Pennantpark Investment Corp (PNNT) 2018 Q1 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's First Fiscal Quarter 2018 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 First Fiscal Quarter 2018 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 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 the 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.

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

For the quarter ended December 31, 2017, we invested $138 million at an average yield of 10.8%. Net investment income was $0.20 per share, which included $0.02 per share of a fee waiver. NAV remained stable at $9.10 per share. A reminder that the board approved an amended investment advisory agreement, lowering the base management fee to 1.5% per annum and the incentive fee to 17.5%. The incentive fee floor will remain at 7%. This new agreement took effect on January 1, 2018.

As of September 30, we had taxable spillover of $0.26 per share. With the new fee agreement, a stable underlying portfolio and substantial spillover, we believe that PNNT stock should be able to provide investors with an attractive dividend stream, along with potential upside as the energy market rebounds and our equity investments mature.

Our primary business of financing middle market sponsors has remained robust. We've managed relationships with about 400 financial sponsors across the country from our offices in New York, Los Angeles, Chicago, Houston and London. We've done business with 181 sponsors. Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective with our investments. In this environment, we have not only been extremely selective, but we have generally moved up capital structure to more secure investments.

A reminder about our long-term track record. PNNT was in business since 2007, primarily as a subordinated and mezzanine debt investor and has now focused on financing middle market financial sponsors. Our performance through the global financial crisis and recession was excellent. Average EBITDA on the underlying portfolio companies was down about 7% to the bottom of the recession. The average high yield EBITDA was down about 40% during that time frame. As a result, we had few defaults and attractive recoveries on that primarily subordinated and mezzanine portfolio.

In this environment, due to our deep and broad investment team, we're seeing more deals than ever. We're using our tried and true underwriting discipline in middle-market sponsor deals. We are generally high in the capital stack and have substantial junior capital beneath us to provide cushion. As a result, we believe that we can continue to provide attractive risk-adjusted returns for our shareholders, even in this environment. We remain focused on long-term value and making investments that will perform well over an extended period of time 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 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.

Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio is performing well. We have cash interest coverage ratio of 2.6x and a debt-to-EBITDA ratio of 5.3x at cost on our cash flow loans. With asset yields coming down over the last several years, we are looking to create attractive risk-adjusted returns in our portfolio. We have a 3-point plan to do so.

Number one: we are focused on lower risk, primarily, secured investments, thereby reducing the volatility of our earnings stream. Investments secured by either our first or second lien are about 75% of the portfolio. Number two: we are also focused on reducing risk from the standpoint of diversification. As our portfolio rotates, we intend to have a more granular portfolio with modest bite sizes relative to our overall capital. And number three: we look forward to continuing to monetize the equity portion of our portfolio. Over time, we are targeting equity being between 5% and 10% of our overall portfolio. As of December 31, it was 16% of the portfolio.

I'm happy to report that, since quarter end, we've monetized 3 equity investments. Equity investments in convergent, goals and track have been exited for aggregate proceeds of about $21 million. This is generally in line with our overall fair value as of December 31. We are looking forward to investing these proceeds into solid cash-paying debt instruments to increase PNNT's income.

With regard to our capital structure, we remain comfortable with our target regulatory debt-to-equity ratio of 0.6 to 0.8x. We are currently at about 0.5x regulatory debt-to-equity. On an overall basis, we are targeting overall GAAP leverage of 0.8x. As of today, we are currently at about 0.8x overall GAAP leverage, and our net leverage debt minus cash is 0.68x.

With regard to our energy portfolio, there are 4 names in our energy portfolio. The 2 that are related to oil field services, American Gilsonite and U.S. Well, are performing better as drilling activity has picked up. With regard to our 2 E&P names, Ram and ETX, they have been aided by the higher oil and gas prices. It will take time for us to maximize our recovery. Even if the 2 E&P investments were marked to 0, our NAV would have been about $7.49 as of December 31. This indicates the potential upside value to our stock as we monetize those and other investments over time.

We are encouraged that the energy markets are rebounding. This enhances the M&A environment in the sector and our ability to evaluate strategic options for our energy-related companies.

PennantPark Investment Corporation has had only 12 companies go on nonaccrual out of 196 investments since inception over 11 years ago. Further, we are proud that, even when we have had those nonaccruals, we've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments and capital and personnel in those companies, we've been able to find ways to add value.

Based on values as of December 31, today we have recovered about 82% of the capital invested in the 12 companies that have been on nonaccrual since inception of the firm. We currently have no investments on nonaccrual.

It might be helpful to highlight our long-term track record over 11 years, including a global financial crisis and recession. Since inception, PNNT has made 196 investments, totaling about $4.6 billion at an average yield of about 13%, including both realized and unrealized losses, PNNT lost only about 34 basis points annually. We're proud of this track record, which includes both our energy investments as well as our primarily subordinated debt investments made prior to the financial crisis.

In terms of new 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 $17 million in the second lien and $1 million in the equity for Condor borrower. Condor provides cybersecurity software, particularly Secure Socket Layer certificates to businesses. Francisco Partners is the sponsor. PT Network is an operator of outpatient physical therapy centers. We won $40 million of the second lien term loan and invested $5 million in equity. CI Capital is the sponsor. We invested $22 million in the first lien term loan and $1 million of equity in Whitney, Bradley and Brown, which is a government contractor, providing technical consulting services. HIG is the sponsor.

Turning to the outlook, we believe that 2018 will 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 December 31, 2017, net investment income totaled $0.20 per share. We had about $0.02 per share of other income, and another $0.02 per share of fee waiver. Looking at some of the expense categories, management fees after waiver totaled $7 million, general and administrative expenses totaled $1 million and interest expense totaled $6 million.

During the quarter ended December 31, unrealized loss from investments was $7 million or $0.10 per share. We also had unrealized gain from our various debt instruments of $1 million or $0.02 per share. We had about $4 million or about $0.06 per share of realized gains. Excess income over dividend was $0.02 per share and, consequently, NAV per share was stable at $9.10 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 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 December 31, our portfolio consisted of 57 companies across 26 different industries. The portfolio was invested in 40% in first lien senior secured debt, 34% in second lien secured debt, 10% in subordinated debt and 16% in preferred and common equity. 82% of the portfolio has a floating rate.

Now let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is to generate attractive risk-adjusted returns through income, 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 off 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) And our first question today will come from Casey Alexander with Compass Research and Trading.

First of all, I noticed that you paid down $15 million of SBA debentures during the quarter. Can you just sort of give us the thought process behind that as opposed to paying down the credit line and sort of why you went in that direction?

Sure. Good question, Casey. Good morning. SBIC I for us is coming, believe it or not, towards the back half of its life. So we do need to contemplate over time gradually paying off SBIC I. We're hoping and looking forward to using SBIC II over time, but we do need to contemplate paying off SBIC I.

How much untapped capacity in SBIC II do you currently have?

I think we have about $70 million of undrawn at this point in SBIC II.

Okay. So as -- so were you to have an opportunity to get more invested, you could use that. How much of your cash on the balance sheet is -- comes from the SBIC subsidiaries?

A big chunk of it, Aviv.

Yes, so a fairly large chunk of it is from SBIC. But as Art mentioned, SBIC I, as it has cash or items rolling off, it's paying down and that's the plan. SBIC II does not have a huge cash knot so, at the end of the day, this applies to ramp down SBIC I, ramp up SBIC II as opportunities are coming.

Okay. In terms of the 4 energy investments, can you kind of walk through if -- were there any changes on their marks quarter-to-quarter?

As a general proposition, net-net-net, it was stable between quarter-on-quarter. I think Ram was down a little bit, ETX was up a little bit, roughly offsetting each other. And I think the other 2, American Gilsonite and U.S. Well, were roughly the same.

And we'll next move to Ryan Lynch with KBW.

Following up on the energy question with -- particularly with Ram, that was marked down a little bit in the quarter. Obviously with the rise in oil prices that provides, I think, a much better operating environment for Ram. So can you just talk about what needs to occur for Ram's valuation to improve? Do you need sustained level of oil prices right here? Do you need them to trend higher? Just any comment on that would be great.

Yes, and so, look, I mean, with the overall energy complex, it's been really nice to see oil go up, natural gas is not going up, but oil's gone up. And then, we'd love to see it stay up for a while and see it stable for a while, which will inevitably lead to more merger and acquisition activity, more potential exit options at nice prices. So it's a relatively new phenomenon, we'd love to see it stay higher for a while. Some people are predicting oil prices are going to go up from here. Some people are predicting that they're going to go down from here. Some people are predicting that they're going to go down before they go up. We just like to see some stability in general upward trend. And so WTI is something that helps natural gas, it's something that's taken into account these valuations and, of course, most importantly, the comparable companies. So if you want an indication of asset values for these underlying companies, look at the comparables. And that'll give you your biggest clue as to where it's headed. So we are certainly encouraged by the better environment. We are hopeful that it will continue. And as it continues, we would hope and expect that M&A will ensue in the industry in a more robust basis, and we can hopefully be beneficiary of that.

Okay. And then in your prepared remarks, you talked about reducing risk in your portfolio via more diversification. So having smaller bite size of investments in your portfolio. Does that mean that you guys are going to move down into smaller companies? Or does that mean that you guys are going to take smaller bite size of the debt capital structure in companies? I just want to know because if you guys are taking smaller bite sizes in the capital structure -- in the debt capital structure of borrowers. Does that give you guys less influence on the structure in terms of those companies? Something goes sideways, will you guys have less influence? So can you just comment on -- provide a little more detail on reducing orders via diversification.

Yes, you're asking a great question. There's a lot gray area in that, right, which is bigger company, smaller bite, smaller company, bigger bite. And for us, it's always case-by-case basis. We had some bigger bites in our portfolio over time and then sometimes 60s and 70s and, certain cases, over and above that. I think that's where we're really looking to curb and will not do going forward. I think the bites that we're taking today, where it's kind of averaging between 20 and 40. Generally, that's the right zone for PNNT. So you will not see the 70s and 80s. You will see more 20s to 40s. And it's going to be a combination of bigger companies, where we're one of a club or the only lender, or, in some cases, it might be a smaller company. But we are trying to -- when we go to smaller companies, we're trying to find very stable companies where we can be very high in the capital structure and get a very attractive risk-adjusted return.

And our next question, we'll hear it from Chris York with JMP Securities.

So Art, following a little bit on Ryan's question, I want to drill down a little bit on Ram. So what drove the write-down quarter-over-quarter specifically?

We don't -- Chris, we don't -- what I said in my prepared remarks to what we're prepared to disclose, obviously, this -- there's confidential information. We have a confidentiality agreement. You can look, though, at the comparables of energy companies during the quarter between 9/30 and 12/31. And despite the fact that WTI went up, in some cases, the comparables were flat or even down. So the comparables will be a key area of how these -- as they always are, how these companies are valued. So we are appreciative and are encouraged that WTI is up, but that is only one factor. Natural gas has a part of it and the comparables have a part of it.

Okay, so, I mean, is your mark here more a function of comp than EBITDA or enterprise value? Is that safe to assume?

If it's comps -- comps are usually, when you're valuing private illiquid names, comparables are usually a key driver. So WTI may be up or natural gas may be up or down. But if the comparables are up a commensurate amount, then there's only so much you can do.

And next we'll hear from Rick Shane with JPMorgan.

It's Melissa for Rick today. Couple of questions for you. I know that in the past, you have always been careful about balancing share repurchase activity with target leverage and wanting to stay -- maintain some credit ratings. I'm wondering how you're thinking about share repurchases and the potential to add value through that tool in this environment?

Sure, sure. It's something we and the board talk about all the time. Our priority has been in the last few quarters and, still today, maintaining our investment-grade rating. The 4.5% bonds are outstanding, they are due in about 18 months. It's important for us, at this point, to maintain our ratings. Share buybacks are not the top use of proceeds from the standpoint of the rating agencies. But it's something that we evaluate and will continually evaluate and within the balance of keeping our rating at this point, consider, but it's something that, right now, our priority is keeping the ratings.

Okay. And as you look at the remainder of the equity portfolio and kind of rotating that into some income-generating investments. As you look at what's left after the activity that you had quarter-to-date so far. What do you think a reasonable timeline could be to get down to your target range of 5% to 10% portfolio investments?

Yes, it's a good question because, by definition, exiting equity investments is a lumpy proposition here and just in the last 5 weeks, we've gone from 16% to 14% roughly. So that's certainly encouraging. But each one of these deals as you can imagine have their own idiosyncratic timeline and dynamic. We'd hope in the next year or so to get it down, the next 12 months is -- our head is down, number one, hopefully finding the risk-adjusted returns and then to part parcel that to the extent we can impact exiting this equity or energy portfolio at rational prices, we're going to try to do that.

And next we'll move on to Kyle Joseph with Jefferies.

Just stepping aside from the energy portfolio, wanted to get a sense for revenue and EBITDA growth trends from the remainder of your portfolio and discuss if you've seen any material changes over the past, call it, year. Yes, just your thoughts there.

Yes, so it's a good question. And look, we -- I think we're seeing similar things to many of our peers. And what the economic reports are, which is from the standpoint of our portfolio, the U.S. economy is strong. We're seeing, by and large, very nice revenue and EBITDA performance of the underlying portfolio. So we feel very good about the credit quality of the portfolio and its ability to generate cash flow for the dividend.

Got it. And then just looking at yield trends, looks like yields expanded sequentially in the quarter. Is that being driven by the rotation of equity assets, the increases in LIBOR or kind of a mix shift at this point? Are we seeing new originations with higher yields than repayments?

Yes, yes, it was kind of idiosyncratic this quarter. We've been indicating that as we are looking to de-risk the portfolio, overall. We're thinking the overall portfolio yield will go from the 11s into the 10s. That's what we've been saying. This quarter, our yield on the portfolio was up. I think it was a combination of the originations we had this quarter. Some of the exits that we had as well, some of the exits were lower-yielding exits. And I do think we're getting a little bit of tailwind from LIBOR, which hopefully will continue to provide tailwind to us and the rest of the industry.

And next we'll move on to Jonathan Bock with Wells Fargo.

I appreciate listening to my dear competitive brother and with questions on the portfolio, et cetera. Maybe I'll go with the $64,000 one. So Art, can you quantify the benefit the investment-grade rating gives to you today?

It's a great question because it's hard to quantify it by definition. There is an imprimatur that -- at least most people who are experts in financial institutions seem to believe that you get when you have an investment-grade rating, and if you lose that rating, there's potential challenges. So that's what we grapple with. I wish I could give you a black or white answer. I'm happy to talk to you offline or whatever, but there is something about being a finance company having investment-grade rating that is not just about dollars and cents from what we think or what most of the experts that we talk to think.

We appreciate that. And I also think investors are pretty clear about the dollar and cents that goes to their pocket with stock repurchases below book, particularly with available capacity. So I understand that you've discussed this with the board and you've made some very shareholder-friendly changes, so this isn't meant to in any way detract from that. But the question remains -- you're pointing as a stock buybacks and the investment-grade rating are mutually exclusive options. You can buy back stock and delever your loan pro rata and maintain investment-grade, while also building NAV and NOI. So is there a reason you're not doing that?

Well, look, we had a close call not too long ago in terms of getting downgraded. I think, at this point, we are focused on making sure that that doesn't happen and then over the coming weeks, months and quarters as we generate, hopefully, some nice proceeds from the equity portfolio, perhaps we can broach those conversations and do it in a way so that there is not a hair-trigger reaction. But we had a close call, Jon, not too long ago. And right now, we just want to calm things down, make sure we maintain things, and I hope to have those conversations in the coming weeks, months and quarters and with that exact question in mind.

That makes sense. And then one other item that kind of adds to it that just -- and forgive me, I'm not the world's best expert on the SBIC. But so if we understand the second license was $75 million in capacity versus $150 million. I just want to make sure that you actually -- while we're paying down the $150 million, does this mean that, over time, your capacity on SBA debentures will only be limited to $75 million until you get another first license?

So over time, we're going to -- over time, and we have a few more years left, I think, Aviv, we're going to gradually pay off I. We're going to draw on II and then potentially go for number III.

Got it. So you're limited to $75 million -- so granted, SBIC I, and we'll call it runoff, right? SBIC II, $75 million of potential total debentures outstanding and then you're going to ask for a license for III. Art and Aviv, I know you've been very diligent in that process, has that third license request started? And if not, what is holding you back?

It has not started. What's holding us back right now is we got to use more of II. Before you go for III, you want to use more of II. So that's the key thing.

And next we'll move on to Mickey Schleien with Ladenberg.

I apologize, I missed the beginning of the call, so maybe my question's already been asked. But just following up on Jonathan's question about the SBIC. How much of the cash on the balance sheet last quarter was in the SBIC in anticipation of paying down more debentures?

Aviv?

Right, so certainly the SBIC I, as we've been indicating, is paying off some of their very little idle cash there. SBIC II, likewise, fairly small cash over there as we're ramping it up. So SBIC II, I think a correction from -- before it does have $150 million, not $75 million, $150 million capability to draw. We have not drawn the remaining $70 million, but it does have $150 million. So we have some mileage to cover there.

Aviv, it was a little hard to hear you. Did you say then that there's minimal or low levels of cash in both of the SBIC subsdiaries?

The answer is yes.

Okay. So the cash balance about more than -- about doubled from September to December, what would be the rationale for that?

We got some nice repayments. And, in this case, exceeded our new deals, and we're managing cash. We retained a small balance on our revolver and that is, at this point, to cover our non-U.S. investments. And the reason we do that is we borrow into multi-currency revolver. We borrow in the relevant currency, whether it'd be euro or pound and as a way to hedge the currency risk in those non-U.S. investments.

All right, so there is effectively a sort of minimum that you want to have on the revolver regardless of the cash that's on the balance sheet.

Right, just to hedge our non-U.S. assets.

And that will conclude today's question-and-answer session. At this time, I would like to turn the call back over to Mr. Art Penn for any additional or closing remarks.

Just want to thank everybody for their interest today and their participation, and we look forward to speaking with you in early May. Talk to you soon.

And that will conclude today's call. We thank you for your participation.