PennantPark Investment Corporation (PNNT) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the PennantPark Investment Corporation's Third 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 third 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 on our website. I'd like to also 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’m going to spend a few minutes discussing current market conditions, followed by a discussion of investment activity, 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 with many economists expecting a slowly growing economy going forward. With regard to the more liquid capital markets, and in particular, the leverage loan in high yield markets, during the quarter ended March 31, those markets were relatively flat as high yield and leverage loan fund experienced some outflows due to expectations of Fed tightening. We saw and participated in a more active environment in the quarter due to increased M&A and financing activity. We remain focused on long term value and making investments that will perform well over several years that can withstand different business cycles. Our focus continues to be on companies or structures that are more defensive, have a low leverage, strong covenants and high returns as credit investors are one of our primary goals as preservation of capital. We preserve capital and 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’ve become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by 150 different financial sponsors. We’ve continued to invest in our platform. We’ve recently hired senior investment professionals for the West Coast and Midwest regions of the United States along with hiring additional senior and mid-level investment professional for our New York Office. With existing senior people on London and Texas, we have substantially widened our geographic footprint. These additional resources along with a broader overall platform resulting from the upcoming merger of MCG Capital with our sister company PennantPark Floating Rate Capital should drive significantly enhanced deal flow as PennantPark entities get more looks and can be even more relevant to our borrower clients. We have been active and are well positioned. For the quarter ended June 30, we invested $113 million. Expected IRRs generally range from 13% to 18%. Net investment income was $0.28 per share. We have met our goal of a steady, stable, consistent dividend stream since our IPO over eight years ago, despite the overall economic and market turmoil throughout that time period. We anticipate continuing the steady, stable dividend stream going forward. As you know, PDCs are required to pay out the shareholders at least 90% of taxable income. As of last September 30, our undistributed taxable income was $0.21 per share. Since last September through 30, future realized gains in our portfolio, our undistributed taxable income has substantially increased. We have plenty of liquidity. As of June 30, we had in total about $480 million of available liquidity, consisting of $325 million of available credit facility, $75 million of SBIC debt financing in our second SBIC and over $80 million of cash on hand. Given the current market backdrop, we remained appropriately levered and have excess liquidity that we can use for both defensive and offensive purposes. Last quarter, our board of directors authorized a stock repurchase program of up to $35 million worth of stock over 12 months. Last quarter we purchased 833,000 shares for about $8 million. We look forward to continuing this program. Our portfolio is constructed to withstand market and economic volatility. We have a cash interest coverage ratio of 2.3 times and a debt-to-EBITDA ratio of 5.1 times at cost on our cash flow loans. We had some attractive realizations last quarter and generated about $14 million of realized gains. We are proud that since inception over eight years ago, through the recession and credit crisis, we’ve generated positive net realized gains for our shareholders. During the quarter ended June 30, we exited $18 million of Acentia subordinated debt and $2 million of equity with a blended IRR of 14.4%. SPG Boyd LTI was sold which generated $14 million of proceeds on our $3 million equity co-invest. This was 81% IRR on the equity and a blended 28.8% IRR on the mezzanine debt and equity including the original $29 million debt investment. Envision was sold leading to our $24 million second lien getting refinanced with a call premium, which generated a 13.2% IRR. IDQ Holdings was sold leading to a 14% IRR on our $11 million first lien position. And finally, Paradigm was sold, generating $6 million of proceeds on our original $2 million equity co-invest leading to a 45.8% IRR in the equity and 25.7% blended IRR including the original $22 million mezzanine investment. As we highlighted in our last few calls, with regard to our exposure to the energy industry, we have successfully invested in energy through 21 different companies since our inception over eight years ago. In 2014, we monetized three large subordinated debt and equity positions that generated proceeds of approximately $170 million and weighted average IRR of 17.8%. We focused on opportunities backed by sponsors or experienced management teams, who 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 have avoided many energy subsectors, geographies as well as many undifferentiated service businesses with low barriers to entry. While the industry is challenged by low oil prices and rising supply, much of our exposure is seen here in the capital structure with an asset-backed focus. Our existing portfolio, including the expiration of production companies, fit into our theme of being senior in the capital structure backed by substantial asset coverage to approve developed and producing reserves with hedges in place. There are also significant additional assets in the form of additional acreage, reserves and midstream assets. For instance, earlier this year New Gulf generated additional liquidity by selling a portion of its non-core midstream assets for $85 million and is looking to sell further non-core assets. With regard to RAM Energy, we are backing an experienced management team who has performed well for us in the past and we are in a first lien position. Since last quarter, the company has remained current on its interest. We have temporarily waived the July 20th maturity of the company’s $20 million tranche B loan as the company continues to evaluate its assets and strategy in this market. We continue to work productively with the company, including evaluating the sale of non-core assets and other options. That said, we do not believe that in the short run option of selling attractive assets at fire sale prices is prudent. In this challenging environment for oil prices, we intend on taking an approach that will maximize value in the long run. We believe that our underwriting criteria of long-term approach should support our investments through this period of low energy prices and allow us to realize attractive returns. We are mindful of our desire to maintain a diversified portfolio, the current situation may also present attractive risk reward opportunities. Across PennantPark entities, we had only nine non-accruals out of 377 investments since inception over eight years ago despite the recession during that timeframe. Further we are proud that even though 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 re-underwrite our deals. In situations where the best long-term value for shareholders is created by taking control over the companies and providing capital and expertise, we do. A positive net realized accumulative gain since inception over eight years ago through the financial crisis are testament to this long-term value orientation. You may recall, our prior investment in UP, Universal Pegasus, an energy services company. Due to a significant downturn in the company’s industry and performance, our debt investment was restructured, we backstopped an equity raise and took control of the company. After changing management and improving performance, we subsequently sold it to strategic buyer and generated a double-digit overall return from inception of the investment. Based on values as of June 30th, we have recovered nearly 90% of the capital invested so far on those nine companies that have been on non-accrual since inception. We have two non-accrual investments as of June 30, 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 has preserved capital for shareholders on generating consistent steady dividend. In terms of new investments, we had another quarter of investing in attractive risk adjusted returns. And virtually all these investments, we’ve known these particular companies for a while, have studied the industries or have a strong relationship with the sponsor. Let’s walk through some of the highlights. We purchased $12 million of Affinion’s second lien debt. Affinion designs markets and services, customer engagement and loyalty solutions. Affinion is an existing portfolio company where we have historically been invested in the subordinated debt. We have found it both relatively safe and opportunistically enhancing to our overall position to move up the capital structure in instances were debt restricted [ph] down in the secondary market. AKA Diversified and Z Wireless is a Verizon Wireless premium retailer based primarily in the Midwest. We invested $9 million of the first lien of revolver. Atlantic Street Capital to sponsor. We purchased $15 million of add-on term loan to AP Gaming. AP Gaming manufactures and develops slot machines. Gaming has historically been one of our most active and successful industries. Interior Specialists is a provider of design center services for homebuilders. We bought $25 million of the first lien term loan, Littlejohn & Co. is the sponsor. We bought an additional $10 million second lien term loan for Jacobs Entertainment, which operates gaming facilities. Prime Security Services provide security monitoring systems and services to residential and commercial customers across the United States. We purchased $28 million of the second lien term loan. Apollo 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 June 30, 2015, recurring net investment income totaled $0.24 per share. In addition, we had $0.04 per share of other income. As a result, net investment income for the quarter was $0.28 per share. Looking at some of the expense categories, management fees totaled $11.7 million, general and administrative expenses totaled $1.7 million, and interest expense totaled $6.6 million. During the quarter ended June 30, net realized gain from investment was $13.8 million or $0.18 per share. Unrealized loss from investments was $30.1 million or $0.40 per share. Unrealized gain from our debt was about $600,000 or $0.01 per share and the accretive effect of our share buyback was $0.01 per share. Consequently, entity per share went down $0.21 from $10.25 to $10.04 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 quotes 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 has a weighted average yield of 12.4%. On June 30, our portfolio consisted of 64 companies across 30 different industries and was invested 30% in senior secured debt, 47% in second lien secured debt, 15% in subordinated debt and 8% in preferred and common equity. 71% of the portfolio has a floating rate including 65% 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’d like to open up the call to questions.

Thank you, sir. [Operator Instructions] And our first question will come from Troy Ward with KBW.

Great. Thank you and good morning, guys. Art, can you speak just a little bit on the energy portfolio. Quarter-to-date, there has obviously been additional oil price volatility and can you just talk a little bit about what the impact to your fair valuation across process, what the impact of actual oil price is on that fair value process?

Yeah. That's a great question. As you know, we have independent valuation firms, looking at each and every investment every quarter. And it’s certainly, oil prices should impact valuation. On the other hand, each company has its own story. They’re doing different things, kind of underlying in terms of what they’re looking at in terms of non-core assets. And it's usually a combination of short-term as well as long-term outlook that the valuation firms take into account each quarter when they’re valuing these investments.

And you spoke about one of the companies actually using an asset as a form of liquidity and year-to-date I think you said. What is the opportunity for some of these energy companies to find buyers of, let’s say, non-core type of assets that they can increase their liquidity in the near term?

That's a great question. That's why we have the comment about both looking at non-core asset sales, but also we're not a [indiscernible] we have to be long-term value investors. So it’s assessing what's available out there in terms of non-core assets as well as the price and the opportunity for the long run. We mentioned UniversalPegasus in the comments, because that’s an excellent case study of a situation, where for that particular company unfortunately, everything went wrong. What we’re getting to do? We converted some debt to equity, we invested more in the company. We changed out the CEO and over time, we worked it and we got back well more than our capital, we ended up getting a double digit return. So we may not get there with some of these companies, but we have a skill and expertise and mentality to do that if needed.

Okay. And then switching gears a little bit here on direct buy, your fair value was 58% in the quarter, obviously that's a name that's been circling for some time and then probably going through some form of additional restructuring. Another BDC in the space, we’ve talked about it before, has it marked at 22%. Can you just provide some color on the valuation process and maybe speak to the differentiation in those two fair value marks?

Sure. Look, we're - on that particular name, we are on the board of the company and I’ve been in an insight perspective, the other BDC is not, the company is in transition, we are seeing that transition taking place. We're hopeful that the company will successfully transition and that could be the explanation for the two different valuations.

Okay. Then Aviv, just one, last question for you, on the income statement, you spoke to it, there is $0.04 of other income in the quarter. Can you provide just a little bit of color maybe on where that income was derived. Was there a fee - I assume there are normal origination fees, but was there an additional fee on maybe existing portfolio of company, for instance maybe RAM, on the tranche B to extend that?

RAM is not one of them, but it’s all over the math, like the ones that we exited or gave us a dividend. Again, it’s non-recurring. IDQ, for example, we recorded some penalty on that tranche. And prepaid legal gave us some amendment fees on the - so these are the three largest making up the $0.04.

Okay, great. Thanks guys.

Thank you.

And now we will hear from Douglas Harter with Credit Suisse.

Hi, this is actually Sam Choe filling in for Doug Harter. So given the recent weakness in the share price, I was wondering how you’re thinking about the rate of the share repurchases going forward?

Choe, it's a great question. Look, we make an assessment each quarter and where the stock is, certainly, the stock is more attractive today than it was last quarter from a buying perspective, so we’re excited actually to go out and buy some stock at this level.

So it’s dependent. So I mean, I was just wondering at what you did this quarter, what’s reflective of how you guys are going to carry out the rest of the year?

It’s hard to and we shouldn’t sit here and pan ourselves into a corner, when we set up the program, we assumed that we would methodically do it and rather at the end, and somewhat even pieces over the course of the year with the stock where it is, we may be a little bit more aggressive this quarter.

Got it, thank you.

And we’ll now take our question from Chris York with JMP Securities.

Good morning guys and thanks for my questions. So just have one this morning, and wanted to take a little bit step back and talk about investment environment, so with the sale of Antares to CPPIB, the pension fund has said that it intends to expand the offerings with the junior capital products. So, as one of the largest BDCs with the focus on sub-debt, how are you expecting the dynamics to change in the markets where you guys traffic?

It’s a great question, we’ll see, this is all kind of prospective, the biggest competitive thread to all of us including Antares is the liquid markets which have generally been variable over the last couple of years, the aggressive high yield market, the aggressive syndicated second lien market, so that’s the biggest competitive thread. We’ve known Antares and the folks there for a lot time, we believe them to be good investors and rational investors, so for us it’s another rationale player in the world that we are going to see. Business as usual for us as lots of good and rational competitors out there that we are happy to partner with, we’d be happy to partner with them.

Great, thanks Art.

Thank you.

And next, we’ll hear from Mickey Schleien with Ladenburg.

Good morning Art and apologize if I’m sort of beating a dead horse here but I do understand that the volatility in the oil and gas markets makes it valuing the energy investments very difficult. But when I look at names like the [indiscernible] I saw the Bloomberg showed a trade on June, 30 of 58 but you valued it at 85 and I just want to understand what are the metrics the board is looking at maybe in that case that supports that kind of disparity?

Sure. Look, every quarter there is an assessment made as to the liquidity and activity of names that are quoted and in this case, it was determined that that was not an active or liquid name, in which case we send it to the external valuation firm for independent valuation, the external valuation, it does take the broker dealer quote such that it is into account, looks at a variety of other factors and comes up with this value.

Okay, we’ve actually saw some of other BDCs nibbling in the energy markets, I understand that PNNT the allocation is already fairly high but is that providing you some opportunities, either PNNT or PFLT to take advantage of?

That’s a good question, we said in our prepared comments that it might be a good time to invest. Look, we are fairly full, we believe in the diversified portfolio and in terms of PNNT and we don’t anticipate much movement up in terms of exposure to energy and oil and gas. And certainly for PFLT, which we set up to be even a different risk over at PNNT we will be very light in energy.

Okay, thanks for your time this morning.

Thank you.

Our next question comes from Christopher Nolan with MLV and Company.

Hey, guys two questions. One, what is the window for your share repurchases this quarter close because according to the Q, you haven’t repurchased any shares so far in the current quarter.

In the Q, we disclosed it for the quarter end being June 30, we bought $8 million worth of share repurchase and according to our quarterly spent or the window opening, usually you’re waiting 24 hours after we release the Q to let the news simmer and the window usually opens.

Okay, because I was just looking at the cover of the Q and it indicates as of August 5, your share count is about the same as it was at June 30.

Well, that’s right, we have a 30 day window after we announce earnings and that window for the prior quarter was over, we bought $8 million worth of stock; the window will open again tomorrow.

Great, thank for the clarification. The second, did I hear you correctly in terms of for RAM Energy on July 20; you are waving a payment from them. Could you give a little detail on that please?

The RAM Energy is current on its interest, they have about $20 million piece that matured July 20, we have temporarily waved at that maturity as they assess options and they’re looking at all the options and we’re working with them. It remains current on interest.

Okay. So, this is really principal repayment, correct?

Yes.

Great, thanks for taking my questions.

Thank you.

And now, we’ll hear from Scott Valentin with FBR Capital Markets.

Hi, this is actually Tim Hayes for Scott. The yield on your debt investments declined in the quarter about 200 basis points I believe. How much of that was due to asset mix and with spreads widening, do you expect yields and new investments to be higher in the September quarter?

It’s a great question. Yields were little lower than our prior. We had a deal that was on the bubble of getting done in the quarter, which would have kind of brought the average yield up to 12%. The mix this quarter was more heavily stretched senior unit tranche personally-oriented deal. So, where we feel safe, we’re happy to take a little lower yield.

Okay. And so, do you expect that one investment to close in the next quarter?

We’re working on it. It may or may not close. We have other deals we’re looking at. Look, we’re shooting overall to get a double-digit ROE, which means we need to have healthy double-digit return on the portfolio and we’re very focused both on credit quality and return.

Sure, okay. And finally, are you seeing any new attractive energy-related opportunities or are you still cautious there just given the continued decline in oil?

We remain focused on our existing portfolio working with those companies and giving them all of our focus and attention to help them through this period of low oil prices. There could be some bargains out there. Too early to tell.

Okay, Great, thank you.

Thank you.

We’ll now move on to a question from Jonathan Bock with Wells Fargo Securities.

Hey guys, thank you, it’s [indiscernible] for John Bock. I just wanted to touch upon Affinion, which sources - good sources of markdowns this quarter and actually with the CFPB, is the markdown related to say a fine or a higher cost structure, which might result in more of a permanent impairment or is this sort of a mark-to-mark given the situation. If we could give us any color there?

Yeah, it’s a mark-to-market on the situation and they did have a deal and they did have a nice agreement with the CFPB, which was less than expected. They did announce earnings a couple of days ago. Their earnings were better than expected the market - the paper, which is liquid did trade up a few points in the secondary market. We still think the value of the some of the parts covers the debt and that’s why we’re still focused heavily on this name impact. Moved up capital structure but some of the secondly in this past quarter, which we think is very safe and had a good yield.

Very well, thank you.

[Operator Instructions] We’ll now take a question from Andrew Kerai with BDC Income Fund.

Yes, hi, good morning. My questions have been asked and answered, but just wanted to reiterate as shareholders, we appreciate the buyback, and unlike certain BDCs who made excuses as to why they choose not to repurchase shares at discounts, we appreciate you being proactive in that approach. So, look forward to some more during the quarter.

Thank you, Andrew.

Our next question comes from Melissa Wedel with JPMorgan.

Hi, this is actually Melissa for Rick Shane. I was hoping to get a quick update on New Gulf and energy and exploration partners, as those seem to have slightly larger markets on the quarter than some other energy investments. Thanks.

New Gulf, as we said in our prepared remarks, last quarter sold some assets for $85 million, some non-core assets, midstream assets. They continue to work their cost structure, they continue to look for reasonable values on non-core assets and that’s all I can really tell you there. The other one was ENXP, was that the one [Technical Difficulty]. Nothing to report there.

Okay, thanks. As a follow-up, can you talk a little bit about how the energy companies in your investment are approaching their hedging practices right now, given where oil is trading?

It’s a great question and each company has its own view and again that’s confidential information and we signed confidentiality agreements, but in some cases, management teams are loathed to be hedging here at these dollar prices. So, that’s the debate that almost all of these guys are having in their board rooms as to [indiscernible]. The hedges from the past do roll off over time. So, those hedges that were higher prices have been rolling off and I could tell you each management team and board is having this discussion about what to do about hedging going forward.

Okay, thanks.

Thank you.

And at this time, I would like to turn the conference back over to Mr. Penn for additional or closing remarks.

Just want to thank everybody for being on the call today and thank you for your questions. We’re happy to speak to you next quarter in next quarterly conference call and intra-quarter, if you like, you know where to get a hold of us. Thank you very much.

Thank you, sir. That does conclude today’s conference call. We do thank you all for your participation.