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CorEnergy Infrastructure Trust, Inc. 10-Q 2009 UNITED STATES Washington, D.C.
20549 FORM 10-Q x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 31, 2009 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to __________ COMMISSION FILE NUMBER: 001-33292 TORTOISE CAPITAL RESOURCES
CORPORATION
11550 Ash Street, Suite
300 (913) 981-1020 Not Applicable 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 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 þ No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ The number of shares of the issuer’s Common Stock, $0.001 par value, outstanding as of September 30, 2009 was 9,055,748. TORTOISE CAPITAL RESOURCES CORPORATION FORM 10-Q FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2009
STATEMENTS OF ASSETS & LIABILITIES
See accompanying Notes to Financial Statements. 1
SCHEDULE
OF INVESTMENTS
August 31, 2009 (Unaudited)
See accompanying Notes to Financial Statements. 2
SCHEDULE
OF INVESTMENTS
November 30, 2008
See accompanying Notes to Financial Statements. 3
STATEMENTS OF OPERATIONS (Unaudited)
4
STATEMENTS OF OPERATIONS (Unaudited)
(Continued)
See accompanying Notes to Financial Statements. 5
STATEMENTS OF CHANGES IN NET ASSETS
See accompanying Notes to Financial Statements. 6
7
(Continued)
8
9
(Continued)
See accompanying Notes to Financial Statements. 10
1. Organization 2. Significant Accounting
Policies B. Investment Valuation — The Company invests primarily in illiquid securities including debt and equity securities of privately-held companies. These investments generally are subject to restrictions on resale, have no established trading market and are fair valued on a quarterly basis. Because of the inherent uncertainty of valuation, the fair values of such investments, which are determined in accordance with procedures approved by the Company’s Board of Directors, may differ materially from the values that would have been used had a ready market existed for the investments. The Company’s Board of Directors may consider other methods of valuing investments as appropriate and in conformity with U.S. generally accepted accounting principles. The Company determines fair value in accordance with Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is applicable in conjunction with other accounting pronouncements that require or permit fair value measurements, but does not expand the use of fair value to any new circumstances. More specifically, SFAS 157 emphasizes that fair value is a market based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority given to quoted prices in active markets and the lowest priority to unobservable inputs. On April 9, 2009, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”). FSP 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP 157-4 did not have a significant impact on the Company’s financial statements. On April 9, 2009, the FASB issued FASB Staff Position (FSP) No. FAS 107-1 and APB 28-1, Interim Disclosures About Fair Value of Financial Instruments, which amends FASB Statement No. 107, Disclosures About Fair Value of Financial Instruments (“FSP 107-1”), to require disclosures about fair value of financial instruments for interim financial statements of publicly traded companies as well as in annual financial statements. FSP 107-1 also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FSP 107-1 is effective for interim reporting periods ending after June 15, 2009. The adoption of FSP 107-1 did not have a significant impact on the Company’s financial statements. Consistent with SFAS 157, the Company determines fair value to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Also, in accordance with SFAS 157, the Company has determined the principal market, or the market in which the Company exits its portfolio investments with the greatest volume and level of activity, to be the private secondary market. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues, or in limited cases, book value. 11 For private company investments, value is often realized through a liquidity event of the entire company. Therefore, the value of the company as a whole (enterprise value) at the reporting date often provides the best evidence of the value of the investment and is the initial step for valuing the Company’s privately issued securities. For any one company, enterprise value may best be expressed as a range of fair values, from which a single estimate of fair value will be derived. In determining the enterprise value of a portfolio company, the Company prepares an analysis consisting of traditional valuation methodologies including market and income approaches. The Company considers some or all of the traditional valuation methods based on the individual circumstances of the portfolio company in order to derive its estimate of enterprise value. The fair value of investments in private portfolio companies is determined based on various factors, including enterprise value, observable market transactions, such as recent offers to purchase a company, recent transactions involving the purchase or sale of the equity securities of the company, or other liquidation events. The determined equity values will generally be discounted when the Company has a minority position, is subject to restrictions on resale, has specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other comparable factors exist. For equity and equity-related securities that are freely tradable and listed on a securities exchange or over-the-counter market, the Company fair values those securities at their last sale price on that exchange or over-the-counter market on the valuation date. If the security is listed on more than one exchange, the Company will use the price from the exchange that it considers to be the principal exchange on which the security is traded. Securities listed on the NASDAQ will be valued at the NASDAQ Official Closing Price, which may not necessarily represent the last sale price. If there has been no sale on such exchange or over-the-counter market on such day, the security will be valued at the mean between bid and ask price on such day. An equity security of a publicly traded company acquired in a private placement transaction without registration is subject to restrictions on resale that can affect the security’s liquidity and fair value. Such securities that are convertible into or otherwise will become freely tradable will be valued based on the market value of the freely tradable security less an applicable discount. Generally, the discount will initially be equal to the discount at which the Company purchased the securities. To the extent that such securities are convertible or otherwise become freely tradable within a time frame that may be reasonably determined, an amortization schedule may be used to determine the discount. The Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of private investments:
C. Interest and Fee Income — Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. When investing in instruments with an original issue discount or payment-in-kind interest (in which case the Company chooses payment-in-kind in lieu of cash), the Company will accrue interest income during the life of the investment, even though the Company will not necessarily be receiving cash as the interest is accrued. Fee income will include fees, if any, for due diligence, structuring, commitment and facility fees, transaction services, consulting services and management services rendered to portfolio companies and other third parties. Commitment and facility fees generally are recognized as income over the life of the underlying loan, whereas due diligence, structuring, transaction service, consulting and management service fees generally are recognized as income when services are rendered. For the three and nine months ended August 31, 2009, the Company accrued $15,000 and $45,000 in fee income, respectively. For the three and nine months ended August 31, 2008, the Company accrued no fee income. D. Security Transactions and Investment Income — Security transactions are accounted for on the date the securities are purchased or sold (trade date). Realized gains and losses are reported on an identified cost basis. Distributions received from the Company’s investments in limited partnerships and limited liability companies generally are comprised of ordinary income, capital gains and 12 return of capital. The Company records investment income, capital gains and return of capital based on estimates made at the time such distributions are received. Such estimates are based on information available from each company and/or other industry sources. These estimates may subsequently be revised based on information received from the entities after their tax reporting periods are concluded, as the actual character of these distributions is not known until after the fiscal year end of the Company. Distributions received from portfolio companies which are paid in stock and are deemed to be income are included in distributions from investments in the Statement of Operations. Such amounts are recorded upon receipt and are based on the fair value of the shares received on that date. For the period from December 1, 2007 through November 30, 2008, the Company estimated the allocation of investment income and return of capital for the distributions received from its portfolio companies within the Statement of Operations. For this period, the Company had estimated these distributions to be approximately 32 percent investment income and 68 percent return of capital. Subsequent to November 30, 2008, the Company reallocated the amount of investment income and return of capital it recognized based on the 2008 tax reporting information received from the individual portfolio companies. This reallocation amounted to a decrease in pre-tax net investment income of approximately $1,415,000 or $0.157 per share ($895,000 or $0.099 per share, net of deferred tax benefit), an increase in unrealized appreciation of approximately $1,580,000 or $0.175 per share ($999,000 or $0.111 per share, net of deferred tax expense) and a decrease in realized gains of approximately $165,000 or $0.018 per share ($104,000 or $0.012 per share, net of deferred tax benefit). Subsequent to the period ended February 28, 2009, the Company reallocated the amount of investment income and return of capital reported in the current fiscal year based on its revised 2009 estimates. This reallocation amounted to a decrease in pre-tax net investment income of approximately $223,000 or $0.025 per share ($141,000 or $0.016 per share, net of deferred tax benefit), a decrease in unrealized appreciation of approximately 486,000 or $0.054 per share ($307,000 or $0.034 per share, net of deferred tax benefit) and an increase in realized gains of approximately $709,000 or $0.079 per share ($448,000 or $0.050 per share, net of deferred tax expense). E. Distributions to Stockholders — The amount of any quarterly distributions will be determined by the Board of Directors. Distributions to stockholders are recorded on the ex-dividend date. The Company may not declare or pay distributions to its common stockholders if it does not meet asset coverage ratios required under the 1940 Act. The character of distributions made during the year may differ from their ultimate characterization for federal income tax purposes. For the year ended November 30, 2008 and the period ended August 31, 2009, the Company’s distributions for book purposes were comprised of 100 percent return of capital. For the year ended November 30, 2008, the Company’s distributions for tax purposes were comprised of 3.2 percent investment income and 96.8 percent return of capital. The tax character of distributions paid for the current year will be determined subsequent to November 30, 2009. F. Federal and State Income Taxation — The Company, as a corporation, is obligated to pay federal and state income tax on its taxable income. Currently, the highest regular marginal federal income tax rate for a corporation is 35 percent; however, the Company anticipates a marginal effective tax rate of 34 percent due to expectations of the level of taxable income relative to the federal graduated tax rates, including the tax rate anticipated when temporary differences reverse. The Company may be subject to a 20 percent federal alternative minimum tax on its federal alternative minimum taxable income to the extent that its alternative minimum tax exceeds its regular federal income tax. The Company invests its assets primarily in limited partnerships or limited liability companies which are treated as partnerships for federal and state income tax purposes. As a limited partner, the Company reports its allocable share of taxable income in computing its own taxable income. The Company’s tax expense or benefit is included in the Statement of Operations based on the component of income or gains (losses) to which such expense or benefit relates. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred income tax asset will not be realized. G. Organization Expenses and Offering Costs — The Company is responsible for paying all organization and offering expenses. Offering costs related to the issuance of common stock are charged to additional paid-in capital when the stock is issued. H. Indemnifications — Under the Company’s organizational documents, its officers and directors are indemnified against certain liabilities arising out of the performance of their duties to the Company. In addition, in the normal course of business, the Company may enter into contracts that provide general indemnification to other parties. The Company’s maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Company that have not yet occurred, and may not occur. However, the Company has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 13 I. Recent Accounting Pronouncement — In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, “The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162” (“SFAS 168”). SFAS 168 replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” and establishes the “FASB Accounting Standards Codification TM” (“Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”). All guidance contained in the Codification carries an equal level of authority. On the effective date of SFAS 168, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of SFAS 168 will not have a significant impact on the Company’s financial statements. 3. Concentration of Risk
4. Agreements The base management fee is 0.375 percent (1.5 percent annualized) of the Company’s average monthly Managed Assets, calculated and paid quarterly in arrears within thirty days of the end of each fiscal quarter. The term “Managed Assets” as used in the calculation of the management fee means total assets (including any assets purchased with or attributable to borrowed funds but excluding any net deferred tax asset) minus accrued liabilities other than (1) net deferred tax liabilities, (2) debt entered into for the purpose of leverage and (3) the aggregate liquidation preference of any outstanding preferred shares. The base management fee for any partial quarter is appropriately prorated. On November 30, 2007, the Company entered into an Expense Reimbursement and Partial Fee Waiver Agreement with the Adviser. Under the terms of the agreement, the Adviser reimbursed the Company for certain expenses incurred beginning September 1, 2007 and ending December 31, 2008 in an amount equal to an annual rate of 0.25 percent of the Company’s average monthly Managed Assets. On November 11, 2008, the Company entered into an Expense Reimbursement Agreement with the Adviser, for which the Adviser will reimburse the Company for certain expenses incurred beginning January 1, 2009 and ending December 31, 2009 in an amount equal to an annual rate of 0.25 percent of the Company’s average monthly Managed Assets. During the three and nine months ended August 31, 2009 the Adviser reimbursed the Company $53,596 and $175,422, respectively. During the three and nine months ended August 31, 2008, the Adviser reimbursed the Company $100,821 and $296,696, respectively. The incentive fee consists of two parts. The first part, the investment income fee, is equal to 15 percent of the excess, if any, of the Company’s Net Investment Income for the fiscal quarter over a quarterly hurdle rate equal to 2 percent (8 percent annualized), and multiplied, in either case, by the Company’s average monthly Net Assets for the quarter. “Net Assets” means the Managed Assets less deferred taxes, debt entered into for the purposes of leverage and the aggregate liquidation preference of any outstanding preferred shares. “Net Investment Income” means interest income (including accrued interest that we have not yet received in cash), dividend and distribution income from equity investments (but excluding that portion of cash distributions that are treated as a return of capital), and any other income (including any fees such as commitment, origination, syndication, structuring, diligence, monitoring, and consulting fees or other fees that the Company is entitled to receive from portfolio companies) accrued during the fiscal quarter, minus the Company’s operating expenses for such quarter (including the base management fee, expense reimbursements payable pursuant to the Investment Advisory Agreement, any interest expense, any accrued income taxes related to net investment income, and distributions paid on issued and outstanding preferred stock, if any, but excluding the incentive fee payable). Net Investment Income also includes, in the case of investments with a deferred interest or income feature (such as original issue discount, debt or equity instruments with a payment-in-kind feature, and zero coupon securities), accrued income that the Company has not yet received in cash. Net Investment Income does not include any realized capital gains, realized capital losses, or unrealized capital appreciation or depreciation. The investment income fee is calculated and payable quarterly in arrears within thirty (30) days of the end of each fiscal quarter. The investment income fee calculation is adjusted appropriately on the basis of the number of calendar days in the first fiscal quarter the fee accrues or the fiscal quarter during which the Agreement is in effect in the event of termination of the Agreement during any fiscal quarter. During the three and nine months ended August 31, 2009 and the three and nine months ended August 31, 2008, the Company accrued no investment income fees. The second part of the incentive fee payable to the Adviser, the capital gain incentive fee, is equal to: (A) 15 percent of (i) the Company’s net realized capital gains (realized capital gains less realized capital losses) on a cumulative basis from inception to the end of each fiscal year, less (ii) any unrealized capital depreciation at the end of such fiscal year, less (B) the aggregate amount 14 of all capital gain fees paid to the Adviser in prior fiscal years. The capital gain incentive fee is calculated and payable annually within thirty (30) days of the end of each fiscal year. In the event the Investment Advisory Agreement is terminated, the capital gain incentive fee calculation shall be undertaken as of, and any resulting capital gain incentive fee shall be paid within thirty (30) days of the date of termination. The Adviser may, from time to time, waive or defer all or any part of the compensation described in the Investment Advisory Agreement. The calculation of the capital gain incentive fee does not include any capital gains that result from that portion of any scheduled periodic distributions made possible by the normally recurring cash flow from the operations of portfolio companies (“Expected Distributions”) that are characterized by the Company as return of capital for U.S. generally accepted accounting principles purposes. In that regard, any such return of capital will not be treated as a decrease in the cost basis of an investment for purposes of calculating the capital gain incentive fee. This does not apply to any portion of any distribution from a portfolio company that is not an Expected Distribution. Realized capital gains on a security will be calculated as the excess of the net amount realized from the sale or other disposition of such security over the adjusted cost basis for the security. Realized capital losses on a security will be calculated as the amount by which the net amount realized from the sale or other disposition of such security is less than the adjusted cost basis of such security. Unrealized capital depreciation on a security will be calculated as the amount by which the Company’s adjusted cost basis of such security exceeds the fair value of such security at the end of a fiscal year. The payable for capital gain incentive fees is a result of the increase or decrease in the fair value of investments and realized gains or losses from investments. For the three and nine months ended August 31, 2009, the Company accrued no capital gain incentive fees. For the three months ended August 31, 2008, the Company decreased the capital gain incentive fee payable by $340,369 as a result of the decrease in the fair value of investments during the period. For the nine months ended August 31, 2008, the Company accrued $747,134 in capital gain incentive fees. Pursuant to the Investment Advisory Agreement, the capital gain incentive fee is paid annually only if there are realization events and only if the calculation defined in the agreement results in an amount due. No capital gain incentive fees have been paid to date. The Company has engaged U.S. Bancorp Fund Services, LLC to serve as the Company’s fund accounting services provider. The Company pays the provider a monthly fee computed at an annual rate of $24,000 on the first $50,000,000 of the Company’s Net Assets, 0.0125 percent on the next $200,000,000 of Net Assets and 0.0075 percent on the balance of the Company’s Net Assets. The Adviser has been engaged as the Company’s administrator. The Company pays the administrator a fee equal to an annual rate of 0.07 percent of aggregate average daily Managed Assets up to and including $150,000,000, 0.06 percent of aggregate average daily Managed Assets on the next $100,000,000, 0.05 percent of aggregate average daily Managed Assets on the next $250,000,000, and 0.02 percent on the balance. This fee is calculated and accrued daily and paid quarterly in arrears. Computershare Trust Company, N.A. serves as the Company’s transfer agent, dividend paying agent, and agent for the automatic dividend reinvestment plan. U.S. Bank, N.A. serves as the Company’s custodian. The Company pays the custodian a monthly fee computed at an annual rate of 0.015 percent on the first $200,000,000 of the Company’s portfolio assets and 0.01 percent on the balance of the Company’s portfolio assets, subject to a minimum annual fee of $4,800. 5. Income Taxes
15 At August 31, 2009, the Company has recorded a valuation allowance in the amount of $5,446,592 for a portion of its deferred tax asset which it does not believe will, more likely than not, be realized. The Company estimates based on existence of sufficient evidence, primarily regarding the amount and timing of distributions to be received from portfolio companies, the ability to realize the remainder of its deferred tax assets. Any adjustments to such estimates will be made in the period such determination is made. Management determined that no reserve for unrecognized tax benefits is necessary when temporary differences represent net future deductible amounts rather than net future taxable amounts. The Company does not expect any change in such amounts of unrecognized tax benefits over the next twelve months subsequent to November 30, 2008. The Company’s policy is to record interest and penalties on uncertain tax positions as part of tax expense. No interest or penalties were accrued at August 31, 2009. All tax years since inception remain open to examination by federal and state tax authorities. Total income tax benefit differs from the amount computed by applying the federal statutory income tax rate of 34 percent to net investment income (loss) and realized and unrealized gains (losses) on investments before taxes as follows:
The provision for income taxes is computed by applying the federal statutory rate plus a blended state income tax rate. The components of income tax include the following for the periods presented:
The deferred income tax expense for both the three month and nine month periods ended August 31, 2009 includes the impact of the change in valuation allowance for such respective periods. As of November 30, 2008, the Company had net operating losses for federal income tax purposes of approximately $7,280,000. The net operating losses may be carried forward for 20 years. If not utilized, these net operating losses will expire as follows: $3,911,000 and $3,369,000 in the years 2027 and 2028, respectively. The amount of deferred tax asset for net operating losses and capital losses at August 31, 2009 also includes amounts for the period from December 1, 2008 through August 31, 2009. For corporations, capital losses can only be used to offset capital gains and cannot be used to offset ordinary income. As of November 30, 2008, an alternative minimum tax credit of $3,109 was available, which may be credited in the future against regular income tax. This credit may be carried forward indefinitely. 16 The aggregate cost of securities for federal income tax purposes and securities with unrealized appreciation and depreciation, were as follows:
6. Fair Value of Financial
Instruments
The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. The following table provides the fair value measurements of applicable Company assets and liabilities by level within the fair value hierarchy as of August 31, 2009. These assets are measured on a recurring basis.
7. Restricted
Securities 17
18
8. Investments in Affiliates and
Control Entities August 31, 2009
19 9. Investment
Transactions On July 17, 2008, LONESTAR Midstream Partners LP (LONESTAR) closed a transaction with Penn Virginia Resource Partners, L.P. (NYSE: PVR) for the sale of its gas gathering and transportation assets. LONESTAR distributed substantially all of the initial sales proceeds to its limited partners but did not redeem partnership interests. On July 24, 2008, the Company received a distribution of $10,476,511 in cash, 468,001 newly issued unregistered common units of PVR, and 59,503 unregistered common units of Penn Virginia GP Holdings, L.P. (NYSE: PVG). On July 24, 2008, the Company recorded the cash and the unregistered PVR and PVG common units it received at a cost basis equal to the fair value on the date of receipt, less a discount for illiquidity. The Company reduced its basis in LONESTAR by $20,427,674, approximately 82 percent of the respective relative value of the entire transaction, resulting in a realized gain of $1,104,244. The Company also reduced its basis in LSMP GP, LP by $403,488, approximately 71 percent of the respective relative value of the entire transaction, resulting in a realized gain of $1,007,962. On February 3, 2009, the Company received a distribution of 37,305 freely tradable common units of PVR and 4,743 freely tradable common units of PVG. The Company recorded the PVR and PVG common units it received at a cost basis equal to the fair value on the date of receipt. The Company reduced its basis in LONESTAR by $746,180, approximately 3 percent of the respective relative value of the entire transaction, resulting in a realized loss of $184,201. The Company also reduced its basis in LSMP GP, LP by $14,996, approximately 3 percent of the respective relative value of the entire transaction, resulting in a realized gain of $11,057. On July 17, 2009, the Company received a distribution of 37,304 freely tradable common units of PVR and 4,744 freely tradable common units of PVG. The Company recorded the PVR and PVG common units it received at a cost basis equal to the fair value on the date of receipt. The Company reduced its basis in LONESTAR by $746,180, approximately 3 percent of the respective relative value of the entire transaction, resulting in a realized loss of $179,731. The Company also reduced its basis in LSMP GP, LP by $14,996, approximately 3 percent of the respective relative value of the entire transaction, resulting in a realized gain of $14,303. The Company anticipates receiving a cash distribution from LONESTAR of approximately $1,038,090 payable on December 31, 2009. There are also two future contingent payments due LONESTAR which are based on the achievement of specific revenue targets by or before June 30, 2013. No payments are due if these revenue targets are not achieved. If received, the Company’s expected portion would total approximately $9,638,829, payable in cash or common units of PVR (at PVR’s election). The fair value of the LONESTAR and LSMP GP, LP units as of August 31, 2009 is based on unobservable inputs related to the potential receipt of these future payments relative to the sales transaction. On October 1, 2008, Millennium sold its partnership interests to Eagle Rock Energy Partners, L.P. (EROC) for approximately $181,000,000 in cash and approximately four million EROC unregistered common units. In exchange for its Millennium partnership interests, the Company received $13,687,081 in cash and 373,224 EROC unregistered common units with an aggregate basis of $5,044,980 for a total implied value at closing of approximately $18,732,061. In addition, approximately 212,404 units with an aggregate cost basis of 2,920,555 were placed in escrow for 18 months from the date of the transaction. This includes a reserve the Company placed against the units held in the escrow for estimated post-closing adjustments. The Company originally invested $17,500,000 in Millennium (including common units and incentive distribution rights), and had an adjusted cost basis at closing of $15,161,125 (after reducing its basis for cash distributions received since investment that were treated as return of capital). At the transaction closing, the Company recorded a realized gain for book purposes of $6,491,491, including a reserve the Company placed against the restricted cash and units held in the escrow for estimated post-closing adjustments. Subsequent to November 30, 2008, the Company increased the reserve against the units held in escrow for additional post-closing adjustments, resulting in a realized loss for the nine months ended August 31, 2009 of $540,925. The Company also recorded an additional $277,724 in realized loss related to the reclassification of investment income and return of capital recognized based on the 2008 tax reporting information received from Millennium (see Note 2D—Security Transactions and Investment Income for additional information). For purposes of the capital gain incentive fee, the realized gain totals approximately $3,611,691, which excludes that portion of the fee that would be due as a result of cash distributions which were characterized as return of capital. Pursuant to the Investment Advisory Agreement, the capital gain incentive fee is paid annually only if there are realization events and only if the calculation defined in the agreement results in an amount due. No capital gain incentive fees have been paid to date. 20 10. Credit
Facility On March 20, 2009, the Company entered into a 90-day extension of its amended credit facility. Terms of the extension provided for a secured revolving credit facility of up to $25,000,000. Effective June 20, 2009, the Company entered into a 60-day extension of its amended credit facility. The terms of the extension provided for a secured revolving credit facility of up to $11,700,000. The credit agreement, as extended, had a termination date of August 20, 2009. Terms of these extensions required the Company to apply 100 percent of the proceeds from any private investment liquidation and 50 percent of the proceeds from the sale of any publicly traded portfolio assets to the outstanding balance of the facility. In addition, each prepayment of principal of the loans under the amended credit facility would permanently reduce the maximum amount of the loans under the amended credit agreement to an amount equal to the outstanding principal balance of the loans under the amended credit agreement immediately following the prepayment. During these extensions, outstanding loan balances accrued interest at a variable rate equal to the greater of (i) one-month LIBOR plus 3.00 percent, and (ii) 5.50 percent. On August 20, 2009, the Company entered into a six-month extension of its amended credit facility through February 20, 2010. Terms of the extension provide for a secured revolving facility of up to $5,000,000. The amended credit facility requires the Company to apply 100 percent of the proceeds from the sale of any investment to the outstanding balance of the facility. In addition, each prepayment of principal of the loans under the amended credit facility will permanently reduce the maximum amount of the loans under the amended credit agreement to an amount equal to the outstanding principal balance of the loans under the amended credit agreement immediately following the prepayment. During this extension, outstanding loan balances generally will accrue interest at a variable rate equal to the greater of (i) one-month LIBOR plus 3.00 percent, and (ii) 5.50 percent. Under the terms of the amended credit facility, the Company must maintain asset coverage required under the 1940 Act. If the Company fails to maintain the required coverage, it may be required to repay a portion of an outstanding balance until the coverage requirement has been met. As of August 31, 2009, the Company was in compliance with the terms of the amended credit facility. For the nine months ended August 31, 2009, the average principal balance and interest rate for the period during which the credit facility was utilized were $17,675,912 and 4.25 percent, respectively. As of August 31, 2009, the principal balance outstanding was $5,000,000 at a rate of 5.50 percent. 11. Common Stock
12. Warrants
21 13. Earnings Per
Share
14. Subsequent
Events On September 1, 2009, the Company paid a distribution in the amount of $0.13 per common share, for a total of $1,173,679. Of this total, the dividend reinvestment amounted to $150,140. On September 15, 2009, the Company entered into a new Investment Advisory Agreement with the Adviser in connection with the September 15, 2009 closing of the transaction previously announced by the Adviser on June 3, 2009. Upon the closing of this transaction, which resulted in a change in control of the Adviser, the previous Investment Advisory Agreement with the Adviser automatically terminated. The terms of the new Investment Advisory Agreement are substantially identical to the previous Investment Advisory Agreement, except for the effective and termination dates, and simply continue the relationship between the Company and the Adviser. On September 15, 2009, effective upon consummation of the transaction resulting in the change in control of the Adviser, Terry Matlack resigned from the Board of Directors of the Company in order to comply with a safe harbor under Section 15(f) of the 1940 Act. Mr. Matlack will remain a member of the Adviser’s Investment Committee and as Chief Financial Officer of the Company. On October 1, 2009, Quest Midstream Partners, L.P. declared a special pro rata dividend on its common units. The distribution is payable in additional common units to all record holders outstanding on that date, for which the Company will receive 35,935 common units. On October 6, 2009, Quest Resources Corp. (NASDAQ: QRCP) and Quest Energy Partners L.P. (NASDAQ: QELP) filed a Form S-4 Registration Statement to recombine with Quest Midstream Partners, L.P. as the newly formed PostRock Energy Corporation, which is expected to be listed on the NASDAQ under the symbol “PSTR.” The recombination is subject to the satisfaction of a number of conditions. On October 5, 2009, Abraxas Petroleum Corporation (NASDAQ: AXAS) (“Abraxas Petroleum”) announced that it closed the merger with Abraxas Energy Partners, L.P. (“Abraxas Energy”). A special meeting of Abraxas Petroleum stockholders was held and the holders of a majority of the shares voting at the special meeting approved the issuance of Abraxas Petroleum common stock to the holders of common units of Abraxas Energy not held by a wholly-owned subsidiary of Abraxas Petroleum in connection with the merger. The unitholders of Abraxas Energy will receive 4.25 shares of Abraxas Petroleum common stock for each common unit of Abraxas Energy. A total of 26.2 million shares of Abraxas Petroleum common stock will be issued in connection with the merger. The shares are subject to an initial 90 day lock-up period followed by a multi-year staggered lock-up period. 22 ADDITIONAL INFORMATION (Unaudited) Director and Officer
Compensation Forward-Looking
Statements Certifications The Company has filed with the SEC the certification of its Chief Executive Officer and Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act. Proxy Voting
Policies Privacy Policy Generally, the Company does not receive any non-public personal information relating to its stockholders, although certain non-public personal information of its stockholders may become available to the Company. The Company does not disclose any non-public personal information about its stockholders or a former stockholder to anyone, except as required by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent). The Company restricts access to non-public personal information about its stockholders to employees of its Adviser with a legitimate business need for the information. The Company maintains physical, electronic and procedural safeguards designed to protect the non-public personal information of its stockholders. 23
Statements contained herein, other than historical facts, may constitute “forward-looking statements.” These statements may relate to, among other things, future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any anticipated results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. For a discussion of factors that could cause our actual results to differ from forward-looking statements contained herein, please see the discussion under the heading “Risk Factors” in Part I, Item 1A. of our most recent Annual Report filed on Form 10-K. We may experience fluctuations in our operating results due to a number of factors, including the return on our equity investments, the interest rates payable on our debt investments, the default rates on such investments, 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. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods. Overview We seek to invest in companies operating in the U.S. energy infrastructure sector, primarily in privately-held and micro-cap public companies focused on the midstream and downstream segments, and to a lesser extent the upstream and coal and aggregates segments. Companies in the midstream segment of the energy infrastructure sector engage in the business of transporting, processing or storing natural gas, natural gas liquids, crude oil, refined petroleum products and renewable energy resources. Companies in the downstream segment of the energy infrastructure sector engage in distributing or marketing such commodities, and companies in the upstream segment of the energy infrastructure sector engage in exploring, developing, managing or producing such commodities. The energy infrastructure sector also includes producers and processors of coal and aggregates, two business segments that also are eligible for master limited partnership (“MLP”) status. We seek to invest in companies in the energy infrastructure sector that generally produce stable cash flows as a result of their fee-based revenues and proactive hedging programs which help to limit direct commodity price risk. Performance Review and Investment
Outlook Our net asset value, however, declined this quarter from $8.91 per share at May 31, 2009 to $8.76 per share at August 31, 2009. The fair value of High Sierra Energy, LP and International Resource Partners LP, increased this quarter due in part to improved operating performance and/or peer multiples. The fair value of Mowood, LLC also increased this quarter, and the company continues to explore strategic alternatives based on growth opportunities at its Timberline subsidiary. The fair value of Abraxas Energy Partners, L.P. (“Abraxas Energy”), Quest Midstream Partners, L.P. (“Quest Midstream”) and VantaCore Partners, L.P. (“VantaCore”) decreased this quarter due to company and/or market-specific issues. The fair value of VantaCore was adversely affected by its decision to reduce its quarterly cash distribution to common unitholders and to suspend its distribution to certain subordinated unitholders in light of reduced distributable cash flow projections in 2009. Quest Midstream and Abraxas announced intentions to merge or recombine with their respective affiliated public entities, which would likely provide liquidity for our investments in the future. On October 6, 2009, Quest Resources Corp. (NASDAQ: QRCP) and Quest Energy Partners, L.P. (NASDAQ: QELP) filed a Form S-4 Registration Statement to recombine with Quest Midstream as the newly formed PostRock Energy Corporation, which is expected to be listed on the NASDAQ under the symbol “PSTR.” The recombination is subject to the satisfaction of a number of conditions, including the arrangement of one or more satisfactory credit lines for the newly formed company, the approval of the transaction by the unitholders of the three existing entities, and consents from each entity’s existing lenders. On October 5, 2009, Abraxas Petroleum Corp. (NASDAQ: AXAS) (“Abraxas Petroleum”) closed the merger with Abraxas Energy. Under the terms of the merger agreement, we will receive 4.25 shares of Abraxas Petroleum in exchange for each common unit of Abraxas Energy we own, which equates to approximately 1,946,377 Abraxas Petroleum shares. These shares are subject to an initial 90 day lock-up period followed by a multi-year staggered lock-up period. 24 This quarter we continued the liquidation of publicly-traded securities to pay down our line of credit, including certain securities previously held in escrow related to the Millennium and Lonestar transactions. On August 20, 2009, we announced a six-month extension to our line of credit through February 20, 2010. The outstanding balance on our line of credit was reduced from $18.8 million at May 31, 2009 to $5.0 million at August 31, 2009. We do not expect any future leverage reductions to materially impact our distribution paying capacity. As of August 31, 2009, the value of our investment portfolio (excluding short-term investments) was $78,274,585 including equity investments of $69,474,585 and debt investments of $8,800,000 across the following segments of the energy infrastructure sector: Allocation of Portfolio
Assets
25
Portfolio Company
Monitoring As part of the monitoring process, our Adviser continually assesses the risk profile of each of our private investments. We intend to disclose, as appropriate, those risk factors that we deem most relevant in assessing the risk of any particular investment. Such factors may include, but are not limited to, the investment’s current cash distribution status, compliance with loan covenants, operating and financial performance, changes in the regulatory environment or other factors that we believe are useful in determining overall investment risk. 26 Abraxas Energy Partners, L.P.
(“Abraxas”) On June 30, 2009, Abraxas entered into a definitive merger agreement with Abraxas Petroleum Corp. The merger is expected to result in a borrowing base sufficient for one tranche of debt, eliminating Abraxas’ second lien debt. However, the merger is expected to result in the permanent discontinuation of distributions as well as a more exploration oriented risk profile. Abraxas Petroleum Corp. has scheduled a special meeting of stockholders on October 5, 2009 to vote on the proposed merger. If approved, the merger is anticipated to be completed in the third quarter of 2009. However, the merger is subject to various conditions set forth in the Merger Agreement and it is possible that certain factors could result in the merger being completed at a later time, or not at all. If the merger is not completed, Abraxas, under its current loan agreements, would be faced with significant debt amortization payments due to the maturity of its second lien debt which would most likely preclude its ability to pay distributions until the second lien debt was paid off or refinanced. See Recent Developments for a discussion of the results of the special meeting of stockholders held on October 5, 2009. High Sierra Energy, LP (“High
Sierra”) High Sierra increased its quarterly cash distribution from $0.61 per unit to $0.63 per unit this quarter. Through June 2009, year-to-date overall performance against budgeted EBITDA (before mark-to-market gains and losses and before minority interests) has been mixed by operating segment, but is near budget in the aggregate, enabling High Sierra to increase its distribution and maintain a strong cash position. Depressed natural gas prices and high basis differentials in certain of the areas served by the company’s water handling operations have continued to dampen drilling and production activities, thereby resulting in revenues and EBITDA for these segments that is below budget. Shortfalls in the water operations have been partially offset however, by the strong performance of the company’s energy marketing businesses, including the natural gas and natural gas liquids segments. Monroe Gas Storage, High Sierra’s Mississippi-based natural gas storage facility joint venture, continues to make progress toward completion. The storage facility is offering limited injection and withdrawal services as it continues development activities. In August 2009, High Sierra extended its marketing segment’s revolving credit facility which, together with the earlier expansion of its corporate revolver, further reduces our concerns regarding the company’s liquidity position. International Resource Partners
LP (“IRP”) While metallurgical coal pricing and demand have shown some improvement, they remain below levels seen in 2008. IRP’s operating results continue to exceed budgeted levels. Year-to-date EBITDA through July 31, 2009 was ahead of budget, largely on the strength of results posted by the company’s sales and marketing arm. This, combined with the company’s strong cash position resulting from last year’s record results, enabled the company to maintain a stable balance sheet position in spite of the challenging coal environment. Metallurgical coal markets showed some improvement during the quarter, as North American and certain overseas steel production increased over the prior quarter. Because steam coal demand has continued to be depressed due to a moderate cooling season and reduced industrial electricity demand, management remains focused on prudently reducing its production costs where possible, and dynamically adjusting its mining plan to suit current conditions. IRP remains in compliance with its bank covenants. Mowood, LLC
(“Mowood”) 27 Through July 2009, Omega has slightly outperformed its budget and is expected to continue to post strong results during the year as expansion projects at Fort Leonard Wood enhance results. Omega’s contracts have been structured to minimize commodity exposure. Timberline has performed moderately below budget for the year-to-date period as a result of startup operational issues. Timberline has been working to resolve its operational issues and to expand capacity at its existing locations which management believes should result in improved performance. Timberline has structured its off-take contracts to eliminate or minimize commodity exposure in an effort to create more predictable performance. Mowood continues to explore strategic alternatives based on growth opportunities at its Timberline subsidiary. Mowood remains in compliance with all bank covenants. Quest Midstream Partners, L.P.
(“Quest”) On July 6, 2009, Quest announced it entered into a definitive merger agreement pursuant to which it would recombine with Quest Resources Corp and Quest Energy Partners. The transaction would result in a new publicly-traded company which is not expected to pay distributions. Under the terms of the merger agreement, current Quest equity holders would own approximately 44 percent of the new company. The new company’s strategy will be to pursue efficient development of unconventional resource plays, including coalbed methane in the Cherokee Basin of southeast Kansas and northeast Oklahoma and the Marcellus Shale in the Appalachian Basin. The merger would change the risk profile of our investment from primarily a gathering company to an integrated company that has increased drilling risk and commodity exposure. If the recombination does not close, we believe Quest would be able to operate profitably for the remainder of 2009, but would face significant operational risk created by a lower gathering rate in 2010 and significant financial pressures on QELP, its primary customer, and QRCP. Quest remains in compliance with its bank covenants. See Recent Developments for an update on the recombination. VantaCore Partners LP
(“VantaCore”) VantaCore reduced its quarterly cash distribution to $0.475 per unit, the minimum quarterly distribution, a decrease of five percent from the prior quarter and from last year. In our view, the distribution reduction, together with a suspension in the quarterly distribution to certain of the subordinated unit holders, was a prudent and proactive step taken in view of the difficult operating environment in certain of VantaCore’s markets. VantaCore’s business is closely linked to the level of commercial construction and infrastructure spending in the two major territories it serves. Due to the weakened economy and difficult credit environment, base line construction spending in these sectors has been significantly reduced, resulting in lower than anticipated revenues. In Clarksville, the lower level of baseline activity has been partially offset by some major projects, including the new Dow/Hemlock semiconductor plant. Vantacore’s Southern Aggregates division, which serves parts of Louisiana, has been slower to recover, in part due to significant regional price competition. Vantacore has responded to these challenges by implementing cost saving initiatives, prudently reducing capital spending and making the aforementioned adjustments to its distribution. VantaCore remains in compliance with its bank covenants. Results of Operations Comparison of the Three and Nine
Months Ended August 31, 2009 and August 31, 2008 Net Expenses: Net expenses totaled $669,570 and $2,160,252 for the three and nine months ended August 31, 2009. This represents a decrease of $143,197 and $2,165,686, respectively, as compared to the three and nine months ended August 31, 2008. The decrease is primarily related to elimination of the capital gain incentive fee accrual, a decrease in leverage costs and a decrease in base management fees payable to the Adviser as a result of the lower value of the investment portfolio. Distributable Cash Flow: Our portfolio generates cash flow to us from which we pay distributions to stockholders. When our Board of Directors determines the amount of any distribution we expect to pay our stockholders, it reviews distributable cash flow (“DCF”). DCF is distributions received from investments less our total expenses. The total distributions received from our investments include the amount received by us as cash distributions from equity investments, paid-in-kind distributions, and 28 dividend and interest payments. Total expenses include current or anticipated operating expenses, leverage costs and current income taxes on our operating income. Total expenses do not include deferred income taxes or accrued capital gain incentive fees. We do not include in distributable cash flow the value of distributions received from portfolio companies which are paid in stock as a result of credit constraints, market dislocation or other similar issues. We disclose DCF in order to provide supplemental information regarding our results of operations and to enhance our investors’ overall understanding of our core financial performance and our prospects for the future. We believe that our investors benefit from seeing the results of DCF in addition to GAAP information. This non-GAAP information facilitates management’s comparison of current results with historical results of operations and with those of our peers. This information is not in accordance with, or an alternative to, GAAP and may not be comparable to similarly titled measures reported by other companies. The following table represents DCF for the three and nine months ended August 31, 2009 as compared to the three and nine months ended August 31, 2008:
29 Distributions: The following table sets forth distributions for the nine months ended August 31, 2009 as compared to the nine months ended August 31, 2008.
Net Investment Income (Loss): Net investment income totaled $81,183 for the three months ended August 31, 2009, and net investment loss totaled $1,184,346 for the nine months ended August 31, 2009. For the three and nine months ended August 31, 2008, net investment loss totaled $226,941 and $1,256,984, respectively. The variance in net investment income (loss) is primarily related to a decrease in net investment income and corresponding decreases in net expenses during the current fiscal periods as described above. Net Realized and Unrealized Gain (Loss): We had net unrealized appreciation of $12,046,028 and $15,768,051 (after deferred taxes) for the three and nine months ended August 31, 2009, respectively, as compared to net unrealized depreciation of $1,508,873 (after deferred taxes) for the three months ended August 31, 2008 and net unrealized appreciation of $3,449,457 (after deferred taxes) for the nine months ended August 31, 2008. We had realized losses for the three and nine months ended August 31, 2009 of $12,224,718 and $20,680,410 (after deferred taxes), respectively. These realized losses are primarily attributable to the sales of publicly-traded securities for which proceeds were used to pay down debt. We had realized gains for the three and nine months ended August 31, 2008 of $1,379,318 (after deferred taxes). Liquidity and Capital
Resources Total leverage outstanding on our credit facility at August 31, 2009 was $5,000,000, representing approximately 6 percent of total assets, including our deferred tax asset. We are, and intend to remain, in compliance with our asset coverage ratios under the Investment Company Act of 1940 and our basic maintenance covenants under our credit facility. Contractual
Obligations
Off-Balance Sheet
Arrangements Borrowings Effective June 20, 2009, we entered into a 60-day extension of our amended credit facility. The terms of the extension provided for a secured revolving credit facility of up to $11,700,000. The credit agreement, as extended, had a termination date of August 20, 2009. Terms of the extensions required us to apply 100 percent of the proceeds from any private investment liquidation and 50 percent of the proceeds from the sale of any publicly traded portfolio assets to the outstanding balance of the facility. In 30 addition, each prepayment of principal of the loans under the amended credit facility would permanently reduce the maximum amount of the loans under the amended credit agreement to an amount equal to the outstanding principal balance of the loans under the amended credit agreement immediately following the prepayment. During these extensions, outstanding loan balances accrued interest at a variable rate equal to the greater of (i) one-month LIBOR plus 3.00 percent, and (ii) 5.50 percent. On August 20, 2009, we entered into a six-month extension of our amended credit facility through February 20, 2010. Terms of the extension provide for a secured revolving facility of up to $5,000,000. The amended credit facility requires us to apply 100 percent of the proceeds from the sale of any investment to the outstanding balance of the facility. In addition, each prepayment of principal of the loans under the amended credit facility will permanently reduce the maximum amount of the loans under the amended credit agreement to an amount equal to the outstanding principal balance of the loans under the amended credit agreement immediately following the prepayment. During this extension, outstanding loan balances generally will accrue interest at a variable rate equal to the greater of (i) one-month LIBOR plus 3.00 percent, and (ii) 5.50 percent. Recent
Developments On September 15, 2009, we entered into a new Investment Advisory Agreement with our Adviser in connection with the September 15, 2009 closing of the transaction previously announced by our Adviser on June 3, 2009. Upon the closing of this transaction, which resulted in a change in control of the Adviser, our previous Investment Advisory Agreement with our Adviser automatically terminated. The terms of the new Investment Advisory Agreement are substantially identical to the previous Investment Advisory Agreement, except for the effective and termination dates, and simply continue the relationship between us and the Adviser. On September 15, 2009, effective upon consummation of the transaction resulting in the change in control of our Adviser, Terry Matlack resigned from our Board of Directors in order to comply with a safe harbor under Section 15(f) of the 1940 Act. Mr. Matlack will remain a member of our Adviser’s Investment Committee and as our Chief Financial Officer. On October 1, 2009, Quest Midstream Partners, L.P. declared a special pro rata dividend on its common units. The distribution is payable in additional common units to all record holders outstanding on that date, for which we will receive 35,935 common units. On October 6, 2009, Quest Resources Corp. (NASDAQ: QRCP) and Quest Energy Partners L.P. (NASDAQ: QELP) filed a Form S-4 Registration Statement to recombine with Quest Midstream Partners, L.P. as the newly formed PostRock Energy Corporation, which is expected to be listed on the NASDAQ under the symbol “PSTR.” The recombination is subject to the satisfaction of a number of conditions. On October 5, 2009, Abraxas Petroleum Corporation (NASDAQ: AXAS) (“Abraxas Petroleum”) announced that it closed the merger with Abraxas Energy Partners, L.P. (“Abraxas Energy”). A special meeting of Abraxas Petroleum stockholders was held and the holders of a majority of the shares voting at the special meeting approved the issuance of Abraxas Petroleum common stock to the holders of common units of Abraxas Energy not held by a wholly-owned subsidiary of Abraxas Petroleum in connection with the merger. Under the terms of the merger agreement, we will receive 4.25 shares of Abraxas Petroleum common stock in exchange for each common unit of Abraxas Energy we own, which equates to approximately 1,946,377 Abraxas Petroleum shares. These shares are subject to an initial 90 day lock-up period followed by a multi-year staggered lock-up period. Critical Accounting
Policies Valuation of Portfolio
Investments Securities Transactions and
Investment Income Recognition 31 Federal and State Income
Taxation ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our business activities contain elements of market risk. We consider fluctuations in the value of our equity securities and the cost of capital under our credit facility to be our principal market risk. We carry our investments at fair value, as determined by our Board of Directors. The fair value of securities is determined using readily available market quotations from the principal market if available. The fair value of securities that are not publicly traded or whose market price is not readily available is determined in good faith by our Board of Directors. Because there are no readily available market quotations for most of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our Board of Directors under a valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have readily available market quotations, the fair value of our investments may differ significantly from the fair values that would have been used had a ready market quotation existed for such investments, and these differences could be material. As of August 31, 2009, the fair value of our investment portfolio (excluding short-term investments) totaled $78,274,585. We estimate that the impact of a 10 percent increase or decrease in the fair value of these investments, net of capital gain incentive fees and related deferred taxes, would increase or decrease net assets applicable to common stockholders by approximately $4,853,024. Debt investments in our portfolio may be based on floating or fixed rates. Loans bearing a floating interest rate are usually based on LIBOR and, in most cases, a spread consisting of additional basis points. The interest rates for these debt instruments typically have one to six-month durations and reset at the current market interest rates. As of August 31, 2009, we had no floating rate debt investments outstanding. We consider the management of risk essential to conducting our businesses. Accordingly, our risk management systems and procedures are designed to identify and analyze our risks, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. ITEM 4. CONTROLS AND PROCEDURES Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There have been no changes in our internal control over financial reporting (identified in connection with the evaluation required by Rules 13a-15(d) or 15d-15 of the Securities Exchange Act of 1934) during the fiscal quarter ended August 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 32 PART II — OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are not currently subject to any material legal proceeding, nor, to our knowledge, is any material legal proceeding threatened against us. ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended November 30, 2008, which could materially affect our business, financial condition or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS We did not sell any securities during the three months ended August 31, 2009 that were not registered under the Securities Act of 1933. We did not repurchase any of our common shares during the three months ended August 31, 2009. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable ITEM 6. EXHIBITS
All other exhibits for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and therefore have been omitted. 33 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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