PennantPark Floating Rate Capital Ltd. (NASDAQ:PFLT) Q1 2017 Earnings Conference Call February 10, 2017 10:00 AM ET
Art Penn - Chairman and Chief Executive Officer
Aviv Efrat - Chief Financial Officer
Peter Malekian - AlpRidge Capital
Ray Cheesman - Anfield Capital
Good morning, and welcome to the PennantPark Floating Rate Capital’s First 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 a 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, please go ahead.
Thank you and good morning, everyone. I’d like to welcome you to PennantPark Floating Rate Capital’s first 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 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 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, 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 leverage loan and high yield markets, during the quarter ended December 31st, those markets experienced strength, as high yield and leverage loan funds experienced some inflows due to a belief in the stronger economy and rising interest rates.
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 financial partner to our clients.
Since inception, PennantPark entities have financed companies backed by over a 170 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 are even more relevant to our borrower clients. We’ve been and well positioned.
For the quarter ended December 31, 2016, we invested a $125 million in primarily first lien senior secured assets at an average yield of 7.6%. Core net investment income was $0.28 per share. Our debt to equity ratio was 0.08 times as we continue to assess leverage levels in the market; we are exploring how to optimize our capital structure in order to potentially grow earnings.
As a result, we are considering the use of additional leverage higher than 0.08 times at PFLT. Additionally, we are exploring the idea of a senior loan fund drawing venture similar to those that some of our BDC peers have pursued. We have not made definitive decisions in this regard.
We have significant spillover income that we can use as cushion to protect our dividend. As of September, 30th 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 or cash flow exceeds cash interest expense continue to be healthy 3.2 times. This provides significant cushion to support stable investment income.
Additionally, at cost, the ratio of debt-to-EBITDA on the overall portfolio was 3.7 times, another indication of prudent risk. Our credit quality since inception nearly six years ago has been excellent. Out of 286 companies in which we’ve invested, we’ve only experienced four non-accruals.
On those four non-accruals, we’ve recovered a 111 cents on the dollar so far. At December 31st, we had no non-accruals on our books. This credit performance has resulted in a 13 basis point annual net gain since inception six years ago, whereas typically there were some net loss on the credit portfolio.
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. And 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 $11 million in the first lien debt of the American Auto Auction Group, which provides used cars, remarketing services to auto dealers, Chiron Capital is the sponsor.
IGM Chemicals is a manufacturer of specialty chemicals, with $18 million of first lien term loan, Arsenal Capital is the sponsor. We invested $11 million in the first lien term debt of Impact Sales, which is a sales and marketing agency that consumer products companies and retailers use, CI Capital Partners is the sponsor.
Infosoft Group is a provider of local job order and federal contractor compliance services. We invested $52 million in the first lien term loan and about $1 million in the equity, Gauge Capital 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 networks 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 December 31, 2016, recurring net investment income totaled $0.26 per share. We also had $0.02 of other income, net of incentive fees which resulted in core net investment income of $0.28 per share. In addition, we had $0.02 per share for incentive fees accrued but not payable. As a result, GAAP net investment income was $0.26 per share.
Looking at some of the expense categories, management fees payable in cash totaled $2.5 million, general and administrative expenses totaled about $900,000 and interest expense totaled about $1.8 million.
During the quarter ended December 31, net unrealized appreciation on investments was $2.5 million or $0.10 per share. And unrealized appreciation on that credit facility was approximately $1.1 million or $0.04 per share. Net realized gain was about $500,000 or $0.02 per share and dividends in excess of income was $800,000 or $0.03 per share. Consequently, NAV was up from $14.06 to $14.11 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 use independent valuation firms to value the investments.
Our portfolio is relatively low risk; it is highly diversified with 98 companies across 24 different industries. 91% is invested in first lien senior secured debt, 6% in second lien secured debt, 3% in subordinated debt and equity. Our overall debt portfolio has a weighted average yield of 7.9%. 98% of the portfolio is floating rate including 91% 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 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 would like to open up the call for questions.
Thank you Mr. Penn. [Operator Instructions] Our first question today is from Peter Malekian from AlpRidge Capital.
Good morning, Art. Could you venture to guess when you will start covering the dividend with the recurring net investment income timeline?
We think we are kind of there at this point and as we’ve ramped the portfolio it’s a $660 million as of 12/31 as we continue to optimize both in terms of slightly higher leverage as we rotate out of lower yielding investments into higher yielding investments and as we consider the use of a senior loan fund JV, again those decisions have been made, we think we are at the point of covering and then overcovering the dividend in a relatively short period of time here.
Okay, thank you.
And that’s all the time we have for questions today. Mr. Penn, I’ll turn the conference. I apologize. I do have another question in my queue now. The next question will come from Ray Cheesman from Anfield Capital.
Good morning, Art. I am wondering if you would just think off the top of your head, I know we don’t know what is going to come out of the new administration on a tax policy base. But if the companies that you see deal flow from are going to be looking potentially at different rules for interest deductability, do you think that will affect the market that you participate in? And might it change the underlying value of those companies as their capital structures adjust to future rules?
Yes, that’s a great question, Ray and it’s really hard to assess until we know it somewhat, it is. In our experience, the kind of debt that we are providing these companies is mostly driven because the financial sponsors who are buying the companies see a higher ROE whether or not the interest is tax deductable.
They are trying to get a 20% or 30% IRR in their equity if they can borrow first lien it’s 6% to 8% or stretching your second lien 8% plus. It’s still accretive for their equity. So, we still think we are going to have plenty of opportunity. The other legislation that’s out there, which is been out there for a while is BDC legislation, which hopefully this administration is more positive to.
And if that goes through, that’s going to help, help PFLT a lot, it’s going to help other BDCs, particularly on PFLT because with a first lien portfolio being able to leverage 2 to 1, you can certainly leverage this type of portfolio and still be very safe at a 2 to 1 leverage and the ROE should for our shareholders go up quite substantially.
So, we are optimistic. It’s hard to say if and when any of the stuff gets done. But we are, as I say, someone said the world’s second oldest profession is lending. They’ve found some tablets from ancient Sumeria showing transactions at an interest rate. So we think no matter what happens, we have an opportunity in the marketplace to lend our capital at attractive risk-adjusted returns.
Thanks very much.
And that’s all the time we have for questions today. Mr. Penn, I’ll turn the conference back to you for additional or closing remarks.
Just want to thank everybody for being on the call today. We are here to answer any other questions today or through the quarter and we look forward to speaking to everybody next quarter.
And that does conclude our conference today. Thank you all for your participation.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!