Pennantpark Investment Corp (PNNT) 2013 Q3 法說會逐字稿

Good morning, and welcome to PennantPark Investment Corporation's Third Fiscal Quarter 2013 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 your conference.

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's Third Fiscal Quarter 2013 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 the discussion about forward-looking statements.

Thank you, Art. I'd 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 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'd 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 discussion of investment activity, the portfolio, the financials, the overall strategy, and then open it up for Q&A.

As you all know, the economic signals have continued to be mixed with many economists expecting a slowly-growing economy going forward. With regard to the more liquid capital markets, and in particular the leverage loan and high yield markets, those markets were extremely strong until June of this year as cash flows into high-yield funds, leverage loan funds and CLOs have been strong. As fears of Fed tightening surfaced in June, the liquid market saw some turbulence but has since bounced back. Risk-reward in the middle market has generally remained attractive as the overall supply of middle market companies who need financing exceeds the relative demand of applicable lending capacity.

As debt investors and lenders, a slow growth economy is fine as long as we've underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome. That said, as the more liquid capital markets rallied in the first half of 2013, that overall tone impacted the middle market. Pricing compressed and purchase price multiples and leverage multiples increased.

As a result, we have been selective about which investments we make in this environment. Given our strong origination at work and size of our company, we believe we can continue to prudently grow.

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 and structures that are more defensive and have low leverage, strong covenants, and high returns. With plenty of dry powder, we are well-positioned to take advantage of investment opportunities as they arise.

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 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. Since inception, PennantPark entities have financed companies backed by nearly 120 different financial sponsors.

We have been active and are well-positioned. For the quarter ended June 30, 2013, we invested $73 million. The average yield on new debt instruments was 12.9%. Expected IRRs generally range from 13% to 18%. Debt investment income was $0.27 per share. We have met our goal of a steady, stable and growing dividend stream since our IPO over six years ago, despite the overall economic and market turmoil throughout that time period. We are one of the only BDCs to not cut its dividend during this time period.

We anticipate continuing the steady, stable dividend stream going forward. We are perfectly content under-earning our dividend temporarily as we carefully and prudently invest in this environment. We are fortunate to have plenty of excess liquidity that we can use for both defensive and offensive purposes.

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, continue to be a healthy 2.6 times. This provides significant cushion to support stable investment income.

Additionally at cost, the ratio of debt to EBITDA on the overall portfolio was 4.7 times, another indication of prudent risk. We have plenty of liquidity. As of June 30 we had in total over $400 million of available liquidity consisting of over $300 million of available credit facility, $75 million of new SBIC debt financing in our second SBIC, and $16 million of cash on hand.

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

We had some attractive realizations last quarter. For example, Tekelec was sold to Oracle which produced a 25% IRR on our $14 million debt investment and over four times our money or $6.3 million realized gain on our $2 million equity investment. Our $16 million subordinated debt and equity positions in TrustHouse were taken out at a blended IRR in the mid-20s, when that company was sold to a strategic buyer.

Veritext refinanced our $16 million subordinated deposition, generating 16% IRR. We retain our equity co-invest in that company.

Despite the recession, across PennantPark Entities we have had only seven non-accruals out of 270 investments since inception six years ago. We currently have no non-accruals on our books.

To refresh your memory about our business model, we try as hard as we can to avoid mistakes but the faults 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. We're optimistic that our co-invest portfolio will generate gains over time.

In terms of new investments, we had another quarter investing in attractive risk adjusted returns. Our activity was primarily driven by refinancings. Virtually all these investments we have known these particular companies for a while, have studied the industries or have a strong relationship with the sponsor. Let's walk through some of the highlights.

We invested about $9 million in additional first-lien debt of Aircell Gogo. Aircell Gogo is the leading provider of in-flight connectivity and other voice and data communication. Ripplewood and Oakleigh Thorne are the sponsors and the company recently went public. Credit Infonet is a leading provider of data solutions to law firms. We purchased $10 million of subordinated debt. Sentinel Capital is the sponsor.

Language Line is the leading global provider of on-demand spoken interpretation services. We purchased $16 million of the second lien debt. ABRY is the sponsor. We purchased $34 million of first lien debt of TRAK Acquisition. TRAK is a leader in outsourced legal collection of consumer receivables. HIG is the sponsor.

Although activity levels have been moderate so far in 2013, we continue to believe that the remainder of the year will be fairly active. Due to our strong sourcing network and client relationships, we are seeing active 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 June 30, 2013, recurring net investment income totaled $0.21 per share. In addition, we had $0.06 per share of other income. As a result, net investment income for the quarter was $0.27 per share.

Looking at some of the expense categories, management fees totaled $9.8 million. general and administrative and excise tax totaled $1.7 million, and interest expenses totaled $4.2 million.

During the quarter ended June 30 net unrealized and realized loss from investments and debt were approximately $4 million, or $0.06 per share. Excess dividend over net income was about $1 million or $0.01 per share. Consequently, [NAV] per share went from $10.50 to $10.43 cents per share.

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

In case [of the] broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall debt portfolio has a weighted average yield of 13.1%. On June 30, our portfolio consisted of 57 companies across 26 different industries and was invested 30% in senior secured debt, 22% in second lien secured debt, 36% in subordinated debt, and 12% in preferred and common equity.

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 we pay out those contractual cash flows in the form of dividends to our shareholders.

In closing, I'd 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) We'll hear first from Troy Ward with KBW. Mr. Ward, your line is open.

Oh, it would help if I take it off mute. Thank you. Art, can you real quickly just talk about your anticipation of equity going forward? You obviously monetized chunky pieces of equity. Can you talk about the equity co-invest you're currently seeing in the market? We've heard a lot about the competitive nature of the lending. Are you still able to get co-invest equity and do you intend to continue to do some of that?

That's a good question. We continue to be able to get the option to co-invest in the equity. We usually negotiate that option so to us, each layer of the capital structure needs to be debated separately. We first assess whether we like the debt, and we think the debt's safe, and then secondly do we want to co-invest in the equity.

We're being more and more skeptical these days about where some of these equity values are so we will still negotiate the option. We will probably take that option less times in this market as purchase price multiples have increased. We will probably be less active.

Okay, thanks. And then when you think about new loan relationships versus current portfolio companies that are looking to refi, kind of what percentage of the portfolio companies that are looking to refi are you defending and trying to keep in the portfolio? And if you don't kind of defend a current position is it typically because of price or structure? Where is the stress in the marketplace?

That's a great question, and it's always on a case-by-case basis. And I'm sure you've heard this from other BDCs. To the extent you know and like a company and it's performed well and you have a comfort level, of course you'll look to defend it on one hand. On the other hand if the risk-reward doesn't make sense in the context of the overall portfolio and that particular deal, you shouldn't do it. So, we let some of them go. Some of them do still kind of hit our risk-reward parameters and we defend them. But ultimately you can't get emotional about this stuff and if it doesn't make sense for our shareholders from a risk-reward standpoint we'll let it go and we'll get refinanced in some cases. We'll get prepayment fees and we'll call that a victory. We never -- when people pay us back we say thank you because sometimes they don't pay you back. So, we're always appreciative when we get paid back, and that just is what it is.

Great, thanks Art.

Thank you.

We'll take our next question from Chris York with JMP Securities.

Good morning guys, thanks for taking the question. Not too many of them this morning, but first I do want to touch on one thing. It appears that SBIC 2 still only has a small amount of regulatory capital pledged. Could you talk about your desire to originate product for that fund and pledge additional capital and potentially access more SBA financing?

Look, we are -- it's a matter of public record that we love the SBIC financing and we'd love to find deals to fill the bucket. In a market where we are generally pickier overall, our over -- as you've seen, we're doing fewer deals and obviously to the extent we do a deal that fits, we'd love to put it in there. The SBIC rules are more restrictive in certain terms of what fits than our overall BDC rules. So, we hope to get that $75 million drawn over the next three or four quarters if we can, if not sooner, but it'll just depend on deal flow.

Okay, that's helpful. And then, clearly you received a strong amount of exits and repayments in the quarter. Are you expecting that to remain elevated or have you had any discussions that would lead you to believe that you'll have some elevated repayments in the current quarter?

It's always a case-by-case basis, Chris. Look, if we're doing our job, we'll always have repayments. You have to assume in our business that on average the whole portfolio, if we're doing a good job, will churn or rotate over a 3 or 4 year time period, so we're going to by definition have some repayments. Will it be as elevated as last quarter, too early to tell here kind of right in the middle of the quarter. But we're going to have some repayments. We'll also have some new deals. We'll also defend some deals, so it'll be a mixture of all the above.

Great, that's it for me. Thanks, Art.

Thank you.

We'll take our next question from John Hecht with Stephens.

Morning guys, thanks for taking my questions. First, with respect to Affinion, can you tell us what the price of those bonds were at the time of the NAV consideration and where they are now?

Sure, that's a good question. Affinion, was it quoted around $0.50 on the dollar as a broker-dealer quoted instrument. This is one of the companies that's been negatively impacted by the consumer financial protection bureau and clamping down on bank marketing.

Since quarter-end, the company announced their earnings. Their earnings were better-than-expected. The paper has traded up to $0.58, $0.59 on the dollar, company seems to have gotten a better grip around the [CFPB] issue in its company and is finding other areas of growth outside of US financial institutions.

So, the numbers were better [expected]. The bonds are up 8, 9 points since quarter end. Management team when they were asked on the conference call how they're going to deal with these bonds, they were very confident that they're not going to be an issue and that they're going to be able to pay them off. So clearly, the market doesn't believe that they're going to pay them off at $0.58 on the dollar yet, but that is what it is. We'll see it play out over the next year-and-a-half. The Company is paying cash interest to its lenders, including us. So, it's kind of a wait-and-see game and see how they deal with the operating environment.

Okay, thanks very much, and then forgive me if you mentioned this but you did have elevated repayments in the quarter. Can you give us a sense for what the repayment income was in the quarter, and maybe kind of where that level has ranged historically?

Yes, so we had -- this is, this shows up in our Q, just so everyone knows, in our other income line. We have two lines in our revenue. One is interest income, the other is other income. And when we get prepayment penalties or amendment fees, it shows up in the other income line, and that's kind of what showed up this quarter was about $3.9 million related to the prepayments we talked about in the call which were Tekelec, Veritext, TrustHouse and Learning Care were the four big repayments of the quarter. Did that answer your question?

Yes, but what is the repayment income, kind of, what's been the range over the past several quarters just to give it a sense for what normal ranges might be?

I mean, it goes from $0.01 to $0.06 a quarter. I mean, it's kind of -- and that's why we've put it in the other income line to indicate that it is variable and it just depends on the prepayment penalties, and the amendment fees. In certain cases, when we're in an equity co-invest or have a warrant position and there's a dividend, that would show up in that line also. So, this is kind of the variable portion of our income, kind of $0.01 to $0.06 is probably a good range. I know that that's a wide range, but that's kind of what it goes.

No, that's helpful. Final question is, I wonder if you could comment on kind of the performance of the portfolio from an EBITDA and revenue growth perspective, and kind of your thoughts on the overall economic trends related to that.

So, in our prepared remarks we said we see a slowly growing economy, grinding out economy going forward. You know, EBITDA as we track EBITDA, the portfolio company since inception of investment, they're still running up 10% or 15% from inception of investment. So, we still feel pretty good about the credit quality of our portfolio. We currently have no non-accruals. So, touch wood, we're doing okay. The areas of weakness continue to be the ones we've been talking about. If you have a company that's involved in defense and aerospace given the sequester, you'll feel the weakness. Sometimes you'll have a company that's involved in healthcare and the healthcare reimbursement policies will change, you might see some weakness. And of course we've been talking about the CFPB for a while. So, but we think the marks are, that you see in the portfolio accurately reflect the credit quality and as a result we think the portfolio is doing pretty well.

Okay, thanks very much, guys.

Thank you.

We'll hear next from Mickey Schleien with Ladenburg.

Good morning, Art. First, big picture question. We've seen many BDCs experience a high level of redemptions in the quarter, but the reasons behind that may vary from company to company. Can you give me a sense of what drove those repayments and where those borrowers went to refinance that money?

Sure, great question. Tekelec was sold to Oracle, the big software company, so that was just an M&A take-out. TrustHouse was an M&A take-out. And then Learning Care and Veritext were mezzanine financings that were high-yielding mezzanine financings. The credit quality was good, and those mezzanine deals were refinanced with first lien bank debt as the credit's de-levered.

Okay, thank you for that. And more of a housekeeping question, Art, can you give me a sense of where spillover taxable income stands at this point? In other words, how much is there today to support the dividend given that you haven't quite covered it the last couple of quarters?

I'm going to let Aviv answer that one.

Yes, certainly from a tax viewpoint you do have a small cushion that is spilling over, so we do -- we are conscious of the cushion and as we said earlier, [NII] for example this quarter exited by $0.01, or actually it was $0.01 less than the dividend. So, we're eating into this cushion and that's exactly the purpose of this cushion. So we do have maybe $0.01 to $0.03 per share remaining cushion at this point, from a taxable viewpoint.

Did you say $0.01 to $0.03 left?

Yes, $0.01 to $0.03, and then by the way, just to put it in perspective as we said in our prepared comments, it's okay. As long as we're earning in and around the zone of our dividend we have no, we do not anticipate cutting our dividend. To us you know, we think oh, we think 2013 is not the best vintage to be investing in and we've been saying it now for a few quarters. So, we're going to be really careful. We're going to keep our powder dry and be prepared to the extent there is an opportunity down the road to take advantage of a broader opportunity.

So we're not forcing it. The nice thing about our size, Mickey, is a few deals a quarter is all we really need, if we actually do need that, to kind of stand still. And that really has not been a problem given our origination at work, our relationships, and we're certainly not forcing the investments. We certainly want to make sure we maintain our investment discipline. We certainly don't have any anticipated sense of cutting our dividend but we're keeping it a lot of powder dry for both defensive and offensive purposes.

Fair enough. I appreciate your time this morning.

Thanks, Mickey.

We'll take our next question from Mark Hughes with SunTrust.

Yes, thank you very much. Art, you suggest you're going to be active or you see things being more active, later in the year. Is that an acceleration of activity? Is deal flow picking up here in July-August?

Yes, I mean it seems to be picking up. It's not dramatic. It seems to be picking up by moderate amounts. It's hard for it to be less than it was, number one, and number two we're really picky and selective about what we put in the portfolio. So, but we are busier than we were. We'll see how much that actually translates to. In many cases, our deals are related to M&A trades or they're strategic financings, and the deal's not done until the wire goes and it's accepted by the other side. So, it's feeling busier, but it's hard to give you real guidance around that.

Right. Are the size of the deals, or is the size of the deals increasing?

Yes, I mean, look. We view ourselves as kind of a $1 billion, $1.1 billion fund in PNNT at this point, so we look at 3% positions or 4% positions as kind of okay. Certainly 2% positions are great, you know, we want to maintain diversification. So, $30 million or $40 million positions will be kind of average, average zoned for us. For us to do $50 million or something more we have to really, really love it. And we'll do that from time to time as you've seen.

Thank you.

We'll hear next from Scott Valentin with FBR Capital Markets.

Good morning, thanks for taking my question. Art, you gave some metrics for the portfolio, I think it was debt service coverage and I think it was [enterprise value to] EBITDA, from the portfolio. Do you have those metrics for the quarterly originations?

Don't have them at hand. I would say in general they're in line with the overall portfolio. We had some of the quarterly originations that were slightly higher than that. We had some that were quite a bit lower than that. So if I had to guess it, I don't have it on hand, it's probably kind of in line with the overall portfolio.

Okay, and then in terms of originations, any industries you're -- I mean, I guess the ones you mentioned or maybe you're avoiding, but any industries you're particularly focused on for originations?

There's nothing -- we know what we're avoiding which we've already mentioned. It's kind of all over the map. It's all over the map. It's still the same companies that hopefully we can find steady free cash flows. So, nothing really new from that standpoint.

Okay, thanks very much.

Thank you.

We'll take our next question from Doug Mewhirter with SunTrust Robinson Humphrey.

Hi, good morning. Just building on the activity question that Mark had, just from my limited viewpoint of the industry it seems like there's a bit of a bifurcation in the BDC space and it seems like larger deals higher in the capital structure seem to be very active, and I guess the lower, the smaller mezzanine deals, I guess drying out may be a very extreme term but just overall seem to be a lot less. Is that a proper characterization, and if it is, is there -- can you explain why there's -- it seems to be sort of a two-tiered mark in terms of activity?

I mean, I think just the -- Doug, just to maybe re-orient the question a little bit, there in the [ebullience] of the liquid capital markets, the leverage loan market and the high-yield market, the liquid syndicated markets because there's so much liquidity through CLOs and bank loan funds, have moved down market in terms of size of company that they will finance. So, to us, there's a nice term and we like second liens. We like that term. We think there's a little bit better structure than subordinated debt, but for all intents and purposes, second lien is subordinated debt. And when you see the syndicated loan market doing second liens at 8% or 9% or 10%, to us we say shouldn't that be mezz at 13% or 14%?

So, we need to maintain our discipline around credit, number one, and also pricing, number two. You know, for those of you who were concerned about originations, we could take our money and put $400 million to work in second lien 9% or 10% liquid syndicated deals, at very high leverage ratios tomorrow, and really ramp and really grow the portfolio and have no issue. Way over-earning our dividend. The problem you run into is, what's your quality? What's your quality. If you had to go back, and I'm not saying we're in '07 again, we don't think 2013 is as bad as '07, but if you had to replay 2007 again would you have invested in anything?

So we're very cognizant of the vintage we're in. We're taking it slow. With our [size] vehicle, we only need a few quarters, a few deals a quarter, even to stand still. If we can find a lot of good deals we will of course do them but we're not forcing it. We're not rushing it. We're not buying these 8% or 9% or 10% more syndicated second liens, and we're going to take it slow right now.

That's definitely a fair answer. Thanks for the color on that. So it looks like, to use a baseball analogy, you're still seeing quite a few pitches, you're just not swinging as many?

Yes, look, we did basically four deals this past quarter. We looked at hundreds, right. I mean, so again we're in the fortunate position of waiting for those fat pitches that we can do something with, and if it's not a fat pitch that's okay. Let it go.

And just a quick follow-up numbers question. Aviv may have covered this or it may have been asked on another question. There was the negative change in your unrealized loss position. Is there anything behind that or is it just a result of certain portfolio actions?

I'm sorry, can you restate the question?

The change, you had a negative change in your unrealized loss position. I guess it was negative $19 million or $19.5 million. I just wondered if there's anything specific behind that.

I think we mentioned that the change in unrealized is primarily due to the marks on Affinion quarter-over-quarter. That I think it was marked about $0.50 on the dollar. That gave rise to the bulk of the change in unrealized losses.

Okay, so that was related to the earlier question. Okay, thank you, that clears it up. Thanks, that's all my questions.

Thanks, Doug.

We'll take our next question from [Ron Jesico] with Wells Fargo.

Good morning, and thank you for taking my questions. Most of my questions have already been asked, I appreciate all the market commentary. Just a quick housekeeping question -- you mentioned the Gogo IPO, and your debt investment. I may have missed this, but does that have any impact on your debt investment?

No, our debt investment stays outstanding. We made it the bulk of the investment, I'm going to say about a year, year-and-a-half ago we did an add-on, that was done just prior to IPO. It will remain outstanding. It is nice, though, to have a company with a $1 billion plus equity market cap that's validated the equity underneath us, that can access the equity markets over time. So we're pleased with that company. We here at PennantPark certainly when we get on planes, we are certainly addicted to that Gogo Wifi, and we assume some other folks on the call are too. Please when you use it next time, think of us.

All right, thanks guys, and thank you for taking my questions.

Thank you.

We'll take our next question from Troy Ward, KBW.

Hey Art, just a quick follow-up. Following the Fed's commentary this spring, summer, about tapering of course, we've seen the ten-year go up to 260 kind of range. The questions regarding, to us regarding the impact of higher rates on the BDC sector as a whole is definitely increased and I think fundamentally the sector is in a good spot because of adding a lot of fixed-rate leverage. But as you do your due diligence into your own portfolio or new investments for the portfolio, how do you view the impact of higher rates on the underlying credit in the portfolios?

It's a great question, and certainly as we do our modeling and down side cases of how companies might perform in different scenarios, we certainly need to take interest rate increases into account as we look at down side cases. On the other hand I guess you have to look at what is driving the Fed tapering, and presumably what's driving the Fed tapering is a stronger economy. And usually if you look at BDCs historically, they've actually done pretty well in rising interest rate environments because when you think about it if you're a middle market debt or equity investor, the most important driver is credit quality and a good economy drives the credit quality.

So, we feel like we certainly need to take it into account and be cognizant, and certainly when we're structuring deals, it's great to have floating rate versus fixed. If we do fixed deals they're usually at pretty high rates that capture a bunch of yield that if the companies perform well, those deals will be taken out anyway. So, don't know if I answered your question but I thought it was a good question.

That's good. Thanks, guys.

Thanks, Troy.

That does conclude the question and answer session today. I'd like to turn the call back to our presenters for closing remarks.

Thanks, everyone. Appreciate your participation today. The next time we're going to be speaking will be after our next quarter, which will be our 10-K quarter so it'll be our annual report quarter, so it's going to be a longer time frame between now and then. It'll be kind of mid to late November, which is when we usually do file our financial reports and do the conference call.

So, we'll speak to you next time in mid to late November. Thank you very much for your attendance today.

This does conclude today's conference. We thank you for your participation. You may now disconnect.