurance Corporation insured limit. On September 15, 2008, Lehman Brothers Holdings Inc. (Lehman Holdings) filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in the Southern District of New York. Subsidiaries of Lehman Holdings, including Lehman Brothers Inc. (Lehman Brothers) and Lehman OTC, were not included in the filing. The business of Lehman Brothers Private Investment Management (PIM), including our money market and bond holdings, was transferred during September 2008 to Barclays Wealth, the wealth management division of Barclays Bank PLC (Barclays), which operates in the United States as Barclays Capital Inc. As of December 31, 2008, our Barclays money market account balance was approximately $1.45 million and the fair market value of our senior notes and corporate notes were $5.76 million and $6.35 million, respectively. We currently believe that the transfer of our Lehman Brothers account to Barclays will not have a material adverse effect on our financial position, results of operations or cash flows.
Investments are carried at fair value, as determined in good faith by the Companys Board of Directors. On a quarterly basis, the investment team of the Manager prepares valuations for all of the assets in the Companys portfolio and presents the valuations to the Companys Valuation Committee and Board of Directors. The valuations are determined and recommended by the Valuation Committee to the Board of Directors, which reviews and ratifies the final portfolio valuations. For more information regarding our portfolio valuation policies and procedures, see Valuation Process in Part I, Item 1. Business above.
Investments in securities for which market quotations are readily available are recorded in the financial statements at such market quotations as of the valuation date adjusted for appropriate liquidity discounts, if applicable. For investments in securities for which market quotations are unavailable, or which have various degrees of trading restrictions, the investment team of the Manager prepares valuation analyses, as generally described below.
Using the most recently available financial statements, forecasts and, when applicable, comparable transaction data, the investment team of the Manager prepares valuation analyses for the various securities in the Companys investment portfolio. These valuation analyses are prepared using traditional valuation methodologies, which rely on estimates of the asset values and enterprise values of portfolio companies issuing securities, as well as estimated current market values for comparable securities.
The methodologies for determining asset valuations include estimates based on: the liquidation or sale value of a portfolio companys assets, the discounted value of expected future net cash flows from the assets and third party valuations of a portfolio companys assets, such as engineering reserve reports of oil and natural gas properties. The Manager considers some or all of the above valuation methods to determine the estimated asset value of a portfolio company.
The methodologies for determining enterprise valuations include estimates based on: valuations of comparable public companies, recent sales of comparable companies, the value of recent investments in the equity securities of a portfolio company and also on the methodologies used for asset valuations. The investment team of the Manager considers some or all of the above valuation methods to determine the estimated enterprise value of a portfolio company.
The methodologies for determining estimated current market values of comparable securities include estimates based on: recent initial offerings of comparable securities of public and private companies; recent secondary market sales of comparable securities of public and private companies; current market implied interest rates for comparable securities in general; and current market implied interest rates for non-comparable securities in general, with adjustments for such things as size of issue, tenor, and liquidity. The investment team of the Manager considers some or all of the above valuation methods to determine the estimated current market value of a comparable security.
Debt Securities: The Company records its investments in non-convertible debt securities at fair value which generally approximates cost plus amortized original issue discount, or OID, to the extent that the estimated asset or enterprise value of the portfolio company exceeds the outstanding debt of the portfolio company, subject to comparison to the estimated current market values of comparable securities. The Company records its investment in convertible debt securities at fair value which generally approximates the higher of: 1) cost plus amortized OID, to the extent that the estimated asset or enterprise value of the portfolio company equals or exceeds the outstanding debt of the portfolio company; and 2) the Companys pro rata share, upon conversion, of the residual equity value of the portfolio company available after deducting all outstanding debt from its estimated enterprise value, both subject to comparison to the estimated current market values of comparable securities. If the estimated asset or enterprise value is less than the sum of the value of the Companys debt investment and all other debt securities of the portfolio company pari passu or senior to the Companys debt investment, the Company reduces the value of the debt investment beginning with the junior-most debt investment such that the asset or enterprise value less the value of the outstanding pari passu or senior debt is zero, subject to comparison to the estimated current market values of comparable securities. Investments in debt securities for which market quotations are readily available are recorded in the financial statements at such market quotations as of the valuation date adjusted for appropriate liquidity discounts, if applicable.
Equity Securities: The Company records its investments in preferred and common equity securities (including warrants or options to acquire equity securities) at fair value based on its pro rata share of the residual equity value available after deducting all outstanding debt from the estimated enterprise value, subject to comparison to the estimated current market values of comparable securities.
Property-Based Equity Participation Rights: The Company records it investments in overriding royalty and net profits interests at fair value based on a multiple of cash flows generated by such investments, multiples from transactions involving the sale of comparable assets and/or the discounted value of expected future net cash flows from such investments. Appropriate cash flow multiples are derived from the review of comparable transactions involving similar assets. The discounted value of future net cash flows is derived, when appropriate, from third party valuations of a portfolio companys assets, such as engineering reserve reports of oil and gas properties.
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned.
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement on Financial Accounting Statement 157, Fair Value Measurements (Statement 157). This standard establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements. Statement 157 applies to fair value measurements already required or permitted by existing standards. Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The changes to current generally accepted accounting principles from the application of Statement 157 relate to the definition of fair value, the methods used to measure fair value and the expanded disclosures about fair value measurements.
As of January 1, 2008, the Company adopted Statement 157. The Company has performed an analysis of all existing investments to determine the significance and character of all inputs to their fair value determination. Based on this assessment, the adoption of this standard did not have a material effect on the Companys net asset value.
Current accounting rules require that all derivative instruments, other than those that meet specific exclusions, be recorded at fair value. Quoted market prices are the best evidence of fair value. If quotations are not available, managements best estimate of fair value is based on the quoted market price of derivatives with similar characteristics or on valuation techniques. The Companys derivative instruments are either exchange traded or transacted in an over-the-counter market. Valuation is determined by reference to readily available public data. Option fair values for the natural gas option transactions are based on the Black-Scholes pricing model and the crude oil transactions are based on the Turnbull-Wakeman pricing model and verified against the applicable counterpartys fair values.
All securities transactions are accounted for on a trade-date basis. Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. Premiums and discounts are accreted into interest income using the effective interest method. Detachable warrants, other equity securities or property interests such as overriding royalty interests obtained in conjunction with the acquisition of debt securities are recorded separately from the debt securities at their initial fair value, with a corresponding amount recorded as a discount to the associated debt security. Income from overriding royalty interests is recognized as received and the recorded assets are amortized using the units of production method. The portion of the loan origination fees paid that represent additional yield or discount on a loan are deferred and accreted into interest income over the life of the loan using the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized premium or discount is recorded as a realized gain or loss. Market premiums or discounts on acquired loans or fixed income investments are accreted into interest income using the effective interest method. Dividend income is recognized on the ex-dividend date. Accruing interest or dividends on investments is deferred when it is determined that the interest or dividend is not collectible. Collectability of the interest and dividends is assessed, based on many factors including the portfolio companys ability to service its loan based on current and projected cash flows as well as the current valuation of the portfolio companys assets.
The Company may have investments in its portfolio that contain payment-in-kind (PIK) provisions. PIK interest or dividends, computed at the contractual rate specified in each investment agreement, are added to the principal balance of the investment and recorded as interest or dividend income. For investments with PIK interest or dividends, the Company bases income accruals on the principal balance including any PIK. If the portfolio companys asset valuation is not sufficient to cover the contractual interest, the Company will not accrue interest income or dividend income on the investment. To maintain the Companys RIC status, this non-cash source of income must be paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash. PIK interest income totaled $2.3 million net of a $0.2 million reserve in 2008, $4.5 million net of a $0.3 million reserve in 2007, and $0.8 million with no reserve in 2006. PIK dividend income was zero after reserving the entire $0.3 million in 2008, $0.2 million after reserving $0.1 million in 2007, and $0.1 million, with no reserve in 2006.
Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, considering unamortized fees and prepayment premiums, and without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period including the reversal of previously recorded unrealized appreciation or depreciation, when capital gains or losses are realized.
Derivative accounting rules require that fair value changes of derivative instruments that do not qualify for hedge accounting be reported in current period, rather than in the period the derivatives are settled and/or the hedged transaction is settled. This can result in significant earnings volatility. The Company has decided not to designate these instruments as hedging instruments for financial accounting purposes. Net unrealized appreciation or depreciation reflects the change in derivative values during the reporting period including the reversal of previously recorded unrealized appreciation or depreciation, when settled gains or losses are realized.
Fees primarily include financial advisory, transaction structuring, loan administration, commitment and prepayment fees. Financial advisory fees represent amounts received for providing advice and analysis to companies and are recognized as earned when such services are performed, provided collection is probable. Transaction structuring fees represent amounts received for structuring, financing and executing transactions and are generally payable only if the transaction closes. Such fees are deferred and accreted into interest income over the life of the loan using the effective interest method. Commitment fees represent amounts received for committed funding and are generally payable whether or not the transaction closes. On transactions that close within the commitment period, commitment fees are deferred and accreted into interest income over the life of the loan using the effective interest method. Commitment fees on transactions that do not close are generally recognized over the period the commitment is outstanding. Prepayment and loan administration fees are recognized as they are received. For the years ended December 31, 2008, 2007 and 2006, the Company accreted approximately $1.5 million, $3.0 million and $1.4 million, respectively, of fee income into interest income.
Dividends to stockholders are recorded on the ex-dividend date. We currently intend that our distributions each year will be sufficient to maintain our status as a RIC for federal income tax purposes and to eliminate our liability for federal excise taxes. We intend to make distributions to stockholders on a quarterly basis of substantially all net taxable income. We also intend to make distributions of net realized capital gains, if any, at least annually. However, we may in the future decide to retain capital gains for investment and designate such retained dividends as a deemed distribution. The amount to be paid out as a dividend is determined by our Board of Directors each quarter and is based on the annual taxable earnings estimated by the Manager. Based on that estimate, a dividend is declared each quarter and paid shortly thereafter.
From commencement of investment operations in November 2004 through December 31, 2006, we had invested $267.9 million in seventeen portfolio companies, all energy-related, and received principal repayments of $95.1 million. During 2007, we added investments of $186.3 million in six new portfolio companies and we funded $46.3 million to existing portfolio companies, for a total of $232.6 million in 2007. Five portfolio companies repaid their loans during 2007 totaling $49.7 million and we received additional principal repayments of $76.6 million for total repayments of $126.3 million. During 2008, we added investments of $62.8 million in five new portfolio companies and we funded $50.3 million to existing portfolio companies, for a total of $113.1 million in 2008. We received principal repayments and realizations of $96.2 million in 2008. From commencement of investment operations in November 2004 through December 31, 2008, we have invested $613.6 million in twenty-eight portfolio companies, all energy-related, and received principal repayments and realizations of $317.6 million. At December 31, 2008, our targeted investment portfolio consisted of nineteen portfolio companies totaling $296.0 million. The table below shows our investment portfolio by type as of December 31, 2008. Yields on investments are computed using interest rates as of the balance sheet date and include amortization of loan discount points, original issue discount and market premium or discount, royalty interest income, net profits income and other similar investment income, weighted by their respective costs when averaged. The yield on income from derivatives is computed using estimated 2009 fair value derivative income, net of 2009 expiring options costs.
|Senior secured term loans||10.37||%||38.7||%|
|Senior subordinated secured notes||13.59||%||4.0||%|
|Participating convertible preferred stock||0.00||%||0.2||%|
|Member and partnership units||0.00||%||6.3||%|
|Limited term royalty interest||3.63||%||3.1||%|
|Net profits interest and other||11.99||%||9.9||%|
|Subtotal targeted investments||9.09||%||62.2||%|
|Commodity derivative instruments||934.57||%||2.1||%|
|Cash and cash equivalents||0.55||%||34.1||%|
Results comparisons are for the years ended December 31, 2008, 2007 and 2006.
For the years ended December 31, 2008, 2007 and 2006, investment income totaled $37.5 million, $37.5 million and $27.5 million, respectively. Increased income from targeted portfolio investments in 2008 compared to 2007 was offset by decreases in income from investments in U.S. Treasury Bills and cash and cash equivalents caused by declining market rates. The increase in investment income in 2007 compared to 2006 was primarily due to the overall growth of our targeted investment portfolio.
While our total targeted portfolio balance, on a cost basis, increased by approximately $16.5 million from December 31, 2007 to December 31, 2008, the balance of non-accruing and non-income producing investments increased from approximately $27.8 million to approximately $80.4 million during the same period, also on a cost basis. Additional discussion concerning non-accrual investments is provided in Portfolio Credit Quality below. Although LIBOR rates dropped significantly in 2008 compared to 2007, this had a minimal effect on our targeted investment income because of LIBOR floors established for new clients and certain other existing clients during 2008. Conversely, significantly lower U.S. Treasury Bill rates during 2008 reduced interest from cash and cash equivalents. Reserves against investment income for the year ended December 31, 2008 totaled approximately $3.5 million compared to $0.3 million for the year ended December 31, 2007.
The weighted average yield on targeted portfolio investments was 9.1% at December 31, 2008. The weighted average yield on investments in corporate notes was 5.8%, on investments in commodity derivative instruments was 934.6% and on investments in cash and cash equivalents was 0.5% as of December 31, 2008. The weighted average yield on our total capital invested at December 31, 2008 was 8.0%.
The weighted average yield on targeted portfolio investments was 11.9% at December 31, 2007. The weighted average yield on investments in corporate notes was 5.8% and on investments in U.S. Treasury Bills, and cash and cash equivalents was 2.8% as of December 31, 2007. The weighted average yield on our total capital invested at December 31, 2007 was 8.2%.
The weighted average yield on targeted portfolio investments was 12.0% at December 31, 2006. The weighted average yield on investments in corporate notes was 5.5% and on investments in U.S. Treasury Bills, and cash and cash equivalents was 4.6% as of December 31, 2006. The weighted average yield on our total capital invested at December 31, 2006 was 8.3%.
Yields on investments are computed using interest rates as of the balance sheet date and include amortization of loan discount points, original issue discount and market premium or discount, royalty interest income, net profits income and other similar investment income, weighted by their respective costs when averaged.
The table below summarizes the components of our operating expenses:
|For the Years Ended||Changes|
|12/31/2008||12/31/2007||12/31/2006||2008 vs. 2007||2007 vs. 2006|
management & incentive fees
|Insurance expenses, professional fees, directors fees & other G&A*||4.6||3.9||3.7||0.7||0.2|
|Interest & credit facility fees||6.6||7.4||2.6||(0.8||)||4.8|
|Total operating expenses||$||18.8||$||18.2||$||11.0||$||0.6||$||7.2|
|*||Other G&A includes allocated share of employee, facilities & shareholder services costs and marketing|
Compared to 2007, the 2008 increase in operating expenses was largely the result of increased investment advisory and management fees due to higher average total assets, increased insurance and general and administrative expenses offset by lower incentive fees and decreased interest expense. Interest expense was lower in 2008 due to lower levels of borrowings under the Credit Facilities. Insurance expense was higher due to an increased level of coverage.
Compared to 2006, the 2007 increase in operating expenses was largely the result of increased investment advisory and management and incentive fees due to higher average total assets, and increased interest expense due to higher levels of borrowings under the Credit Facilities.
For the years ended December 31, 2008 and 2007, net investment income before income taxes was $18.6 million and $19.3 million, respectively. The 3.2% decrease was primarily due to relatively flat investment income growth resulting from growth of non-accruing investments in 2008 offset by increased operating expenses. An income tax benefit of $4.9 million in 2008 resulted in $23.6 million after tax net investment income, a 23.2% increase compared to $19.1 million after tax net investment income in 2007.
For the years ended December 31, 2007 and 2006, net investment income before income taxes was $19.3 million and $16.5 million, respectively. The 16.4% increase was primarily due to increased interest income on higher portfolio balances in 2007 partially offset by increased management fees and higher interest expense and fees from larger credit facility balances. An income tax provision of $0.2 million in 2007 resulted in $19.1 million after tax net investment income, a 15.7% increase compared to $16.5 million after tax net investment income in 2006.
For the years ended December 31, 2006 and 2005, net investment income was $16.5 million and $10.4 million, respectively. The 59.0% increase was primarily due to increased interest on the higher portfolio balances in 2006 partially offset by higher management fees and general and administrative expenses.
The table below summarizes the components of our unrealized appreciation or depreciation on investments for the years ended December 31, 2008, 2007 and 2006:
|For the Years Ended||Changes|
|12/31/2008||12/31/2007||12/31/2006||2008 vs. 2007||2007 vs. 2006|
|Investments in targeted portfolio||$||(56.5||)||$||5.1||$||||$||(61.6||)||$||5.1|
|Investments in corporate bonds||(2.5||)||(0.1||)||(1.3||)||(2.4||)||1.2|
|Investments in commodity derivative instruments||7.4||||||7.4|||
|Total unrealized appreciation/(depreciation)||$||(51.6||)||$||5.0||$||(1.3||)||$||(56.6||)||$||6.3|
For the year ended December 31, 2008, net unrealized depreciation was $51.6 million, compared to net unrealized appreciation of $5.0 million for the year ended December 31, 2007. The $56.6 million decrease from 2007 was attributable to an unrealized depreciation on our portfolio securities of $61.6 million more than in 2007, unrealized depreciation on our corporate notes that was $2.4 million more than in 2007, and unrealized appreciation of commodity derivative instruments of $7.4 million.
For the year ended December 31, 2007, net unrealized appreciation was $5.0 million, compared to net unrealized depreciation of $1.3 million for the year ended December 31, 2006. The $6.3 million increase was attributable to unrealized appreciation on our portfolio securities of $5.1 million and unrealized depreciation on our corporate notes that was $1.2 million less than the 2006 amount.
For the year ended December 31, 2008, we realized net capital gains before taxes of $19.3 million, consisting of a $6.0 million gain from the sale of overriding royalty interests and common stock associated with our Resaca Exploitation investment and from a $13.3 million gain from the sale of the underlying assets associated with our investment in Rubicon Energy, LLC units. Because our investment in Rubicon Energy, LLC units was held by a taxable consolidated subsidiary, we accrued a $4.5 million estimated tax provision associated with the gain on the sale of those underlying Rubicon assets, resulting in realized net capital gains after taxes of $14.8 million.
For the year ended December 31, 2007, we realized net capital gains of $6.7 million, consisting of a $5.1 million gain from the sale of warrants and LP units associated with our Piceance Basin investment, a $1.6 million gain from the sale of overriding royalty interests associated with our Chroma investment, a $0.4 million gain from the sale of overriding royalty interests associated with our Sonoran investment, and a $0.4 million loss from the sale of $6.0 million in corporate notes.
For the year ended December 31, 2006, we realized capital losses of $0.3 million on the sale of $4.0 million in corporate notes.
For the year ended December 31, 2008, we had a 143% net decrease in stockholders equity (net assets) resulting from operations of $13.3 million, or a decrease of $0.62 per share, compared to a net increase in stockholders equity (net assets) of $30.9 million, or an increase of $1.78 per share for the year ended December 31, 2007.
For the year ended December 31, 2007, we had a 105.8% net increase in stockholders equity (net assets) resulting from operations of $30.9 million, or an increase of $1.78 per share, compared to a net increase of $15.0 million, or an increase of $0.86 per share for the year ended December 31, 2006.
During the twelve months ended December 31, 2008, we generated cash from operations, including interest earned on our portfolio securities, as well as our investments in corporate notes and U.S. government securities. We received cash repayments and realizations of $74.4 million. At December 31, 2008, we had cash and cash equivalents of $133.8 million and investments in corporate notes of $6.4 million.
Our investments in portfolio securities at December 31, 2008 totaled $296.0 million and consisted of nineteen portfolio companies. During 2008, on a cash basis, we funded investments of $61.7 million in five new portfolio companies and we funded $34.6 million to existing portfolio companies, for total funding of $96.3 million in 2008. We have commitments to fund an additional $68.5 million on total committed amounts of $364.5 million. We expect to fund our investments in 2009 from income earned on our portfolio and temporary investments and from borrowings under our Credit Facility (see description under Credit Facility below). In the future, we may also fund a portion of our investments with issuances of equity or senior debt securities. We may also securitize a portion of our investments in mezzanine or senior secured loans or other assets. We expect our primary use of funds to be investments in portfolio companies, cash distributions to holders of our common stock and payment of fees and other operating expenses.
A summary of our contractual payment obligations at December 31, 2008 is as follows:
December 31, 2008:
|Long-term debt obligations revolving credit facilities (1)||$||120,000,000||$||75,000,000||$||45,000,000||$||||$|||
|(1)||Excludes accrued interest amounts.|
Currently, we do not engage in any off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.
Under the terms of the Companys Treasury Secured Revolving Credit Agreement (as amended, the Treasury Facility), the lenders party thereto and SunTrust Bank, as administrative agent for the lenders, have extended credit available under the Treasury Facility to an amount not to exceed $175 million by obtaining additional commitments from existing lenders or new lenders. The total amount committed and outstanding under the Treasury Agreement as of December 31, 2008 was $75.0 million compared to the $126.25 million balance as of December 31, 2007. Proceeds from the Treasury Facility are used to facilitate the growth of the Companys investment portfolio and provide flexibility in the sizing of its portfolio investments. The Treasury Facility has a three-year term, maturing on August 31, 2009, and bears interest, at the Companys option, at either (i) LIBOR plus 25 basis points or (ii) the base rate. On September 29, 2008, the required lenders exercised their option to convert pricing of the Treasury Facility from LIBOR-based to Prime-based. The prime rate was 5.00% as of September 29, 2008 and 3.25% as of December 31, 2008. As of December 31, 2008, the interest rate on our outstanding borrowings under the Treasury Facility was 3.25% (Prime rate) on $75.0 million.
The obligations under the Treasury Facility are collateralized by certain securities and are guaranteed by the Companys existing and future subsidiaries, other than special purpose subsidiaries and certain other subsidiaries. The Treasury Facility contains affirmative and reporting covenants and certain financial ratio and restrictive covenants, including: (a) maintaining a ratio of net asset value to consolidated total indebtedness (excluding net hedging liabilities) of the Company and its subsidiaries, of not less than 2.25:1.0, (b) maintaining a ratio of net asset value to consolidated total indebtedness (including net hedging liabilities) of the Company and its
subsidiaries, of not less than 2.0:1.0, (c) maintaining a ratio of net income (excluding revenue from cash collateral) plus interest, taxes, depreciation and amortization expenses (EBITDA) to interest expense (excluding interest on loans under the Treasury Facility) of the Company and its subsidiaries of not less than 3.0:1.0, (d) maintaining a ratio of collateral to the aggregate principal amount of loans under the Treasury Facility of not less than 1.01:1.0, (e) limitations on additional indebtedness, (f) limitations on liens, (g) limitations on mergers and other fundamental changes, (h) limitations on dividends, (i) limitations on disposition of assets other than in the normal course of business, (j) limitations on transactions with affiliates, (k) limitations on agreements that prohibit liens on properties of the Company and its subsidiary guarantors, (l) limitations on sale and leaseback transactions, (m) limitations on speculative hedging transactions, and (n) limitations on the aggregate amount of unfunded commitments.
Under the terms of the Companys Amended and Restated Revolving Credit Agreement (as amended, the Investment Facility), the lenders have agreed to extend revolving credit to the Company in an amount not to exceed $87.5 million, with the ability to increase the credit available to an amount not to exceed $175 million by obtaining additional commitments from existing lenders or new lenders. The total amount committed was $87.5 million and $45.0 million was outstanding under the Investment Facility as of December 31, 2008. By comparison, the total amount committed as of December 31, 2007 was $100 million and $89.75 million was outstanding under the Investment Facility. The Investment Facility matures on August 31, 2010, and bears interest, at the Companys option, at either (i) LIBOR plus 150 to 250 basis points, based on the degree of leverage of the Company or (ii) the base rate plus 0 to 75 basis points, based on the degree of leverage of the Company. Proceeds from the Investment Facility will be used to supplement the Companys equity capital to make portfolio investments. As of December 31, 2008, the interest rate was 3.50% on $45.0 million (Prime plus 25 basis points).
The obligations under the Investment Facility are collateralized by substantially all of the Companys assets, except certain assets that collateralize the Treasury Facility and are guaranteed by the Companys existing and future subsidiaries, other than special purpose subsidiaries and certain other subsidiaries. The Investment Facility contains affirmative and reporting covenants and certain financial ratio and restrictive covenants, including: (a) maintaining a ratio of net asset value to consolidated total indebtedness (excluding net hedging liabilities) of the Company and its subsidiaries, of not less than 2.25:1.0, (b) maintaining a ratio of net asset value to consolidated total indebtedness (including net hedging liabilities) of the Company and its subsidiaries, of not less than 2.0:1.0, (c) maintaining a ratio of EBITDA (excluding revenue from collateral under the Treasury Facility) to interest expense (excluding interest on loans under the Treasury Facility) of the Company and its subsidiaries of not less than 3.0:1.0, (d) limitations on additional indebtedness, (e) limitations on liens, (f) limitations on mergers and other fundamental changes, (g) limitations on dividends, (h) limitations on disposition of assets other than in the normal course of business, (i) limitations on transactions with affiliates, (j) limitations on agreements that prohibit liens on properties of the Company and its subsidiary guarantors, (k) limitations on sale and leaseback transactions, (l) limitations on speculative hedging transactions and (m) limitations on the aggregate amount of unfunded commitments. From time to time, certain of the lenders may provide customary commercial and investment banking services to the Company.
The Manager has agreed to waive permanently, subsequent to September 30, 2007, that portion of the management fee attributable to U.S. Treasury securities acquired with borrowings under our credit facilities to the extent the amount of such securities exceeds $100 million.
In addition to our Credit Facility, we may also fund a portion of our investments with issuances of equity or senior debt securities. We may also securitize a portion of our investments in mezzanine or senior secured loans or other assets. We expect our primary use of funds to be investments in portfolio companies, cash distributions to holders of our common stock and payment of fees and other operating expenses.
We intend to continue to pay quarterly dividends to our stockholders out of assets legally available for distribution. Our Board of Directors determines our quarterly dividends, if any.
We have elected to operate our business so as to be taxable as a RIC for federal income tax purposes. As a RIC, we generally will not be required to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders as dividends. To maintain our RIC status, we must meet specific source-of-income and asset diversification requirements and distribute annually an amount equal to at least 90%
of our investment company taxable income (which generally consists of ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses) and net tax-exempt interest. In order to avoid certain excise taxes imposed on RICs, we must distribute during each calendar year an amount at least equal to the sum of (1) 98% of our ordinary income for the calendar year, (2) 98% of our capital gain net income (i.e., realized capital gains in excess of realized capital losses) for the one-year period ending on October 31 in that calendar year, and (3) 100% of any ordinary income or capital gain net income not distributed in prior years. We currently intend to make sufficient distributions to satisfy the annual distribution requirement and to avoid the excise taxes.
Although we currently intend to distribute realized net capital gains (i.e., net long-term capital gains in excess of short-term capital losses), if any, at least annually, we may in the future decide to retain such capital gains for investment and designate such retained amount as a deemed distribution.
We have established a dividend reinvestment plan that provides for reinvestment of our dividends and distributions on behalf of our stockholders, unless a stockholder elects to receive cash as provided below. As a result, if our Board of Directors authorizes, and we declare, a cash dividend, then our stockholders who have not opted out of our dividend reinvestment plan will have their dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash dividends.
No action is required on the part of a registered stockholder to have the stockholders dividend reinvested in shares of our common stock. The plan administrator will set up an account for shares acquired through the plan for each stockholder who has not elected to receive dividends in cash, a participant, and hold such shares in non-certificated form. A registered stockholder may terminate participation in the plan at any time and elect to receive dividends in cash by notifying the plan administrator in writing so that such notice is received by the plan administrator no later than 10 days prior to the record date for dividends to stockholders. Participants may terminate participation in the plan by notifying the plan administrator via its website at www.amstock.com, by filling out the transaction request form located at the bottom of their statement and sending it to the plan administrator at American Stock Transfer & Trust Company, P. O. Box 922, Wall Street Station, New York, NY 10269-0560 or by calling the plan administrators Interactive Voice Response System at 1-888-888-0313. Within 20 days following receipt of a termination notice by the plan administrator and according to a participants instructions, the plan administrator will either: (a) maintain all shares held by such participant in a plan account designated to receive all future dividends and distributions in cash; (b) issue certificates for the whole shares credited to such participants plan account and issue a check representing the value of any fractional shares to such participant; or (c) sell the shares held in the plan account and remit the proceeds of the sale, less any brokerage commissions that may be incurred and a $15.00 transaction fee, to such participant at his or her address of record at the time of such liquidation. A stockholder who has elected to receive dividends in cash may re-enroll in the plan at any time by providing notice to the plan administrator.
Those stockholders whose shares are held by a broker or other financial intermediary may receive dividends in cash by notifying their broker or other financial intermediary of their election.
We intend to primarily use newly issued shares to implement the plan. However, we reserve the right to purchase shares in the open market in connection with our implementation of the plan. The number of newly issued shares to be issued to a stockholder is determined by dividing the total dollar amount of the dividend payable to such stockholder by the average market price per share of our common stock at the close of regular trading on the exchange or market on which our shares of common stock are listed for the five trading days preceding the valuation date for such dividend. The number of shares of our common stock to be outstanding after giving effect to payment of the dividend cannot be established until the value per share at which additional shares will be issued has been determined and elections of our stockholders have been tabulated.
We may not use newly issued shares to pay a dividend if the market price of our shares is less than our net asset value per share. In such event, the cash dividend will be paid to the plan administrator who will purchase shares in the open market for credit to the accounts of plan participants unless the average of the closing sales prices for the shares for the five days immediately preceding the payment date exceeds 110% of the most recently reported net asset value per share. The allocation of shares to the participants plan accounts will be based on the average cost of the shares so purchased, including brokerage commissions. The plan administrator will reinvest
all dividends and distributions as soon as practicable, but no later than the next ex-dividend date, except to the extent necessary to comply with applicable provisions of the federal securities laws. Interest will not be paid on any uninvested cash payment.
There will be no brokerage charges or other charges to stockholders who participate in the plan. The plan administrators fees under the plan will be paid by us.
The plan may be terminated by us upon notice in writing mailed to each participant at least 30 days prior to any record date for the payment of any dividend by us. When a plan participant withdraws from the plan or when the plan is terminated, the participant will receive a cash payment for any fractional shares of our common stock based on the market price on the date of withdrawal or termination. All correspondence concerning the plan should be directed to the plan administrator by mail at American Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY 10038.
The automatic reinvestment of dividends and distributions will not relieve a participant of any income tax liability associated with such dividend or distribution. A U.S. stockholder participating in the plan will be treated for U.S. federal income tax purposes as having received a dividend or distribution in an equal amount to the cash that the participant could have received instead of shares. The tax basis of such shares will equal the amount of such cash. A participant will not realize any taxable income upon receipt of a certificate for whole shares credited to the participants account whether upon the participants request for a specified number of shares or upon termination of enrollment in the plan. Each participant will receive each year a Form 1099 with respect to the U.S. federal income tax status of all dividends and distributions during the previous year. For tax consequences associated with the dividend reinvestment plan, see the discussion under Material U.S. Federal Income Tax Considerations.
A copy of our dividend reinvestment plan is available on our corporate website, www.ngpcrc.com , in the investor relations section.
As of December 31, 2008, holders of 1,749,954 shares, or approximately 8.1% of outstanding shares, were participants in our dividend reinvestment plan.
During 2008, we declared dividends totaling $1.61 per share on our common stock for our stockholders.
Virtually all of our portfolio investments are in negotiated, and often illiquid, securities of energy companies. We maintain a system to evaluate the credit quality of these investments. While incorporating quantitative analysis, this system is a qualitative assessment. This system is intended to reflect the overall, long term performance of a portfolio companys business, the collateral coverage of an investment, and other relevant factors. Based on this system, as of December 31, 2008, our investments in portfolio companies are generally performing satisfactorily. As a consequence of the general economic downturn and associated weakness in the energy markets, some of our investments may experience stress in the near term; however, we believe that they generally have cost structures that should tolerate it. Of the twenty-two rated investments in nineteen portfolio companies, compared to the prior quarter end, one improved in rating, six declined in rating, fourteen retained the same rating, and one new investment was not previously rated. Eleven investments approximating $136.7 million, or approximately 47% of the $294.4 million in targeted investments on a cost basis, are carried on our watch list due to slower than expected development of the assets supporting the investments, deterioration in asset coverage, or the downturn in general economic and commodity market conditions. While restructuring of some of these watch list investments may be required, subject to general economic and commodity market conditions in the long term, we do not currently foresee significant permanent long-term deterioration in the existing portfolio.
The combined decrease in targeted portfolio fair value and hedge position fair value of $49.1 million ($56.5 million decrease in targeted portfolio fair value offset by $7.4 million increase in hedge position) is the result of a combination of adjustments. Approximately 20% of the change is due to changes in the current market values of traded securities, approximately 20% is due to changes in the estimated current market yields required for comparable securities, approximately 10% is due to changes in the current market values for commodities, approximately 35% is due to changes in the estimated current market values of underlying assets and approximately 15% is due to the reversal of unrealized gain upon realization.
The $56.5 million decrease in targeted portfolio fair value consisted primarily of increases in unrealized depreciation on the following investments: Venoco, Inc. Senior Notes, $6.1 million; Formidable, LLC Senior Secured Note and warrants, $15.3 million; Nighthawk Transport I, LP (Nighthawk) LP units and warrants, $4.6 million; DeanLake Operator, LLC preferred units, $3.9 million; TierraMar Energy LP preferred LP units, $3.1 million; Resaca Exploitation Inc. common stock, $2.9 million; and Chroma Exploration & Production, Inc. preferred stock, $1.1 million. Additional unrealized depreciation of $5.5 million was recorded on the Alden Resources, LLC (Alden) notes, partially offset by an increase in unrealized appreciation on the Alden royalty interest of $4.8 million. Unrealized depreciation of $12.1 million was recorded on the ATP Oil & Gas Corporation royalty interest, partially offset by the increase in unrealized appreciation in the value of the associated commodity derivative instruments of $7.4 million. The balance of the increase in unrealized depreciation comprises the reversal of $7.3 million of unrealized gain upon the realization of substantially all of the investment in Rubicon Energy Partners, LLC. That transaction, which closed in August 2008, resulted in a realized capital gain, after estimated taxes, of $8.8 million.
In January 2009, the Company repaid the entire $45 million balance on its Investment Facility. As of the date of this release, the Company has no outstanding borrowings under the Investment Facility, therefore, the entire $87.5 million committed is available. Presently, the only outstanding indebtedness of the Company is $75 million under its Treasury Facility which is fully secured by cash or U.S. Treasuries.
In February 2009, the Company accelerated and demanded immediate repayment of its $37.3 million Senior Secured Note from Formidable, LLC. The Company also made demand on a partial guaranty from the principal owner of Formidable, LLC. At this time, the Company is pursuing a number of options with respect to Formidable, LLC, including an outright sale of the properties, a negotiated deed-in-lieu of foreclosure on the properties and foreclosure on the properties.
In March 2009, the Company restructured its $14 million Second Lien Term Loan B from Nighthawk. Terms of the restructuring include increasing the interest rate on the notes from 15% to 21%, with the additional 6% interest payable in kind at the option of Nighthawk. In addition, the warrant position granted to the lenders increased from 15% to 40% of the equity of Nighthawk, increasing the Companys warrant position from 2.5% to 6.8% of the outstanding equity of Nighthawk. The maturity of the notes, set at October 3, 2010, did not change.
Our business activities contain elements of risk. We consider the principal market risks to be: credit risk, risks related to the energy industry, illiquidity of individual investments in our investment portfolio, leverage risk, risks related to fluctuations in interest rates, commodity price risk and foreign currency exchange rate risk.
Credit risk is the principal market risk associated with our business. Credit risk originates from the fact that some of our portfolio companies may become unable or unwilling to fulfill their contractual payment obligations to us and may eventually default on those obligations. These contractual payment obligations arise under the debt securities and other investments that we hold. They include payment of interest, principal, dividends, royalties, fees and payments under guarantees and similar instruments. Our Manager endeavors to mitigate and manage credit risk through the analysis, structure, and requirements of our investments. Prior to making an investment, our Manager evaluates it under a variety of scenarios to understand its sensitivity to changes in critical variables and assumptions and to assess its potential credit risk. The structures for our investments are designed to mitigate credit risk. For example, debt investments are often secured by the underlying assets of our portfolio companies; for some investments, our Manager may require that our portfolio companies enter into commodity price hedges on a portion of their production to minimize the sensitivity of their projected cash flows to declines in commodity prices; and, in many instances, there is capital junior to ours in the capital structure of our portfolio companies. Our investments generally require routine reporting, periodic appraisal of asset values, and covenant requirements designed to minimize and detect developing credit risk.
We concentrate our investments in the securities of companies that operate in the energy industry. That industry is replete with risks that may affect individual companies or may systematically affect our entire investment portfolio. The revenues, income (or losses), cash flow available for debt service or distribution, and valuations of energy companies can be significantly impacted by any one or more of the following factors:
commodity pricing risk, operational risk, weather risk, depletion and exploration risk, production risk, demand risk, competition risk, valuation risk, financing risk, and regulatory risk. Elaboration of these risks is provided in Risk Factors. Through our credit risk management process, we endeavor to mitigate and manage these risks as they relate to individual portfolio companies and, by extension, to our entire portfolio of investments. However, we cannot be assured that our Managers efforts to mitigate and manage credit risk and the risks associated with the energy industry will successfully insulate us from any and all losses, either at the level of individual portfolio companies or, more broadly, for our entire investment portfolio.
We primarily invest in illiquid debt and other securities of private companies. In some cases these investments include additional equity components. Our investments generally have no established trading market or are generally subject to restrictions on resale. The illiquidity of our investments may adversely affect our ability to dispose of debt and equity securities at times when it may be otherwise advantageous for us to liquidate such investments (for example, for management of the various diversification requirements we are subject to as a business development company and as a RIC, or for management of credit risk). In such instances, the proceeds realized from such a liquidation would likely be significantly less than the long term value of the liquidated investments.
We anticipate that we will use a combination of long-term and short-term borrowings to supplement our equity capital to finance our investing activities. We expect to use our revolving line of credit as a means to bridge to long-term financing. These borrowings will rank senior in our capital structure to interests of our stockholders and, thus, will have a senior claim on earnings and cash flows generated by our investment portfolio. To the extent that we are able to invest the borrowed money at rates in excess of the cost of that money, we will generate greater returns on our equity capital than would have been the case without the borrowed money. However, if we have losses in our investment portfolio, we must first service or repay the borrowings. This would potentially subject our stockholders to the risk of greater loss than would have been the case without the borrowed money. Elaboration of the risks associated with the issue of senior securities is provided in Risk Factors.
Another facet of utilizing borrowed money to make investments is that our net investment income will be dependent upon the difference, or spread, between the rate at which we borrow funds and the rate at which we invest those funds. We generally mitigate the risk of asymmetric movements in the cost of borrowing versus investment return by following a practice of funding floating rate investments with equity capital or floating rate debt. As of December 31, 2008, approximately 15% of the investments in our portfolio were at fixed rates, while approximately 85% were at variable rates. In addition, we may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.
We acquired a limited term royalty interest from ATP Oil & Gas Corporation on June 4, 2008. We will receive royalty payments from this investment which will be impacted by fluctuations in the price of crude oil and natural gas. We have purchased a series of oil and gas put options at various price levels covering periods from 12 24 months to protect a portion of our royalty payments from declines in prices. Earnings on these put options will partially offset lower levels of royalty payments in the event that prices decline below the minimum prices set by the put options. At December 31, 2008, our open commodity derivative instruments were in a net asset position with a fair value of approximately $8.2 million.
Investments in derivative instruments represent future commitments or options to purchase or sell other financial instruments or commodities at specific prices at specified future dates, which expose us to market risk if the market value of the contract is higher or lower than the contract price at the maturity date. Additionally, these derivative instruments expose us to credit risk arising from the potential inability of counterparties to perform under the terms of the contracts. BP Corporation North America Inc. is currently the only counterparty to our commodity derivatives positions. We are exposed to credit losses in the event of nonperformance by the counterparty on our commodity derivatives positions. However, we do not anticipate nonperformance by the counterparty over the term of the commodity derivatives positions.
In July 2008, we converted our Senior Subordinated Secured Convertible Term Loan with Resaca Exploitation, Inc. (Resaca) into shares of common stock of Resaca. Resacas common stock is traded on the Alternative Investment Market of the London Stock Exchange. We continue to hold approximately 6.6 million shares of Resaca common stock or approximately 7.1% of Resacas issued and outstanding common shares.
Exchange rate fluctuations between the U.S. dollar and the British pound result in fluctuations in the gross value of this investment on our consolidated financial statements. Foreign currency exchange rates can fluctuate widely due to numerous factors, such as supply and demand for foreign and U.S. currencies and U.S. and foreign country economic conditions. Fluctuations of exchange rates are beyond the control of our management.
|Reports of Independent Registered Public Accounting Firms||48|
|Consolidated Balance Sheets||50|
|Consolidated Statements of Operations||51|
|Consolidated Statement of Changes in Stockholders Equity (Net Assets)||52|
|Consolidated Statements of Cash Flows||53|
|Consolidated Schedules of Investments||54|
|Notes to Consolidated Financial Statements||61|
|Consolidated Financial Highlights||80|
|Selected Quarterly Financial Data (unaudited)||81|
To the Board of Directors and Stockholders
of NGP Capital Resources Company:
In our opinion, the accompanying consolidated balance sheets, including the consolidated schedules of investments, and the related consolidated statements of operations, of changes in stockholders' equity (net assets) and of cash flows and the consolidated financial highlights present fairly, in all material respects, the financial position of NGP Capital Resources Company and its subsidiaries at December 31, 2008 and December 31, 2007, and the results of their operations, and their cash flows for each of the three years in the period ended December 31, 2008 and the financial highlights for each of the four years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because a material weakness in internal control over financial reporting related to the determination and reporting of the provision for income taxes existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements or financial highlights will not be prevented or detected on a timely basis. The material weakness referred to above is described in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the 2008 consolidated financial statements and financial highlights (hereafter referred to as financial statements), and our opinion regarding the effectiveness of the Companys internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in management's report referred to above. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
March 13, 2009
The Board of Directors and Shareholders
NGP Capital Resources Company:
We have audited the accompanying financial highlights of NGP Capital Resources Company for the period August 6, 2004 (commencement of operations) through December 31, 2004. These financial highlights are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial highlights based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial highlights. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial highlight presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial highlights referred to above present fairly, in all material respects, the financial highlights of NGP Capital Resources Company for the period August 6, 2004 (commencement of operations) through December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Fort Worth, Texas
April 7, 2005
Investments in portfolio securities at fair value
(cost: $294,432,215 and $277,947,454, respectively)
Investments in corporate notes at fair value
(cost: $11,586,899 and $11,631,599, respectively)
Investments in commodity derivative instruments at fair value
(cost: $774,095 and $0, respectively)
|Investments in U.S. Treasury Bills, at amortized cost which approximates fair value||||163,925,625|
|Cash and cash equivalents||133,805,575||18,437,115|
|Deferred tax assets||200,000|||
|Total current assets||138,356,217||21,123,178|
|Deferred tax assets||3,600,000|||
LIABILITIES AND STOCKHOLDERS EQUITY (NET ASSETS)
|Accounts payable and accrued expenses||$||512,926||$||780,832|
|Management and incentive fees payable||2,016,214||2,032,107|
|Income taxes payable||3,529,308||147,929|
|Current portion of long-term debt||75,000,000|||
|Total current liabilities||89,926,011||11,973,539|
|Long-term debt, less current portion||45,000,000||216,000,000|
Commitments and contingencies (Note 8)
Stockholders equity (net assets)
|Common stock, $.001 par value, 250,000,000 shares authorized; 21,628,202 and 17,500,332 shares issued and outstanding, respectively||21,628||17,500|
|Paid-in capital in excess of par||315,184,191||245,881,078|
|Undistributed net investment income (loss)||(3,420,716||)||(103,394||)|
|Undistributed net realized capital gain (loss)||2,038,312||859,133|
|Net unrealized appreciation (depreciation) of portfolio securities, corporate notes and commodity derivative instruments||(48,000,769||)||3,605,020|
|Total stockholders equity (net assets)||265,822,646||250,259,337|
|Total liabilities and stockholders equity (net assets)||$||400,748,657||$||478,232,876|
|Net asset value per share||$||12.29||$||14.30|
(See accompanying notes to consolidated financial statements)
|Commodity derivative income, net of expired options||2,315,484|||||
|Total investment income||37,460,916||37,499,360||27,517,093|
|Interest expense and fees||6,636,236||7,397,543||2,554,546|
|State and excise taxes||148,003||71,932||142,517|
|Other general and administrative expenses||2,846,102||2,549,948||2,251,668|
|Total operating expenses||18,814,380||18,238,203||10,970,889|
|Net investment income (loss) before income taxes||18,646,536||19,261,157||16,546,204|
|Benefit (provision) for income taxes||4,931,941||(122,808||)|||
|Net investment income (loss)||23,578,477||19,138,349||16,546,204|
Net realized capital gain (loss) on investments
|Net realized capital gain (loss) on portfolio securities, corporate notes and commodity derivative instruments||19,251,090||6,721,176||(245,859||)|
|Benefit (provision) for taxes on capital gain||(4,500,000||)|||||
|Total net realized capital gain (loss) on investments||14,751,090||6,721,176||(245,859||)|
|Net increase (decrease) in unrealized appreciation (depreciation) on portfolio securities, corporate notes and commodity derivative instruments||(51,605,789||)||5,008,291||(1,299,127||)|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||$||(13,276,222||)||$||30,867,816||$||15,001,218|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations per common share||$||(0.62||)||$||1.78||$||0.86|
(See accompanying notes to consolidated financial statements)
|Balance at December 31, 2005||17,400,100||$||17,400||$||244,309,260||$||(324,031||)||$||||$||(104,144||)||$||243,898,485|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||||||(15,710||)||16,561,914||(245,859||)||(1,299,127||)||15,001,218|
|Issuance of common stock under dividend reinvestment plan||22,168||22||366,623||||||||366,645|
|Balance at December 31, 2006||17,422,268||$||17,422||$||244,660,173||$||229,791||$||(245,859||)||$||(1,403,271||)||$||243,258,256|
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||||||(64,170||)||19,202,519||6,721,176||5,008,291||30,867,816|
|Issuance of common stock under dividend reinvestment plan||78,064||78||1,285,075||||||||1,285,153|
|Balance at December 31, 2007||17,500,332||$||17,500||$||245,881,078||$||(103,394||)||$||859,133||$||3,605,020||$||250,259,337|
|Net increase in stockholders equity (net assets) resulting from operations||||||7,297,453||23,714,040||7,318,074||(51,605,789||)||(13,276,222||)|
|Issuance of common stock from public offering (net of underwriting costs)||4,086,388||4,086||62,109,012||||||||62,113,098|
|Issuance of common stock under dividend reinvestment plan||41,482||42||677,276||||||||677,318|
|Balance at December 31, 2008||21,628,202||$||21,628||$||315,184,191||$||(3,420,716||)||$||2,038,312||$||(48,000,769||)||$||265,822,646|
(See accompanying notes to consolidated financial statements)
Cash flows from operating activities
|Net increase (decrease) in stockholders equity (net assets) resulting from operations||$||(13,276,222||)||$||30,867,816||$||15,001,218|
Adjustments to reconcile net increase (decrease) in stockholders equity (net assets) resulting from operations to net cash used in operating activities
|Net amortization of premiums, discounts and fees||7,105,321||(2,961,360||)||(1,435,683||)|
|Change in unrealized (appreciation) depreciation on portfolio securities, corporate notes and commodity derivative instruments||51,605,789||(5,008,291||)||1,299,127|
Effects of changes in operating assets and liabilities
|Deferred tax assets current||(200,000||)|||||
|Deferred tax assets non-current||(3,600,000||)|||||
|Accounts payable and accrued expenses||(283,799||)||473,535||1,532,649|
|Income taxes payable||3,381,379||147,929|||
|Purchase of investments in portfolio securities, corporate notes and commodity derivative instruments||(96,348,703||)||(225,828,429||)||(138,180,371||)|
|Redemption of investments in portfolio securities, corporate notes and commodity derivative instruments||74,364,600||126,356,095||61,486,485|
|Sale of investments in corporate notes||||6,007,370||4,005,371|
|Net sale of investments in U.S. Treasury Bills||163,925,625||(21,256,046||)||(21,151,383||)|
|Net cash provided by (used in) operating activities||182,674,037||(95,043,150||)||(80,589,784||)|
Cash flows from financing activities
|Proceeds from the issuance of common stock, net of underwriting costs||62,113,098|||||
|Borrowings under revolving credit facility||196,000,000||123,285,000||100,000,000|
|Repayments on revolving credit facility||(292,000,000||)||(7,285,000||)|||
|Offering costs from the issuance of common stock||(780,628||)|||||
|Net cash provided by (used in) financing activities||(67,305,577||)||101,145,936||79,573,525|
|Net increase (decrease) in cash and cash equivalents||115,368,460||6,102,786||(1,016,259||)|
|Cash and cash equivalents, beginning of period||18,437,115||12,334,329||13,350,588|
|Cash and cash equivalents, end of period||$||133,805,575||$||18,437,115||$||12,334,329|
|Cash paid for interest||$||5,890,111||$||6,766,621||$||1,906,916|
|Cash paid for taxes||$||185,624||$||46,811||$||142,517|
Non-cash financing activities
|Issuance of common stock in conjunction with dividend reinvestment plan||$||677,318||$||1,285,153||$||366,645|
(See accompanying notes to consolidated financial statements)
|Portfolio Company||Energy Industry Segment||Investment (2) (4)||Principal||Cost||Fair Value (3)|
|Venoco, Inc. (1) (23)||
Oil & Natural Gas
Production and Development
(8.75%, due 12/15/2011)
|Chroma Exploration & Production, Inc. (1) (23)||
Oil & Natural Gas
Production and Development
9,711 Shares Series A Participating
Convertible Preferred Stock (9)
8,868 Shares Series AA Participating
Convertible Preferred Stock (9)
|8.11 Shares Common Stock (5)|||||||
|Warrants (5) (11)|||||||
|Resaca Exploitation Inc. (1) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(The greater of 10.0% or LIBOR +
6.00%, due 5/01/2012)
|Common Stock (6,574,216 shares) (5) (6) (20)||3,235,256||3,235,256||1,093,688|
|Crossroads Energy, LP (1) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(The greater of 10.0% or LIBOR + 5.50%, due 6/29/2009)
|Overriding Royalty Interest (6)||10,000||5,120||250,000|
|Rubicon Energy Partners, LLC (8) (23)||
Oil & Natural Gas
Production and Development
|LLC Units (4,000 units) (5)||||||750,000|
|BSR Loco Bayou, LLC (1) (10) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(LIBOR + 5.50% cash, LIBOR + 8.50%
default, due 8/15/2009) (9)
|Overriding Royalty Interest||20,000||19,372||20,000|
|Warrants (5) (12)||10,000||10,000|||
|Sonoran Energy, Inc. (1) (23)||
Oil & Natural Gas
Production and Development
|Warrants (5) (13)||10,000||10,000|||
|Nighthawk Transport I, LP (1) (23)||Energy Services||
Term Loan B
(The greater of 15.0% or
LIBOR + 10.50%, due 10/03/2010)
|LP Units (5)||224||224|||
|Warrants (5) (14)||850,000||850,000|||
Delayed Draw Term Loan B
(The greater of 15.0% or LIBOR +
10.50%, due 10/03/2010)
|Alden Resources, LLC (1) (21) (23)||Coal Production||
Multiple-Advance Term Loan
(LIBOR + 8.00% cash, due 1/05/2013
|Warrants (5) (15)||100,000||100,000|||
(See accompanying notes to consolidated financial statements)
|Portfolio Company||Energy Industry Segment||Investment (2) (4)||Principal||Cost||Fair Value (3)|
Targeted Investments Continued
|Tammany Oil & Gas, LLC (1) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(The greater of 11.0% or LIBOR + 6.00%, due 3/21/2010)
|Overriding Royalty Interest (5) (6)||200,000||200,000||550,000|
|TierraMar Energy LP (8) (23)||
Oil & Natural Gas
Production and Development
|Overriding Royalty Interest||20,000||16,828||300,000|
|Class A Preferred LP Units (5)||16,634,830||16,634,830||13,500,000|
Anadarko Petroleum Corporation
2007-III Drilling Fund (1) (23)
Oil & Natural Gas
Production and Development
Multiple-Advance Net Profits Interest
|Formidable, LLC (1) (19) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(LIBOR + 5.50% cash, LIBOR + 8.50%
default, due 5/31/2008) (9)
|Warrants (5) (16)||500,000||500,000|||
|DeanLake Operator, LLC (8) (23)||
Oil & Natural Gas
Production and Development
|Class A Preferred Units (5)||13,900,255||13,900,255||10,000,000|
|Overriding Royalty Interest||20,000||18,897||20,000|
|Bionol Clearfield, LLC (1) (23)||
Alternative Fuels and
Senior Secured Tranche C
(LIBOR + 7.00%, due 9/06/2016)
|BioEnergy Holding, LLC (1) (23)||
Alternative Fuels and
Senior Secured Notes
(15.00%, due 3/06/2015)
|BioEnergy International Warrants (5) (17)||595,845||595,845||595,845|
|BioEnergy Holding Units (5)||376,687||376,687||376,687|
|Greenleaf Investments, LLC (1) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(The greater of 10.50% or LIBOR +
6.50%, due 4/30/2011)
|Overriding Royalty Interest (6)||100,000||86,263||300,000|
|ATP Oil & Gas Corporation (1) (23)||
Oil & Natural Gas
Production and Development
|Limited Term Royalty Interest||32,814,792||24,319,585||12,219,000|
|Black Pool Energy Partners, LLC (1) (23)||
Oil & Natural Gas
Production and Development
Multiple-Advance Term Loan
(The greater of 12.00% or LIBOR + 8.00% cash, 14.00% or LIBOR + 10.00% PIK,
|Overriding Royalty Interest (5) (6)||10,000||10,000||10,000|
|Warrants (5) (22)||10,000||10,000||10,000|
|Subtotal Targeted Investments (62.2% of total investments)||$294,432,215||$244,229,568|
(See accompanying notes to consolidated financial statements)
|Issuing Company||Energy Industry Segment||Investment (2) (4)||Principal||Cost||Fair Value (3)|
|Pioneer Natural Resources Co. (23)||
Oil & Natural Gas
Production and Development
|Senior Notes, 7.2%, due 2028||$||10,000,000||$||11,586,899||$||6,350,000|
|Subtotal Corporate Notes ( 1.62% of total investments)||$ 11,586,899||$6,350,000|
Commodity Derivative Instruments
|Put Options (18) (23)||
Put Options with BP Corporation North America, Inc. to sell up to
615,000 MMBtu of natural gas at a strike price of $10.00 per MMBtu.
12 monthly contracts beginning on July 1, 2008 and expiring on June 30, 2009.
Put Options with BP Corporation North America, Inc. to sell up to
237,750 Bbls of crude oil at a strike price of $101.00 per Bbl. 15 monthly
contracts beginning on July 1, 2008 and expiring on September 30, 2009.
Put Options with BP Corporation North America, Inc. to sell up to
32,750 Bbls of crude oil at a strike price of $85.00 per Bbl. 4 monthly
contracts beginning on October 1, 2009 and expiring on January 31, 2010.
|Subtotal Commodity Derivatives (2.1% of total investments)||$ 774,095||$8,212,872|
|Subtotal Cash (34.08% of total investments)||$133,805,575||$133,805,575|
|Total investments, cash and cash equivalents||$440,598,784||$||392,598,015|
|Liabilities in excess of other assets|