PennantPark Floating Rate Capital Ltd (PFLT) 2015 Q4 法說會逐字稿

Good morning and welcome to the PennantPark Floating Rate Capital's fourth fiscal quarter 2015 earnings conference call. Today's conference is being recorded.

(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 including a 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 on 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 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 leveraged loan and high yield markets, during the quarter ended September 30, those markets softened, as high yield and leveraged 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 risk reward.

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 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'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 well positioned to drive significantly enhanced deal flow, as we get more looks 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 been upsized from $200 million to $290 million and subsequent to quarter end, upsized 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, continue 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 4.5 years ago has been excellent. Prior to this quarter we experienced only one small nonaccrual, which has had a strong recovery. This past quarter ended September 30 we experienced our second nonaccrual in 4.5 years, Affinion, which represented 1.6% of the portfolio at 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 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 $5 million in the first lien debt of CareCentrix, which provides a specialty benefit management services to help plans in the post-acute segment. Summit Partners is the sponsor. CRGT is a provider of custom software development to federal government agencies. We purchased $7 million of the first lien term loan. Bridge Growth Partners is the sponsor. We 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 net 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 expenses totaled about $800,000. During the quarter ended September 30, net unrealized depreciation from investments and credit facility was about $2.4 million, or $0.12 per share. And dividends 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 an independent valuation firm or independent broker/dealer quotations when active markets are available under ASC820 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 the 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 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)

Ryan Lynch, KBW.

Congratulations on closing the MCG acquisition. With that said, we estimate you guys have approximately $250 million of capital now to deploy 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 quarter to date in the December quarter?

That's 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 to 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 trade to BDCs. In this particular case with the collateral and the underlying assets here, we think we could take it a little bit higher leverage.

It's always tough for us to give a pipeline as you've looked back at our history. Past prior equity offerings, we been able to ramp fairly quickly. As we've said publicly we think in a few quarters we could utilize the incremental capital here. It's hard to make an exact assumption of how quickly that will ramp.

We might have been very fortunate here. We closed the deal with MCG in late August. Clearly not much was going on in late August and then the overall market started getting a little shakier, which to us as 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. Every day we wait, risk/reward keeps getting a little bit better. We've seen the broadly syndicated loan market sell off quite substantially. The high yield market sold 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's coming our direction.

Obviously if we see compelling deals along the way, we're going to be doing them. And we have been doing what we think are compelling deals along the way. But we're not necessarily in the greatest rush right now because each passing day we're getting better and better risk/reward. We're 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 to us always, it's deal by deal by deal not credit underwriting.

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

It's a good question. It just depends on the complexion. Clearly we're willing, when the credit's really strong, to take a lower yield and really have a protected and diversified portfolio. So I think and generally we've been running around that 8% area blended. I think that's a fine overall blended assumption to make. There will be times when it's going to be a little below, there's times when it maybe a little bit higher. It's always deal by deal underwriting that we're focused on.

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

Yes, every time we do it, and 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. Usually you could see a relative to what we've done between -- the leg that we have through September 30. I don't want to give a [prelude] to it, but it's the same relativity to our upsizing for the September quarter, and will be the same thing.

Okay. That's all for me. Thanks, guys.

Thank you.

Mickey Schleien, Landenburg.

I want to ask Ryan's first question a little different way. The last couple of years, PFLT's made new investments in the neighborhood of $225 million to $250 million. Has there been any changes to the platform at the external manager that would allow you to increase that deal flow in a substantially on a go-forward basis?

Yes. That's a great question, and I think we talked about it a bit in this call. There's a lot of things going on. First, the industrial logic behind the MCGC deal was 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 could take a bigger bite, we can do $10 million, $15 million, $20 million bites more regularly. We can have a front row seat on financings. We can drive better yields. We can drive better fees. So you should expect us on average to have the 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're hoping that a bigger, more liquid market cap generates more interest, both from the research community and from the investment community.

Additionally, as we've mentioned in both today's call and the call the other day on PNNT, we have invested significantly in our platform. We've added very senior people in New York, in London, in Chicago, on the West Coast. One of our partners moved to Texas. We've added significant resources in the mid-level investment side of our shop.

So we really are going at in terms of building our platform in all the ways that we can build our platform. We're happy to do it. We think it'll 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 1.5 times what it was a couple years ago, something like that, general order of magnitude.

50% growth?

Yes, I think that's fine. I think that's fair. We've also beefed up Aviv's team in the admin and finance side. We're committed to the business.

We think the market is coming our direction. We think there's better risk-adjusted returns out there. And we're committed to delivering those returns to our shareholders.

And looking at returns, Art, clearly a lot of volatility in the third calendar quarter. And we saw meaningful widening of spreads in second lien loans versus first lien. The portfolio now is running on a fair value basis, 12% in second lien. Do you think there's a better trade there, 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. That will still -- always be the key driver, key core strategy here. We hope that this Company is safe enough for your grandmother. That's our mantra.

We're 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're hoping to do.

And then we've always thought that there's an opportunistic bucket in this portfolio. We say it could be up to one-third. We've, in reality, kept it 10%, 15% of the portfolio. I wouldn't expect any dramatic shift.

Obviously, always deal by deal. If there's a fantastic risk-adjusted return we're going to look at it. But we want to maintain massive diversification, not have any one industry or one company be too big of a 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 sub-debt, 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.

(Operator instructions)

And that concludes today's question-and-answer session. I'd like to turn the conference back over to Mr. Penn for any additional or closing remarks.

Just want to thank everybody for their support and interest in us. And we'll 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. We thank you all for your participation.