Pennantpark Investment Corp (PNNT) 2014 Q4 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's fourth fiscal quarter 2014 earnings conference call. Today's conference is being recorded.

(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 fourth fiscal quarter 2014 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 provided in our earnings press release, as well as on our website. 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 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 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 leverage loan and high yield markets, during the quarter ended September 30, those markets experienced volatility due to cash outflows and leverage loan and high yield funds. Those outflows were a result of the global economic concerns, geo-political risk, and expectations that The Federal Reserve would tighten monetary policy. A less robust broadly syndicated loan and high yield market 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've 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 at work 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 we 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 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, 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 September 30, 2014, we invested $233 million. The average yield on new debt investments was 13%.

Expected IRRs generally ranged from 13% to 18%. Core net investment income was $0.34 per share. We are pleased that we issued 8.5 million shares of common stock, as well as $250 million of investment grade rated five-year bonds and an attractive coupon of 4.5%, which will add to our liquidity.

We have met our goal of a steady, stable, and consistent dividend stream since our IPO nearly eight 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've remained appropriately levered and have plenty of excess liquidity that we can use for both defensive and offensive purposes.

At quarter end, our net leverage ratio, accounting for cash on the balance sheet, was approximately 56%, and only 37% excluding SBIC debt. As a result, 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, 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 4.5 times, another indication of prudent risk. We have plenty of liquidity. As of September 30, we had in total over $630 million of available liquidity, consisting of $490 million of available credit facility, $75 million of new SBIC debt financing in our second SBIC, and over $65 million of cash on hand.

We had some attractive realizations last quarter. For example, Vestcom refinanced our $39 million subordinated debt position, which generated a 15.8% IRR.

We remain an equity co-investor and received a dividend as part of that financing. Our $20 million second lien debt position in [Ares] loan acquisition was exited at an IRR of 19.8% as part of a refinancing.

Despite the recession, across PennantPark entities, we've had only eight companies on nonaccrual, out of 344 investments since inception, nearly eight years ago. Further, we are proud that even when we have had those eight nonaccruals, 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 September 30, we have recovered 89% of the capital invested so far in those eight companies.

We had one nonaccrual investment as of September 30, representing only 0.3% of the portfolio at cost. As a result of this track record of low nonaccruals 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 investing in attractive risk adjusted returns. Our activity was primarily driven by growth financings, refinancings, and acquisition financings. In virtually all of these investments, we have known these particular companies for a while, have studied the industries, or have a strong relationship with a sponsor.

Let's walk through some of the highlights. AKA Diversified and Z wireless is a Verizon Wireless premium retailer based primarily in the Midwest. We purchased $10 million of unfunded revolver and $9 million of additional first lien term loan. Atlantic Street Capital is the sponsor.

We invested $41 million in the second lien debt of Novitex acquisition. Novitex provides outsourced mail, print, and document management solutions. Apollo is the sponsor.

Patriot national provides workers' compensation claims administration solutions to insurance carriers. We purchased $22 million of additional tranche of first lien term loan and $1 million of equity. The company is owned by management.

We purchased $100 million of first lien term loan, and $1 million of equity of Ram energy. Ram is an exploration production company focused on operation in the Ark-La-Tex and Permian regions. The company is primarily owned by management.

Sotera Defense solutions is a technology and engineering solutions firm. We purchased $19 million of the first lien term loan. Ares is the sponsor.

Turning to the outlook, we believe that the remainder of 2014 will continue to be active, due to growth in 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 September 30, 2014, recurring net investment income totaled $0.29 per share. In addition, we had $0.05 per share of other income. (inaudible) result core net investment income for the quarter was $0.34 per share.

Additionally, we had $0.07 per share of upfront expenses due to the issuance of the $250 million bond and $0.02 a share of reversal of capital gains incentive fees that were accrued, but not payable. As a result, GAAP net investment income was $0.29 per share.

Looking at some of the expense categories, management fees totaled $9 million, after $2 million of reversal of incentive fees accrued, but not payable. General and administrative expenses totaled $600,000. Interest expense totaled $5.6 million, and one-time bond issuance costs were $4.5 million.

During the quarter ended September 30, net realized gain from investment was $1 million, or $0.02 per share. Unrealized loss on investment was $25 million, or $0.36 per share, and unrealized gain from our notes was $2 million, or $0.03 per share.

Excess dividends over net income was about $1 million, or $0.01 per share. And the accretive effect of the issuance of new shares was $0.02 per share. Consequently, [entity] per share went down $0.30 from $11.33 to $11.03 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 evaluation firms, securities and 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 12.5%. On September 30, our portfolio consisted of 67 companies across 30 different industries and was invested 35% in senior secured debt, 37% in second lien secure debt, 19% in subordinated debt, and 9% in preferred and common equity. 68% of the portfolio has a floating rate, including 60% 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 at debt instruments and 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 up the call to questions.

(Operator Instructions)

Doug Mewhirter, SunTrust.

Good morning.

Question on the balance sheet. Now you have those investment grade notes out there, might have a little bit more scrutiny from bondholders and rating agencies, et cetera. Are there any hard caps on your total leverage now that you have those notes outstanding? I know that there is -- one of your competitors had mentioned that they were limited [0.75], even including SBIC. I didn't know if there were any similar constraints now that you have this debt outstanding.

No, we live within the SEC asset coverage constraints, as always. So there's nothing specifically in the notes, but other than staying within the SEC guidance.

And remind me of your comfort range with and without SBIC, your debt to equity? It seems like you're well within that -- you're pretty comfortable now. Could you remind me how high you generally get to that range before you think about issuing equity?

So our target range is 0.6 times to 0.8 times, inclusive of SBIC debt. That's the way we think about it. It gives us plenty of cushion, both defensively and offensively. Given the SBIC exemptive relief, we could theoretically take leverage above 1 to 1. Given the portfolio we have, we're comfortable in the 0.6 times to 0.8 times. And so that's where we generally like to be.

Okay. Thanks. That's all my questions.

Greg Mason, KBW.

Great. Good morning, everybody.

First, could you talk about Ram Energy? It's a really big deal for your size -- I believe 8% of the portfolio. And just maybe a little broader discussion on how you're viewing underwriting oil and gas, given some of the volatilities here recently in oil?

Sure, it's a good question.

First, as backdrop, we've been involved in energy investing since the get-go. It's been a big part of what we've done. I think we've invested something like $500 million and have generated mid-teens returns. It's a space we know, and we like, and we have some good experience in.

We like oil and gas particularly where we think there's good asset value -- which is the case here in Ram -- where we're lending against proven developed producing reserves, where we're at the top of the capital structure, and where there's hedges in place. So all those elements happen to be in Ram, which is one of the reasons we like it. And we're comfortable with the position due to that. There is a piece of the position, about $27 million, that is a shorter-term position. It's a one-year maturity that we think the Company's going to derisk and deleverage through several different ways. They could deleverage, derisk through several different ways over the course of the next year.

So you're right. It is a big position. We didn't take it lightly. We agonized over it. We do think a chunk of it will be short-term.

Okay, great.

And then the marks down in the book in the quarter, can you talk about the potential drivers there, as well as the one new nonaccrual, Intermediate Transportation?

Sure. So just Intermediate Transportation, that's the official name of it. It goes by the name of Great White. It was a nonaccrual we had early on, four or five years ago. It has under performed. We've put it on nonaccrual again. It's a very small position, as we said -- 0.3% of the portfolio at cost. But it has remained weak.

In terms of the NAV reduction, first, as many of you know, the liquid credit markets -- and as we said, we're down towards quarter end. A piece of our portfolio is broker dealer quoted and that certainly reflects that. The biggest driver of the markdown was our position in Affinion, which is a company we've been involved with for, I don't know, six years. We've invested in it over a long period of time in different formats. We feel very good about the deal.

There was an exchange that was done six, nine months ago to really give the Company three, four years of cushion. So we do not see this as a near-term nonaccrual at all. Part of the mark was due to just weakness in the liquid markets. Part of it was there was a rumor that there was a large forced seller who was liquidating their portfolio. The management towards the end -- after quarter end -- reiterated their guidance for the full year in the paper has traded better since then.

So we're comfortable with the position, albeit we never like to see the market volatility like that.

Great, thanks, Art. Thanks, guys.

Thank you.

Chris York, JMP Securities.

Good morning, guys. Just one question this morning.

So outstanding as the BA debentures have been flat throughout the year. Yet we've recently seen a couple BDCs issue debentures to maximize their licenses. Can you help me understand how you're thinking about that? That capacity? And has recent deal flow not been SBA-compliant?

Yes, we love our SBICs. Our first port of call is when we have a deal to put it in those vehicles. Unfortunately, for a number of reasons, we haven't found any recently. There will be a deal this upcoming quarter ended December that will fit into the SBIC. And we're looking for more.

There's very rigorous boxes that the SBA sets up. SBA does not like energy, unfortunately. So we're trying hard. It is the first port of call. And we are hopeful that we will use the cash in SBIC 1 and hopefully draw down $75 million in SBIC 2 over time.

Got it. That's it for me. Thanks.

Thank you.

Mickey Schleien, Ladenburg.

Yes, good morning, Art.

Can you remind me what percentage of assets are in the non-qualified bucket as of September?

It's very small. I don't have the number.

It's about 4%.

Aviv is saying it's 4% or 5%, something like that.

Okay.

So we've got a big bucket.

And given that, how do you think about employing that bucket? Some of your peers have done things like the SSLP, or they've gone out and acquired asset-based lenders -- a number of things to improve yield and synthetically increase leverages. Is that something PNNT would consider doing? And if so, can you give us some color on what that might look like and when?

Sure. We look at everything, as our fiduciary responsibility is to look at all these different types of things. We have used it a little bit so far in Europe. We did a deal in the UK, trust ends, which was financing a pub estate in the UK. We've looked at all these things, and we'll continue to look at all these things. There's nothing near term that we see, other than potentially gradually looking at deals in Europe for that vehicle. But we'll continue to look and see if any of these partnerships make sense.

Okay, and just a follow-up: if I'm not mistaken, you're carrying $0.21 of spill-over taxable income?

Yes.

I think in the past you've pretty much decided to retain that. Is that the expectation going forward? Or are you considering a special?

We like operating with some cushion, and so we're going to retain it for now.

Okay, and lastly, there was a pretty meaningful increase in PIC interest in the quarter. Was that idiosyncratic? Or was there a conscious decision to move toward PIC deals? Or what was going on?

There -- just to be clear -- there is never a conscious decision to move towards PIC deals. It's got to be idiosyncratic due to a particular deal or two. We prefer cash. We always prefer cash. If there's a particularly good risk/reward that's more PIC-oriented, we'll look to do that.

So let's look into that. And we can talk to you later on in the day as to what particular deal or two may have driven that. But we generally like cash.

Okay. Thanks, Art.

Thank you.

Matthew Freedman, Credit Suisse.

Thanks. It's actually Doug Harter.

Art, I was wondering if you could talk about the opportunity set you're seeing today at the higher yields you were able to achieve in the current quarter?

So, the opportunity set for us is always deal by deal by deal. It's tough. We're never -- other than when there's a market correction [HC], we've got to be deploying a lot of capital. This is always deal by deal by deal. We saw some good risk/reward this past quarter. We highlighted some of the names, Ram Energy, Novitex, Sotera -- we highlighted those in the comments -- Z Wireless.

You may remember the prior quarter we actually shrunk in size. This quarter we grew in size. So it's always idiosyncratic based on the deal. We're seeing less attractive opportunities in the down the middle of the fairway LBO -- middle market LBO. We're seeing more attractive opportunities either, as we said, in the energy space or in -- we're doing some of these build-ups. Z Wireless is essentially a buildup that we're doing with the sponsor, where they're consolidating the wireless retailing industry.

So we have some of these consolidation plays. We have some energy investments going on. It's looking at stuff that still fits our parameters, which is low debt to EBITDA, attractive returns, good covenants. And if it fits, we'll do it. And if it doesn't, we'll shrink.

Thanks. And acknowledging that you look at every deal on an individual basis, how would you think about what level of sector concentration in energy you would be comfortable with?

It's a great question. We are focused on diversification everywhere we can be diversified. So we think we can do a little bit more energy. Not a ton. I think what we'd hope is to get refinanced and taking off some of the existing energy deals.

We think we have a little bit more room in energy. But I would not expect the energy percentage in our portfolio to go dramatically higher from here.

Great. Thank you, Art.

Arren Cyganovich, Evercore.

Thanks. Just looking at the origination activity over the past -- I don't know -- five quarters or so, it's been pretty strong. Do you expect to have a similar pace going into next year? And were there any deals pulled forward into the third quarter? Because it seemed a little bit heavier than normal.

Yes, so it's a good point. A lot of what we did in this past quarter was front-end loaded in the quarter. So that's true. In terms of pacing, we've -- our statement is, we expect to see slow growth. So we are seeing repayments and refinancings decline this quarter, quarter to date. And that may just be because a little bit of the ebullience is off the market, which is a positive thing in some ways.

Of course we always like to get paid back. And we say thank you when people pay us back. If we like a company and we like the risk/reward, we like being in it.

All right, thanks.

And then the interest income was a little bit elevated, or higher than I was anticipating. Was there a certain amount of prepayment income or other nontypical interest income in the quarter?

Sure, yes. So, Arren, if you look at our income statement, we have this line in there called other income. That's where we've put one-time repayment penalties, fees, amendments, waiver fees; and that was higher this quarter. There were two companies that got repaid. One's name was Vestcom. The other is [Harslan] Acquisition. The prepayment penalties in those two deals were pretty good.

Okay. I was actually talking just about the interest income line itself.

No, I think the 13% yield that we generated this quarter and having it earlier in the quarter probably helped that.

Got it. Okay. Thank you.

Thank you.

Rick Shane, JPMorgan.

Thanks for taking my question this morning, guys.

We've seen the group trade below NAV, and you guys had a what in hindsight turns out to be a very timely equity offering during the quarter. Are you seeing any evolution to the competitive landscape? Are people pulling back a little bit with the group trading below NAV and capital becoming a little bit more precious?

It's a great question. It's certainly something to be attuned to going forward. You would think that over time, if BDCs trade below book value, they would be more cautious with their capital. That's certainly our hope -- not only other BDCs, but the general credit markets, including the liquid markets. It feels like the markets, including the middle market, are a little bit more cautious than they were right after Labor Day. I think the market started to slide mid-September.

So it's feeling a little bit more cautious. And to us, that's a good sign. Don't know how much is directly linked to NAV, where NAVs are in the BDC industry.

Great. Thank you, Art.

Thank you.

(Operator Instructions)

Rob Brock, West Family Investments.

Good morning, Art.

You had mentioned that the debt to EBITDA was 4.5 times. Could you talk a little bit about attachment points and how they've changed? And where they are in the capital structure at different levels? Thanks.

Sure. We like being kind of mid-4s overall. You can see our book, though, year to year is moving higher up in the capital stack.

I think we're at about 35% first lien now, which is higher than it's been in a while. So we've been steady, stable, mid-4s debt to EBITDA over the course of last year. We think we've improved our position both higher in the capital stack, as well as maintaining discipline around debt to EBITDA.

But that's really how we manage our risk, is by keeping the debt to EBITDA multiples low. The market certainly is well beyond 4.5 time its general proposition. We're seeing deals clearly at 5.5, 6, 6.5; in certain cases in the liquid markets, 7, 7.5 times debt to EBITDA -- very reminiscent of 2007, unfortunately. So if you take 4.5 times, has kind of been steady for us over the course of the last year, and you take the percentages that we have in first lien and second lien, sub and equity, you can see that we've improved, gradually improving our [attachment] point.

We're also pleased that we are now two-thirds floating rate on the asset side and almost all fixed on the liability side. So we think we've repositioned our fixed/floating mix well, as well. So we're going to continue to try to stay as high in the capital stack as we can. Try to keep debt to EBITDA as low as we can. Try to generate as much return as we can, as well as get the covenant protections. And that may mean there might be quarters that we shrink, as we did the prior quarter.

I don't know if I'm giving you what you wanted in that question, but hopefully I did.

Yes, thank you very much.

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

I just want to thank everybody for participating today. We will talk to you next in early February. Thank you very much.

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