Pennantpark Investment Corp (PNNT) 2016 Q3 法說會逐字稿

Good morning and welcome to the PennantPark Investment Corporation's third fiscal quarter 2016 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 third fiscal quarter 2016 earnings conference call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start off by disclosing some general conference call information and include the discussion about forward-looking statements.

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and pin provided in our earnings press release 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 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'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thank you, Aviv. I'm going to provide an update on the business starting with financial highlights, a discussion of our energy portfolio; followed by a discussion of the overall market, the overall portfolio, investment activity, the financials; and then open it up for Q&A.

For the quarter ended June 30, 2016 we invested $90 million at an average yield of 12.4%. Expected IRRs generally range from 12% to 17%. Net investment income was $0.25 per share. NAV increased 1.2% from $8.83 per share to $8.94 per share. Given the continued headwinds and volatility, we continue to focus on our energy portfolio, which includes those companies in our schedule of investments listed as oil and gas and energy and utilities. Our focus is on companies that have strong management teams, attractive asset portfolios, and the ability and time to endure the current market conditions.

We intend to work with our portfolio of companies to ensure that they have the resources, personnel, capital, and runway to maximize our long-term recovery to weather this tumultuous period. Energy prices increased and stabilized this past quarter, but will continue to be low on an absolute historical basis. As of June 30, 2016 our energy portfolio had a cost of $178 million and was marked at $131 million. This represents 13% of the cost and 11% of the market value of our overall portfolio respectively. Valuations on our energy investments increased by $17 million from the quarter ended March 31, 2016 representing $0.24 per share. As we have mentioned previously, independent third-party valuation firms value all of our non-actively quoted investments. Many have asked us what happens to NAV and NII if our energy investments are completely written off.

While we do not think all our energy investments are worthless and we believe they're fairly valued, as of June 30 NAV would have been $7.10 per share or about 20% lower if all the energy investments were written off. If all the energy investments were put on non-accrual, NII would decrease by about $0.03 per share per quarter. As shareholders and managers, we're disappointed with the performance of our energy portfolio and intend to work diligently to recover our capital on our energy investments and to grow our NII back to historical levels. We do not believe that the short run option of selling these assets at fire sale prices is prudent. That said, we monitor each situation and investment on a case by case basis. In this challenging environment for oil prices, we intend on taking an approach that will maximize value in the long run.

We are encouraged by the increase in energy prices since March 30 and believe that the recovery in this sector will be gradual and take time. For the quarter ended June 30 we waived base and incentive fees, which equaled the percentage of the cost value of our energy portfolio, 16% as of December 31, 2015. This waiver amounted to $1.6 million representing $0.02 per share. This waiver will continue until December 31, 2016. We believe that this waiver demonstrates a strong commitment to our shareholders and our focus on our energy portfolio. In addition to this fee waiver, two other positive factors are helping to offset the energy issues. First, other income is a category that we have in our income statement to represent prepayment fees or waiver and amendment fees that are not part of ongoing interest income.

Other income was $0.02 per share for the quarter ended June 30 and it averaged $0.04 per share per quarter over the last couple of years. Second, last December SBIC legislation was passed which raised the amount of available borrowings to $350 million, which will enable us to continue to use this program and create value for our shareholders. We are finding attractive investments for SBICs and believe that our SBIC licenses will enable us to avail ourselves of that capital. During the quarter, we borrowed $25 million in SBIC II. We look forward to fully utilizing the upside to $150 million of borrowing capacity in SBIC II and utilizing an additional $50 million of borrowing capacity in a potential SBIC III. With regard to our dividend, our Board regularly evaluates the earning power of the Company relative to the dividend.

Our substantial spillover cushion which was $0.53 per share as of last September 30, the fee waiver through 12/31/2016, substantial other income from prepayment fees, and SBIC usage give us the flexibility to continue to evaluate our portfolio and the market without rushing to make a decision on any change to the dividend at this point. With regard to the market, the economic signals are mixed. 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 experienced strength as high yield and leveraged loan funds experienced inflows due to expectations of the fed keeping rates lower for longer and stability in the energy market. The overall market has strengthened and remains attractive. As debt investors and lenders, a flat 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 for us. 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 and structures that are more defensive, have low leverage, strong covenants, and high returns. 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've become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by over 160 different financial sponsors. Our portfolio is constructed to withstand market and economic volatility. In general, our non-energy portfolio is performing well despite a mixed domestic and global economy. We have a cash interest coverage ratio of 2.5 times and a debt to EBITDA ratio of 5 times at cost on our cash flow loans. We are pleased that we have diversified funding sources with several features that reduce the overall risk to the Company. First, we have $321 million of long-term unsecured bonds and have only utilized 20% of our long-term $545 million credit facility. Second, as we discussed, we're utilizing the expanded capacity under the new SBIC legislation.

SBIC financing creates financial cushion in that we have exempted relief from the SEC to exclude SBIC debt from our BDC asset coverage test and SBIC accounting is cost accounting not mark-to-market accounting. Third, to better align the measurement of asset and liability values for both GAAP and the BDC asset coverage test, we mark both our assets and our liabilities to market. As a result of all these features, we've provided substantial safety to our shareholders, bondholders, and lenders in the event of market volatility. On the asset side of our balance sheet, during the last three years the percentage of our investments that are secured by either a first or a second lien has increased from about 50% of the portfolio to 75% of the portfolio. Due to all these factors, we remain comfortable with our targeted regulatory debt to equity ratio of 0.6 times to 0.8 times.

There's been no material change to our energy portfolio since last quarter. Bennu Oil & Gas remains on non-accrual. RAM Energy continues to execute its current business plan and strategy. And as mentioned previously, New Gulf emerged from bankruptcy last quarter, we own a convertible debt instrument that will convert into approximately 17% equity ownership. Across PennantPark entities, we've had only 13 companies on non-accrual out of 412 investments since inception nine years ago despite the recession during that time frame. Further, we are proud that even when we have had those non-accruals, we've been able to preserve capital for our shareholders. Through hard work, patience, and judicious additional investments in capital and personnel in those companies; we've been able to find ways to add value.

We constantly monitor our deals and reunderwrite them in the face of new information. 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. Based on values as of June 30, today we have recovered nearly 80% of capital invested in those 13 companies that have been on non-accrual since inception of the firm.

We are proud of our long-term track record over nine years including the recession. Since inception, PNNT has made nearly 180 investments totaling about $4 billion at an average yield of 12.5%. Including both realized and unrealized losses, PNNT has lost only 56 basis points annually. In terms of new investments, we had another quarter investing in attractive risk-adjusted returns.

In 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 a couple of the highlights. We won $26 million of a second lien term loan to MailSouth. MailSouth is a provider of direct mail solutions focused on the rural and suburban markets, Court Square is the sponsor. Randall-Reilly is a business-to-business data and marketing services company serving the trucking, construction, and industrial markets. We invested $27 million of senior subordinated debt, Investcorp is the sponsor. Turning to the outlook, we believe that the remainder of 2016 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 us through the financial results.

Thank you, Art. For the quarter ended June 30, 2016, recurring net investment income totaled $0.21 per share. In addition, we had $0.02 per share of other income net of incentive fees and $0.02 per share from the fee waiver. As a result, net investment income for the quarter was $0.25 per share. Looking at some of the expense categories; management fees after waiver totaled $8.6 million, general and administrative expenses totaled $1.8 million, and interest expense totaled $7 million. During the quarter ended June 30, unrealized gain from investment was $58 million or $0.81 per share primarily due to a reversal into realized loss from investment, which was $46 million or $0.64 per share.

We also had unrealized loss from our various debt instruments of $2 million or $0.30 per share. Excess dividend over net income was $2 million or $0.30 per share. Consequently, NAV per share went up $0.11 from $8.83 per share to $8.94 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 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 11.8%.

On June 30, our portfolio consisted of 59 companies across 28 different industries. The portfolio was invested in 34% senior secured debt, 41% in second lien secured debt, 14% in subordinated debt, and 11% in preferred and common equity. 81% of the portfolio has a floating rate including 77% with a floor and the average LIBOR floor is 1.2%. 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 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.

Just had a sort of market related question. Obviously you have a lot of energy assets, which you're in the process of restructuring or post restructuring, and I know that there's always people out there who are looking for oil in the ground so to speak and I'm sure you've gotten offers, but I'm sure they've been lowball offers. Have you seen any sort of creeping up in the bid value of the vultures swooping around these oil assets given the slightly higher oil prices?

It's great question, Doug. We are starting to see more M&A in the sector and we're hearing about more M&A in the sector. So, that's a positive sign when deals start getting cut and there's kind of a base evaluation from which the market can move. Of course we could capitulate and sell at a fire sale price, it's not what we think is in the best interest of our shareholders. So, most of these companies either have been restructured or are in the process of being restructured or are in a situation where they can make them run in the status quo and are set up to weather the cycle for a while. And the cycle may last for a while, it may end soon, we don't know; but we are setting up this portfolio to create the option to weather the storm for a while.

Next a technical question on your New Gulf restructuring. This convertible note, where and how would it convert and also is it paying cash interest while it's still sort of in note form?

It's currently a pick instrument and it will convert when there's an event, either a significant equity offering or a sale of the company.

Mickey Schleien, Ladenburg.

Just a couple of questions and I apologize, but we're just slammed with earnings on our end. I do see the New Gulf refinancing, which looks like it caused the bulk of the realized loss, but I think there was something else. Can you clarify what else you took a realized loss on?

The realized loss on New Gulf is like 70% of the rest of it. We do not give each name by name highlight, but the New Gulf is primarily what you see in there. But you can see quarter-over-quarter which names we exited, but we do not give a name by name indication of what's the realized loss.

So, the balance was spread out amongst many names or was there one or two names that really --?

There is a couple of names that we exited during the quarter that we realized a loss other than New Gulf.

Other than New Gulf. And on your floating rate investments, do you use typically one, two, or three month LIBOR as the reference rate?

This is usually a one month, but it does vary so I cannot say that one month is the rule. Some of them reset monthly, some of them reset quarterly. So if it resets quarterly, it's a three-month LIBOR.

John Hecht, Jefferies.

First one just a clarification, Art. Are you able to give us any update on kind of where you are with the third application under the SBIC program?

We are working diligently to invest SBIC II. Once we get towards the end of SBIC II, we would then approach the SBA for license number three.

Okay. And then you seem focused at this point in time in kind of optimizing I guess your capital structure and balance sheet around the SBA. Can you tell us just to understand how that kind of focus in the intermediate term might affect things? How does that trend vary within the SBA versus investments you have outside the SBA maybe in terms of the average size, the average term, the average rate and what might that mean towards kind of the metrics we look at in the business in the near term?

So, the important thing for us is we invest the same way across the fund however it's financed; whether it's financed with our credit facility or our unsecured debt, unsecured bonds or the SBIC. So, we task our investment professionals with bringing good deals in first and foremost and then we'll figure out where to put them. Per my remarks, we really love the SBIC financing for many, many reasons and people know that if there is a good deal to do and it fits the SBIC, that's terrific. But we do not change how we invest across the platform.

Okay. And then I guess sort of an extension that last question. What do you see going on in the general middle markets? So are you seeing any kind of stabilization of competitive trends, any pockets of opportunity where there may be better risk-adjusted returns at this in point in time?

We really like the middle market and we continue to like it. We've been active in both of our publicly traded vehicles, PNNT and PFLT. PFLT announces earnings tonight. We're seeing very good risk-reward due to kind of the pullback from the regulated entities and the lack of capital there. So, it's a pretty interesting time for us. Where we are in the middle market is a little bit away from the fray of the broadly syndicated world given that we are in the middle of the middle market. Those funds in those firms that are at the upper end of the middle market may be more subject to the ins and outs of the broadly syndicated or public high yield market, which have rallied in the last few weeks. We haven't really seen much of that rally in our part of the middle market.

(Operator Instructions) Jonathan Bock, Wells Fargo Securities.

This is Joe Mazzoli filling in for Jonathan Bock. The first question relates to dividend policy and of course the fee waivers have been very shareholder friendly and no doubt that investors appreciate that. But we see that NOI fell below the dividend despite the current fee waivers and while there are several levers to pull with the SBICs, we have seen several BDCs re-evaluate their dividend policies to better align. So given this, how should shareholders view the dividend policy moving forward?

It's a great question, Joe. Look, it's something that the Board and we as managers are always thinking about. It's something we evaluate all the time. I think the game plan six months ago when we decided to do the fee waiver tied to the energy portfolio, we looked at the situation and said there's significant spillover, which by the way still remains six months later. The fee waiver, which we totally support, is certainly helpful to the income of the vehicle and the substantial other income that we've had and we typically have as well as the SBIC opportunity give us an opportunity to put our head down and focus on the portfolio for this year. See where the portfolio is, see where energy is, see what the outlook in the economy and leveraged middle market is; and lift our head up at the end of the year and see what the facts and circumstances are at the time. So, we are always looking at it. We understand all the plusses and minuses, but due to a bunch of various factors, we do not need to take a decision on that at this time.

That totally makes sense. And now with the SBIC with your two licenses, you now have just under $200 million drawn of SBA debentures and you have the ability to go up to $300 million with the two licenses. And if you could remind us, do you have to receive an additional approval for additional SBA debentures to reach to the $300 million?

So, essentially you're absolutely right. The two SBICs can draw $300 million and that's ongoing so we are all hopeful even though it depends on our investment activity. And then once you get close to that, you start on SBIC III which can draw an additional $50 million, but that's not in the near future. But right now we're working to ramping up SBIC II, want it to be fully ramped up, then we're talking about SBIC III.

Okay. And then one final question relates to a specific investment, Sunborn International. It was marked down by $2.1 million this quarter so it looks like this investment is a UK based company with the loan denominated in British pounds. So, is this related to the Brexit or volatility in currencies? If you could provide some color, that would be helpful.

You've got a sharp eye, Joe. So, Sunborn the mark is solely due to currency. The credit is a par credit and we hedge the currency risk by borrowing in the currency so we borrowed in sterling. So, we made up for that mark-to-market loss with a mark-to-market gain essentially on our credit facility. So, we're hedged on principal and interest on Sunborn. So, that mark had nothing to do with credit but just currency.

Chris York, JMP Securities.

I was hoping if you could update us on fundraising adviser. And then I guess more specifically, have you been active and then could you remind us how many assets under management and investment professionals are at the adviser as well?

So, as you know and this is kind of has been a trend over the last 18 months, we have been building up the adviser as we've seen more opportunity in the middle market as PNNT and PFLT has grown. PFLT has doubled in the last year due to MCG so we now have offices in Los Angeles, Chicago, Houston, and London, as well as we've added professionals here. Outside of the two publicly traded business development companies, we have a private GPLP fund which has available AUM of about $100 million. And we're looking to potentially grow outside of the BDCs due to the BDCs not trading at book value, which limits our ability to grow. We do see a massive opportunity in the middle market as regulated entities have pulled back and we've got great sponsor clients who would like us to provide financing for them. So, we want to be helpful to our sponsor clients and provide them capital when the risk reward makes sense. We've got about 35 employees in total across the offices.

Greg Mason, Ares Management.

I just have one quick follow-up to Joe's question. On your comments of keeping your head down to the end of the year and then re-evaluating the dividend. Just want to clarify do you view that as your fiscal year-end September 30 or calendar year-end?

That's a great question. We view it as calendar year-end. We took the fee waiver as of December 31 and we're thinking of it as a 12-month time period for us to focus on the portfolio and work it and work the raised leverage we have and then lift our head up at the end of the calendar year and make an assessment.

That will conclude the question-and-answer session. I'd like to turn the conference back over to Mr. Art Penn for any additional or closing remarks.

Thanks, everybody, for being on the call today. A reminder that for September 30, that's our 10-K time of year, so we report a few weeks later than normal due to the annual 10-K process. So, looking forward to talking to everybody in November and have a great rest of the summer.

That does concludes today's conference. Thank you all for your participation.