PennantPark Investment Corporation ($PNNT)

Good afternoon, and welcome to the PennantPark Investment Corporation's Second Fiscal Quarter 2026 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 begin your conference.

Good afternoon, everyone, and thank you for joining PennantPark Investment Corporation's Second Fiscal Quarter 2026 Earnings Call. I'm joined today by Jose Briones, Senior Partner at PennantPark. Rick Allorto, our CFO, is unable to be with us today due to a prior commitment. Jose, please start off by disclosing some general conference call information include a discussion about forward-looking statements.

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

Thanks, Jose. I'll begin with an overview of our second quarter results, including a review of the portfolio. I'll then share our perspective on the current market environment and how we believe PNNT is positioned going forward. Jose will follow up with a detailed review of our financial results, after which we will open up the call for questions. For the quarter ended March 31, core NII was $0.14 per share. As of March 31, our portfolio totaled $1.2 billion. And during the quarter, we continue to originate attractive investment opportunities and invested a total of $108 million, including 6 new platform investments with a median debt-to-EBITDA of 3x, interest coverage of 3.4x and loan-to-value of only 28%. Our portfolio remains conservatively positioned with median leverage of 4.7x, median interest coverage of 2x and median loan-to-value of 45%. We ended the quarter with 4 nonaccrual investments, representing 2.7% of the portfolio at cost and 1.3% at market value. Our PSLF joint venture portfolio continues to be a significant contributor to our core NII. At March 31, the JV portfolio totaled $1.3 billion. And over the last 12 months, PNNT's average NII yield on invested capital in the JV was 15.8%. The JV has the capacity to increase its portfolio to $1.5 billion, and we expect that with this additional growth, the JV investment will enhance PNNT's earnings momentum into the future. Turning to software exposure, which has been an area of recent market focus. Our exposure remains limited at approximately 4.6% of the portfolio and is structured consistently with our core middle market strategy. These investments are primarily cash pay, covenant protected loans with moderate leverage and shorter durations. Importantly, they are concentrated in mission-critical enterprise software serving regulated industries such as defense, health care and financial institutions. We believe this represents a meaningful point of differentiation relative to our peers. Turning to the market environment. We believe that the current environment favors lenders with strong private equity sponsor relationships and disciplined underwriting; areas where we have a clear competitive advantage. In the core middle market, the pricing on high-quality first lien term loans remains attractive, typically ranging from SOFR plus 500 to 550 basis points with leverage of approximately 4.5x EBITDA. Importantly, we continue to get meaningful covenant protections in contrast to the covenant-light structures prevalent in the upper middle market. M&A activity has increased over the past 6 to 9 months, although overall conditions remain uneven. Private equity sponsors remain active and we're seeing a growing pipeline of attractive opportunities across both the new originations and add-on investments. However, activity levels remain below the unusually strong levels observed in 2024 as the market transitions towards a more normalized backdrop. We expect increased transaction activity to drive repayments across the portfolio, including opportunities to monetize equity co-investments and we'll redeploy that capital into income-generating investments. Notably, we expect a meaningful realization from our equity co-investment in Echelon this quarter. Echelon is a leading defense technology company sponsored by Sage Wind Capital, our long-term sponsor relationship. Echelon announced that it is agreed to be acquired by Shield AI, another cutting-edge defense technology company. Upon closing, we expect our $1.1 million equity co-investment to generate approximately $16 million in total proceeds. Proceeds will consist of $14 million of cash and $2 million of value in Shield AI stock. This represents nearly 15x multiple on invested capital and demonstrates the value of our equity co-investment program. Given the current geopolitical environment and the Echelon news, it's important to highlight that approximately 12% of our portfolio is exposed to government services and defense. Now I'd like to speak about why we believe that our folks on the core middle market provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. The core middle market, companies with $10 million to $50 million of EBITDA is below the threshold and does not compete with a broadly syndicated loan or high-yield markets, unlike our peers in the upper middle market. In the core middle market, because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity co-investment. Additionally, from a monitoring perspective, we received monthly financial statements to help us stay on top of the companies. Our rigorous underwriting standards remain central to our investment philosophy. Nearly all of our originated first lien loans include meaningful covenant protections; a key differentiator versus the upper middle market or covenant-light structures are more common. Since our inception nearly 19 years ago, PNNT has invested $9.3 billion at an average yield of 11.2%, while maintaining a loss ratio on invested capital of roughly 20 basis points annually; a testament to our consistent and disciplined approach through multiple market cycles. As a provider of strategic capital, we fuels the growth of our portfolio companies. In many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall for our platform from inception through March 31, we've invested over $618 million in equity co-investments and have generated an IRR of 25% and a multiple on invested capital of 2x. Looking ahead, our experienced team and broad origination platform position us well to generate attractive deal flow. We remain steadfast in our commitment to capital preservation and maintaining a disciplined patient investment approach. We continue to focus on investing in high-quality, middle-market companies with strong free cash flow generation. We capture that value through first lien senior secured loans, and we pay out those contractual cash flows in the form of dividends to our shareholders. With that overview, I'll turn the call over to Jose for a more detailed review of our financial results.

Thank you, Art. For the quarter ended March 31, both GAAP net investment income and core net investment income were $0.14 per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $8.1 million, base management incentive fees were $5.6 million. General and administrative expenses were $1.5 million, and provision for excise taxes were $0.5 million. For the quarter ended March 31, net realized and unrealized change on investments and debt, including provision for taxes was a loss of $11.7 million. As of March 31, our NAV was $6.73 per share, which is down 3.9% from $7 per share in the prior quarter. . At March 31, our debt-to-equity ratio was 1.35x, and our capital structure was diversified across multiple funding sources including both secured and unsecured debt. In January, we raised $75 million of new unsecured debt, which was used to repay our unsecured debt that matured on May 1. As of March 31, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 160 companies across 38 different industries. The weighted average yield on our debt investment was 10.9%. The portfolio is comprised of 48% first lien senior secured debt, 2% second lien secured debt, 14% supported notes to PSLF, 7% of other subordinate debt, 5% equity in PSLF, and 24% in other preferred and common equity co-investments. 88% of our debt portfolio is floating rate, debt-to-EBITDA in the portfolio is 4.7x and interest coverage is 2-point times. With that, I'll turn the call back to Art for closing remarks.

Thank you, Jose. In conclusion, we remain committed to delivering consistent performance, preserving capital and creating long-term value for all stakeholders. Thank you to our team for their dedication and our shareholders for their continued partnership and confidence in PennantPark. That concludes our remarks. At this time, I'd like to open up the call to questions.

[Operator Instructions] We'll take our first question from Robert Dodd with Raymond James.

On just a question about the market outlook, if I could, in kind of sort of 3 segments. Overall, you gave some color, obviously, conditions are still below what they were last year, et cetera. I mean is there any mainly some false scenario where that really meaningfully accelerates as we go through the year given the level of uncertainty? And then within two subsectors there, like what are your thoughts on software right now because spreads are widening, but it's not an area you've typically done a lot of? On the other hand, an area where you have done a lot is government in contracting, et cetera, which you've just got a really nice gain lining up. Do you expect the competitive dynamics to change in that segment of the market, given how stable and budget talk for defense, except is looking going forward? I mean that's a lot of a question there, sorry.

Thanks, Robert. I'll try to cover the market outlook and software, and I'll kick it over to Jose to talk about Government Services. Look, on M&A flows, we're certainly hopeful. We're seeing some green shoots or more than green shoots. It's just not as robust as it was. Certainly, it takes a real -- kind of a more stable market we think, to see more volume. We hope there is. Last year, we had Liberation Day kind of spike the punch bowl this year, whether it's the war or some of the other issues. We're certainly hopeful that we'll see a more normalized environment. We're hearing that it will be, but we've heard that before. So the proof will be in the pudding. Echelon and some other deals we're seeing are good indications that there is still deal flow. With regard to software, we never really did much in software, primarily because the leverage multiples were higher than we were comfortable with. So the software that we do have, which is relatively small, it's kind of 4x, 5x leverage. It's certainly not levered 6x, 7x, 8x are levered against ARR. So even though the -- so we're just still not seeing a market. And certainly, with AI coming on, there's just probably too much secular risk on the system. We're open-minded. We always want to learn, and maybe there will be opportunities in this reassessment of the technology stack. So we're open to it. But as always, we want to make sure leverage is reasonable that we can get comfortable that the company's have a strong moat and that the companies have a real reason to exist long term. So with that, Jose, do you want to comment on Government Services defense?

Sure. Robert, great to hear from you. Look, Government Services is a sector that we've been involved for quite some time. It's a very nuanced space that we like, where we have very long relationship with private equity sponsors that know that space really well. We think that's an area of growth in an area of opportunity for us. Acquisition of Echelon by Shield is a great example of that. to the market in general, the first quarter is seasonally slow for our business and then usually picks up. With regards to the government services and government contracting clearly given the confident in the Middle East, there's a lot of emphasis on that, and we're still seeing interesting opportunities in that part of the market. Another area that we do spend a lot of time with is health care and health care services, as you know. And that's an area that we do like and we do see interesting opportunities. Pricing for the market generally has been in that $500 million to $550 million. We haven't seen much change in that in the past couple of quarters. So our expectation, to Art's point earlier, is to continue to focus on the areas where we like in the areas where we have expertise in.

Got it. One more if I can. I mean, it seems like every quarter we're asking like, oh, what's your exposure to or the risk from this, it was software a year ago to your point, it was tariffs, a lot of things. Now I've got to ask about oil and commodity prices. I mean, the uncertainty in the oil markets and the supply there. I don't think you have a ton of exposure anymore. But what's kind of the portfolio exposure if oil were to go meaningfully higher for a sustained period or supply issues for that matter, right?

Yes. So it's a good question. And as you know, in our history, we did oil and gas, and that was not -- that's why we don't do it today, enough said there. I guess you could think of kind of other areas could impact -- could it impact the American consumer if gas prices are higher? For sure. And consumer is a sector of ours. Now in most cases, we're doing consumer services that we think are a little less discretionary like HVAC. When your air conditioning breaks, other services around the home. Consumer is a piece of the portfolio, it's not an overweight piece of the portfolio, but it is. So you can certainly think about all the -- we don't do much in manufacturing, so kind of none of that plastics kind of manufacturing paper packaging, we don't really have any exposure there. So I'd say it's really the American consumer, which -- by the way, the American consumer is a big, big chunk. The overall economy of the American consumer is weaker that has a lot of other impacts that may happen. But I would say that's the closest thing we have to oil exposure.

We'll go next to Arren Cyganovich with Truist Securities. .

So the Echelon transaction that's going to close in the second quarter, I think, is that what you said? And then what -- is the sale price consistent with where it was marked at 3/31?

Yes, we think it will close in the next 60 days, and it's marked at fair value at the good price. .

Okay. I just wanted to clarify that. Any other equity positions that are in talks or anything you can identify that might potentially move over the next quarter or two?

Yes. No, these are less impactful. There's a company called Guild Garage, which was marked at fair value at 3/31, which has since exited. So there's an equity co-invest there which is a few million dollars. And we have others that are kind of in the wings. Nothing as impactful as Echelon, but getting some singles and doubles here and there should be helpful. .

We'll take our next question from Rick Shane with JPMorgan.

Guess I'm glad that we're not revisiting the whole oil and gas thing. It seems like the last time we were talking, that was a big issue years ago. The question we've been asking everybody this quarter, and I'm curious, given your focus is sort of where in the continuum we are in terms of pricing and more importantly, deal structure? And I took your comments to mean that you just don't ever see the sort of variance that we might see in the BSL market. And should we sort of -- how should we think about this?

Well, we should -- look, I mean you have the upper market where many of our -- many of the large peers play above [ 50 EBITDA ]. And that's been covenant life for a while because those borrowers have options in the broadly syndicated loan market. So that market also similarly as the companies there only report to those lenders every 3 months. So -- and then they don't get co-invest even if they wanted it, they may or may not want it, they don't get co-invest. And just kind of the deal decision-making is much tighter. Our prototypical deal is we're working on a company where a fund or a family or an entrepreneur is selling to the middle market private equity sponsor and the company does $10 million or $20 million of EBITDA. And the game plan is to take that company and grow it and buy add-on acquisitions and get it to $30 million, $40 million, $50 million, $60 million, so that it can then be sold or then financed in the upper market. So as a result, in our world and our capital is strategic capital. It's there usually with the lay draw term loan to help fuel the growth. So we've become very much a strategic partner of that company. We've become the strategic partner of that management team, a strategic partner of the sponsor. And our loan is the fuel. So because we're the strategic partner, we have plenty of time to do our diligence. We really understand and we need to understand what we're lending to. We, of course, get maintenance covenants, quarterly tests that need to be met contractually. We get monthly financial statements. We have the option and make cases, we take the option to co-invest in the equity because, of course, if we're helping to create the equity value with our loan, why wouldn't we help participate in -- participating in an upside and you see the benefit of that. Echelon is an excellent example. You can see the benefit of having something in this portfolio or these portfolios that's got some lift that can offset. And the inevitable nonaccruals you have. We all have nonaccruals. There's no private credit manager that's perfect. You try to develop a diversified book, minimize nonaccruals, but you're going to have nonaccruals. So having some equity co-invest in these portfolios we found helpful to help fill in for some of those gaps. So we're operating in an entirely different world than the upper market. And it just doesn't make sense for the business model of those folks in the upper market to come down and spend their time on companies of this size given the size of check. If you're managing $100 billion or $200 billion or whatever you're managing in private credit, it just doesn't make sense to be focused on this end of the world. And therefore, that's why there's only a handful of real competitors that we have in this kind of below $50 million of EBITDA. It's a long-winded answer, Rick, I don't know if I answered your question. But please continue to ask if I didn't get to.

No, you did. And again, I think that helps on the asset side. Curious on the funding side, if there's anything that we should be thinking about here banks have been very reliable partners in the space, but you always do wonder about sort of selectivity of credit. And curious if you're seeing any opportunity or any risk on the financing side.

Yes. No, we having -- it's a great question because having started our business right before the global financial crisis. We learned very early that lender transparency, relationship with lenders is so key, and they become our partners. So we are always reaching out to our lenders and offering to bring them in and transparently go name by name. Interesting, a month or 2 or 3 ago when the headlines about private credit started to to come out, we proactively reached out to every one of our lenders that we said, come on in. We'd be happy to walk through loan by loan, what's going on with our portfolio. We feel really good about it and feel like we've underwritten a very solid book. And the vast majority of the lenders said to us, "You know what, you don't have much software exposure. Your way down on our list of who we're going to come visit. We've got plenty of other people to go visit." So we're always doing that. We're always out with our lenders, developing relationships. As you know, in PNNT, we have different types of debt capital. We have good old credit facilities, we have bonds, and we have securitizations that we use. They're all useful tools, and we have a diversified strategy of using.

Got it. Well, if there is any credit contraction on that side, you remain at the bottom of their list in terms of visits as well.

Yes.

We'll go next to Christopher Nolan with Ladenburg Thalmann.

Do you know the reason for the drop in total interest income quarter-over-quarter?

Let me come back to you on that.

No problem at all.

I'm sorry, Eric Leeds is here from our finance. But Eric, do you have anything you'd like to add on that?

Basically, the smaller average portfolio over the quarter, I believe.

Great. I mean we ended up generating $0.14. I think consensus was $0.15, but we were certainly happy to go into the detail with you, Chris, if you'd like.

No, no, that's okay. And in general, are you seeing a migration of portfolio companies from high tax states to lower tax states at all?

Yes. No, we aren't. We do have a very diversified portfolio geographically around the United States. Certainly, we tend to lend the companies that are growing companies wherever they may be, but we haven't yet seen movement of headquarters given what's going on. .

At this time, there are no further questions. I'll now turn the call back to Art for any additional or closing remarks.

Thank you, everybody. Really appreciate everyone's participation today. Wishing everyone a Happy Mother's Day. And we look forward to speaking to you next in early August at our next earnings report. Thank you very much.

This does conclude today's conference. We thank you for your participation.