PennantPark Investment's (PNNT) CEO Art Penn on Q2 2014 Results - Earnings Call Transcript

May. 8.14 | About: PennantPark Investment (PNNT)

PennantPark Investment Corporation (NASDAQ:PNNT)

Q2 2014 Results Earnings Conference Call

May 08, 2014 10:00 AM ET

Executives

Art Penn - Chairman and CEO

Aviv Efrat - Chief Financial Officer

Analysts

Mickey Schleien - Ladenburg Thalmann

John Hecht - Stephens

Ryan Lynch - KBW

Doug Mewhirter - SunTrust

Operator

Good morning, and welcome to the PennantPark Investment Corporation’s Second Fiscal Quarter 2014 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 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 for PennantPark Investment Corporation. Mr. Penn you may begin your conference.

Art Penn

Thank you and good morning everyone. I would like to welcome you to PennantPark Investment Corporation’s second fiscal quarter 2014 earnings conference call. I am 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.

Aviv Efrat

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 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 would 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.

Art Penn

Thank you, Aviv. I'm going to spend a few minutes discussing current market conditions, followed by discussion of investment activity, the portfolio, the financials, the overall strategy, and then open it up for Q&A.

As you all know, the economic signals have turned 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, those markets have remained strong due to substantial cash flows into high yield funds, leverage loan funds and CLOs.

Risk reward in the middle market has generally remained attractive as the overall supply of middle-market companies who needs financing exceeded the relative demand of applicable lending capacity. As debt investors and lenders, a slow growth economy is fine as long as we’ve underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome.

We have continued to be selective about which investments we make in this environment. Given our strong origination network and size of our company, we believe we can continue to prudently grow. We remain focused on long-term value and making investments that will perform well over several years and can withstand different economic cycles.

We continue to set a high bar in terms of our investment parameters and remain cautious and selective about which investments we add to our portfolio. Our focus continues to be on companies or structures that are more defensive, have low leverage, strong covenants and high returns. With plenty of dry powder, we are well positioned to take advantage of the 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 companies, management teams, financial sponsors, intermediaries, our credit providers and of course our shareholders. We are first to call for middle-market financial sponsors and management teams and intermediaries who want consistent credible capital. As an independent provider free of conflicts or affiliations, we have become a trusted financing partner for our clients. Since inception, PennantPark entities have finance companies backed by a 136 different financial sponsors, we have been active and are well positioned.

For the quarter ended March 31, 2014, we invested $142 million, the average yield on new debt investments was 12%; expected IRRs generally range from 13% to 18%; net investment income was $0.30 per share. We have met our goal of a steady, stable, consistent dividend stream since our IPO 7 years ago, despite the overall economic and market turmoil throughout that time period. We are one of the only BDCs to not cut its dividend during this time period. We anticipate continuing the steady, stable dividend stream going forward.

Given the current market backdrop, we remain conservatively levered and have plenty of excess liquidity that we can use for both defensive and offensive purposes. For the quarter ended March 31, our overall net leverage ratio accounting for cash on the balance sheet was approximately 64% with only about 44% excluding SBIC debt.

As a result of our focus on high quality and new investments, solid performance of existing investments and continuing diversification, our portfolio is constructed to withstand market and economic volatility.

The cash interest coverage ratio, the amount by which EBITDA or cash flow exceeds cash interest expense continue to be a healthy 3 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 4.4 times, another indication of prudent risk.

We have plenty of liquidity. As of March 31st, we had in total over $260 million of available liquidity consisting of $130 million of available credit facility, $75 million of new SBIC debt financing in our second SBIC and over $56 million of cash on hand.

As a reminder we have exemptive relief from the SEC to exclude SBIC debt from our asset coverage ratios and SBIC accounting is cost accounting, not mark-to-market accounting. These facts highlight how the SBIC debt reduces overall risk of the company.

We had some attractive realizations last quarter. For example, Eureka Hunter Pipeline refinanced our $45 million second-lien, which generated 16.6% IRR. After quarter-end we sold our Magnum Hunter equity, which generated about $7.4 million of realized gains and a 37.6% IRR. The blended IRR on Eureka Hunter debt and Magnum Hunter equity was 20.4%.

Instant Web refinanced our $44 million investment in first-lien debt, which generated 19.8% IRR. Interactive Health Solutions refinanced our $18 million first-lien investment, generating a 13.5% IRR. We remained an equity co-investor in that company.

Our overall NAV was up again 3% this quarter and a key driver of that upside was due to the positive price movement of our investment in UP, Universal Pegasus. UP’s financial results have rebounded significantly. Additionally improvements in the value of our investments in (inaudible) and Affinion helped drive NAV growth.

Despite the recession across PennantPark entities, we’ve had only seven of non-accruals out of 327 investments since inception seven years ago. We currently have no non-accruals on our book. Further, we are probably even when we had have those seven non-accruals, we have been to preserve value for our shareholders through hard work, patience and judicious and additional investments in those companies. We have been able find ways to add value. Based on values as of 331, we have recovered 84% of the capital invested so far in those seven companies.

In terms of new investments we had another quarter investing an attractive risk adjusted returns. Our activity was primarily driven by refinancings, growth financings and acquisition financings. And virtually all these investments we have known these particular companies for a while, have studied the industries or have a strong relationship with this sponsor.

Let’s walk through some of the highlights. We invested another $14 million in first-lien debt and $1 million in the common equity of [AKA] diversified, which is a Verizon wireless premium retailer based in the Midwest, Atlantic Street Capital is the sponsor. Foundation Building Material is a distributor of drywall and other building products. We purchased an add-on of $10 million of the second-lien term loan, CI Capital is the sponsor.

We purchased $26 million of two tranches of subordinated debt in (inaudible) George Woods does business at [Streaks] Limited manufactures (inaudible) data controls for small domestic appliances, primarily (inaudible), AAC Capital UK is the sponsor. JA Cosmetics is a multichannel beauty company that operates under the brand Elf, with cosmetics entails at value retail prices. We purchased $33 million of second-lien term loan and $3 million of equity. TPG group is the sponsor. We invested $45 million in the first-lien term loan of Trust Inns Limited. Trust Inns is a tentative pub company based in the UK. The company is owned by Trevor Hemmings.

Turning to the outlook we believe that the remainder of 2014 will continue to be active due to both growth and 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.

Aviv Efrat

Thank you, Art. For the quarter ended March 31, 2014 recurring net investment income totaled $0.26 per share. In addition we have $0.04 per share of other income. As a result net investment income for the quarter was $0.30 per share.

Looking at some of the expense categories management fees totaled $11 million, general and administrative expenses totaled $1.7 million and interest expense totaled $5.1 million.

During the quarter ended March 31st net unrealized gain from investment was $24 million or $0.36 per share. Realized gain from investment was $3 million or $0.05 per share and unrealized loss from our note was $6 million or $0.10 per share. Excess net income over dividend was about $1.4 million or $0.02 per share.

Consequently entity per share was up $0.33 from $10.80 to $11.13 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, security and exchanges or independent broker dealer quotations where active markets are available under ASC 820, and 825. In case our booker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall debt portfolio has a weighted average yield of 12.7%. On March 31, our portfolio consisted of 68 companies across 28 different industries and was invested 26% in senior secured debt, 32% in second-lien secured debt, 30% in subordinated debt and 12% in preferred and common equity. 56% of the portfolio has a floating rate including 48% [on the floor] and the average LIBOR floor is 1.4%.

Now let me turn the call back to Art.

Art Penn

Thanks Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable, consistent dividend stream, coupled with the 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 the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we'll first here from Mickey Schleien out of Ladenburg Thalmann.

Mickey Schleien - Ladenburg Thalmann

Good morning, Art and Aviv. I was glad to see that the leverage ratios for the new originations in the quarter were good. But I did notice that your originations dropped pretty meaningfully from the previous quarter. So, I was curious, was that a function -- was it idiosyncratic, was it a function of more difficult market environment? And the follow-on question, have you moved the needle at all in terms of the average EBITDA of the companies that you're looking for?

Art Penn

Thanks Mickey. It was probably idiosyncratic, obviously we did see a major bump up of deal flow prior to 12/31; usually you do, we saw a little bit more. So that perhaps had something to do with a little bit more active quarter ended 12/31. And usually as you know this is seasonality to the business where the first calendar quarter at the 3/31 was a little slower. So that probably impacted it a little bit.

But as you know, we don't -- it's hard for us as investors, we're trying to make each individual investment a good investment. It just depends on what comes in and what we see and what yields we can make, they make sense for us. So that's kind of the question around volume quote unquote.

In terms of leverage, we kind of like where we are in a blended basis right now kind of mid 4s, 4.4, 4.5 debt-to-EBITDA, we do on occasion do deals with higher leverage. We start getting very skeptical in the mid to upper 5s, obviously deal dependent, company dependent, industry dependent. But one of the key lessons that we've learned over many cycles is you have to have rational capital structures, you have to have rational credit statistics.

And when it gets irrational, will just stand out.

Mickey Schleien - Ladenburg Thalmann

And Art, have you moved the down market at all in terms of average EBITDA of the companies you are lending to?

Art Penn

No, it's pretty much the same as it has been, the middle of the bell curve for us is kind of 20 to 50 of EBITDA, we'll do some that are little smaller, we'll do some that are little bigger.

Mickey Schleien - Ladenburg Thalmann

Okay. And my last question and I'll get back in the queue is, you have some very nice gains in some of your equity positions and you are pretty consistently carrying it, it's probably not a bad time to sell businesses, maybe not as good time to buy businesses. That might be also true of some of these equity positions. What's your view on harvesting some of those gains for the quarter or the rest of the year and rotating that into income producing assets?

Art Penn

Yes, that's a great question. We are looking forward to continue harvesting of those equity gains and reinvesting those proceeds into income paying securities. We mentioned on the call a few minutes ago that we sold our Magnum Hunter equity for about $10 million, $11 million post quarter end which is a great exit for us, we made over 3 times our money. So, we hope to see continued realizations and harvesting of those equity co-invest positions and reinvesting those into income paying debt securities.

Mickey Schleien - Ladenburg Thalmann

Thank you for your time.

Art Penn

Thank you.

Operator

And next we'll hear from John Hecht with Stephens.

John Hecht - Stephens

Good morning guys. Thanks for taking my questions. The first question just related to model, just based on the revenue trends or the interest income trends, it would like that deal flow was kind of late on average last quarter and early on average this quarter, and I'm just trying to confirm if that’s accurate?

Art Penn

That's confirmed.

John Hecht - Stephens

Okay. Second and this is a little bit of a follow on related to the last question. Is the third quarter where you have experienced good book value growth or net asset value growth? It does appear that you’re harvesting some of these value and the equity side of the business. I am wondering, can you characterize your equity portfolio and talk about ongoing opportunities to enhance the book value? And on a related topic, is it more difficult to get an equity piece of the deal now or is that not changed?

Aviv Efrat

On the first question, we continue to hope and believe that NAV will continue to see positive movement. We continue to see positive momentum in Universal Pegasus and the numbers and the bookings from that particular company. We continue to see positive price movement in Affinion, as well as some of the other equity co-investments in our portfolio. So, touchwood, if this environment continues, we’ll continue to see modest small growth on the debt side of the portfolio making sure we’re making investments on the debt side as our capital preservative that have the right risk adjusted returns and continued harvesting of equity positions that we have. So that’s kind of the game and which is what we’ve been doing over the last few quarters.

Aviv Efrat

John what was the second part of your question?

John Hecht - Stephens

It was, is it getting more difficult to get an equity piece with the deal right now?

Aviv Efrat

Well it’s great question. Not necessarily more difficult, usually we’ll do a piece of debt and we’ll have an equity co-investment opportunity and that’s our option. Sometimes we invest, sometimes we graciously decline the offer to co-invest in the equity. With multiples creeping up in terms of purchase price multiples, inevitably we’re probably going to turn that opportunity down a little bit more than we have. We’re very disciplined around multiples, we’re very disciplined around pricing. We want our debt to EBITDA multiples on our debt securities to be low and we want our equity multiples to be low as well.

So, it will be by definition harder to find attractive equity opportunities, but that’s okay. We know we’re in a business that does have a cycle and we need to be cognizant of that.

John Hecht - Stephens

Okay. And then final question, anything it worth mentioning on the competitive front, any recent changes or pretty much the same environment we’ve seen in the last several quarters?

Art Penn

It’s a great question. Look, the biggest competitor, the middle market lenders has been the liquids syndicated market that has been very bullion as cash flows have come to the mutual funds and CLOs. And as the liquid markets are providing return and also creep down the finance companies that are smaller than they otherwise would traditionally thus put pressure on middle market lenders.

We in the last few weeks have been seeing and you may have heard this from somewhere, colleagues in the BBC industry, in the last few weeks we have been seeing some negative cash flows to some of those mutual funds. We have been seeing deals back-up and yields increase in the syndicated market which we like that puts a smile on our face that means perhaps there has been a risk reward coming down the pike.

John Hecht - Stephens

Okay. Thanks very much.

Art Penn

Thank you.

Operator

And now we will take a question from Ryan Lynch with KBW.

Ryan Lynch - KBW

Good morning. Just to follow-up on John’s question about higher interest income in the quarter that was just more of a function of late funding into last quarter and kind of maybe early funding this quarter pose any big one-time items or sizable fee income in that number?

Art Penn

That’s correct. As we have said, $0.26 or the $0.30 was recurring. Our $0.04 was other income which is the line item which captures any amendment fees we have any prepayment down the lease or any dividend income we have. So that $0.04 was mostly prepayment fees into the net income.

Ryan Lynch - KBW

Okay. And then actually you guys made a couple of new investments in Europe in this quarter. Can you just kind of talk about what you are seeing in the European markets that make you guys think that that’s an attractive geographic region? And then also should we expect any more investments coming out of that geography in the future?

Art Penn

That’s a great question, Ryan. We are looking at Europe more closely. The European banking sector is having problems as you may all have read. We do think there is an opportunity in the middle market there just like there is an opportunity in the middle market here in the U.S. So we will one-by-one gradually methodically deal-by-deal look to find good risk rewards for our shareholders that makes sense.

In Western Europe it will be primarily Western or Northern Europe where the rule of law for lenders and creditors is similar to the rule of law here in the United States where there is a consistent process if things go wrong. So Eric could be this past quarter was in the UK, which obviously is a great similar legal system and system of creditors’ rights.

So it’s a deal-by-deal opportunity for us, we’ll take a one step at a time. But we do anticipate higher percentage of our portfolio gradually being in Europe.

Ryan Lynch - KBW

Okay. And then it looks like you guys made four investments in the new portfolio of companies and six into existing portfolio of companies. Should we read anything into that of how you are viewing your current portfolio that you have attractiveness of reinvesting in current portfolio of companies versus the opportunities in the broader markets?

Art Penn

You are raising a great point which is sometimes the best opportunities are right in front of you. And for us certainly, in UK it’s diversified which is the Z Wireless and Foundation Building Materials or FBM, Superior Digital, I mean the companies we’re investors in. We like what’s going on, we like the management and these companies are growing. We certainly like fueling their growth and creating value and job. So we’re looking forward to continuing to support these companies as they grow.

Ryan Lynch - KBW

Great, thanks guys.

Art Penn

Thank you.

Operator

And now we’ll take a question from Doug Mewhirter out of SunTrust.

Doug Mewhirter - SunTrust

Hi, good morning. As far as -- maybe a bigger picture question about the economy. I know that, I have heard before that from you and your competitors that a slow growth economy is actually good for BDCs because the companies are very healthy, they stood for good cash flows, but they can’t grow their way out of your universe, at least that fast as maybe a higher growing economy.

We have seen a lot of exits from you and competitors; is that more of a function of maybe the economy picking up a little quicker than expected or is that just more a function of sort of the hunger of yield seeking capital markets maybe picking them off on better, on terms that maybe you wouldn’t willing to do or maybe through IPOs or other exits?

Art Penn

Yes. It’s a good question, Doug and it’s all idiosyncratic depending on the particular company. We’ve had some companies of portfolio growing very well. To extend we have an equity co-investment, you could see the values of those co-investments go up. In certain cases, because those companies get sold or in certain cases they get refinanced to much lower yield levels.

Look, there is a combination of things that BDC is trying to do, we are trying to provide a steady stable dividend yield, we are trying to preserve capita., We have this equity co-investment of warrant portfolio as a way to have some securities in the portfolio that have some upside, because we never really know that as a vendor we're going to make some mistakes sometimes and we need to fill those gaps.

But I’d say primarily a lot of the refinancings are due to just in ebullient market where if you have a higher yielding piece of paper and the company is performing even if this is a flat company, it's deleveraging, it can refinance, they can refinance you out at a lower yield. We and I think many of our peers underwrite cash flow.

And we underwrite cash flow such that if the cash flow is even flat or down, those companies are deleveraging because there is high free cash flow conversion and the company that you own money to 4.5 times debt-to-EBITDA, two years later at 3.5 times or 3 times. And they can take you out at a much lower level, and that's good.

Again, we say thank you when our borrowers pay it back, sometimes they don't. So we're very appreciative getting paid back there is other deals out there, there is always people knocking on your door to access your capital. And we need to be very focused on only doing deals where we’re comfortable that makes sense to us.

Doug Mewhirter - SunTrust

Okay, thanks. That's all my questions.

Art Penn

Great.

Operator

Okay. And now I would like to turn the call back over to Mr. Art Penn for any additional or closing remarks.

Art Penn

I would like to thanks everybody for being on the call today. Thank you for your support. And we will talk to you after our next quarterly earnings report, which will be in early August. Speak to you then.

Operator

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

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