PennantPark Floating Rate Capital Ltd. (PFLT) Q4 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the PennantPark Floating Rate Capital’s Fourth Fiscal Quarter 2015 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 opened for 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 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 discussion – 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 pennantpark.com or call us at 212-905-1000. At this time, I’d like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Thanks, Aviv. I’m going to spend a few minutes discussing current market conditions, followed by a discussion of the portfolio, investment activity, the financials, and 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 high yield markets, during the quarter ended September 30, those markets softened as high yield and leverage loan funds experienced some outflows due to expectations of Fed tightening and a potential weakening economy. This has impacted the tone of the middle-market and has generally resulted in a better opportunity to invest in attractive reward. We remain primarily focused on long-term value and making investments that perform well over several years and can withstand different business cycles. Our focus continues to be on companies and structures that are more defensive, have a 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 finance company is backed by a 150 different financial sponsors. We are excited to be approaching this improving investing market with substantially more capital and resources. As a result of our merger with MCG Capital we have nearly doubled the financial resources at PFLT. Combined with our recent investment in senior and middle-level investment professionals across different geographies, we are well positioned to drive significantly enhanced deal flow, as we get more lux and can be even more relevant to our borrower clients. We have been active and are well positioned. For the quarter ended September 30, 2015, we invested $63 million at an average yield of 8.3%. Core net investment income was $0.26 per share excluding one-time cost from amending and increasing our credit facility. We closed the merger with MCG on August 18, 2015. At closing, we received about $147 million of cash and less than a month later, an $18 million investment paid-off. We intend to invest this capital prudently over the next few quarters. We amended and increased our attractive low-cost LIBOR plus 200 credit facility in order to match the new equity capital resulting from the merger with MCG. By quarter end, the facility has an upside from $200 million to $290 million and subsequent to quarter end, upside again to $350 million. Additionally, the maturity has been extended to 2020. We have substantial spillover income that we can use as cushion to protect our dividend while we ramp the portfolio. As of September 30, our spillover was $0.47 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 healthy 3.9 times. This provides significant cushion to support stable investment income. Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 3.8 times, another indication of prudent risk. Our credit quality since inception over four-and-a-half years ago has been excellent. Prior to this quarter, we experienced only one small non-accrual which has had a strong recovery. This past quarter ended September 30, we experienced our second non-accrual in four-and-a-half years. Affinion which represented 1.6% of the portfolio cost and less than 1% at market. We are optimistic that our new equity position in Affinion will generate attractive returns over time. 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 of these investments, we have known these particular companies for a while; have studied the industries or have a strong relationship with the sponsor. Let’s walk through some of the highlights. We invested $5 million in the first-lien debt of CareCentrix which provides specialty benefit management services to health plans in the post-acute segment, Summit Partners is the sponsor. CRTG is a provider of custom software development to Federal government agencies. We purchased $7 million of the first-lien term loan. Ridge Growth Partners is the sponsor. We’ve invested $11 million in second-lien term debt of Language Line, which is a provider of on-demand spoken interpretation services, ABRY Partners is the sponsor. Vistage Worldwide is a member-based advisory firm that assembles and facilitates private advisory boards of senior managers, TowerBrook Capital is the sponsor. Turning to the outlook. We believe that the remainder of 2015 will 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, 2015, core net investment income totaled $0.26 per share and reversal of accrued, not payable incentive fees was $0.03 per share resulting in that investment income of $0.29 per share. Additionally, we had $0.11 per share of one-time credit facility fees. This resulted in GAAP net investment income of $0.18 per share. Looking at some of the expense categories, management fees totaled about $1 million; taxes, and general and administrative expenses totaled about $800,000; and interest expense totaled about $800,000. During the quarter ended September 30, net unrealized depreciation from investments and credit facilities was approximately $2.4 million or $0.12 per share. And dividend in excess of income was $2.9 million, or $0.14 per share. Legal and banking expenses from the MCG merger were $2.3 million or $0.12 per share. Consequently, NAV was down $0.38 per share from $14.33 to $13.95 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 and independent valuation firm 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 76 companies across 22 different industries. 86% is invested in first-lien senior secured debt, 12% in second-lien secured debt, and 2% in subordinated debt and equity. Our overall debt portfolio has a weighted average yield of 7.9%. 97% of that portfolio is floating rate, including 92% with a floor, and the average LIBOR floor is 1.1%. Now, let me turn the call back to Art.

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady stable and protected dividend stream coupled with a 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-off 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 will move first to Ryan Lynch with KBW.

Hey, good morning, Art and congratulations on closing the MCGC acquisition. With that said, we estimate you guys have approximately $250 million of capital now at a pro rata to get to roughly 0.75 debt-to-equity post to closing of MCGC. So, just wondering, what is a reasonable expectation for how much capital Pennant Float can deploy on a quarterly basis going forward? And how are deployments going on a quarter to-date in the December quarter?

That’s exactly a great question, Ryan. Thank you. I guess, first part of your question was 0.75 leverage which I think is fine. As we’ve always said, with PFLT given the senior orientation of the portfolio we feel – we could get a little bit more higher leverage in this case over time, let’s say 0.9 times. Still keeping it within the 1-to-1 threshold of the 1-to-1 leverage rate in the BDCs but in this particular case with the collateral and the underlying assets here, we think we could take a little bit higher leverage. So, it’s always tough for us to get kind of a pipeline as you look back at our history, past – prior equity offerings, we’ve been able to ramp fairly quickly. As we’ve said publicly, we think in a few quarters we can utilize the incremental capital here. It’s hard to make any exact assumption of how quickly that will ramp. I mean, we might have been very fortunate here we closed the deal with MCG in late August, clearly not much was going on late August and then the overall markets started getting a little shakier, which tosses buyers is good. We always like a little bit of shakiness, better risk reward, we can drive better terms, get higher yields, perhaps get better covenants, more upfront fees. So we haven’t necessarily been in that much of a rush since late August when the market is getting shaky to deploy the capital because the market is coming in our direction. Everyday, we wait risk reward keeps getting a little bit better, we’ve seen the broadly syndicated loan market sell-off quite substantially to high yield market sell-off quite substantially. That doesn’t immediately transfer to the middle-market, but the tone does definitely seep into the middle-market. So the market is coming our direction obviously if we see compelling deals along the way we are going to be doing them and we have been doing what we think are compelling deals along the way. But we are not necessarily in the greatest rush right now, because each passing day, we are getting better and better risk rewards. So, we are still hopeful that over the next two to four quarters, we will deploy the capital, get up to a more normalized leverage ratio of 0.75 times perhaps up to 0.9 times leverage. But that’s always it’s a deal-by-deal-by-deal on a credit underwriting.

Great. Talking about the volatility in the loan markets, it looks like, in the quarter, you guys portfolio yields for new investments was about 8.3% which was a bit higher than your overall portfolio yield of 7.9%. So, or is 8.3% is that a good estimate of the yields that you guys are seeing in the market right now. What we should maybe expect going forward?

It just did, it’s a good question. It just depends on the complexion clearly we are willing when the credit is really strong to take a lower yield and really have a protected and diversified portfolio. So, I think in general, we are running around an 8% area blended. I think that’s a fine overall blended assumption to make. There will be times when it’s going to be low to lower, there is times when it’s maybe a little bit higher, so it’s deal-by-deal underwriting that we are focused on.

Okay and then just one more housekeeping question. In the December quarter, you guys increased your credit facility a bit. Should we expect any one-time fees associated with that expansion?

Yes, every time we do it, we saw in this quarter, we had some one-time credit facility expenses, yes, there will be a little bit of expense associated with the upsizing from $290 million to $350 million.

Can you quantify that, just for modeling purposes?

Yes, I mean, usually, you can see relative to what we have done between the latest we have done through September 30, I don’t want to give the affiliate to it, but it’s the same relativity to our upsizing for the September quarter end will be the same thing.

Okay, that’s all for me. Thanks guys.

Thank you.

We will now take our next question from Mickey Schleien with Ladenburg.

Good morning, Art and Aviv. I want to – I guess, ask Ryan’s first question a little different way. The last couple of years, PFLT has made new investments in the neighborhood of 225 to 250. So, has there been any changes to the platform of external manager that would allow you to increase that deal flow substantially on a go-forward basis?

Yes, so, look, that’s a great question and I think we talked about a bit in this call. I mean, there is a lot of things going on. First the industrial logic behind the MCGC CDO with the following, on the investment side, we think being bigger and more important and being able to take bigger bites with sponsors and other borrowers, is a big part of the industrial logic. We can take a bigger bite we can do $10 million, $15 million, $20 million bites more regularly, we can have front row seat on financings. We can drive better yields, we can drive better fees. So you should expect us on average to have bigger bites in the portfolio with a bigger portfolio. And also, hopefully get, really attractive risk-adjusted returns because we are a more important lender to our borrower clients. Conversely, on the other side of the equation, we are open at a bigger more liquid market cap that generates more and more interest both from the research community and from the investment community. Additionally, as we have mentioned in both today’s call and the call the other day on PNNT, we have invested significantly in our platform. We have added very senior people in New York, in London, in Chicago, on the West Coast, one of our partners moved to Texas. We have added significant resources in the middle level investment side of our shop. So we really are going at it in terms of building our platform and all the way so we can build our platform. We are happy to do it. We think it will generate even better risk-adjusted returns for our shareholders.

So, Art, can you disclose how many employees you have at the external manager now versus a year ago?

I don’t have the exact number right now. It’s kind of in the upper 30s, which is maybe one-and-a-half times where it was a couple of years ago, some point as general order of magnitude.

And you have the present growth?

Yes, I think that’s fine. I think that’s fair. We’ve also beefed up each team in the admin and finance side. So, we are committed to the business we think the market is coming our direction. We think there is better risk-adjusted returns out there and we are committed to delivering those returns to our shareholders.

And looking at returns, Art, clearly lot of volatility in the third calendar quarter and we saw meaningful widening of spreads in the second-lien loans versus first-lien. The portfolio now is running on a fair value basis, 12% in second-lien. Would – do you think there is a better trade there? Or you are going to stick, or you think the trade is better at the first-lien level?

Look, in general, the focus of this firm is first-lien senior secured. So that will still always be kind of the key driver, key core strategy – up at this company is safe enough for your grandmother, that’s our mantra. So, we are going to keep to the focus on first-lien senior secured. We might be able to get better risk-adjusted returns in first-lien senior secured which we are hoping to do. And then we’ve always thought that there is an opportunistic bucket in this portfolio, we say, it could be up to a third. We’ve - in reality, get to 10%, 15% of the portfolio. I wouldn’t expect any dramatic shift, obviously always deal-by-deal if there is a fantastic risk-adjusted return we are going to look at it, but we want to maintain massive diversification, not have any one industry or one company be too big of the piece of our portfolio. So, don’t expect any massive changes to portfolio construction.

Okay, that’s helpful. And my last question, just to confirm the Affinion subject, the two pieces that are at PFLT, post-quarter, those have been converted into equity in Affinion. Is that correct?

Correct.

Okay, thanks for your time, Art.

Thanks, Mickey.

[Operator Instructions] And that concludes today’s question-and answer-session. I’d like to turn the conference back to Mr. Penn for any additional or closing remarks.

Just want to thank everybody for their support and interest in us and we will be chatting with you next in early February after the next filing of the 10-Q. Thank you very much.

And once again, that does conclude today’s conference and we thank you all for your participation.