Pennantpark Investment Corp (PNNT) 2012 Q1 法說會逐字稿

Good morning and welcome to today's PennantPark Investment Corporation's first fiscal quarter 2012 earnings conference call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the speaker's remarks. (Operator Instructions).

It is now my pleasure to turn the conference 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 would like to welcome you to our first fiscal quarter 2012 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 would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's call is 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 or 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 few minutes discussing current market conditions, followed by a discussion of investment activity, the portfolio, our overall strategy and then open it up for Q&A.

As you all know, the economic signals have continued to be mixed to slightly better with many economists expecting a flat to slowly growing economy going forward.

With regard to the more liquid capital markets and in particular the leverage loan and high-yield markets, starting in the middle of 2011, the quoted prices of liquid leverage finance assets saw a downturn during the summer and remained fragile through the end of the year. The market softness has brought a much needed breather to the more liquid capital markets which had rallied for two years.

As investors, we appreciate the pause in the more liquid capital markets and are pleased that there is more skepticism in the market. We have been benefiting on both the primary side of our businesses as well as taking advantage of selected opportunities in the secondary market. That said, the liquid credit markets have rallied so far in 2012 as cash flows in the leverage loan and high-yield funds have been strong.

As debt investors and lenders, a flat economy is fine as long as we have underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome.

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.

We significantly reduced competition in the middle market and we have taken advantage of the 2009 through 2011 vintages. The upcoming 2012 vintage should remain solid. With plenty of dry powder, we are well positioned to take advantage of the market opportunity.

As credit investors, one of our primary goals is preservation of capital. If we preserve capital usually the upside takes care of itself. As a business, one of our primary goals is building long-term trust. Our focus is on building long-term trust with our portfolio companies, management teams, financial sponsors, intermediaries, our lenders and of course, our shareholders.

We are a First Call for middle-market financial sponsors, management teams and intermediaries who want consistent, credible capital. As an independent provider, free of conflicts or affiliations, we have become a trusted financing partner for our clients.

As the market has gotten more active, we are completing more transactions for well-regarded financial sponsors with whom we have had long-term relationships. Since inception, PennantPark entities have financed companies backed by 81 different financial sponsors.

We have been active and are well-positioned. For the quarter ended December 31, 2011, we invested about $43 million with an average yield on debt of 16.4% up from 12.8% the prior quarter. Expected IRRs generally range from 13% to 18%.

We have some attractive investments which did not get close by year-end but were closed in early 2012. Since December 31, we have invested $73 million.

Net investment income was $0.33 a share. We have met our goal of steady, stable and growing dividend stream since our IPO about five years ago despite the overall economic and market turmoil. We announced a dividend increase to $0.28 a share for the December quarter.

We are in the process of renewing our credit facility on attractive terms. The facility will have a four-year maturity with a one-year term out after year three, we will price at LIBOR plus 275. The size will be at least $350 million. We appreciate the support and long-term partnership of the lending community to our Company.

To enhance our liquidity to take advantage of opportunities in the market in late January, we raised $105 million of net proceeds in an equity offering. Incremental float and liquidity and our shares should continue to help attract investors to our stock.

In the last couple weeks, both Standard & Poor's and Fitch have rated our debt investment grade BBB-. This is a significant milestone for our Company as it confirms our solid track record over time and the institutionalization of our business. Importantly, it should help us continue to raise debt capital efficiently over time.

As a result of our focus on high-quality new investments, solid performance of existing investments and continuing diversification, our portfolio is constructed to withstand market and economic volatility. The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense, continued to be healthy three times. This provides significant cushion to support stable investment income.

Additionally at cost, the ratio of debt to EBITDA on the overall portfolio was 4.6 times, another indication of prudent risk.

The structure of our investments in the portfolio is relatively low risk as well. It consists primarily of cash paid debt instruments and only 9% of the portfolio is preferred and common inequity. We are pleased with the performance of the portfolio through the stress test of the last few years.

During the recession on a weighted average basis, based on cost, the EBITDA of the core portfolio was down only 7.2% from initial investment to its lowest point.

We have plenty of liquidity. As of December 31, we had in total about $190 million of available liquidity which included $123 million available under our credit facility, about $26 million of assets with coupons less than 9% which we intend to continue selling and rotating into higher yielding new investments, and $41 million of cash in our SBIC. With the proceeds of the equity transaction and an upside credit facility, we have plenty of dry powder.

We continue to grow our SBIC and Aviv will give an SBIC update later. We are looking forward to applying for a second SBIC license when appropriate to be able to access up to another $75 million of debt capital.

As a reminder, we have exempted relief from the SEC to exclude SBIC debt from our asset coverage ratios and SBIC accounting is cost accounting, not marked to market accounting. These facts highlight how the SBIC debt reduces overall risk of our Company.

We had some significant realizations last quarter. Our $29 million position in Kadmon Three Rivers debt was refinanced and generated an IRR of 26%. Consolidated Foundries was sold and our $8 million debt investment was taken out at an IRR of 14.5% and our equity and our investment in the equity generated an IRR of 36%.

Out of the 116 investments we have made since inception about five years ago, we have had only five companies on non-accrual, four of which have been reorganized. Last quarter, as expected, two of those companies went on non-accrual, Hanley-Wood and DirectBuy. The Hanley-Wood restructuring was the catalyst that we had been anticipating in order to convert a portion of our debt investment to equity and capture some upside in the Company at an attractive valuation at an attractive point in the cycle.

As of December 31, Hanley-Wood was only an $8.7 million position, or 1% of the portfolio at cost and 0.5% market value and the income that was being generated at LIBOR plus 225 was not material. The market value of that position as of December 31 was $4.2 million.

Hanley-Wood was the first default we have had in nearly two years. The restructuring was completed quickly and as of today, we have a $1.8 million piece of cash paying debt and $2.5 million of equity including an additional $800,000 equity investment we made as part of the restructuring. The Company comes out of the restructuring as an industry leading, high-quality, low-leverage Company.

With regard to our investment in DirectBuy, we are disappointed with the situation and the debt continues to trade poorly. The November 1 interest payment was made but the February 1 interest payment was not made. As a result, we put the investment on non-accrual as of November 2. As of December 31, committee investment represented 3.8% of the portfolio at cost and 1% on a market value basis. We are continuing diligence on the Company and the situation. In any event we do not believe that this situation is material to the earnings of PNNT.

To refresh your memory about our business model, we try as hard as we can to avoid mistakes but defaults and realized losses are inevitable as a lender. We are proud of our track record of underwriting credit through the cycle. One way we mitigate those losses is through our equity co-investment portfolio. Realized gains on investments such as Consolidated Foundries help offset the inevitable losses that we have from time to time.

We are optimistic that our co-invest portfolio which includes names such as TriZetto, [TT HealtPort], Magnum Hunter, Kadmon and Veritext, will generate gains over time.

From an interest rate standpoint, 8% of the portfolio has an interest rate that floats, another 29% floats but has a floor which protects income in this low base rate environment and the remaining 63% is fixed rate.

In terms of new investments, we had another quarter investing in attractive risk-adjusted returns. Our activity was driven by a mixture of M&A deals and purchases in the secondary market at a discount. In virtually all these investments we have known these particular companies for a while, have studied the industries, have a strong relationship with a sponsor or a differentiated information flow.

Let's walk through some of the highlights. We invested $17 million in the subordinated debt and about $2 million in the equity of JF Acquisition. JF is a leading provider of repair, maintenance, distribution and installation services to the fueling infrastructure industry. MidOcean Partners is the financial sponsor.

We also invested in select secondary market opportunities and names we know well in the existing portfolio such as Affinion and Brand at attractive risk adjusted returns. The turmoil in the liquid markets resulted in those opportunities.

Turning to the outlook, we continue to believe that the remainder of 2012 will be active. We are seeing a significant amount of middle-market M&A which over time should drive a substantial portion of our investment activities. Much of our business will be driven by companies that need a financing solution and don't have many options as finance companies, TLOs and local banks have exited the market.

Due to our strong sourcing network and client relationships we are seeing strong deal flow.

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 December 31, 2011, investment income totaled $26.8 million and expenses totaled $11.8 million. Management fees totaled $7.8 million. General and administrative expenses totaled approximately $1.6 million. SBA and credit facility interest expense totaled about $2.4 million. Accordingly, net and investment income was $15 million or $0.33 per share. This includes $0.04 of other or nonrecurring income.

During the quarter ended December 31, net unrealized gain from investments was $10 million or $0.21 per share. Net realized loss was $8 million or $0.18 per share. Unrealized loss from appreciation of the credit facility was $1.1 million or $0.02 per share and excess net investment income over dividend was approximately $2.2 million, or $0.05 per share. Consequently, entity per share went from $10.13 to $10.19 per share.

As a reminder, our entire portfolio and our credit facility are marked to market by our Board of Directors each quarter using the exit price provided by an independent valuation firm or independent broker-dealer quotations when active markets are available under ASC 820 and ASC 825.

In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall net portfolio has a weighted average yield of 13.2%. On December 31, our portfolio consisted of 46 companies and was invested 32% in senior secured debt, 20% in second lien secured debt, 39% in subordinated debt, and 9% in preferred and common equity.

Our SBIC has drawn the maximum amount, $150 million of SBA debentures and we had $41 million of cash available as of December 31. We feel fortunate to have locked in the entire $150 million at a fixed all-in rate of 4% for 10 years when treasuries were near all-time lows.

We are exploring applying for a second SBIC license when appropriate which would result in up to additional $75 million of SBA loans. As of December 31, undistributed taxable net investment income in access of dividend paid was approximately $7.6 million or $0.17 per share, as of December 31 providing cushion for future dividends.

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 less risky middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in debt instruments and pay off those contractual cash flows in the form of dividends to our shareholders.

In closing, I would like to thank our extremely talented team of professionals for their commitment and dedication. 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 the call to questions.

(Operator Instructions). Joel Houck, Wells Fargo.

Good morning, Art, Aviv. Hope you are doing well. Question is really more broader around the industry as I am sure you are aware, yesterday one of the larger BDCs announced a restructuring and notwithstanding the management changes, they indicated a different direction into more private assets. I guess the question is twofold.

One, do you see that impact come down more into your style of credits as that impacts returns? And second, how do you strike a balance between the more liquid securities that are perhaps more volatile versus where we would consider the higher alpha in the private middle-market deals? How do you look at that in terms of balancing your own portfolio?

Those are great returns -- those are great questions, Joe, and very topical. I guess in terms of competition, we have to assume everyone is our competition, whether they be other BDCs, whether they be the private GP mezz funds, whether they be PLOs, etc. We still think there is a massive opportunity in the market. We are just scratching the surface in terms of financing middle market companies with banks and others and finance companies kind of moving away from the market.

You could add a lot of competition. We still think there is going to be great risk/reward in the marketplace. And the important thing is that competitors behave rationally and we believe the folks at Apollo and others are generally very rational and we welcome rational competition.

In terms of liquid versus illiquid, it is something at least we think about all the time. We like having a portion of our portfolio in liquid instruments both from an offensive standpoint and a defensive standpoint. Although the overall portion is probably moving down over the coming quarters given the volatility of NAVs and protecting ourselves against some event in Greece or Spain or Portugal or where ever. We do like having call it 20%, 25% in liquid instruments both for defenses purposes which is if you need liquidity quickly, it is nice to be able to do that, to access that.

And also there are times in the market where people give you dollars for $0.80 because they are scared and if you have a really nice view of the credit, you have good information flow, you've got good relationships with the management team and the sponsor, if you can pick up a dollar for $0.80, you should try to do that and that is one of the ways you can create upside in your portfolio.

You know, as a lender, we recognize every day that we have got a lot of downside relative to our upside and our good deals get taken out and we are left with sometimes with the deals that aren't so good. So we're always looking for ways where we can take that asymmetry and make it a little bit better, whether it be equity coinvestment from time to time, whether it be warrants from time to time or whether it be buying paper in the more liquid market at discounts when others are scared.

But we do think there is, for us, a 20%, 25% is a prudent liquid portion of our portfolio, which is lower than it has been historically because we really do like the private scenarios where we are in there, we are driving the financing, we are driving the covenants, we are in a more controlled position. To the extent something goes wrong, so that will continue to be the vast majority of our portfolio will be those self originated, private illiquid, highly negotiated transactions.

Great. Thank you very much, Art.

Greg Mason, Stifel Nicolaus.

Great, thank you. Art, you had pretty impressive yields this quarter on your new investments. That $73 million of assets that got pushed into January, can you give us any color on those types of investments? Were they primarily these proprietary middle-market private deals? And what coupons you were seeing on those?

Yes, that primarily was our private self originated deals in the 13% to 14% zone.

Okay, great. And then on the new credit facility, if it is done, one of the things you had on the last one is you are able to take FAS 159, the mark-to-market of your liabilities. Will you be able to take that again under the new credit facility? How does that work?

Yes, no -- it's a good question. We haven't gone public yet with the final terms, but unfortunately the banks have been clamping down on that, you can look at recent other BDC credit facilities and that will be one of the tweaks that will come out of this credit facility so we will still use 159. We will still provide protection for the SEC asset coverage test.

So we still think that is a proper insurance policy to have for the SEC asset coverage test, but it looks like in this upcoming credit facility, we will not get that ability for the credit facility covenants to use 159.

We still think it is a very attractive facility with lots of flexibility. We obviously were appreciative of the upsizing which is nice. We think the pricing at LIBOR plus 275 is attractive also. So generally we are very, very pleased, but it probably will not have that 159 in it.

And then with a potential size of 350 that you mentioned, you would have a significant amount of capacity there in that credit facility, yet you also got investment grade rating which I think should open up some bond markets or other private debt issuance to you. But probably at higher costs versus the LIBOR plus 275.

So as you think about your capacity and where you want to move your capital structure, how are you thinking about your liabilities and what buckets you put them in going forward?

That's a great question. It is something -- first of all, there is nothing near-term really to talk about. We have got an upsized credit facility. We just raised equity. We have SBIC too we're going to go for, and there is potential legislation which could increase the SBIC buckets over the course of the next 12 months, which would be great. That is obviously very cost effective financing.

But look, we are going to look over time to diversify our financing sources. We think that is the proper way to manage the Company, so there is other methodologies to finance BDCs, there is private debt sold to insurance companies that is usually secured. There's baby bonds which BDCs are now doing well. There is potentially at some point, converts. It has been out of favor recently, but potentially converts, etc.

So there are all kinds of different flavors of debt. We think it is prudent to have a myriad of different debt financing sources over time as we grow. We will hopefully judiciously leg into some of those.

Great. Thank you, Art. Thank you, guys.

John Stilmar, SunTrust. Mr. Stilmar, you line is now open

Looks like we lost him. Let's go to the next question, please.

Jasper Burch, Macquarie.

Hey, good morning, guys. This is Jasper with Macquarie. Art, and Aviv, just following up on Greg's question. On the new facility, good job with the rate on the (inaudible). But I was just wondering if you could give us color on what the revolving period might be and if you will have a term out on it?

Yes, we disclosed this that it is a four-year final with a term out after year three.

Excellent. That's all I have.

Arren Cyganovich, Evercore.

Good morning. If you could just talk about the leverage and where you are willing to take that. You have the SBIC exemption and you just kind of raised capital here. Your leverage excluding the SBICs was not particularly high. Is there any kind of guidance that you have been given from the rating agencies that have to keep the leverage at a relatively low level to get your investment grade rating?

Thank you for the question. They don't give us guidance. We told them what our general zone is. Our general zone is 0.6 to 0.8 times; that is our general zone. Obviously, both for offensive and defensive purposes we can take it significantly above that particularly with the SBIC exemption. Not our anticipation now. It would either mean for defensive purposes, we need to increase leverage or because we see such amazing deals in the marketplace that we want to nudge it up a little bit. But those would be unusual circumstances. In general, 0.6 to 0.8 is the zone of where we are targeting.

And that is inclusive of the SBIC debt?

That is inclusive of the SBIC debt.

Okay, and then also could you talk about -- you have several -- not several, but a few investments that are 100% PIK. What is the process for putting a company on a 100% PIK status? It doesn't look like there are any issues with the company, just maybe just a financing mechanism that they are using. Can I just have a little clarity on that?

Well, if we own -- we don't like PIK, just to put it out there, we hate PIK. It is part of the industry unfortunately. In some cases, we have to deal with it, we have to manage it, we have to maintain our liquidity to deal with it. So we don't do any all PIK deals unless we view them in the way that we view them which is they are really equity.

Sometimes a company will underperform and as part of an amendment, you go all PIK for a while. That is usually not a good news event. But it is something that we really try to avoid.

Okay, and then did you mention what you have in terms of exits or sales from the portfolio year-to-date?

You know, was is it, Aviv?

About $68 million or so that we have exited during the quarter.

During the quarter ended December. Are you talking about the -- are you talking about the quarter ended --

I said year to date this year.

So you are talking about March. There are two companies that -- and these -- this is public information that have taken that have refinanced this out. One is a company called RAM Energy. They got basically taken over and got a big equity injection. So that deal was refinanced out. And we have an investment or we had an investment in Chester Downs and that got taken out by a high-yield deal.

Okay. Thank you very much.

(Operator Instructions). Casey Alexander, Gilford Securities.

Hey, good morning, Art. How are you? I don't remember exactly -- what was the -- the percentage that you had on nonaccrual at the end of the quarter, was it 2% of the portfolio?

Well, we will give it to you on both cost and market. On cost, it's 4.8%; on market, it's about 1.5%.

About 1.5%? Okay. Secondly, on your unrealized gains, the statement in the release was that it was due to changes in the leveraged credit markets, but you did take a realized loss. Was there some portion of the unrealized gain that was actually a reversal of a previously unrealized loss?

No, I mean what happened was we had a unrealized loss which was due to our exit of a -- of Aquilex, which was an investment that didn't work out for us. We decided to exit. That was the primary reason for the realized loss. Unrealized gains that we had -- and so between Aquilex, that was a realized loss. We had some unrealized losses from DirectBuy which offset some of the unrealized gains we had in the overall portfolio, the leveraged loan and high-yield markets were up in general over the quarter.

So Aquilex had not been written down before? It was just something that you recognized in the quarter and took the loss?

It had been written down but wasn't realized.

Okay.

So it became -- it went from an unrealized loss to a realized loss.

So there was some reversal of an unrealized loss then?

Correct. So call it was 8 of unrealized loss to 8 of realized cost for that particular name as an example.

Okay, great. Thank you.

John Hecht, JMP Securities.

Good afternoon. Thanks for taking my questions, or morning I guess. First question, Art, I think you talked about the EBITDA from peak to trough in terms of the trends in the market. What can you tell me of the EBITDA performance for the portfolio companies over the past say three to six months?

I mean, you know we track it from inception) I don't have that off the top of my head but it gets -- I can get back to you on the last three to six. In general from inception to today, it is up call at 15-ish%. At the bottom of -- 15%. So at the bottom of the recession, it was kind of down 7%, now it is kind of up 15%.

Okay, and you guys have historically focused on more secured senior type investments and then of course you mentioned some uncertainties with respect to Europe, etc. But if those clouds are lifted and you feel better about the economy, would you take this more subordinate portion of a particular capital structure in order to increase your overall yields?

Look, we look at every deal on an individual deal by deal basis. Clearly the farther you go down the capital structure the more conviction you need to have because recoveries are not as good. So we take every investment very seriously. Obviously if you are way at the top of the capital structure you've got more cushion than if you are in a subordinated piece. So it is deal by deal, company by company, industry by industry. We are looking for the best risk/reward wherever we can get it with the focus on number one preservation of capital.

Okay, can you give us an update and your perspective of the M&A trends in the middle market and what that might mean for deal flow over the next couple of quarters?

So, we are going through what we would call the typical January effect, where January is usually pretty slow as the deal machinery takes a little while to get out of the gates. So it has been a little slow in terms of M&A. We have been active because a lot of our deals kind of float over from the December quarter into the January quarter. That is why we have been -- on the 70 some million so far this year. But that was -- those were really '11 deals that didn't make it in before December 31.

So things are starting to percolate up again in terms of M&A. But it is still a little slow quarter to date, can't really give you any guidance as to what is going to close before March 30 or not. The liquid capital markets as we said in the preface have been rallying. It is something to be focused on just in terms of if people start getting silly again and they start mispricing risk/reward again, it does certainly hurt the liquid markets and it does in some way trickle down to the illiquid markets as people lose fear.

We like a little bit of fear in the market for us because that makes for better risk/reward and better negotiations. So if people continue to lose fear and if you see people doing second lien deals at 9% or 10% which to us is really mispriced mezzanine risk, should be 13%, 14%. If you start seeing 9%, 10% secondly deals again just like you saw the beginning of '11, that is kind of a warning signal at least for us to stand down and get less active and raise our bar of pickiness, etc.

So you may see some of that as the high-yield mutual fund flows and leverage of loan flows have been positive. It's something to watch out for.

Okay, but just putting aside the trends in the capital markets, are you hearing a greater eagerness from sponsors to put money to work? More acceptability on the business owners to put businesses on the market and willing to sell? Just sort of a secular trend that we might look over say the next four to eight quarters?

No, it is more of the same, John, that we have seen over the last few years. Sponsors do have a lot of money to deploy and they are willing to plow thankfully a lot of equity underneath us. We are seeing in many cases 40%, 50% equity checks underneath the debt in many of these capital structures.

So sponsors have a lot of money. Middle-market M&A machinery should be decent for '12. We think it will be just fine. It just takes a little while for that machinery to get going in the typical January timeframe, which this is the way things work in the middle-market world, people try to get a deals done by year-end. They take the break and then they start again in January.

And typically you see a little bit of seasonality in our business, where the quarters two and three and sometimes quarters four on the calendar year basis are heavier than calendar year one -- than Q1.

Great, thanks, Art. I appreciate the flavor.

(Operator Instructions). With no questions in the queue, I would like to turn the call back to our presenters for any additional or closing remarks.

Thank you, everyone, for your time today and we look forward to talking to you next quarter.

Ladies and gentlemen, that does conclude today's conference. We thank you all for joining.