PennantPark Floating Rate Capital Ltd. (PFLT) Q4 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the PennantPark Floating Rate Capital’s Fourth Fiscal Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the 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 Floating Rate Capital. Mr. Penn, you may begin your conference.

Thank you, and good morning, everyone. I’d like to welcome you to PennantPark Floating Rate Capital’s fourth fiscal quarter 2014 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 included discussion about forward-looking statements.

Thank you, Art. I’d like to remind everyone that today’s call is being recorded. Please note that this call is the property of PennantPark Floating Rate Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in our earnings press release as well as on our Web site. I’d like to also 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 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 Web site 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.

Thank you, Aviv. I’m going to spend a few minutes discussing current market conditions, followed by a discussion on the investment activity, the portfolio, the financials, our overall strategy, then open it up for Q&A. As you all know, the economic signals are moderately positive with many economists expecting a slowly growing economy going forward. With regard to the more liquid capital markets and in particular the leverage loan in our high yield markets, during the quarter ended September 30, those markets experienced volatility due to cash outflows and leverage loans and high yield funds. Those outflows were a result of global economic concerns, geopolitical risk and expectations that the Federal Reserve would tighten monetary policy. Our less robust, broadly syndicated loan and high yield market helps the overall tone in the middle market. Risk reward in the middle market has generally remained attractive as the overall supply of middle market companies who need financing exceed the relative demand of applicable lending capacity. As debt investors and lenders, a slow growth economy is fine, as long as we’ve underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome. We’ve continued to be selective about which investments we make in this environment. Given our strong origination network and size of our company, we believe we can continue to prudently grow. We remain primarily focused on long-term value and making investments that will perform well over several years and can withstand different business cycles. We continue to set a high bar in terms of our investment parameters and remain cautious and selective about which investments we add to the portfolio. Our focus continues to be on companies or structures that are more defensive, have low leverage, strong covenants and high returns. As credit investors, one of our primary goals is preservation of capital. If we preserve capital, usually the upside takes care of itself. As a business, one of our primary goals is building long-term trust. Our focus is on building long-term trust with our portfolio companies, management teams, financial sponsors, intermediaries, our credit providers and of course our shareholders. We are a first call for middle market financial sponsors, management teams and intermediaries who want consistent credible capital. As an independent provider free of conflicts or affiliations, we’ve become a trusted financing partner for our clients. Since inception PennantPark entities have financed companies backed by a 140 different financial sponsors. We have been active and are well positioned for the quarter ended September 30, 2014. We’ve invested 63 million with an average yield of 9.3%. Net investment income was $0.32 per share. As a result of our focus on high-quality companies, seniority in the capital structure, floating rate assets and continuing diversification, our portfolio is constructed to withstand market and economic volatility. The cash interest coverage ratio, the amount by which EBITDA, cash flow exceeds cash interest expense, continued to be a healthy 3.4 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 3.6 times, another indication of prudent risk. Credit quality since inception nearly four years ago has been excellent. This past quarter, we experienced our first nonaccrual and as of September 30, that nonaccrual represented 0.6% of the portfolio at costs. In terms of new investments, we had another active quarter investing in attractive risk adjusted returns. Our activity was driven by a mixture of M&A deals, growth financings and refinancings. In virtually all these investments, we have known these particular companies for a while; have studied the industries or have a strong relationship with its sponsor. Let’s walk through some of the highlights. We invested $8 million in the first lien debt of Baltimore, AMF, which is the largest bowling center operator in the world, [indiscernible] is the sponsor. Hunter Defense is a provider of highly engineered, rapidly deployable tactical shelters. We purchased $7 million of our first lien term loan. Metalmark Capital was its sponsor. We purchased $5 million of the first lien term loan of the Tensar Corporation. Tensar is a provider of safe development solutions related to roadway reinforcement, earth retention and foundations. Castle Harlan is the sponsor. Zest Holdings develops manufacturers and supplies of dental product solutions. We invested 9 million in the first lien term loan. Avista Capital is the sponsor. Turning to the outlook, we believe that the reminder of 2014 will continue to be active due to both growth and M&A-driven financings. Due to our strong sourcing network and client relationships, we are seeing active deal flow. Let me now turn the call over to Aviv, our CFO to take us through the financial results.

Thank you, Art. For the quarter ended September 30, 2014, recurring net investment income totaled $0.27 per share. In addition, we had $0.05 per share of other income. As a result, core net investment income was $0.32 per share. Additionally, we have $0.04 per share of reversal of capital gain incentive fee that were accrued by not payable. This resulted in GAAP net investment income of $0.36 per share. Looking at some of the expense categories. Management fees totaled $1.5 million. After 600,000 of the reversal of capital gain incentive fees, taxes and general administrative expenses totaled $600,000 and interest expenses totaled $900,000. During the quarter ended September 30, realized gains were $1.1 million or $0.07 a share. Net unrealized depreciation from investments was approximately $3.6 million or $0.24 per share. Unrealized losses from credit facility was $0.04 per share and income in excess of dividend was $1.3 million or $0.09 per share. Consequently, NAV was down $0.12 per share from $14.52 to $14.40 per share. Our entire portfolio and our credit facility are mark-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm or independent broker dealer quotations when active markets are available under ASC 820 and 825. In cases where broker dealer's quotes are inactive, we use independent valuation firms to value the investments. Our portfolio is relatively low risk. It is highly diversified with 72 companies across 20 different industries. 87% is invested in first lien senior secured debt, 10% in second lien secured debt, 3% in subordinated debt and equity. Our debt to equity ratio is 69%. Our overall debt portfolio has a weighted average yield of 8.2%. 95% of the portfolio is floating rate including 92% with a floor and the average LIBOR floor is 1.2%. Now let me turn the call back to Art.

Thank you, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable and protective dividend stream coupled with the 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 first lien, senior secured floating rate 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 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]. We’ll hear first from Troy Ward with KBW. Troy Ward - Keefe, Bruette & Woods, Inc.: Great. Thank you. Good morning. Art, can you give us a little color on what’s going on with the Unitech process? Obviously, with the bankruptcy filing, how far along in that process are they? And does the fair value of your debt reflect a specific plan that is being communicated and that proposed value is going to be a spread to your level of your seniority of debt or is this still kind of in the earlier stages where that market is kind of internally generated by your staff?

It’s a great question. We believe the process is fairly far along and we’ll wrap up hopefully pretty soon and perhaps even by calendar year-end. The mark obviously would – we send it out to independent external valuation firms. They did this. We believe and they believe this market is around plan value. Every time you do a bankruptcy, there’s a plan value. Of course, there a band high and low to that, but we believe this market is around plan value. Troy Ward - Keefe, Bruette & Woods, Inc.: Okay. So, if it kind of goes, the calendar works how you think it will even if it’s this fair value, which is obviously not where you’d like to see it but that could be capital that’s returned back to working capital, so to speak in early 2015?

I think it’s roughly marked at $0.60 on the dollar, at least our independent valuation firm marked it there. It’s a combination of debt and equity. So the new securities that we would be getting are a combination of debt and equity that add up to this general value. So we will not be getting cash back. It would be a reinstated piece of debt and a piece of equity in the new company. Troy Ward - Keefe, Bruette & Woods, Inc.: Right. So only part of that would be interest bearing at that point?

Part of that would be interest bearing, part of it would be equity in the recapitalized company. Troy Ward - Keefe, Bruette & Woods, Inc.: Great. That makes sense. And then, as I look at your exits in the quarter, it looks like typical stuff here and obviously some very nice prepayment penalties on stuff that paid. If we look at the industries, I do note that there’s three exits in the hotel, gaming and leisure industry. Is there something you’re seeing there or what are you seeing with regard to industries both in exits and where you’re putting your money to work?

Yes, it’s a great question. Gaming has been a core industry of ours. It’s kind of the key vertical and we’ve done well. I think we deploy across our entities over time a couple hundred million in gaming-related deals, mid-teen returns. Some of these deals were just prepayments. They worked out well. Some in certain jurisdictions there’s saturation in the market and certain cases we are actively taking chips off the table. And certain cases you’ll see new investments in what we think are under-saturated markets. But gaming as a general rule, going back it obviously was Las Vegas centered and then Atlantic City centered and it’s obviously been proliferating around the United States and we’ve been a participant in that. But some of these jurisdictions are getting pretty saturated. So we’re generally going to be a little bit more cautious in gaming going forward. Troy Ward - Keefe, Bruette & Woods, Inc.: So, do you have any – I mean obviously the Atlantic City gaming industry has been talked a lot about here in the last year. Do you have any exposure directly to Atlantic City?

No. You may remember we were pretty active in Pennsylvania gaming through SugarHouse and Harrah's Chester which were two good investments we made, which we’ve exited. So we’ve always kind of taken the other side of Atlantic City gaming as proliferated. You’ll see in our portfolio, Baltimore which is doing well, the Horseshoe facility in Baltimore is doing very well. So you have to be really on top of the competitive dynamics and try and understand kind of the market dynamics. So it’s an active space for us and we think we’re on top of it. It’s not to say we won’t make mistakes from time to time, of course we will. From our track record, it’s been pretty good. We hope to maintain that track record. Troy Ward - Keefe, Bruette & Woods, Inc.: Great. And then just one more. You may have said this, but what percentage of the portfolio is in kind of what you had called just a little, a higher yielding deals where you’re trying to get a little bit more income into the portfolio. Where do you stand on that as a percentage of the whole portfolio? And then do you have the ability to add – do you feel like you want to add any more yield to your stuff and what does that mean for the overall portfolio yield?

Yes, it’s a great question. So, as of quarter end, about 87% was first lien, 10% second lien, 3% in what was the catch-all for sub-debt and equity. It’s deal by deal. When we did the IPO, we said we would consider up to about a third of the portfolio as opportunistic under the threshold that we still want this portfolio to be very safe and secure and our mantra is that you be safe enough for your grandmother. So, again, we look at each deal on a deal by deal basis. If we’re going to do second lien or sub-debt, it’s got to obviously have a higher bar and a higher – we got to feel very comfortable when we do second lien, sub-debt or equity. So, again, we take it deal by deal by deal. We don’t have any kind of overall portfolio target on that opportunistic bucket. It’s just kind of a deal by deal basis. Troy Ward - Keefe, Bruette & Woods, Inc.: Okay, that’s very helpful. Thanks, Art.

Thank you.

We’ll take our next question from Hannah Kim with JMP Securities.

Hi. Thanks for taking my questions. I’m calling in for Chris York. Good morning, Art. So it was really nice to see an increase in weighted average yield on new investments during the quarter. So I was wondering if you can comment on maybe just at a very high level the competitive landscape of the industry at the moment given the market volatility as well as whether you think the yield on new investments going forward will be sustainable at this level?

It’s a good question. Look, as we said, the liquid markets had been more volatile which provides us with more opportunity. We like to see a little bit more fear in the market. It means we can get better risk-adjusted returns and we think we were the beneficiary of that this past quarter. We hope that continues, but just like with our other publicly traded vehicle PennantPark Investment Corporation, we’re not focusing the investments. If there’s a deal that comes along that has an attractive risk reward, we’re happy to do it and we don’t come to the office and say, gee, we want to get absolutely fully invested this quarter. At this point, we’re just kind of chugging along. We’re kind of viewing this as a $350 million to $400 million portfolio. It should be safe enough for your grandmother. If there’s good deals, terrific. If there’s not, that’s fine too. We will get repaid and refied and we’ll look for the next deal. We’re just kind of taking it deal by deal. We’re in a position where we can be really, really picky about what goes into the portfolio, which is where we are as we’ve been saying for nearly two years now. We’re probably too early and as we – two years ago, we started getting cautious on the market. So we’ve been cautious. We feel very good about the credit quality. We did have our first nonaccrual though this past quarter with Unitech, and we’re just taking it one deal at a time and we’re not forcing the investments.

Great. Then a follow-up question regarding exits and repayments. In fiscal year 2014, clearly we saw the exits and repayments really elevated throughout the entire fiscal year. And going into fiscal year 2015, what is your expectations for exits and repayments and do you think it will abate from this level?

Well, it has slowed up a little bit. I mean with the liquid markets experiencing some choppiness, the repayments and refis have slowed down, that’s for sure. Will they pick up again? Will the market be back to the race this year? Your guess is as good as ours. Again, we say this and we’ll say it a lot. When people pay us back, we say thank you, because sometimes they don’t pay you back and that can be painful. So, we’re happy to get paid back, we’re happy to take prepayment penalties. There’s always other companies that want your capital whether the quality is good or not, that’s for us to determine, but we’re happy when we get paid back by companies.

Great. Thank you. And just one last question. I think the cash balance for the quarter end was the highest since the company went public. So I just wanted to know if there was any particular reason for holding the cash in the account versus paying down the revolver?

It’s just timing of deals around quarter end, whether you’re going to buys and sells and whatever was happening around quarter end, so there’s nothing strategic about it. It was just timing.

Okay, great. Thank you. That is all from me.

Thank you.

This will conclude the question-and-answer session. At this time, I’d like to turn the call back to Mr. Art Penn for closing remarks.

Thanks, everybody. We appreciate your time and interest today. We will be talking to you in early February. Have a Happy Thanksgiving and New Year.

This does conclude today’s conference. We thank you for your participation. You may now disconnect.