PennantPark Investment Corporation (NASDAQ:PNNT)
Q3 2016 Earnings Conference Call
August 9, 2016 10:00 AM ET
Arthur Penn - Chairman and Chief Executive Officer
Aviv Efrat - Chief Financial Officer and Treasurer
Douglas Mewhirter - SunTrust Robinson Humphrey
Mickey Schleien - Ladenburg Thalmann Financial Services Inc.
John Hecht - Jefferies & Company, Inc.
Joseph Mazzoli - Wells Fargo Securities, LLC
Chris York - JMP Securities
Greg Mason - Ares Management LLC
Good morning and welcome to the PennantPark Investment Corporation's Third Fiscal Quarter 2016 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 2016 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 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 the financial highlights, a discussion of our energy portfolio, 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 June 30, 2016, we invested $90 million at an average yield of 12.4%. Expected IRRs generally range from 12% to 17%. Net investment income was $0.25 per share. NAV increased 1.2% from $8.83 per share to $8.94 per share. Given the continued headwinds and volatility, we continue to focus on our energy portfolio which includes those companies and our schedule of investments listed as oil and gas and energy and utilities.
Our focus is on companies that have strong management teams, attractive asset portfolios, and the ability and time to endure the current market conditions. We intend to work with our portfolio companies to ensure that they have the resources, personnel, capital, and runway to maximize our long-term recovery to weather this tumultuous period. Energy prices increased in stabilize this past quarter although continue to be low on an absolute historical basis.
As of June 30, 2016, our energy portfolio had a cost of $178 million and was marked at $131 million. This represents 13% of the cost and 11% of the market value of our overall portfolio respectively. Valuations on our energy investments increased by $17 million from the quarter ended March 31, 2016, representing $0.24 per share. As we have mentioned previously, independent third-party valuation firms value all of our non-actively quoted investments.
Many have asked us what happens to NAV and NII if our energy investments are completely written off. While we do not think all of our energy investments are worthless and believe they are fairly valued, as of June 30 NAV would have been at $7.10 per share or about 20% lower if all of the energy investments were written off. If all of the energy investments were put on non-accrual, NII would decrease by about $0.03 per share per quarter.
As shareholders and managers we are disappointed with the performance of our energy portfolio and intend to work diligently to recover our capital on our energy investments and to grow our NII back to historical levels. We do not believe that the short run option of selling these assets at fire sale prices is prudent, that said we monitor each situation and investment on a case by case basis and in this challenging environment for oil prices, we intend on taking an approach that will maximize value in the long run.
We are encouraged by the increase in energy prices since March 30 and believe that the recovery in the sector will be gradual and take time. For the quarter ended June 30 we waived base and incentive fees which equaled the percentage of the cost value of our energy portfolio, 16% as of December 31, 2015. This waiver amounted to $1.6 million, representing $0.02 per share. This waiver will continue until December 31, 2016. We believe that this waiver demonstrates a strong commitment to our shareholders and our focus on our energy portfolio.
In addition to this fee waiver, two other positive factors are helping to offset the energy issues. First, other income is a category that we have in our income statement to represent prepayment fees or waiver and amendment fees that are not part of ongoing interest income. Other income has $0.02 per share for the quarter ended June 30, and it averaged $0.04 per share per quarter over the last couple years.
Second last December, SBIC legislation was passed which raised the amount of available borrowings to $350 million which will enable us to continue to use this program and create value for our shareholders. We are finding attractive investments for SBIC’s and believe that our SBIC licenses will enable us to avail ourselves of that capital.
During the quarter we borrowed $25 million in SBIC II. We look forward to fully utilizing the upsized $150 million of borrowing capacity in SBIC II and utilizing an additional $50 million of borrowing capacity in a potential SBIC III. With regards to our dividend, our Board regularly evaluates the earning power of the company relative to the dividend.
Our substantial spillover cushion which was $0.53 per share as of last September 30, the fee waiver through 12/31/2016, substantial other income from prepayment fees, and SBIC usage give us the flexibility to continue to evaluate our portfolio and the market without rushing to make a decision on any change to the dividend at this point.
With regard to the market, the economic signals are mixed. With regard to the more liquid capital markets and in particular the leveraged loan and high yield markets, during the quarter ended June 30 of those markets experienced strength as high yield and leveraged loan funds experienced inflows due to expectations of the Fed keeping rate to lower for longer and stability in the energy market.
The overall market has strengthened and remains attractive as debt investors and lenders a flat 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 for us. 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 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 the 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 over 160 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 a cash interest coverage ratio of 2.4 times and a debt-to-EBITDA ratio of 5 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 20% of our long-term $545 million credit facility. Second, as we discussed, we're utilizing the expanded capacity under the new SBIC legislation. SBIC financing creates a financial cushion and that we have exemptive relief from the SEC to exclude SBIC debt from our BDC asset coverage test and SBIC accounting is 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 all these features we have provided substantial safety to our shareholders, bond holders, and lenders in the event of market volatility.
On the asset side of our balance sheet during the last three years, the percentage of our investments that are secured by either our first or second lien as increased from about 50% of the portfolio to 75% of the portfolio. Due to all these factors, we remain comfortable with our target regulatory debt-equity ratio of 0.6 to 0.8 times. There has been no material change to our energy portfolio since last quarter. The oil and gas remains on non-accrual.
Ram Energy continues to execute its current business plan and strategy. And as mentioned previously, New Gulf emerged from bankruptcy last quarter. We had a convertible debt instrument that will convert it to approximately 17% equity ownership. Across PennantPark entities, we've had only 13 companies on non-accrual and 412 investments since inception nine years ago, despite the recession during that time frame.
Further, we are proud that even when we have had those non-accruals, we've been able to preserve capital for our shareholders. Through hard work, patience and judicious additional investments in capital and personnel and those companies we've been able to find ways to add value. We constantly monitor our deals and we underwrite them in the face of new information and situations where the best long-term value for shareholders is created by taking control over the companies and providing capital and expertise we do.
Based on values as of June 30, today we have recovered nearly 80% of capital invested in those 13 companies that have been on non-accrual since inception of the firm. We are proud of our long-term track record over nine years including the recession. Since inception PNNT has made nearly 180 investments totaling about $4 billion at an average yield of 12.5% including both realized and unrealized losses PNNT has last only 56 basis points annually.
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 of a strong relationship with the sponsor.
Let's walk through a couple of the highlights. We won $26 million of a second lien term loan to MailSouth. MailSouth is a provider of direct mail solutions focused on the rural and suburban markets, Court Square is the sponsor. Randall-Reilly is a business-to-business data and marketing services company serving the trucking, construction, and industrial markets. We invested $27 million of senior subordinated debt and West Corp is the sponsor.
Turning to the outlook, we believe that the remainder of 2016 will continue to 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 June 30, 2016 recurring net investment income totaled $0.21 per share. In addition, we had $0.02 per share of other income net of incentive fees and $0.02 per share from the fee waiver. As a result, net investment income for the quarter was $0.25 per share.
Looking at some of the expense categories, management fees after waiver totaled $8.6 million, general and administrative expenses totaled $1.8 million, and interest expense totaled $7 million. During the quarter ended June 30, unrealized gain from investment was $58 million or $0.81 per share primarily due to reversal into realized loss from investments which was $46 million or $0.64 per share. We also had unrealized loss from our various debt instruments of $2 million or $0.30 per share. Excess dividend over net income was $2 million or $0.03 per share. Consequently, NAV per share went up $0.11 from $8.83 to $8.94 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 ASC820 and ASC825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investment.
Our overall debt portfolio has a weighted average yield of 11.8%. On June 30, our portfolio consisted of 59 companies across 28 different industries. The portfolio was invested in 34% in senior secured debt, 41% in second lien secured debt, 14% in subordinated debt, and 11% in preferred and common equity. 81% of the portfolio has a floating rate, including 77% with a floor. And the average LIBOR floor is 1.2%.
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 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.
[Operator Instructions] And we’ll go first to Doug Mewhirter with SunTrust.
Good morning. Just had a sort of market related question. Obviously you have a lot of energy assets which you're in the process of restructuring or post restructuring and I know that there's always people out there who are looking for oil in the ground so to speak and I know I'm sure you've gotten offers, but I'm sure they've been lowball offers. Have you seen any sort of creeping up in the bit value of the sort of the vultures sweeping around these oil assets are given slightly higher oil prices?
It’s a great question, Doug, and thank you. We are starting to see more M&A in the sector and we're hearing about more M&A in the sector. So that's a positive sign when deals are start getting cut and there's kind of a base of valuation from which the market can move. Of course we could capitulate and sell at a fire sale price. Is not what we think is - in the best interest of our shareholders.
So you know most of these companies either have been restructured or are in the process of being restructured or are in a situation where they can run in the status quo and are set up to whether the cycle for a while and this cycle may last for a while it may end soon we don't know but we are setting up this portfolio to create the option to weather the storm for a while.
Thanks for that. And next technical question on your New Gulf restructuring. This convertible note where and how would it convert and also is it paying cash interest while it's still sort of note form?
It's certainly a big instrument and it will convert when there is an event either an Aqua a significant equity offering more or sale of the company.
Okay thanks for that. That's all my questions.
We’ll go next Mickey Schleien with Ladenburg.
Good morning, Art, and Aviv. Just a couple of questions and I apologize but we're just slammed with earnings on our end. I do see the New Gulf refinancing which looks like it caused the bulk of the realized loss, but I think there was something else can you clarify what else you took realize loss on?
Right, the realize loss on New Gulf fees like 70% of the rest of it we do not gave each name by name highlight, but there are New Gulf fees primarily what you're seeing there, but you can see quarter-over-quarter which names we exited it, but we do not give a name by name indication what’s the realized loss.
So the balance was spread out amongst many names or was there one or two names that really…
There is a couple names that we were exited during the quarter that we realized the loss other than New Gulf.
Other than New Gulf and on your floating rate investments. Do you use typically one two or three month LIBOR as the reference rate?
Right on this is usually one-month but it does vary so I cannot say that one month is the rule. Some of them resets monthly, some of them recent quarterly. So if it's resets quarterly it’s a three months LIBOR.
Okay thanks. Those are all my questions.
We will go next to John Hecht with Jefferies.
Good morning, guys. Thanks for taking my questions. First one just a clarification - are you able to give us any update on kind of where you are with the third application under the SBA program or the SBIC program.
Sure. We are working diligently to invest SBIC II once we get towards the end of SBIC II, we would then approach the SBA for license number three.
Okay. And then you’ve seen focus at this point in time and kind of optimizing I guess your capital structure and balance sheet around the SBA. Can you tell us just we kind of understand how that kind of focus [near-to-medium] might affecting? How do the trend vary within the SBA versus investments you have outside the SBA maybe in terms of average size, average term, average rate and what might that mean toward kind of the metrics, we’ve look at them in the business and the near-term?
The important thing for us is it is, we invest the same way across the fund. However it's financed whether it's financed with our credit facility or unsecured debt or unsecured bonds or the SBIC. So we task our investment professionals with bringing good deals in. First and foremost and then we’ll figure out where to put them per my remarks, we really love the SBIC financing for many, many reasons. And people know that if there is a good deal to do it and fits the SBIC that's terrific. But we do not change how we invest across the platform.
Okay. And then I wonder just I guess sort of an extension of that last questions. What you see going on in the general and middle markets. Are you seeing any kind of stabilization of competitive trends? Any pockets of opportunity where there may be a better risk adjusted returns at this point?
We really like the middle market, we continue to like it, and we’ve been active in both of our publicly traded vehicles PNNT and PFLT. PFLT announces earnings tonight. We are seeing very good risk reward due to kind of the pullback from the regulated entities and the lack of capital there. So it's a pretty interesting time for us. You know where we are in the middle market is a little bit away from the fray of the broadly syndicated world. Given that we are kind of in the middle of the middle market. Those funds and those firms that are kind of at the operands of the middle market may be more subject to the ins and outs of the broadly syndicated or public high yield market, which have rallied in the last few weeks. We haven't really seen much of that rally in our part of the middle market.
Okay. Thanks very much guys.
[Operator Instructions] We’ll go next to Jonathan Bock, Wells Fargo Securities.
Good morning. This is Joe Mazzoli filling in for Jonathan Bock. The first question relates to dividend policy and of course the fee waivers have been very shareholder friendly and no doubt that investors appreciate that, but we see that NOI fell below the dividend despite the current fee waivers and you know while there are several levers to pull over with the SBIC’s. We have seen several BDCs evaluate their dividend policies to better align with NOI. So given this how should shareholders view the dividend policy moving forward?
Great question, Joe and thank you. Look at something the Board and we as managers are always thinking about. It's something we evaluate all the time. I think the game plan six months ago when we decided to do to the fee waiver tied to the energy portfolio. We look at the situation as they are significant spillover which by the way still remains six months later.
The fee waiver which we totally support is certainly helpful to the income of the vehicle and the substantial other income that we've had and we typically have as well as the SBIC opportunity give us an opportunity to put our head down focus on the portfolio for this year, see where the portfolio is, see where energy is, see what the outlook in the economy and leverage middle market is.
And lift our head up at the end of the year and see what the facts and circumstances are at the time. So we are always looking at it and we understand all the pluses and minuses, but due to a bunch of various factors we do not need to take a decision on that at this time.
That totally makes sense. Thank you for that. And now with the SBIC with your two licenses you now have just under $200 million drawn of SBA debentures and you have the ability to go up to $300 million with the two licenses. Do you have to receive and if you could remind us, do you have to receive an additional approval for additional debt SBA debentures to get to reach to the $300 million?
Yes. So essentially you're absolutely right. The two SBIC’s can draw $300 million and that’s ongoing, so we are hopeful even though it depends on our investment activity. And then once you get close to that you start an SBIC III which can draw an additional $50 million, but that's not in the near future. But right now we're working to ramping up SBIC II it’s close to be fully ramped up then we're talking about SBIC III.
Okay. Got it. Thank you. And then one final question relates to a specific investment, Sunborn International, it was marked down by $2.1 million this quarter, so it looks like this investment is a UK. It's a UK based company with the loan denominated in British pounds. So is this related to the Brexit or volatility in currencies, if you could provide some color that would be helpful?
Yes. He's got a [shot by] Joe, so Sunborn the market is solely due to currency. The credit is a par credit and we hedged the currency risk by borrowing in the currency, so we borrowed in sterling. So we made up for that mark to market loss with a with a mark to market gain essentially on our credit facility, so we're hedged on principal and interest on Sunborn, so that market had nothing to do with the credit which is currency.
It totally makes sense. Thank you, Art and thank you for taking my questions today.
We’ll go next to Chris York with JMP Securities.
Good morning, guys and thanks for taking the questions. I was hoping if you could update us on fundraising advisor. And then I guess more specifically have you been active and then could you remind us how many assets under management and investment professionals are at advisor as well?
Sure. So as you know and this kind of has been a trend over the last 18 months, we have been building up the advisor as we've seen more opportunity in the middle market as PNNT and PFLT has grown, PFLT is doubled in the last year due to MCG, so we now have offices in Los Angeles, Chicago, Houston, and London as well as we've added professionals here. Outside of the two publicly traded business development companies, we have a private GPLP fund which has available AUM of about $100 million.
And we're looking to potentially grow outside of the BDCs, due to the BDC is not trading at book value which limits our ability to grow. We do see a massive opportunity in the middle market as regulated entities have pulled back. And we've got great sponsor clients who would like us to provide financing for them. So we want to be helpful to our sponsor clients and provide them capital when the risk reward makes sense. We’ve got about 35 employees in total across the offices.
Got it. That’s it. Thanks for the color Art.
Thank you, Chris.
We’ll go to Greg Mason with Ares Management.
Hey. Good morning, guys. I just have one quick follow-up to Joe's question. On your comments of keeping your head down to the end of the year and then reevaluating the dividend, I just want to clarify is that you view that as your fiscal year end September 30 or calendar year end?
That's a great question. We view it as a calendar year and we took the fee waiver as of December 31 and we're thinking of it’s a 12-month time period for us to focus on the portfolio and work with the various levers we have and then lift our head up at the end of the calendar year and make an assessment.
Thanks Art. Appreciated.
We will conclude the question-and-answer session. I'd like to turn the conference back over to Mr. Art Penn for any additional or closing remarks.
Great. Thanks everybody for being on the call today. A reminder that for September 30, that’s our 10-K time of year, so we report a few weeks later than normal due to the annual 10-K process. So looking forward to talking to everybody in November and have a great rest of the summer.
That does conclude today's conference. Thank you all for your participation.
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