Pennantpark Investment Corp (PNNT) 2018 Q3 法說會逐字稿

Good morning, and welcome to the PennantPark Investment Corporation's Third 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 Third 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 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 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 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 June 30, 2018, we invested $188 million in primarily first and second lien secured debt at an average yield of 10.5%. Net investment income was $0.17 per share. Our recurring run rate income is now $0.18 per share, excluding other income which we received for items such as pre-payment penalties.

We purchased $7.8 million of our common stock at an average price of $7.25 per share as part of a $30 million stock repurchase program which was authorized by our board last quarter. The stock buyback program is accretive to both NAV and income per share. We are looking forward to continuing this program over the coming quarters.

As of September 30, we had taxable spillover of $0.26 per share, which provides further dividend cushion. With a generally 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 our equity investments mature.

Our primary business of financing middle market sponsors has remained robust. We manage relationships with about 400 private equity sponsors across the country from our offices in New York, Los Angeles, Chicago, Houston and London. We have done business with about 180 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 environments, we have not only been extremely selective, but we have generally moved up capital structure to more secure investments.

Reminder about our long-term track record. PNNT was in business in 2007, then, as now, focused on financing middle market financial sponsors. Our performance through the global financial crisis and recession was solid. Prior to the onset of the global financial price crisis in September 2008, we initiated investments which ultimately aggregated $480 million. Average EBITDA of that underlying portfolio was down about 7% to the bottom of the recession. According to the Bloomberg North American High Yield Index, the average high-yield company EBITDA was down about 40% during that time frame. As a result, we had few defaults and attractive recoveries on that portfolio. The IRR of those underlying investments was 80%, even though they were done prior to the financial crisis and recession. We are proud of this downside case track record.

We've had only 12 companies go on non-accrual out of 204 investments since inception over 11 years ago. Further, we are proud that even when we've had those non-accruals, we've been able to preserve capital for our shareholders. Through hard work, patience, judicious additional investments in capital and personnel in those companies, we've been able to find ways to add value. Based on the values as of June 30, today we have recovered about 80% of capital invested on the 12 companies that have been on non-accrual since inception of the firm. We currently have no investments on non-accrual.

Since inception, PNNT has made 204 investments totaling about $4.9 billion at an average yield of 12.4%. This compares to an annualized loss ratio, including both realized and unrealized losses, of about 30 basis points annually. We are 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 this environment, due to our deep and broad investment team, we're seeing more deals than ever. We're using our proven underwriting discipline in middle market sponsored 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.

At this point in time, our underlying portfolio indicates a strong U.S. economy and no signs of recession. 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 are positioned to weather different economic scenarios. 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.

Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio's performing well. We have a cash interest coverage ratio of 2.6x and a debt to EBITDA ratio of 5.1x at cost on our cash flow loans.

With asset yields coming down over the last several years, we're looking to create attractive risk-adjusted returns. We're executing a 3-point plan to do so. Number one, we are focused on lower risk, primarily secured investments, thereby reducing the volatility on our earnings stream. Investments secured by either a first or second lien are about 81% of the portfolio.

We are also focused on reducing risk from the standpoint of diversification. So number two, as our portfolio rotates, we intend to have a more diversified portfolio with generally 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're targeting equity being between 5% to 10% of our overall portfolio. As of June 30, it was about 16% of the portfolio.

As you all know, the Small Business Credit Availability Act was signed into law in late March. At the current time, we're not going to increase leverage at PNNT. Our intention is to maintain our investment grade ratings on our bonds through their maturity in October 2019. As we get closer to October 2019, we will assess the investment and financing landscape and evaluate our strategy with the goal of maximizing long-term value for our stakeholders. We remain comfortable with our target regulatory debt to equity ratio of 0.6x to 0.8x. We are currently at about 0.5x regulatory debt to equity. On an overall basis, we are targeting GAAP leverage of 0.8x. As of June 30, we were at about 0.73x overall GAAP leverage, and our net leverage, debt minus cash, was 0.56x.

In addition to being active on new investments, we had significant cash realizations in the quarter ended June 30. The most significant realization was our investment in prepaid legal. We realized an IRR of 11.2% on our $62 million second lien position, and proceeds of $18 million on our $3 million equity co-invest. The equity co-invest was a 6.1x multiple of invested capital and an IRR of 38% over nearly 7 years. We also exited our $1.3 million equity co-investment in Roto Holdings with proceeds of approximately $5.6 million resulting in an IRR of 50% and a multiple on invested capital of 4.2x.

This might be a good time to highlight the value of the equity co-invest strategy as part of our portfolio. Since inception, across our platform, we've invested $187 million in 58 equity co-investments where we make a portion of our overall investment side by side with financial sponsors and private equity, along with the debt we provide. The IRR on that money since inception is 24%, which represents a multiple on invested capital of nearly 2x. These returns help to offset losses and provide upside to the portfolio.

With regard to our energy-related portfolio, we are pleased that we continue to make progress monetizing those investments at reasonable values. We started 2018 with 4 investments in energy with a stated goal of monetization over time. We held these investments over the last several years during the energy downturn with a goal of maximizing value over the long run. We believe that we are starting to see the fruits of that strategy. You may remember that last quarter we exited the first of those names, American Gilsonite, which ended up generating an 8.6% IRR and 1.4x multiple on invested capital over our whole period of 5.5 years.

On July 15, U.S. Well Services announced a merger with MatlinPatterson Acquisition Corporation, which will result in U.S. Well becoming a publicly traded company. The proposed merger is subject to regulatory and stockholder approval and is expected to be completed in the fourth quarter of calendar 2018. As a result of the proposed merger, our $10 million loan will be refinanced. The equity position we made for $7 million at cost was marked at about $12 million at June 30, approximating the value of the stock in the proposed merger. Based on this valuation, our overall investment in U.S. Well has generated an IRR of 18% at a 1.7x multiple on invested capital.

With regard to our 2 remaining equity names, Ram and ETX, they have been aided by the higher oil and gas prices and will take time for us to maximize our recovery. 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 remaining equity-related companies.

In terms of new investments, we have 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 lent $32 million of a first lien debt to alphabroder, a leading national distributor of promotional products. Littlejohn & Co. is the sponsor.

Impact Group provides outsource sales marketing and merchandising services to consumer packaged goods companies. We invested $20 in a first lien term loan. The company's owned by CI Capital.

We invested $23 million in a first lien term loan to Research Horizons, which is a marketing and brand measurement services company. CS Fund is the sponsor.

Wheel Pros is a leading national distributor of branded aftermarket custom wheels and performance tires. We made a $32 million second lien loan to the company, which is owned by Clearlake Capital.

We loaned $15 million in a second lien term loan to MBS Holdings, or Momentum Telecom. Momentum is a provider of a variety of telecom services for business and public schools. Court Square Capital is the sponsor.

Turning to the outlook, we believe that the rest of 2018 will 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 June 30, 2018, net investment income totaled $0.17 per share. We had about $0.02 per share of other income. Looking at some of the expense categories, management fees totaled $6.3 million, general and administrative expenses totaled $1.1 million, and interest expense totaled $5.6 million.

During the quarter ended June 30, unrealized loss from investment was $14 million or $0.20 per share. Unrealized gains on our debt instrument was $2 million or $0.02 per share. We had about $17 million or about $0.25 per share of realized gains.

The accretive effect of our share buyback was about $0.03 per share. Excess dividends over income was about $0.01 per share. Consequently, $10.80 per share went from $9.00 per share to $9.09 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 the 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 11.4%. On June 30, our portfolio consisted of 51 companies across 25 different industries. Their portfolio was invested in 43% first lien secured debt, 38% in second lien secured debt, 3% in subordinated debt, and 16% in preferred and common equity. 91% of their 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 at 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.

(Operator Instructions) And we'll take our first question from Casey Alexander with Compass Point.

And I'm sure this quarter feels good. Feels like you're turning the corner. Let me ask you a question, Art. You've got probably capacity to make an additional $50 million or so of investments just out of cash without negatively affecting your leverage ratio, and bringing that effective leverage ratio kind of up closer to where your actual leverage ratio is right now. So how does the funnel look, and how do you feel about what's in the funnel and maybe the pace of deployments versus repayments, which I know is an edgy subject. But how do you feel about the funnel and how do you feel about deployments over the next couple quarters?

Thanks, Casey, and yes, it does feel like we're making really nice progress on a lot of fronts here. So feeling good about the opportunity. We also are feeling good about the opportunity in the market, particularly as we've invested in our platform and have a terrific group of investment professionals now across the country. Not only in New York but L.A., Chicago, Houston, London. And we see some really nice deal flow coming in from the middle market financial sponsors. You're seeing a greater opportunity for us higher in the capital stack, first lien and [struct] senior, and some nice second liens from time to time. So we feel good about the opportunity to deploy capital, to live within the 80% leverage ratio at this point, utilize our enhanced platform, and continue to drive income that covers the dividends. As I said in my remarks, our recurring NII today covers our dividend, and that excludes the other income that we typically get between $0.01 and $0.03 per share per quarter to enhance that recurring income. So we feel very good about the dividend coverage, feel good about the economy, the portfolio, and we're on a mission to monetize the equity investments and energy investments over time that hopefully can provide upside. We do have idle cash. Some of that is stuck in the SBICs. And that's just we utilize that as SBIC-eligible investments come into the platform.

Okay. I saw that you -- did you pay down any SBA debentures this quarter?

Yes, we're gradually paying down SBIC I. We're down to $30 million in SBIC I. We'll continue to gradually pay that off. And we're into the SBA with an application for SBIC III, and we're hopeful that at some point we can move forward on that.

And could you repeat again how much spillover income you have on a cents per share.

Yes, it was in the $0.26 per share as of September 30. We only disclose once a year. It's still right around that number.

Okay. And I appreciate your remarks on Ram and ETX. Can you give me a feel, just save me time from looking it up. How did they mark against each other quarter to quarter? And do you think that you're going to have to put any more incremental capital into either one of them to help them get across the finish line?

So they were both marked up a little bit from quarter to quarter. We did provide an incremental revolver to Ram, a $15 million size. I think they've drawn $4 million on it. And this is to prove out some acreage that they have which we think has a good shot of being very productive.

And we'll take our next question from Paul Johnson with KBW.

My first question was just you guys had a pretty robust quarter as far as funding goes, but you were just a little bit lighter than our -- than on interest income. Was that just kind of due to the timing being a little bit more weighted to the back end of the quarter?

Yes, that's exactly right. Again, it's almost every quarter. For some reason when you're doing -- when you're financing these deals, everyone coalesces around quarter end. And deals have to get done by quarter end. It makes the accounting helpful. It's just -- so usually, I would say for BDCs in general, but certainly, for us, the new deals come right around quarter end.

Okay. Thanks for that. And then I guess on a similar note as far as repayments go, I think they're down a little bit as far as kind of the sort of the level that you were running at with repayments to start the year out. We've heard from other BDCs that they've kind of seen more normalized level of repayments kind of coming in here in the back half of the year. Is that sort of what you guys have seen? Have you been seeing a more normalized level of repayments?

Yes. Look, it's kind of -- it's a good question and it's also linked to spread compression. If there's higher spread compression -- if there's more spread compression, you're likely to see more repayments. If there's less spread compression or no spread compression or there's spread expansion, you're going to see fewer repayments. So, we've seen less spread compression. We've seen really no spread compression over the last quarter, quarter and a half, and the repayments have been less as a result. So one of the reasons we've seen healthy growth is due to that.

Sure. That makes sense. Then my last question was just on your investment in U.S. Well Services. I'm just curious after that transaction is completed, I think you said you expect the fourth quarter of this year. Do you expect to be able to exit your equity position shortly after, or is there any sort of mandatory lock-up period that follows the close?

That's a good question. So there is 50% lock-up for 6 months and another 50% at 12 months. Look, I think if you look at the comps, we think U.S. Well, even at this price, is cheap and has a reasonable shot to trade up and generate more NAV upside for our shareholders.

Okay, that's great. Those are all my questions. Thanks for taking me this morning.

And we'll take a follow-up question from Casey Alexander with Compass Point.

Oh, no. I must have had a fat finger or something. I don't have any follow up.

And we'll take our next question from Kyle Joseph with Jefferies.

Art, just going back to the 3-point plan you laid out, factor that in with the rising rates. Just kind of want to blend all that together and get your outlook for yields over time. Obviously, you'll have some upside from equity monetizations and rising rates, but then also moving up the capital spectrum may offset that. But just kind of your outlook for yields going forward.

Yes, you're right; there are some cross occurrences. We move up the capital stack, our overall yield in the portfolios come down a bit. That said, we're starting to get some offset from LIBOR. And then again, rotating our equity and energy investments into cash paying debt securities over time should be a positive. So look, we think there's upside. You saw it this quarter. We're now -- our run rate, our recurring NII before our other income is covering our dividend now. And we think it has a reasonable shot to continue to grow as LIBOR goes up over time, as we rotate those energy and equity investments, and should provide a very solid, comfortable hopefully cushion to our dividend stream.

Got it. And I know you mentioned earlier you're not seeing any signs of a recession, but could you give us a sense for sort of revenue and EBITDA growth trends of your portfolio companies and any changes you've seen there in recent quarters?

Look, I still think our portfolio, which between our various vehicles adds up to about 150 companies, it's a growing economy, based on what we can see. Is it between slow growth and a little middle, moderate growth? I'd say it's like moderate growth, which means 5% to 7% EBITDA growth as a general proposition across the portfolio. Some's greater, some's worse, but probably a moderate 5% to 7% growth of EBITDA. So we're still seeing a strong economy. We feel good about the underlying portfolio. But we remain vigilant. We remain vigilant. We do underwrite as if a recession is coming, and we do very robust downside cases in our models. It has to be on the right credit. As I said, we are one of the middle market direct lenders that was in business before the global financial crisis and recession, and we've got a very nice track record of underwriting credit through that period of time. And that was on a primarily subordinated or mezzanine debt portfolio. So we're using that same underwriting discipline. So we feel, and hopefully, that will be protected if and when the economy softens. But right now we're seeing a very nice, moderately growing economy.

(Operator Instructions) We'll take our next question from Paul Johnson with KBW.

Sorry, I don't have any follow-up questions. I'm not sure how I got back in queue.

And we'll take our next question from Mickey Schleien with Ladenburg.

I just wanted to follow up on the interest income question. I sort of had the same question as a previous caller. If I look at the average debt portfolio at cost, it was down about 3%, and the yield was pretty stable but interest income was down about 6%. So I understand that you said net investments were skewed toward the end of the quarter but was there some other sort of adjustment or reversal also in the interest income line that we should be aware of?

No. It's kind of -- I think it was the combination of kind of probably being back-end weighted in the quarter and LIBOR helping, and kind of like we said, right now our recurring run rate is $0.18. Aviv would be happy I'm sure to go through your model with you later if you like, Mickey.

Yes, I might do that. And just a couple more, if I may. At a high level, could you give us the main sources of the realized gains and the unrealized losses this quarter?

Yes. So the realized gains I mentioned in the prepared remarks, which were legal field, big realized gain there. Roto Holdings, big realized gain there. And then the unrealized losses, there were just kind of nothing big, but small markdowns in Affinion, small markdown in J&F Holding, small markdown in Superior Digital. So those were kind of the highlights and lowlights.

Okay. And lastly, on the cash, you had mentioned some of it is in the SBIC. Can you give us an idea of how much that is? And also, how much cash is being held in relation to the credit facility to hedge foreign investments?

So in SBIC II, there's about 50-ish of cash. And the credit facility that we currently have drawn is primarily for our non-U. S. investments, and it's drawn in whether it be euro or pounds sterling to hedge those investments. But we have ample credit facility space. As we look at refinancing the bonds at some point, one option is to just draw down our credit facility and pay down the bonds with our credit facility. So it's nice to have that extra super liquidity that we have in our system.

Okay. And just lastly, you have a pretty meaningful then liquidity in the SBIC. How does the pipeline look for SBIC-qualified deals and your ability to put that money to work let's say over the next few quarters?

It's a great question. We're optimistic, but it's in our -- a lot of these rules and regulations and buckets and baskets that the definition of what fits in what industry vertical and the regulations in certain cases makes it challenging to find stuff that fits. And again, we don't do anything different from the standpoint of our underwriting standards. If we like a deal, we like it for the SBICs, or we like it for however we finance it. So it's the same underwriting standard, and our team knows that it's great when we can find stuff that fits. It's been challenging recently, but we're hopeful that we can use the $50 million or so of cash in SBIC II and hopefully get a license for SBIC III. And it's been a very nice relationship we've had with the SBA.

And we'll take our next question from Mark Hughes with SunTrust.

The last time around going into the financial crisis, did you have any particular orientation in terms of end markets or types of businesses that you had focused on at that time that led to weather the crisis better than peers or was it the underwriting process that was more relevant?

Yes, it's a great question, and it's lots of lessons learned. We got in business in April of 2007, and by the summer of 2007, we could tell from our portfolio companies that the economy was starting to soften. So we said at that point, look; we're going to raise the bar. We're still going to invest, but the deals that we do are going to be in industries that we feel are recession resistant, that are less cyclical where we can get good covenant packages, good returns, and where we feel really comfortable. So we did deals between June of 2007 and September of 2008. We had raised the bar. And it's interesting; that vintage of deals that we did before September of 2008 ended up being a really nice vintage, even though it was done before the global financial crisis and recession because we had proactively raised the bar. And that was based on real-time data we were getting from our portfolio companies. So when we say today we're seeing no signs of a recession, right now we're not seeing signs of recession. Of course, we're going to try to find recession-resistant companies and have good covenants and good returns and underwrite as if a recession is going to come, but we're not seeing signs at this point. And we get monthly financial statements from most of our companies.

(Operator Instructions) We'll take our next question from Rick Shane with JP Morgan.

It's Melissa on for Rick today. I wanted to check in with you on the share repurchase activity. There was some pretty healthy repurchases during the quarter, and it would imply if that's the run rate, that you would pretty much fully use the $30 million authorization. Is that consistent with how you're thinking about it?

We've -- thanks, Melissa. Good question. We're thinking -- the Board authorized $30 million. We're thinking about it like 25% a quarter for 4 quarters. That's how we think about it. So this was $7 million, $8 million, that's the game plan. Now obviously, if the stock -- if there's an opportunity to buy more at lower prices, we may accelerate that, but the thought going into it is about 25% a quarter.

It appears there are no further questions at this time. Mr. Penn, I'd like to turn the conference back to you for any additional or closing remarks.

I just want to thank everybody for being on the call today. We're very excited about PennantPark Investment Corporation, as hopefully, you can tell. We thank you for your time today. Our next conference call will be probably mid-November. A reminder that that's our 10-K, so it takes a little bit longer for us to get our 10-K done than our 10-Q. So it'll be a little later next quarter, but certainly, by mid-November, we look forward to speaking with you then. Hope everyone has a great rest of the summer and we'll be talking to you soon. Thank you very much.

This concludes today's call. Thank you for your participation. You may now disconnect.