Pennantpark Investment Corp Q2 FY2021 Earnings Call

Good afternoon and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2021 Earnings Conference Call. Today's conference is being recorded. 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.

Good morning, everyone. I would like to welcome you to PennantPark Investment Corporation's second fiscal quarter 2021 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 include a discussion of our forward-looking statements.

Thank you, Art. I would 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 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 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.

Thank you, Aviv. I am going to spend a few minutes discussing how we fared in the quarter ended March 31, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials, and then open it up for Q&A. We are pleased with our performance this past quarter; we achieved a 5.8% increase in adjusted NAV. Adjusted NAV went up $0.51 per share from $8.69 to $9.20 per share. We are particularly pleased that our NAV today is up over 5% from what it was pre-COVID on December 31, 2019. We have several portfolio companies in which our equity investments have materially appreciated in value as they're benefiting from the recovery. This is solidifying and bolstering our NAV, and we will highlight these companies in a few minutes. As part of our business model, alongside the debt investments we make, we selectively choose to co-invest in equity side by side with a financial sponsor. Our returns on these equity investments have been excellent over time. Overall for our platform from inception through March 31, our $226 million of equity investments have generated an IRR of 28% and a multiple on invested capital of 2.9 times. In a world where investors may want to understand differentiation among middle market lenders, our long-term returns on our equity investment program are a clear differentiator. With regard to income generation, we have the opportunity to rotate out of our equity investments over time and into yield instruments. In addition, we have the ability to grow the P&L balance sheet, and that of our PSLF JV with Pantheon, which should also generate additional income for the company.

Thank you, Art. For the quarter ended March 31, net investment income totaled $0.13 per share. Looking at some of the expense categories, base fees totaled $4.3 million, taxes, general and administrative expenses totaled $1.3 million, and interest expense totaled $5 million. Net unrealized gain on our investments was $33 million or $0.50 per share. Net unrealized depreciation on our core facilities was $0.06 per share. Net realized gains on investments were $0.01 per share. Our net investment income exceeded our dividend by $0.01 per share. Consequently, NAV per share went from $8.78 to $9.24 per share. Adjusted NAV, excluding the mark to market of our liabilities, was $9.20 per share, up 5.8% from $8.69 per share. As a reminder, our entire portfolio, including senior notes, is marked to market by our board of directors each quarter using the exit price provided by independent valuation firms, security 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 spillover as of September 30 was $0.33 per share. Our GAAP debt to equity ratio, net of cash, was 0.9 times. Regulatory debt to equity ratio, net of cash, which excludes FDIC, was 0.7 times. With regard to NAV, our GAAP NAV was $9.24 as of March 31, up approximately 5% from the prior quarter, which reflects both the markup of assets offset by the markup of certain liabilities.

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 questions.

And we'll take our first question from Casey Alexander with Compass Point.

Hi, good afternoon. I first wanted to just make sure that I heard that correctly of the 36%. That's equity. Only 3% of that is represented by the JV and the other 33% is straight equity. Is that the right number?

Just take a look here. Maybe you may have it right in front of you.

Yes, that is the right number. About 3.4% is a PSLF. That is correct.

Okay, so is there, I mean PSLF at 3% of the entire portfolio, is there room to grow that? You know, many BDCs have JVs that are twice that size in terms of their relative position in the portfolio? And could there be any room to increase the dividends that come from the JV?

Yes, it's a good question. And just to refer to the equity, we also have subordinated debt in PSLF too, so I'm going to say, you know, our sub-debt piece is roughly twice as big as our equity piece. So call it, Aviv, 9%.

Oh, yes, 6% or so.

Yes. So 9% in total. But yes, I mean, our goal is to, you know, fully extend the existing JV and we have a little bit of room to go there. And then, you know, subject to Pantheon's approval, of course, in partnership, we would be totally open to expanding that JV and optimizing it. If you look at what's going on over PFLT, our sister company with Camper, we've grown that JV, we're growing more, and we've optimized the financing by doing a CLO transaction to get a higher ROI. So, you know, we're not there quite yet; you know, Pantheon is newer to the business. But that would be an aspirational goal, at least from PennantPark's standpoint, to grow it and optimize it.

Okay. And then secondly, if you could just give us a flavor for how the outlook looks for originations over the next quarter, how your pipeline looks, how you would compare that pipeline to what your expected repayments are, and, you know, the potential ability to grow the interest-earning side of the portfolio?

We're busy. Now busy is good. And also, busy also sometimes means repayments. So, you know, it's an active market; again, the market has fallen out, and it's kind of very, very active now. We are getting some repayments, and we're also putting new money out. We've never had a real challenge ramping our portfolio, subject to our quality control constraints; we obviously only want to do deals that we are very comfortable with. So if you look at our history over 14 years, we've never had a problem originating assets that fit our box. You know, the deals, because they are more bespoke, take time. You know, they take a couple of months to work, and you're negotiating covenants and things like that. It's not like you're flipping a switch. But that said, we are active; we do hope and expect to grow both the JV PSLF as well as the P&L on balance sheet. Importantly, we are starting to see the green shoots with Wheel Pros and Walker Edison, taking those equity proceeds and converting them to yield is obviously a key part of the strategy, and we're looking forward to doing that.

All right, great. I appreciate you taking my questions.

Our second question will come from Robert Dodd with Raymond James.

I got some semi housekeeping questions. On Walker Edison, you mentioned that $3.8 million cash payment. What should we expect, say half of that to be recognized as dividends and maybe the other half to be returned to capital and take your cost basis down to zero or is the whole thing a dividend?

It'll be based on what we could tell; it'll be the first, obviously the first part of its return on capital. And the second part of it looks like it can be counted as a capital gain. Capital gains will not be in good; it'll be a capital gain.

Then just on the debt side, I mean, obviously, the liability stack looks in good shape. Would you? Is it currently anticipated that you'd call the $86 million when that becomes callable in October? Or are you going to let that stay?

The 86 million from?

The baby bond.

The baby bonds. Okay, that's a good question. I think we'll have to see what our cost of capital is then and do the math and the fees. You know, obviously, we just did a deal that was much less expensive. So yes, haven't made any pre-decisions, but that is certainly an opportunity.

Okay, great. Thank you. Then lastly, I mean, the long term goal, to get equity, obviously, non-equity down to 10%. What's a realistic timeframe to achieve that goal? I mean, is that three years out? Is it going to take longer than that? It's certainly not going to happen in 12 months? So I mean, three, five, shorter, maybe?

You're right. It's a great, it's an imponderable question, right? It's kind of guessing. Certainly not a year and hopefully not three years. You know, you're right. I mean, I don't know if that's a tight enough band for you. Some of these we control; some of these we don't control. We control RAM, to some extent, but we don't control where the oil and gas M&A market is. When the oil and gas M&A market starts to heat up, we will meet in a hopefully more active RAM. We do control PT pivot, and that, you know, is more in our control in that market strong. So that may be, you know, sooner rather than later; does that mean 12 months or 18 months? It's kind of something in that zone. We don't control Cano. We don't control Walker Edison, etc. So, you know, Cano is going through the dispatch process hopefully in the next month or six weeks. We said we'll control it after the back, but at least it's more and more on its way to a liquidity event. That'll be a big milestone. So yes, a year to three, year to three years, just as a general; you know, if you really want to say let's run the table, get it down to 10%. I think that's probably right.

So, thank you. So those were my questions, and I really appreciate all the detail on the portfolio companies of that target market. So thank you for that.

Our next question will come from Ryan Lynch with KBW.

Good afternoon, guys. Thanks for taking my questions. First off, congrats on a really nice quarter. I just have one today. Can you talk about, has there been any, obviously, you guys historically making equity co-investments has been a very successful part of your success story to generate some nice NAVs through this COVID downturn. Has been a part of your long-term investment thesis of making some of these investments to offset some of the losses in your credit book and hopefully, generate some gains longer term. I'm just wondering now with such a large equity exposure and your desire to reduce that position in your portfolio somewhat, does that change the way you guys are working? When you guys are looking at new investments? Is that making you more hesitant to make equity co-investments? Is that adding more equity to your books? Or is that just as you know, keeping that investment philosophy unchanged as it's worked so well for you in the past?

It's a good question. Most of these equity co-investments are $1 million to $3 million bites. Every once in a while, you know, we'll do one that's a $4 million bite. So individually, they're not that big. And usually, they're maybe 5% or maybe 10% of the amount of debt that we're lending. So as individual bites, they're relatively small; they can have a nice asymmetric upside when they work, like some of the names we've talked about. So I think we're going to continue to do that. As long as we continue to make progress on exits, like Wheel Pro and like Walker Edison, it's kind of just like a reloading. You know, we're reloading the next Walker Edison, we're reloading the next Wheel Pro. We're reloading the next Cano. So, kind of Wheel Pro was a seven to one, Cano has been whatever it has been ‘21, or whatever it is. So I think it's important that we reload actually as we're exiting these bigger positions that have grown.

Okay, that's it. That makes sense. That's all for me today. I appreciate your time.

We'll take our next question from Mickey Schlein with Ladenburg.

Yes, good morning Art and Aviv. Art, I want to follow up on Ryan's question about portfolio strategy. Given how strong the economy is and how much support the federal government is providing to the economy, are you more interested in investing in second lien and subordinated debt in this environment? You know, considering that administration for a while, and I imagine we can expect more support if needed? And if so, are the terms that you can get in those markets acceptable to you on a risk-adjusted basis?

Yes. So yes, great question Mickey. And we think about a lot of PNNT, utilizes and across the capital structure strategy. So what's our cross-capital structure strategy? It's exactly what it means. It means first lien, some select second lien, mezzanine, and equity column. So we have been doing a little second lien, and as we will continue to do some of it, the bar is high. You know, the economy and the tailwinds of the economy are helpful factors. Where we can see quick leveraging and de-risking, whether it be first or second lien, that certainly helps us get comfortable with the debt security and also making that equity co-investment. So Wheel Pro was a secondary deal. You know, that wasn't that was a secondary deal we did, you know, a handful of years ago. We did a healthy co-invest. And that's worked out well. Walker Edison, on the other hand, was kind of a first lien where we stretch senior. Cano was a first lien, so it's been a mixture. So, but the point is, yes, we're open for business on the second lien mezzanine side. I'm not saying it's a massive part of what we're doing because it's something where we've learned the hard way you need to be really, really careful. But the risk-adjusted returns when you find the right ones, like Wheel Pro where you can see a quick de-leveraging and de-risking, can be very, very profitable. So we will continue to be part of the mix.

I appreciate that. And thanks for that, Art. You mentioned RAM a little bit in your comments, and I don't want to beat a dead horse. But, you know, the price of oil has remained in that sort of $60 plus level, which I think in the past you've mentioned is where you expected M&A in the oil patch to start to develop. Are you seeing any green shoots at all, vis-a-vis that segment and outlook for RAM eventually being acquired by a strategic buyer?

Yes, so a couple of responses. The first is, at $60, the company's generating good cash flow and paying off debt, that's always helpful. It creates equity; if you create equity value when you pay off debt, that’s certainly what's going on here. So that’s nice. With regard to M&A, we’re seeing green shoots or green shoots. I think we're seeing more green shoots as opposed to green shoots area. But inevitably and hopefully, as the market continues to be stable, you know, we'll see more shoots, and therefore more M&A activity will come in. At some point, there’ll be a robust market, hopefully, for RAM. In the meantime, hunker down, generating cash flow, paying off debt. The acreage of the RAM has now been proven out very nicely, it's often a matter of public information; it's on the RAM website. So anybody who's looking for productive acreage in that Austin chalk area can see the numbers and they're very attractive; some of the best wells in that area. So we're doing everything we can. We can't control that environment; the ministry loan, we got really extends that option out nicely. Again, we want to sell and find the right buyer at the right price at the right time. But we do have a long tail option at this point. In the last 12 months have done a really good job extending that option. That said, I do also want to say that I highlighted this with the lowest percentage of oil and gas in our portfolio in the last eight years. We hope RAM does well, and we hope we can get great value for RAM over time. But in the meantime, you know, we have some companies in industries that are kind of more of our forte, where we have domain expertise in healthcare, consumer, etc., where we see real secular growth and really nice tailwind. So, whether RAM a year from now is out of our portfolio or still 6.7% of our portfolio or a smaller percentage of our portfolio because the portfolio has grown as some of these other companies keep growing, you know, time will tell, but we feel like we've got to manage as best we can at this point.

As a follow-up, given the uncertainty as to timing of a potential exit on RAM? Is there any room in their financials, given the cash flow profile, for them to eventually pay you a dividend?

As part of this good question, and we have thought about that you might imagine as part of the loan with the Fed Main Street program, which is a great loan, we are prohibited from paying dividends. So at this point, so you know, look, let's see what happens. Let's see the company's results. Certainly, when we pay down debt, we by definition, increase equity value, and let's keep that option alive. At this point, we think keeping the option alive as long as possible is probably the best thing to do of any option we have here.

Understand, just a couple of housekeeping questions maybe for Aviv. I apologize, but we're just swamped with earnings. Could you give me the main drivers of the unrealized gains this quarter and also the undistributed taxable income per share figure?

If you want to go through the main drivers, I know it's certainly the same names that Art has mentioned before, PT like positive $0.09 unrealized gain quarter over quarter, RAM energy, we just discussed about positive $0.12 quarter over quarter. A bunch of Wheel Pros had positive contributions, they're the larger movers quarter-to-quarter.

And UTI per share?

I think we said it was $0.30.

$0.30. Okay. Sorry for that. I appreciate you taking my questions, Art. That's it for me this morning.

We'll take our next question from Kyle Joseph with Jeffrey's.

A good morning here, afternoon there. Thanks for taking my questions. Most of them have been asked and answered, but I just wanted to follow up for kind of your sense of where you're thinking about portfolio yields, as we think about the market recovering, rotation of equity assets, and then the potential for higher repayments. Give us a sense of how you see yields trending throughout the remainder of the year?

Yes, that's a great question, probably kind of relates to the earlier question about second lien. So prototypical first lien deals today are L525 to L650; prototypical second lien is L800 to L900. All of these, I'm assuming, are 1% floor. So it's really a mixed question about how much second lien measures that we're going to see that we like. I think last quarter, our yields on our new loans were a little higher because we had a slightly higher mix of secondary or mezzanine. This quarter, we didn't have quite as much, you know. So that's kind of where we see the market today. It's still probably going to be mostly first lien, probably still going to be most of what we're doing in terms of new, but we will opportunistically and when the credits meet our thresholds, do some second lien and mezzanine.

Got it, very helpful. Thanks for answering my question.

We'll take our next question from Melissa Waddell with JP Morgan.

Morning, guys. Thanks for taking my questions. I really appreciate all the detail on the equity positions, particularly around timing and the ones that you control versus the ones that you don't. Specifically, I just want to make sure I heard you guys right. On Cano, that's the only one I heard you guys talk about a lockup on in terms of Wheel Pros and Walker Edison. Those are things that are two queue events that will be completed and done, no lockup, is that right?

Yes, so we'll probably be out entirely, you know, here in the next couple of weeks. Walker Edison, we've got two times our cost back already, and we still own the same percentage of the company that we owned prior. So with Walker Edison, we anticipate an event in the next year or two. We hope so; we think so. Again, we're not in control of that, but the company is doing amazingly well via a sponsor. So gravity should take hold, and at some point, the sponsor should find a full exit. Cano is getting merged in with a SPAC, so that's the one where you can look at a publicly traded stock price every day. It's Jaws acquisition, JWS is the ticker. We are in a limited partnership controlled by a sponsor, that will end up owning a bunch of Jaw stock after the D-SPAC. So, that's when you can look at every day. The independent valuation firm took a 6% illiquidity discount from the publicly traded price. Additionally, because we're locked up with a sponsor, there's a 20% exit, the sponsor getting 20% of the exit proceeds. That kind of works its way down with the 6% discount with the 20% exit payment to the sponsor to the value you see at 331 in the value you could ascertain today if you want it; it's a little bit less than what it was on 331. So, once these SPACs happen, there's a six-month lockup now because the sponsor, LPs, including us, will own a majority of the company. It's not like you wave a magic wand and you're totally liquid, you know, in six months and one day. It’s something like any sponsor deal that goes public; it's something that needs to happen over time, the liquidity events need to be done judiciously. Certainly, the company itself, you know, will probably want to raise equity for growth. So you probably think about it over a couple of years.

Alright, that's really helpful. Thanks so much.

And our final question today will be a follow-up from Casey Alexander with Compass Point.

Yes, one of the things we always tried to track is industry concentration risk, and looking at the portfolio. In looking at the 10-Q, I see 23% in healthcare, education, and child care. Normally, that would be a number that would bother me, but I think that's such a broad category that it's probably capturing a lot of companies that really aren't very comparable to each other. Does it make any sense to cut that into a couple of different baskets to better define it for investors?

It's a great idea. You know, we do quite a bit in healthcare, and healthcare itself has a number of different verticals. They're not all correlated. We've benefited from the Cano mark-up. And yes, we do some education deals as well that are not correlated to healthcare. So I think it's a good suggestion. Maybe we'll start doing that or figure out some way to disclose that in a more granular basis. Good idea.

Okay. All right. Great. Thanks for taking my question.

And that will conclude today's question and answer session. I will now turn the call over to Mr. Art Penn for additional closing remarks.

Just want to thank everybody for being on the call today. I know it's a busy time in the BDC space. So thank you for your attention and focus. We appreciate it, and we look forward to talking to you next in early August after next quarter. Thank you so much.

That will conclude today's conference. Thank you for your participation. You may now disconnect.