Pennantpark Investment Corp (PNNT) 2008 Q4 法說會逐字稿

Good morning and welcome to this PennantPark Investment Corporation's fourth fiscal quarter 2008 earnings conference call. As a reminder, this call is being recorded. At this time, all participants have been placed on listen-only mode. The call will be open for a question-and-answer session following the speakers' remarks. (Operator Instructions). It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

Thank you and good morning, everyone. I would like to welcome you to our fourth fiscal quarter 2008 earnings conference call. I am joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Thank you, Art. I would like to remind everyone that today's call is being recorded. Please note that this call is the property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release.

I would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.pennantpark.com or call us at 212-905-1000. At this time, I would like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thank you, Aviv. I'm going to spend a minute discussing current market conditions and follow up with a discussion of our strategy. As you all know, we are experiencing a time of historic market volatility, which is now combined with significant economic weakness. A crisis of confidence has led to forced selling and all-time low secondary market prices of leveraged loans and other high-yield instruments. These fire sale prices implied default and recovery rates well outside the band of historical peak levels seen during past steep downturns. Many of our competitors have been sidelined. M&A, which drives much of the new deal flow, has ground to a halt as buyers find financing scarce and remain far apart from sellers on valuation. The outlook is uncertain as experts debate the length and depth of the recession.

We believe that the market is in a bottoming process, which may last a while. We will continue to set a high bar in terms of our investment parameters and remain cautious and selective about which investments we add to our portfolio. Our focus continues to be on companies that are more defensive in a recession and have low leverage, strong covenants and high returns. As prior cycles have proven, the investments we make in this environment may end up being some of the best we will make over time.

In terms of PennantPark, we are well-positioned to deal with the challenging market and economic environment due to several factors. On our underlying existing portfolio, the average cash interest coverage ratio, the amount by which EBITDA exceeds cash interest expense, is over 2.5 times. As a result, we feel that the cash flows coming out of the portfolio to us as interest income are in good shape. As we run recession cases on our portfolio, we expect that ratio will come down, but should still provide a reasonable amount of cushion and stable investment income.

That investment income exceeds our dividend and on a cash basis, matches our dividend. We don't depend on realizations to pay our dividends. Our portfolio consists primarily of cash paid debt instruments and only has a limited amount of PIK and equity investments. Out of the 68 investments we have made since inception 20 months ago, we have had only one small non-accrual. To the extent we have more non-accruals, which is certainly possible in this recessionary environment, we have ample liquidity to make more investments to cushion the gaps in income resulting from further non-accruals.

From a value perspective, we have invested in companies at reasonable multiples of cash flow. A reminder, when a company declines to pay us the cash interest they owe us, our debt security generally takes ownership of the company. On average at cost, we have created a portfolio of 37 companies at 4.5 to 5 times EBITDA or cash flow.

At the NAV mark on September 30, net value was 85% of cost or 3.8 to 4.3 times cash flow. At prices below NAV, we, the shareholders, own a portfolio of companies and multiples as low as one times cash flow. Even in a recession with potential declines in cash flow, value investors can appreciate those low multiples.

Lastly, on October 1, 2008, we elected to mark our credit facility to market under FAS 159. We think this will better align values of assets and liabilities and essentially hedge much of the market volatility going forward. Certainly, since September 30, prices of broker-dealer quotes have continued to decline and impacted asset values. Much of this will be offset by an increase in the value of our liabilities.

For the quarter ended September 30, 2008, PennantPark originated $58 million of core assets in three different names and generated proceeds of $55 million by selling nearly half of our non-core first lien portfolio at prices that now look attractive. From a net asset value perspective, our NAV fell from $10.77 per share to $10. Our NAV fell due to the more volatile market for liquid leveraged finance instruments, offset to some extent by the maturation and growth of some of our core mezzanine and equity co-investments. Net investment income was $0.26 a share, exceeding our dividend of $0.24 a share.

The portfolio is increasingly diversified in more defensive industries. We made investments this quarter in companies tied to healthcare and waste markets. As you know, over the past year, we have been prioritizing more recession-resistant sectors such as healthcare, education and defense. Excluding Realogy and [Swift], the average EBITDA of our core mezzanine and second lien investments grew 19% from investment date to September 30 and EBITDA to interest coverage ratio grew from 2.4 times to 2.7 times.

Greatwide Logistics is one of our small, liquid non-core senior secured investments and with our first non-accrual loan out of 68 companies. It represents about 1.6% of our portfolio at cost and 1.2% at market. As we mentioned earlier, we are in good shape from the standpoint of liquidity. We have well north of $100 million of our credit facility available to us. Additionally, for liquidity purposes, we could continue to sell some of our lower yielding, non-core, senior secured assets and invest the capital in higher-yielding core assets if we choose. Although many of those assets are quoted at levels that make it economically prudent to hold at this point.

Based on the liquidity we have as we add assets at attractive yields over the next few quarters, our net investment income should grow. The primary offset to this would be potential portfolio companies that default on their interest. We are closely monitoring all portfolio companies and think that with an average EBITDA to interest ratio of over 2.5 times, our Company should be able to stay current on their interest, even in this unprecedented economic environment. The sponsors we have chosen to partner with on our deals have committed substantial equity beneath us and we believe will do everything in their power to support their portfolio of companies, including contributing more capital.

Nonetheless, an inevitable part of our business, particularly in a recessionary environment, is defaults. The combination of our existing portfolio and new investments over the next few quarters should position us to have a stable dividend, even if we experience more defaults. Our investment activity last quarter involved purchasing fixed-rate investments and selling floating-rate investments. We are now almost fully matched from the standpoint of fixed and floating interest rates and our asset liability mix. As a result, if LIBOR continues to go down, our net investment income will not be materially impacted.

For the quarter ended September 30, we invested $58 million in three companies in our core asset classes, which includes select senior secured loans, second lien secured debt, subordinated debt and equity. Two of these investments were new mezzanine deals related to healthcare and one was an opportunistic investment in senior secured debt in the secondary market at a substantial discount of a company we know well. Our core debt investments during this quarter had an average yield of 14.2%.

Let's walk through some of the highlights. We invested $20 million in subordinated debt and $3 million in the equity of CT Technologies' HealthPort. CT is the leading outsource provider of release of information services to healthcare facilities. [Avery] is the financial sponsor of the company.

TZ Merger TriZetto is a leading healthcare information technology company that develops software solutions to service health insurance plans and third-party administrators. We invested $20 million in the subordinated debt and $2 million in the equity of this buyout. The company is owned by Apax.

In addition, we invested $13 million in the senior secured debt of EnviroSolutions, a leading vertically-integrated waste disposal company. EnviroSolutions is a company we have followed in the past and we were able to purchase the senior secured debt in the secondary market at an attractive price. EnviroSolutions is owned by Investcorp. We will continue to be opportunistic in the secondary market with a focus on purchasing investments in high-quality companies at attractive prices.

With regard to the primary market, we expect it will be slow for a while. We are well-positioned to be one of the few players who can be active and we expect that some of the structures will contemplate us and others filling the void of the senior secured market with stretched senior or unit tranche structures that combine senior secured and mezzanine in one strip.

From the standpoint of exits, in order to rotate our portfolio to higher-yielding investments and to preserve liquidity, we sold about 40% of our non-core senior secured investments during the quarter. We sold investments in nine different companies, aggregating $55 million of proceeds at prices that now look attractive. The average price on exit was $0.84 on the dollar. Let me now turn the call over to Aviv, our CFO, to take us through the financial results.

Thank you, Art. For the quarter ended September 30, investment income totaled $11.4 million and net expenses totaled $6 million. Management fee totaled $3.3 million and general and administrative expenses totaled approximately $800,000. Interest and credit facility expenses totaled $1.9 million. Accordingly, net investment income was $5.4 million, or $0.26 per share, exceeding our dividend of $0.24 per share.

Net unrealized loss from investments was $5.9 million, or $0.28 per share and realized losses was $10.5 million, or $0.50 per share for the quarter ended September 30, 2008. Our overall debt portfolio has a weighted average yield of 11.1%. The non-core senior secured debt portfolio yielded 5.2% and the core debt portfolio of selected senior secured debt, second lien secured and subordinated debt yielded 12.5%.

On September 30, our portfolio consisted of 37 companies and was invested 45% in subordinated debt, 28% in second lien secured debt, 2.5% in preferred equity, 3.5% in common equity and 21% in senior secured loans. Our core portfolio has 19 companies with an average interest investment size of $16 million and our non-core senior secured debt portfolio has 19 companies, including one also in our core portfolio, with an average investment size of $3.5 million.

As of September 30, our net asset value per share was $10 down from $10.77 last quarter. This decrease was due to volatility of liquid leveraged finance markets, somewhat offset by the maturation and growth of our core mezzanine debt and equity coinvestment portfolio. As a reminder, our entire portfolio is mark to market by our Board of Directors each quarter using the exit price provided by independent broker-dealer market quotations when active markets are available or by independent valuation firms under FAS 157. Additionally, as Art mentioned, as of October 1, 2008, we elected, under FAS 159, to mark our credit facility to market to match our assets and liabilities.

With regards to the dividend, we increased our dividend to $0.24 per share last quarter from $0.22 and for the full fiscal year, we declared total dividends of $0.90 per share. As of September 30, our run rate net investment income, assuming no changes, was greater than $0.24 per share. As you know. BDCs are obligated to pay out at least 90% of their net investment income. If we make no new investments and our portfolio continues to perform, our income will continue to be higher than our dividends. Now let me turn the call back to Art.

Thanks, Aviv. In summary, we are well-positioned to deal with the challenging market and economic environment. Throughout our structure, we are well-matched. Our underlying portfolio of companies generally has strong interest coverage that is paid to us as interest income and covers our dividend. We have substantial liquidity to make new investments in this opportunistic environment to generate more cash flow to either pay out to shareholders or cushion for potential defaults. Our asset and liability values are matched under FAS 157 and 159. Our portfolio is also matched from the standpoint of fixed and floating interest rates.

We have the illiquidity to add more investments at the most attractive risk reward we have seen in years. On new investments, we will continue to be selective and focus on companies and capital structures that we believe will be defensive in this environment. Our team is experienced and has managed through multiple cycles over 20 plus years. All of this should translate into a stable dividend stream and over time growth in net asset value.

Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

(Operator Instructions). Sanjay Sakhrani, KBW.

Hi, thanks, good morning. Just based on the performance of your stock, it would appear to me that investors are kind of concerned about the potential for future negative marks and therefore, the liquidity as it relates to your revolver. Could you just talk about how you're managing through this and tie that into the potential for future dividend payments?

Thanks, Sanjay, good morning. On the marks, we follow a very rigorous process with independent external valuation firms with broker-dealer quotes. I must say there are, on some of the broker-dealer quotes, we are finding increasingly inactive markets and when we get a -- we're considering when we get a broker-dealer quote that it is not active sending out some of those names to the external valuation firms under FAS 157.

But we feel that under the 157, 159 accounting mechanisms, the marks on the asset side are, in large part, offset by the marks on the liability side so that volatility of net asset value is reduced, as well as our liquidity is enhanced through those two mechanisms. That is why we said on the presentation a moment ago that we have well north of $100 million of liquidity available to us from our credit facility.

And you guys feel like instituting FAS 159 should help the revolver and you have cleared that with the respective parties that it needs to be cleared with?

This is GAAP and we are in good shape from that standpoint. GAAP is GAAP.

Okay. And that is kind of what is stated in your revolver covenants, right?

Yes.

That is GAAP. And perhaps you could just talk about how much of the portfolio is liquid that you could kind of get in and out of easily just in case you got closer to that one to one.

At this point, about half our portfolio is valued by independent valuation firms and about half of the portfolio is quoted by broker-dealers. Levels on how liquid that stuff vary. The first lien portfolio is more liquid than the second lien portfolio in general. The second lien portfolio, in general, was usually essentially privately placed with us and a few others. We do get broker-dealer quotes on them. I can't tell you those are active markets and some of those situations we may end up sending out to external valuation firms because those quotes are inactive. The first lien portfolio is generally pretty active.

Okay. And then just on credit quality -- thanks for discussing that one non-accrual. But if you could talk about other companies that are potentially on a watch list that you are a little bit more concerned about, that would be helpful as well.

We disclosed some statistics. Our core kind of mezz portfolio, by and large, is in very good shape. I gave you the statistics about kind of how EBITDA has grown 19% and how EBITDA -- the interest coverage has improved. Obviously, we have Swift and Realogy issues that we are working through. We both feel that, on those situations, both those companies will continue to pay us cash interest, but those are on watch lists. Both those companies have liquidity through their revolvers. They just have to work through covenant issues, which the equity in those cases is certainly incentivized to do because, as you know, as I said earlier, when you don't pay cash interest, your equity goes to zero. So in both those situations, we think they will pay cash interest.

Ultimately, in your analysis if you want to impair those or mark those down or say that less interest coverage is going to come out of it, you can certainly do that. We feel we have got ample liquidity to fill in the gaps that would result from any defaults -- from those defaults or others that we have in our portfolio.

Okay, great. And maybe one last one. Clearly, the stock is down a lot and it doesn't seem like your peers are doing any better of late. But what do you think is being missed here? What are your thoughts on the stock here?

Look, we are a small BDC. When the two largest BDCs stopped their dividends, which has been a concern of mine for a long time about the space, you have got the two biggest BDCs that stopped their dividends unfortunately and working through issues. I think we are in a different position, which is kind of the presentation we made this morning, which is we are actually pretty well-matched. We are generating strong interest coverage out of these portfolios. It is coming to us as interest income. It is being paid out to the shareholders. We don't depend on realizations. We don't depend on capital gains, we don't depend on PIK. What we are focused on is a stable and hopefully growing dividend, but certainly at a minimum a stable dividend and offsetting any potential defaults we have with additional investments that we make in the future.

So if you look at us as a yield play at this point, hopefully NAV will start to grow over time but certainly at a very minimum a stable yield play. We think hopefully people will be attracted to that certainly as LIBOR and short-term interest rates and money market rates continue to come down. At some point, people will want yield again.

All right. Great. Thank you very much.

Thank you, Sanjay.

Kenneth James, Robert W. Baird.

Good morning. I think this was largely covered in the last set of questions, but I just want to make sure -- maybe you can throw a hard number here that there is no covenants on your credit facility that you are worried about at all that would give the banks a reason to take kind of that gold LIBOR plus 100 away or have to renegotiate that.

We don't believe so. FAS 159 was in GAAP well before our company was set up, well before our credit facility was signed.

Okay. And do you have a minimum tangible net worth covenant because that seems to be what everybody is kind of focusing on for some others that may have problems?

Yes, but again, first of all, it is a low number. It is $120 million. Our NAV was [210] before we did 159. And then 159 will continue to offset. Just one other point while I have got you on 159. One side benefit on behalf of shareholders is it is very shareholder-friendly from the standpoint of that it does increase our NAV, which also, in essence, increases the hurdle on our incentive fee. So as you know, the hurdle on our incentive fee is 7%. In essence by doing this on a pro forma basis, the hurdle ends up somewhere in the mid-8s as a result because your incentive fee is calculated off of NAV.

Okay. And then in terms of your debt-to-equity ratio at 75%, 76% or 77% -- excuse me -- do you feel like you need to maintain kind of that cushion even with the FAS 159 because obviously that is going to help you with movements in the market from a spread perspective, but not any potential problems from a credit perspective. So do you think you kind of need to kind of hold fast where you are right now or is there a potential that you could use some of that liquidity that you have to lever up a little bit?

We are going to play cautious offense. We are not going to go out and kind of deploy all the capital certainly at this point. We're very cautious, we're very selective. We are only going to do deals that meet our very high parameters at this point, but we can play some offense and we will and we are going to play some offense to both hopefully grow investment income and also cushion for potential defaults. At the same time, we are not going to go crazy and kind of spend all the money today. We are always going to maintain a bit of defensiveness and cushion to make sure that we weather any storm that might hit us.

Okay. And then just kind of a housekeeping item here. It looks like the SG&A line and the expense in the income statement was quite a bit lower than it had been or are a little bit lower than it had been the previous three quarters, the lowest quarter of the year. Was there anything there that was nonrecurring where that number should jump back up next quarter?

We are obviously in this environment working on all the cost savings we can work on. We are insourcing and bringing in-house some things that were done externally, whether it be Sarbox stuff or administrative stuff. So we are working hard to keep G&A as low as it can possibly be.

Okay. All right. Thanks a lot, gentlemen.

Rolf Ruben, Merrill Corp.

Yes, on the mark to market on the credit facility, how much did that add in kind of dollars and cents to the book value?

It didn't add anything for September 30 and I believe in footnote 2 of the K, we disclosed that it adds roughly $2.00 a share as of October 1, $1.98, something like that.

Is there any other color you can give on the watch list? That seems to be the thing that has people most concerned about BDCs at this point.

Yes, as we look at the portfolio, as we said on average, the interest coverage is over 2.5 times. Yes, there are a few names where the numbers are under two times coverage and look, we are watching all the names in our portfolio and we'll see how the numbers roll in over the coming months and coming quarters, but we feel like we have got ample cushion in the vast majority of these names to weather the downturn and hopefully play a little bit of offense so that we can increase income and certainly more than offset any defaults we may have.

Great. Thank you very much.

That concludes the question-and-answer session today. At this time, Mr. Penn, I will turn the conference back over to you for any additional or closing remarks.

Great. I want to thank everybody for their interest and support and we are looking forward to talking to you in early February when we come out with our next Q. Take care.

That does conclude today's conference. Thank you for joining and have a great day.