PennantPark Investment Corporation (PNNT) Q1 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the PennantPark Investment Corporation’s First Fiscal Quarter 2013 Earnings Conference Call. At this time, all participants have been placed on 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 first fiscal quarter 2013 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 filling 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 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 slowly growing economy going forward. With regard to the more liquid capital markets and in particular, the leveraged loan and 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, a slow growth economy is fine as long as we have underwritten 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 capital markets have rallied, the overall turn has impacted the middle market. Pricing has continued to compress and purchase price multiples and leverage multiples have increased. As a result, we have continued to be 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 quarter ended December 31, we were busier than normal due to deal flow resulting from 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 focus continues to be on companies or structures that are…

Thank you, Art. For the quarter ended December 31, 2012 investment income totaled $30 million and expenses totaled $14.8 million, management fees totaled $9.7 million, general and administrative expenses and excise tax totaled approximately $2 million. SBA and credit facility interest expense totaled about $3.1 million. Accordingly net investment income was $18.2 million or $0.28 per share. During the quarter ended December 31, net unrealized and realized gains from investments and credit facility were approximately $10.4 million or $0.16 per share. Consequently NAV per share went from $10.22 to $10.38 per share. As a reminder, our entire portfolio and our credit facility are mark-to-market by our Board of Directors, each quarter using the exit price provided by an independent evaluation 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 on 13.3%. On December 31, our portfolio consists of 56 companies across 30 different industries and has invested 29% in senior secured debts, 20% in second lien secured debt, 39% in subordinated debt and 12% in preferred and common equity. 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 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 and thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

Thank you. (Operator Instructions) We will take our first question from Greg Mason with Stifel Nicolaus. Greg M. Mason – Stifel, Nicolaus & Co., Inc.: Good morning, gentlemen. First congratulations on the second SBIC license. Can you talk about – a law almost got done last year to expand the SBIC process, it got through the house, didn't get through the Senate in time. Can you talk about any rumblings on that being brought up again and just what you're hearing from the lobbying effort on that front?

Thank you. Thanks, Greg. Yes, look obviously that would be a tremendous benefit to us and other BDC’s who have SBIC licenses or who are looking to get SBIC licenses. It didn't make it through last time. There seems to be good by partners and support on what we hear there maybe a few people who are just anti-government on anything that comes up regarding the government, who have kind of been holding back here, supported this type of measure even though this type of measure does not cost the shareholders a dime. That said we are optimistic that hopefully able to course of 2013 it will be some support as the legislation gets passed. Greg M. Mason – Stifel, Nicolaus & Co., Inc.: Great. And then on the Realogy equity now with the common stock, can you talk about your thoughts, does that continues to rise in terms of continuing to invest in the equity or potentially monetize and then redeploying the capital?

It's a great question. We haven't yet made up our mind. We don't restrict it. The stock at this point it becomes unrestricted in early April. So that's when the decision point is whether we continue to hold and potentially ride a little bit more. And the housing cycle, whether we take some or all of our chips off the table, haven't made a decision on that yet. Greg M. Mason – Stifel, Nicolaus & Co., Inc.: Okay, great. And then one last question and I can hop back in the queue. You’d mentioned about the significant flows in high-yield bond and the CLO’s and that’s really up market, but are you seeing any increased competition or new players in the middle market?

It’s good question. In the middle market, it’s still generally the same folks we’ve seen for a long time. We generally remain relatively rational. So although the tone does sweep down a little bit from the more liquid market, in general so far the competition has been rational. Greg M. Mason – Stifel, Nicolaus & Co., Inc.: Okay, great. Thanks, Art.

Thank you.

Next we will hear from Doug Harter with Credit Suisse. Douglas Harter – Credit Suisse: Thanks, Art. I was hoping you could talk a little bit about your plans for deploying that ample liquidity and sort of with increased liquidity where you’d feel comfortable taking a look at leveraged deal? Thank you.

As we said, we think this quarter, the quarter ended March will be relatively moderate in terms of deal flow. I don’t really have a good crystal ball for you in terms of the rest of 2013, although we think it will be relatively active, it’s hard to give you a real answer or substantiate it at this point based on what we’re seeing here in early February. Douglas Harter – Credit Suisse: Great, thanks for that color.

Thank you.

Next we will hear from John Hecht with Stephens John Hecht – Stephens, Inc.: Good morning guys. Thanks for taking my questions. First question is, can you tell us within the market, you did mention there is, you talked about the increased competition, maybe some with the CLO, and that volumes and high yield driving us. Can you just kind of quantify the factor, maybe like a first lien and then kind of a upper middle markets, where yield has come and where it has gone I guess and what has happened to leverage ratios in that category?

John, are you referring to more of the liquid markets? John Hecht – Stephens, Inc.: Yeah, it sounds like you are more concerned about what’s going on in the liquid markets. I am just trying to quantify that. And well maybe in that ramp, you could give us some detail how secure or stable the less liquid markets have been?

Yes. So in the more liquid markets, this is the liquid syndicated market that’s been driven in many cases by CLOs and leverage loan funds. Average LIBOR spreads have gone from let’s say 550 to 660 about a year ago to 400, 450 today, as a general rule of thumb. So there has been some decent compression in the more liquid markets. In addition leverage is starting to creep up to see a four times first lien leverage deal and the liquid market is not unusual. Over the year ago you would be talking about 3.25, 3.5 times first lien debt-to-EBITDA. So it gives you a thumb nail sketch of kind of more liquid markets in the more middle market traffic certainly not dichromatic at all. But as we’ve said, we’ve seen bit of erosion whether it would be 25 to maybe 50 basis points on the spread and call it a quarter of a multiple or so on the leverage. There has been some impact though. John Hecht – Stephens, Inc.: Okay. That's a great color, thanks. And second question, is it related to the – if you’re just thinking about the economy and the performance of the portfolio, you are sitting on a pristine book right now. But do you have any facts to discuss what your EBITDA growth and revenue growth within the portfolio?

. : We’ve seen some softness as we’ve discussed in the past due to this Consumer Financial Protection Bureau and making the rules more adhere for companies like Pinion, and Instant Web, and as we talked about in the past, the Keystone Pipeline, our investment in UK. So these teams have been working their way through, usually it’s where something touches some area of the federal government, whether it be military, general government spending or regulation. PAS Technologies is the most recent one that we’ve seen get hurt and that one, we’re evaluating and watching as we speak. We’ve seen some softness as we’ve discussed in the past due to this Consumer Financial Protection Bureau and making the rules more adhere for companies like Pinion, and Instant Web, and as we talked about in the past, the Keystone Pipeline, our investment in UK. So these teams have been working their way through, usually it’s where something touches some area of the federal government, whether it be military, general government spending or regulation. PAS Technologies is the most recent one that we’ve seen get hurt and that one, we’re evaluating and watching as we speak. John Hecht – Stephens, Inc.: Okay. And the last question, obviously I think you referred to four investments there, some of which we’ve heard about before and a couple of new ones as you relate to the government and defense sector. Are those the four that are on the watch list now or is there anything else we should be aware of?

Look, everything is on the watch list. We’ve mentioned in the past prior calls, the CFPB and what’s meant for Pinion and Instant Web and we’ve mentioned Keystone Pipeline for – PAS is the new one, that’s been hurt by the military issue. So again it was marked about a $0.90 to $1 December. The number since the quarter end has become worse, just to highlight that for you, it’s something that we’re watching. Generally the portfolio as you’ve said, in very good shape. Generally EBITDA’s were up. So in general we’re feeling pretty good as a lender. But as a lender with 50, 60 some name drill is going to have add points to that net or softer. John Hecht – Stephens, Inc.: Understood. Thanks very much.

Thank you. Next we'll hear from Rich Shane with JPMorgan. Richard B. Shane – JPMorgan Chase & Co.: Thanks for taking my questions this morning I wanted to go a little bit into timing issues and run rate issues on a couple of items. When we think about the quarter, we basically had all of the new equity in place for the entire quarter. And by my estimates, it probably on a levered bases deployed about 40% of the incremental equity. So there is a drag from that. I am wondering about the timing of originations in the quarter and repayments, was there – I’ve seen some back loading there?

Yeah, that's exactly right. I mean as it is usual, deal happen to close in the last couple of days of the quarter inevitably. No matter what you do. So there certainly was a bunch of backend loading on the new deals and in terms of refinances and takeouts and exits. There were kind of I’d say on an average in the middle of the quarter. So there was a little bit of a drag there, where we had most of our new deals come kind of right at the tail end of December. Richard B. Shane – JPMorgan Chase & Co.: Got it. And then the other item that obviously increased was the other income and dividend. And I am trying to figure out how much of that’s recurring and how much of that was driven by the heightened origination and repayment activity just to get a sense of where the run rate on that might be?

That's a great question. We always put these kind of, what we call non-recurring elements and line item in our income statement or the other income. And for us that is amendment fees, repayment fees, waivers if we get a dividend. So the two big elements this quarter were in the equity co-invest of prepaid legal dividends to the equity and we got on 1.3 million from that, as an example. So given that, recap activity should start helping the equity co-invest portfolio and we’re hopeful that it will again in the quarter ended March. Realogy was due to the IPO, was part of agreeing to convert our debt to shares in the IPO. We got some free shares of Realogy. So those free shares were one-time essentially fee that we earn for agreeing to convert and that was about 1.7 million of the other income. So other income, we never count as recurring, because it is always due to transactions that you can’t count as, is not recurring. That said, every quarter there seems to be some other income. So it’s just hard for us to predict and it’s hard for us to articulate to the market because it is not recurring interest income, it’s events. There are some dividend recaps getting charted about in our equity co-invest portfolio. There are some repayments that have been charted about in our debt portfolio. It would be surprising if we do not have some other income in the quarter ended March, but it’s tough for us to hang our head to articulate it to you at this point. Richard B. Shane – JPMorgan Chase & Co.: Got it. And I guess the one question, the follow-up question I would ask, that is that - I agree to you, it’s one of these things that’s not predictable, but is just a degree of recurring that you see quarter-after-quarter. You mentioned that you expect yield volume to be lower this quarter implicitly that would suggest a normalization of the other income, is that the way I think we should be looking at it?

Yes. That’s a fair way to look at it. And look I will just kind of state kind of what you are getting at, which is we like being very liquid right now and we are not going to rush our investment base. We are all about quality control and having deals that make sense and if that means that we have excess liquidity and we take our time, deploying for a quarter or two, we may under earn our dividend on a recurring basis. And that’s totally fine. We are not going to cut our dividend. We have plenty of liquidity. We certainly believe that as we deploy, we will earn our dividend if not more than our dividend and have a potential to grow our dividend. Well, we feel like we're in great shape, we don't need to rush our originations. We're going to take our time, make sure quality is high and we like to have an excess liquidity. Richard B. Shane – JPMorgan Chase & Co.: Very helpful. Thanks, Art.

Thank you.

Doug Mewhirter with SunTrust Robinson Humphrey, comes our next question. Doug R. Mewhirter – SunTrust Robinson Humphrey : Hi, good morning. I just had one question, I guess broader question. Do you see any differentiation right now between the opportunities in the lower end of capital structure versus higher mezzanine versus more of the security of the first lien type loans right now?

Yeah it is a good question. It's obvious specifically and you can see even from the deals we did in December, there is the smattering of both first lien as well as mezz. We are very focused on having appropriate ROE for our shareholders. So you saw average originations, on an average had 12.7% yield. We're focused on getting a proper ROE, in certain cases, first lien we can get there. In certain cases, it’s mezz, it’s deal by deal specific. Clearly we understand that we’re going to do subordinated debt. We better really love it because if things don't go well the recoveries are not as high, generally as if we did senior debt. That said we still feel our desired obligation and duty to try to generate appropriate return for our shareholders, and appropriate ROE. So we are really disciplined about that. You're not seeing us chase the second lien market down to 9% or 8% or even 10%. To us second lien is really just another form of subordinated debt. Let's call what it is, unless we see or try to package second lien as secured debt or however they try to package it. Second lien to us is another form of subordinated debt, whether you call it mezzanine second lien or unsecured debt, it's another form of subordinated debt and if we’re going to do second lien or subordinated debt or mezzanine, or whatever you want to call it, we better really love the risk and we better think that return is appropriate. So our last quarter we saw a mixture and I think you will continue to see mixture going forward. Doug R. Mewhirter – SunTrust Robinson Humphrey : Okay. Thank you very much. That's all my question.

Thank you.

We will hear from Mark Hughes with SunTrust. Mark Hughes – SunTrust: Good morning. It sounds like new investments basically, how about except the repayments is that activity you think really going to provide?

Good morning. Mark Hughes – SunTrust: It sounds like the new investments, as you say that basically slow a bit, how about the exit to repayments, is that activity you think going to slow as well?

It’s a good question. It is a little bit high activity levels, activity levels generally sometimes, one is higher than other whether it would be new origins or higher than exists or exists are little higher than originations, but generally you see them somewhat correlated. So we think it's going to be a mellower quarter both from the standpoint of originations as well as exits. Mark Hughes – SunTrust: Then, the feelings like – current year debt if you look at your pipeline and think about the full year. How it might stack up with last fiscal year, giving a very good strong quarter. What do you think the full year holds for you?

We don't give guidance or expectations. Hughes, you know what? We really don't know. All we know is we’re trying to make good investments and that we just don't give guidance and no clue. It’s beyond – anybody who tells you they know what Q2, Q3 and Q4 are going to be in 2013 maybe they are smattering the way, but it just can't help. Mark Hughes – SunTrust: Okay. Thank you.

Thank you.

Next we will hear from John Stilmar with JMP Securities. John W. Stilmar – JMP Securities LLC: Good morning, Art. Just because you are so actively involved in the sponsor network, what is your sense about the velocity of capital risk coming out of the sponsors? So are we getting that sort of instant private equity starting to move through the pipe here, or is it really what we’re seeing at least in terms of dealer active and the refinancing that’s come, that’s pushing some of the debt multiples, a function of the macro environment that’s driving excess liquidity around. I am wondering kind of which way the capital flows are coming? Is it really coming from excess liquidity in the fixed income market or this instant private equity that’s starting to come of the sidelines? I am wondering if you could give us at least your opinion from your capacity of which one of those kind of macro drivers is, will pass way through the types of investments that you are looking at?

Thanks John. The sponsor capital has been fairly aggressive over the last year or two. Anyway, I mean sponsors raised the kind of money 2006, 2007 that meant that they needed to deploy it over the last couple of years. So the sponsor capital has been aggressive over the last couple of years. The debt capital is the new element as we have stated, what’s going on in the liquid markets and the bullions there. So now you have the combination of the two. So we will see on the big cap space, what is the impact if any to deal by that has on the big cap space. That catalyze new deals, that’s of up the liquidity, we will see, time will tell over the next few months is that percolates through. So you are in a world where interest rates are low and people wanted the money to work. So that means we have to continue to be highly, highly selective about what we’re putting in these portfolios. John W. Stilmar – JMP Securities LLC: Got it. I appreciate your discipline, Art. Thanks a lot.

Thank you.

Next we will hear from Bryce Rowe with Robert W. Baird. Bryce W. Rowe – Robert W. Baird & Co.: Hi thanks. Good morning.

Good morning. Bryce W. Rowe – Robert W. Baird & Co.: I am going to ask about the SBIC and some of the deployment that we might see there. I know you can’t predict timing, but trying to get a feel for how you’re kind of flow the investments into the SBIC, the second SBIC? And maybe talk about the percentage of investments now that kind of fit the SBIC mold if you will?

That’s a great question Bryce. And again it’s hard for us to give any kind of sense of originations. What we will tell you is today probably about a third of what we do fits the SBIC. That’s come down from about 50% and I think that’s nothing specific on our part, it’s just kind of the way deal flows happen. That said, we can come to you next quarter and say every deal we did in this quarter fit the SBIC or we can come to you next quarter and say none of them fit the SBIC because it is such an idiosyncratic business. But today roughly about a third in general are fitting. Bryce W. Rowe – Robert W. Baird & Co.: Okay, that’s helpful, thank you.

Thank you.

That will conclude our question-and-answer session. I will turn the conference over to Mr. Penn for any additional or closing comments.

Great, I just want to thank everybody for their participation today and their interest in our company and we look forward to speaking with you next quarter. Thank you very much.

That does conclude today’s conference call. Thank you for your participation.