Earnings call transcript: PennantPark misses Q4 2024 forecasts

PennantPark Investment Corporation (PNNT) reported its earnings for the fourth quarter of 2024, revealing a slight miss on both earnings per share (EPS) and revenue forecasts. The company reported an EPS of $0.20, falling short of the anticipated $0.21. Revenue reached $34.21 million, below the forecasted $35.34 million. Following the announcement, PennantPark’s stock experienced a minor decline of 0.76%, closing at $7.19, as investors digested the results. According to InvestingPro data, the company maintains a market capitalization of $465.89 million and trades at an attractive P/E ratio of 9.49, suggesting potential value for investors. InvestingPro subscribers have access to 6 additional key insights about PNNT’s valuation and growth prospects.

Key Takeaways

• PennantPark’s EPS and revenue both fell short of expectations.
• The company’s net asset value (NAV) increased by 0.1% to $7.57 per share.
• Stock price decreased by 0.76% in after-hours trading.
• Joint Venture portfolio expanded significantly, with a return of 18.4%.

Company Performance

PennantPark Investment Corporation showed resilience in a challenging market, focusing on its core middle market strategy. The company managed to grow its Joint Venture (JV) portfolio to $1.3 billion, investing $354 million during the quarter. Despite missing earnings forecasts, PennantPark achieved a net realized and unrealized gain of $3.1 million on investments. The company’s NAV saw a modest increase, reflecting its strong portfolio management.

Financial Highlights

• Revenue: $34.21 million, compared to a forecast of $35.34 million.
• Earnings per share: $0.20, compared to a forecast of $0.21.
• Operating expenses included $11.7 million in interest and credit facility expenses, and $7 million in management fees.
• Debt to equity ratio stood at 1.57x.

Earnings vs. Forecast

PennantPark’s EPS of $0.20 was slightly below the forecast of $0.21, marking a minor miss of approximately 4.8%. Revenue also fell short by about 3.2%, coming in at $34.21 million versus the expected $35.34 million. These results represent a slight deviation from the company’s historical performance, where it has often met or exceeded forecasts.

Market Reaction

Following the earnings announcement, PennantPark’s stock price fell by 0.76% in after-hours trading, closing at $7.19. This movement places the stock closer to its 52-week low of $6.43, indicating cautious investor sentiment. The decline reflects concerns over the earnings miss, despite the company’s stable NAV and robust JV performance. InvestingPro analysis reveals that PNNT has maintained dividend payments for 19 consecutive years, with a substantial current dividend yield of 13.35%. The stock’s beta of 1.52 indicates higher volatility compared to the market, which may present opportunities for tactical investors.

Outlook & Guidance

Looking ahead, PennantPark plans to optimize its JV over the next two to three quarters, aiming to reduce equity exposure from 20% to 10%. The company remains focused on capital preservation and anticipates increased M&A activity in the core middle market in 2025. PennantPark’s strategic emphasis on sectors with strong free cash flow and recession resilience positions it well for future growth.

Executive Commentary

CEO Art Penn emphasized the company’s strategy, stating, "We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities." He also highlighted the company’s commitment to capital preservation, noting, "Our continued focus remains on capital preservation and being patient investors."

Risks and Challenges

• Potential economic downturns could impact middle market companies.
• Interest rate fluctuations may affect floating rate debt investments.
• Increased competition in the middle market could pressure margins.
• Regulatory changes in targeted sectors could pose challenges.
• Dependence on JV performance for growth may introduce volatility.

Q&A

During the earnings call, analysts inquired about the potential merger with PennantPark Floating Rate Capital (NYSE:PFLT) and strategies for equity rotation. Executives addressed concerns about the company’s exposure to government services and healthcare sectors, and explained the growth and dividend distribution strategy for the JV.

Full transcript - PennantPark Investment Corporation (PNNT) Q1 2025:

Art Penn, CEO, PennantPark: opportunities and invested $296,000,000 in 12 new and 61 existing portfolio companies at a weighted average yield of 10.6%. We continue to see an attractive vintage in the core middle market. For investments in new portfolio companies, the weighted average debt to EBITDA was four times, the weighted average interest coverage was 2.2 times and the weighted average loan to value was 62%. As of December 31, the portfolio’s weighted average leverage ratio through our debt security was 4.9 times and the portfolio’s weighted average interest coverage was 1.9 times. These attractive credit statistics are a testament to our selectivity, conservative orientation and our focus on the core middle market.

In the core middle market, the market yield on first lien term loans appears to have stabilized in the so for plus 500 to $5.50 range. As the credit statistics just highlighted indicate, we continue to believe that the current vintage of core middle market loans is excellent and the core middle market leverage is lower, spreads are higher and covenants are tighter than the upper middle market. And we are still getting meaningful covenant protections. Our JV portfolio continues to grow and be a significant contributor to our NII. At December 31, the JV portfolio grew to $1,300,000,000 And during the quarter, the JV invested $354,000,000 including $286,000,000 of purchases from PNNT.

Over the last twelve months, PNNT earned an 18.4% return on invested capital in the JV. The JV has the capacity to increase its portfolio to $1,600,000,000 and we expect that with the continued growth in this portfolio, the JV investment will enhance PNNT’s earnings momentum in future quarters. The credit quality of our investment portfolio remains strong. We had two non accruals as of December 31, which represented 4.3% of the portfolio cost and 1.5 of market value. Now let me turn to the current market environment.

We’re well positioned as a lender focused on capital preservation in The United States. We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we provide important strategic capital to our borrowers. We have a long term track record of generating value by successfully financing growing middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right question to ask and have an excellent track record. They are business services, consumer, government services and defense, healthcare and software technology.

These sectors have been recession resilient and tend to generate strong free cash flow. In the core middle market, companies with $10,000,000 to $50,000,000 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 stats, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity and co investments.

Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. With regard to covenants, unlike the erosion in the upper middle market, virtually all of our originated first lien loans have meaningful covenants, which help protect our capital. This is a significant reason why we believe we are well positioned in this environment. Many of our peers who focus on the upper middle market state that those bigger companies are less risky. That is a perception and may make some intuitive sense, but the reality is different.

According to S and P loans with companies with less than $50,000,000 of EBITDA have a lower default rate and a higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of the core middle market where there’s more careful diligence and tighter monitoring have been an important part of this differentiated performance. As a provider of strategic capital, it 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 December 31, we’ve invested over $563,000,000 in equity co investments and have generated an IRR of 26% and a multiple on invested capital of two times. Since inception nearly eighteen years ago, PNNT has invested $8,600,000,000 at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 20 basis points annually. This strong track record includes the investments of primarily subordinated debt that we made prior to the global financial crisis, legacy energy investments and recently the pandemic. With regard to the outlook, new loans in our target market are attractive. Our experienced and talented team and our wide origination funnels producing active deal flow.

Our continued focus remains on capital preservation and being patient investors. We want to reiterate our goal to generate attractive risk adjusted returns through income coupled with long term preservation of capital. We seek to find out investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily through debt instruments and we pay out those cash flows in the form of dividends to our shareholders. Let me now turn the call over to Rick, our CFO to take us through the financial results.

Rick, CFO, PennantPark: Thank you, Art. For the quarter ended December 31, GAAP and core net investment income was $0.2 per share. For the quarter, NII was negatively impacted by $0.012 per share as a result of placing our investment in Pragmatic Institute on full non accrual. Operating expenses for the quarter were as follows: Interest and credit facility expenses were $11,700,000 Base management and incentive fees were $7,000,000 General and administrative expenses were $1,750,000 and provision for excise taxes was $700,000 For the quarter ended December 31, net realized and unrealized change on investments and debt, including provision for taxes, was a gain of $3,100,000 dollars As of December 31, our GAAP and adjusted NAV was 7.57 per share, which is up 0.1% from $7.56 per share in the prior quarter. As of December 31, our debt to equity ratio was 1.57x and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.

As of December 31, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 158 companies across 35 different industries. The weighted average yield on our debt investments was 12%. We had two non accruals, which represent 4.3 of the portfolio at cost and 1.5% at market value. The portfolio is comprised of fifty percent first lien secured debt, four percent second lien secured debt, 11% subordinated notes to PSLF, six percent other subordinated debt, 6% equity in PSLF and 23 other preferred and common equity.

94% of the debt portfolio is floating rate. Debt to EBITDA on the portfolio is 4.9 times and interest coverage is 1.9 times. Now let me turn the call back to Art.

Art Penn, CEO, PennantPark: Thanks, Rick. In closing, I’d like to thank our dedicated and talented team of professionals for their continued commitment to PNNT and its shareholders. 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.

Conference Operator: We’ll now take our first question from Mark Hughes with Truist.

Mark Hughes, Analyst, Truist: Yes. Thank you. Bart, I’m just sort of curious that any commentary about the level of capacity or competition in the core middle market? I think you described spreads as relatively stable, so that’s one meaningful indicator. So I’m just curious whether you’ve seen more folks in the market pursuing these type of loans?

Art Penn, CEO, PennantPark: Good question, Mark. We have not seen new players. The larger players have not chosen to come down into this kind of space. We’ve seen them exit and go up market. So there’s really just a handful of players that we view as kind of peers in this market.

And frankly, there’s not many of those peers who kind of have our game plan of being willing and able to finance a $10,000,000 EBITDA company, for instance, and then have a game plan to finance the growth of that company up to $30,000,000 40 million dollars 50 million dollars of EBITDA. So we’re one of the only couple of players I think that can kind of are willing, able and would like to do that kind of growth financing. In many cases, we’ll make an initial loan to the platform and we will structure a delay draw term loan to fuel the growth of that company. So no new competitors of meaning, spreads have kind of stabilized to $500,000,000 5 50 million dollars in general and it’s been a pretty good environment to be a lender.

Mark Hughes, Analyst, Truist: How about your appetite or the companies or private equity, the appetite for the equity co investments? Is that something you’re pursuing more or less? Is that going to be a stable part of the investment portfolio?

Art Penn, CEO, PennantPark: I don’t think we do it more or less. They’re each individual investment decisions. We first try to figure out if we can make a good and safe loan. And then separately as a separate investment, we evaluate the equity co invest. In those prototypical deals where we’re fueling the growth and we’re helping these companies and private equity sponsors grow,

Mark Hughes, Analyst, Truist: we

Art Penn, CEO, PennantPark: think it makes a lot of sense to be participating in that upside to some extent that we’re helping to create with our loans. So in many of those cases, we will ask for and receive some form of upside equity co invest instrument to capture some of that growth. And we think it makes a lot of sense as a portfolio matter because even though we’re highly diversified and we’re very selective and we try to keep leverage low. We like having something in our portfolio that’s

Robert Dodd, Analyst, Raymond (NSE:RYMD) James: got a

Art Penn, CEO, PennantPark: little bit of lift. And on those co invest over time, as we’ve said, we’ve had a 26% IRR and two times MOIC. So that’s helped to solidify NAV over time.

Mark Hughes, Analyst, Truist: Yes. And then when we think about net investment activity for PNNT, obviously the JV took down a lot of the investments. How do you think that will trend in the kind of the first half of the year? Would we expect PNNT to be a net investor, net positive investment activity?

Art Penn, CEO, PennantPark: At this point, PNNT is optimized. I still think we believe PNNT long term should be leveraged in the 1.25 times, 1.3 times debt to equity range. So PNNT is a little bit higher than that right now, really just as a holding pen for assets that are going to end up in that growing joint venture. So long term, we’re still anticipating PNNT’s leverage back down to that 1.25 times, 1.3 times zone, but a little bit more leverage than that for now temporarily as it holds assets that will ultimately end up in that joint venture.

Mickey Schleien, Analyst, Ladenburg: Thank you.

Robert Dodd, Analyst, Raymond James: Thank you.

Conference Operator: We’ll now take our next question from Robert Dodd with Raymond James.

Robert Dodd, Analyst, Raymond James: Good morning. How are you doing? On the spillover income question, I mean, you’ve got to your point in the prepared remarks or sell for me $0.99 I mean, that’s basically your dividend run rate, which means functionally you can’t cut the dividend until that’s worked down, not without paying corporate tax at least. So where would you like to work that spillover income down to in terms of like how many quarters of dividend or a dollar number? I mean, because that’s it’s to your point, it’s going to take a long time at the rate it’s getting eaten into.

But just give us any color on what your target kind of level would be for that?

Art Penn, CEO, PennantPark: It’s a great question. And part of it is what’s the market opportunity? Where is the yield in the market? What’s our equity rotation looking like? At this point, we’re kind of steady as she goes.

We think we should be earning more than 20 on a core basis. As we said, 2021, ’20 ’20 ’2, we should be. We’re hoping that 2025 will give us an opportunity to rotate equity. And you see some of the names that have been marked up. We would hope we can turn some of those into cash.

So I don’t necessarily know that we have a target. We know that our shareholders like a steady stable dividend stream and we think we’ve got plenty of runway to do that under the current construct. But we’ll kind of grind through 2025, see where we end up and continuously speak to our board about it and try to understand where the market is and how the overall platform is doing in terms of kind of getting rotation on the equity. And I don’t really have an exact answer for you. It’s kind of like we take it as it goes.

This year, the game plan is clear for 2025. Steady she goes, grind our way through it, try to rotate some equity, come up for air in a year and we are committed to keeping the dividend where it is.

Robert Dodd, Analyst, Raymond James: Got it. Got it. Thank you. Moving on to the on pragmatic, obviously, you’re full on a call now. What are the prospects for a restructuring there?

Like maybe some of that, equidization of some of the debt or something like that where the remainder of the debt comes back onto accrual? I mean, is that a likely or potential outcome in the near medium term for that asset?

Art Penn, CEO, PennantPark: Yes, it’s a good question and we’re figuring out as we speak. Our current assumption is that during this quarter, the quarter ended March, there will be some form of restructuring there, some debt will be converted and there’ll be a yield instrument coming out of that.

Robert Dodd, Analyst, Raymond James: Got it. Got it. Thank you. And then just kind of following on from Mark’s questions. In terms of the environment, I mean, you are very active.

What areas do you and you’ve talked about some really attractive vintage, but I mean, what other areas in particular that you’d like to ramp up exposure more in the portfolio? Obviously, there’s even within the JV as well, right? I mean, there’s industry concentrations you’re trying to manage and things like that. So I mean, are you seeing the right kind of industries that in terms of being attractive also to manage your concentrations in that vehicle and directly on balance sheet as well?

Art Penn, CEO, PennantPark: Yes. So as you know, we kind of respond to what’s being shown us in the marketplace and where the middle market private equity community finds value. So certainly, we can deemphasize certain areas and we can emphasize others. Healthcare is the biggest portion of the economy. It’s the biggest portion of our portfolio.

And we try to, in healthcare, particularly with reimbursement risk, try to find areas that are on the right side of cost containment, try to find providers, service providers and other types of companies that can provide health care at a lower cost and still maintain high quality. So that’s something that is probably just a big part of the portfolio. I think our performance in healthcare has probably been better than some of our peers. I think some of our peers have gotten caught in it, whether it’s just not picking the right credits that are on the right side of cost containment or just having higher leverage as you’ve heard our incoming debt to EBITDA for new loans is under four times. So when you or four times exactly here in this vehicle.

So when you structure deals with more reasonable leverage, you can deal with a curve ball or two. So healthcare will remain. Government services, again, that’s topical given what’s going on with the government. We believe we’re on the right side of financing companies that are driving cost containment for the government and are aligned with government payment. Again, we’re responding to what our sponsors are showing us.

And there’s a whole proliferation of other types of industries, business services, consumer and others that were shown. But we do not we can kind of dial things up or dial things down. For us, it always begins with, is it a steady stable cash flow stream that is protected? Is anyone really going to care if this company goes away or not? And trying to keep leverage as low as we possibly can.

And then of course alignment with the sponsors putting in a lot of equity beneath us.

Robert Dodd, Analyst, Raymond James: Got it. Thank you. Appreciate it.

Rick, CFO, PennantPark: Thank you.

Conference Operator: We’ll now take our next question from Brian McKenna with Citizens JMP.

Brian McKenna, Analyst, Citizens JMP: Great. Thanks. So just on the portfolio rotation opportunity, is there any way to think about the timing and magnitude of monetizing some of your equity investments and then redeploying this capital into loans? And I guess, ultimately, where does the percent of equity investments within the portfolio settle in that longer term?

Art Penn, CEO, PennantPark: Yes. So I’ll try to deal with the last question first, which is what are we targeting? We’re certainly targeting less equity. Certainly, you can look at the equity book and see where there’s been markups. And the goal would be that’s kind of a leading indicator for where there might be some monetization opportunities.

But in terms of the equity book, I mean, let’s exclude the JV equity, which is about 6% of the portfolio and that’s just part of this JV that’s generating a very healthy 18% return in cash. And there’s over 20% in other equity. Some of it’s co invest, I think about half of it’s kind of from co invest where we’ve co invested and the other half is restructured equity where we converted debt to equity. Some of that some of both of those has been marked up. So we hope that ’25 is the year where we’re going to see more M and A activity in this core middle market, where we can monetize some of those names and convert that equity to cash and ultimately yield.

Look, we’d like to get that 20 ish percent number down in half if we can. That’s our goal. Try to cut that in half over time. We have not met that goal. It’s taken us too long to be honest with you.

And some of it we kind of control, some of it we don’t, but that’s got to be our target and that’s what we’re going to try to do.

Brian McKenna, Analyst, Citizens JMP: Okay, great. That’s helpful. And then Art, I’ve mentioned this in the past, but assuming you are successful kind of rotating out of the equity and into loans and that kind of ratio looks similar and the percent looks similar to PFLT. I mean, do you ultimately maybe potentially look to merge the two? So you have one publicly traded BDC.

I just love to get your updated thoughts there.

Art Penn, CEO, PennantPark: Yes. Look, there’s nothing more updated than what we’ve talked is, which is we got a we’ve got a little bit of a cleanup scenario here. We’ve got to focus on it. Then we’ll lift our head up and kind of look at the options. There’s certainly arguments to do something.

There’s certainly arguments not to do something. All options are always on the table. There has been historically differentiated portfolio, difference in yields, difference in underlying portfolio. We got a little bit of a job to do first and then we’ll come up and try to assess what’s best for shareholders.

Brian McKenna, Analyst, Citizens JMP: Okay. Great. That’s helpful. I’ll leave it there.

Art Penn, CEO, PennantPark: Thank you.

Conference Operator: We’ll now move to Paul Johnson with KBW.

Paul Johnson, Analyst, KBW: Hey, good afternoon. Thanks for taking my questions. On some of those investments that were marked higher, I noticed BioLite was marked higher again this quarter. That’s a mark that’s been moving up over the past few quarters. I mean, should we take that as an indication of interest that you might think the company’s been receiving or is that just been more of a result of just performance?

Art Penn, CEO, PennantPark: Yes. Look, it’s hard for me to I can’t comment on M and A and all that. I can’t comment that the company has performed well and you’ve seen that in the markups. And most of these companies are owned by private equity firms who ultimately try to sell. I can’t comment on a specific name, but the company has been performing well.

Paul Johnson, Analyst, KBW: Got it. Thanks Art. And then last question was, I noticed that PNNT participated in the marketplace events loan that PennantPark reinvested with the company following the sale of the business. Just given that I don’t believe PNNT participated in the previous investment, and it’s just a slightly lower yield. I was just curious as to why PNNT participated this time.

Art Penn, CEO, PennantPark: I’m going to defer to Rick. I don’t think that PNNT was involved in marketplace. Rick, any color? You’re correct in terms of the

Rick, CFO, PennantPark: realization, but PNNT did participate in the new loan. And the thought there, Paul, is again that that loan will ultimately live at the joint venture.

Art Penn, CEO, PennantPark: Yes, the new loan, yes. And

Rick, CFO, PennantPark: then the new.

Art Penn, CEO, PennantPark: Right. So there was a new buyer that came in and bought marketplace events, PFLT and a group of other lenders were the shareholders, and PFLT was the lead equity investor. A new private equity sponsor came in, bought the company at an attractive price. And as part of that, there was an attractive loan to be made in a company that we obviously knew very well. So we did buy that loan across the platform PFLT, PNNT and ultimately the joint venture as well.

We’ll own a piece of that marketplace events loan.

Paul Johnson, Analyst, KBW: Got it. And when you made that loan, was that a loan that you chose to reinvest in the company or was that a loan that was essentially carried over to enact the deal?

Art Penn, CEO, PennantPark: Yes, it was a separate transaction. So the funds that were in the old marketplace events got cash and then we evaluated where the new loan and a new equity co invest would make sense and then across the platform, PennantPark platform bought new senior debt and new equity co invest in the new marketplace events where another sponsor came in and bought the company and that’s been allocated across the platform.

Paul Johnson, Analyst, KBW: Okay. Thank you, Art. That’s all for me.

Rick, CFO, PennantPark: Thank you.

Conference Operator: We’ll now move to Mickey Schleien with Ladenburg.

Mickey Schleien, Analyst, Ladenburg: Yeah. Art, just a couple of questions from me. What did you assume in terms of the Fund’s balance sheet leverage and equity rotation in your core NII guidance?

Art Penn, CEO, PennantPark: Core NII was actual NII. There’s no this kind of actual for the quarter ended December 31. In terms of the guidance going forward, your question is about the guidance going forward. We just said that’s kind of just assuming continued growth of the joint venture.

Mickey Schleien, Analyst, Ladenburg: Okay. And the balance sheet leverage remaining where it is?

Art Penn, CEO, PennantPark: Yes. And over time, kind of getting back down to $1,300,000 after we fill up that joint venture, we could acquire that joint venture, we could do another joint venture. We hope to be able to get some equity realizations here in the next number of quarters, which will certainly be helpful.

Mickey Schleien, Analyst, Ladenburg: For sure. And just a housekeeping question maybe for Rick, what were the main drivers of the realized loss and the unrealized gains?

Art Penn, CEO, PennantPark: Sure.

Rick, CFO, PennantPark: Let’s see. So the main drivers for the unrealized, there was a write up in JF intermediate and a write up in Federal Advisory Partners. Those are the two larger write ups on the write downs that netted that down, the equity investment in Cascade Environmental and additional write down on pragmatic were the two main large drivers on the write down side. In terms of realized gain or sorry, realized loss for PNNT, that was a restructuring for STG also goes by reception purchaser. That was the main driver for the realized loss during the quarter.

Mickey Schleien, Analyst, Ladenburg: I understand. That’s it for me this afternoon. Thank you.

Art Penn, CEO, PennantPark: Thanks, Becky.

Conference Operator: We’ll now move to Melissa Weddell with JPMorgan.

Melissa Weddell, Analyst, JPMorgan: Good afternoon. Thanks for taking my questions. Most of mine have been asked, but I thought I would follow-up and clarify a couple of things. Firstly, on the growth of the JV, when we look at the dividend income to the BDC from that JV, it looks like that was pretty flat quarter over quarter, except that the portfolio asset that the JV had grown pretty decently, even since September 30. How should we think about the growth in the dividend to the BDC from PSLS and like the cadence of that going forward?

Art Penn, CEO, PennantPark: Yes, it’s a great question and the growth in the underlying JV portfolio should match what comes over to PNNT, but we don’t book income unless it’s actually distributed. So there’s a bit of a reserve that we create at the joint venture and there’s no particular reason we’re creating reserve there. There’s other than just have excess cash so that we have a bit of a reserve, but you would imagine and it would certainly normalize over time where growth in the joint venture and growth in the investment in that joint venture will yield the dividends. Rick, I don’t know if you have any particular explanation for why the phenomenon Melissa is talking about in this particular quarter?

Rick, CFO, PennantPark: Yes, sure. Melissa, last quarter, the JV did distribute some of that reserve Art just mentioned. And I believe we detailed that out last quarter as kind of a core NII adjustment because that portion was, I’ll say, less recurring. Additionally, we fund the JV through both debt and equity. So as we fund additional capital to fuel the growth of that JV portfolio, the economics back to us a portion is in that debt instrument.

So you just don’t see it in that dividend line item on the income statement.

Mark Hughes, Analyst, Truist: Okay. Right.

Art Penn, CEO, PennantPark: So there’s some of one way to look at it is comprehensively between the debt instrument and the equity instrument, right?

Melissa Weddell, Analyst, JPMorgan: Yes. And then just to clarify, I wasn’t quite sure I fully followed your comments on the exposure to government services and defense companies. Do you how much exposure is there in the portfolio to this any potential sort of reimbursement risk, whether that’s in the government segment and defense segment or even in the healthcare segment of the portfolio? Have you taken a more critical look at that?

Art Penn, CEO, PennantPark: Yes. No, we’re looking at it Sorry,

Melissa Weddell, Analyst, JPMorgan: same question for any tariff exposure as well.

Art Penn, CEO, PennantPark: Yes. We have limited tariff exposure. Most of the companies that would be impacted by tariffs were not really involved in and the ones that we are kind of had a dry run of tariff exposure during the last Trump administration. So the tariff exposure is very, very limited. Biggest part of The U.

S. Economy and biggest part of our portfolio is healthcare. So for sure, there is government reimbursement risk in healthcare. The way we comport ourselves in that is we try to focus on healthcare companies that are driving lower costs with reasonable quality. So if we’re on the right side of that, which is lower cost, reasonable quality in any environment, we’re likely to be okay.

And then we layer on the fact that we keep leverage lower. The average new loan is four times debt to EBITDA in this portfolio with at least 50% equity beneath us. So where some of our peers may have stumbled occasionally in healthcare, to date we’re relatively clean because of those two facts. So same applies on the government services and defense side. When you look at that portfolio, we’re not doing tanks, we’re not doing missiles.

We are focused typically on service companies where you have individuals, people walking into offices and sitting behind computers doing things like cybersecurity, intelligence, maneuvering satellites, doing technology updates, those again typically are what we will call on the right side of cost, on the right side of being very efficient with taxpayer dollars, going into government contracting and defense. And then when you drill down one layer deeper in those companies, they typically get paid in two ways. One is cost plus, where they provide the cost and they create a margin above that. And on those companies, those companies by and larger in making single digit EBITDA margins, they’re not making excess margins on cost plus. If they were making excess margins on cost plus, they would be more at risk.

And then the other way companies get paid is through fixed price, where they take risk, they essentially go long providing a service for a fixed price, in which case the government’s dishing the risk off to the provider, the provider is taking risk. In those cases, those companies could earn higher margins and they could also earn lower margins depending on how they priced their service relative to their cost. Again, if you look at that piece of that portfolio, we’ve seen that very good operators who are generating fair margins, not exorbitant, but fair margins and they’re taking risk off the government and they’re going long a service. So we think we’re relatively well insulated, but every day is a new day, as you know. We don’t know, but kind of we’ve comported ourselves in those two industries, which have government exposure to be focused on the right side of cost containment and then add on the layer of keeping debt to EBITDA four times or below, so that if there are curveballs, they could be dealt with appropriately.

Melissa Weddell, Analyst, JPMorgan: I appreciate all the detail there. Actually one final question for you. I take your point on looking to hoping for some equity rotation in the coming quarters as you said. It occurs to me though that you also have a pretty elevated balance in treasuries. Is that something that could be a source of funds to deploy into something higher yielding until you get that equity rotation?

Thanks very much.

Art Penn, CEO, PennantPark: Yes. The treasury thank you. Good question. The treasuries are balance sheet management that we do at quarter end typically that’s temporary to optimize our 30% bucket. We want to optimize our 30% bucket for the JV and for other 30% type assets.

So that is a technique we use to optimize that bucket.

Melissa Weddell, Analyst, JPMorgan: Thank you.

Conference Operator: We’ll now move to Casey Alexander with Compass Point.

Casey Alexander, Analyst, Compass Point: Hi, good afternoon. Art, I’ve got a few questions for you. First of all, we know that base rates have gone down 100 basis points, but there’s a delay in the way in which they flow through your balance sheet. What percentage of that 100 basis points would you suggest has already flowed through?

Art Penn, CEO, PennantPark: That’s a really good question. Rick, any I’ll defer to Rick. I don’t know if you have an estimate, Rick, or also Coffer, we can certainly get back to you, Casey, later on, but

Paul Johnson, Analyst, KBW: any sense?

Rick, CFO, PennantPark: It isn’t off the cuff. I would say the majority of the borrowers are electing three month LIBOR contracts. So they are flowing through on kind of a three month basis. The quarter ends are there’s a higher volume, a higher number of borrowers that kind of roll their contracts towards the quarter end, but they do roll all throughout the period. Off the cuff, I would say, it’s in that 50% to 75% is already in the numbers.

Casey Alexander, Analyst, Compass Point: So you’re halfway through flowing through to maybe three quarters of the way flowing through.

Art Penn, CEO, PennantPark: That would be your guess. Yes. And we also have liabilities obviously that are floating as well. So we have some fixed and we have some floating liabilities. So there’s some matching going on.

Casey Alexander, Analyst, Compass Point: Yes. I’m aware. Thanks. Based upon the amount that you shipped down to the JV this quarter, another quarter like that and you’re basically going to be at capacity. Do you think that you’ll be at or near that capacity by the end of the first calendar quarter?

Art Penn, CEO, PennantPark: I’d say the next I’d say it probably takes us two to three quarters to get that JV more fully ramped and optimized. Gives us time to evaluate financing options, gives us time to evaluate equity rotation options. And then once we’re optimized, we’re optimized, and we’ll do everything we can to add value thereafter. But kind of we’re expecting and hoping for some kind of equity rotation between now and then.

Casey Alexander, Analyst, Compass Point: So we should be thinking about a little bit slower pace going down to the JV over the next couple of quarters if we compared it relative to this last quarter?

Art Penn, CEO, PennantPark: Yes, yes. And then part of it is just the activity level. So we’re seeing a, what I’ll call, normal quarterly flow. The December was very busy. As you saw, the March that we’re in today is a little bit slower.

That’s a normal seasonal activity. We still think 25% can be a very active year, but this quarter that we’re in right now is a little bit slower.

Casey Alexander, Analyst, Compass Point: Right. Okay. So let’s have a conversation about the dividend distribution. I’m just curious, have you guys considered switching off to a year end special distribution to clear up some of the spillover and rightsizing the dividend because it’s pretty common knowledge that when you appear as though you’re chronically under earning your dividend, the market tends to impact your valuation in a negative way because you’re doing that. And if you switch to a year end special distribution, you could right size the dividend relative to your current earnings power and perhaps the market would treat your valuation better.

Have you considered that as an option?

Art Penn, CEO, PennantPark: And we have. And in case you were happy to consider it and happy to talk to you anytime you like about dividend policy and try to figure out the optimal way to get our stock trading even better. So we can talk about that and talk about different things and what our shareholders would prefer. Is there I don’t know, like what you have institutional shareholders, you have retail shareholders, what’s the preference, what do people want, what’s the reaction going to be. So we can we don’t have to have a call here, have that discussion in front of the community, but we’re always happy to talk about it and talk about it with our board as to what’s going to help our stock trade better.

And if there’s other methodologies or other ways to do it, we are all ears.

Casey Alexander, Analyst, Compass Point: I would be more than happy to have that conversation with you.

Art Penn, CEO, PennantPark: Great.

Casey Alexander, Analyst, Compass Point: You mentioned that the JV, when it reaches its capacity that you might enact another JV. I’m just is there any technical limitations given that when this JV has completed its capacity, it’s going to be larger than the on balance sheet BDC itself. And so I’m just wondering if there’s any practical limitations to how much you can take off balance sheet relative to the size of the on balance sheet BDC itself?

Art Penn, CEO, PennantPark: It’s a great question. And certainly there’s a couple of limitations. A, it’s part of the 30% bucket, right? So no more than 30 of our overall balance sheet at PNNT can be in one of these vehicles. And you’re correct that the BDC that the JV itself can get quite large, but PNNT’s ownership of it can be a different number, right?

Where PNNT is a little bit more than 50% owners of it. The JV can continue to grow and PNNT can own less than 50%. I mean, there are some of our peers who have the BDC owning 10% or 12% or 15% or 20% of a JV that can be very large with third party investor capital. So the relevant thing is what’s the 30% bucket and how much of that is in a JV type structure. The JVs are have been very accretive for us here.

It’s been generating an 18%, which is accretive to PNNT. And when you think about it, kind of our investment management company is managing all these assets and we’re not charging our shareholders an incremental management fee for it. It’s just showing up in the form of incremental ROE. So we think it has some benefits. It’s been a good thing for PNNT and we’ve seen it be a good thing for other BDCs.

So we’ll continue to look at it and we’ll continue to look at our 30% bucket and continue to figure out if we can add value through using the JV mechanism to do so.

Casey Alexander, Analyst, Compass Point: Lastly, have there been any notable credit events that have taken place in the portfolio since the end of the quarter?

Art Penn, CEO, PennantPark: There’s a company called Zips Car Wash,

Mickey Schleien, Analyst, Ladenburg: which

Art Penn, CEO, PennantPark: has filed a prepackaged bankruptcy. It’s not particularly big in our vehicle here, but it is out there, it’s public information. It’s not that material. It was appropriately marked, we believe as of twelvethirty one and is in the marks. If you were to flow through the potential income impact, it might be $0.05 a share.

Casey Alexander, Analyst, Compass Point: That includes the amount of zips that is located within the JV? Yes.

Art Penn, CEO, PennantPark: JV and on balance sheet.

Casey Alexander, Analyst, Compass Point: All right, great. Thank you for taking my questions. I appreciate it.

Art Penn, CEO, PennantPark: Thank you.

Conference Operator: We’ll now take a follow-up from Robert Dodd with Raymond James.

Robert Dodd, Analyst, Raymond James: Hi, guys. Yes, just a quick follow-up from Melissa’s question. I mean there is a visible gap to your point in terms of stocking a reserve, so to speak. And there was an extra couple of million that that paid out in June. So I mean is that going to be a true distribution from the JV kind of is it going to be once a year or is it going to be once in a while?

I mean, should we expect an annual distribution from that vehicle that kind of captures that or is it just a true up whenever you and the partner decide it’s appropriate?

Art Penn, CEO, PennantPark: More of the latter, kind of we try really to distribute the vast majority of NII out on a quarterly basis. Every so often because the credit performance has been good there, we just have a little bit of excess and we’ll distribute it when appropriate.

Robert Dodd, Analyst, Raymond James: Got it. Thank you.

Conference Operator: And we’ll now take a follow-up from Melissa Weddell with JPMorgan.

Melissa Weddell, Analyst, JPMorgan: Thanks. One more follow-up actually to Brian’s question about, you know, whether PNNT and PFLT, whatever, make more sense in a combined vehicle. You mentioned that there’s a little bit of cleanup work to do. And I just wanted to better understand what that means to you. Is that a function of non accruals, equity exposure, something else?

And I asked that because in the past, I know you’ve probably gotten that question a number of times over the years. In the past, you had referenced the multiple, and the disparity between multiples on the two vehicles and that seems to be less of an issue now. So appreciate any clarifying thoughts you have on that.

Art Penn, CEO, PennantPark: Yes. And that could be it’s all kind of maybe the same thing, Melissa, which is, I believe if we can get some reasonable equity rotation, which will de risk the portfolio, de risk the NII that will be cleanup, right? That’ll be the cleanup I’m referring to. And then we can take a look and evaluate different options.

Melissa Weddell, Analyst, JPMorgan: Thank you.

Conference Operator: That does conclude today’s question and answer session. I’d like to turn the conference back over to Mr. Penn for any additional or closing comments.

Art Penn, CEO, PennantPark: Just really want to thank everybody for their participation. I want to thank the research community for your excellent questions. It’s good that there’s engagement and some interest. And we look forward to speaking with you all again next in early May as we discuss the March numbers. Thank you very much.

Have a good rest of the winter.

Conference Operator: And once again, that does conclude today’s conference. We thank you all for your participation. You may now disconnect.

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