Pennantpark Investment Corp (PNNT) 2009 Q4 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation fourth fiscal quarter 2009 earnings conference call. (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.

Thank you, and good morning, everyone. I'd like to welcome you to our fourth fiscal quarter 2009 earnings conference call. I'm 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'd also like to call your attention to the customary Safe Harbor information 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 filing with 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 am going to spend a few minutes discussing current market conditions, followed by a discussion of our strategy, then open up for Q&A. As you all know, the economic signals are mixed, with economic statistics pointing in various directions. Many economists expect a flat to slightly growing economy going forward. With regard to the more liquid capital market, and in particular, the leveraged loan and high yield market, there's been a significant rally and the levels seem to be holding. Yield-oriented investors have been investing in high yield and leveraged loan funds, as LIBOR and other money market rates are at record lows. This cash flow into the market has been driving both secondary levels and new issues. Many leverage companies have issued high yield debt, as part of covenant renegotiations and to push out maturities which reduces default risk.

We believe that the mixed economic conditions may last awhile, as primarily a lender, a flat economy is manageable as long as capital structure has appropriate leverage and interest coverage. In this environment, we remain focused on long-term value and making investments that will perform well over several years. We 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 or structures that are more defensive, and have low leverage, strong covenants and high returns. As prior cycles have proven, our new investments in this environment may end up being some of our best. With respect to PennantPark, we have been active and are well positioned.

For the quarter ended September 30, 2009, we invested about $65 million, primarily in lower risk first lien senior secured debt at an average yield of 13.8%, and expected IRRs generally ranging from 12% to 18%. Average debt to EBITDA on these new investments was below 3.5 times. We expect to continue to find attractive risk reward in this environment to grow our income in safer, more secure investments. Net investment income grew from $0.27 per share to $0.28 per share during the quarter, including dilution from our equity offering in September. Net investment income is $0.29 per share, excluding this dilution. Additionally, many of our investments last quarter were completed towards quarter end.

We have continued to invest since quarter end, to continue to grow income. Due to the stability and growth of our income, we announced a dividend increase to $0.25 per share. Our run rate income continues to be higher than our newly increased dividend. As a result of our initiatives to focus on higher quality new investments, combined with solid performance of existing investments, our portfolio is demonstrably safer. The credit statistics of the overall portfolio continue to improve. The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense, continued to be a healthy 2.8 times. This provides significant cushion to weather the weak economy, and provide stable investment income. Additionally, at cost, the ratio of debt to EBITDA came down again this quarter to 4.5 times, and another indication of reduced risk in the portfolio.

Our portfolio is relatively low risk. It consists primarily of cash pay debt instruments, and only 6% of the portfolio is preferred and common equity. Out of the 79 investments we've made since inception over two-and-a-half years ago, we've had only two companies on non accrual, one of which has subsequently been reorganized. We currently have one company on non accrual representing about 3.5% of the portfolio at cost. To the extent we have more non accruals, which is probable in this economic environment, we have substantial cushion between our interest income and our dividend. From a value perspective, we have invested in companies at reasonable multiples of cash flow. As a reminder, if a company ever fails to pay us the cash interest they owe us, our debt security generally either receives better terms, higher yields and tighter covenants. Or alternatively, take some form of equity ownership in the company.

As we have mentioned earlier on average at cost we have created a portfolio at approximately 4.5 times EBITDA or cash flow. At the fair market value on September 30th, that value was about 4.2 times cash flow. At the stock price of PNNT today below NAV, we the shareholders, on a portfolio of companies, at a multiple at about 3.5 times cash flow. Value investors should be able to appreciate that attractive and low multiple. The statistics we have mentioned relating to interest coverage and EBITDA multiples, highlight an important point about the vintage of our investments.

At cost, about 82% of our current core investments were made after June 2007, when the credit markets started to deteriorate. As a result, the investments completed after June 2007, tend to be a more defensive sectors, have lower leverage multiples, tighter covenants and better pricing. To date our investment thesis on those companies remains generally on track. We are in good shape from the standpoint of liquidity. In late September we completed a follow-on stock offering of 4.3 million shares at $8.00 per share, resulting in net proceeds to the company of about $33 million. In mid-October the underwriters exercised their over-allotment option, and purchased an additional 440,000 shares resulting in an additional $3.3 million of net proceeds. As of September 30th, we had about $90 million of our credit facility and cash available to us, in addition to our noncore first lien portfolio of about $43 million.

We will continue to gradually sell down this noncore portfolio, and rotate to higher yielding assets. We continue to be substantially matched from the standpoint of fixed, and floating interest rates and our asset liability mix. As we had a assets at attractive yields over the next few quarters, our net investment income should grow. An inevitable part of our business, particularly in a soft economy, is defaults. The combination of our existing portfolio and new investments should position us to have a stable dividend, even if we experience non accruals. That being said, to be clear, we will do our best to maintain a stable dividend, and potentially grow the dividend, but it is not guaranteed.

With regard to portfolio developments, we've had some positive events that have helped make our investment and income more secure. For instance during the quarter, the value of our position in Swift Transportation increased significantly, from a value in the low 30s to now in the low to mid-70s. This is due to a capital structure fix, which resulted in easing of the covenants on the bank debt and de-leveraging the balance sheet. For Realogy, recent housing statistics have indicated a bottom in housing prices and activity levels, which have been helpful to the value of our position. We used the significant rally in the Realogy subordinated debt as an avenue to exit about two-thirds of our position, and we reinvested the proceeds in an attractive new second lien instrument higher in the capital structure. This new second lien instrument also helped the company, by creating significant liquidity and covenant room to enable it to works its way through much more of the housing cycle.

In terms of new investments, we had an active quarter primarily investing in senior secured debt at attractive returns. On the secondary side we found some interesting opportunities at significant discounts to par, by purchasing more Rex Air and investing in US Express. On the primary side, much of our activity was driven by refinancing. We found attractive risk/reward in senior secured debt of some of the only gaming properties licensed and permitted in large urban areas. Yonkers Raceway, Chester Downs and Sugar House are uniquely positioned in the New York and Philadelphia markets. Additionally we invested at the top of the capital structure in Ceva, a global logistics provider.

With regard to the outlook, we've continued to see activity levels pick up. New deals have primarily been driven by refinancing of existing capital structures, as companies look to extend maturities and replace lenders who are exiting the market. We've also seen a rise in the level of middle market M&A activity, which over time should drive substantial portion of our investments. Much of our business will be driven by companies that need a financing solution, and don't have many options as finance companies, CLOs and local banks have exited the market. Let me now turn the call over to Aviv, our CFO, to take you through the financial results.

Thank you, Art. For the quarter ended September 30, 2009, investment income totaled $11.8 million, and expenses totaled $5.8 million. Management fees totaled $3.7 million. General and administrative expenses totaled approximately $1.3 million. Interest and credit facility expenses totaled about $800,000, and accordingly, net investment income was $6 million, or $0.28 per share. Excluding dilution from our equity offering, net investment income is $0.29 per share. During the quarter ended September 30, 2009, net unrealized change from investments was a gain of $32.2 million, or $1.52 per share. Net unrealized change from credit facility was a loss of $3.6 million, or $0.17 per share. Realized losses was approximately $8.4 million, or $0.39 per share. Excess net investment income over dividend was approximately $1 million, or $0.05 per share. And dilution from our stock offering was $0.88 per share. Consequently, NAV per share went from $11.72 to $11.85 per share.

As reminder, our entire portfolio and our credit facility are mark- to-market by our Board of Directors each quarter, using the exit price provided by an independent valuation firm or independent broker dealer quotation, when active markets are available. Under ASC 820 and ASC 825, formerly FAS 157 and FAS 159, in cases where a broker dealer quote are inactive, we use independent valuation firm to value these investments. Our overall debt portfolio has a weighted average yield of 11.4%, up from 10.4%, primarily due to the origination of higher yielding assets. The noncore senior secured debt portfolio yielded 3.1%, and the core debt portfolio yielded -- increased to 12.5%, up from 11.6% the prior quarter.

On September 30, 2009, our portfolio consisted of 42 companies, and was invested 32% in senior secured debt, 29% in second lien secured debt, 33% in subordinated debt, and 6% in preferred and common equity. Our core portfolio has 30 companies with an average investment size of $14.2 million. And our noncore senior secured debt portfolio has 13 companies, including one also in our core portfolio with an average investment size of $3.3 million. With regard to the dividend, as of September 30, our run rate net investment income, assuming no changes, continues to be greater than our dividend. As you know, BDC's are obligated to pay out 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 dividend. Now let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable, and growing dividend stream. Everything we do is aligned to that goal. We try to find larger, less risky, middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. Thank you all for your time today, and your continued investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

Thank you. (Operator Instructions). We'll go first to Sanjay Sakhrani with KBW.

Alright, thank you. A couple of questions. First, obviously very strong quarter for investment growth relative to what we've seen. Could you just talk about what we should expect near term. And maybe just following up to that question, could you just talk about that in context of your liquidity, as well as how much leverage you're willing to take on before considering another capital raise? Thanks.

Thanks, Sanjay, $65 million is a big quarter for us, 10 of that was basically a reinvestment in Realogy. The prior quarter was in the low 30s -- 30 to 40 to 50 is probably the right zone. Of course, we're value investors, and if there's lots of good deals, we'll do them. If there's no good deals to do, we won't. So it's hard -- hard to pin it down. And also, since more of the upcoming product is going to be M&A driven, there's going to be an inherent lumpiness and unpredictability of that flow.

But for modeling purposes, 30, 40, 25 to 40, 30 to 50, it's hard to pin it down, but that's probably the right zone. Probably gives us couple of quarters between our credit facility and our noncore first lien, putting our head down, focusing on -- on finding good investments, that's the focus. We've gotten the question, are you going to be back to the equity markets. We have no current intention of coming back to the equity markets. We've got plenty of liquidity, between the credit facility and the noncore portfolio. We're just focused on trying to find some deals for the next couple quarters of the year.

Okay. And then just on Realogy and Swift, obviously the debt has kind of rallied significantly. I mean do you think that could be used as a source of liquidity?

Look, you always -- that is one of the positives of liquid investments, that is if you find better uses of that capital, you can sell those down, and certainly it's easier to sell things at higher prices than lower prices. We have no current intention at this point on those two names. But, we'll keep watching those two names in particular. We'll keep trying to find some good deals. I would just say that's probably a lower priority right now, than the noncore portfolio in terms of sell-down.

Okay. And one final one. You mentioned the non accrual. I guess another piece of that investment that was on nonaccrual, went on nonaccrual. Are there any other investments that you're kind of worried about, within that portfolio? I saw one senior debt investment was marked down significantly. Could you just talk about that as well?

Yes, the one that you're referring to is Levlad Natural Product, which is underperforming. I can't say whether we've sold that position down or not, post quarter-end. It is liquid. We evaluate situations like that periodically. And in certain cases you have seen us either choose in more stressed situations, either to sell. Or in some cases we've held on, and worked it through, such as Greatwide where, we worked it through the bankruptcy, and now have a piece of debt and a piece of equity in the post reorganized structure. We feel very good about at least having our arms around the portfolio, and what the -- where the areas of stress are. That's kind of, I guess, inherent in our decision to increase the dividend. It was not only because our income is growing, but we feel like we've got our arms around the portfolio very well. And to the extent there are situations that we need to focus on, we're focused on them, and feel like we understand the downside. So we're feeling pretty confident about the portfolio at this point.

All right. Great, thanks a lot.

Thanks, Sanjay.

We'll take our next question from Scott Valentin, FBR Capital Markets.

Thanks, and good morning, and thanks for taking my question. Regarding the status of the SBIC, can you update us on that?

Yeah. We have not yet filed an application for the SBIC. We probably will in the coming weeks. It's a -- you may have heard it's a pretty large application to fill out, and very detailed, and we're in the process of doing that. So hopefully sometime in the next month or so, we will file that application.

Okay. What -- do you have any idea what a historical turn around time is for a decision on that?

Look, it is a lengthy process. There's at least one other BDC in the process now. I think you have to assume it's a 12-month process from end zone to end zone, kind of midway through they say go -- they let you -- they say kind of go for it. You can start using your equity to fund an SBIC. And call that anywhere, from three to six months after the initial filing.

Okay. Then in terms of the -- your originations jumped quite a bit this quarter. Are you seeing more competition now, that it seems that the markets are getting more liquid, or is it still pretty much a dearth of competition out there?

Look, there's a -- it depends on what you call the competition. On the bigger names that can access the public liquid market, the public high yield market, the more liquid leverage loan market, those markets as we've said have rallied significantly. So on some of the larger companies that have access to the public or the private markets, the public markets are pretty stiff competition right now. On the companies that are -- that don't have that access, that are smaller, which are the traditional middle market names that we've historically focused on, there's still a dearth of lenders. We still feel like the competitive playing field is small. And the people who remain in the playing field, generally, we think are rational investors. And we're happy to partner with, and club deals, so we're feeling very good about the opportunity in our core market.

One final question, and I'll get back in the queue. But just the G&A line, relative to the prior quarter jumped percentage-wise quite a bit. Anything one time or special?

It's a great question. I mean -- we -- the good news and bad news. Bad news is G&A is up. The good news is we are traveling a lot more, which means we're going off doing due diligence, writing commitment letters. On an annual basis, it's still kind of $4.5 million a year, on an annual basis, which is kind of right in line with this past quarter. So nothing unusual in the big picture. It was just it was a little lighter a couple quarters ago, when we were not traveling as much.

Okay, alright Thanks very much.

Thanks, Scott.

We'll take our next question from Greg Mason, Stifel Nicolaus.

Great, thanks, this is actually Troy. Just a follow-up on Sanjay's question. You have the ability -- you have $225 million outstanding now, the ability to go up to $300 in leverage. Where are you comfortable with? Taking that all the way to three?

Well, we're -- 225, it's really 210 if you look at the balance sheet, and net off the $33 million of cash on the balance sheet at quarter end, and the unsettled trades as a net, it ends up about 210. Look, I think -- we think given the liquidity in the portfolio, you probably -- you could probably take it to 270ish, call it, plus or minus -- given the liquidity of many of the names in our portfolio which is kind of a 10% cushion, plus the -- plus the noncore, which every passing day gets easier to sell that because, number one, the prices have been going up, and number two, it's more liquid.

And that leads right into my next question. On the noncore portfolio, I know you said you have no plans to come back with equity. And clearly this quarter, these originations you had the equity offering. But as we think about modeling forward, would you anticipate the noncore portfolio being exited entirely before you go back to the equity market?

That's case by case. Some of the names that are lower values, if we believe in the investment thesis, are harder to exit. But if you look at that portfolio, call it 75% - ish or so are at reasonable prices, i.e., 80 and above, 75 and above, and easier to exit. And a bunch of them are in the 90s. The vast majority in the 80s and 90s, those are easy sales. And then you really debate if something is at 70 or 75, that's a harder debate to have. You have to assess what you think of the credit, and the likely value is. And we're focused on preserving and enhancing NAV, and also growing income. And that's the balancing act that we all have as BDCs.

Okay, and then one more. And then on your new Ceva, it says it's a logistics company. Can you give a little color on what exactly they do?

It's a non asset based global logistics company. It's very large, over $400 million of EBITDA. This was an opportunistic financing. We're very high in the capital structure. We're under two times EBITDA from where we are. The company is pretty leveraged overall, if you look at the leverage throughout. It's a pretty leveraged company, but we felt we're safe, very high in the capital structure, and we're clipping pretty nice coupon where we are. So it's a very large global transportation logistics company.

Great. Thanks, guys.

Thank you.

We'll take our next question from Erin Caddell with Hovde Capital .

Hi, can you hear me okay?

Yes, Erin.

Hi, how are you? Am I correct in assuming that based on the schedule, later this year you'd have an additional $20 million from the Lyondell, which I understand was a DIP loan, so that would presumably have to be reinvested? Or would that go just into your excess liquidity?

You're making a great point, Erin, to the extent of our liquidity. Whether we like it or not, and some of you -- you never -- you never don't like it when someone pays you back. So we have a average short maturity in Lyondell. We have some other situations that are under-levered, that where people are paying us 13.5% 14% coupon, and they're under two times debt to cash flow. There will be refi's. We will get some liquidity from the existing portfolio, and have the opportunity to roll that into new deals.

Okay. Then just in terms of maybe kind of big picture -- in terms of your daily interaction with -- in listening to the calls of your current and potential investments many of which are in, I guess, kind of in the real economy, and forgetting about kind of the capital markets, and what the high yield market has done, would you say that your companies are optimistic about 2010, pessimistic,-- just in terms of the revenue and EBITDA outlook, just their outlook for their overall business in their industries?

Look, it's -- the sentiment is certainly changing. I'll give you the kind of right in the middle of the storm, Realogy did a conference call a few days ago, and for the first time ever, they -- they had an optimistic tone to it. We'll see the reality, if the numbers come out over the coming quarters. We're feeling -- feeling --certainly stability, and the key question is, is their growth. And we don't necessarily model that as lenders, stable and flat is okay, if we've got the right capital structure. And the ups is really kind of create the -- create the exits in certain elements of the portfolio, and refinancings and M&A deals, and IPOs. But we're feeling -- I think we're feeling okay, and I mean inherent again in the dividend increase is a confidence about -- our confidence about our portfolio, and how we think it's going to play out here.

Sure. Thank you for taking my questions.

Thank you.

We'll take our next question from [Wayne Juntkins], investor.

Yes, sir. I have a question regarding your secondary offering. At what discount, percent NAV, do you guys -- sitting there -- will you guys say, we won't sell these things? It looks like we did this -- you did it at a, I guess, a 35% discount. When would that not make sense to be selling equity and diluting the shareholders?

It's a great question. It's hard to draw a hard and fast rule, because it also depends on the opportunities you are seeing in the market, and you play off the dilution on NAV versus the growth in income. And we were not happy with $8.00 a share. I will say that right now. We do see a wonderful opportunity in the market to grow income. And ultimately, we think for us the main mission here, as you've heard in our comments, is growing income, which will ultimately mean growing dividends.

So we hate selling stock below book. Something we don't -- we don't do lightly. But if we think we can use the proceeds to grow income, and grow the dividends, and we're seeing great opportunities in the market, we will certainly consider doing it again.

Is there ever any thought, as the Board of Directors, has the firm ever looked at questioning the management fee? When you start issuing that big of a discount, and do no adjustments to the management fee, it turns the investment to $0.50 on the dollar to the shareholders.

We look at it as how we can grow income, and if we grow income, we're all aligned, both the shareholder and the management. There's a piece of our fee, which is way out of the money, which is the capital gains piece of the fee. We are going to work hard to build NAV, and get back some of those losses that we've realized. But we feel we're amply aligned. I think that you can see from management's actions every quarter we're in buying the stock ourselves consistently, and reinvesting and aligning ourselves already with shareholders, aligning ourselves even more.

Thank you much. That does conclude the question-and-answer session. I'd like to turn the call back to our speakers for any additional or closing remarks.

Great, I just want to thank everybody for participating, and thank you for your support, and we'll be talking to you next in early February. Good-bye.

Once again, that does conclude today's call. We do appreciate your participation.