PennantPark Floating Rate Capital Ltd. (PFLT) Q4 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the PennantPark Floating Rate Capital’s Fourth Fiscal Quarter 2016 Earnings Conference Call. Today’s conference is being recorded. At this time, all participants are placed in a listen-only mode. The call will be open 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 2016 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 a 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.

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 open it up for Q&A. As you all know, the economic signals have been moderately positive with regard to the more liquid capital markets, in particular the leverage loan and high yield markets, during the quarter ended September 30th, those markets experienced strength, as high yield and leverage loan funds experienced some inflows due to a continuing benign interest rate environment and stability in the energy markets. The overall market has strengthened and remains attractive. As debt investors and lenders, a flat economy is fine, as long as we have underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow over time is a favorable outcome for us. 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 companies and 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 over a 160 different financial sponsors. We are pleased that we’ve been approaching this investing market with substantially more capital and resources. As a result of our merger with MCG Capital last year, we’ve nearly doubled the financial resources of PFLT. Combined with our recent investment in senior and mid-level investment professionals across different geographies, we are driving significantly enhanced deal flow, as we get more luxe and be even more relevant to our borrower clients. The industrial logic of the MCG merger has been validated; prior to the merger more than 70% of our investments, we were only a participant in a transaction for the quarter ended September 30th, and about 70% of our transactions we had a leadership role as a sole lender, club lead, club member or anchor awarder. We have been active and are well-positioned. For the quarter ended September 30, 2016, we invested a $107 million in primarily first lien senior secured assets at an average yield of 7%. Since quarter end, we’ve invested about $50 million and believe that the rest of the quarter will be active. Net investment income was $0.31 per share. Our run rate income excluding other income is $0.27 per share. Our debt-to-equity ratio is only 0.6 times, leaving us with substantial liquidity. We’ve significant spillover income that can be used as cushion to protect our dividend while we ramp the portfolio. As of September 30th, our spillover was $0.38 per share. Other income is a category that we have on our income statement to represent prepayment fees or waiver amendment fees that are not part of our ongoing interest income. Net other income has averaged $0.02 per share per quarter over the last couple of years. For the quarter ended September 30th, other income of $0.l4 per share was exceptionally high, primarily due to litigation settlements related to a former portfolio Company of MCG. 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, continue to be 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 3.8 times, another indication of prudent risk. Our credit quality since inception over five years ago has been excellent. Out of over 270 companies in which we’ve invested in over five years, we’ve experienced only four non-accruals. On these four non-accruals, we’ve recovered a $1.06 [ph] on the $1 so far. At September 30th, we had one non-accrual on our books, representing only 0.2% of the portfolio at cost. 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’ve 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 $12 million in the first lien debt and common equity of Advanced Cable Communications, which is a cable company that provides television, internet and phone service to customers in Florida. Twin Point Capital is the sponsor. CD&R TZ Purchaser is a provider of direct-to-consumer sales and marketing solutions for insurance carriers. We won $12 million of first lien term loan. Clayton Dubilier & Rice is the sponsor. We invested $10 million in the first lien term debt of DBI Holdings, which is a provider of transportation infrastructure operation and maintenance services. Sterling Partners is the sponsor. Efficient Collaborative Retail Marketing Company hosts events to facilitate the purchase of products between consumer product goods manufacturers and retailers. We invested $11 million in the first lien term loan. Snow Phipps is the sponsor. We invested $10 million in the first lien term loan of Quick Weight Loss Centers which operates weight loss centers and sells nutritional foods. Sentinel Capital is the sponsor. Turning to the outlook, we believe that the remainder of 2016 will continue to be active due to both growth and M&A driven financings. Due to our strong sourcing network and client relationships, we’re 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, 2016, recurring net investment income totaled $0.27 per share. We also had $0.08 per share of other income net of incentive fees as well as $0.04 per share charge for incentive fees accrued but not payable. As a result, net investment income was $0.31 per share. Looking at some of the expense categories, management fees payable in cash totaled $3.8 million. General and administrative expenses totaled about $700,000. And interest expense totaled about $1.6 million. During the quarter ended September 30th, net unrealized appreciation from investments and credit facility was approximately $7.1 million or $0.27 per share. Net realized gain was about $600,000 or $0.02 per share. And income in excess of dividend was about $500,000 or $0.02 per share. Consequently, NAV was up $0.31 per share from $13.75 to $14.06 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 quotes are inactive, we are using independent valuation firms to value these investments. Our portfolio is relatively lower risk; it is highly diversified with 98 companies across 25 different industries. 92% is invested in first lien senior secured debt, 6% in second lien secured debt, 2% in subordinated debt and equity. Our overall debt portfolio has a weighted average yield of 7.8%. 99% of the portfolio is floating rate including 94% with a floor. The average LIBOR floor is 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 the preservation of capital. Everything we do is aligned with that goal. We try to find less risky middle-market companies that have higher 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’d like to open up the call to questions.

Thank you. [Operator Instructions] And we’ll take our first question from Paul Johnson with KBW. Please go ahead.

Yes. Good morning, guys. Thanks for taking my question. I just wanted to ask a question. Forgive me, I think you may have mentioned this on the call but I just wanted to make sure I’m thinking about this correctly. I’m trying to get a sense of what NII would have been without the impact of the one-time settlement fees of $3.3 million, because when I run my calculation, I’m getting closer to the $0.24, or $0.25 range. But, I was hoping that maybe you guys could provide a little more insight into that?

So, as of September 30th, excluding any new investments we’ve made since then, our recurring run rate was $0.27 a share.

And then, I had another question. The other question I had was a little bit more general, but I was hoping maybe you guys could provide a little bit of color into the potential for the average floor to go up over time. I think looking back over the last four, five years or so, I know it was a little bit closer to 1.5%, I think you sized 1.7% range if that’s possible or we’re just sort of in an environment where it’s at where it’s at and not likely to see that?

Yes. So, it’s interesting, a little historical context. The LIBOR floors came into being in the 2008, 2009, 2010 time period when LIBOR plummeted. And when we got in business 10 years ago, LIBOR was about 5%. Here we are -- what was it about a year ago or not even that long ago, it was basically 25 basis points. So, when LIBOR plummeted in the ‘08, ‘09 time period, that’s when LIBOR floors came in; when they first came in and we were in the throes of a credit crunch, and they were more like a 1.5% on average; you saw a couple or 2%, and the average LIBOR floor over the last few years has kind of solidified around 1%, which is kind of what the average LIBOR floor in PFLT portfolio is today. Interesting, if you see -- if you believe interest rates are going up, the 1%, we’re kind of almost 1% right now; so this portfolio should benefit from upside. I think if I’d to guess and I don’t know -- we don’t know, we don’t have any particular insight, we probably say that average floor of 1% is going to stay kind of in existence going forward, unless we have another plummet on one hand or we have a credit crunch -- a credit crunch on the other hand allowing that floor to be renegotiated.

So, I mean, do you’ve a maybe an idea, like a range where you’d like to see LIBOR kind of get to the possibly get that start building up or…?

Look, I mean it’s -- for our BDC as well as for the industry, given the industry is mostly LIBOR oriented or floating rate oriented, PFLT is 99% floating rate. LIBOR going up is a big positive, big positive for PFLT; we outlined it in our financial statements as every other BDC. And so that would be a nice event for us. We’ve been waiting a long time for that to happen. It’s been -- people have been talking about interest rates going up now for five, six years, and they’re just starting to. So, it would be a positive and we would hope it’d happen at some time and we all be the beneficiary of that. Okay, everybody -- any other questions?

No further questions at this time.

Alright, everybody, thank you very much for listening in today; wishing everybody a great Thanksgiving, and we’ll be talking to you in early February at our next quarterly call. Talk to you soon.

Once again that does conclude today’s conference. Thank you for your participation. You may now disconnect.