Pennantpark Investment Corp (PNNT) 2014 Q2 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's second fiscal quarter 2014 earnings conference call. Today's conference 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 speakers' remarks. (Operator Instructions).

It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer for PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

Thank you, and good morning, everyone. I would like to welcome you to PennantPark Investment Corporation's second fiscal quarter 2014 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 a 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 filing 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 few minutes discussing current market conditions, followed by a 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 turned positive, 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 have remained strong, due to substantial cash flows into high-yield funds, leveraged loan funds, and CLOs.

Risk/reward in the middle market has generally remained attractive as the overall supply of middle-market companies who meet financing exceeds the relative demand of applicable lending capacity. As debt investors and lenders, a slow growth 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 have continued to be selective about which investments we make in this environment. Given our strong origination network 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 and can withstand different economic cycles. 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, 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 credit providers, and, of course, our shareholders.

We are a first call for middle-market financial sponsors and 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 136 different financial sponsors. We have been active, and are well positioned.

For the quarter ended March 31, 2014, we invested $142 million. The average yield on new debt instruments was 12%. Expected IRRs generally ranged from 13% to 18%. Net investment income was $0.30 per share.

We have met our goal of a steady, stable, consistent dividend stream since our IPO seven 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. Given the current market backdrop, we remain conservatively levered, and have plenty of excess liquidity that we can use for both defensive and offensive purposes.

For the quarter ended March 31, our overall net leverage ratio, accounting for cash on the balance sheet, was approximately 64%, with only about 44% excluding SBIC debt.

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 a healthy 3 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 4.4 times, another indication of prudent risk.

We have plenty of liquidity. As of March 31, we had in total over $260 million of available liquidity, consisting of $130 million of available credit facility, $75 million of new SBIC debt financing in our second SBIC, and over $56 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, the Eureka Hunter Pipeline refinanced our $45 million second lien, which generated a 16.6% IRR. After quarter-end, we sold our Magnum Hunter equity, which generated about $7.4 million of realized gains, and a 37.6% IRR. The blended IRR on Eureka Hunter debt and Magnum Hunter equity was 20.4%.

Instant Web refinanced our $44 million investment and first lien debt, which generated a 19.8% IRR. Interactive Health Solutions refinanced our $18 million first lien investment, generating a 13.5% IRR. We remain an equity co-investor in that company.

Our overall NAV was up again 3% this quarter, and a key driver of that upside was due to the positive price movement of our investment in UP, Universal Pegasus. UP's financial results have rebounded significantly. Additionally, improvements in the value of our investments in Varel and Affinion helped to drive NAV growth.

Despite the recession across PennantPark entities, we have had only seven at non-accruals out of 327 investments since inception seven years ago. We currently have no non-accruals on our books. Further, we are proud that even when we have had those seven non-accruals, we have been able to preserve value for our shareholders. Through hard work, patience, and judicious additional investments in those companies, we have been able to find ways to add value. Based on values as of 3/31, we have recovered 84% of the capital invested so far in those seven companies.

In terms of new investments, we had another quarter investing in attractive, risk-adjusted returns. Our activity was primarily driven by refinancings, growth financings, and acquisition financings. And 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 another $14 million in first lien debt, and $1 million in the common equity of AKA Diversified, which is a Verizon Wireless premium retailer, based in the Midwest. Atlantic Street Capital is the sponsor. Foundation Building Materials is a distributor of drywall and other building products. We purchased an add-on of $10 million of the second lien term loan. CI Capital is the sponsor.

We purchased $26 million of two tranches of the subordinated debt in George Limited. George, which does business as [Stritch] Limited, manufacturers thermostatic controls for small, domestic appliances, primarily tea kettles. AAC Capital UK is the sponsor. JA Cosmetics is a multi-channel beauty company that operates under the brand e.l.f., with cosmetics and tools at value retail prices. We purchased $33 million of second lien term loan, and $3 million of equity. TPG Growth is the sponsor. We invested $45 million in the first lien term loan of Trust Inns Limited. Trust Inns is a tentative pub company based in the UK. The company is owned by Trevor Hemmings.

Turning to the outlook, we believe that the remainder of 2014 will continue to be active, due to both growth and M&A-driven financings. 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 March 31, 2014, recurring net investment income totaled $0.26 per share. In addition, we had $0.04 per share of other income. As a result, net investment income for the quarter was $0.30 per share.

Looking at some of the expense categories, management fees totaled $11 million. General and administrative expenses totaled $1.7 million, and interest expense totaled $5.1 million.

During the quarter ended March 31, net unrealized gain from investment was $24 million or $0.36 per share. The realized gain from investment was $3 million or $0.05 per share. And unrealized loss from our note was $6 million or $0.10 per share. Excess net income over dividend was about $1.4 million or $0.02 per share. Consequently, entity per share was up $0.33 from $10.80 to $11.13 per share.

As a reminder, our entire portfolio, credit facility, and senior notes are marked-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 12.7%. On March 31, our portfolio consisted of 68 companies across 28 different industries, and was invested 26% in senior secured debt; 32% in second lien secured debt; 30% in subordinated debt; and 12% in preferred and common equity. 56% of the portfolio had a floating rate, including 48% with a floor. And the average LIBOR floor is 1.4%.

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 consistent dividend stream, coupled with the preservation of capital. 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 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). Mickey Schleien, Ladenburg Thalmann.

I was glad to see that the leverage ratios for the new originations in the quarter were good. But I did notice that your originations dropped pretty meaningfully from the previous quarter.

So I was curious, was that a function of -- was it idiosyncratic? Was it a function of a more difficult market environment?

And a follow-on question, have you moved the needle at all, in terms of the average EBITDA of the companies that you are looking for?

Thanks, Mickey. It was probably idiosyncratic. Obviously, we didn't see a major bump-up of deal flow prior to 12/31. Usually you do. We saw a little bit more. So that, perhaps, had something to do with a little bit more active quarter ended 12/31. And usually, as you know, there is a seasonality to the business, where the first calendar quarter ended 3/31 is a little slower. So that probably impacted it a little bit.

But, as you know, we don't -- it is hard for us, as investors who are trying to make each individual investment a good investment, it just depends on what comes in and what we see, and what deals we can make that make sense for us. So that is kind of the question around volume, quote/unquote.

In terms of leverage, we kind of like where we are on a blended basis right now, kind of mid-fours -- 4.44, 4.45 debt to EBITDA. We do, on occasion, do deals with higher leverage. We start getting very skeptical in the mid- to upper-5s. Obviously, deal-dependent, company-dependent, industry-dependent. But one of the key lessons that we have learned over many cycles is, you have to have rational capital structures. You have to have rational credit statistics. And when it gets irrational, we will just stand down.

And, Art, have you moved downmarket at all in terms of average EBITDA of the companies you are lending to?

No. It is pretty much the same as it has been. The middle of the Bell curve for us is kind of 20 to 50 of EBITDA. We will do some that are a little smaller. We will do some that are a little bigger.

Okay. And my last question, and I will get back in the queue, is you have some very nice gains in some of your equity positions. And we are pretty consistently hearing it is probably not a bad time to sell businesses; maybe not as good a time to buy businesses. That might also be true of some of these equity positions. What is your view on harvesting some of those gains for the rest of the year, and rotating that into income-producing assets?

Yes. That is a great question. We are looking forward to continue to harvesting of those equity gains, and reinvesting those proceeds into income-paying securities. We mentioned on the call a few minutes ago that we sold our Magnum Hunter equity for about $10 million, $11 million, post-quarter-end, which is a great exit for us. We made over three times our money. So we hope to see continued realizations in harvesting of those equity co-invest positions and reinvesting those into income-paying debt securities.

Thank you for your time.

John Hecht, Stephens.

The first question just related to model -- just based on the revenue trends or the interest income trends, it would look like that deal flow was kind of late on average last quarter, and early on average this quarter. And I am just trying to confirm if that is accurate.

That is confirmed.

Okay. Second, and this is a little bit of follow-on related to the last question. It is the third quarter; we have experienced good book value growth, or net asset value growth. It does appear that you are harvesting some of the value in the equity side of the business.

I am wondering, can you characterize your equity portfolio and talk about ongoing opportunities to enhance the book value? And, on a related topic, is it more difficult to get an equity piece in the deal now, or is that not changed?

On the first question, we continue to hope and believe that NAV will continue to see positive movement. We continue to see positive momentum in Universal Pegasus, and the numbers and the bookings from that particular company. We continue to see positive price movement in Affinion, as well as some of the other equity co-investments in our portfolio.

So, touch wood, if this environment continues, we will continue to see modest to small growth on the debt side of the portfolio; making sure we are making investments on the debt side that are capital-preservative that have the right risk-adjusted returns, and continued harvesting of equity positions that we have. So that is kind of the game plan, which is what we have been doing over the last few quarters.

John, what was the second part of your question?

It was -- is it getting more difficult to get an equity piece with a deal right now?

Well, it's a great question. It is not necessarily more difficult. Usually, we will do a piece of debt and we will have a equity co-investment opportunity. And that is our option. Sometimes we invest; sometimes we graciously decline the offer to co-invest in the equity. With multiples creeping up in terms of purchase price multiples, inevitably, we are probably going to turn that opportunity down a little bit more than we have. We are very disciplined around multiples. We are very disciplined around pricing. We want our debt to EBITDA multiples on our debt securities to be low. And we want our equity multiples to be low, as well. So it will be, by definition, a little harder to find attractive equity opportunities, but that's okay. We know we are in a business that does have its cycles, and we need to be cognizant of that.

Okay. And then, final question. Anything worth mentioning on the competitive front? Any recent changes, or pretty much the same environment we have seen in the last several quarters?

It's a great question. Look, the biggest competitor to middle-market lenders has been the liquid syndicated market that has been very ebullient, as cash flows have come into mutual funds and CLOs. And as the liquid markets provide a tone, and also creep down in finance companies that are smaller than they otherwise would traditionally, that does put pressure on middle-market lenders.

We, in the last few weeks, have been seeing -- and you may have heard this from some of our colleagues in the BDC industry. In the last few weeks, we have been seeing some negative cash flows to some of those mutual funds. We have been seeing deals back up, and yields increase in the syndicated market, which we like. That puts a little smile on our face. That means, perhaps, there is better risk/reward coming down the pike.

Great. Thanks very much.

Ryan Lynch, KBW.

Just a follow-up on John's question about higher interest income in the quarter. That was just more of a function of late fundings last quarter, and maybe early fundings this quarter, opposed to any big one-time items or sizable fee income in that number?

That is correct. As Aviv said, $0.26 of the $0.30 was recurring. $0.04 was other income, which is the line item which captures any amendment fees we have, any pre-payment penalties or any dividend income we have. So that $0.04 was mostly pre-payment fees and dividend income.

Okay. And then, I see you guys made a couple of new investments in Europe in this quarter. Can you talk about what you are seeing in the European markets that make you guys think that that is an attractive geographic region? And then, also, should we expect any more investments coming out of that geography in the future?

That is a great question, Ryan. We are looking at Europe more closely. The European banking sector is having problems, as you may all have read. We do think there is an opportunity in the middle market there, just like there is an opportunity in the middle market here in the US. So we will, one by one, gradually, methodically, deal by deal, look to find good risk/rewards for our shareholders that make sense.

In Western Europe, it will be primarily Western or Northern Europe where the rule of law for lenders and creditors is similar to the rule of law here in the United States, where there is a consistent process if things go wrong. So our activity this past quarter was in the UK, which, obviously, has a very similar legal system, and system of creditors' rights.

So, it is a deal-by-deal opportunity for us. We will take it one step at a time. But we do anticipate a higher percentage of our portfolio gradually being in Europe.

Okay. Then it looks like you guys made four investments in the new portfolio companies, and six into existing portfolio companies. Should we read anything into that of how you are viewing your current portfolio, the attractiveness of reinvesting in current portfolio companies, versus the opportunities in the broader markets?

You know, you are raising a great point, which is sometimes the best opportunities are right in front of you. And, for us, certainly an AKA Diversified, which is a Z Wireless in Foundation Building Materials, or FBN; Superior Digital. I mean, these are companies we are investors in. We like what is going on. We like the management. These companies are growing. We certainly like fueling their growth, and creating value and jobs. So we are looking forward to continuing to support these companies as they grow.

Doug Mewhirter, SunTrust.

Just wanted maybe a bigger-picture question about the economy. I know that -- I have heard before that, from you and your competitors, that a slow-growth economy is actually good for BDCs because the companies are very healthy. They still report good cash flows, but they can't grow their way out of your universe, at least as fast as maybe a higher-growing economy.

We have seen a lot of exits from you and competitors. Is that more of a function of maybe the economy picking up a little quicker than expected? Or is that just more a function of the hunger of yield-seeking capital markets, maybe picking them off, on better -- on terms that maybe you wouldn't be willing to do, or maybe through IPOs or other exits?

You know, it's a good question, Doug. And it is all idiosyncratic depending on the particular company. We have had some companies in the portfolio that are growing very well. To the extent we have an equity co-investment, you can see the values of those equity co-investments go up. In certain cases, those companies get sold, and a certain cases they get refinanced to much lower yield levels.

Look, there is a combination of things that BDCs try to do. We are trying to provide steady, stable dividend yield. We are trying to preserve capital. We have this equity co-investment and warrant portfolio as a way to have some securities in the portfolio that have some upside. Because we inevitably know that, as a lender, we are going to make some mistakes sometimes, and we need to fill those gaps.

But I would say, primarily, a lot of the refinancings are due to just an ebullient market. Where if you have a higher-yielding piece of paper and the company is performing, and even if it is a flat company, it is deleveraging -- it can refinance -- they can refinance you out at a lower yield. We, and I think many of our peers, underwrite cash flow. And we underwrite cash flow such that if the cash flow is even flat or down, those companies are deleveraging because there is high free cash flow conversion. And a company that you lend money to at 4.5 times debt to EBITDA, two years later is at 3.5 times or 3 times, and they can take you out at a much lower level. And that is good.

Again, we say thank you when our borrowers pay us back. Sometimes they don't. So we are very appreciative of getting paid back. There's other deals out there. There's always people knocking on your door to access your capital. And we need to be very focused on only doing deals where we are comfortable that make sense to us.

Okay, thanks. That's all my questions.

And now I would like to turn the call back over to Mr. Art Penn for any additional or closing remarks.

Great. We would like to thank everybody for being on the call today. Thank you for your support. And we will be talking to you after our next quarterly earnings report, which will be in early August. Speak to you then.

Thank you, sir. That does conclude our conference call for today. We do thank you all for your participation.