PennantPark Investment Corporation (PNNT) Q4 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the PennantPark Investment Corporation Fourth Fiscal Quarter, 2012 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode. The call will be opened for question-and-answer session, following the speakers’ remarks. (Operator Instructions) It’s 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 our fourth fiscal quarter 2012 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 included 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 PennantPart 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. 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 fillings 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, our overall strategy, and then open it up for Q&A. As you all know, the economic signals have continued to be mixed with many economists expecting a flat to slowly growing economy going forward. With regard to the more liquid capital markets and in particularly the leveraged loan in high yield markets, those markets have continued to rally this year as cash flows into high yield funds, leveraged loan funds, and CLO's have been strong. Risk reward in the middle market has generally remained attractive as the overall supply of middle market companies who need financing exceeds the relative demand of applicable lending capacity. As debt investors and lenders, our flat economy is fine as long as we have underwriting capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome. That said, as the more liquid markets have rally, that overall turn has impacted the middle market. Pricing has continued to compressed and purchase price multiples and leverage multiples have increased. As a result, we have continued to be increasingly selective about which investments we make in this environment. Given our strong origination network and size of our company, we can continue to prudently grow. In fact, for the upcoming quarter ended December 31, it looks as though, we may be busier than normal due to deal flow resulting from potential year-end tax law changes. We remain focused on long term value and making investments that will perform well over several years. We continue to set a high bar in terms of our investment parameters and remained cautious and selective about which investments we add to our portfolio. Our…

Thank you, Art. For the quarter ended September 30, 2012 investment income totaled $30.8 million and expenses totaled $14.1 million, management fees totaled $9 million. General and administrative expenses and excise tax totaled approximately $1.7 million. SBA and credit facility interest expenses totaled about $3.4 million accordingly net investment income was $16.7 million or $0.30 per share. During the quarter-ended September 30, net unrealized and realized gains from investments and credit facility was approximately $0.5 million or $0.01 per share, income in excess of dividends was $1 million or $0.02 per share. And accretion in book value from our equity offering in September was $0.03 per share, consequently NAV per share went from $10.16 to $10.22 per share. As a reminder, our entire portfolio in our credit facility are mark-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm or independent broker, dealer quotations when active markets are available under ASC 820 and 825. In case where a booker dealer quotes are inactive we use independent valuation firms to value the investments. Our overall debt portfolio has a weighted average yield of 13.2%. On September 30 our portfolio consisted of 54 companies across 31 different industries and was invested 30% in senior secured debt, 19% in secondly insecure debt, 40% in subordinate debt and 11% in preferred and common equity. Our SBIC has drawn the maximum amount $150 million of SBA debentures. We feel fortunate to have locked in the entire $150 million at a fixed all in rate of 4% for 10 years when treasury is near all time lows. We’ve applied for our second SBIC license. 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 growing dividend stream. 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 captured the free cash flow primarily in debt instruments and we pay out those contractual cash flows in the form of dividend 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’d like to open the call to questions.

(Operator instructions) And we’ll first go to Greg Mason of Stifel. Greg Mason – Stifel Nicolaus: Great, thank you, guys. Art, could you talk a little bit about Affinion ahead of markdown this quarter. I know there has been a lot of public information about that. Could you just give us an update on that investment in your portfolio?

Sure. And this is public information, and then this is an investment that is a broker-dealer quoted. Today, it’s quoted kind of in the low to mid 70s, it's a company that does marketing add-on services to credit cards primarily and other membership and Affinity marketing. This company is operating in a little bit more of a marquee regulatory environment given the advent of the Consumer Financial Protection Bureau, and it's made it a uncertain environment for large financial institutions to hire Affinion for their marketing needs. So they are operating in a bit of uncertainty at this point. Since then it is came at about the CFPB, they have gone out, the company has gone and told people that they estimate EBITDA is going to be down about 5% to 10%, excuse me, mid to high single-digit rate this year. Companies does north of $300 million of EBITDA, they’ve also given more disclosure about how much business they do with the top 10 U.S. financial institutions, which is about 28% of their total revenue. So that's kind of comps the market. They’ve indicated that they see no problem paying their debts at this point. So we’re hopeful watching waiting company generates a lot of free cash flow once the rules become a little bit clear, we believe we’ll get going again and be able to operate well once the rolls have been clarified by the CFPB. Greg Mason – Stifel Nicolaus: Great. I appreciate the color. And then have you seen anything in the deal pipeline changing, I know this is more real time, but in the last week since the election, you’ve seen a big change in the equity markets, has there been any change in the deal pipeline, peoples added toward getting deals done quicker or is it really not seen any change since the election specifically?

That’s a great question and you would think so, we haven’t seen it yet. I guess if you are contemplating an M&A process, which by definition takes a long-time to get done, you probably would have been contemplating it pre-election. That said if you are in an M&A process and you are negotiating, you maybe more apt to do something between now and year-end, we’ve got a several situations that we are following where we could be a lender to the buyer where the buyers and sellers may or may not come to an agreement, but given the election perhaps it helps in the favorable seller agreeing to certain terms because of potential tax law changes. Greg Mason – Stifel Nicolaus: Great. And then one last question, I will hope back in queue. We’ve heard commentary that the CLO market has been heating up, is that – what are you seeing in that market and is that impacting your middle market at all?

That’s a great question. Certainly CLO market is back and has heated up and has impacted and it’s been one of the big impactors of the broadly syndicated market or the liquid market. As you may or may not know as CLOs get going, they have to ramp or forced to buy product, so you have an element of the market being forced buyers, which we think is in some cases in the broadly syndicate space leading to high leverage, easy or no covenants and low yields. Again the middle market we believe is cushioned from that, but the tone does impact the middle market, and that has made it more difficult to get the types of response that we like. Again, we still are seeing plenty of deal flow and given our size, we feel like we can prudently grow and still get good risk reward, but it does impact the overall tone. Greg Mason – Stifel Nicolaus: Thanks guys.

Thank you.

And next we’ll go to Mickey Schleien of Ladenburg. Mickey M. Schleien – Ladenburg Thalmann Financial Services Inc.: Hello, good morning, Art. You answered my question about yield compression, but I also wanted to ask you, I noticed that you did sell a little bit of your Eureka Hunter, but it’s still a large position. Can we expect that potentially to come down some more and are you still considering potentially reducing your position in last mile?

That’s a good question. We did have a buyer of Eureka Hunter and we did want to (inaudible) relationship but we do want to do the deal because we like the relationship with the buyer. Also a $50 million bite is our biggest bite so we wanted to reduce that. We do believe from the standpoint of diversification or how we measure a company diversification is key now, we manage our risk. We debated selling down little more to Eureka. We certainly got buyers still there. We haven’t yet come to a conclusion on that. Last mile similarly a large position we could sell some of that down, the company is performing very well as you – so it’s something we continually do debate, Mickey. We don’t have any decisions today to tell you but we are committed. You should know we are committed to diversification and you will continue to see us manage a very diversified portfolio. Mickey M. Schleien – Ladenburg Thalmann Financial Services Inc.: Thanks Art.

Thank you.

And next we have John Stilmar of JMP Securities. John Stilmar – JMP Securities: Great. Good morning. I have just a real one quick question. You talked about making the equity co-invest being realized part of your portfolio and potentially giving a little bit more upside? But also if you take control now, it seems like in the 30% today, the company that – we went through this restructuring, I guess the question is what capabilities or skill sets are required to be successful in being a control equity owner versus a debt owner, and what sort of comp in either a skill sets or infrastructure in place of tenant?

It’s a great. It is definitely a skill set. We’ve done it in EnviroSolutions successfully as an example, which is the waste collection company or you move from being as a lender to being on the creditors committee and then moving on to the Board of the company. We’ve got extremely experienced folks here at the firm, who have been through many workouts over the course of their multi-decade carriers. EnviroSolutions is an example. UP is an example, Directbuy is an example. But it is skill set and I think you can hopefully rely on the depth of experience and the seniority of our team here. I mean I’d placed our senior team here against any other BDC or any other middle market leader for that matter in terms of the depth and knowledge, the experience in judgment and the ability to deal with workout and control situation. So we think we’ve got covered with our senior team here. That said, we’re also looking as we grow to bring talent into the organization and bring fresh people in with fresh views and fresh looks and as we growth we’ll inevitably we’ll continue to bring more talent into the organization. John Stilmar – JMP Securities: Great, thanks, Art.

And next we have Jonathan Bock of Wells Fargo Securities. Jonathan G. Bock – Wells Fargo Securities LLC: Good morning and thank you for taking my questions. Most of my questions have been asked and answered. So perhaps I need to log in a bit earlier than Mr. Mason, but one quick question as it relates to repayments this quarter. I was under the impression that perhaps Brand Energy as well as TD Holdings that those are potential replacements that could come in with no guarantees and to the extent that’s the case what should we be looking at on the fee line, I know there are particular prepayment fees that might come in income that quarter?

So, what I’m giving you now is public information, if you follow the loan news although we haven’t disclosed it yet, but I disclose it here, but it’s already public information. Brand Energy did refinance their second lean after quarter-end. So that was a lower yielding instrument that was in our portfolio and the instrument has a much higher yield some more to come on that. TransFirst announced a deal yesterday through GE Capital where they’re looking to refinance their capital structure. So those were two pieces of paper on our balance sheet that we’re sub-yielding. Both of those at this point unfortunately are out of their call premium environment. So they were lower yielding pieces of paper that we’ve kind of owned through the cycle and for a while, and so unfortunately, we’re not going to much of prepayment on those, but we are pleased that we can move off lower yielding suboptimal assets alter of our balance sheet. Jonathan G. Bock – Wells Fargo Securities LLC: We would agree. So thanks for that. And then maybe one broad item as it relates to the competitive environment, when you are looking for a transaction and bidding competitively, can you talk about the types of competitors you’re running into and maybe give us some segmentation as the additional other BDC's, private mess, how would you define the competitive threats right now as you are deploying loans and who do you run into the most?

The biggest competitive threat is the broadly syndicated liquid market to the extent of companies, a larger company and can access those markets that's going to be very attractive market outlook for those companies. So that's the biggest competitive threat. And then in terms of the day-to-day M&A strategic driven financing, generally, it is the same folks that we compete with and partner with and have done so for many years, whether it be some other BDC's. We know unlike whether it be some private GP, LP funds, we know unlike. So it's the same group of players by and large, we haven't really seen in our market, really new entrance that have significantly moved the needle. Jonathan G. Bock – Wells Fargo Securities LLC: Okay, great. Thank you so much.

Thank you.

And next we’ll move to Douglas Harter of Credit Suisse. Douglas Harter – Credit Suisse Group: I was wondering if you could just, on the current pipeline is the deal that you recognized on the new investments in this current quarter representative of kind of the opportunities you see today?

Yes. So, 12.2% was the average yield to maturity on the debt investments we’ve made for the quarter ended September. It’s probably going to trend a little bit higher for the quarter ended December, primarily because it is a little bit more strategically driven financing that we are doing in the quarter ended December. Whether it be M&A, or strategic growth financing. So the yield is probably for the quarter ended December, probably going to touch higher. We're credibly focused on maintaining a rationale ROE for our shareholders and at some point we just want to yield down. Certainly, credit is hugely important, we have to make sure first and foremost we’re investing in the right credits. But if we are not getting right return, we’ll just let it go and let somebody else do the deal. So kind of, we are hopeful that 12.2 is perhaps a low point. We will maintain discipline around that was most importantly credit quality. Douglas Harter – Credit Suisse Group: Great. Thank you.

And next we have John Hecht with Stephens. John Hecht – Stephens Inc.: Good morning, guys. Thanks for taking my questions. First, Art, you commented that in Q4 you are a little busier maybe than you anticipated lot of that your time to potential tax law changes and owners and operators and investors getting front of that. So if you think this is just fully forward from calendar year 2013 to the latter part of calendar year 2012, or is there more of a trend basis that you’d point actually that might give you optimism that the calendar year 2013 is going to be another decent year for balance sheet opportunities?

That’s a great question, so just to clarify, we don’t know yet “how busy” we are going to be even though it’s November 15. When we talked to you in early February, it will be kind of crystal clear obviously it would be crystal clear last January 1. It could be just an average one of the mill quarter for us there, coupled two, three M&A related deals that might fall, which would mean in elevated level of activity for the quarter ended December. And you are right, we are in a seasonal business and M&A trades tend to happen year end more than they happened in the first quarter. So, it’s likely that for the quarter ended March just looking at traditional seasonal trends it will be little bit lighter than it is in the fourth calendar quarter. So you’ve raised a good point, but again we are in a deal-by-deal business, it’s hard for us ever to kind of say, here is our run rate, here is our flow because that’s not how we invest. We come in everyday and try to find a good deal, and if there is a good deal to do, we will do it and if there is not we will (inaudible). So it’s always hard to predict these things. John Hecht – Stephens Inc.: Okay. And then second question is, you have a very clean book credit right now, I’m wondering outside of some of the investments specific investments you discussed earlier, is there anything on a credit watch list or any kind of trends you are watching that would make you feel either better or worse about the kind of economic environment?

We’ve already talked about Affinion, which has been – is now marketed in kind of low-to-mid 70s, certainly the one bright spot appears to be the homebuilding related industry. As you know we’ve had an investment in Realogy. After quarter end Realogy did an IPO and the piece of paper that we had second lien was taken out and we had a convert that was converted into stock. And so that’s been a very positive mover in our portfolio post quarter end due to this housing turnaround. We see at last we certainly hope it does, but that is a bright spot in the portfolio. But rest of it – rest of the portfolio is kind of steady issue goes somewhere a little bit – some companies are doing a little bit better than normal, some are doing a little bit worse, but there is nothing that’s really kind of moving big one way or the other. John Hecht – Stephens Inc.: Great, I appreciate the color. Thanks.

And next we will move to Arren Cyganovich. Arren Cyganovich – Evercore Partners: Thanks. Just on the restructuring that you had at UP Support Services, did you lose – did you have any realized losses on that position?

We realized losses on our equity co-invest, but due to the accounting of the mezzanine debt, we had to keep the cost of them as what it was and then you have the new mark-to-market on, the equity comp has got that was realized loss and them as which converted to equity that’s an realized loss. Arren Cyganovich – Evercore Partners: Okay. The fair value on your 10-K looked it was actually a little bit higher than it was a year ago.

As we said in the remarks we did invest additional equity into that company, so there were three elements we converted our first lean and to second lean you converted them as into equity and then we invested additional equity. Arren Cyganovich – Evercore Partners: Okay, and then the direct buy restructuring would that be basically kind of a loss close ahead of the market at the end of the quarter?

So the piece of debt that we are swapping into is roughly the value of the quarter-end mark and then we get a 10% equity ownership in addition to that. Arren Cyganovich – Evercore Partners: Okay and then lastly on the December quarter activity, do you have many exclusive deals that you are working on, are you more or less bidding against other competitors?

Now we have quite a few of them our deals we just need to see if the M&A transactions are going to close or not? Arren Cyganovich – Evercore Partners: Great. Thanks a lot.

And we’ll now move to Rick Shane of JPMorgan. Richard B. Shane – JPMorgan Chase & Co.: Thanks guys for taking my questions this morning. Most of have been asked and answered, but I just want to follow-up. It sounds like the take away from the pipeline right now is the turnover in the fourth question is likely to accelerate modestly, but it doesn’t sound like you think that it’s going to lead to much yield compression.

That’s correct. And in fact given that some of the lower yielding stuff is moving off to the side lines they are out of the portfolio that will help things. Richard B. Shane – JPMorgan Chase & Co.: Great and then the second question is, is there anything in the portfolio as you started to get feedback related to storm Sandy that we need to be thinking about that businesses that are affected.

That’s a great question, we’re still getting information in our for instance, we have investment in Yonkers Raceway up in the BRONX, they certainly have couple of days off and the storm certainly impacted their operations, we’re getting feedback from them hopefully soon as to what it really mean this business Worley that we just invested in this claims adjustment, so they on the other hand has been really busy adjusting claims due to the storm, so it’s probably not a positive, we have unheard of anything really major negative to any particular company, but more color for you in early February. Richard B. Shane – JPMorgan Chase & Co.: Got it and from a mechanical standpoint, if you where to see what we would agree is temporal impacts related to that, how quickly do you shuffle that through the valuations and you are more focused on the future earnings and so you sort of dismiss anything sort of a short term in nature related to that.

That’s right that’s the key question, which is there is some long-term impairment or it’s the cash flow generation ability of the company consist with what it was, so that’s what we need to assess. Richard B. Shane – JPMorgan Chase & Co.: Great. Thank you guys

Thank you

We will now go back to Greg Mason of Stifel for a follow-up. Greg Mason – Stifel Nicolaus: Great, one quick follow up on the reality converse how many shares that you get converted into so we could track they that move up here.

Off the cuff, I believe its 417,000 shares. Greg Mason – Stifel Nicolaus: And was that the $10 million or 11% coupon piece or 13% or 11%.

Yeah, 13.5% secondly got reified, and the 11% those were the converts. Greg Mason – Stifel Nicolaus: Great. Thank you guys.

And that appears to be all the time we do have for question today. We’d like to turn the conference back over to our speakers for any additional or closing remarks.

So just really want to thank everybody for participating today and we will talk to you in early February.