PennantPark Floating Rate Capital Ltd. (PFLT) Q1 2015 Earnings Report, Transcript and Summary

Good day everyone, and welcome to the PennantPark Floating Rate Capital's First Fiscal Quarter 2015 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode. The call will be open for your 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 first fiscal quarter 2015 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 website. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.pennantpark.com or call us at 212-905-1000. At this time, I'd like to turn the call back to our Chairman and Chief Executive officer, Art Penn.

Thank you, Aviv. I'm going to spend a few minutes discussing current market conditions, followed by a discussion of 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 December 31, those markets experienced volatility due to cash outflows and leverage loans and high yield funds. In 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. After several years of split compression, we believe 2015 could finally be a year for yield expansion. We remain primarily focused on long term value and making investments that will perform well over several years and can withstand different business cycles. Our focus continues to be on company's restructures, and 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 provider 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 finance company is backed by a 140 different financial sponsors. We have been active and are well positioned. For the quarter ended December 31, 2014 we invested $47 million with the average yield of 8.5%. Core net investment income was $0.30 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 or cash flow exceeds cash interest expense, continued to be a healthy 3.2x. This provides significant cushion to support stable investment income. Additionally at cost, the ratio of debt to EBITDA on the overall portfolio was 3.8x, another indication of prudent risk. Our credit quality since inception nearly four years ago has been excellent. As of December 31, we had one nonaccrual UniTek representing 0.7% of the portfolio of that cost. This was our first nonaccrual since inception. Since quarter end, the company has completed its restructuring and we currently have no nonaccruals. After quarter end, Patriot National priced in IPO, our proceeds of $14 million resulted in a realized gain of $0.09 per share, an increase in NAV of $0.06 and about $0.05 per share of other income. 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 $5 million in the first lien debt of CRGT, which is a provider of custom software development to federal government agencies, Bridge Growth Partners is the sponsor. DISA Global Solutions is a provider of workplace, safety, and compliance services. We purchased 5 million of the first lien term loan, Court Square is the sponsor. We purchased 11 million of the second lien term loan of Howard Berger. Howard Berger is a provider of blended and private label hardware and houseware related products in North America, Littlejohn & Company is the sponsor. Icynene is a manufacturer of spray polyurethane foam insulation. We invested 7 million in the first lien term loan, Friedman Fleischer & Lowe is the sponsor. Turning to the outlook, we believe that the reminder of 2015 we'll 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 December 31, 2014, recurring net investment income totaled $0.30 per share resulting in core net investment was $0.30 per share. Additionally, we had $0.04 per share of our reversal of capital gain incentive fee that were accrued but not payable and $0.03 per share of our reversal of realized gain incentive fee. This resulted in GAAP net investment income of $0.37 per share. Looking at some of the expenses. Management fees totaled about $600,000 after a $600,000 reversal of capital gain incentive fees accrued but not payable and our reversal of $450,000 of realized gain incentive fees. Taxes and general administrative expenses totaled about $600,000 and interest expenses totaled about $900,000. During the quarter ended December 31, realized losses were $174,000 or $0.01 per share. Net unrealized depreciation from investment was approximately $4.9 million or $0.33 per share. Income in excess of dividend was $1.4 million or $0.10 per share. Consequently, NAV was down $0.24 per share from $14.40 to $14.16 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 firms or independent broker dealer quotations when active markets are available under ASC 820 and 825. In cases where broker dealer 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 21 different industries. 84% is invested in first lien senior secured debt, 13% in second lien secured debt and 3% in subordinated debt and equity. Our debt to equity ratio net of cash is 60%. Our overall debt portfolio has a weighted average yield of 8.5%. 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. Before we conclude, I want to address the shareholder proposal. To ask for pre-approval to issue shares below NAV. Our sister company, PennantPark Investment Corporation has received approval for the last six years as a long standing shareholders that have come to trust that will behave in their best interest. Our historical track record is clear, during the financial crisis, PennantPark Investment Corporation did exercise the ability to issue shares below NAV when it was absolutely clear that the proceeds could be deployed in a way that would increase both net income and shareholder dividends. This strategy was in fact one of the drivers of the growth in dividends over time for PennantPark Investment Corporation. The strategy and intent is the same for PennantPark Floating Rate Capital. To conclude, we want to reiterate our mission. Our goal is steady, stable and protected 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.

[Operator Instructions] And we'll first hear from Greg Mason of KBW Investments.

Thanks, good morning everyone. First Art and Aviv on the UniTek restructuring post quarter end obviously back on the accrual status, did you have any loss of principal on the restructuring?

Yes, we did have restructuring. So we did have a realize loss and we’re starting over. So it depends - during restructuring, you can carry the old cost over and continue or you can realize a loss. In this case we did realize a loss.

So as we think about that the amount of essentially investments that are going to return to paying status, should it be fairly close to the - the mark at the end of the quarter?

Yes, right now we have about just to be clear, we have about 600 - we have about 500,000 of tranche A which yields about 11%. We have about 600,000 of tranche B which yields about 12%, we have 100,000 of [indiscernible] which is 15% piece of paper and we have $1 million worth of equity.

Great. In the quarter for the decline in the portfolio values, any of those declines related to credit issues or predominantly just mark-to-market liquid quotes?

Predominately mark-to-market. One energy investment [indiscernible], was marked down, that's a pipeline company, if you're going to be energy it’s the best place to be today since quarter end there has been some nice news which has helped that company rebound from a mark-to-market basis. Everything else is just in line with the overall market.

And then one last question, looks like on that portfolio statistics of the leverage as well as the interest coverage, went down slightly a little bit, so debt to EBITDA went from 3.6 last quarter to 3.8 this quarter, interest coverage to 3.2 down from 3.4 last quarter. Any color on, those - the minor changes, but any color on those changes?

No, this is what happens in our business, the deals that deleverage which are [indiscernible], which is what we want taken out and refinanced. And I would characterize it more as a timing thing in terms of having some refinancings of some lower leveraged instruments and hopefully this portfolio over time will deleverage as well.

So more of portfolio mix change versus deterioration of the existing credits.

That's correct.

Great. Thanks guys, appreciated.

Next we’ll hear from Chris York of JMP Securities.

Art, just wanted to quick follow up on your comments first, as they were Midstream, - was any of the principle paid back last month when the deal was amended?

We got some - I think we had about 5 million, I think we got $1 million back in par, the company is increasing the yield. We got a fee, just to be clear, just so everyone knows that, they are taking some of their assets and they are putting it into a publicly traded MLP which creates liquidity and an exit for some of their assets, that's a positive credit event, I think the paper’s up 5 or 10 points since quarter end.

And then secondly you commented that you’re expecting yield expansion in 2015. Should we expect maybe another 50 to 100 basis point incremental increase, like your comments were on PNNT?

Sure, it's a good question. PNNT we said that PNNT again has a different strategy. When we talked about the 50, 100 bps, we're talking about more either unit tranche or second lien or subordinated debt. For true first liens, we don’t think it’s going to be that big, call it 25 to 50 bps.

That's helpful. That's it for me. Good quarter. Thank you.

And next we'll hear from Mickey Schleien of Ladenburg.

Good morning, Art. A few questions, given your generally positive tone on the market, can you help me understand why we didn’t really see any growth in the portfolio during the quarter?

PFLT, we think of it as kind of a maximum $400 million vehicle given the debt-to-equity constraints we have as BDC. So how far do you take it? We never take it up to 99% of course to equity. So whether it’s 350, 340, 370 or 380 that's the zone and it just depends on the deals that you're seeing going at given point in time. We'd rather find deals that we really like, if it means we're a little bit smaller, I mean it's little smaller, if we find a lot of deals we really like, will be a little bit bigger but we are somewhat constrained from an overall size standpoint.

Okay, I understand. Art, this BDC has been consistently out-earning its dividend for a while and retaining capital. I'd like to understand under what conditions the Board would consider raising the dividend, the regular dividend or perhaps declaring a special.

Board considers all options including special dividends and raising dividends is something we think about. We also think about interest rates rising at some point with this vehicle having assets that are above floating and liabilities that are above floating at least first 100 basis points or so income will take a hit. If interest rates ever do go up, there will be little bit of a hit in income for that first 100 basis points or so and then income will rise nicely after that. So, we certainly want to keep some extra capital on the cookie jar in case interest rates do go up to handle that first 100 basis points or so but the Board does consider all options regarding dividends et cetera.

I understand. Art, the fee income was down quarter-to-quarter. Was that driven by lower pre-payments or was there something else going on?

That's exactly right. The other income is driven by pre-payment penalties or amendment or waiver fees.

Okay. And just quickly could you give us an update on Virtual Radiologic, Cannery Casino and Affinion, these are just the distressed assets.

Virtual Radiologic, Cannery, and Affinion. Virtual Radiologic is one of these that has been marked down for quite sometime now. It's gradually and slowly improving its operations I think over time we’ve seen a gradual slow improvement in the valuation. It is slow. It is the one you always debate do get out of it, $0.70 or $0.80 on the dollar and realize a loss or do you just hold it. We think over time that we will work its way back to par. So nothing major but that's a gradually improving situation. Cannery is a different situation. They have an agreement to sell themselves or sell a large asset. The buy, there was set - the buyer is trying to get out of it. There is some litigation going on between the two parties. So, again not a big exposure for us but that's resulted in the lower pricing on the Cannery valuation. This litigation it’s something you follow, we’ll see how that works its way through. Affinion is the same old same old. Company went through a redo of the capital structure call it nine months ago. Created 3.5 years of option to get through any consumer financial protection bureau issues, build-up their businesses. We think, and we are optimistic that during that three year time period, they will be able to get past the consumer financial protection bureau issues and build their businesses and we ultimately still believe that, that is a par piece of paper in the long run.

And you are comfortable with the Cannery Casino's operations aside from the legal issues?

Yeah, we were comfortable with the operations sight from the legal issues. Right now it's all mired in litigation. So, it's kind of a “wait and see” kind of thing. Again that's not a very big position of errors but something we focus on.

Okay. Those were all my questions. Thanks for your time.

And next we will hear from Abigail Latour of Standard & Poor's.

I was wondering if you could comment more on UniTek and the impact of that restructuring?

So, again we now have several different pieces of paper. We have 110,000 of an undrawn revolver. We have about $500,000 of tranche A first lean. We have about $600,000 of tranche B first lien. We have about $100,000 of [HoldCo Pik] debt, we have about $1 million of equity. The yields are revolvers, in 0.5% cash pay 1% tick. The term loan A is in 0.5% cash pay. These are LIBOR - LIBOR 51% floor, - LIBOR [751] [ph] floor but the revolver and term loan A and then 1% tick for the term loan A in addition. The term loan Because, LIBOR plus 750 1% floor and if that piece of paper outstanding after the second year it increases a 100 basis points per year. After that the HoldCo, the $100,000 or so HoldCo has 15% pick and $1 million of stock is the value of this stock. At the time the restructuring happens in a planned value, that's what that is. So that's what we and the valuation firms take and when these restructurings happen, $1 billion penalty value going forward.

Okay. Thank you.

And it appears there are no further questions. At this time, I'll turn the conference back over to Mr. Penn for any additional or closing comments.

Thank you very much. We appreciate everyone's interest in PennantPark Floating Rate Capital. And we'll talk to you next quarter.