PennantPark Floating Rate Capital Ltd (PFLT) 2017 Q2 法說會逐字稿

Good day, and welcome to the PennantPark Floating Rate Capital's Second Fiscal Quarter 2017 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 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 include 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 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 related 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 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 with regard to the more liquid capital markets and, in particular, the leveraged loan and high-yield markets.

During the quarter ended March 31, those markets experienced strength as high-yield and leveraged loan funds experienced some inflows due to a belief in the stronger economy and the 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've 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.

When 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 of companies, management teams, financial sponsors, intermediaries, our credit providers and, of course, our shareholders.

We are a first call for middle-market financials sponsors and 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-originated deal flow.

This enhanced deal flow has meant that we can get more looks and be 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 who can drive terms.

We've taken 4 steps in order to build this increased relevance over the last 2 years.

Number one, our merger with MCG Capital nearly doubled the financial resources of PFLT at that time.

Number two, we brought on to 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 deal flow.

Number three, we completed a follow-on equity offering last quarter, which raised $80 million.

And four, last night, we announced a new senior secured loan fund joint venture with Kemper Corporation.

This 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.

This senior secured loan fund initiative has benefits to us and our clients.

Together, PFLT and senior secured loan fund can write larger checks to our sponsored 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 secured loan fund to be in the low to mid-teens, which should be accretive to the overall ROE of PFLT as well as net investment income per share.

For the quarter ended March 31, we've been active and are well positioned.

We invested $146 million in primarily first-lien senior secured assets at an average yield of 7.8%.

Net investment income was $0.27 per share.

Our debt-to-equity ratio is 0.66x.

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 to withstand market and economic volatility.

The cash interest coverage ratio, the amount by which EBITDA and cash flow exceeds cash interest expense, continue to be a healthy 3.5x.

This provides significant cushion to support stable investment income.

Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 4.2x, another indication of prudent risk.

Our credit quality since inception 6 years ago has been excellent.

Out of 295 companies in which we have invested, we've experienced only 5 nonaccruals.

On those 5 nonaccruals, we've recovered $0.99 on the dollar so far.

As of March 31, we had 1 nonaccrual 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 had another active quarter investing on 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 $17 million on 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.

Kainos Capital is the sponsor.

Morrisey LLC is a cosmetics company providing color cosmetics and cosmetic brushes, primarily selling direct to consumer.

We lent $19 million of first-lien term loan.

Summit Partners is the sponsor.

We lent $20 million of first-lien term loan to Salient CRGT.

Salient CRGT provides software development, data analytics and other technology services to federal government agencies.

Bridge Growth is the sponsor.

Veterinary Specialist of North America, also known as Compassion-First Pet Hospitals, owns and operates special veterinary hospitals.

We invested $11 million in the first-lien term loan.

Quad-C is the sponsor.

Turning to the outlook.

We believe that the remainder of 2017 will 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 you 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 on investment was $2.7 million or $0.09 per share.

Net realized gains was $2 million or $0.07 per share.

Operating cost was 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 are marked 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 that our broker-dealer quotes are inactive, we use independent valuation firms to value the investments.

Our portfolio is relatively lower risk.

It is highly diversified, with 96 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 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) Our first question comes from Ryan Lynch from Keefe, Bruyette & Woods.

First question has to do with kind of the ramp-up of the new joint venture senior loan fund.

So if I look at it when it's fully levered, assuming the equity contributions and leverage of 250 -- or I mean, leverage -- with the leverage and then total assets of maybe about $250 million to $275 million within the JV, I'm just wondering, what is your expected time frame in order to get that fully ramped up?

I mean, if I look at your balance sheet originations, you guys have regularly done, from an origination standpoint, $250 million-plus of originations per year, so you guys have robust origination capabilities.

So what is your time frame of when you guys expect to fully ramp this up?

Thanks, Ryan.

Our goal would be kind of 2 to 3 quarters in terms of targeted ramp of the JV.

To just be clear, that would be 2 to 3 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 -- it's obviously a competitive environment with a lot of competition.

You guys were able to maintain a pretty healthy portfolio yield.

It didn't look like there was really much compression.

So can you just talk about how you guys are able to 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, and that's a balance we try to have every day.

We are in a fairly buoyant time frame.

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 come to 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 a yield-compressed environment.

That's why this JV is really interesting for us, is because it can be a tool for us to continue to have a higher ROE or even higher ROE and, hopefully, higher NII while, at the same time, hopefully maintaining credit quality in a market where there is a bunch of yields compression.

So we fought a good fight.

We think we battled it well this past quarter by maintaining blended yield, which includes some classic first liens, some stretch seniors as well as a little bit of second lien to get to that kind of 7.8% this quarter.

But the JV gives us the ability to maintain absolute credit quality, which is our primary goal.

We will give up yield to 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 giving up some yield as far as -- but maintaining credit quality.

Credit quality is definitely paramount.

Sticking with the 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 some equity valuations going up.

You guys have several equity co-investments that have -- have been written up, have some nice gains in them today.

Can you talk about, one, your guys' ability to be able to exit any of those, whether you guys control your own destiny as far as when those are exited?

And then as well as, if you guys don't control your own destiny, do you guys have any sort of outlook on the potential for any of the -- you guys being able to monetize any of these equity co-investments in 2017?

Yes, it's a good question.

And by 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.

Pick out a name, e.l.f., which is valued at about $1.5 million.

We sold about half our position this past quarter.

That's public equity.

That was an equity co-investment, the company ultimately went public.

Obviously, we hope, in the coming quarters, to exit that particular one.

We're not a controlling shareholder, but it is a public equity that does trade.

Affinion is one that's been there for a while.

We did take a markdown this quarter that was in line with a redo of the capital structure, which is going to give us liquidity on our 2 pieces of Affinion debt.

And the new capital that came in diluted 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 co-investment, relatively small.

American Gilsonite, that was a restructured deal.

We're optimistic on that company.

That's an oilfield services minerals company.

The company is doing very well on this environment.

And we have a couple other names that -- where we're not in control.

We're basically an equity coinvestor.

But all in all, it 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.

However, you guys did have one small loan go on nonaccrual this quarter, Sunshine Oilsands.

Obviously, when on nonaccrual, 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.

So can you just talk about what's going on there that results in you guys moving into nonaccrual 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.

It ultimately trades in the Hong Kong Stock Exchange.

The backers of the equity are Chinese investors who continue to plumb 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 to have a very supportive equity group, which is continuing to invest.

Our call this quarter was at the mark of 55% or 56% or wherever it was marked.

We were not getting cash interest.

We're now getting interest in PIK.

We elected this quarter to put it on nonaccrual given the mark and given the PIK.

That said, we're optimistic that over time, we can get our money back, but it's a relatively small position.

The cost is about $2.8 million.

Our next question comes from Doug Mewhirter from SunTrust.

Going -- addressing the -- your JV with the affiliate of Kemper.

It seems like you have a pretty good pipeline, have some pretty good originations this quarter.

You are bumping up against or getting on the higher end of that leverage range.

So assuming that you're 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 basically fill up the JV bucket completely before going back to your balance sheet?

Is it going to be some pro rata where one loan goes here, one goes there?

Or is there a certain kind of loans that are maybe slightly different that you would target for the JV versus your balance sheet?

It's a great question, and I can't give you definitive answers.

We're working some through that -- some of those -- through some of that now.

We are probably going to put a -- we're going to probably seed it with a portfolio from PFLT.

So you'll see some amount of PFLT's portfolio move over into the JV, assuming our partner approves those deals and the lender approves those deals.

But you could 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, and it's also very efficient for stretch senior deals.

So some of the stretch senior deals are -- will end up there.

And obviously, the JV needs to have a diversification for -- like any other portfolio.

So we'd imagine, over time, there's going to be 30 to 50 names in this portfolio.

You'll see some names -- you'll see probably very similar names between the 2. Both PFLT and the JV will have very diversified portfolios.

In certain cases, we'll do a $25 million bite, $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.

That's very helpful.

And my last question, maybe a broader question, again hitting on the competitive environment.

I know that -- it seems -- I mean, obviously, the competitive environment has been increasing or intensifying, and PFLT is -- obviously sits a little higher on the capital structure versus PNNT or the more traditional BDCs.

Do you see any difference in the competitive conditions on the senior pieces versus the second lien or the uni-tranche market?

Yes.

Look, it's competitive everywhere.

I'll just say that -- PFLT was always sent -- set up 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, is still relatively midsized in that universe.

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, not stretch for yield, take a lower yield if the credit's really good and still provide a very attractive risk-adjusted return to our shareholder.

And the joint venture, with the ability to enhance the ROE and the NII, really helps feed into that theme.

So we're really excited about PFLT where it sits.

We're excited about the increased heft.

We're excited about the industrial logic of MCG feeding into -- the added talent we've brought on feeding into the equity offering we did a month 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're excited about getting out and talking to our sponsor clients about our enhanced capability.

And this does conclude today's question-and-answer session.

I'd 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're pleased with what's going on with PFLT.

And we look forward to speaking to you in early August on our next quarterly conference call.

Thank you very much.

This does conclude our conference for today.

Thank you for your participation.

You may disconnect.