Pennantpark Investment Corp (PNNT) 2015 Q2 法說會逐字稿

Good morning and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2015 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'd like to welcome you to PennantPark Investment Corporation's Second Fiscal Quarter 2015 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'd 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 as well as our Web site.

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, our overall strategy, and then open it up for Q&A. As you all know, the economic signals are moderately positive, many economists expecting a slowly growing economy going forward.

With regard to the more liquid capital markets, and in particular, the leveraged loan in high-yield markets, during the quarter ended March 31, those markets experienced strength due to cash coming from CLO formation and substantial repayment activity. Contributing to the strength was a modest rebound in oil prices, which to some extent calmed investor fears. Middle-market M&A activity was muted in the quarter, we are seeing a more active environment since quarter-end and are hopeful that activity and attractive supply will be realized through the remainder of the year.

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 remain focused on long-term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on companies or 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 investment opportunities as they arise. As credit investors, one of our primary goal 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 a 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 sponsor's management teams and intermediaries who want consistent credible capital. As an independent provider free of conflicts or affiliations, we've 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 March 31, 2015, we invested $73 million. The average yield on new debt investments was 12.9%. Expected IRRs generally range from 13% to 18%. Net investment income was $0.29 per share. We have met our goal of a steady stable, consistent dividend stream since our IPO eight years ago, despite the overall economic and market turmoil throughout that time period. We anticipate continuing the steady, stable dividend stream going forward. We've plenty of liquidity, as on March 31, we had in total about $480 million of available liquidity consisting of $340 million of available credit facility, $75 million of new SPIC debt financing [in] our second SPIC and over $63 million of cash on hand.

Given the current market backdrop, we've remained appropriately levered and 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 66% and only about 46% excluding SBIC debt. Our Board of Directors has authorized a stock repurchase program of up to $35 million worth of stock over the next 12 months.

Our portfolio is constructed to withstand market and economic volatility. We have a cash interest coverage ratio of 2.4 times and a debt-EBITDA ratio of 4.9 times at cost on our cash flow loans. We had some attractive realizations last quarter and generated $9.5 million of realized gains.

We are proud that since inception 8 years ago through the recession and credit crisis, we've generated positive net realized gains for our shareholders, during the quarter ended March 31, we exited $48 million in Patriot National first lien debt plus warrants and realized a gain of $9.4 million, an IRR of 27%. We still have warrants worth $1.2 million in this company. A $15 million position in Power Products mezzanine was refinanced and generated an IRR of 28%, and fees systems repaid our $8 million loan and generated an IRR of 16.5%. As we highlighted on our last call, with regard to our exposure to the energy industry, we've successfully invested in energy through 21 different companies since our inception eight years ago.

In 2014, we monetized three large subordinated debt and equity positions, they generated proceeds of approximately $170 million and a weighted average IRR of 17.8%. We focused on opportunities backed by sponsors or experienced management teams who have deep experience to be successful across the industry. Together with their own contacts, industry consultants and engineers, these resources have aided us meaningfully in the past. We've avoided certain energy subsectors, geographies, as well as many undifferentiated service businesses with [low] barriers to entry. For exploration and production, we'd like to be senior in the capital structure with an asset backed focus and hedging to mitigate the downside. We look to remain in low-cost areas with growing production and experience management teams with proven project capabilities.

Our existing portfolio including the exploration and production companies fit into our theme of being senior in the capital structure, backed by substantial asset coverage including proved, developed and producing reserves with substantial hedges in place. There are also significant additional assets in the form of additional acreage, reserves and midstream assets.

With regard to Ram Energy, we're backing an experienced management team, who has performed well for PennantPark in the past and we are in the first lien position. Through our non-core asset sales, the company paid down $7.5 million of debt since the last quarter and is continuing to evaluate their assets and strategy.

Likewise, new (inaudible) generated substantial liquidity by selling a portion of their non-core midstream assets for $85 million as looking to sell further non-core Midstream and E&P assets.

We believe that our underwriting criteria and long-term approach should support our investments through this period of low energy prices, allow us to realize attractive returns. While mindful of our desire to maintain a diversified portfolio, the current situation may well present [attractive risk or award] opportunities.

Across PennantPark entities, we had only nine companies on non-accrual, out of 360 investments since inception eight years ago, despite the recession during that time period. Further, we are proud that even when we have had those nine 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. We always monitor and re-underwrite our deals, in situations where the best long-term value for shareholders is created by taking control of the companies and providing capital and expertise, we do.

Our positive net realized cumulative gain since inception eight years ago through the financial crises, are testament to this long-term value orientation. Based on values as of March 31, we've recovered nearly 90% of capital invested so far on those nine companies that have been on non-accrual since inception. We have two non-accrual investments as of March 31, representing only 1.2% of the portfolio at cost.

As a result of the track record of low non-accruals and high recovery rate, we're one of the few BDC's who was in operation before the recession, has preserved capital for shareholders while generating consistent steady dividend. In terms of new investments, we had another quarter investing in attractive risk-adjusted returns and virtually all 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. The above capital provides the equipment lease financing to businesses in the United States. We purchased $10 million of second lien debt, the Company is owned by the founder. We purchased $23 million of subordinated debt and $2 million of equity in Cascade LP. Cascade is a provider of services for environmental projects, Snow Phipps is the sponsor. Randall-Reilly is a business-to-business media and information company; we purchased $12 million of subordinated debt and Westcore business sponsor.

Turning to the outlook, we believe that the remainder of 2015 will continue to be active due to growth and 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 March 31, 2015, recurring net investment income totaled $0.24 per share. In addition, we had $0.05 per share of other income, net of fees and our -- as a result to net investment income for the quarter was $0.29 per share.

Looking at some of the expense categories, management fees totaled $12.3 million. General and administrative expenses totaled $1.7 million and interest expense totaled $6.6 million. During the quarter ended March 31, a net realized gain from investment was $9.5 million or $0.13 per share, unrealized losses from investments was $24.8 million or $0.33 per share and unrealized gain from our debt was $600,000 or $0.01 per share. Excess net income over dividends was about $1 million or $0.01 per share. Consequently, NAV per share went down $0.18 from $10.43 to $10.25 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 and exchanges or independent broker-dealer quotations, when active markets are available under ASC 820 and ASC 825. In case of 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 12.4%.

On March 31, our portfolio consisted of 67 companies across 31 different industries and was invested 27% in senior secured debt, 47% in second lien secured debt,17% in subordinated debt and 9% in preferred and common equity; 68% of the portfolio has a floating rate, including 61% with the 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 long-term 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'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.

Thank you. (Operator Instructions) Troy Ward, KBW.

Great. Thank you. and good morning, Art and Aviv. Real quick on, couple of movements in the portfolio on the credit side, I saw it looks like your restructured JF. Can you just give us some detail around that and it looks like maybe you put in more capital. Could you provide some color there?

JF acquisition is a distributor of gas pumps; it's been having some bumps in the road for a while, last quarter, we put on non-accrual. The results have continued to slide unfortunately due to a failed ERP software implementation and some accounting and as a result there -- we resulted in some accounting issues. So that restructuring was done, we converted our debt into equity. We put more equity in, we own about 37% of the company, MidOcean is the original sponsor put, a bigger equity check in, they are on a bigger piece of the equity, we're hopeful like some of the other restructurings that we've had over time that, that equity will help us recover value over time; certainly, it's very disappointing for us.

And then you said gas [pumps] that's more -- if you remind me, though that on the retail side, not necessarily the industrial drilling side, correct?

That's right. This is, you know you go down to the corner gas station.

Okay great. And then, I believe direct by with on non-accrual this quarter as JF came off, so that's still two in the non-accrual bucket. Can you speak to the direct buy?

Sure. Direct buy, has been undergoing a business transition, they're changing their business model, the one where it's more of an ongoing relationship with their customers than a one-time payment. So while it's in transition, we put it on non-accrual. It's not going to certainly be paying us cash interest for a while as that company undergoes hopefully a transition.

And then, can you speak a little bit about kind of the different investment places in the capital structure. I think over a multi-year period, you really kept PNNT kind of focused in the same point in the capital structure and that is the true subordinated, we call traditional mezz. And while many of the peers in the BDC space have moved up and down the capital structure, I think maybe in the more recent quarters, we've seen actually some BDCs move more into second lien. We've seen maybe were -- they went to senior prior, they're starting to maybe back up a little bit in the capital structure. Can you just speak to where you think the attractiveness is or maybe has changed or has there been any change in the attractiveness of different pieces in the capital structure?

That's a great question. When we set up in PNNT eight years ago, we always anticipated and viewed it as a publicly traded mezzanine debt fund and sometimes that traditional mezz debt, sometimes it means second lien. Secondly lien is subordinated and has some protections that make it slightly better than traditional subordinated debt, but we still view it as subordinated debt. And certain cases when we can get an appropriate yield on first lien on this market stretch for senior unitranche, that's a piece of the portfolio as well and why we've done that, we're focused on, on having a certain ROE for our shareholders to make the math work. We want a double-digit ROE, we need to find investments with those yields. The exception was of course in 2008, 2009, and 2010, when you can move up capital structure and by first lien and get mezzanine returns. Of course we did that, that was the best and PNNT at that time did move up capital structure and if that type of market happens again of course, PNNT will move up. But we're very focused on, on our box and our box is kind of a double-digit ROE, being very conservative with what we underwrite, it means in certain cases we grow, in certain cases we shrink. We shrank this past quarter, and if that's the right answer, because the risk-reward isn't in the market and not available to us. So be, it will shrink, we as you know, Troy we don't come to the office every day and talk about how we grow, we talk about is there a good deal to do. And PNNT has had somewhat muted growth over the last couple of years as a result of that.

Great. That's all from me thanks.

Thank you.

Doug Mewhirter, SunTrust.

My first question actually you'd covered very thoroughly, but your non-accruals, I appreciate that detail. My second question about your energy investments, I mean it's no secret that these guys have to get pretty creative on maintaining their business and their cash flows. With the recent pop in energy prices into the 50s at least on the futures markets, have any of your borrowers taken the opportunity to maybe put on some more hedges with the pop to maybe protect sort of extend that protection out a little longer or is sort of the clock still running on their existing hedges?

They haven't yet put on hedges as well as have moved back up to 60. We still reiterate that what we said last quarter is, we hope to kind of a year from now oil will be in the 70s and in that case we think these companies will be fine. In the meantime, as we said with both new Ram and New Gulf there shedding non-core assets, trying to create liquidity and make it through the cycle. Certainly, we're feeling better now that oils are over 60, we had no guarantee that's going to stay over 60 or go higher or go down again you can spend all day, every day, thinking about where oil is going to be with no real certainty. So these companies are doing what they need to do to preserve the liquidity and make it through.

And just to clarify something on Ram and New Gulf, where -- they made some non-core asset sales, you said Ram Energy paid down a little bit of debt and New Gulf got some cash from their midstream sales. Did any of that cash (inaudible) or both cases come back to you or did they pay down on other debt or just keep the cash on hand?

Well, in Ram it pay down some debt and then they keep the cash on hand to pay its interest and to operate.

Okay. With New Gulf, they sort of just maintain their own liquidity, they didn't pay...

That's correct.

(Operator Instructions) Chris York, JMP Securities.

So just wanted to touch a little bit more on your views for the competitive environment and more specifically, what is the exit or what is your view of the exit of GE Capital from the sponsor finance business due to your opportunity set and then potentially opportunities to add new employees?

It's a great question. It's very early to tell what the GE fallout will be, if any, depends on how it all plays through. We still like the middle market long run, obviously, we're very optimistic. Just think about, what we all do in the BDC World, GE turmoil if it were to happen, would present opportunities for all of us, whether it be in assets or market share or talented people. So our years at the ground were opportunistic. We certainly wish the GE folks the best, we've many friends over there and whatever you, whatever will be, will be. We like the overall marketplace.

Jonathan Bock, Wells Fargo Securities.

Hey guys, this is actually Greg in for John. A couple quick questions. So first on, I believe if (inaudible) was marked down pretty substantially and this is a deal, where there is a debt exchange rate in 2013 and you guys actually put an additional capital expressing comfort with the credit. So just want to get your thoughts around that.

It's a great question. It was marked it down this quarter for a couple reasons. Number one, the strength of the dollar would have significant foreign operations. Number two, they've had an issue with a large client, so that has resulted in the mark down, we still believe in the long run that the asset value is there, the sum of the parts should mean we get our whole on our debt if not have some equity value.

So we still believe that thesis when they did the work out restructuring, couple of years ago, they bought themselves nearly three years of time to operate. So we still believe investment thesis to mark to market at this point, we'll, we'll continue to monitor and beyond it and. And, that's kind of the answer to the question.

Sure and then, obviously everyone appreciates the repurchase program that you announced, certain graphs on that. But -- so one question on that, as you think about utilization obviously it's a program that's more subject to restrictions and timing restrictions relative to some 10b5-1 programs. So just get your thoughts on utilization and then also, how you think of utilization as an inherent investment in your current portfolio wherein have declined 10% over the past four quarters.

We believe in the portfolio, which is one of the reasons we authorized this plan and we wouldn't have authorized the plan, unless we were going to use it.

Christopher Nolan, MLV & Co.

Can you give a little detail, in terms of the incremental write-down on Ram Energy.

I mean that was just I think, it went from 90 to 88, there was nothing really I just got the valuation firms came up with, was not material. That's what they came up with this quarter versus 90 last quarter.

(inaudible) the energy sector, does that reflect the EBITDA for these companies or does it also reflect the potential, I guess nervousness of banks that might hold revolver and could basically pursue some sort of --

Yes. This is our mark-to-market. I mean, we still believe on these names that we are covered by asset value and in the long run, we'll get all our money back, but when energy goes down, the big chunk like it did in the last six months, you have to recognize that in your mark-to-market, otherwise put your head in the sand. So, there's been a mark-to-market and then the biggest chunk of our unrealized losses over last couple of quarter had been due to that. Again, we reaffirmed that our energy and that are exposures is covered by assets and we feel good about it.

Final question on the repurchase. At what price level, share price levels do you start, those the -- returns on a repurchase start looking more attractive and actually making incremental investments?

Look, we would -- again, we wouldn't have made this announcement unless we intended to actually execute. So, we don't disclose that, but we made the announcement with the intent that we will buy stock back.

Andrew Kerai, BDC Income Fund.

I apologize if this was asked already, but on terms of Ram Energy, I noticed you re-classed from a non-control, non-affiliate whole into an affiliate investment. Obviously, they have -- the B Tranche has maturity coming up here later this year. Was there any change in the sort of I guess, you're seeing at the table from a voting rights perspective or just any reasoning behind the re-class would be helpful.

Yes, that's a great question. When we did the deal originally, we set some thresholds for getting paid back on that term B, and if we weren't paid back by certain period of time, we would get warrants. So, we're just over the 5% equity ownership threshold as of (inaudible), that's why it got classified that way.

Okay. Great. Now, that certainly makes sense. And then just a follow-up on the energy as well. With the oil obviously post 3.31, sort of moving up here -- I think, if you look at WTI, it's about 60 now. Is there any potential for I guess maybe at least marginal write ups for some of the investments that it had markdowns over the past couple of quarters?

Look, we're certainly encouraged by oil prices being up a little bit. You would think the mark-to-market on the portfolio will be somewhat related to oil prices because it certainly was on the way down. We'll see if it's substantial enough, as we work with the independent valuation firms and we see where the market prices have comparable securities. That's really what drives and where are the comparable securities, whether it would be debt or equity that are in the liquid markets and our independent valuation firms take their cues from that.

Great, now that certainly makes sense. And then just on the buyback again, with the earnings out now and based (inaudible) I guess you guys out of a quiet period, there's nothing restricting at this point for example, repurchasing stock, this week or even today, right.

That's correct.

Okay, great. Thank you and congrats again on the buyback, we certainly appreciate the color and look forward for you guys hopefully utilizing a material portion of it.

Thank you very much.

And with no questions remaining, I'd like to turn the call back over to management for any additional or closing comments.

I just want to thank everybody for being on the call today. We look forward to speaking to you next quarter.

Ladies and gentlemen, that does conclude today's' conference and we thank you for your participation.