Good morning, and welcome to the PennantPark Investment Corporation's Third Fiscal Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be opened for a question-and-answer session following the speakers' remarks. [Operator Instructions] It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

Thank you, and good morning, everyone. I'd like to welcome you to PennantPark Investment Corporation's third fiscal quarter 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.

Thank you, Art. I'd like to remind everyone that today's call is being recorded. Please note that this call is a property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using 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 the projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.pennantpark.com, or call us at 212-905-1000. At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thanks, Aviv. I'm going to provide an update on the business starting with financial highlights, followed by discussion of the overall market, the portfolio, investment activity, the financials, and then open it up for Q&A. For the quarter ended June 30, 2018, we invested $188 million in primarily first and second lien secured debt at an average yield of 10.5%. Net investment income was $0.17 per share. Our recurring run rate income is now $0.18 per share, excluding other income, which we received for items such as prepayment penalties. We purchased $7.8 million of our common stock at an average price of $7.25 per share as part of a $30 million stock repurchase program, which was authorized by our Board last quarter. 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 $0.26 per share, which provides further dividend cushion. With a generally stable underlying portfolio and substantial 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. 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 secured investments. Reminder about our long-term track record, PNNT was in business since 2007,…

Thank you, Art. For the quarter ended June 30, 2018, net investment income totaled $0.17 per share. We had about $0.02 per share of other income. Looking at some of the expense categories, management fees totaled $6.3 million, general and administrative expenses totaled $1.1 million, and interest expense totaled $5.6 million. During the quarter ended June 30, unrealized loss from investment was $14 million, or $0.20 per share. Unrealized gains on our debt instruments was $2 million or $0.02 per share. We had about $17 million or about $0.25 per share of realized gains. The accretive effect of our share buyback was about $0.03 per share, excess dividends over income was about $0.01 per share. Consequently, NAV per share went from $0.09 per share to $9.09 per share. As a reminder, our entire portfolio, credit facility, and senior notes are mark-to-market by our Board of Directors each quarter using the exit price provided by independent valuation firms, Security and Exchanges or independent broker dealer quotations, when active markets are available under ASC 820 and 825. In case where broker dealer quotes are in active, we use independent valuation firms to value the investments. Our overall debt portfolio has a weighted average yield of 11.4%. On June 30, our portfolio consisted of 51 companies across 25 different industries. Their portfolio was invested in 43% first lien secured debt, 38% in second lien secured debt, 3% in subordinated debt, and 16% in preferred and common equity. 91% of their portfolio has a floating rate. 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 couple 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.

Thank you. [Operator Instructions] And we'll take our first question from Casey Alexander with Compass Point.

I'm sure this quarter feels good. Feels like you're turning the corner. May I ask you a question, Art? You've got probably capacity to make an additional $50 million or so of investments just out of cash without negatively affecting your leverage ratio, and bringing that effective leverage ratio kind of up closer to where your actual leverage ratio is right now. So how does the funnel look and how do you feel about what's in the funnel and maybe the pace of deployments versus repayments which I know is an edgy subject? But how do you feel about the funnel and how do you feel about deployments over the next couple of quarters?

Thanks, Casey. Yes, it does feel like we're making really nice progress on a lot of fronts here. So I'm feeling good about the opportunity. We're also feeling good about the opportunity in the market, particularly as we've invested in our platform and have a terrific group of investment professionals now across the country, not only New York, but LA, Chicago, Houston, London. And we see some really nice deal flow coming in from the middle-market financial sponsors. You're seeing a greater opportunity for us, higher in the capital stack, first lien and stretch senior, and some nice second liens from time to time. So we feel good about the opportunity to deploy capital to live within the 80% leverage ratio at this point, utilize our enhanced platform, and continue to drive income that covers the dividends. As I said in my remarks, our recovering NII today covers our dividend, and that excludes the other income that we typically get between $0.01 and $0.03 per share per quarter, to enhance that recurring income. So we feel very good about the dividend coverage. Feel good about the economies of portfolio and we're on the mission to monetize the equity investments and energy investments over time hopefully can provide upside. We do have idle cash, some of that is stuck in the SBICs and that's just, we utilize that as SBIC eligible investments come into the platform.

Okay. I saw that you - did you pay down any SBI debentures this quarter?

We're gradually paying down SBIC I. We're down to $30 million in SBIC I. We'll continue to gradually pay that off. And we're into the SBA with an application for SBIC III. And we're hopeful that at some point we can move forward on that.

And could you repeat again how much spillover income you have - on a segment [ph] per share?

Yeah, it was in the - $0.26 per share as of September 30. We only disclose once year. It's still right around that number.

Okay. And I appreciate your remarks on RAM and ATX. Can you give any feel, just save me time from looking it up? How do they mark against each other quarter to quarter? And do you think that you're going to have to put any more incremental capital into either one of them to help them get across the finish line?

Yeah, so they were both marked up a little bit from quarter to quarter. We did provide an incremental revolver to RAM, a $15 million - $15 million size. I think they've drawn $4 million on it. And this is to prove out some acreage that they have, which we think is a good shot of being very productive.

All right, great. Well, thank you very much for taking my questions.

Thank you.

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

Good morning, guys. Thanks for taking my questions. My first question was just you guys had a pretty robust quarter as far as funding goes, but you were just a little bit lighter then on interest income. Was that just kind of due to the timing being a little bit more weighted to the back-end of the quarter?

Yeah, yeah, that's exactly right again. It's almost every quarter. For some reason when you're doing - when you're financing these deals everyone [colesses] [ph] around quarter end. And deals have to get done by quarter end. It makes the accounting helpful. It's just - so usually, most - it's I would say for BDCs in general, but certainly for us the new deals comes right around quarter end.

Yeah. Thanks for that. And then, I guess on a similar note, as far as repayments go, I think, there are down a little bit as far as kind of the - sort of the level that you running out repayments to start to year out. We've heard from other BDCs that they've kind of seen more normalized level of debt repayments kind of coming in here in the back half of that year, is that sort of what you guys have seen - you've been seeing a more normalized level of repayments?

Yeah, and look, it's kind of - it's a good question and it's also link to spread compression, if there is higher spread - there is more spread compression, and likely to see more repayments, if there is less spread compression and no spread compression or there is spread expansion, you're going to see fewer repayments. So we've seen less spread compression, we've seen really no spread compression over the last quarter, quarter-and-a-half, and the repayments have been less as a result. So one of the reasons we've seen healthy growth is due to that.

Sure. That makes sense. And my last question was just on your investment in U.S. Well Services. I'm just curious, after that transaction is completed, I think, you said, you expect fourth quarter of this year. Do you expect to be able to exit your equity position shortly after or is there any sort of mandatory lockup period that follows close?

It's a good question - that's a good question. So there is 50% lockup for six months and another 50% at 12 months. Look, I think, if you look at the comps, we think U.S. Well even at this price is cheap and as a reasonable start to trade up in generally more NAV upside for our shareholders.

Okay. That's great. Those are all my questions. Thanks for taking me this morning.

Thank you.

And we will take a follow-up question from Casey Alexander with Compass Point.

No. I must have had a fat finger or something. I don't have any follow-up. Thank you.

And we will take our next question from Kyle Joseph with Jefferies.

Good morning, guys. Thanks for taking my questions. Just going back to the 3 point plan you laid out factored that in with rising rate, just kind of want to blend all that together and get your outlook for yields over time. Obviously, you have some upside from equity monetization and rising rates, but then also moving up the capital spectrum may offset that. But just kind of your outlook for yields going forward?

Yeah, you're right. There are some cross currents. As we move up the capital stack, our overall yield in the portfolio has come down a bit. That said, we're starting to get some offset from LIBOR. And then again rotating our equity and energy investments into cash paying debt securities over time should be a positive. And so, look, we think there is upside you saw this quarter on our run rate, our recurring NII, before our other income is covering our dividend now. And we think it has a reasonable shot continue to grow as LIBOR, it goes up over time, as we rotate those energy in equity investments, and we should provide a very solid comfortable hopefully cushion to our dividend stream.

Got it. And then, I know you mentioned earlier, you're not seeing any signs of recession. But could you give us a sense for sort of revenue and EBITDA growth trends of your portfolio companies and any changes you've seen there in recent quarters?

Yeah. Look, I still think our portfolio which between our various vehicles, it's up to about 150 companies. It's a growing economy based on what we can see. Is it between slow growth and a little middle - moderate growth? I'd say it's like moderate growth, which means, I don't know, 5% to 7% EBITDA growth, as a general proposition across the portfolio, some greater, some lowers, but probably a moderate 5% to 7% growth of EBITDA. So we're still seeing a strong economy. We feel good about the underlying portfolio. But we remain vigilant. We remain vigilant. We do underwrite as if a recession is coming. And we do very robust downside cases in our models and as we underwrite credit. As I said, we are one of the middle-market direct lenders that as in business before the global financial crisis and recession. We've got a very nice track record of underwriting credit through that period of time, and that was on a primarily subordinated or mezzanine debt portfolio. So we're using that same underwriting discipline. So we feel - and hopefully, that will be protected if and when the economy softens. But right now, we are seeing a very nice moderately growing economy.

Great. Thanks very much for answering my question.

[Operator Instructions] We will take our next question from Paul Johnson with KBW.

Sorry. I don't have any follow-up questions. I hop back in queue.

And we'll take our next question form Mickey Schleien with Ladenburg.

Yes, good morning, Art and Aviv. I just wanted to follow-up on the interest income question, I sort of have the same question as a previous caller. If I look at the average debt portfolio at cost, it was down about 3% and yield was pretty stable, but interest income was about 6%. So I understand that you said net investments for skew toward the end of the quarter. But is there some other sort of adjustment or reversal also in the interest income line that we should aware of?

No. It's kind of - I think, the combination of kind of probably be backend weighted in the quarter, LIBOR helping in kind of like we said, right now our recurring run rate is $0.18. So Aviv will be happy I'm sure to go through your model with you later if you'd like, Mickey.

Yeah, I might do that. And just a couple of more if I may at a high level. Could you give us the sources of - the main sources of the realized gains and the unrealized losses this quarter?

Yeah, so the realized gains, I mentioned in the prepared remarks, which were Legal field, big realized gain there. Roto Holdings, big realized gain there. And then the unrealized losses, they were just kind of nothing big, but small markdowns, and if any, on small markdown in [J&F Holding, small markdown in Superior Digital] [ph]. So that was kind of the highlights and lowlights.

Okay. And lastly on the cash, you had mentioned some of it is in the SBIC. Can you give us an idea of how much that is and also how much cash is being held in relation to the credit facility to hedge foreign investments?

So in SBIC II, there is about 50-ish of cash. And the credit facility that we currently have drawn is primarily for our non-U.S. investments. And it's drawn in whether it'd be euro or pound/sterling to hedge those investments. But we have ample credit facility space, as we look at refinancing the bonds at some point. And one option is to just draw down our credit facility and pay down the bonds with our credit facility. So it's nice to have that extra super-liquidity that we have in our system.

Okay. And just lastly, you have a pretty meaningful then, liquidity in the SBIC. How does the pipeline look for SBIC qualified deals and your ability to put that money to work, let's say, over the next few quarters?

It's a great question. We're optimistic. But it's in our - lot of these rules and regulations and buckets and baskets that - and the definition of what fits and what industry vertical in regulations, in certain cases makes it challenging to find stuff that fits. But - and again, we're not - we don't do anything different from the standpoint of our underwriting standards. If we like a deal, we like it for the SBICs and where we like it for however we finance it. So it's the same underwriting standards. And our team knows that it's great when we could find stuff that fits. It's been challenging recently, more helpful that we can use the $50-million-or-so of cash in SBIC II and hopefully get a license for SBIC III. And it's been very nice relationship we've had with the SBA.

Okay, terrific. Those are all my questions this morning. I appreciate your time and, I guess, we're talking about half an hour.

Right.

And we'll take our next question from Mark Hughes with SunTrust.

Yeah, thank you. Good morning, Art. Good morning, Aviv.

Hey, Mark.

Last time around, going into the financial crisis, did you have any particular orientation in terms of end-markets or types of businesses that you had focused on at that time that let you weather the crisis better than peers or was it the underwriting process that was more relevant?

Yeah, it's a great question. And it's lots of lessons learned. We got in business in April of 2007. And by the summer of 2007, we could tell from our portfolio of companies that the economy was starting to soften. So we said at that point, look, we're going to raise the bar. We're still going to invest. But the deals that we do were going to be in industries that view as recession-resistant that are less cyclical, where we can get good covenant packages, good returns, and where we feel really comfortable. So we did deals between June of 2007 and September of 2008. We had raised the bar. And it's interesting, that vintage of deals that we did before September of 2008 ended up being a really nice vintage even though it was done before the global financial crisis and recession, because we had proactively raised the bar. And that was based on real-time data we were getting from our portfolio of companies. So when we say today, we're seeing those signs of recession. Right now, we're not seeing any signs recession. Of course, we're going to try to find recession-resistant companies and have good covenants and good returns, and underwrite as if a recession is going to come. But we're not seeing signs at this point. And we get monthly financial statements from most of our companies.

I appreciate the color. Thank you.

[Operator Instructions] We'll take our next question from Rick Shane with J.P. Morgan.

Hey, guys. It's Melissa on for Rick today. I wanted to check in with you on the share repurchase activity. There were some pretty healthy repurchases during the quarter. And it would imply if that's the run rate that you would pretty much fully use the $30 million authorization. Is that consistent with how you're thinking about it?

Yeah, we've - thanks, Melissa, good question. And, look, we're thinking - we authorized - the Board authorized $30 million. We're thinking about it like 25% a quarter for four quarters. That's how we think about it. So this was $7 million, $8 million. I mean, that's the game plan. Now, obviously, if there is an opportunity to buy more at lower prices, we may accelerate that. But the thought going into it is about 25% a quarter.

Right, thanks, Art.

Thank you.

It appears there are no further questions at this time. Mr. Penn, I'd like to turn the conference back to you for any additional or closing remarks.

I just want to thank everybody for being on the call today. We're very excited about PennantPark Investment Corporation as hopefully you can tell. We thank you for your time today. Our next conference call will be probably mid-November. A reminder that that's our 10-K, so it takes a little bit longer for us to get our 10-K done, then our 10-Q. So it will be a little later next quarter, but certainly by mid-November. We look forward to speaking with you then. Hope everyone has a great rest of the summer and we'll be talking to you soon. Thank you very much.

This concludes today's call. Thank you for your participation. You may now disconnect.