PennantPark Investment Corporation

Good morning and welcome to the Pennant Park Investment Corporation's fourth fiscal quarter 2020 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 speaker's remarks. If you would like to ask a question at that time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, please press star 2 on your telephone keypad. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of Pennant Park Investment Corporation. Mr. Penn, you may begin your conference.

Good morning, everyone. I'd like to welcome you to Pennant Park Investment Corporation's fourth fiscal quarter 2020 earnings conference call. I'm joined today by Aviv Efrat, our Chief Financial Officer. Aviv, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of Penn and Park 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 customer 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 212-422-7000. 905-1000. At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Arthur Penn.

Thanks, Aviv. First, we hope that you, your families, and those you work with are staying healthy. I'm going to spend a few minutes discussing how we fared in the quarter ended September 30th, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials, and then open it up for Q&A. Despite the challenging economic conditions brought on by the pandemic, we are pleased with our performance this past quarter. We achieved a 1.7% increase in adjusted NAV as the portfolio continued to improve during the quarter. We have several portfolio companies in which we have substantial equity positions that are benefiting from the K-shaped recovery. This is solidifying and bolstering NAV. We will highlight those companies in a few minutes. Additionally, we are pleased with formation of Penn and Park Senior Loan Fund, PSLF, our joint venture with Pantheon, a leading global private markets investor. On October 30th, Pantheon upsized their commitment to PSSL by another $27.5 million, bringing their total contribution to $62.5 million. Pantheon's additional investment came into PSLF at NAV. The equity from Pantheon into our platform not only validates the value proposition of the existing portfolio, but it also helped scale the Penn and Park platform to continue to be a leading lending partner in the market and create additional capital for future investment into the attractive new vintage of loans that we are seeing today. Pantheon's new $27.5 million investment into PSLF was again split into approximately 65% subordinated debt and 35% equity. PNNT also invested an additional $2 million into PSLF at NAV on October 30th. Performer for the new investments PNNT owns 60.5% of the JV and Pantheon 39.5%. Although we never predicted a global pandemic, as you may know, we've been preparing for an eventual recession for some time. Prior to the COVID-19 crisis, we proactively positioned the portfolio as defensively as possible. Over the past several years, we've generally been moving into senior secured positions, higher in the capital structure and into a more diversified portfolio. Over 60% of the portfolio is in first and second lien secured positions across 80 investments. The overall portfolio is constructed to withstand market and economic volatility. As of September 30th, the average debt to EBITDA on the portfolio was 4.5 times and the average interest coverage ratio, the amount by which cash income exceeds cash interest expense, was 3.1 times. We have only two non-accruals in our book out of 89 different names in PNNT and PSLF. This represents 4.9% of the portfolio at cost and 3.4% at market value. We have largely avoided some of the sectors that have been hurt most by the pandemic, such as retail, restaurants, health clubs, apparel, and airlines. Although PNNT does have exposure to oil and gas, which we will discuss later, the portfolio is highly diversified with 80 companies in 29 different industries. Since inception, PNNT has invested $5.9 billion at an average yield of 12%, This compares to an annualized realized loss ratio of about 24 basis points annually. If we include both realized and unrealized losses, the annualized loss ratio is only 35 basis points annually. This strong track record includes our energy investments and primarily subordinated debt investments made prior to the financial crisis and now some portion of the pandemic. Our performance through the global financial crisis and recession was excellent. During that recession, the weighted average EBITDA of our underlying portfolio companies declined by 7.2% at the bottom of the recession. This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%. We are proud of this downside case track record in the prior recession. Based on tracking EBITDA of our underlying companies through COVID so far, we believe that our EBITDA decline will be substantially less than it was during the global financial crisis. Now let's turn to the outlook ahead in the coming quarters and how our portfolio is positioned. We are gratified that our historical investment focus has protected us from some of the worst hit areas of the economy, such as retail, restaurants, health clubs, apparel, and airlines. We've been pleased with the way our portfolio companies have moved to rapidly adjust cost and focused on shoring up liquidity. Many of our portfolio companies are in industries such as government services, healthcare, software, communications, and cybersecurity. which collectively comprise a substantial portion of our portfolio and are less impacted by COVID. Additionally, alongside the debt investments we make in many companies, we invest in the equity, usually as a co-investor with a financial sponsor. Our returns on these equity and co-investments have been excellent over time. Overall for our platform from inception through September 30th, our 209 million of equity co-invests have generated an IRR of 25.3% and a multiple on invested capital of 2.3 times. We believe that we are experiencing a K-shaped recovery with some companies and industries being large beneficiaries of the environment. We are pleased that we have attractive debt and significant equity investments in four of these companies which can substantially move the needle of our NAV. I would like to highlight those four companies. The four companies are Kano, Wheel Pros, Walker Edison, and PT Network. Kano Health is a national leader in primary health care who is leading the way in transforming health care to provide high quality care at a reasonable cost to a large population. Our equity position has a cost and fair market value on September 30th of $4.3 million and $18.8 million respectively. Kano has been experiencing rapid growth with revenues nearly quintupling and EBITDA more than tripling over the last three years. We believe that there is a massive market opportunity for Kano to grow in the years ahead with the Medicare Advantage program. Based on the recently announced transaction with Jaws Acquisition and where Jaws is trading, that position would be valued at $72 million. About 12% of that value is in cash that we will receive before and at consummation of the deal in early 2021, and the rest is in shares of Jaws Acquisition. Our shares are locked up in a limited partnership controlled by the financial sponsor and will likely be valued by an independent valuation firm at a discount to the traded value. Wheel Pros is the largest national distributor of aftermarket custom wheels. The company has consistently grown since our initial investment with revenue doubling and EBITDA tripling over the last 2.5 years. Our position has a cost of $4.5 million and a fair market value of $23 million as of September 30th. Walker Edison is a leading e-commerce platform focused on selling furniture exclusively online and through top e-commerce companies. Since our investment was made in 2018, sales have more than tripled and EBITDA is up almost four times. Our position has a cost of $1.9 million and a fair market value of $12 million as of September 30th. PT Network is the leading physical and occupational therapy provider in the mid-Atlantic states. Our equity investment in PT came through a restructuring, which came about after the company made several operational mistakes. We've always had a positive view of the industry and outlook through the industry tailwinds and demographics, which result in comparable companies trading at EBITDA multiples of 12 to 15 times. Under our ownership, we've brought in an excellent management team who corrected those operational mistakes and has shepherded the company well through COVID. Our equity position has a cost of $23 million and a fair market value of $39 million as of September 30th. All four of these companies are gaining financial momentum in this environment and our NEV should be solidified and bolstered from these substantial equity investments as their momentum continues. Energy investments represent 8.8% of the overall portfolio. Despite the challenges facing the oil and gas industry, Ram Energy successfully refinanced all its outstanding debt with a new credit facility led by Vast Bank under the Main Street Lending Program. The new loan materially lowers Ram's cost of capital and provides runway to execute on its operating plan and time to wait for a recovery in prices. Our gaming portfolio has proven to be extremely resilient and continues to perform well. With a repayment of Peninsula Pacific Colonial Downs since quarter end as an 11% IRR, gaming exposure has been reduced from 3.6% of the portfolio to 2.6%. We continue to review and will look to selectively make new investments. The outlook for new financings is attractive. We believe that middle market lending is a vintage business. This upcoming vintage of loans is likely to be the most attractive we've seen since the 2009 to 2012 time period. Leverage levels are lower, equity cushion is higher, yields are higher, and the package of protections, including covenants, are tighter. After enduring about five years of a late cycle market for middle market lending, it's refreshing to have attractive risk reward available to us. 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 September 30th, core net investment income totaled $0.14 per share. Gap net investment income was $0.11 per share due to a $0.03 per share one-time cost related to the creation of the SMS. Looking at some of the expense categories, base fee totaled $4.4 million Taxes, general and administrative expenses totaled $1.4 million, and interest expense totaled $8 million, including a $2.1 million one-time cost. Net unrealized gain on our investment was $21 million, or $0.32 per share. Net unrealized depreciation on our credit facilities was $0.14 per share, almost all of which was due to the deconsolidation of the SLF. Net realized loss on investment was 15 cents per share, again, almost all of which was due to the deconsolidation of PSLA. Our dividend exceeded our net income by 1 cent per share. Consequently, NAD per share went from $7.82 to $7.84 per share. Adjusted NAD, excluding the mark-to-market of our liabilities, were $7.59 per share, up 1.7% from $7.46 per share prior quarter. The increase in NAV was primarily due to almost 3% valuation increase on the investment portfolio. As a reminder, our entire portfolio, credit facility, and senior notes are marked to market by our board of directors each quarter using the exit price provided by independent valuation firms, Thank you for joining us. Deformation of DSLS. Our gap debt-to-equity ratio net of cash was one times down from 1.5 times last quarter. Regulatory debt-to-equity ratio net of cash, which excludes FBIC debt, was 0.9 times down from 1.4 times last quarter. With regard to NAV, our gap NAV was $7.84 as of September 30th, up Approximately 0.3% from the prior quarter, which reflects both the marked up of assets offset by the markup of certain liabilities. Assuming liabilities were not marked to market, adjusted NAV is $7.59, up approximately 1.7% from the prior quarter. We had ample liquidity to fund revolver draws and were in compliance with all of our facilities at September 30th. We have readily available borrowing capacity and cash liquidity to support our commitments. We have a strong capital structure with diversified funding sources and no near-term maturities. We have $475 million of revolving credit facility maturing in 2024 with a syndicate of banks, $119 million of SBA debentures maturing in 2026, and $86 million of unsecured notes We have been in consistent dialogue with our lenders and are thankful for their support. We have withdrawn our application for a new SBIC at this time. We intend to gradually pay down SBIC 2 while also proving out our portfolio through COVID before reassessing. Our overall debt portfolio has a weighted average yield of 8.9%. On September 30th, our portfolio consisted of 80 companies across 29 different industries. The portfolio was invested 41% in first-link secured debt, 20% in second-link secured debt, 10% in subordinated debt, including 6% in PSLS, and 29% in preferred and common equity, including 3% in PSLS. 93% of the portfolio has a floating rate of which 90% has a LIBOR floor. The average libel floor is 1%. We have concluded in consultation with our board to extend the incentive fee waiver through December 31, 2020. Now, let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is to generate attractive risk-adjusted returns through income, coupled with long-term preservation of capital. Everything we do is aligned to that goal. We try to find less risky middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. In closing, I'd like to thank our extremely talented team of professionals for their commitment and dedication. Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks. At this time, I'd like to open up the call to questions.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. And if you're using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, that is star 1 to signal. And our first question today comes from Robert Dodd of Raven James.

Hi, guys. A few questions, if I can. On the JV first, I mean, it looks like obviously no technical question first, I guess. No dividend paid this quarter. Obviously, it had earnings. Is it going to be the intent that it's going to pay the dividend on kind of a lagging basis? Or was it just a timing function as to why there was no distribution from it this quarter?

Yeah, thanks, Robert. Yeah, it was just because we had just closed and we were getting squirted away with everything. But going forward, it'll be paying Dividends each quarter, this first quarter was just kind of a quarter getting set up. Understood.

Just on that as well, I mean, with Pentium putting more money in, what was the discussion there? Obviously, after selling the assets off your balance sheet into the JV, you have capital as well. Was there any discussion about whether you would put in more capital there? Thank you for joining us.

Thank you for joining us.

Yeah, so any colleague can give us that?

Yeah, so I think for PNNT, I think it's going to be something like $3 or $3.5 million of cash.

We don't yet know whether that will be characterized as a return of capital or a dividend.

So we're waiting for their estimate of how they're going to characterize that, but that will be cash that's coming to PNNT.

Okay, got it. Thank you. And then just in general terms, you went through all this, you can, I will, etc., Any more colleagues about the timeline of realizing some of these things? As long as we can, there's going to be a lockup, etc. Any idea about how fast some of this equity could be monetized? Given it does seem the M&A environment is picking up, that might be an environment where some of these assets do potentially get sold. Any balance there?

Yeah, so I think we're getting taken out of our debt in the next week or two. So that'll be a liquidity then. And I think we're getting a little bit of the cash on the equity also at that same time. Either before or at closing of the total value that we're talking about, 12% will be cash, either in the next couple weeks or at closing. And then the other 88% will be stock in this limited partnership that's controlled by the sponsor. that owns the Jaws acquisition stock. There will be at least a six-month lockup on that stock, and the sponsor and management will own about 65% of Cano, which is obviously a lot of value, so it's not like we're going to be able to flip a switch and punch out of the stock. You can take that in one of two ways. Way number one is she would be nice to punch out and flip a switch, A, or B, You know, and I encourage you and others to take a look at the public information on the Charles Adquisition website about Kano itself, about the marketplace they're in, about their comparable, which is a great company called Oak Street Health, which traded about an $11 billion valuation. And if you were to line up Kano side by side with Oak Street Health, it lines up very favorably in terms of revenues, in terms of EBITDA, in terms of members, in terms of medical loss ratios. There is a case, and I think we believe this case, that Cano should be a very attractive stock and has the ability to double or even triple potentially from here. We'll see. We are locked up for a while, and that might actually be a good thing.

I appreciate that. The one equity position I think you control, since you and the restructuring would be PP Networks. Any interest in potentially monetizing that or is it still too early with the new management team and getting that back on track?

Yeah, so we do control that particular company. We brought in a new management team who's done a great job through COVID. I think we need another 12 to 18 months, you know, to kind of get that in a good position, get beyond COVID. And there's a myriad of other physical therapy companies, either in the public domain or privately, you know, are valued at 12 to 15 times EBITDA. So, you know, I think we want to, you know, kind of, you know, enhance that. We might do some small token acquisitions and try to get that EBITDA up a little bit so that we can then, you know, exit at an attractive multiple.

Thank you. Those are all my questions.

Thank you, Robert.

And our next question comes from Casey Alexander with Compass Point.

Yeah. Good morning. I have a couple of questions. You've got room to invest now. I mean, your regulatory debt to equity ratio is 0.88 times. Can you talk about what the origination pipeline looks like coming into the end of the year here and what sort of opportunities that you're seeing to enhance your earnings power?

Yeah, look, you know, in terms of the vintage, we think it's an attractive vintage where the machine is operating and we're looking at a lot of deals. and we are looking at ways to enhance the earnings power, to your point. Right now, the last six, eight months, we've been focused obviously on the portfolio, COVID, getting the right positioning, but I do think we are in a time frame now when we can look at opportunities in the market as well. And we're going to look now to, as the NAB feels like it's Thank you for joining us.

Looking at the RAM website, it certainly appears from the press releases or the updates on the RAM website that it's a better picture and in some ways a considerably better picture than what we had looked at over the last several quarters. Can you discuss and give some more color there? Wells that are operating, how sustainable is it? The impact of the Main Street lending program and how that extends your runway. I'm really curious to hear, you know, because it sure seems by looking at it that things have changed a bit to the better there.

You know, the company is generating cash flow and, you know, the Main Street lending facility took out our former lender, McQuarrie, and put, you know, more cash on the balance sheet. So the wells are operating. It's a cash flow generative, cash flow positive company. We would hope that we could, you know, pay down that debt, a portion of that debt over the next two, three years. It's very low cost debt. There's a pick option for it so we can benefit from being an issuer of that pick. It's kind of like LIBOR plus 300, so it's very, very cheap. You know, the Macquarie facility was and more like a 10% yielding facility. So, you know, the idea there is to, you know, generate free cash flow, pay down the debt to the extent we can and position the company as best we can for sale, you know, should or if and when there's a good opportunity, you know, to maximize that sale. But the Main Street lending program certainly for RAM is transformational and the company's wells are doing what they are doing actually very well in this environment. So we're hopeful. It's been a long ride, but we think we've positioned RAM as well as can be positioned at this point.

All right. Well, thank you for taking my questions. And I guess when you have almost a 20-bagger on Canoe Health, congratulations are certainly in order for that one.

It's a nice way it works. Thank you.

And our next question comes from Mickey Swain of Leidenberg.

Good morning, Art and Aviv. Hope you're well. Just a few housekeeping sort of questions. I noticed the other income line was up pretty meaningfully, quarter to quarter, and repayments and exits were actually down. Can you give us some insight into what drove that increase?

I'm looking at my notes, Abib, if you have any follow-up.

Yeah, we do have some prepayment penalties that we have recorded that are large this quarter.

So you're right, about $0.04 per share that we have recorded is fairly large. Usually you should look at it on a pro forma basis, maybe $0.01 or $0.02. It's kind of abnormal. extraordinary or large, fairly large one-time income that we have booked. Again, hard to handicap what it's going to be next quarter, but it's primarily prepayment penalties on exits.

Thank you for that, Aviv. That's what I suspected. Art, can you remind us sort of what's your target blended return on investment on PSSL?

You know, PSSL, we're targeting, is PSSL, is over in PFLT, you mean PSLF?

I'm sorry, PS, yeah, PSLF.

There's a lot of Ps and a lot of Fs and a lot of Ls, so I get it. PSLF, the Detroit venture with Pantheon, we're targeting kind of the same, you know, 12-ish percent, you know, ROE on PSLF as we are on PSSL as well. The similar, you know, very senior portfolios, similar, you know, kind of leverage ratios. So we think it's a very nice adjunct to the mix for PNNT.

And are you including the sub-debt investment in that calculation?

That's right. All of the capital that we're putting to work, yes, correct.

And lastly, in the past, you gave us a target leverage on your balance sheet and a regulatory leverage of If I recall correctly, 1.1 to 1.5, but now you've announced you're going to unwind the SBA. I'm sorry, the SBIC subsidiaries. Can you give us a sense with the current conditions of the market, what your target leverage is on a go-forward basis?

Yeah, so I think right now, particularly with the portfolio that's equity-heavy, which is what it is, and many of these equities are because of value creation, We said 1.1 to 1.5. I think we're going to be at the lower end. We're below the lower end. We would stick to the lower end of that range.

And that's regulatory, correct?

That's regulatory.

I appreciate that. Those are all my questions. I appreciate your time. Thank you.

Hello?

Hello?

We'll take our next question from Ryan Lynch with KBW. I just have a one question. You mentioned kind of the prospects for Cano Health, and by the way, congrats on that. That's really great, great news. You also talked about PT Networks, which you guys are the controlling equity position. The other two, though, Walker Edison and Wheels Pro, I believe that you guys are in the minority equity position, but just given the strength of both of those businesses over the last several years, as well as the increase in the M&A market that we've heard with pipelines increasing, private equity getting more active, as a general commentary, what do you think about the prospects of being able to exit those over the next six to 12 months?

Yeah, it's a great question. We're not in control of those two, but the companies are doing very well. So certainly we would think within the next 12 months, six months is a possibility, but kind of hard to put a pin in it. But I'd say six to 12 months is a fine timeframe to be thinking about.

Okay, that was my only question. Again, congrats on the really nice quarter. Thank you.

And we'll go next to Kyle Joseph with Jefferies.

Good morning, Art and Indy. Thanks for taking my questions. Most have been answered. I just wanted to get a sense for yields. Obviously, there were some moving parts in the quarter. with the JV, you know, given your pipeline, interest rates, floors in your portfolio, can you give us a sense for where you would expect yields to trend from here?

You know, look, we think yields will be roughly steady. I think it's a question of starting to put money to work to drive income and then also equity rotation, so You know, I probably model steady yields for me.

All right. That's it for me. Thanks for having me on. Thank you.

We'll go next to Rick Shane with JPMorgan.

Hey, guys. Thanks for taking my questions this morning. One of the things we noticed is that your upcoming portfolio maturities in 2021 are very low and very manageable. It looks like one of the factors that's dampened that is, and Pierce Cascade was restructured or sort of rolled forward. I'm curious how we should look at this transaction. That was a transaction that was a large deal with 100% pick. It looks now that it's been vibratated into a prep and a pick. I'm curious how these crude picks works on that transaction, if there's a reversal of any income associated with that, and whether or not the PREP will be cash paid.

Yeah, the PREP, thank you, Rick. The PREP is not cash pay. On that particular investment, we're accruing the company's doing well. This was a situation where the can was kicked down the road because of the timing of COVID, but we believe that company will be sold in the next 12 to 18 months. and it's actually doing very well through COVID and seeing a little bit of a lift. So we are, we're accruing, we're accruing income. Got it.

And so when the, so I guess what I'm trying to understand is that if I look at the notionals of both the prep and the PIC historically, it looks like your basis is roughly the same is that the case and so effectively your accruing pick now and your cash exit will be essentially where you thought it was going to be before or is there a change?

So there'll be pick accrual and then we hope that when we exit we get the principal amount you know the entire principal amount you know paid back. I think so I mean we can circle back after the call and I can drill down into the specifics with you, but I believe off the cuff here that we are picking those amounts. The company has had a bounce here with the goal of the company being sold here in the not too distant future.

Got it. And so the idea in terms of giving an additional time with the maturity, I think the maturity was supposed to be August of 21, give them additional time to work through the transaction, but it did look like the coupon on the pick was lower. The net coupon to you guys is actually lower between the press and the pick.

What's the benefit that you received from this transaction? Rick, I have to go back and take a look at it. I don't remember the exact facts and circumstances on this. This was probably six months ago. and many more. This was a sponsor putting money in, restructuring of the balance sheet to kick the can down the road to put the company in a better position for exit, you know, kind of post-COVID. And I think it's a general theme, the specifics of exactly the coupons. I don't remember off the cuff here, but we can certainly get into that after the call. Perfect. Thank you guys very much. Thank you.

We'll go next to Devin Ryan with J&P Securities.

Hi, good morning. This is Kevin Poulton for Devon. You've talked about focusing on portfolio management over the past two quarters, while at the same time, this vintage is particularly attractive. I'm just curious, how do you evaluate making new investments versus preserving liquidity for a potential second lockdown?

That's a great question. And perhaps that's the reason we've been a little, you know, particularly with this company, a little bit more careful about and many more. Thank you. Thank you. Thank you.

and then also the percent of floating rate investments that are currently at their floor.

So 93% of the portfolio has a floating rate, 90% of which, 90% of the 93% have a LIBOR floor and the average floor is 1%.

Okay, thank you. I appreciate you taking my question.

That concludes the question and answer session. I'd like to turn the call back over to Mr. Art Penn for any additional or closing remarks.

Thanks, everybody, for being on the call today. Wishing everyone health and safety, a great Thanksgiving, and early February is a short time around from here at the end of November since this is the case, but we look forward to speaking to you in early February. Thank you very much.

And again, this does conclude today's call. We appreciate everyone's participation today, and you may now disconnect.