PennantPark Floating Rate Capital Ltd.
Q2 2013 Earnings Call Transcript

Published: 9 May 2013

[Operator:]

Good day, everyone, and welcome to the PennantPark Floating Rate Capital second fiscal quarter 2013 earnings conference call. (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.

[Arthur Penn:]

Thank you, and good morning, everyone. I'd like to welcome you to our second fiscal quarter 2013 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.

[Aviv Efrat:]

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. 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 filling 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.

[Arthur Penn:]

Thank you, Aviv. I'm going to spend a few minutes discussing current market conditions, followed by the discussion of investment activity, the portfolio, the financials, our overall strategy, and then open it up for Q&A. As you all know, the economics and signals have continued to be mixed, with many economists expecting a slowly growing economy going forward. With regard to the more liquid capital markets and in particular the leverage loan and high yield markets, those markets have continued to rally this year as cash flows into high yield funds, leveraged loan funds and CLO's has been strong. Risk reward in the middle market has generally remained attractive as the overall supply of middle-market companies who needs financing, exceeds the relative demand of applicable lending capacity. As debt investors and lenders, a slow growth economy is fine, as long as we have underwritten capital structures prudently. A healthy current coupon with deleveraging from free cash flow is a favorable outcome. That said, as the more liquid capital markets have rallied, that overall turn has impacted the middle market. Pricing has continued to compress and purchase price multiples and leverage multiples have increased. As a result, we have continued to be selective about which investments we make in this environment. Given our strong origination network and size of our company, we believe we can continue to prudently grow. We remain primarily focused on long-term value and making investments that will perform well over several years. We continue to set a high bar in terms of our investment parameters and remain cautious and selective about which investments we add to our portfolio. Our focus continues to be on companies or 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 trusts with our portfolio companies, management teams, financial sponsors, intermediaries, our lenders and of course our shareholders. We are first called 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. Since inception, PennantPark entities have financed companies backed by a 110 different financial sponsors. We have been active and are well positioned. For the quarter ended March 31, 2012, we've invested $45 million with an average yield on debt of 7.9%. Net investment income was $0.31 per share, excluding one-time transaction cost of the recent credit facility upsizing. We recently raised $48 million of gross proceeds from an equity offering. This capital will allow us to grow, take advantage of opportunities in the market, provide more liquidity in the stock and help company achieve accretion in earnings as we take our relatively fixed amount of general and administrative expenses and apply over a larger asset base. Additionally, we recently increased our credit facility from $100 million to $125 million, reducing interest rates to 200 basis points from 225 basis points, and extended the maturity one year. 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 EBIDTA or cash flow exceeds cash interest expense to a healthy 3.4 times. This provide significant cushion to support stable investment income. Additionally, add cost, the ratio of debt-to-EBIDTA on the overall portfolio was 3.6 times, another indication of prudent risk. In terms of new investments, we had another quarter investing in attractive risk-adjusted returns. Our activity was driven by mixture of M&A deals and refinancings. And virtually all of these investments, we have 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 $8.4 million in the first lien term loans of ALG USA. ALG is a vertically integrated leisure company focused on vacations for travelers, primarily in Mexico and the Caribbean. Bain is the sponsor. We purchased $3 million of the first lien term loans in BBB Industries. BBB is a leading supplier of remanufactured starters and alternators to the North American light-duty vehicle aftermarket. Windjammer Capital is the sponsor. We purchased $3 million as a first lien term loan in eResearch Technologies. eResearch is the provider of outsource data collection and testing services to pharmaceutical trial sponsors. Genstar is the sponsor. (inaudible) Incorporated provides integrated systems for delivering a therapy used to treat immune system diseases. We purchased $3 million of the first lien term loan. The company is own by (Gores Group). Let me now turn the call over to Aviv, our CFO, to take us through the financial results.

[Aviv Efrat:]

Thank you, Art. For the quarter ended March 31, 2013, recurring net investment income totaled $0.33 per share. In addition, we had $0.02 per share of other income, $0.07 per share of one-time credit facility amendment expenses as well as $0.04 per share of incentive fee expenses accrued for GAAP purposes only, which will not be payable to the advisor. As a result, net investment income for the quarter was $0.24 per share. Looking at some of the expense categories, management fees totaled about $700,000. General and administrative expenses totaled about $400,000. And interest expenses totaled $500,000. During the quarter ended March 31, net unrealized appreciation from investments was approximately $400,000 or $0.06 per share. Realized gains were $1.1 million or $0.16 per share, and dividends in excess of income was $100,000 or $0.01per share, after one-time credit facility amendment transactions costing $500,000 or $0.07 per share. Additionally, equity operating cost and the effects of the offerings were $0.10 per share. Consequently, NAV was up $0.11 per share from $13.99 to $14.10 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 63 companies across 44 different industries. 87% is invested in first lien senior secured debt, 6% in second lien secured debt, 6% in subordinated debt and 1% in equity. Our overall debt portfolio has a weighted average yield of 8.8%. 68% of the portfolio is floating rate, including 83% with floor and 12% is fixed rate. And the average LIBOR floor is 1.5%. Now, let me turn the call back to Art.

[Arthur Penn:]

Thanks, Aviv. To conclude, we want to reiterate our mission. Our goal is a steady, stable and protective dividend stream. Everything we do is in line 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 and first lien senior floating rate debt instruments and we payout 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 the call to questions.

[Operator:]

(Operator Instructions) And we'll first hear from Christopher York, JMP Securities.

[Christopher York:]

I know that repayments in excess can be unpredictable, but how do you budget or think about repayments or portfolio amortization on a quarterly or annual basis, as appears that the portfolio is averaged close to 15% since inception?

[Arthur Penn:]

We're seeing a quite a few repayments in this environment as these markets have been strong. It's really hard to budget. And I know you're trying to do a model, it's hard to sit here with any certainty, and so you X percent a quarter or Y percent a quarter. So it's hard for me to give you any guidance, I'm sorry about it. But we do think as we said in our prepared remarks that we can prudently grow in this environment. We think risk award is generally favorable. We'd like first to win senior secured floating rate assets. So we do believe we are going to grow on a net basis in coming quarters. It was nice to get the additional capital at the end of the quarter. And we are deploying that with the goal being that we do grow. It's hard for us to tell you or predict with real certainly what the numbers are going to be.

[Christopher York:]

And then how much senior stretch investments do you have in your portfolio and what is the yield on those investments versus traditional firstly lien secured investments?

[Arthur Penn:]

Well, it's a great question, because you're trying to differentiate what is viewed as a traditional firstly lien versus a stretch. And (inaudible) hold just traditional first lien stopped three times. Does traditional first lien stop at four times? The stretch go to four times, the stretch go to five times. These definition or meanings are hard to really pinpoint and the market frankly has moved. Typically a year ago first lien would be the three times debt to EBITDA. It started in many cases pick it up four times. And that's not you to stretch here, that is plane old first lien bank debt have four times. So again I am not giving you a rough precise answer because these things are fluid and we do disclose as we did in our prepared remarks that debt to EBITDA on overall portfolio basis is 3.6 times and that includes some of our opportunistic second lien and sub-debt investments. So we feel really good about that in a market where traditional first lien is starting to get the four times, non-stretch first lien is starting to get to four times and we have portfolio, which includes sub-debt and second lien at 3.6. We feel really comfortable with the credit quality.

[Operator:]

Next, we'll hear from (Ryan Wint) of KBW.

[Unidentified Analyst:]

We've all kind of heard about how the credit markets are heating up, loans price compressing, leverage ticking up and some more covenant like deals getting done. Can you guys talk about your ability to what capital, given your guys recent offering in this kind of high competition market?

[Arthur Penn:]

I'm sorry, (Ryan) say that again.

[Unidentified Analyst:]

Just as a market heating up and there is spreads on new investments are compressing. With your guys free equity offering can you guys talk about your ability to deploy that capital and good risk adjusted returned investments?

[Arthur Penn:]

So we do believe, Ryan that we can prudently grow. We are being highly selective in this environment. We feel comfortable that we can deploy the capital over the coming quarters and solid risk adjusted returns. This portfolio for us is fairly modest size portfolio. So if you think of it as $250 million to $300 million portfolio for us, it's not a stretch for us or hard for us, given our platform to find descent risk reward. We're not rushing it. We're not actually either had one quarter with all the new capital we have and put it into the yields, so as usual we're going to methodically and carefully grow the portfolio. We think the market environment is fine. We do need to be more selective. We think in the coming few quarters it will be deployed.

[Unidentified Analyst:]

And you guys had about $45 million originations and $44 million of excess for about totally $90 million of portfolio churn based on your guidance, $180 million portfolio. That seems kind of high. Can you just talk about why there is so much portfolio churn this quarter?

[Arthur Penn:]

Well, first of all, as you may remember we basically were out of capital as of the end our March. So we were pretty optimally leveraged, so at that point without additional capital we needed to work the portfolio harder. And that meant selling some positions off and rotating as a, new positions on a net-net basis. We didn't have the ability to grow up until the time we did the equity offering.

[Unidentified Analyst:]

And then you guys also recorded about a $500,000 credit facility amendment fee in the quarter, both BDCs amortized that over the life of credit facility. Can you guys talk about why that was recognized all in this quarter?

[Arthur Penn:]

To refresh everyone's memory around our accounting, we mark-to-market our debt facilities and we're more marking to market the credit facility going forward. If you elect to do that, you're obligating under GAAP to take the fee upfront and then amortize it. Again, to refresh everybody's every memory around why we do that? We do that because we think it makes the less risky in times of volatility. We think its important to match how you value asset and your liabilities. It becomes particularly important in down markets. The markets feel fine now. We don't think there is any near term issue here, but in the case of a down market it gives us more flexibility around SEC asset coverage tests and other things. We like the matching attributes of both assets and liabilities.

[Unidentified Analyst:]

And then, one kind of housekeeping question, do you guys have the average LIBOR floor of your portfolio?

[Arthur Penn:]

Yes, 1.5%.

[Operator:]

And it appears there are no further questions. At this time, I will turn the conference back over to Mr. Penn for any additional or closing comments.

[Arthur Penn:]

Well, I just want to thank everybody for their participation today. And we look forward to speaking to you next quarter. Thank you very much.

[Operator:]

And that does conclude today's conference. Thank you all for your participation.