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Edited Transcript of PNNT earnings conference call or presentation 16-Nov-18 3:00pm GMT

Q4 2018 PennantPark Investment Corp Earnings Call

NEW YORK Jan 14, 2019 (Thomson StreetEvents) -- Edited Transcript of PennantPark Investment Corp earnings conference call or presentation Friday, November 16, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Arthur H. Penn

PennantPark Investment Corporation - Founder, Chairman and CEO

* Aviv Efrat

PennantPark Investment Corporation - Treasurer & CFO

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Conference Call Participants

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* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* Kyle M. Joseph

Jefferies LLC, Research Division - Equity Analyst

* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Paul Conrad Johnson

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Thomas Quinn Wenk

JMP Securities LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good morning, and welcome to PennantPark Investment Corporation's Fourth Fiscal Quarter 2018 Earnings Conference Call. Today's conference is being recorded. (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 now begin your conference.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [2]

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Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's Fourth Fiscal Quarter 2018 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.

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [3]

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Thank you, Art. I would 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 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 SEC for information -- 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.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [4]

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Thanks, Aviv. I'm going to provide an update on the business, starting with financial highlights, followed by a discussion of the overall market, the portfolio, investment activity, the financials and then open it up for Q&A.

For the first quarter ended September 30, 2018, we invested $181 million in primarily first and second lien secured debt at an average yield of 10.1%. Net investment income was $0.20 per share. Our recurring run rate income is now $0.19 per share, excluding other income we received for such items as prepayment penalties. On average, other income, such as prepayment penalties, has been between $0.02 and $0.03 per share per quarter.

We purchased $7.2 million of our common stock as part of a $30 million stock repurchase program, which is authorized by our board last quarter. To date, we have purchased $15 million. The stock buyback program is accretive to both NAV and income per share. We are looking forward to continuing this program over the coming quarters.

As of September 30, we had taxable spillover of $0.30 per share, which provides substantial dividend cushion. With a generally stable underlying portfolio and significant spillover, we believe that PNNT stock should be able to provide investors with an attractive dividend stream, along with potential upside, as our equity investments mature.

As you all know, the Small Business Credit Availability Act was signed into law in late March 2018. Our board just approved the reduction of the asset coverage test from 200% to 150% as well as authorized a submission of a proposal for shareholders for the upcoming February 2019 annual meeting to vote on the asset coverage reduction. In connection with this reduction, our board also approved a reduction in our base fee from 1.5% to 1% on gross assets that exceed 200% of PNNT's NAV at the beginning of each quarter.

Since our $250 million bond issue matures within a year, our board has also authorized us to redeem those notes. In early 2019, we anticipate prepaying the notes at 100% of the principal amount plus accrued and unpaid interest as well as a make-whole premium.

Our primary business of financing middle-market sponsors has remained robust. We manage relationships with about 400 private equity sponsors across the country from our offices in New York, Los Angeles, Chicago, Houston and London. We have done business with about 180 sponsors.

Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective with our investments. In this environment, we have not only been extremely selective, but we have generally moved up capital structure to more secure investments.

A reminder about our long-term track record. PNNT was in business since 2007, then as now, focused on financing middle-market financial sponsors. Our performance through the global financial crisis and recession was solid. Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million. Average EBITDA on the underlying portfolio companies was down about 7% to the bottom of the recession.

According to the Bloomberg North American High Yield Index, the average high-yield company EBITDA was down about 40% during that time frame. As a result, we had few defaults and attractive recoveries on that portfolio. The IRR of those underlying investments was 8%, even though they were done prior to the financial crisis and recession. We are proud of this downside case track record.

We have had only 12 companies go on nonaccrual out of 208 investments since inception over 11 years ago. 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 in those companies, we've been able to find ways to add value.

Based on values as of September 30, today, we have recovered about 80% of capital invested on the 12 companies that have been on nonaccrual since inception of the firm. We currently have no investments on nonaccrual.

Since inception, PNNT has made 208 investments totaling about $5.1 billion at an average yield of about 12.4%. This compares to an annualized loss ratio, including both realized and unrealized losses, of about 30 basis points annually. This strong track record includes both our energy investments as well as our primarily subordinated debt investments made prior to the financial crisis.

In this environment, due to our deep and broad investment team, we are seeing more deals than ever. We're using our proven underwriting discipline in middle-market sponsored deals. We are generally high in the capital stack and have substantial junior capital beneath us to provide cushion. As a result, we believe that we can continue to provide attractive risk-adjusted returns to our shareholders.

At this point in time, our underlying portfolio indicates a strong U.S. economy and no signs of a recession. We remain focused on long-term value and making investments that will perform well over an extended period of time and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have a low leverage, strong covenants and are positioned to weather different economic scenarios.

We are a first call for middle-market financial sponsors, management teams and intermediaries who want consistent and credible capital. As an independent provider who's free of conflicts or affiliation, we've become a trusted financing partner for our clients.

Our portfolio is constructed to withstand market and economic volatility. In general, our overall portfolio is performing well. We have cash interest coverage ratio of 2.8x and a debt-to-EBITDA ratio of 4.9x at cost on our cash flow loans.

With asset yields coming down over the last several years, we're looking to create attractive risk-adjusted returns in our portfolio. We're executing a 3-point plan to do so. Number one, we're focused on lower risk, primarily secured investments, thereby reducing the volatility of our earnings stream. Investments secured by either a first or second lien are about 82% of the portfolio.

We're focused on -- number two, we're also focused on reducing risk from the standpoint of diversification. As our portfolio rotates, we intend to have a more diversified portfolio with generally modest bite sizes relative to our overall capital.

Number three, we look forward to continuing to monetize the equity portion of our portfolio. Over time, we're targeting equity being 5% to 10% of our overall portfolio. As of September 30, it was 14% of the portfolio.

In addition to being active on new investments, we had significant cash realizations in the quarter ended September 30. Some of our significant realizations include: our investment in Howard Berger where we realized an IRR of 14.5% on our $39 million second lien position. We also exited our investment in Veritext where we realized an IRR of 14.7% on our $28 million second lien position. In addition, we exited our $1 million equity co-investment in Alegeus with proceeds of almost $3 million, resulting in about a 20% IRR and a multiple on invested capital of 3x.

This might be a good time to highlight the value of the equity co-invest strategy as part of our portfolio. Since inception, across our platform, we invested $148 million in 58 equity co-investments, where we make a portion of our overall investments side by side with financial sponsors and the private equity, along with the debt that we provide. The IRR on that $148 million invested since inception is 23%, which represents a multiple on invested capital of 2x. Those returns help to offset losses and provide upside to the portfolio.

With regard to our energy-related portfolio, we are pleased that we continue to make progress monetizing those investments at reasonable values. We started 2018 with 4 investments in energy with a stated goal of monetization over time. We held these investments over the last several years during the energy downturn with a goal of maximizing value over the long run. We believe we're starting to see the fruits of that strategy. You may remember that during the March quarter, we exited the first of those names, American Gilsonite, which ended up generating an 8.6% IRR and 1.4x multiple on invested capital on our whole period of 5.5 years.

Last quarter, U.S. Well Services announced a merger with Matlin & Partners Acquisition Corporation. That merger closed on November 9, 2018. As a result of that transaction, our loan was refinanced. We hold equity in the public company with a current value of $13 million. Based on this valuation, our overall investment in U.S. Well has generated an IRR of 18% at a 1.7x multiple on invested capital.

With regard to our 2 remaining energy names, Ram and ETX, they've been aided by the higher oil prices. It will take time for us to maximize our recovery.

In terms of new 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 $13 million of subordinated debt and $2 million in common equity at Blackhawk Industrial Distribution, which is an independent distributor of metalworking and industrial maintenance, repair and overhaul products of cutting tools. Snow Phipps is the sponsor. [e.l.f.] is a provider of services that help companies promote their brands and engage employees by distributing promotional products. We invested $44 million in the second lien loan. TPG Growth is the sponsor.

U.S. Dominion is a global provider of election tabulation solutions and services. We invested $30 million of first lien and $1.5 million in common equity. Staple Street Capital is the sponsor. We purchased $22 million of first lien and $2 million of common equity of Walker Edison Furniture. The company is an e-commerce platform focused on designing and selling ready-to-assemble furniture. J.W. Childs is the sponsor.

Turning to the outlook. We believe that 2019 will be active due to the growth and M&A-driven financings we're seeing. 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.

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [5]

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Thank you, Art. For the quarter ended September 30, 2018, net investment income totaled $0.20 per share. We had about $0.02 per share of other income. Looking at some of the expense categories, management fees totaled $7.1 million, general and administrative expenses totaled $1.1 million and interest expense totaled $5.5 million.

During the quarter ended September 30, unrealized loss from investment was $5 million or $0.07 per share. Unrealized loss on our debt instruments was $1 million or $0.01 per share. We had about [$3 million] or about $0.04 per share of realized gains. The accretive effect of our share buybacks was about $0.02 per share. Excess income over dividend was $0.02 per share. Consequently, NAV per share went from $9.09 to $9.11 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 ASC 820 and 825. In cases where broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our overall debt portfolio has a weighted average yield of 11.2%. On September 30, our portfolio consisted of 53 companies across 27 different industries. Debt portfolio was invested in 47% first lien senior secured debt, 35% in second lien secured debt, 4% in subordinated debt and 14% in preferred and common equity. 90% of the portfolio had a floating rate.

Now let me turn the call back to Art.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [6]

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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, and thank you all for your time today and for you're continued investment and confidence in us.

That concludes our remarks. At this time, I would like to open up the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Casey Alexander with Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [2]

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Art, the $250 million note that you're taking out in January, how much is the make-whole premium going to be charged to the income statement?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [3]

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Yes. It's going to be roughly $2.5 million to maybe $3 million, depending on the timing and what yields are at that point in time.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [4]

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Okay. So explain to me why -- with being 9 months ahead of maturity, why wouldn't you just pay it off at maturity and not have to take a $2.5 million or $3 million charge?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [5]

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Well, yes, it's a good question, Casey. I don't think many people would actually hold it to maturity. They usually like to deal with looming maturities ahead of time. Once you're within 365 days, you, from a balance sheet perspective, it becomes a short-term liability. So we know we have this short-term liability we have to deal with. We have an undrawn credit facility that we're paying unused fees on. And our lenders there actually want to be drawn. They've been relatively undrawn during the life of their commitment to us. So we think this is a win-win where both bondholders and our lenders are going to like this outcome, and we think everyone will be happy.

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Operator [6]

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We'll take our next question from Paul Johnson with KBW.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [7]

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Regarding those bonds that you're going to be calling next year, I'm just curious, I mean, after that, what do you guys sort of see, your liability structure kind of going up, towards that 2:1 leverage effective date? I mean, are you guys looking at replacing them with other unsecured notes or you're looking at just simply adding it to the credit facility or other sort of financing options? Just wondering what you guys are thinking about.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [8]

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Yes. So look -- and from the standpoint of strategy, it's the same investment strategy we've been pursuing for a while, so steady as she goes. And in terms of leverage, we haven't made any long-term decisions at this point. We're not providing guidance as to what our leverage is at this point in time. We're going to evaluate all the options, and we think it's prudent just to get the 2:1 leverage option just to reduce risk of the company and then have even more cushion from the SEC asset coverage test. So I think we're just going to take it one step at a time. Look at the portfolio, call back the bonds, draw the credit facility and think about other options over the long term. That could be floating rate debt, it could be fixed rate debt, it could be secured, it could be unsecured, it could be a number of different things. So we're going to take a deep breath and assess all the different options. One of the nice things that's happened in the industry in the last few months is just one of our peers got a no action letter around securitization in CLO technology. To the extent you have a first lien portfolio, BDCs can get very attractive and efficient financing using that securitization technology. In a sense, you saw with the sister company, PFLT, when we announced last week that we had a nice upsize and we had a lot of demand for a securitization-style credit facility. So we think BDCs and certainly PNNT can be a beneficiary of looking at that kind of financing option as we go forward.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [9]

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Sure. And are there any amendments currently in your credit facility that prevent you from growing above 1:1?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [10]

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Right now, the credit facility is consistent with the SEC asset coverage test 1:1, carving out the SBICs. So in theory, we could go above 1:1 using the SBICs on a GAAP basis if we wanted to at this point in time. So we're talking to the lending community, the lenders in assessing where the market is there and going to figure that out over time as well.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [11]

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Sure. Also, you guys have been pretty consistent with your share repurchases. You've done a good job in utilizing that so far. I'm just curious, I mean, do you also, in the meantime, intend to use those share repurchases sort of as a means of managing leverage as we go into next year? Or do you sort of view this separately from managing your balance sheet leverage?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [12]

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Well, it's a good question. It certainly does impact leverage. To the extent you're reducing the equity counts, it's something that we certainly look at. In our minds though, we think of this stock buyback program as something we've committed to over a 4-quarter time period, and we're going to roughly do 25% of the $30 million each quarter. So that's kind of how we view it in our minds.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [13]

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Sure, okay. The next question just really has to kind of do with the energy markets and then one of your energy investments, but the commodity markets were fairly strong in the third quarter. I mean, obviously, oil reached multi years high. But your Ram Energy equity investment was marked down about $6 million in the quarter. There's obviously been a little bit of volatility in that market post quarter end. But I think, at this point, I mean, investors are just really looking to kind of get a sense maybe what the outlook is for the investment, how they should feel about the market and the company today. And just wondering if there's any sort of outlook for that sector or that business that you could provide that would shed a little bit of light on Ram Energy.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [14]

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Sure, sure. So the Ram mark was really because we provided a revolver to Ram so there was more debt on the balance sheet. So from a total enterprise value basis, if things are constant, if there's more debt, the equity value goes down. So that's what's driving that Ram situation. The enterprise value, we think, or the independent valuation firms more importantly valued similarly quarter-to-quarter with just a -- because there was more debt on the balance sheet to finance a drilling program. That's what drove that. We were hopeful and optimistic that Ram's drilling program will prove out and equity value will be really good going forward. We won't know until we know, of course, but we're optimistic that the drilling program will be successful. In terms of the overall sector, again, we have really 2 E&P names left, both of them are pursuing a similar strategy where they're drilling some wells and we're hopeful of the outcome. Certainly, oil in the $55, $60 range is much, much better than it was in the depths. It's come down in the last couple of weeks. It's obviously hard for us to predict or control. Both companies are executing their plans, and we're hopeful that those plans will be successful.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [15]

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Okay. And then my last question just kind of have to do with 2:1 leverage that you talked about a little bit. But I mean, is there ideally any kind of any sort of investment or part of the market that you'd be looking to target for that incremental leverage?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [16]

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Yes. So ever since the law was being bandied about, was it 7, 8 years ago, we've said consistently that on first lien debt, you can prudently leverage first lien debt more than 1:1 and still provide a safe return. And that for second lien or mezzanine, even if you could leverage those assets more than 1:1, you shouldn't. So as we go forward, we're going to look at the underlying portfolio and assess what we think is prudent leverage depending on the investment and type of investment.

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Operator [17]

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

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [18]

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I just wanted to step back for a minute and ask you to remind us what the total committed AUM is across the entire Pennant platform and how large a check you can write. What I'm getting at is your competitive position within the market.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [19]

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Yes. So first, let's talk about the market we're in. It's a really great question, Mickey. We're more focused, as we said on yesterday's PFLT call, on companies generally with $15 million to $40 million of EBITDA, kind of the mean or median is probably about $25 million of EBITDA, and we're generating some really nice relationships. Today, AUM across the platform is about $2.7 billion. And of course, in each vehicle, we need to provide really nice diversification. So we want kind of at least 40 names in any particular vehicle. So depending on which vehicle deals fit into, from the standpoint of risk and reward, we can write up to a $75 million, $80 million check. We can write a check as low as $10 million. Also, in our non-BDC vehicles, we have limited partners who are looking for co-investments and we can provide co-investments to those limited partners on occasion. So case by case, the most important thing we've done really is add talent to the team over the last few years, open up these offices in L.A., Chicago, Houston, London, beef up New York and develop the relationships. Because if you develop relationships, you'll get a lot of looks, which allow you to be highly selective and more importantly, become a trusted partner and trusted adviser to these sponsor clients. If you're doing it right, it's never about the last basis point or last week of leverage. It's about developing this trusted partnership, where they want us to provide capital to them, and we want to provide capital to them because it's a mutually beneficial relationship.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [20]

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And Art, in terms of providing capital this quarter, at least in PNNT, growth was focused on first lien. I know it can be idiosyncratic, but it's now 43% of the portfolio at cost. And I'm curious whether you expect that to go higher while still sticking to the spirit of PNNT's investment style as opposed to PFLT, which is obviously a lower-risk vehicle?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [21]

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Yes, and that's a good question. I mean, we think of -- we have 2 strategies here. One is strictly a first lien strategy, and that's represented by PFLT, and the other strategy, which is represented by PNNT, as we say, it's across the capital structure. So it will do first lien, it will do second lien and occasionally mezz, and it will be nimble and opportunistic and go where we think the best risk-adjusted returns are up and down the balance sheet. Today, by and large, we like the first lien strict senior. PNNT did some second lien and mezz last quarter. But PNNT will be opportunistic and nimble between the different areas of the marketplace. And as a result, we'll provide 2 different risk-adjusted returns to our potential shareholders. So PNNT, the average yield on the portfolio is around 11%. That's probably coming down a little bit. PFLT, the average yield is around 8% on the underlying portfolio. So 2 different returns, 2 different risk-adjusted returns and 2 different investment focuses.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [22]

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And Art, my last question then in relation to that, as you talked about in your prepared remarks, PNNT was around during the crisis 10 years ago. But I -- off the top of my head, I don't remember how high your first lien position went. What I really like to ask is, I agree with you, I don't think we're anywhere -- I don't think we're near a recession. I don't think a recession's around the corner. But if you were to start to get worried seriously about a recession, could we see PNNT's first lien allocation climb to 60%, 70% of the portfolio [would add] cost?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [23]

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Sure. So what happened -- let's take a step back. What happened is PNNT got going in April of '07. Primarily, we thought at that point is a mezzanine debt provider, subordinated debt provider. And by the summer of '07, we felt, from our underlying portfolio companies, that the economy was weakening. So we slowed it down. First things first, we just slowed it down. We raised the bar for a deal to get approved. We felt like it had to be in a recession-resistant industry, reasonable leverage, high yield and importantly, strong covenants. And we raised the bar. And during that time, we did -- we still did primarily second lien and mezz, but it was a very picky and selective orientation then. And that vintage of investments that we made between June of '07 and September of '08 turned out to be a really strong vintage because we had proactively raised the bar. In this particular -- and at that point, PNNT was, we thought, primarily second lien and subordinated debt vehicle. Today, obviously, PNNT is now up and down the capital structure. We do not, as we said in the prepared remarks, see signs of economic weakness. And certainly, as we underwrite new deals, we are putting in downside cases, assuming a recession is next year or assuming a recession is the following year, really to stress case and understand what a downside might look like for any new investment we make. But we feel as though we're in a really good position now with a big chunk of the portfolio in first lien. Any new second lien we're doing, we're really scrubbing it hard. And to the extent that we see economic weakness, we'll do the same thing again. We will raise the bar. You're right. We probably will prioritize first lien in that type of scenario if we were to get that type of scenario again and preserve capital and create liquidity and just try to batten down the hatches if we have to resolve some economic weakness. So that's how we think about it. Right now, the economy seems strong in the U.S. at least, but we're watchful.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [24]

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And lastly, Art, when you say scrubbing the bar in the second lien today, can you give us a sense of what kind of leverage? I know it's dependent on industries and growth profiles. But in general, what kind of leverage is acceptable to you for a second lien investment, given that you're modeling for a recession maybe within a couple of years?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [25]

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Yes. It's case by case obviously, based on the industry. I mean, our big thing is we need to find really great, great companies that we think have a real reason to be in companies that we think can generate very high free cash flow conversion where CapEx is low relative to EBITDA so that even if the economy were to weaken, you'd still got derisked and deleveraged. So we say, in this portfolio, the average debt to EBITDA is 4.8x. The new deals we did this past quarter were, I think we said, about 4.9x the portfolio, 4.8x with the new deals we did this past quarter. When we start getting above 5x in general, we start getting more and more careful and cautious. Not to say we won't do a financing above 5x occasionally, but we really have to love the company and we have to love the cash flow conversion.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [26]

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So industries you would like today would be software or a health care without reimbursement risk, things like that, right?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [27]

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Yes, yes.

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Operator [28]

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(Operator Instructions) We'll hear now from Kyle Joseph with Jefferies.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [29]

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Just following up on your thoughts on the economy, Art. Can you give us sort of underlying revenue and EBITDA trends you're seeing at the portfolio company level? And any really changes you've seen over the last 3 months, if any?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [30]

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Yes. Thanks, Kyle. A good question. No real changes. We're seeing, on average, single-digit revenue and EBITDA growth as a general proposition. So a nice place to be a lender at this point in time.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [31]

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Got it. And then can you just remind us on your outlook for yields given moving up capital spectrum. Again, we have to leverage changes, we have to have rates increasing. So kind of your long-term outlook for the overall portfolio yield.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [32]

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So look, you've had cross currents. LIBOR has certainly been a big benefit. For several years, we've had yield -- we had spread compression. We're not seeing spread compression at this point, so don't know where LIBOR's headed in the future, but we're feeling pretty good about the wind at our back from the standpoint of LIBOR going up.

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Operator [33]

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We'll take our next question from Chris York with JMP Securities.

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Thomas Quinn Wenk, JMP Securities LLC, Research Division - Associate [34]

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This is Thomas Wenk in here for Chris York. We have one question for you this morning regarding credit ratings. With the board's approval for the reduction in leverage, you presumably had conversations with all your stakeholders. So with your investment grade rating at BBB minus with negative watch outlooks as well as S&P's comments in April regarding the pursuit of additional leverage on ratings, do you guys think your investment grade rating is at risk of being adjusted at all?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [35]

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Yes. Thanks, Thomas. Good question. We don't know at this point. And the agencies are going to do what the agencies are going to do. And we've had a very constructive, communicative partnership with the agencies. The bonds are coming up in January at a make-whole before any shareholder vote, which would be in February. So our investment strategy and our leverage won't change between now and then. The shareholder vote is coming after the bonds will be taken out of the make-whole. We think our bondholders will be very happy with the outcome here.

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Operator [36]

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We'll now take a follow-up question from Casey Alexander with Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [37]

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Well, first of all, congrats on the commitment to the shareholder repurchase program. I think shareholders are clearly benefiting by it, and I think that they appreciate the company's commitment to the share repurchase program. And also, congrats on the repayment of the loan from U.S. Well Services. I'm wondering because the company and the board had really a kind of a strict intention to stick to that leverage ratio of 0.8x and maintain that investment grade rating. Did the ability to potentially do securitizations where the rating is kind of independent of the BDC and more dependent upon the structure of the securitization factor in your thinking about going ahead and authorizing more leverage at the board level and going to the shareholders?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [38]

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Well, it's a good question, Mickey. Obviously, everyone's aware of the no action release that one of our peers got, which should help the entire industry, not only our vehicles. I think it was more just that we had to deal with the bonds anyway. They were coming due. They -- as of December 31, they become a short-term liability, so we had to deal with them anyway. And we have enjoyed and appreciated being investment grade rated. And it's something that's been important to us, but the bonds that are coming due anyway, we had to -- we just had to deal with them. Now we will take out the bonds. We will draw on the credit facility and we're going to look around and see what the different options are. There's no -- there's not going to be any change in investment strategy. It's -- our investment strategy will organically flow from where we see the best risk-adjusted returns in the marketplace. And then we're going to assess all the different financing tools, including the securitization style as one. But we are a believer in having diversified financing tools, whether they be bonds or credit facility or SBIC licenses, and we anticipate continuing to have diversified financing tools going forward.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [39]

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Great. That's a thoughtful answer. Could you share with us what the date is or the prospective date for the annual meeting at which shareholders will be voting on the measure?

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [40]

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It could be in early February, I think February 4, 5 kind of zone. February 5 Aviv is telling me.

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Operator [41]

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And we'll take our final question from Paul Johnson with KBW.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [42]

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I just had one quick follow-up question for Aviv. Regarding that $2.5 million, $3 million of the make-whole premium that you're going to have when you call out bonds, do you guys expect that to flow through the interest income line? Or do you expect to put that probably down below in the gains and loss category?

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Aviv Efrat, PennantPark Investment Corporation - Treasurer & CFO [43]

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Yes, it's going to be a onetime hit, and you're going to see that going as a onetime expense on the P&L, and it's going to affect the March quarter end if we're doing it in January.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [44]

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So Paul, as you know, sometimes we give core NII and GAAP NII. Certainly, it'll impact GAAP NII, but the core -- it'll be below the line from a core standpoint.

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Operator [45]

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And that does conclude today's question-and-answer session. I would like to turn the conference back over to Mr. Penn for any additional or closing remarks.

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Arthur H. Penn, PennantPark Investment Corporation - Founder, Chairman and CEO [46]

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Just want to thank everybody for being on the call today. We're just hoping everybody has a great Thanksgiving and then holiday season, and we'll be talking to everybody in early February. Thank you very much.

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Operator [47]

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