Pennantpark Investment Corp (PNNT) 2014 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's Third 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 opened for a question-and-answer session following the speakers' remarks. (Operator Instructions)

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

Thank you and good morning everyone. I would like to welcome you to PennantPark Investment Corporation's third 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 included 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 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 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, our overall strategy, and then open it up for Q&A.

As you all know, the economic signals are moderately positive with many economists expecting a slowly growing economy going forward. With regard to the more liquid capital markets and in particular the leveraged loan and high yield markets. During the quarter ended June 30, those markets generally remained strong due to substantial cash flows in the high yield funds, leveraged loan funds and CLOs.

Since quarter-end, there's been some cash outflows from high yield and leveraged loan funds, resulting in a less robust, broadly syndicated and liquid high yield market, which helps the overall tone in the middle-market. 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 have underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome.

We've continued to be selective about which investments we make in this environment. Given our strong origination network and the 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 business 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 and structures that are more defensive, have a low leverage, strong covenants and high returns. With plenty of dry powder, we are well positioned to take advantage of the 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 140 different financial sponsors.

We have been active and are well positioned. For the quarter ended June 30, 2014, we invested $192 million. The average yield on new debt instruments was 11.7%. Expected IRRs generally range from 13% to 18%. Net asset value per share increased 1.8% for the quarter and has increased 8% over the last three quarters. Core net investment income was $0.28 per share.

We are pleased that we increased our credit facility by $100 million to $545 million, reduced the rate to LIBOR plus 225 from LIBOR plus 275 and extended the maturity to five years. We have met our goal of a steady, stable and consistent dividend stream since our IPO over seven years ago, despite the overall economic and market turmoil throughout that time period. We're one of the only BDCs to not cut its dividend during this time period. We anticipate continuing this steady, stable dividend stream going forward.

Given the current market backdrop, we have remained appropriately levered, have plenty of excess liquidity that can be used for both defensive and offensive purposes. At quarter end, our overall net leverage ratio accounting for cash on the balance sheet was approximately 55% and was only about 35% 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 2.7 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.

We have plenty of liquidity. As of June 30, we had in total over $420 million of available liquidity, consisting of $290 million of available credit facility, $75 million of new SBIC debt financing in our second SBIC and over $60 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've had some attractive realizations last quarter. For example, LTI Flexible refinanced our $30 million subordinated debt position, which generated a 16.8% IRR. We remain an equity co-investor and received a dividend as part of that financing. The Learning Care Group was sold and our $8 million subordinated debt and warrant position was taken out at a 22% IRR. Our $38 million subordinated debt position in [Blair] was exited at an IRR of 26.3% on the Company result.

Our overall NAV was up again 1.8% this quarter, and the key driver of that upside was due to the realization of our investment in UP, Universal Pegasus. UP was sold to a strategic buyer early in the quarter. As many of you know, UP at one point was a non-accrual that resulted in us converting some debt to equity in a restructuring and investing additional equity to provide liquidity to the Company. We ended up owning about 28% of the equity and taking an active position on the Board. As a result of the sale, the IRR from inception of investment to exit was 12%, not bad for a restructuring.

Despite the recession across PennantPark entities, we've had only seven non-accruals out of 334 investments since inception over 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've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in those companies, we've been able to find ways to add value. Based on values as of June 30, we have recovered 92% of capital invested so far on those seven companies.

As a result of this track record of low non-accruals and a high recovery rate, we are one of the few BDCs who was in operation before the recession, who has preserved capital for shareholders, while generating a consistent, steady dividend.

In terms of new investments, we had another quarter of investing and attractive risk-adjusted returns. Our activity was primarily driven by growth financings, refinancings and acquisition financings. In virtually all of these investments, we've 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 $22 million in the second lien debt of Bennu Oil & Gas. Bennu is an exploration and production company focused in the deepwater and shelf of the Gulf of Mexico. Foundation Building Materials is a distributor of drywall and other building products. We purchased an add-on of $45 million of the second lien term loan. CI Capital is the sponsor.

We purchased $12 million of the first lien debt in Fox US Bidco, Robertshaw. Robertshaw is a manufacturer of control system components for white good appliances. Sun Capital is the sponsor. New Gulf Resources is an exploration and production company focused on oil and gas assets in Eastern Texas. We purchased $45 million of second lien debt and $13.5 million of subordinated debt and warrants in the company. We invested $14 million in the first lien term loan of U. S. Well Services. U. S. Well is a provider of pressure pumping services, primarily in the Marcellus Shale basin. [Orbit Investment] is the majority shareholder.

Turning to the outlook, we believe that 2014 will continue to be active, due to growth in M&A-driven financings. Due to our strong sourcing network and client relationships, we're seeing active deal flow.

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 June 30, 2014, recurring net investment income totaled $0.26 per share. In addition, we had $0.02 per share of other income. As a result, core net investment income for the quarter was $0.28 per share. Additionally, we had $0.06 per share of upfront expenses due to the new credit facility and $0.02 a share of capital gain incentive fee that are accrued but not payable. As a result, GAAP net investment income was $0.20 per share.

Looking at some of the expense categories, management fees totaled $12 million, including $2 million of incentive fees accrued but not payable. General and administrative expenses totaled $1.9 million and interest expense totaled $5 million.

During the quarter ended June 30, net realized gain from investments was $23 million or $0.35 per share. Unrealized loss from investments was $1 million or $0.02 per share and unrealized loss from our notes was $3 million or $0.05 per share. Excess net dividend over income was about $5.4 million or $0.08 per share. Consequently, NAV per share went up $0.20, from $11.13 to $11.33 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 cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall debt portfolio has a weighted average yield of 12.3%. On June 30, our portfolio consisted of 66 companies across 28 different industries and was invested 26% in senior secured debt, 40% in second lien secured debt, 24% in subordinated debt and 10% in preferred and common equity. 61% of the portfolio has a floating rate, including 53% with a floor and the average LIBOR floor is 1.3%.

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 dividend 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 up the call to questions.

(Operator Instructions) Doug Mewhirter, SunTrust.

Just talk a little bit about industry activity and expected portfolio activity. You had indicated that the pipeline seemed pretty robust in July, August, maybe September, and that's actually been repeated by a lot of your competitors. But would you also say that maybe you would expect a maybe above-trend activity on exits, because [they are also] -- maybe seem to be a lot of companies who are maybe want to refinance while the rates are still low or maybe because M&A activity is just generating a lot more churn in your portfolio. Could you just comment on the balance between originations and exits (multiple speakers)?

That's a great question. Hard to say and it's been made harder to answer that question given the activity in the last couple weeks with regard to the liquid markets and the backup in the liquid markets, the liquid high yield market, the broadly syndicated loan market. As you know, the middle-market takes its tone from that to some extent, even though we believe we're shielded from that. So, if the liquid markets continue to experience choppiness, we would anticipate that the re-financings would abate substantially. Hard to say exactly what's going to happen, we're only a couple weeks into this at this point. So, you might have the -- you might have the scenario where activity is pretty high, M&A levels are pretty high and the refinancings are not as high. So, that might be a scenario, but it's hard to say, it's early.

Thanks for that. And just to finish a related follow-up question. Are there any large transactions, either originations or exits this quarter to-date that you're willing to disclose?

We don't disclose intra-quarter information. So, the tone that we've been giving, which is we are active is the tone we're giving. It's hard to say, here we are at August 6, quarter ends September 30. So, a lot of time between now and then. M&A activity has picked up. We don't know how much of it's going to close between now and 9/30 or year-end. Most of it gets done in that last quarter of the calendar year.

And frankly, to the extent these M&A deals are financed with very high leverage levels and low yields and lesser covenant packages, we will not be involved in some of those. To the extent they get financed with what we think are rational leverage levels, good covenant packages and good yields, we'd be happy and will be involved in some of those. So, again, given the market, what's going on in the liquid markets, the M&A activity and a lot of it usually being back-ended to the last calendar quarter of the year, it's really hard to give you much guidance at this point unfortunately.

Greg Mason, KBW.

As I look at some of the new investments that you made, U.S. Well, Bennu, New Gulf, all those related to oil and gas, it seems like heightened exposure there this quarter. Anything particular you're seeing in the energy markets or is that just happened to be lumpy in the quarter?

It's a great question. It is, as you know, oil and gas and energy are big themes in the American economy today. It is one sector that's growing and does have a lot of capital needs. So, that's a big positive. We have exited deals like Barrow and UP, which also were energy related. So, on an overall portfolio standpoint, our overall exposure is -- it's kind of consistent with what it's been. We've had a very nice track record in energy over the last seven years. I think we've invested something like $450 million in energy deals since inception to-date and have like a 14%, 15% IRR. So it's a space that we know well, we've had decent performance, and it will continue to be a reasonably large industry concentration for us.

Great. And just on the equity in the portfolio, obviously that's a source of real earnings drivers to the extent that you can exit those and you exited UP this quarter. Is there anything kind of on the horizon that you're seeing of potential exits from any of the meaningful equity positions?

Again, that's also wrapped up in the kind of the first question, which is how much M&A is there going to be, how much exits versus entries are there going to be. I mean, there's some of those deals, you can look at through the co-invest portfolio where you're seeing fairly nice markups. Those would be the ones, obviously, where there's potentially some activity, for instance, LTI, or LTI Boyd, you saw a mark-up. We did get a dividend on that last quarter, we got it refinanced out of our mezz and we got a dividend and that is one that continues to perform well. That's just one example of some of the increases that we've seen in equity value.

Vestcom is another one that had a nice quarter. Hard to say, hard to predict, hard to guarantee any of this, but where you've seen the markups would be where you'd either see some kind of recap opportunity or some kind of exit.

Great. And then one last question on the SBIC, you've been at $150 million drawn for quite a while. You've got the second license, but haven't utilized it, just the thought process on utilizing the remaining $75 million of debentures in your SBIC program?

We'd love to use it. It would be the first capital that we'd love to use to the extent we can find deals that fit the SBIC, SBA criteria. SBA doesn't like oil and gas, as a general proposition doesn't really fit. So, we're working hard to find deals that fit, that do meet our rigorous risk-adjusted return portfolio guidelines. To the extent, we do regular [white] financings for non-oil and gas deals, we're going to work hard to see if those do fit.

Is it just you're not seeing the small deals or the small deals you're seeing you just don't like the underwriting prospects of those small deals?

It's more of the latter. We don't have a problem with seeing deal flow. Thankfully, we see a lot of deal flow around here, it's just a question of us meeting our risk adjusted return criteria. We're happy, we have a 4.6 times average debt to EBITDA on the portfolio at PNNT. We get allergic once you get to the mid-fives and up generally about some of these credits, not to say that smaller companies are necessary levered that high, but we're being awfully cautious in this environment, making sure that we preserve shareholder capital and we're not going to force investments that don't feel right to us.

Chris York, JMP Securities.

Greg asked two of mine, but wanted to ask one additional question. Could you give us an update on your view of the investment opportunities in Europe and how you plan to manage international investment allocations within the investment portfolio?

Yes, we did do some European deals last quarter, we did not do any European deals this quarter. To us, Europe is like the US, it's a deal by deal business. We think the turmoil in the banking sector over there does help alternative lenders, such as ourselves. We have a senior colleague on the ground in London who we've worked with for a long, long time, as our feet on the ground at this point. Perhaps we grow that presence over time, but it's going to be a very methodical, thoughtful, deal-by-deal approach like we do it here in the United States. We do -- to hedge our currency risk, we do use our multi-currency credit facility to draw on any European deals. So, we have a British pound deal, a sterling deal in the portfolio. We finance that with our multi-currency credit facility and finance it in pounds.

So, you talked a little bit about boots on the ground there. Could you help me understand the deal flow internationally, how does PennantPark source its international deals, and maybe give me an idea for the flavor of type of borrowers in Europe that are seeking alternative lenders?

We source the same way we source here, it's based on reputation, relationship, knowledge and trust. It's not a -- it's not a footprint where we have stores in retail malls, it's more of a wholesale strategy, one-on-one relationship, deal by deal approach. There's all sorts of borrowers who need capital over there, similar to the borrowers who need capital over here that are not finding their banks helpful or constructive, their banks are shrinking. In this particular case, one of the two deals we did last quarter, it was a bank who is downsizing their own book due to regulatory issues and they needed a solution and we were part of the solution to provide capital to that company. They are very similar characteristics to what's going on around here.

Mickey Schleien, Ladenburg.

I just wanted to get your sense of whether you are willing to run the Company at somewhat higher leverage, given that we've generally seen positive trends in the numbers. I do agree that it's a little choppy, but the direction in terms of the strength of the economy here seems to be upward, and as a result, you might be in a position to run a little bit higher leverage and generate some higher ROE?

That's a great question, Mickey. And we think about it a lot. I mean in general, from day one, we've consistently said 0.6 to 0.8 debt to equity, in our minds, including the SBIC financing knowing that that SBIC financing and the exemptive relief gives us extra dry powder, both for defensive and offensive purposes. I think, in general, we're still thinking that's the right zone, particularly since we have a reasonable percentage of the portfolio in second lien and mezz securities. Even if -- we always say this, even if you could finance mezz higher than one-to-one, we won't want to do it anyway, we don't think it's prudent from a long run standpoint. So, again, we're taking a day-by-day, deal-by-deal, month-by-month of 0.6 to 0.8, would still be the general zone of leverage we'd still look to be within.

Okay, understand. And second question is little bit more on a housekeeping issue, and it's probably got a straightforward answer. But I noticed that there is a second lien in Transportation 100 that's marked at 45, but it's on accruals. So typically, when I see that it might be something where the credit has got some sort of a market quote, but I just wanted to get your explanation of how that can be?

That's the old [Gray Wide], which was one of our non-accruals from the early days. That's still a residual small position and not performing well, obviously given the mark. So that's one of our non-accruals that we've had for a long time.

So that is a non-accrual?

That is -- we have not been accruing that recently.

Scott Valentin, FBR & Co.

Just with regard to -- Art, you mentioned the goal is strong, stable dividend going forward. Just trying to figure out, given the -- appears to still be some yield compression pressure on the portfolio, given, I think quarterly debt yields are 11.7% and originations in the current portfolio is at 12.3%. So I imagine that will come down over time. Just wondering, as yields come down, is the response just to continue growing the portfolio, to kind of offset that pressure?

Yes, I mean, I think we say we are in the slow growth. Assuming the environment is the environment we had a few weeks ago, it's a slow-growth environment. We're being cautious, we're being careful. We think we can gradually grow. We had some big exits last quarter and we're happy we got out of UP. It was a big, big exit for us, it was a nice realized return, but over time we expect to be in a slow-growth environment, assuming the environment stays the way it was a couple weeks ago. If the environment in the liquid market gets choppy, continues, and that tone seeps into the middle-market, we would expect to be more active.

And then in terms of portfolio mix, I think second lien and sub debt is about 65%, 64% of the portfolio. Is that about where you want it to be, is that the ideal mix between first, senior sub and then equity?

We don't come to the office everyday and say, we have an ideal mix or what's the ideal mix or what kind of mix are we trying to achieve. We come to the office and say, is there a good deal to do that makes sense, whether it be first lien, second lien, mezz or whatever. And wherever the deals are that make sense, we will do them. So, subject to having good credit stats and getting the right return for our shareholders, we're very protective of the ROEs for our shareholders. So, we're balancing both credit as well as yield.

Okay. And one final question, and I don't know if it's a specific number, but maybe a trend over time. You mentioned you are getting a lot of looks from sponsors on deals. Just wondering, maybe there's a ratio or a percentage that kind of looks to actual that get approved, you guys approve. Will they get funding or not it's up to the sponsor, but just wondering if you have had a trend there, maybe you're seeing more looks, but they're proving less, because of looser covenants or higher debt ratios?

Yes, for sure, it's -- I don't off of the top of my head have a specific statistic to share with you, but we are turning down more, because we're not comfortable -- at least until recently we're not comfortable with the risk-adjusted returns. We're not going to be doing six times levered LBO financings in our vehicles. Unless there's a really, really, really incredible reason why we should. So, we like that we're sitting here with a 4.6 times debt to EBITDA portfolio. We like that. Our yields overall today are still north of 12%. We think that's an attractive risk-adjusted return for our shareholders.

Greg Nelson, Wells Fargo Securities.

We saw during the quarter, we saw several large subordinated pieces coming back at you with yields 15%, 14%. Just trying to gauge repayment philosophy in the portfolio and then how you are thinking about reinvestment risk, and getting those type yields without sacrificing on terms?

It's a great question, and a lot of it will kind of be answered with regard to the tone in the market here going forward. Clearly, there's been yield compression, clearly we have participated in that, we have participated in some of it, we are letting a lot of it go, lot of the new deals go and we're trying to have as high credit quality as possible. So the trend has been what it's been. We hope that stops. It's certainly in the last few weeks has abated and then we'll see. We don't mind shrinking every once in a while. We shrunk this past quarter, and if that's the right answer, that's the right answer. I mean we're not -- again, we don't come to the office every day to say we have to grow. We come to the office and try to find good deals for our shareholders.

So this past quarter, we shrunk a little bit and that may happen. And that may happen from time-to-time. We are optimistic that between M&A volume increasing and the market backing up a little bit that we will continue at a minimum to slowly grow over time. Perhaps the market backs up more and the growth will be faster over time.

Just kind of -- just following up on that. How do you -- obviously the M&A market picking up is a good thing, but when you're looking at kind of the things in the portfolio, the M&A environment can also result in those investments being taken off your balance sheet and coming to market with lower rate sponsors look to do some financial engineering. So, how do you kind of think about that?

Again, we don't have a problem seeing deals. It's a question of which deals we end up choosing to do. Over seven years, we've been able to generally originate good risk-adjusted return relative to our repayments. Quarter-to-quarter there's going to be some variability. We've -- sometimes we'll go into industry verticals very deeply. Oil and gas and energy is an industry vertical we're going into. At one point we did a lot in gaming. And that was an interesting industry vertical.

So, we take it as it comes. We have not had a problem over seven years in different kinds of market environments, both good and bad markets, finding good risk-adjusted return. But again, we're in the investment business, we have to find good investments. If there's not good investments, we won't do them.

So, I don't know how to answer the question. You see our seven-year -- seven and a half year track record now, which is out there for everyone to see. You've seen how we've invested, you've seen how we've grown, you've seen how our deals have performed, you've seen how our bad deals have recovered, you've seen how we've been able to deliver a consistent dividend to our shareholders. That's our track record in seven years, seven and a half years at this point. You guys can all evaluate what you think of our ability to execute the business plan. There is no major change from what it was seven and a half years ago.

Okay, great. And then just a quick one on -- I think I saw that Enviro-Solutions was marked down, it was previously carried at a higher premium on the equity position and then it was marked down about $5 million during the quarter. Was there something going on with the position that we should be aware of?

Yes, there is a -- there is a landfill that they've been hoping to get an extension for. Doesn't look like they're getting the extension at this point. So, we and the independent valuation firms and the Board thought it prudent to mark that equity down a little bit.

And it does conclude today's question-and-answer session. I'd like to turn the conference back over to Mr. Penn for any additional or closing comments.

Great, thanks everybody. I appreciate everybody's attendance today, and we will be talking to you next quarter. Next quarter, just a reminder is our 10-K -- our 10-K quarter. So our quarterly conference call would be a few days later than it normally is. It'll be coming right before Thanksgiving. Thank you very much.

And with that ladies and gentlemen, that does conclude today's conference call. We'd like to thank you again for your participation.