PennantPark Floating Rate Capital Ltd (PFLT) 2019 Q2 法說會逐字稿

Good morning and welcome to the PennantPark Floating Rate Capital's Second Fiscal Quarter 2019 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 2019 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 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 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.

Thank you, Aviv.

I'm going to spend a few minutes discussing financial highlights, followed by discussion of the portfolio, investment activity, the financials and then open it up for Q&A.

For the quarter ended March 31, we invested $136 million, primarily in first lien senior secured assets at an average yield of 8.7%.

PennantPark Senior Secured Loan Fund or PSSL, continued to perform well.

As of March 31, PSSL owned a $503 million diversified pool of 43 names with an average yield of 8%.

Over the last several years, we have substantially grown our platform by adding senior and mid-level investment professionals in regional offices as well as New York.

The additional people in offices, combined with the additional equity and debt capital we have raised, has significantly enhanced our deal flow.

This puts us in a position to be both active and selective.

Net investment income was $0.30 per share.

Due to our activity level and the maturation of PSSL, we are pleased that our current run rate net investment income covers our dividend.

Our earnings stream should have a nice tailwind based on gradual increase in our debt to equity ratio while still maintaining a prudent debt profile.

As of September 30, our spillover was $0.31 per share.

With regard to the Small Business Credit Availability Act, a reminder that our Board approved and modified the asset coverage that was included in the law, reducing asset coverage from 200% to 150% effective April 5, 2019.

Over time, we are targeting a debt to equity ratio of 1.4 to 1.7x.

We will not reach this target overnight.

We will continue to carefully invest, and it may take us several quarters to teach the new target.

Given the seniority of our assets, we are actively considering utilizing CLO financing to help achieve the target.

The company has generated an excellent track record over the last 8 years, investing in lower-risk first lien senior secured floating rate assets.

We believe that such assets represent an appropriate risk profile that can be prudently leveraged to provide attractive returns for our investors.

Our successful operation of PSSL, which is today operating at that same targeted debt to equity ratio is evidence of this strategy.

Our primary business of financing middle-market financial sponsors has remained robust.

We have relationships with about 400 private equity sponsors across the country and elsewhere that we manage from our offices in New York, Los Angeles, Chicago, Houston and London.

We have done business with about 180 sponsors to date.

Due to the wide funnel of deal flow that we receive relative to the size of our vehicles, we can be extremely selective about what we ultimately invest in.

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.

We are 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 have become a trusted financing partner for our clients.

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 our EBITDA, our cash flow exceeds cash interest expense, continue to be a healthy 2.8x.

This provides significant cushion to support stable investment income.

Additionally, at cost, the ratio of debt to EBITDA on the overall portfolio was 4.3x, another indication of prudent risk.

In our core market of companies with $15 million to $50 million of EBITDA, our capital is generally important to the borrowers and sponsors, and we are still seeing attractive risk/reward, receiving covenants, which help protect our capital.

It's been 2 years since we've had a nonaccrual at PFLT and that run had to end at some point.

As of March 31, 2019, we had 4 nonaccruals.

These names represent about 3.2% of our overall portfolio at cost, and 1.5% on a market value basis.

The 4 nonaccruals, along with the markup of our credit facility and bonds, contributed to most of the NAV decline in the quarter.

Our credit quality since inception 8 years ago has been excellent.

Out of 349 companies in which we have invested since inception, we've experienced only 9 nonaccruals.

Since inception, PFLT has made 349 investment totaling about $3 billion at an average yield of 8%.

This compares to an annualized loss ratio, including both realized and unrealized losses of only about 6 basis points annually.

With regard to the economy and credit cycle, at this point, our underlying portfolio indicates a strong U.S. economy and no sign of a recession.

From an experience standpoint, we're one of the few middle-market direct lenders who was in business prior to the global financial crisis and had a strong underwriting track record during that time.

Although PFLT was not in existence back then, PennantPark as an organization was, and at that time, was focused primarily on investing in subordinated and mezzanine debt.

Prior to the onset of the global financial crisis in September 2008, we initiated investments which ultimately aggregated $480 million, again primarily in subordinated debt.

During the recession, the weighted average EBITDA of those underlying portfolio companies declined by 7.2% at the trough of the recession.

This compares to the average EBITDA decline of the Bloomberg North American High Yield Index of down 42%.

As a result, the IRR of those underlying investments was 8%, even though they were down prior to the financial crisis and recession.

We are proud of this downside case track record on primarily subordinated debt.

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 purchased $7.5 million of the first lien term loan of By Light Professional IT Services.

The company is a provider of IT services to the government.

Sagewind Capital is the sponsor.

We funded $300,000 of revolver and $26.7 million of first lien term loan of Perforce Software.

The company is a provider of version control project management and code testing software.

Clearlake Capital is the sponsor.

We funded $1.7 million of revolver and $13.3 million of first lien term loan of Solutionreach.

The company is a provider of software-as-a-service patient relationship management tools for the health care market.

Summit Partners the sponsor.

We purchased $20 million of the first lien term loan and funded $200,000 of the revolver of T.B.C.

Enterprises.

We also purchased $500,000 of the common equity.

The company provides membership-based legal services to commercial truck drivers.

Gauge Capital is the sponsor.

Turning to the outlook.

We believe that the rest of 2019 will be active due to both growth and M&A-driven financings.

Due to our strong sources 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 March 31, 2019, net investment income was $0.30 per share.

Looking at some of the expense categories.

Management fees totaled about $4.9 million, general and administrative expenses totaled about $1 million and interest expense totaled about $5.3 million.

During the quarter ended March 31, net unrealized depreciation on investment was about $12.7 million or $0.33 per share.

Net realized gain was about $1.1 million or $0.03 per share.

Net unrealized appreciation on our credit facility and notes was $5.6 million or $0.14 per share.

Net investment income exceeded the dividend by $0.02 per share.

Consequently, NAV went from $13.66 per share to $13.24 per share.

Our entire portfolio, our credit facility and notes are mark-to-market by our Board of Directors each quarter using the exit price provided by an independent valuation firm, exchanges 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 remains highly diversified with 88 companies across 29 different industries.

88% is invested in first lien senior secured debt, including 13% in PSSL, 3% in second lien debt, and 9% in equity, including 5% in PSSL.

Our overall debt portfolio has a weighted average yield of 9.1%.

100% 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 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.

(Operator Instructions) And our first question comes from Mark Hughes with SunTrust.

This is Michael Ramirez in for Mark Hughes.

Regarding your other income line, it seems, I guess, it was elevated again this quarter similar to the September period.

Could you please give us some sense about how much of the repayment fees account for this line item over -- in this quarter and over the last few years?

Sure.

There were some structuring fees we received this quarter, which were most of it.

We did have a small residual proceeds from the MCG litigation that we're involved in.

That was part of it as well.

So that was a piece of it, but it was mostly repayment fees and structuring fees.

Okay.

And just additionally, I guess, a quick follow up on that.

Given that the prospects for short-term interest rates are not going to rise as quickly as in prior years, could you please give us a sense of, I guess -- I know this is hard to quantify, but repayment activity over the next year?

Yes.

So look, repayment in this environment is due mostly to companies performing, getting sold or refinancing.

Most of the portfolio is performing well.

We typically see 1/4 to 1/3 of the book transferring over each year, and I think this year would be -- we'd estimate the same amount.

Okay.

Great.

That's helpful.

And then, I guess, on the nonaccruals, it seems like you've been marking these 4 companies down for the last few quarters or so.

I guess our question is, have you changed your criteria or potentially lowered the bar for what constitutes a nonaccrual investment on your books?

No, the nonaccrual is very simple, which is they stop paying us interest.

So that's what happened.

We -- look, we haven't had a nonaccrual in over 2 years.

It looks lumpy here, and we're certainly disappointed.

But a nonaccrual -- nonaccruals are part of this business.

It's unfortunate that they all happened in this 1 quarter, but if we -- normally they'd be smoothed out over time.

And we had -- as we said, we had already marked these down by and large.

So this should not have been a big surprise to people given all 4 of them were exhibiting weakness in the past.

So it's part of our business.

Again, our track record over a long period of time at PFLT, now 8 years, is really only an annualized loss of 6 basis points, I'm you're talking about an averaging 8% type yield, that's very low.

It's unfortunate all these happened in the same quarter, but that's just kind of the business we're in.

Sure.

That's helpful.

And I guess maybe one last housekeeping one from us.

I believe spillover is $0.31 last quarter.

Do you have an update for this quarter?

Yes.

So we disclose once a year, and that's September.

So it was that $0.30, $0.31 that we talked about, it's not much different today than what it was in September.

It's right around that.

(Operator Instructions) Our next question comes from Ryan Lynch with Keefe, Bruyette, & Woods.

First question or, I guess in part, is a comment.

Overall, I would agree, you guys' long-term track record is still very good.

It was just the timing of these 4 was definitely unexpected, of these 4 new nonaccruals.

As far as you guys marks on them, LifeCare Holdings and New Trident, the 2 health care investments are marked down significantly more than the other 2, Holland and Quick Weight.

Can you just give a comment on, I guess, what you guys are seeing with maybe particularly how Holland Sleep products was on nonaccrual, but you still have a pretty high fair value mark?

Yes.

Look, we and, more importantly, the independent valuation firms and auditors look at every deal every quarter.

The independent valuation firms come up with these marks.

They are based on a number of different factors, including largely, when a company goes on nonaccrual, kind of, enterprise value waterfall approach, taking a look at comparables, taking a look at the company where those comparables are trading, what a waterfall will look like and valuation of the company will look like in a restructuring scenario.

So that's where these numbers came up with.

The 2 health care deals, Trident and Lifecare have marked down for a while.

They were -- they're both relatively small.

They were on the wrong side of changes in health care.

Those should not have been surprises.

And you said it was unexpected.

I guess if you've had no nonaccruals for 2 years, it is unexpected to have 4 in 1 quarter.

But hopefully, people understand nonaccruals are part of this business, we get them from time to time.

And it is -- and we hadn't marked these -- the vast majority of the deals are already down.

So hopefully, it wasn't a total shock to people.

But I don't know if I answered your question.

Ryan, any other element of that question that you wanted to get some more detail about?

Well, maybe just a slightly different question on that.

I mean with the 2 health care deals you mentioned being on the wrong side of maybe some ruling or regulation with those.

Does that change your outlook or strategy for investing in the health care industry?

What did you basically learn from these 2 investments?

And does that change your outlook for that industry?

Yes.

Look, we try to learn lessons from every mistake we make.

And I think certainly the filter around health care will be even higher going forward.

And knowing that shifts in health care can move quickly.

And importantly, what we've tried to do -- and by and large, our health care performance has been very good, what we've tried to do is when we've invested in health care companies, invest in companies that are driving the change, that are helping bring higher quality at a lower cost to patients.

So by and large, our health care track record has been very good over time.

These 2 relatively small investments got caught on the wrong side of it, and we got caught on the wrong side of it.

So we will continue to try to learn lessons from our mistakes, increase the filter and try to reduce mistakes in health care and elsewhere going forward.

And then one more company-specific question.

As far as Country Fresh goes, that was a -- it's fairly sizable investment.

That had a pretty big markdown this quarter.

It's still on accrual status, obviously, it's still paying you guys interest income.

But any sort of outlook on that investment given that it's now marked down at 66% of your cost.

Yes.

You're going to see a restructuring of that investment in this quarter, end of June.

Okay.

And then one final one.

You guys have done a really good job of growing PSSL.

I think you guys are getting pretty close to that investment being fully funded with the original commitments you guys set up.

What is the outlook?

Are you guys just planning on growing that -- your original, sort of, commitment size and then having that run as is?

Or is there any thought to potentially expand that further or do any other sort of JVs?

Look, it's worked well.

The relationship and partnership with Kemper is excellent.

It's getting kind of mature but we like it.

So we have no current thoughts of collapsing it on to our balance sheet.

We like it.

I think our intention is to keep running it.

It's getting up there in terms of getting fairly optimized.

So I think it's probably steady as she goes, maybe it could be optimized a little bit more.

But we kind of like it the way it is.

It's generating a very healthy income for our shareholders, and I think we're just going to kind of keep running it as is, where you might see changes or -- and I alluded to it in the script is the CLO securitization-style financing that we're looking at within PFLT itself.

So it's something that may happen here in the coming months, where we do kind of a CLO within PFLT, which is a very cost-effective financing, and also will help us get to our target leverage, which should increase our NII and our ROE.

And the next question comes from Ray Cheesman with Anfield Capital.

Thanks very much for answering Ryan's question about always learning from mistakes, that's always a good thing to hear.

I would like your opinion on rates and spreads.

Obviously, the markets have been jumping 60% rate cut, 40% rate cut, 60% rate rise, 40% rate rise.

What do you guys see down in the level that you play in from a spread and rate trend basis, so as you look out across the next couple of quarters?

Again, we all can see the Bloomberg big articles about the economy and rates and people's opinions.

But what's happening down in the trenches where you guys are actually cutting deals?

Like you mentioned you're getting indenture provisions.

You got to go pretty far down to get something nowadays, otherwise you just take plain vanilla and that doesn't come with much protection.

So I'm interested in your views.

Yes.

So we're -- Ray, we're focused on companies with -- and it's a good question, we're focused on companies with $10 million to $50 million of EBITDA, the median or mean is probably about $25 million of EBITDA.

And clearly, the closer you get up to $40 million or $50 million, the more you're competing with the broadly syndicated, what you call in the plain vanilla space broadly syndicated covenant light.

So we're typically getting covenants.

We're typically important to the borrower.

We can typically drive upfront fees, and we think the package of senior debt that we can originate in structures pretty attractive.

The economy overall is pretty good.

Where we've seen bumps and we saw some this quarter, it's either a change in health care here or there or some of these pro forma supplemental adjustments don't come in.

People are doing acquisitions and they stub their toe doing acquisitions.

So it comes out of a relatively healthy economy, but there are mistakes.

Now we are seeing labor costs rise.

So companies that do have more labor as a component of their costs are having challenges keeping labor, paying labor and that's where we've seen a little bit of tension.

But it's hard to really complain about high labor cost because that really comes from a strong economy and a strong economy is very good for these portfolios.

In terms of the rates.

Look, the economy remains strong and that would kind of lead you to believe that the Fed may not want to reduce rates.

But as you know, and I'm reading like you what's on Bloomberg, sometimes what's going on in the real economy doesn't have that much of an effect on Fed policy.

But what we're seeing is the economy is relatively strong and with labor cost rising, there might be a little bit of inflation.

And we don't assume anything there's going to be any great changes in the intermediate term.

And we'll take the next question from Doug Crimmins with RVP.

I was looking for you to comment on the loans on nonaccrual.

Obviously, the market has been quite surprised.

Given the reactions, and I understand, what do you think are the prospects for these loans recoveries, et cetera, going forward.

Yes.

Look, we -- the loans have been marked fairly by independent third-party valuation firms.

We agree with the marks, I mean, I think inherent in the marks gives you a sense of what we think at least value is today.

I will mentioned, Doug, that we do have a really good long-term track record, working things out and getting really good recoveries over time.

We've had a lot of experience.

When we have to convert debt to equity and we have, we've been in business a dozen years including -- doing [even secondly in] the subordinated debt.

We've had a very good track record working things out, getting value back for our shareholders.

And in some cases, the equity securities that we end up owning performed very, very well.

So we, of course believe the marks -- the current marks are accurate, but current may or may not reflect future value.

So I do want to mention, we also have a very healthy equity co-invest piece of this portfolio, which is performing well and we expect names like By Light, DecoPac, GCOM, IIN, which are already marked up to continue to perform well to help fill some of the gaps we have on some of our nonaccruals.

That's one of the reasons we have a little bit of an equity co-investment portfolio.

If it has some securities in the portfolio that have some upside, that can fill some gaps.

And I think if you look at the portfolio, you'll see some nice embedded gains that should continue to grow over time.

It is unfortunate we had 4 nonaccruals this one quarter after having 2 years without a nonaccrual.

To us, there is no big macro change to what's going on.

We expect nonaccruals in our business, it's unfortunate it -- 4 of them happened in 1 quarter, but we still think we're generating very attractive risk-adjusted return including the debt, including the equity co-investments, even including when we have to convert debt to equity and getting shareholders back their capital.

Right.

But I mean, like Life Care marked at 20 and New Trident marked at 4. I mean it doesn't sound like the prospects are particularly optimistic.

That's correct.

We think those are marked -- we think they are all marked accurately.

We'll see where it all comes out in the wash when we exit, but we think the prospects hence the mark of those companies is reflected in the market.

Conversely, if you looked at some of the equity investments we had, By Light, DecoPac, GCOM, et cetera, we think there is very good prospects for those companies.

So that's why you have a diversified portfolio when you have some -- you're going to have some losses and you're going to have some gains in the long run and it all comes out in the wash.

6% -- 6 basis point annualized loss over 8 years compares very favorably to anyone in the marketplace.

And Mr. Crimmins, did you have any further questions?

No, that's it.

And that does conclude the question-and-answer session.

I now turn the conference back over to Mr. Penn for any additional or closing remarks.

I want to thank everybody for their participation today.

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

Thank you very much.

Well, thank you.

That does conclude today's conference.

We do thank you for your participation.

Have a wonderful day.