PennantPark Investment Corporation (PNNT) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to PennantPark Investment Corporation’s Third Fiscal Quarter 2013 Earnings Conference Call. At this time, all participants have been placed on listen-only mode. The call will be opened for a question-and-answer session following the speakers’ remarks. (Operator Instructions) It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn you may begin your conference.

Thank you and good morning everyone. I’d like to welcome you to PennantPark Investment Corporation’s third fiscal quarter 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 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 would like to turn the call back to our Chairman and Chief Executive officer, Art Penn.

Thank you, Aviv. I am going to spend a few minutes discussing current market conditions, followed by discussion of investment activity, the portfolio, the financials, the 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 slowly growing economy going forward. With regard to the more liquid capital markets and in particular the leveraged loan in high yield markets, those markets were extremely strong until June of this year as cash flows into high yield funds, leveraged loan funds, and CLO’s have been strong. As (inaudible) tightening surfaced in June the liquid market saw some turbulence but has since bounced back. Risk reward in the middle-market has generally remained attractive as the overall supply of middle-market companies in each 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 de-leveraging from free cash flow over time is a favorable outcome. That said, as the more liquid capital markets rallied in the first half of 2013, that overall tone impacted the middle market. Pricing compressed and purchase price multiples and leverage multiples increased. As a result, we have been selective about which investments we make in this environment. Given our strong origination network and size of our company, we believe we can continue to prudently grow. 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 remain cautious and selective about which investments we had to our portfolio. Our focus continues to be on companies or structures that are more defensive…

Thank you, Art. For the quarter ended June 30, 2013 recurring net investment income totaled $0.21 per share. In addition, we had $0.06 per share of other income. As a result, net investment income for the quarter was $0.27 per share. Looking at some of the expense categories, management fees totaled $9.8 million. General and administrative and excise tax totaled $1.7 million and interest expense totaled $4.2 million. During the quarter ended June 30, net unrealized and realized loss from investments and debt was approximately $4 million or $0.06 per share. Excess dividend over net income was about $1 million or $0.01 per share. Consequently, entity for share went from $10.50 to $10.43 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 exchanges 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 13.1%. On June 30, our portfolio consisted of 57 companies across 26 different industries and was invested 30% in senior secured debt, 22% in second-lien secured debt, 36% 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 captured that free cash flow primarily in debt instruments and we pay out for 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 the call to questions.

Thank you. (Operator instructions) We’ll hear first from Troy Ward with KBW. Mr. Ward, your line is open. Troy Ward – KBW: (inaudible) if I take it off mute. Thank you. Art, can you real quickly just talk about your anticipation of equity going forward, you obviously monetized several big chunky pieces of equity. Can you talk about the equity co invest you’re currently seeing in the market, we’ve heard a lot about the competitive nature of the lending. Are you still able to get co invest equity and do you intend to continue to do some of that?

It’s a good question. We continue to be able to get the options to co invest in the equity. We usually negotiate that option so to us each layer of the capital structure needs to be debated separately refresh the sense whether we like the debt and we think the debts taken. And secondly, do we want to co-invest in the equity. We’re being more and more skeptical these days about where some of these equity values are so we will still negotiate the option. We will probably take that option less times in this market as purchase price multiples had increased. We will probably be less active. Troy Ward – KBW: Good. Thanks. And then on – when you think about new loan relationships versus current portfolio companies that are looking to reside. Kind of what percentage of the further companies that are looking to reify you depending in and trying to keeping the portfolio. And if you don’t kind of defend the current position, is it typically because of price restructure kind of where is the stress in the marketplace?

It’s a great question. And it’s always on a case by case basis and I’m sure you’ve heard this from other BDCs. To the extent you know unlike a company and it’s performed well and you have a comfort level of course you’ll look to defend it, on one hand. On the other hand if their risk reward doesn’t make sense in the context to the overall market – in the overall portfolio and that particular dealer you shouldn’t do it. So, we let some of them go, some of them do still kind of in our risk reward parameters and we defend them. But ultimately you can’t get emotional about this stuff and if it doesn’t make sense for our shareholders from a risk reward standpoint, let it go and we’ll get refinance in some cases, we get prepayment fees and we’ll call that a victory. We never – when people pay us back we say thank you because sometimes they don’t pay you back. So, we’re always appreciated when we get paid back. And that just is what it is. Troy Ward – KBW: Great. Thanks Art.

Thank you.

We’ll take our next question from Chris York with JMP Securities. Chris York – JMP Securities: Good morning guys. Thanks for taking the question. Not too many of them this morning but first I do want to touch on one thing, it appears that SBIC too still only had small amount of regulatory capital budget. Could you talk about your desire to originate product response and budget additional capital and potentially access more SBIC financing.

Look, we are – it’s a matter of public record that we love the SBIC financing and we love to find deals to fill the bucket in a market where we are generally pick here overall. However, as you’ve seen we’re doing fewer deals and obviously to the extent we do a deal that fits, we love to put it in there. The SBIC rules are more restrictive in terms of what fits than our overall BDC rules. So, we hope to get that $75 million drawn over the next three, four quarters if we can if not sooner but it will just depend on the deal club. Chris York – JMP Securities: Okay, that’s helpful. And then clearly you received a strong amount of excess repayments in the quarter. Are you expecting that to remain elevated or have you had any discussions that would made you to believe that you’ll have some elevated repayments in the current quarter.

It’s always a case by case basis, Chris. Look, if we’re doing our job, we’ll always have repayments which you have to assuming our business that on average the whole portfolio if we’re doing a good job we’ll turn, rotate over three or four year time period. So, we’re going to by definition have some repayments as it well be as elevated in the last quarter, it’s early to tell you’re kind of right in the middle of the quarter. We’re going to have some repayments, we’ll also have some new deals, we’ll also defend some deals, so it will be a mixture of all the above. Chris York – JMP Securities: Great. That’s it from me. Thanks Art.

Thank you.

We’ll take our next question from John Heck with Stevens. John Heck – Stevens: Good morning guys. Thanks for taking my questions. First, with respect to Affinion, can you tell us what the price of those bonds were at the time of the NAV consideration and where they are now?

Sure. It’s a good question. Affinion was quoted around $1.50 the broker dealer quoted instrument. This is one of the companies that’s been negatively impacted by the Consumer Financial Protection Bureau and clamping down on bank of marketing. Since, quarter end the company announced their earnings, the earnings were better than expected. The paper is traded up to $1.58 $1.59. Company seems to have gotten a better grip around the CFPB issue and it’s company and is finding other areas of growth outside of U.S. Financial Institution. So, the numbers were better than expected, the bonds are up 8, 9 points since quarter end. Management team when they were asked in the conference call how they’re going to deal with these bonds, they were very confident that they’re not to be an issue and that they’re going to able to pay them off. So, clearly market doesn’t believe that they’re going to pay them off a $1.58 yet but that is what it is, we’ll see a play out over the next year and a half. The company is paying cash interest to its lenders including us. So, it’s kind of a wait and see game and see how they deal with the operating environment. John Heck – Stevens: Okay. Thanks very much. And then forgive me if you mentioned this, but you did have elevated repayments in the quarter. Can you give us a sense for what the repayment income was in the quarter and maybe kind of where that level has ranged historically?

Yeah. So, we had – this shows up in our queue just everyone knows in our other income line, we have two lines in our revenue, one is interest income, the other is other income. And we have debt repayments penalties or amendment fees it shows up in the other income line and that’s kind of what showed up this quarter was about $3.9 million related to the prepayments we talked in the call which were Tekelec, Veritext, Trust House and Learning Care were the four big repayments of the quarter. Did I answer it? John Heck – Stevens: That answered, yeah but what is the repayment income kind of what’s been the range over the past several quarters, just to give us a sense through what a normal ranges maybe?

I mean it goes from $0.01 to $0.06 a quarter, I mean it’s kind of – then that’s why we put it in the other income line to indicate that it is variable. And it just depends on the prepayment penalties and the amendment fees. In certain cases when we were in an equity co investor have a one position and there is a dividend that would show up in that line also. So, this is kind of the variable portion of our income and $0.01 to $0.06 is probably good range, I know that’s a wide range but that’s kind of what it goes. John Heck – Stevens: Okay, that’s helpful. Final question is, I wonder if you could comment on kind of the performance portfolio from an EBITDA and revenue growth perspective in getting your thoughts on the overall economic trends related to that.

So, in our prepared remarks we said we see a slowly growing economy (inaudible) economy going forward. EBITDA as we track EBITDA the portfolio company since inception of investment, they’re still running up to 10% to 15% from inception in investment so we still feel pretty good about the credit quality of our portfolio we currently have no non-accruals. So, Touchwood, we’re doing okay, the areas that weakened is continue to be once we’ve been talking about it if you have a company that’s involved in defense and aerospace given the sequester you see all the weakness sometimes you have a company that’s involved in healthcare and healthcare reimbursement policies that will change you might see some weakness. And of course we’ve been talking about the CFPB for a while. So, but we think the marks are that you see in the portfolio accurately reflect the credit quality and as a result we think the portfolio has done pretty well. John Heck – Stevens: Okay. Thanks very much guys.

Thank you. We’ll hear next from Mickey Schleien with Ladenburg. Mickey Schleien – Ladenburg: Good morning, Art. First, big picture question. We’ve seen many BDC’s experience a high level of redemptions in the quarter. But the reasons behind that may vary from company to company. Can you give me a sense of what drove those repayments and where those borrowers went to refinance that money?

Sure. Great question. Tekelec was sold to Oracle the big software company, so we just an M&A takeout, Trust House was an M&A takeout. And then Learning Care and Veritext were mezzanine financings that were high yielding mezzanine financings the credit quality was good and those mezzanine deals were refinanced with first-lien bank debt as the credit delevers. Mickey Schleien – Ladenburg: Okay, thank you for that. And more of a housekeeping question, Art can you give me a sense of where spill over taxable income stands at this point, in other words how much is there today to support the dividend given that you haven’t quite covered at the last couple of quarters.

I’m going to let Aviv to answer that one.

Yeah, certainly from a tax view point, you do have a small cushion that is a spilling over, so we do we are conscious of the cushion and as we said earlier in IRR for example this quarter exceeded by one penny, we’re actually was one penny less than the dividend. So, we’re eating into this cushion and that’s exactly the purpose of this cushion. So, we do have maybe $0.1 or $0.02 $0.03 per share remaining cushion and just going from a taxable view point. Mickey Schleien – Ladenburg: Did you say $0.01 to $0.03 left?

Yeah, $0.01 to $0.03. I mean by the way just to put in perspective as we said in our prepared comments, it’s okay I mean as long as we’re earning in and around the zone of our dividend we have no – we do not anticipate cutting our dividend, to us we think 2013 is not the best message to be investing in and we’ve been saying it now for a few quarters. So, we’re going to be really careful, we’re going to keep our powder dry. And be prepared here to the extent there is an opportunity down the road to take advantage of a broader opportunity so we’re not forcing – nice thing about our seismic is a few deals a quarter is all we really need if we actually do need, that’s the kind of standstill and that really has not been a problem given our origination that work our relationships. We were certainly now forcing the investments we certainly want to make sure we maintain our investment discipline. We certainly don’t have any anticipated sense of cutting our dividend but we are keeping a lot of power to drive for both defensive and offensive purposes. Mickey Schleien – Ladenburg: Fair enough I appreciate your time at this morning.

Thanks, Mickey

We’ll take our next question from Mark Hughes with SunTrust. Mark Hughes – SunTrust: Yeah thank you very much. Art you suggested you are going to be active or you see things been more active later in the year. Is that an acceleration active is the outflow picking up here in July, August?

Yeah I mean it seems to be picking up it’s not dramatic it seems to be picking up by moderate amounts. It’s hard for to be less than it was number one and number two we’re really picky and selective about what we put in the portfolio. So but we are busy than we were, we’ll see how much that actually translates to many cases their deals are related to M&A trades or there are strategic financings and the deals not done until the wire goes and it’s accepted by the other side. So it’s feeling busier but it’s hard to give you real guidance around that. Mark Hughes – SunTrust: Right. Are the size of the deals or is the size of the deals increasing?

Yeah I mean Mark we view ourselves as kind of a $1 billion, $1.1 billion funds in PNNT at this point. So we look at 3% positions or 4% positions as kind of okay certainly 2% positions array. We want to maintain diversification so $30 million to $40 million will be kind of average zone for us. For us 250 or something more we have to really, really love it and we’ll do that from time to time as you’ve seen. Mark Hughes – SunTrust: Thank you.

We’ll here next from Scott Valentin with FBR Capital Markets. Scott Valentin – FBR Capital Markets: Good morning. Thanks for taking my question. Art you gave some metrics for the portfolio I think it was debt service coverage and I think it’s enterprise value to EBITA some of the portfolio. Do you have those metrics for the quarterly originations?

Don’t have him at hand I would say in general they are in line with the overall portfolio. We had some of the quarterly originations were slightly higher than that. We had some that were quite a bit lower than that. So if I had to guess it I don’t have it on hand where it’s probably kind of in line with the overall portfolio. Scott Valentin – FBR Capital Markets: Okay. And then in terms of originations any industries your and I guess the once you mentioned or maybe you are avoiding but any industries you are particularly focused on for originations?

There is nothing we know what we are avoiding which we’ve already mentioned. It’s kind of all through the map it’s all over the map it’s still the same companies that hopefully we can find steady free cash flows. So nothing really new from that stand point. Scott Valentin – FBR Capital Markets: Okay. Thanks very much.

Thank you.

We’ll take our next question from Doug Mewhirter with SunTrust Robinson Humphrey. Doug Mewhirter – SunTrust Robinson Humphrey: Hi, good morning. Just building on the activity question that Mark had. Just from my limited view point of the industry. It seems like there is a bit of a bifurcation in the BDC space and it seems like larger deals higher in the capital structure seemed to be very active and the I guess the lower the smaller mezzanine deals I guess drying out maybe a very extreme term but this overall seemed to be a lot less. Is that a profit characterization and if it is if there are can you explain why there is it seems to be sort of a two tiered market in terms of activity.

I mean I think just Doug just maybe reorient the question a little bit. There in the ebullience of the liquid capital market the leverage loan market and the higher yield market. The liquids syndicated markets because there is so much liquidity through CLOs and bank loan funds have moved down market in terms of size of company that they will finance. So to us there is a nice term and we like second lien we like that term, we think at a little bit better structure than subordinated debt but for all intents and purposes second lien is subordinated debt and when you see the syndicated loan market doing second liens at 8% or 9% or 10% us we say shouldn’t that be mezz of 13% or 14%. So we need to maintain our discipline around credit number one and also pricing number two. For those of you who are concerned about originations we could take our money and put 4400 million to work and second lien 9% or 10% liquids syndicated deals at very high leverage ratios tomorrow and really ramp and really grow the portfolio and have no issue way over earning our dividend. The problem you run into is what’s your quality what’s your quality if you had to go back and I’m not saying we are in 2007 again we don’t think 2013 or 2013 is better than 2007 but if you had the replay 2007 again. Would you have invested in anything so we are very cognizant of the vintage we’re in. We are taking it slow with our size vehicle. We only need a few quarters few deals a quarter even this stands still and we can find a lot of good deals we’ll of course do them but we are not forcing it we are not rushing it. We are not buying these 8%,9%,10% more syndicated second liens and we are going to take a slow right now. Doug Mewhirter – SunTrust Robinson Humphrey That’s a fair it’s definitely fair answer. Thanks for the color that. So it’s look like these are baseball analogy. You are still saying quite a few pictures here does not swing and as many.

Yeah what we did basically four deals this past quarter. We look at hundreds right I mean so again we are in the fortune position of waiting for those fat pitches that we can do something with and if it’s not a fat pitch that’s okay. Let it go. Doug Mewhirter – SunTrust Robinson Humphrey: And just a quick follow-up numbers question. You’ve may have covered this or may have been asked another question. There is the negative change in your unrealized loss position. Is there anything behind that or is it just result of certain portfolio actions?

I’m sorry can you restate the question. Doug Mewhirter – SunTrust Robinson Humphrey: The change you had a negative change in your unrealized loss position if it was negative $19 million or $19.5 million I just wondered if there is anything specific behind that?

I think we mentioned that the change in unrealized primarily due to the marks on a Affinion quarter-over-quarter that’s I mean and it was marked about $0.50 on a $1 that gave rise to the bulk of the change in unrealized losses. Doug Mewhirter – SunTrust Robinson Humphrey: Okay. So that was really the earlier question. Okay. Thank you. I appreciated that. Thanks that’s all my questions.

Thanks, Doug.

We’ll take our next question from Ron Jewsikow with Wells Fargo. Ron Jewsikow – Wells Fargo: Yeah. Good morning and thank you for taking my questions. Most of my questions have already been asked. I appreciate all the market commentary. Just a quick housekeeping question. You mentioned the Gogo IPO and your debt investment I mean this but. Is that have any impact on your debt investment?

No, our debt investment stays outstanding we made the bulk investment I’m going to say about a year, year and a half ago we did an add-on that was on just prior IPO it will remain outstanding it is nice though it will have a company with the billion dollar plus equity market cap is validated the equity underneath us that can access the equity markets over time. So we are pleased with that company. We hear PennantPark certainly when we get on planes we are certainly addicted to that Gogo WiFi and we see some other folks on the call are to please when you’re using next time think of us. Ron Jewsikow – Wells Fargo: All right. Thanks guys and thank you for taking the question.

Thank you.

We’ll take our next question from Troy Ward, KBW. Troy Ward – KBW: Hey just a quick follow-up following the Fed’s commentary the spring, summer about tapering of course you’ve seen the tenure go up to 260 kind of range. The questions regarding to us regarding the impact of higher rates on the BDC sector as a whole is definitely increased and I think fundamentally the sectors neglect about because adding a lot of fixed rate leverage but as you do your due diligence in the year on portfolio or new investments for the portfolio. How do you view the impact of higher rates on the underlying credit in the portfolios?

It’s a great question it certainly as we are modeling and downside cases of how companies might perform in different scenarios as we certainly need to take interest rate increases into account as we look at downside cases. On the other hand I guess you have to look at what is driving the Fed tapering and presumably what’s driving the Fed tapering is a stronger economy. And usually if you look at BDC historically we’ve actually done pretty well and rising interest rate environments piece when you think about it if your middle market debt or equity investor the most important driver is credit quality and a good economy drives the credit quality. So we feel like we certainly need to take it into account and be cognizant and certainly when we are structuring deals it’s great that floating rate versus fixed. If we do fixed the deals or usually at pretty high rates that capture a bunch of yield that if the companies perform well the deals will be taken out anyway. So don’t know if I answered your question but I thought it was a good question. Troy Ward – KBW: That’s good. Thanks guys.

Thanks, Troy.

That does conclude the question-and-answer session today. I would like to turn the call back to our presenters for closing remarks.

Thanks everyone and I appreciate your participation today. The next time we are going to be speaking will be after our next quarter which will be our 10-K quarter so it will be our annual report quarter so it’s going to be a longer timeframe between now and then it will be kind of mid to late October which is when we usually do file our financial reports and do the conference call. So we’ll speak to you next time in mid to late November. Thank you very much for your attendance today.

This does conclude today’s conference. We thank you for your participation. You may now disconnect.