PennantPark Investment Corporation (PNNT) Q2 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2017 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 2017 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 the 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 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'm going to provide an update on the business starting with financial highlights, followed by a discussion of the overall market, the overall portfolio, investment activity, the financials, and then open it up for Q&A. For the quarter ended March 31, 2017, we invested $60 million and an average yield of 9.5%. Net investment income was $0.23 per share, which included $0.02 per share of a fee waiver. NAV was stable at $9.09 per share, down slightly from $9.11 per share on December 31. We believe that our new dividend rate of $0.18 per share is sustainable. As a result, we believe that PNNT stock should be able to provide investors with a steady dividend stream, along with potential upside as the energy market stabilizes and our equity call investments mature. With regard to the overall market, the economic signals have been moderately positive. With regard to the more liquid capital markets, and in particular the leverage loan and high yield markets, during the quarter ended March 31, those markets experienced strength as high yield and leverage loan funds experienced inflows due to a belief in a stronger economy and a benign interest rates. We remain focused on long-term value of making investments that will perform well over a long period of time and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns. 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 companies, management teams, financial sponsors, intermediaries, our credit providers, and of course our shareholders. We are first call for middle market financial sponsors, management teams and intermediaries who want consistent, credible capital. As an independent provider free of conflicts or affiliations, we've become a trusted financing partner for our clients. Since inception, PennantPark entities have financed companies backed by 170 different financial sponsors. Our portfolio is constructed to withstand market and economic volatility. In general, our non-energy portfolio is performing well, despite a mixed domestic and global economy. We have cash interest coverage ratio of 2.4 times and a net debt to EBITDA ratio of 5.1 times at cost on our cash flow loans. We are pleased that we have diversified funding sources with several features that reduce overall risk to the company. First, we have $321 million of long-term unsecured bonds and have only utilized about 15% of our long-term $545 million credit facility. Second, we are utilizing the expanded capacity under the new SBIC legislation. SBIC financing creates financial cushion and that we have exempted relief from the SEC to exclude SBIC debt from our BDC asset coverage test, and SBIC accounting's cost accounting, not mark-to-market accounting. Third, to better align the measurement of asset and liability values for both GAAP and the BDC asset coverage test, we mark both our assets and our liabilities to market. As a result of these features, we've provided substantial safety to our shareholders, bondholders and lenders in the event of market volatility. Additionally, with assets yields coming down over the last several years, we're looking to create attractive risk adjusted returns in our portfolio. We intend to focus on lower risk primarily secured investments, thereby reducing the volatility of our earnings stream. Investments secured by either our first or second lien are 75% of the portfolio. As a part of the portfolio repositioning, we also look forward to gradually reducing the equity portfolio of the portfolio which was 12% as of March 31. For example, we exited half of our position in the public equity of health cosmetics [ph] during the quarter as well as our equity coinvest and service channel. The sales of these equity positions generated $18 million of cash. Due to all these factors, we remain comfortable with our targeted regulatory debt-to-equity ratio of 0.6 to 0.8 times. On an overall basis, our net leverage debt minus cash is 0.84 times as we are targeting overall GAAP leverage of 0.8 times. During the past year, we've had the opportunity to restructure most of our challenging energy names. Generally, post restructuring, these companies are now positioned to weather a period of prolonged lower energy prices and should benefit from the gradually improving environment. We believe it will take us more time for us to maximize the recovery on the energy portfolio. Despite the great recession and credit crisis, PennantPark Investment Corporation has had only 12 companies going on accrual out of 185 investments since inception 10 years ago. Further, we are proud that even when we've have had these non-accruals, we've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in capital and personnel in those companies, we've been able to find ways to add value. We constantly monitor our deals and re-underwrite them in the face of new information. 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. We currently have one investment on non-accrual which represents 0.3% of the overall portfolio on a cost basis. Based on values as of March 31, today we have recovered about 81% of the capital invested in those 12 companies that have been on non-accrual since inception of the firm. It might be helpful to highlight our long-term track record over 10 years, including the great recession. Since inception, PNNT has made 185 investments totaling about $4.2 billion at an average yield of about 13%. Including both realized and unrealized losses, PNNT lost only about 40 basis points annually. In terms of exits, we had a solid quarter of attractive exits of Jacks Entertainment, AP Gaming, Service Champ and [indiscernible] Holdings Debt. We also realized the loss of our investment and direct buy. In terms of new investments, our focus is on senior oriented secured assets and virtually all of 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 invested $20 million in the first lean term loan for bottom-line systems which provides healthcare revenue cycle management and consulting services; Riverside Partners is the sponsor. [Indiscernible] Industries manufactures and distributes skincare and wound care products. We lend [ph] $10 million of first lien term loan, Cowen [ph] Capital is the sponsor. We've invested $16 million in the term loan B of 160 over 90 which provides consultative branding and marketing services, primarily to the higher education sector, Searchlight [ph] Capital Partners is the sponsor. Turning to the outlook, we believe that through remainder of 2017 we'll be active due to growth in M&A driven financings. Due to our strong sourcing network and client relationships, we're 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, 2017, recurring net investment income totaled $0.19 per share. In addition, we had $0.02 cents per share of other income and $0.02 per share from the fee waiver. As a result, net investment income for the quarter was $0.23 per share. Looking at some of the expense categories; management fees after waiver totaled $8.4 million. General and administration expenses totaled $1.6 million and interest expense totaled $7.2 million. During the quarter ended March 31, unrealized gain from investment was $20 million or $0.28 per share. We also had unrealized losses from our various debt instruments of $6 million or $0.09 per share. We had about $18 million or $0.26 cents per share of realized losses. Excess income over dividend was $3 million or $0.05 per share. Consequently NAV per share went down $0.02 from $9.11 to $9.09 per share. As a reminder, our entire portfolio; credit facility and senior notes are marked to market by our board of directors each quarter using the exit price provided by independent valuation firms, Securities and Exchange or independent broker dealer quotations when active markets are available under ASC 820 and 825 In cases where broker dealer quotes are inactive use independent valuation firms to value investments. Our overall debt portfolio has a weighted average yield of 11.9%.On March 31st our portfolio consisted of 56 companies across 26 different industries. The portfolio was invested in the 42% senior secured debt, 32% in second lien secured debt, 14% in subordinated debt and 12% in preferred and common equity. 83% of the portfolio has a floating rate, Now, let me turn to call back to art.

Thanks Aviv. To conclude, we want to reiterate our mission. Our goal is to generate attractive risk adjusted returns through income 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 question.

Thank you. [Operator Instructions] We'll take our first question from Thai Ratzenberger of Suntrust. Please go ahead.

Good morning. Thank you for taking a questions. You touched on – in prepared remarked but would you say that your repayments in sell this quarter were primarily driven by your or it is more a reflection of pricing times per market.

It was it was more of just what was going on in the market. We had a very large quarter of originations. The quarter ended December; that's usually inactive -- active quarter -- typically the first calendar quarter then year ended March, a slow as it was for us. And there was a fairly robust market which meant Jacobs Entertainment and a bunch of other deals got taken out in some cases with nice prepayment penalties. So that was that was the key driver. We kind of knew we'd have a robust December quarter. We kind of knew we'd have a more mellow March quarter.

Got it. Thank you. And your portfolio yield remained flat this quarter despite the exit activity -- a lot of your exits yielding and can you start from the drivers behind that?

Yes. Some of the exits were lower yielding. Again, don't really have a precise reason as to why net -- you know the portfolio kind of has the same overall yield albeit you know the new deals that we -- I guess maybe the new deal that we put on which were 9.5% yielding deals were or somewhat comparable to the deals that we actually did. But we can get you more precise data later much of.

Got it. Thank you. And then I'm just wondering if you could give us your perspective on how tax reform and the regulatory environment can affect your portfolio companies and potential origination that was actively used here?

You know look, this is not certainly our expertise. We think we know a little bit about credit in the middle market or a lot about credit in a market. We certainly are not tax experts. We would say though that if the economy can be helped by tax reform that would help the underlying portfolio companies in our portfolio which would generate you know better returns for us. So anything that can help the economy we would be in favor of.

Great. Thank you. That's all I have for now.

Thank you.

We will next hear from Rick Shane of JP Morgan. Please go ahead.

Thanks guys for taking my question. I'm curious I mean look, you pointed out that during the first quarter, during the March quarter for you guys that you generated some good repayment fees. I'm curious in the current environment with yield terms evolving and frankly probably longer durations on the assets that you're going to originate now look higher rates. How you're shifting terms? Are there other features that you're adding to the loans you know given the current outlook?

So it's a good question Rick. I think the most important thing for us is credit quality. You know we continue to be in an environment of yield compression. So for us in this environment we focus on credit quality first. We're willing to give up a little bit of a yield to have a better credit or move a little higher in the capital structure. You saw that this quarter when we were you know it was a slow quarter but we're relatively selective -- the vast majority well it was at the top of the capital structure. It was a little bit lower yield than we what we normally do and we're totally fine with that with that kind of focus in this particular market environment of relatively you know relatively simple in a billionth time in the credit markets. So you know it's essentially a seller's market these days for both companies and credit .So for us we just have to be very good credit eskers. We have to protect our capital, get a reasonable yield for our capital and take it slow.

Got it. And again I think related to that given some of the objectives it seems like said out last quarter and taking down the leverage this quarter; is this where you're comfortable in terms of what the capital structure looks like in the current environment?

Yes, well so we said reiterate on an overall GAAP basis. We're targeting 0.8 times leverage which we think is reasonable in this environment gives us a good defensive posture and gives us a good offensive posture. So that's kind of what we're targeting on an overall leverage basis.

Perfect. Thanks Art.

Thank you.

[Operator Instructions] And next we'll hear from Jonathan Bach of Wells Fargo Securities. Please go ahead.

Hey guys. Fin O'Shea for Jonathan this morning, thanks for taking our question. Just kind to just way off Rick's commentary spreads in valuations. If you look at a lot of your higher yielding names, we had several names and double-digit spreads that are marked above par. Can you can you kind of walk us through how much that is driven by anticipated repayment and call protection or is this just kind of looking at high earning spreads and assigning premium valuations to these names?

Good question Fin. And it's a little bit case-by-case you know, the evaluation firms look at both absolute yields in the marketplace as well as call protection. In some case we have very substantial call protection which is terrific in this environment. Some cases we have less call protection; which means as long as the credits are performing you know we'll probably get taken out. And you know that's just the life we -- that's the life we chose when we got into the direct lending, middle market lending business. And so it's a little bit of a little bit of each element. I don't have a specific percentage off the top of my head at this point. We can try to get in it with you later on today. But it's a relatively high yielding portfolio. And look, if we get paid back, which we do from time-to-time we say thank you. You know we never crunch our borrower's desire to pay us back because sometimes they don't pay us back and we are appreciative when people pay us back. So it is what it is; we're going to you know take the opportunity in the market hopefully to get liquid on some of our equity cone vests and de-risk of the portfolio that way as well. You know use that extra liquidity to deleverage or put into new deals with you know contract or risk adjusted returns. And you know easily hopefully cover our dividend, work through our energy names and have a very solid you know lower risk portfolio in this environment.

Really thank you on that matters -- there one that should be fresh in your minds --come to mind US Well Services that was just restructured. You have that already marked up with think. Black Rock reported last week with the same piece but marked to add cost. Can you may be explained the difference? Is that based on market valuations?

No. I mean I think if we go through later. I think we marked at the valuation at the time of restructuring. So we did not market up beyond the value at restructuring. We go through those numbers with you later. The company is doing well. So and then I think one of the piece of paper is broker dealer quoted up higher and then the value at restructuring. So hopefully that deal goes pretty well over time.

Okay. Appreciate that and one more company specific one is; do you have any guidance on the equity versus your 331 fair value for Pennat given that restructuring?

So what's going on with the Pennat, we have as of 331 two pieces of debt and a piece of equity. The restructuring basically does a whole refinancing of the capital structure pushes out maturities. It's going to mean our two debt pieces are taken out. One will be taken out above par and we'll have the remaining equity piece which we're going to ride. You saw the marked down in the Pennant equity and that was due to the dilution of new capital coming in to extend the timing on this company's capital structure. We're actually very optimistic. We needed or the independent valuation terms need to reduce the value of the equity because of the dilution of the new investors coming in but because you've taken away all the short term maturities and you've extended the option. We still remain optimistic about the value that equity in the long term.

Very well. I appreciate that and I guess just one more global question. Can you give us an update on your view -- stock buybacks today in the current environment and can we – whether we would be expecting any continuation of that program this year? And that's all for me. Thank you very much.

Yes. So look, we always have or have always considered stocks buybacks puts a substantial stock buyback last year. With our focus on having a less leverage capital structure, less risky capital structure and plenty of [inaudible] environment and targeting 1.8 times overall GAAP, leverage and knowing how the rating agencies feel about rating -- about stock buybacks. We're always considering it. We have elected not to do it here in the short run but we're always considering it but we're sensitive to all the other various factors.

Very well, thank you.

And next we will hear from Chris York of JMP Securities. Please go ahead.

Good morning, guys and thanks for taking my questions. Just have a couple; I haven't come to the schedules of investments yet but it appears pick income accelerating meaningfully in the quarter relative to the historical quarters. So could you provide some color on maybe that attribution in increase. And then secondly, how are you looking at pricing uptake versus cash for new investments given your changes to more senior secured loans.

Sure. So when you're looking at the stable cash flows and you're seeing the big income accelerating a little bit. You need to think it's kind of for year-to-date. We called it some of the big income records; let's say semiannually instead of quarterlies. So it's not evenly distributed. So maybe March quarter end we recorded that whereas December quarter end we did not record it on similar cash flows. But if you look at the six months, I think that will be safe for you to compare six months versus far six months and you'll see that pretty steady. There is no increase in picking come that we have recorded. And then Chris, so second for your question; certainly on new investments we are minimizing or having no pick to the extent possible and terms of existing investments some of those are in some a lower in the capital structure types investments that we hope to get out of an exit in the in the not too distant future. So the goal again in line with our overall less risky portfolio is to not book new big deals and to get liquid appropriate prices on an existing pick deals.

Got it. Make sense and then secondly yet the next quarter of originations but I'm curious how much of your pipeline that you said today would you quantify would be SBIC eligible?

It's a great question because we're always grappling with what's SBIC eligible or not. Look, we're trying we are again, we just to reiterate we never reduce our credit metrics just to find deals that fit the SBIC. We need to make sure first and foremost just like every other year we put our portfolio, the credit is solid that we're not taking capital risk on those credits. Obviously when credits do come in and they can fit the SBIC's -- say great port of first call; we go through -- it's a lumpy business; to have business overall is lumpy and the SBIC business is even lumpier, we go through time periods where for whatever reason we're very prolific in finding deals that fit our parameters and fit the SBIC and then there is other times when we don't. So it's great financing, we love it, we want to use it but we don't want to reduce our credit standards.

Fair enough. Lastly, so as I look at your portfolio mix preferred and common equity is about 12% on fair value; what is your portfolio management preference for that as a percentage of the portfolio given your change essentially and your focus on senior secured loans?

Look, from day one we've always said that common equity bucket is targeted to be a 5% to 10% bucket and that consists of two elements; one is equity that we invested in from the get-go [ph] which is typically equity call invests; and our track record of equity call invests and maybe -- and for next quarter we'll actually be able to dig out their track record for everybody, our track record as equity call invests is pretty solid and that has been accretive to ROE. The other kind of equity we get is where we convert debt equity, which is the equity we don't enjoy getting but it's just part of our business. So that 5% to 10% includes both, equity call invests, as well as the conversions of debt equity which inevitably happen in our business from time to time.

Helpful. And then on the co-investor not taking any more or less than we historically have in the way that you price and position your capital?

At this point in time we're a little bit more skeptical of the equity call invest, we might be able to feel good about being a lender, 4 times, 4.5 times or even 5 times debt-to-EBITDA. Many times we are less comfortable with being an equity co-investors when it's a double-digit multiple of EBITDA. So we generally feel pretty good about this credit environment, we feel like the economy is in pretty good shape, the leverage multiples are relatively reasonable, particularly in the middle market. There is a lot of private equity capital out there, the benefit of being a lender today is as big equity slugs beneath you and that makes you feel good if a project there is a problem, the sponsor is more likely to solve it by putting some more equity in. That said we're becoming more and more -- we're more and more reluctant to coinvest in the equity at double-digit multiples, let's put it that way.

Yes, makes sense, helpful color. That's it from me, thanks.

And from Baird we will hear from Bryce Rowe.

Thank you. Just wanted to follow-up on Chris's question about tick there; so over the first six months of this fiscal year; you've got a little over $11 million of tick income and as you've said Aviv, if you can average that out, you're about $5.6 million per quarter. Is that that kind of a good run rate from tick perspective to assume roughly $5.5 million to $6 million per quarter of tick income?

I mean you can refer that from the numbers; our goal though Bryce is to reduce that number. And whether that means, you know, judiciously printing the portfolio or exiting some of those names or figuring out how to redo those capital structures to get more cash. Our goal -- just like our goal is to reduce for the rest of the risk or portfolio go on the tick side is; yes, you could assume the existing run rate is the run rate but our goal there -- we're going to chip away at over the coming quarters as to reduce that pick.

Great. Thank you.

That concludes today's question-and-answer session. Mr. Penn, at this time I will turn the conference back to you for any additional or closing remarks.

We really appreciate everyone's time today and focus and we look forward to speaking to you in early August which is our next quarterly conference call.

This concludes today's conference. Thank you for your participation. You may now disconnect.