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NGPC > SEC Filings for NGPC > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for NGP CAPITAL RESOURCES CO


9-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following analysis of our financial condition and results of operations in conjunction with management's discussion and analysis contained in our 2012 Annual Report on Form 10-K, as well as our consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q.

Forward-Looking Statements

Certain statements in this Quarterly Report on Form 10-Q 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;

the future operating results of our portfolio companies and their ability to achieve their objectives;

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;

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, or the SEC.

We may use words such as "anticipates," "believes," "intends," "plans," "expects," "projects," "estimates," "will," "should," "may" and similar expressions to identify forward-looking statements. These forward-looking statements are subject to various risks and uncertainties. Certain factors could cause actual results and conditions to differ materially from those projected and our historical experience. You should not place undue reliance on such forward-looking statements, which speak only as of the date they are made. We undertake no obligation to update any forward-looking statements made herein, unless required by law.

Overview

We are a financial services company created to invest primarily in debt securities of small and mid-size private energy companies. In early 2012, we expanded our investment strategy to also include middle market companies not engaged in the energy industry. We have elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, or 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 include securities of private U.S. companies, U.S. companies whose securities are listed on a national securities exchange but whose market capitalization is less than $250 million, 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 regulated investment company, or RIC, under the Internal Revenue Code of 1986, as amended. Pursuant to these elections, we generally do not have to pay corporate-level taxes on any income and capital gains we distribute to our stockholders. We have several direct and indirect subsidiaries that are single member limited liability companies and wholly-owned limited partnerships established to hold certain portfolio investments or provide services to us in accordance with specific rules prescribed for a company operating as a RIC. We consolidate the financial results of our subsidiaries for financial reporting purposes, and do not consolidate the financial results of our 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 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 and energy services. We also target middle market investments within diversified industry sectors, including manufacturing, value-added distribution, business services, healthcare products and services, consumer services and select other sectors. 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 Manager's view of a particular investment opportunity. Our portfolio 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 or royalty interests on a stand-alone basis.

We generate revenue in the form of interest income on the debt securities and limited-term royalty interests that we own, dividend income on common or preferred stock that we own, royalty income on royalty interests that we own and capital gains or losses on 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 paid-in-kind, or PIK, 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. We recognize any such fees generated in connection with our investments as earned.

Our level of investment activity can and does vary substantially from period to period depending on many factors. Some of these factors are 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 environment and the competitive environment for the types of investments we make, and our own ability to raise capital to fund our investments, both through issuance of debt and equity securities. While we currently have capital available to invest, we do not have unlimited capital. We remain committed to our underwriting and investment disciplines in selectively investing in appropriate risk-reward opportunities within the energy and middle market sectors.

Portfolio and Investment Activity

On April 22, 2013, we provided $17.5 million of financing to Nekoosa Coated Products, or NEK, a private manufacturer of carbonless sheets and specialty products used in the commercial printing industry, in the form of a Second Lien Term Loan, to facilitate the acquisition of IGI Corp., a leading manufacturer of specialty pressure sensitive graphic arts materials used in the signage and visual communications industry. The Second Lien Term Loan earns interest payable in cash at an annual rate of 13% plus paid-in-kind interest of 2% per annum and matures on October 19, 2018.

In 2011 and 2012, we purchased from ATP Oil & Gas Corporation, or ATP, limited-term ORRIs in certain offshore oil and gas producing properties operated by ATP in the Gulf of Mexico, including $25.0 million advanced on July 3, 2012. Under this arrangement, we own the right to portions (ranging from 5.0% to 10.8%) of the monthly production proceeds from the various oil and gas properties subject to the ORRI in ATP's Gomez and Telemark properties. The terms of the ORRI provide that it will terminate after we receive payments that equal our investment in the ORRI plus a time-value factor that is calculated at a rate of 13.2 % per annum. On August 17, 2012, ATP filed for protection under Chapter 11 of the U.S. Bankruptcy Code, and received authorization to incur debtor-in-possession financing of approximately $600 million. ATP failed or refused to deliver our proportionate share of production proceeds for the production months of May and June 2012, which proceeds were due to be distributed on July 31, 2012 and August 31, 2012, respectively. On August 23, 2012, the bankruptcy judge presiding over ATP's case signed an order allowing ATP to pay amounts received after August 17, 2012 to those parties entitled to receive them, including the ORRI holders, provided that the owners of the ORRIs execute the Disgorgement Agreement providing for the repayment to ATP of any amounts that the bankruptcy court later finds to have been inappropriately paid. We executed the Disgorgement Agreement and began receiving monthly distributions in September 2012 from ATP of our share of production proceeds received by ATP after August 17, 2012. On October 17, 2012, we filed a lawsuit against ATP in the U.S. Bankruptcy Court, seeking a declaration that the ORRIs are valid, fully enforceable, and not voidable. ATP has responded by seeking a determination that the ORRIs are not enforceable as a conveyance, but rather are in the nature of a debt instrument. In that connection, ATP seeks disgorgement of amounts paid to us in accordance with the Disgorgement Agreement. This lawsuit is currently pending and trial is scheduled for July 25, 2013. We intend to vigorously defend our position that the ORRIs constitute real property interests and are fully valid and enforceable pursuant to their terms. Our unrecovered investment as of March 31, 2013 was $32.1 million, and we had received aggregate production payments of $15.1 million subject to the Disgorgement Agreement. In addition, as of March 31, 2013, we had incurred legal and consulting fees totaling $1.7 million in connection with the enforcement of our rights under the ORRIs, which will ultimately be added to the unrecovered investment balance under the terms of the ORRI agreements. These legal and consulting fees, totaling $1.7 million and $0.6 million as of March 31, 2013 and December 31, 2012, respectively, are included in accounts receivable and other current assets on our consolidated balance sheets.

On April 23, 2013, the Department of the Interior, on behalf of the Bureau of Safety and Environmental Enforcement, issued an order directing that the wells on the Gomez properties be shut in and that operations cease. Operations and production ceased on the Gomez properties on April 30, 2013. As a result of the shut-in of the Gomez wells, our cash flows attributable to the ORRIs will be negatively affected, but we should continue to receive our share of monthly production payments attributable to the Telemark properties, subject to the Disgorgement Agreement referred to above. Of the $6.2 million of ORRI distribution we received in the first quarter of 2013, $2.8 million was attributable to Gomez production and $3.4 million was attributable to Telemark production.

On April 1, 2013, GMX Resources, or GMX, and certain of its affiliates filed petitions for relief under Chapter 11 of the U.S. Bankruptcy Code. In connection with its bankruptcy filing, GMX announced that it is pursuing an asset purchase agreement with certain senior first-lien creditors to acquire substantially all of GMX's operating assets and undeveloped acreage. Once the contemplated asset purchase agreement with such senior creditors is finalized, the sale would then be subject to a public auction, pursuant to procedures to be approved by the Bankruptcy Court. We hold $12.7 million face amount of GMX's Senior Secured Second-Priority Notes due 2018, or the GMX 2018 Notes, which are subordinate to the debt held by the senior creditors mentioned above. As a result of these proceedings, we reduced the estimated fair value of our investment in the GMX 2018 Notes to zero as of March 31, 2013, resulting in an unrealized loss of $7.4 million, or $0.35 per share.

On February 15, 2013, we closed a $17.5 million investment in OCI Holdings, LLC, or OCI. Our investment in OCI includes a $15.0 million Subordinated Note and a $2.5 million direct equity co-investment. OCI is a home health provider of physical, occupational and speech therapy services to pediatric patients in the state of Texas. Proceeds from the investment were used to refinance OCI and to finance OCI's strategic acquisition of a provider of similar services. The OCI Subordinated Note matures August 15, 2018 and earns interest payable in cash at a rate of 11% per annum (LIBOR + 10%) plus paid-in-kind interest of 2% per annum.

On February 15, 2013, we provided $9.0 million of financing to KOVA International, Inc., or KOVA, in the form of Senior Subordinated Notes, to facilitate the acquisition of the urinalysis division of Hycor Biomedical, Inc. by a group of private equity sponsors. Since 1974, the KOVA product lines have been among the leading disposable plastics and liquid controls products used in the urinalysis testing market. The KOVA Senior Subordinated Notes earn interest payable in cash at an annual rate of 12.75% and mature on August 15, 2018.

On February 6, 2013, we purchased $20.0 million of the $300 million 9.75% Senior Notes offering issued by Talos Production LLC and Talos Production Finance Inc., collectively, Talos, to partially fund Talos's acquisition of Energy Resource Technology GOM, Inc., the oil and gas subsidiary of Helix Energy Solutions Group, Inc. On February 15, 2013, we purchased an additional $5.0 million face value of the Talos Senior Notes in the secondary market. Talos is headquartered in Houston, Texas, and its parent company is a portfolio company of funds affiliated with Apollo Global Management, LLC and Riverstone Holdings LLC, which committed up to $600 million in equity to Talos's parent company in February 2012. The Talos Senior Notes mature February 15, 2018, and were issued at 99.025 for an effective yield of 10.0% per annum.

On January 25, 2013, we restructured our $13.5 million Senior Secured Term Loan, or the Original Term Loan, with Spirit Resources, LLC, or Spirit. Under the terms of the restructuring, (i) $8.0 million of the Original Term Loan was converted into Preferred Units, with the remaining $5.5 million structured as a Senior Secured Tranche A Term Loan; (ii) we provided $4.5 million of additional borrowing capacity in the form of a Senior Secured Tranche B Term Loan; (iii) we received a 3% overriding royalty interest in Spirit's oil and gas properties; and (iv) we conveyed our 33% penny warrants back to Spirit. The Tranche A Term Loan matures April 28, 2015 and earns interest payable monthly in cash at an annual rate of the greater of 8% or LIBOR + 4%. The Tranche B Term Loan matures October 28, 2015 and initially earns interest payable-in-kind at an annual rate of the greater of 15% or LIBOR + 11%. Beginning in January 2015, interest on the Tranche B Term Loan is payable monthly in cash at an annual rate of the greater of 13% or LIBOR + 9%. Borrowings under the Tranche B Term Loan will be used to execute relatively low-risk, high return development plans at Spirit's oil and gas properties and to provide additional working capital. The Preferred Units represent a preferred interest on 100% of any equity distributions from Spirit until certain hurdles are met, after which Spirit management would participate in 25% of any such distributions.

On January 25, 2013, Southern Pacific Resource Corp., or STP, repaid its debt obligations under its $272.2 million Second Lien Term Loan, including the $9.8 million face amount that we held, with a 1% call premium. Our investment in the STP Second Lien Term Loan, which was initially funded in the first quarter of 2012, generated an internal rate of return of 10.7% with a return on investment of 1.09x.

Also in January 2013, we sold our remaining $10.0 million face amount of EP Energy, LLC Senior Unsecured Notes at a price of 113.375 resulting in a realized capital gain of $1.3 million, or $0.06 per common share. Our total investment in EP Energy, LLC Senior Unsecured Notes, which began as a $25 million participation in their original issuance in April 2012, generated an internal rate of return of 36.5% with a return on investment of 1.16x.

From commencement of investment operations in November 2004 through March 31, 2013, we have invested $1.1 billion in 45 portfolio companies and received principal repayments, realizations and settlements of $813.9 million. The following table summarizes our investment activity for the three months ended March 31, 2013 and 2012 (dollars in millions):

                                                             2013        2012
       Investment portfolio, beginning of period            $ 219.9     $ 175.0
       New investments                                         51.5         7.1
       Additional investments in existing clients               3.5         1.3
       Principal repayments, realizations and settlements     (24.8 )     (23.3 )
       Investment portfolio, end of period                  $ 250.1     $ 160.1

       Number of portfolio clients at end of period              15          17

The table below shows our portfolio investments by type as of March 31, 2013 and December 31, 2012. We compute yields on investments using interest rates as of the balance sheet date and include amortization of original issue discount, or OID, and market premium or discount, royalty interest income, net profits income and other similar investment income, weighted by their respective costs when averaged. We compute the yield on income from derivatives using estimated derivative income, net of expired options costs. These yields do not include income from any investments on non-accrual status but do include the cost basis of such investments in the denominator. Such weighted average yields are not necessarily indicative of expected total returns on a portfolio.

                                            March 31, 2013                                     December 31, 2012
                             Weighted                                            Weighted
                              Average           Percentage of Portfolio           Average           Percentage of Portfolio
                              Yields            Cost            Fair Value        Yields            Cost            Fair Value
Senior secured debt                11.7 %           24.0 %             25.7 %          12.0 %           29.2 %             30.1 %
Subordinated debt                  10.6 %           34.9 %             33.6 %           9.3 %           26.0 %             26.4 %
Limited term royalties             13.7 %           12.9 %             13.9 %          13.6 %           16.8 %             17.3 %
Contingent earn-out                 0.0 %            0.0 %              0.0 %           0.0 %            0.0 %              0.1 %
Commodity derivative
instruments                         0.0 %            0.1 %              0.0 %           0.0 %            0.1 %              0.0 %
Royalty interests                   0.0 %            0.0 %              0.2 %           0.0 %            0.0 %              0.0 %
Redeemable preferred
units                               8.0 %           20.4 %             22.2 %           8.0 %           23.0 %             24.0 %
Equity securities
Membership and
partnership units                   0.0 %            4.5 %              4.4 %           0.0 %            0.2 %              0.8 %
Participating preferred
stock                               0.0 %            1.8 %              0.0 %           0.0 %            2.0 %              0.0 %
Common stock                        0.0 %            1.3 %              0.0 %           0.0 %            2.6 %              0.8 %
Warrants                            0.0 %            0.1 %              0.0 %           0.0 %            0.1 %              0.5 %
Total equity securities             0.0 %            7.7 %              4.4 %           0.0 %            4.9 %              2.1 %
Total portfolio
investments                         9.9 %          100.0 %            100.0 %          10.0 %          100.0 %            100.0 %

As of March 31, 2013 and December 31, 2012, the total fair value of our portfolio investments was $231.2 million and $213.6 million, respectively. Of those fair value totals, approximately $190.8 million, or 83%, as of March 31, 2013, and $185.7 million, or 87%, as of December 31, 2012, are measured using significant unobservable (i.e., Level 3) inputs.

The table below summarizes our non-accruing and non-income producing investments:

                                                 March 31, 2013                December 31, 2012
(Dollars in thousands)                       Cost         Fair Value         Cost         Fair Value
Non-accruing investments
Chroma Exploration & Production, Inc.      $   4,312     $         27     $    4,312     $         43
GMX Resources, Inc. subordinated notes
(non-accrual 1/1/13)                           9,452                -            N/A              N/A
Total non-accruing investments                13,764               27          4,312               43
Non-income producing investments
BP Corporation NA, Inc. put options              151                -            245                9
Castex Energy Development Fund, LP units           0              740              0              910
Globe BG, LLC (contingent Alden
Resources royalty earn-out)                        -               60              -              240
GMX Resources, Inc. common stock (sold
3/01/13)                                           -                -          2,317            1,488
Myriant Corporation common stock and
warrants                                         468              830            468              880
NGP/OCI Investments, LLC Class A Units         2,500            2,610              -                -
Pallas Contour Mining, LLC units                   -              900              -              500
Resaca Exploitation, Inc. common stock
and warrants                                   3,485               91          3,485              220
Spirit Resources, LLC preferred units
(acquired on 1/25/13)                          8,000            5,166              -                -
Spirit Resources, LLC warrants
(relinquished 1/25/13)                             -                -             25              520
Total non-income producing investments        14,604           10,397          6,540            4,767
Total non-accruing and non-income
producing investments                      $  28,368     $     10,424     $   10,852     $      4,810

Results of Operations

Investment Income

During the three months ended March 31, 2013, our total investment income was $5.8 million, increasing $0.2 million, or 3%, compared to the corresponding period of 2012. The small increase in 2013 was primarily attributable to higher overall portfolio balances offset by lower weighted average yields. Our portfolio balance, on a cost basis, increased from $158.1 million at March 31, 2012 to $245.0 million at March 31, 2013, primarily as a result of new investments in excess of net redemptions and settlements. Our weighted average yields decreased from 12.1% at March 31, 2012 to 9.9% at March 31, 2013, primarily as a result of new investments in the portfolio with improved credit quality and lower risk, and as a result of the GMX 2018 Notes being placed on non-accrual status in 2013.

Operating Expenses



The table below summarizes the components of our operating expenses (in
thousands):



                                                                  For The Three Months Ended
                                                                           March 31,
                                                                   2013                2012
Interest expense and bank fees                                 $         815       $         334
Management and incentive fees                                          1,367               1,084
Professional fees, insurance expenses and other G&A                    1,286               1,223
Total operating expenses                                       $       3,468       $       2,641

For the three months ended March 31, 2013, operating expenses were $3.5 million, increasing $0.8 million, or 31%, compared to the quarter ended March 31, 2012. Interest expense and fees on our credit facilities were $0.8 million for the three months ended March 31, 2013 compared to $0.3 million for the three months ended March 31, 2012, as a result of increased average borrowing levels supporting our larger investment portfolio. Management and incentive fees were higher in the quarter ended March 31, 2013 at $1.4 million compared to $1.1 million for the quarter ended March 31, 2012, primarily as a result of higher average total asset balances, which are the basis for the base management fee computation. Professional fees, insurance expense and other general and administrative expenses for the quarter ended March 31, 2013 increased $0.1 million, or 5%, to $1.3 million, compared to $1.2 million for the quarter ended March 31, 2012, primarily as a result of higher professional fees.

Operating expenses include our allocable portion of the total organizational and operating expenses incurred by us, our Manager and our Administrator, as determined by our Board of Directors and representatives of our Manager and our Administrator. According to the terms of the Investment Advisory Agreement, we calculate the base management fee quarterly as 0.45% of the average of our total assets as of the end of the two previous quarters. Other general and administrative expenses include our allocated share of employee, facilities, stockholder services and marketing costs incurred by our Administrator.

Net Investment Income

For the three months ended March 31, 2013, net investment income was $2.3 million, or $0.11 per common share, compared to $3.0 million, or $0.14 per common share, for the three months ended March 31, 2012. The $0.6 million, or 22%, decrease was attributable to the $0.8 million increase in operating expenses, partially offset by the $0.2 million increase in investment income, both of which are described above.

Net Realized Gains (Losses)

For the three months ended March 31, 2013, we recognized net realized capital losses of $0.2 million resulting from a $1.6 million loss from the sale of our 228,853 shares of GMX common stock at an average price of $3.28, partially offset by a $1.3 million gain from the sale of $10.0 million face amount of EP Energy Senior Unsecured Notes at an average price of 113.375.

Unrealized Appreciation or Depreciation on Investments

For the three months ended March 31, 2013, net unrealized depreciation on portfolio investments was $9.7 million, or $0.46 per share, primarily due to decreases in the estimated fair value of our investments in GMX 2018 Notes of $7.4 million and Spirit preferred units of $2.8 million and the reversal of unrealized appreciation, due to realization of the gain, on our EP Energy Senior Unsecured Notes of $1.3 million, partially offset by net increases in the fair value of our remaining investments of $1.8 million. By comparison, for the three months ended March 31, 2012, net unrealized appreciation was $1.3 million, largely due to increases the estimated fair value of our investments in GMX Senior Convertible Notes of $1.0 million, Spirit warrants of $0.6 million and Castex Energy Development Fund, LLC, or Castex, units of $0.6 million, partially offset by the decrease in the value of our investment in Resaca Exploitation Inc.'s common stock and warrants of $0.6 million and a $0.4 million decrease in the fair value of our commodity derivative instruments.

Net Increase (Decrease) in Net Assets Resulting from Operations

For the three months ended March 31, 2013, we recorded a net decrease in net . . .

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