PennantPark Floating Rate Capital Ltd. (PFLT) Q2 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the PennantPark Floating Rate Capital's Second Fiscal Quarter 2017 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 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 second fiscal quarter 2017 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 Web site. 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 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 of the portfolio, investment activity, the financials, and then open it up for Q&A. As you all know, the economic signals have been moderately positive was regard to the more liquid capital markets, in particular the leverage loan and high yield markets, during the quarter ended March 31, those markets experienced strength, as high yield and leverage loan funds experienced some inflows due to a belief and stronger economy and benign interest rate environment. 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 175 different financial sponsors. We are pleased that we've been approaching this investing market with substantially more capital and resources in order to drive significantly enhanced self coverage deal flow. This enhanced deal flow has meant that we can get more lucks and even more relevant to our borrower clients. Being more relevant means that we can be increasingly selective about which investments we make as well as giving us the ability to be an important leader in transactions that can drive comps. We've taken four steps in order to build this increased relevance over the last two years. Number one a merger with MCG capital nearly double the financial resources of PFLT at that time. Number two we've brought onto our platform talented senior and mid-level investment professionals across different geographies including New York, Los Angeles, Chicago and London and opened an office in Houston in order to drive incremental relationships and to flow. Number three we completed a follow on equity offering last quarter were $380 million and four last night we announced a new senior secured loan fund joint venture with Kemper Corporation. The senior secured loan fund will invest in loans consistent with our core strategy and will be funded with $87.5 million of subordinated notes and equity from us $12.5 million of subordinated notes and equity from Kemper and up to $200 million of third party debt financing. The senior secured loan fund initiative has benefits to us and our clients. Together PFLT and the senior secured loan fund by a larger checks to our sponsor clients and be more relevant to them driving enhanced deal flow and better terms. And number two we expect the ROE on the overall investment in the senior secure loan fund to be in the low to mid teens which should be created to the overall ROE of PFLT as well as a net investment income per share. For the quarter ended March 31 we've been active in a well position. We invested $146 million and primarily first lien senior secured assets at an average yield of 7.8%. Net investment income was $0.27 per share adjusted equity ratio is 0.66 times. We have significant spillover income that we can use as cushion to protect our dividend while we ramp the portfolio at September 30 our spillover was $0.38 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 that withstand market and economic volatility. The cash interest coverage ratio the amount by which EBITDA or cash flow exceeds cash interest expenses continued to be healthy 3.5 times. This provides significant cushion to support stable investment income. Additionally at cost, the ratio debt to EBITDA on the overall portfolio was 4.2 times, another indication of prudent risk. Our credit quality since inception six years ago it's been excellent out of 295 companies in which we have invested we've experienced only five non-accruals on those five non-accruals we've recovered $0.99 on the dollar so far as of March 31 we had one non-accruals on our books representing 0.4% of the portfolio on a cost basis and 0.2% on a market value basis in terms of new investments. We've another active quarter investing in attractive risk adjusted returns. Our activity was driven by mixture of M&A deals growth financings and refinancings virtually all these investments we've known these particular companies for a while have studied the industries for the strong relationship with the sponsor. Let's walk through some of the highlights. We've invested $17 million in the first lien debt of Country Fresh Holdings, Country Fresh is a provider of fresh cut fruits and vegetables to the grocery and food service markets Sentinel capitals the sponsor. Morrissey L.L.C. is a cosmetics company providing color cosmetics and cosmetic brushes primarily selling direct to consumer. We had $19 million of first lien term one; Summit Partners is the sponsor. We lend $20 million of first lien term loan to Salient CRGT. Salient CRGT is a software development, data analytics and other technology services to federal government agencies. City growth is the sponsor. Veterinary specialists in North America also known as Compassion First Pet Hospitals owns and operates special veterinary hospitals invest $11 million in the first lien term loan. Quad C is the sponsor. Turning to the outlook, we believe that's the remainder of 2017 will continue to be active due to both growth and M&A driven financing due to our strong sourcing networking and client relationships we are seeing active deal flow. Let me now turn the call over to Aviv, our CFO, to take it through the financial results.

Thank you, Art. For the quarter ended March 31, 2017 net investment income was $0.27 per share. Looking at some of the expense categories management fees totaled $2.2 million. General and administrative expenses totaled about $900,000 and interest expense totaled about $2 million. During the quarter ended March 31 net unrealized appreciation from investment was $2.7 million or $0.09 per share. Net realized gains or $2 million or $0.07 per share. Operating cost for about $0.02 per share and dividend in excess of income was $700,000 or $0.02 per share consequently NAV was down slightly from $14.11 to $14.05 per share. Our entire portfolio and our credit facility our mark-to- market by a 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 90 companies across 24 different industries. 93% is invested in first lien senior secured debt, 5% in second lien secured debt, 2% in subordinated debt and equity. Our overall debt portfolio has a weighted average yield of 7.9%. 98% of the portfolio is floating rate. 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] Our first question comes from Ryan Lynch from Keefe, Bruyette & Woods. Please go ahead.

Good morning, guys. First question has to do with kind of the ramp up of the new joint venture senior loan fund. So, as I look at it, when it's fully levered, you know, assuming the equity contributions and leverage of 250, or I mean, leverage -- with the leverage and the total assets of about $250 million to $270 million within the JV, I'm just wondering you know what is your expected timeframe in order to get that fully ramped up? I mean if I look at your balance sheet originations, you guys have regularly done, you know, from origination standpoint $250 million plus of originations per year, and so, you guys have a robust origination capability. So, what is your timeframe of when you guys expect to fully ramp this up?

Thanks, Ryan. Our goal would be two to three quarters in terms of targeted ramp of the JV.

Just to be clear; that would be two to three quarters of deploying all the equity plus additional leverage, so roughly $250 million or $275 million?

That's correct.

Okay. And then as far as environment today, when I look at -- you know, it's obviously a competitive environment with a lot of competition, you guys were able to maintain a pretty healthy portfolio yields, and look like there was really much compression, so can you just talk about how you guys are able to you know maintain a pretty strong portfolio yield with not too much decline, but also not take on too much credit risk?

That's a great question. That's a balance we try to have every day. We are in a fairly billionth [ph] timeframe. Yields are compressing. The benefit of PFLT even though we're bigger particularly now with our JV, we are still relatively modest sized in the universe of direct lenders. So, we can be -- we can afford to be picky. We don't have to come to the office every day to fill the bucket. We from the office trying to find good risk adjusted returns. So we're very focused on maintaining credit quality and yield although look we're in the yield compressed environment as why this JV is really interesting for us is because it can be a tool for us to continue to have a high ROE or even higher ROE and hopefully higher NII while at the same time, hopefully maintaining credit quality in a market where there's a bunch of yield compression. So, we thought, we thought to glorify. We think we battled it well this past quarter by maintaining blended yields, which include some classic first lien and secured seniors as well the little bit second lien to get to that kind of 7.8% this quarter but you know the JV gives us the ability to, to maintain absolute credit quality which is our primary goal. We will give up yields and maintain credit quality that's our first and foremost goal the JV allows us to potentially do that.

Okay. Yes, I totally agree with that. Totally agree with the commentary of, given us some yield as far as you know but maintaining credit quality that credit quality is the thing paramount sticking with that kind of heated market conversation, one benefit I guess of, I would say maybe heated markets is the equity markets are definitely very hot right now and we've seen that some equity valuations going up you guys have, several equity co vestments that that have, haven't written up have some nice gains and then today can you talk about one you guys ability to be able to at any of those whether you guys control your own destiny as far as when those are exceed and then as well as if you guys don't control their own destiny and you guys have any sort of outlook on the potential for you know any of the you guys being able to monetize any of these equity co-investments in 2017?

It's a good question. And buy and large, these equity co-investments that we have, and again it's only about 1% of the portfolio in total. So it's relatively small in PFLT, I'll pick out a name, Elf [ph], which is valid about $1.5 we sold an better half our position this past quarter that's public equity, that was an equity comp invested, company ultimately when public obviously we hope in the coming quarters that actually that particular one we're not a control shareholder but it is a public equity that does trade. Finian [ph] is one that's been there for a while we did take a markdown this quarter that, that was in line with a redo of the capital structure which is going to give us liquidity on our two pieces of the Finian debt and the new capital that came and diluted this existing capital. We are hopeful and optimistic that we're going to in the long run do pretty well on that equity investment. The rest of the equity investment relatively small American Gilsonite that was a restructured deal we're optimistic on that company that's a Oil field services minerals company, company is doing very well in this environment and we have a couple other, couple other names that we were not control or basically and equity investor but all in all that adds up to 1% of the portfolio about on a market value basis.

Okay. And then one last one, overall the portfolio continues to be very strong in terms of credit quality how are you guys that have one small loan going non-accrual the accrual sunshine oilsands obviously accrual stop you guys stop recording interest income from that the fair value mark is pretty consistent quarter-over-quarter marked around 55% or so of your costs you can just talk about what's going on there that that you know results and you guys moving into non-accrual but having a relatively unchanged fair value mark?

That's a great question, and we grappled with this one. This again is a public company, ultimately trades on Hong Kong Stock Exchange, the backers of the equity are Chinese investors who continue to plum equity capital into this company beneath the debt, which has been comforting to us as lenders. Obviously, the Canadian oil sands have been having problems in general but this company seems very support of equity group, which is continuing to invest, our call this quarter was at the mark of 55 or 56 whatever was marked. We were not getting cash interest. We are now getting interest in tech. We elected this quarter to it on non-accrual given the mark and given the pick. That said, we are optimistic that overtime we can get our money back, but it's relatively small position, the cost is about $2.8 million.

Okay. Thank you for taking my questions.

Thank you.

The next question comes from [indiscernible]. Please go ahead.

Hi, good morning.

Good morning.

Addressing your JV with [indiscernible], it seems like they have a pretty good pipeline as pretty good organization this quarter. You are bumping up against or getting on the higher in debt leverage rain, so assuming that you are sort of open for business in the JV right away this quarter. How are you going to allocate your new loans coming in the door? Are you going to as we fill JV bucket completely before going back to your balance sheet, is it going to be some pro rata where one among us, here among there or is there a certain kind of loans that are slightly different that you will target for the JV for your balance sheet?

It's a great question and I can't give you the affinitive answers. We are working some of through that and some of that. We are probably going to put a - we are going to probably seated with a portfolio from PFLT, so you will see some amount of the PFLTs portfolio move over and to the JV assuming our partner approves those deals and the lender approves those deals but you probably see those names move over, get a seed portfolio have diversification, have some leverage. The JV is a very similar financing to our regular credit facility, it's also very efficient for stretch senior deals, so some stretch senior deals are will end up there and obviously the JV needs that diversification for like any other portfolio. So we would imagine overtime it is going to be 30 to 50 names in this portfolio, you will see some names and you will see probably very similar names between the two both PFLT and the JV will have very diversified portfolios, in certain cases will do a $25 million by $5 million or $7 million will go into the Joint Venture, $15 million to $20 million will go into PFLT, it will be that kind of thing.

Okay. Thanks. That's very helpful. And my last question maybe a broader question. Again, hitting on the competitive environment, I know that obviously the competitive environment spend is increasing or intensifying and PFLT is obviously sets a little higher and it's able to structure versus P&T or the more traditional PDCs, can you see any difference in the competitive conditions on the senior PCs versus the second main or the unitranche in the market?

Yes, well its competitive everywhere I'll just say that PFLT was always setup to kind of primarily focus on either classic first lien or stretch senior that's always been the primary mission of PFLT. That's a massive, massive market in the United States. PFLT is even with its increased size, with the additional equity, with the Joint Venture still relatively midsized in that [technical difficulty]. So and with a lower yield threshold and lower cost and expenses, PFLT is in a great place to continue to focus on high credit quality and not stretch for yield, take a lower yield if the credit is really good and still provide very attractive risk adjusted return to our shareholder and the Joint Venture with the ability to enhance the ROE in the NII really helps feed into that theme. So we are really excited about PFLT where it sits, we are excited about the increase after we are excited about the industrial logic of MCG feeding into the [indiscernible] we brought on feeding into the equity offering we did it months back, feeding into the JV PFLT is really, really well positioned in the market as a senior - as a leading senior debt provider to middle market sponsor clients and we are excited about getting on probably to sponsor clients about to enhance the capability.

Great. That's all my questions. Thank you.

And this does conclude today's question-and-answer session. I would like to turn it back to Mr. Penn for any additional or closing remarks.

Thank you, everybody. We are pleased that you participated today. We are pleased with what's going on with PFLT and we look forward to speaking to you in early August on a next quarterly conference call. Thank you very much.

This does conclude our conference for today. Thank you for your participation. You may disconnect.