PennantPark Investment (PNNT) - 2023 Q4 - Annual Report

Part I Item 1. Business PennantPark Investment Corporation (PNNT) is a Business Development Company (BDC) focused on generating income and capital appreciation by investing in U.S. middle-market companies - PNNT's primary business objective is to generate both current income and capital appreciation by investing in U.S. middle-market companies with annual revenues between $50 million and $1 billion[20][21] - The company is an externally managed, non-diversified investment company that has elected to be treated as a BDC under the 1940 Act and a RIC for federal income tax purposes[23] - PNNT's investment adviser, PennantPark Investment Advisers, has invested $18.5 billion in 653 companies since its inception in 2007, demonstrating extensive experience in the middle-market lending space[28] Portfolio Composition by Fair Value (as of September 30, 2023) | Investment Type | Percentage of Portfolio | | :--- | :--- | | First Lien Secured Debt | 48% | | Second Lien Secured Debt | 7% | | Subordinated Debt (incl. PSLF) | 14% | | Preferred and Common Equity (incl. PSLF) | 22% | | U.S. Government Securities | 9% | Top Industries by Portfolio Assets (as of September 30, 2023) | Industry | Percentage of Portfolio | | :--- | :--- | | Business Services | 18% | | Healthcare, Education and Childcare | 14% | | Consumer Products | 9% | | Distribution | 8% | | Financial Services | 6% | Leverage The company utilizes various debt instruments, including credit facilities and notes, to finance its investments and operations Outstanding Debt as of September 30, 2023 | Debt Instrument | Total Commitment/Principal | Outstanding Borrowings | Interest Rate/Coupon | | :--- | :--- | :--- | :--- | | Truist Credit Facility | $475.0 million | $212.4 million | 7.7% (weighted avg.) | | 2026 Notes | $150.0 million | $150.0 million | 4.50% | | 2026 Notes-2 | $165.0 million | $165.0 million | 4.00% | - The company's asset coverage requirement for senior securities was reduced from 200% to 150% following stockholder approval on February 5, 2019, allowing for increased leverage[47] Investment Management Agreement The company's investment adviser earns fees based on a combination of base management fees and performance-based incentive fees - The base management fee is 1.50% of average adjusted gross assets, reduced to 1.00% on gross assets exceeding 200% of total net assets[81] - The incentive fee has two parts: one based on Pre-Incentive Fee Net Investment Income exceeding a 1.75% quarterly hurdle rate, and a second part equal to 17.5% of cumulative realized capital gains net of losses and unrealized depreciation[83][85] Fees Earned by Investment Adviser (in millions) | Fee Type | FY 2023 | FY 2022 | FY 2021 | | :--- | :--- | :--- | :--- | | Base Management Fee | $16.5 | $19.8 | $17.3 | | Incentive Fee on NII | $13.9 | $2.7 | $0.6 | Regulation The company operates under specific regulatory requirements as a Business Development Company (BDC) and a Regulated Investment Company (RIC) - As a BDC, the company must invest at least 70% of its assets in "qualifying assets," which are primarily securities of private or thinly traded U.S. companies[105] - To maintain its RIC status for tax purposes, the company must annually distribute at least 90% of its investment company taxable income[127] - The company's subsidiary, SBIC II, was licensed by the SBA but has since repaid all outstanding debentures and surrendered its license[141] Item 1A. Risk Factors This section details the significant risks associated with investing in the company's securities, including business, liquidity, investment, and market risks Risks Relating to Our Business and Structure The company faces risks related to market competition, reliance on key personnel, interest rate fluctuations, internal control deficiencies, and the use of leverage - The company operates in a highly competitive market for investment opportunities, competing with other BDCs, banks, and private funds, which could limit its ability to find attractive investments[150] - Dependence on the Investment Adviser's key personnel is a significant risk; their departure could harm the company's ability to achieve its investment objectives[158] - The company is exposed to interest rate risk, as rising rates increase borrowing costs and could lead to defaults from portfolio companies with floating-rate debt[160][163] - Material weaknesses in internal control over financial reporting have been identified, which could impact the accuracy of financial reporting if not remediated[170] - The use of leverage, permitted up to a 150% asset coverage ratio, increases the risk of loss for common stockholders if the value of assets declines[180][189] Risks Relating to the Illiquid Nature of Portfolio Assets The company's investments in illiquid assets pose valuation challenges and may restrict its ability to sell assets when necessary - The company invests in illiquid assets, and its valuation procedures may result in recorded values that differ materially from the values ultimately received upon disposition[225] - The lack of liquidity in investments may make it difficult or impossible to sell assets when needed, potentially forcing sales at a significant loss, especially during market disruptions[229] Risks Relating to Our Investments Investments in middle-market companies carry inherent risks due to their characteristics and the company's non-diversified investment strategy - Investments in middle-market companies are inherently risky due to factors such as high leverage, limited financial resources, and dependence on small management teams[235] - The company is a non-diversified investment company, meaning it can invest a large portion of its assets in a small number of issuers, increasing risk concentration[240] - The incentive fee structure may induce the Investment Adviser to make more speculative investments to increase its compensation, potentially leading to higher investment losses[248] Risks Relating to an Investment in Our Common Stock Investing in the company's common stock carries risks including potential trading discounts to NAV, dilution from future issuances, and uncertainty regarding distributions - The company's shares may trade at a significant discount to their Net Asset Value (NAV), a risk separate from the risk of NAV declining[266] - Future issuances of common stock below the then-current NAV per share, if approved by stockholders, could materially dilute existing shareholders' interests[258][260] - There is a risk that stockholders may not receive distributions or that distributions may not grow, and they may be limited by asset coverage requirements[262] Risks Relating to an Investment in Our Debt Securities The company's debt securities are subject to subordination risks and limited protective covenants - The 2026 Notes and 2026-2 Notes are unsecured and are effectively subordinated to any current or future secured indebtedness, such as the Truist Credit Facility[274] - The notes are structurally subordinated to all indebtedness and liabilities of the company's subsidiaries, as the assets of subsidiaries are not directly available to satisfy the claims of the company's creditors[275][276] - The indenture governing the notes offers limited protection to holders and does not restrict the company from incurring additional debt or engaging in various corporate transactions that could adversely impact the notes' value[277] Item 1B. Unresolved Staff Comments The company reports that it has no unresolved staff comments from the SEC - None[301] Item 2. Properties The company does not own any real estate or other material physical properties, utilizing facilities provided by its Investment Adviser and Administrator - As of September 30, 2023, the company did not own any real estate or other physical properties material to its operation[303] Item 3. Legal Proceedings The company, its Investment Adviser, and its Administrator are not currently subject to any material legal proceedings, nor are any known to be threatened - The company reports no material legal proceedings against itself, its Investment Adviser, or its Administrator[304] Part II Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities This section provides information on the company's common stock (PNNT), including its trading price relative to NAV, share repurchase program status, and distribution details Quarterly Stock Price and NAV Per Share (FY 2023) | Quarter | NAV per Share | High Price | Low Price | High Price to NAV | Low Price to NAV | | :--- | :--- | :--- | :--- | :--- | :--- | | Q4 2023 | $7.70 | $6.92 | $5.95 | (10)% | (23)% | | Q3 2023 | $7.72 | $6.00 | $4.76 | (22)% | (38)% | | Q2 2023 | $7.60 | $6.25 | $4.99 | (18)% | (34)% | | Q1 2023 | $7.71 | $6.30 | $5.45 | (18)% | (29)% | - The company's share repurchase program, which allowed for up to $25 million in repurchases, expired on March 31, 2023[312] - No shares were repurchased during the fiscal year ended September 30, 2023[312] - For the fiscal year ended September 30, 2023, total distributions from ordinary income were $49.6 million, or $0.76 per share[316] - No distributions were made from long-term capital gains[316] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This section analyzes the company's financial performance for FY 2023, highlighting increased net investment income, significant realized losses, and portfolio value changes Portfolio and Investment Activity This section summarizes the company's investment portfolio characteristics and activity for the fiscal year ended September 30, 2023 Portfolio Summary (as of Sept 30) | Metric | 2023 | 2022 | | :--- | :--- | :--- | | Total Portfolio Value | $1,101.7 million | $1,226.3 million | | Number of Companies | 129 | 123 | | Avg. Investment Size | $7.8 million | $10.0 million | | Weighted Avg. Yield on Debt | 13.0% | 10.8% | | Non-Accrual (Cost Basis) | 1.2% | 1.2% | Investment Activity (Year Ended Sept 30) | Activity | 2023 | 2022 | | :--- | :--- | :--- | | Investments Made | $275.4 million | $933.8 million | | Sales and Repayments | $418.6 million | $911.6 million | Results of Operations This section details the company's financial results, including investment income, expenses, and net changes in assets for the fiscal year ended September 30, 2023 Results of Operations Summary (Year Ended Sept 30) | Metric (in millions) | 2023 | 2022 | | :--- | :--- | :--- | | Total Investment Income | $145.4 | $105.0 | | Net Expenses | $79.8 | $61.0 | | Net Investment Income | $65.5 | $43.9 | | Net Realized Gain (Loss) | $(156.8) | $34.8 | | Net Unrealized Appreciation (Depreciation) | $59.6 | $(110.0) | | Net Change in Net Assets | $(33.8) | $(24.7) | - The increase in investment income in FY 2023 was primarily due to higher SOFR base rates[385] - The significant net realized loss in FY 2023 was primarily due to the realization of the investment in RAM Energy Holdings LLC[390] Liquidity and Capital Resources This section outlines the company's financial flexibility, including its asset coverage ratio, available borrowing capacity, and cash position - As of September 30, 2023, the company's asset coverage ratio was 195%, compliant with the 150% regulatory requirement[397] - The company had $262.6 million of unused borrowing capacity under its Truist Credit Facility as of September 30, 2023[398] - The company repaid the remaining $20.0 million of its SBA debentures during the nine months ended June 30, 2023[406] - As of September 30, 2023, the company had cash and cash equivalents of $38.8 million available for investing and general corporate purposes[410] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company is primarily exposed to market risk through interest rate fluctuations, given its significant portfolio of variable-rate investments - As of September 30, 2023, 95% of the company's debt portfolio consisted of variable-rate investments, making it sensitive to interest rate fluctuations[440] Annualized Impact of Hypothetical Interest Rate Changes | Change in Interest Rates | Change in Net Interest Income (in thousands) | Change in Net Interest Income Per Share | | :--- | :--- | :--- | | Down 1% | $(5,373) | $(0.08) | | Up 1% | $5,373 | $0.08 | | Up 2% | $10,746 | $0.16 | | Up 3% | $16,120 | $0.25 | | Up 4% | $21,497 | $0.33 | Item 8. Consolidated Financial Statements and Supplementary Data This section contains the company's audited consolidated financial statements for FY 2023, including management's report on internal controls and the independent auditor's reports Management's Report on Internal Control Over Financial Reporting Management concluded that the company's internal control over financial reporting was not effective as of September 30, 2023, due to identified material weaknesses - Management concluded that as of September 30, 2023, the company did not maintain effective internal control over financial reporting due to identified material weaknesses[450] - Material weaknesses were identified in controls related to the review of quarterly cash and investment reconciliations, as well as the review of interest income and non-accrual classification of investments[451] - Management has begun remediation efforts, including enhancing existing controls and policies to improve the overall control environment[452][454] Report of Independent Registered Public Accounting Firm The independent auditor issued an adverse opinion on internal controls but an unqualified opinion on the consolidated financial statements - The independent auditor, RSM US LLP, issued an adverse opinion on the effectiveness of the company's internal control over financial reporting as of September 30, 2023, due to the identified material weaknesses[455][457] - The auditor issued an unqualified (clean) opinion on the consolidated financial statements, stating they present fairly, in all material respects, the financial position and results of operations of the company[456][462] - The audit report includes an Emphasis of Matter paragraph noting that the 2022 financial statements were restated to reclassify certain amounts[464] Consolidated Financial Statements This section presents the company's key financial statements, including the Statement of Assets and Liabilities and the Statement of Operations Consolidated Statement of Assets and Liabilities (in thousands) | | Sep 30, 2023 | Sep 30, 2022 | | :--- | :--- | :--- | | Total Investments (at fair value) | $1,101,647 | $1,226,301 | | Total Assets | $1,156,977 | $1,320,619 | | Total Liabilities | $654,790 | $735,054 | | Total Net Assets | $502,187 | $585,565 | | Net Asset Value per Share | $7.70 | $8.98 | Consolidated Statement of Operations (in thousands) | | FY 2023 | FY 2022 | FY 2021 | | :--- | :--- | :--- | :--- | | Total Investment Income | $145,366 | $104,966 | $81,588 | | Net Expenses | $79,833 | $61,023 | $45,112 | | Net Investment Income | $65,533 | $43,943 | $36,476 | | Net Realized/Unrealized Gain (Loss) | $(99,340) | $(68,683) | $130,141 | | Net Increase (Decrease) in Net Assets | $(33,807) | $(24,740) | $166,617 | Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and procedures were not effective as of September 30, 2023, due to identified material weaknesses, but remediation efforts are underway - Management concluded that disclosure controls and procedures were not effective as of September 30, 2023, due to the material weaknesses identified in internal controls[647] - The company has begun remediation efforts for the current material weaknesses, which include enhancing review controls and policies[648][655] - A material weakness identified as of September 30, 2022, related to providing information to valuation services, was successfully remediated during fiscal year 2023[650][651][652] Part III Item 10. Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance will be incorporated by reference from the forthcoming 2024 Proxy Statement - Information regarding directors, executive officers, and corporate governance is incorporated by reference from the forthcoming 2024 Proxy Statement[661] Item 11. Executive Compensation Information regarding executive compensation will be incorporated by reference from the forthcoming 2024 Proxy Statement - Information regarding executive compensation is incorporated by reference from the forthcoming 2024 Proxy Statement[662] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership of certain beneficial owners and management, and related stockholder matters, will be incorporated by reference from the forthcoming 2024 Proxy Statement - Information regarding security ownership is incorporated by reference from the forthcoming 2024 Proxy Statement[663] Item 13. Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships and related transactions, and director independence, will be incorporated by reference from the forthcoming 2024 Proxy Statement - Information regarding related transactions and director independence is incorporated by reference from the forthcoming 2024 Proxy Statement[664] Item 14. Principal Accountant Fees and Services Information regarding principal accountant fees and services will be incorporated by reference from the forthcoming 2024 Proxy Statement - Information regarding principal accountant fees and services is incorporated by reference from the forthcoming 2024 Proxy Statement[665] Part IV Item 15. Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed as part of the Annual Report on Form 10-K - This section lists all financial statements, schedules, and exhibits filed with the Form 10-K, including key corporate documents, debt agreements, and management agreements[667]