PennantPark Investment Corporation (PNNT) Q2 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open 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 second fiscal quarter 2015 earnings conference call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start-off by disclosing some general conference call information and include a discussion about forward-looking statements.

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is a property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release as well as our web site. 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.

Thank you, Aviv. I am going to spend a few minutes discussing current market conditions, followed by a discussion of investment activities, the portfolio, the financials, our overall strategy, and then open it up for Q&A. As you all know, the economic signals are moderately positive. Many economists are expecting a slowly growing economy going forward. With regard to the more capital markets, and in particular, the leverage alone high yield markets, during the quarter ended March 31, those markets experienced stress, due to cash coming from CLL formation, and substantial repayment activity. Contributing to the stress, was a modest rebound in oil prices, which to some extent, calmed investor fears. Middle market M&A activity was muted in the quarter. We are seeing more active environments since quarter end, and are hopeful that activity and attractive supply will be realized for the remainder of the year. 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. We remain focused on long term value and making investments that will perform well over several years, and can withstand different business cycles. Our focus continues to be on companies or structures, that are more defensive, have low leverage, strong covenants and high returns. With plenty of drypowder, we are well positioned to take advantage of investment opportunities as they arise. As credit investors, one of our primary goals is preservation of capital. If we preserve capital, usually the upside takes care of itself. As a business, one of our primary goals is building long term trust. Our focus is on building long term trust with our portfolio of companies, management teams, financial sponsors, intermediaries, our credit providers, and of course, our shareholders. 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 complex or affiliations, we have become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by 145 different financial sponsors. We have been active and are well positioned. For the quarter ended March 31, 2015, we invested $73 million. The average yield on new debt investments was 12.9%. Expected IRRs generally range from 13% to 18%. Net investment income was $0.29 per share. We have met our goal of a steady, stable consistent dividend stream since our IPO eight years ago, despite the overall economic and market turmoil throughout that time period. We anticipate continuing the steady, stable dividend stream going forward. We have plenty of liquidity. As of March 31st, we had in total, about $480 million of available liquidity, consisting of $340 million of available credit facility, $75 million of new SBIC debt financing and our second SBIC and over $63 million of cash on-hand. Given the current market backdrop, we have remained appropriately levered and have plenty of excess liquidity that can be used for both defenses and offensive purposes. At quarter end, our overall net leverage ratio, accounting for cash on the balance sheet, was approximately 66% and only about 46% excluding SBIC debt. Our Board of Directors has authorized a stock repurchase program of up to $35 million worth of stock over the next 12 months. Our portfolio is constructed to withstand market and economic volatility. We have a cash interest coverage ratio of 2.4 times, and a debt-to-EBITDA ratio of 4.9 times at cost on our cash flow loans. We had some attractive realizations last quarter, and generated $9.5 million of realized gains. We are proud that since inception eight years go, through the recession and credit crisis, we have generated positive net realized gains for our shareholders. During the quarter ended March 31, we exited $48 million in Patriot National first lien debt plus warrants, and realized a gain of $9.4 million and an IRR of 27%. We still have warrants worth $1.2 million in this company. Our $15 million in Power Products mezzanine was refinanced and generated IRR of 28%. Amtech Systems repaid our $8 million loan and generated an IRR of 16.5%. As we highlighted on our last call, with regard to our exposure to the energy industry, we have successfully invested in energy through 21 different companies since our inception eight years ago. In 2014, we monetized three large subordinated debt and equity positions, that generated proceeds of approximately $170 million and a weighted average IRR of 17.8%. We focus on opportunities backed by sponsors of experienced management teams, that have deep experience to be successful across the industry. Together with our own contacts, industry consultants and engineers, these resources have aided us meaningfully in the past. We were awarded certain energy subsectors, geographies, as well as many undifferentiated service businesses, with low barriers to entry. For exploration and production, we like to be senior in the capital structure, with an asset-backed focus and hedging to mitigate the downside. We look to remain in the low cost areas of withdrawing production, and experienced management teams with proven project capabilities. Our existing portfolio, including the exploration and production companies, fit into our team of being senior in the capital structure, backed by substantial asset coverage, including proved, developed and producing reserves, with substantial hedges in place. There are also significant additional assets, in the form of additional acreage, reserves and midstream assets. With regard to Ram Energy, we are backing an experienced management team, who has performed well for PennantPark in the past, and we are in a first lien position. Through our non-core asset sales, the company paid down $7.5 million of debt since the last quarter, and is continuing to evaluate their assets and strategy. Likewise, New Gulf generated substantial liquidity, by selling a portion of their non-core midstream assets for $85 million, and looking to sell further non-core, midstream and E&P assets. We believe that our underwriting criteria and long term approach should support our investments through this period of low energy prices, and allow us to realize attractive returns. While mindful of our desire to maintain a diversified portfolio, the current situation may well present attractive risk-reward opportunities. Across PennantPark entities, we had only nine companies on non-accrual, out of 360 investments since inception eight years ago, despite recession during that time period. Further, we are proud that even when we have had those nine non-accruals, we have been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in those companies, we have been able to find ways to add value. We always monitor and reunderwrite our deals, in situations where the best long term value for shareholders is created, by taking control of the companies and providing capital and expertise we do. Our positive net realized cumulative gains since inception eight years ago, through the financial crisis, are a testament to this long term value orientation. Based on values, as of March 31, we have recovered nearly 90% of capital invested so far on those nine companies that have been on non-accrual since inception. We have two non-accrual investments as of March 31, representing only 1.2% of the portfolio at cost. As a result of this track record of low non-accruals and high recovery rate, we are one of the few BDCs who was in operation before the recession, which preserved capital for shareholders, while generating consistent steady dividend. In terms of new investments, we had another quarter investing in attractive risk adjusted returns. In virtually all these investments, we have known each 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; to [indiscernible] capital provided equipment lease financing to businesses in the United States. We purchased $10 million of second-lien debt. The company is owned by the founder. We purchased $23 million of subordinated debt, and $2 million of equity in Cascade LP. Cascade is a provider of services for environmental projects, Snow Phipps is the sponsor. Randall Reilly is a business-to-business media and information company. We have purchased $12 million of subordinated debt, Investcorp is the sponsor. Turning to the outlook, we believe that the remainder of 2015 will continue to 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 March 31, 2015, recurring net investment income totaled $0.24 per share. In addition, we had $0.05 per share of other income, net of fees and as a result, total net investment income for the quarter was $0.29 per share. Looking at some of the expense categories; management fees totaled $12.3 million, general and administrative expenses totaled $1.7 million and interest expense totaled $6.6 million. During the quarter ended March 31, net realized gains on investments was $9.5 million or $0.13 per share. Unrealized losses from investments, was $24.8 million or $0.33 per share, and unrealized gains from our debt was $600,000 or $0.01 per share. Excess net income over dividends was about $1 million or $0.01 per share. Consequently, entity per share went down $0.18 from $10.43 to $10.25 per share. As a reminder, our entire portfolio, credit facility and senior notes are mark-to-market by our Board of Directors each quarter, using the exit price provided by independent valuation firms, securities and exchanges or independent broker/dealer quotations, when active markets are available under ASC 820 and 825. In cases where broker/dealer quotes are inactive, we use independent valuation firms to value the investments. Our overall debt portfolio had a weighted average yield of 12.4%. On March 31st, our portfolio consisted of 67 companies across 31 different industries and was invested 27% in senior secured debt, 47% in second-lien secured debt, 17% in subordinated debt and 9% in preferred and common equity. 68% of the portfolio has a floating rate, including 61% with the floor and the average LIBOR floor is 1.3%. 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 consistent dividend stream, coupled with long term preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in debt instruments, and we pay 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.

Thank you. [Operator Instructions]. We will take our first question from Troy Ward with KBW. Please go ahead.

Great. Thank you and good morning Art and Aviv. Real quick, Art, couple of movements in the portfolio on the credit side. I saw, it looks like you restructured JF, can you just give us some detail around that, and it looks like, maybe you have put in more capital. Could you provide some color there?

Sure. JF acquisition is a distributor of gas pumps, and it has been having some bumps in the road for a while. Last quarter, we put a non-accrual. The results have continued to slide, unfortunately, due to a failed ERP software implementation and some accounting, and as a result -- resulted in some accounting issues. So that restructuring was done. We converted our debt into equity, we put more equity in. We own about 37% of the company, MidOcean is the original sponsor, who put a bigger equity check in. They own a bigger piece of the equity. We are hopeful like some of the other restructurings that we have had over time, that had equity, will help us recover value over time. Certainly, it's very disappointing for us.

And you said gas pumps. Remind me though, that's on the retail side, not necessarily the industrial drilling side, correct?

That's right. This is -- you know, you go down to the corner gas station.

Okay, great. And then I believe, DirectBuy on non-accrual this quarter as JF came off, so that's still two in the non-accrual, can you speak to the DirectBuy?

Sure, DirectBuy has been undergoing a business transition. They are changing their business model, the one where it's more of an ongoing relationship with their customers and a onetime payment. So while it's in transition, we put it on non-accrual. It's not going to certainly be paying us cash interest for a while, as that company undergoes, hopefully, a transition.

Okay. And then, can you speak a little bit, Art, about kind of the different investment places in the capital structure? I think over a multiyear period, you really kept PNNT kind of focused in the same point in the capital structure, and that is the true subordinated, we call traditional mezz. And while, many other peers maybe in the BDC space, have moved up and down the capital structure. I think maybe in the more recent quarters, we have seen actually some BDCs move, more into second lien. We have seen, maybe where -- they went to senior prior, they are starting to maybe back up a little bit in the capital structure. Can you just speak to where you think the attractiveness is or maybe has changed? Has there been any change in the attractiveness of the different pieces in the capital structure?

That's a great question, when we setup PNNT eight years ago, we always anticipated and viewed it as a publicly traded mezzanine debt fund. And sometimes that mezzanine -- traditional mezz debt, sometimes it means second lien. Second lien is subordinated and has some protections that make it slightly better than traditional subordinated debt, but we still view it as subordinated debt. And in certain cases, when we can get an appropriate yield on first lien or in this market, stretch virtually or unit tranche, that's a piece of the portfolio as well. And why have we done that? We have focused on having a certain ROE for our shareholders, to make the math work, we want a double digit ROE. We need to find investments with the yields. The exception was of course, in 2008, 2009, 2010, when you can move up capital structure and buy first lien and get mezzanine returns, of course, we did that. That was the best, and PNNT at that time did move up capital structure. And if that type of market happens again, then of course, PNNT will move up. But we are very focused on our box, and our box is kind of a double digit ROE, being very conservative with what we underwrite, it means in certain cases, we grow, in certain cases we shrink. We shrank this past quarter, and if that's the right answer, because the risk/reward in the market are not available to us. So beat it, we will shrink. As you know Troy, we don't come to the office everyday, and talk about how we grow. We talk about, is there a good yield to do, and PNNT has had somewhat muted growth over the last couple of years, as a result of that.

Great. That's all for me. Thanks.

Thank you.

We will take our next question from Doug Mewhirter with SunTrust. Please go ahead.

Hi, good morning. My first question actually, you covered very thoroughly about your non-accruals, I appreciate that detail. My second question, about your energy investments, I mean, it's nice to see growth that these guys have to get pretty creative on maintaining their business and their cash flows. With the recent pop in energy prices into the 50s, at least on the future markets, have any of your borrowers taken the opportunity to maybe put on some more hedges with the pop to maybe protect -- sort of extend that protection out a little longer, or is sort of the clock still running on their existing hedges?

They haven't yet put on hedges, as oil has moved back up to $60. We still reiterate, that what we said last quarter is, we hoped kind of a year from now, oil will be in the 70s, and in that case, we think these companies will be fine. In the meantime, as we have said with both Ram and New Gulf there, shedding non-core assets, trying to create liquidity and make it through the cycle. Certainly, we are feeling better, now that oil is over $60. We had no guarantee that's going to stay over $60 or go higher or go down again. You can spend all day, every day, thinking about where oil is going to be, with no real certainty. So these companies are doing what they need to do to preserve their liquidity and make it through.

And just to clarify something on Ram and New Gulf, where they made some non-core asset sales. You said Ram Energy paid down a little bit of debt, and that New Gulf cut some cash from their midstream sales. Any of that cash, here or both cases, come back to you, or did they pay down other debt, or just keep the cash on hand?

Well in Ram, it paid down some debt, and then they keep the cash on hand to pay us interest and to operate.

Okay. But New Gulf, they sort of just maintain they are on liquidity, they didn't pay the --

That's right.

Thanks. That's all my questions.

Thanks Doug.

[Operator Instructions]. We will take the next question from Chris York with JMP Securities. Please go ahead.

Good morning guys and thanks for taking my questions. So I just wanted to touch a little bit more on your views for the competitive environment, and more specifically, what is the exit or what is your view of the exit of GE Capital from the sponsor finance business, due to your opportunity set, and then potentially, opportunities to add new employees?

It’s a great question, its very early to tell what the GE follow-on would be if any, depends on how it all plays through. We still like the middle market long run obviously. We are very optimistic about what we all do in the BDC world. GE turmoil, if it were to happen, would present opportunities for all of us, whether it be in assets or market share, or talented people. So our ears are to the ground, we are opportunistic, we certainly wish the GE folks the best, we have many friends over there, and whatever will be, will be, we like the overall marketplace.

Great. That's it for me. Thanks Art.

Our next question will come from Jonathan Bock with Wells Fargo Securities.

Hey guys, this is actually Greg in for Jon. Couple of quick questions; so first on, I believe [indiscernible] was marked down pretty substantially. Now this is a deal, where there is a debt exchange late in 2013, and you guys actually put in additional capital, expressing comfort with the credit. So just wanted to get your thoughts around that?

It’s a great question. It was markdown this quarter for a couple of reasons. Number one, the strength of the dollar, they have significant foreign operations. Number two, they have had an issue with a large client, so that has resulted in the markdown. We still believe in the long run that the asset value is there, the sum of the parts should mean we get our whole line [ph] on our debt, if not, have some equity value. So we still believe that thesis when we did the workout or restructuring couple of years ago, they bought themselves nearly three years of time to operate. So we still believe in investment thesis to mark-to-market at this point, and we will continue to monitor and be on it, and that's kind of the answer to the question.

Sure. And then obviously, everyone appreciates the repurchase program that you announced certain grants on that. But so, one question on that, as you're thinking about utilization, obviously, it’s a program that's more subject to restrictions and timing restrictions relative to some 10B51 programs. So just to get your thoughts on utilization, and then also, how you think of utilization as an inherent investment in your current portfolio, where NAVs declined 10% over the past four quarters?

We believe in the portfolio, which is one of the reasons we authorized this plan, and we wouldn’t have authorized the plan, unless we were going to use it.

All right. Thanks for taking my questions.

Thank you.

Our next question today comes from Christopher Nolan with MLV and Company. Please go ahead.

Art, can you give a little detail in terms of the incremental write-down on Ram Energies?

I mean, that was just I think, it went from 90 to 88. There was nothing really, just what the valuation firms came up with, it was not material, and that's what they came up with this quarter versus the 90 last quarter.

And [indiscernible] the right times in the energy sector, does that reflect the EBITDA for these companies, or does it also reflect the potential, I guess, nervousness of banks that might hold a revolver, until it basically precipitates some sort of --?

No, this is all mark-to-market. I mean, we still believe on these names, that we are covered by asset value, than in the long run, we will get all of our money back. But when energy goes down a big chunk, like it did over the last six months, you have to recognize that in your mark-to-market, otherwise put your head in the sands. So there has been a mark-to-market and the biggest chunk of our unrealized losses over the last couple of quarters had been due to that. Again, we reaffirm that our energy exposures is covered by assets, and we feel good about it.

Final question on the repurchase, at what price level, share price levels do you start -- the returns on the repurchase start looking more attractive than actually making incremental investments?

Again, we wouldn't have made this announcement, unless we intended to actually execute. So we don't disclose that, but we made the announcement with the intent that we will buy stock back.

Great. Thanks for taking my questions.

Thank you.

[Operator Instructions]. We will go next to Andrew Kerai with BDC Income Fund. Please go ahead.

Yes. Hi good morning and thank you for taking my questions. I mean, I apologize, if it was asked already, but in terms of Ram Energy, I noticed you reclassed that from, a non-controlled non-affiliate holding to an affiliate investment. Obviously they have -- the B tranche has maturity coming up here later this year. Was there any change in sort of, I guess, your seat at the table from a voting rights perspective, or just any reasoning behind the reclass would be helpful?

That's a great question. When we did the deal originally, we set some thresholds for getting paid back on that term B, and if we weren't paid back by certain period of time, we would get warrants. So we are just over the 5% equity ownership threshold as of 3/31, that's why it got classified that way.

Okay, great. That certainly makes sense, and then just a follow-up on the energy as well. With oil obviously close to 3/31, sort of moving up here, seeing, I think -- if you look at WTI, it's above $60 now, is there any potential for, I guess maybe, at least marginal write-ups for some of the investments that had markdowns over the past couple of quarters?

We are certainly encouraged by oil prices being up a little bit. You would think, the mark-to-market on the portfolio would be somewhat related to oil prices, because it certainly was on the way down. We will see, we will see if its substantial enough, as we work with the independent valuation firms, and we see where the market prices of comparable securities, that's really what drives it, where are the comparable securities, whether it'd be debt or equity that are in the liquid markets, and our independent valuation firms take their cues from that.

Great. That certainly makes sense. Then just on the buyback again, with the earnings out now, and basically, I guess, you guys had a quite period. There is nothing restricting you, at this point, for example repurchasing stock this week or even today, right?

That's correct.

Okay, great. Thank you and congrats again on the buyback. We certainly appreciate the color and look forward to you guys, hopefully utilizing a material portion of this.

Thank you very much.

And with no questions remaining, I'd like to turn the call back over to management for any additional or closing comments.

Just want to thank everybody for being on the call today. We look forward to speaking to you next quarter.