PennantPark Floating Rate Capital Ltd. Q4 FY2025 Earnings Call

Good morning, and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2020 Earnings Conference Call. Today's conference is being recorded. 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. Welcome to PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2025 Earnings Conference Call. I'm joined today by Rick Allorto, our Chief Financial Officer. Rick, 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 and is the property of PennantPark Floating Rate Capital. Any unauthorized broadcast of this call in any form is strictly prohibited. An audio replay of the call will be available 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. Our remarks today may also include forward-looking statements and projections. Please refer to our most recent SEC filings 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 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, Rick. I'll begin today's call with an overview of our fourth quarter results and recent strategic initiatives, including the $250 million portfolio acquisition and our new joint venture, PSSL. I'll then share our perspective on the current market environment and how PFLT is positioned for continued growth. Rick will conclude with a detailed review of the financials, and then we'll open up the call for Q&A. For the quarter ended September 30, core net investment income for the quarter was $0.28 per share. We previously announced the acquisition of a $250 million portfolio and the formation of a new joint venture with an initial targeted portfolio of $500 million. These initiatives underscore our focus on enhancing PFLT's earnings power through scale diversification and disciplined capital deployment, key pillars of our long-term growth strategy. The portfolio acquisition adds high-quality, well-known assets that are projected to increase net investment income by $0.01 to $0.02 per share on a quarterly basis. The JV with Hamilton Lane, a respected global investor, enhances our funding sources and provides a scalable platform for future growth. The PSSL 2 JV began investing this month and closed a $150 million revolving credit facility, which bears interest at SOFR plus 175 basis points. The credit facility has an accordion feature, allowing total commitments to increase to $350 million. Our run rate NII is projected to approximate our current dividend as we ramp the PSSL 2 portfolio. Our game plan is to grow PSSL 2 to be in excess of $1 billion in assets, similar to our existing joint ventures. As we achieve this game plan, our NII should be well in excess of our current dividend. Regarding the current market environment for private middle market lending, we are encouraged by a steady increase in transaction activity, which we expect will translate into higher loan origination volumes in the quarters ahead. Additionally, we continue to provide capital to many of our existing portfolio companies as they execute their respective growth initiatives, demonstrating the depth and resilience of our origination platform. We are optimistic that the increase in transaction activity will also result in opportunities to exit some of our equity co-investments and rotate that capital into new income-producing investments. We believe the current environment will favor lenders with strong private equity sponsor relationships and disciplined underwriting, areas where PFLT has a clear advantage. We continue to see opportunities to deploy capital into core middle market companies where leverage is lower and spreads are higher than in the upper middle market. In the core middle market, the pricing on high-quality first lien term loans is SOFR plus $4.75 to $5.25. Leverage is reasonable, and we continue to get meaningful covenant protections while the upper middle market is primarily characterized as covenant light. Turning to our current portfolio, we continue to maintain what we believe is one of the most conservatively structured portfolios in the direct lending industry. This is evidenced by having among the lowest PIK percentages in the industry at 1.8% for the quarter. As of September 30, our portfolio's median leverage ratio through our debt security was 4.5x, and the portfolio's median interest coverage was 2x. For new platform investments made during the quarter, the median debt-to-EBITDA was 4.4x. Interest coverage was 2.3x and the loan-to-value was 44%. We had three investments on non-accrual status, and total non-accruals represent only 0.4% of the portfolio at cost and 0.2% at market value. These strong credit metrics reflect the rigor of our underwriting process and the discipline of our investment approach. We continue to believe that our focus on core middle market provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. The PennantPark platform has a demonstrated track record of value creation through the successful financing of growing middle market companies across five key sectors. These sectors, in which we possess deep domain expertise, enabling us to ask the right questions and consistently deliver strong investment outcomes, are business services, consumer government services and defense, health care, and software technology. These sectors have been recession resilient, tend to generate strong free cash flow and have a limited direct impact from the recent tariff increases and uncertainty. Core middle market companies, typically those with $10 million to $50 million of EBITDA, operate below the threshold of broadly syndicated loan or high-yield markets. In the core middle market, because we are an important strategic lending partner, the terms we receive are attractive. We have many weeks to do our diligence with care. We thoughtfully structure transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, and equity co-investment. Additionally, from a monitoring perspective, we receive monthly financial statements to help us stay on top of the companies. Regarding covenant protections, while the upper middle market has seen significant erosion, our originated first lien loans consistently include meaningful covenants that safeguard our capital. Our credit quality since our inception over 14 years ago has been excellent. PFLT has invested $8.4 billion and 539 companies, and we have only experienced 25 non-accruals. Since inception, PFLT's loss ratio on invested capital is only 11 basis points annually. As a provider of strategic capital, we fuel the growth of our portfolio companies. In many cases, we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform from inception through September 30, we've invested over $596 million in equity co-investments and have generated an IRR of 25% and a multiple on invested capital of 2x. As of September 30, our portfolio grew to $2.8 billion, up from $2.4 billion in the prior quarter. During the quarter, we continued to originate attractive investment opportunities and invested $633 million in 11 new and 105 existing portfolio companies at a weighted average yield of 10.5%. As of September 30, the PSSL 1 portfolio totaled $1.1 billion, and during the quarter, we invested $89 million in 4 new and 14 existing portfolio companies. We believe that the increase in scale of PSSL's balance sheet will continue to drive attractive mid-teens return on invested capital and enhance PFLT's earnings momentum. From an outlook perspective, our experienced team and wide origination funnel are well positioned to generate strong deal flow. Our mission and goal is a steady, stable, and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. With that overview, I'll turn it over to Rick for a more detailed review of our financial results.

Thank you, Art. For the quarter ended September 30, GAAP net investment income and core net investment income were both $0.28 per share. Operating expenses for the quarter were as follows: interest and expenses on debt were $25.8 million, base management and performance-based incentive fees were $13.4 million. General and administrative expenses were $2 million and provision for taxes was $0.2 million. For the quarter ended September 30, net realized and unrealized change on investments, including provision for taxes, was a loss of $10 million. As of September 30, NAV was $10.83 per share, which is down 1.2% from $10.96 per share last quarter. As of September 30, our debt-to-equity ratio was 1.6x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. Subsequent to quarter-end, we sold $118 million of assets to the PSSL 1 joint venture and $191 million of assets to the new PSSL 2 joint venture. We used the net proceeds from these sales to pay down our revolving credit facility, reducing our debt-to-equity ratio to 1.4x, which is at the lower end of our target range of 1.4x to 1.6x. As of September 30, our key portfolio statistics were as follows: the portfolio remains well diversified, comprising 164 companies across 50 industries. The weighted average yield on our debt investments was 10.2%, and approximately 99% of the debt portfolio is floating rate. PIK income equaled only 1.8% of total interest income. We have three non-accruals, which represent 0.4% of the portfolio at cost and 0.2% at market value. The portfolio is comprised of 90% first lien senior secured debt, second lien and subordinated debt, 2% in equity of PSSL and 7% in equity co-investments. The debt to EBITDA on the portfolio is 4.5x and interest coverage was 2x. Now let me turn the call back to Art.

Thanks, Rick. In conclusion, I'd like to thank our exceptional team for their continued dedication and our shareholders for their trust and partnership. We remain committed to delivering strong performance, preserving capital, and creating long-term value for all stakeholders. That concludes our remarks. At this time, I would like to open up the call to questions.

We will take our first question from Robert Dodd with Raymond James.

I would like to know how the portfolio acquisition came about and if there are more opportunities like that. What do you think the value is of acquiring a large pool of assets, given that you don't have the option to choose individual investments, compared to deploying capital into individual investments?

Thanks, Robert. Just to take a step back. That was another joint venture that we had with a third party with all of the same assets in self-originated assets that we originated. Actually, those were originated a couple of years ago, so the spreads are high. We know the portfolio very well. So that was really just an acquisition of more of the same type of assets that we already have in PFLT and, in fact, many of the same assets that we already have in PFLT.

Got it. On the market front, it appears to be picking up. Are you noticing any kind of division? It seems that logistics companies have faced challenges post-COVID, but not you, right? So, are you observing any applications regarding what you would like to pursue or what is coming to market considering there are still some COVID-related impacts or any thoughts there?

Logistics is still facing challenges from the post-COVID landscape. We're observing a general trend of returning to average performance across the economy, which has been widely reported, indicating some softness. The average consumer is experiencing this softness as inflation remains high, exacerbated by tariffs. Consequently, when we consider credit underwriting, this consumer softness is in our thoughts. Our investments in consumer brands are minimal, but we do engage in consumer services, particularly those related to home, which are performing relatively well. Additionally, we are concentrating on government services and defense, while health care continues to show strength.

Got it. You do have some good exposure to government contracting. Did the recent government shutdown have any impact on the portfolio companies?

We have very little exposure to so-called civilian government activities. It's more defense, intelligence and things of that nature where the shutdown did not really have an impact. So we're no pun intended, we're well defended there.

We will take our next question from Brian McKenna with Citizens.

Good morning, Art and Rick. I appreciate the disclosure around the $310 million of assets that were sold to both JVs post quarter-end. I'm curious, when were these loans initially originated? And I'm just trying to figure out the NII contribution from these assets in fiscal 4Q, and then really the starting point for NII in fiscal 1Q, given these sales, the scaling of the second JV as well as the full quarter run rate from the portfolio acquisition.

Yes. We issued a press release regarding the portfolio acquisition around the middle of the quarter. As a result, we didn't receive a full quarter's ramp from the $250 million portfolio we acquired. When we mentioned a full quarter, we expect it to contribute about $0.01 to $0.02 per share of net investment income for the full quarter of those assets. The joint venture starts to become significantly more beneficial as it grows. While it’s not immediately accretive, as it reaches $500 million, $750 million, and $1.2 billion like our other joint ventures, the advantages of scaling begin to emerge, along with improved financing. You can observe the returns from our existing JVs, like the one in PFLT and the one in PNNT. If you project a 15% return on that junior capital and invest a reasonable amount in the Hamilton Lane JV, which represents 75% of the junior capital, it becomes a highly appealing addition to net investment income. However, it might take a year or two to realize the benefits from that increase. We certainly aim to ramp it up, but we also want to proceed cautiously, ensuring we are introducing solid assets into the joint venture. The contribution to net investment income from that is likely to materialize over approximately a year, depending on deal flow. I'm not sure if that fully answered your question, Brian, but feel free to ask if you need more information.

Yes. No, that's helpful. I appreciate it. And then I guess just a follow-up on the dividend. I think in the prepared remarks, you said as the second JV scales NII should be well in excess of the dividend. And so I appreciate your prior comments; it's going to take a year or two for full ramp. But thinking about that comment in excess or well in excess of the dividend, I mean is that contemplating the forward curve? Is that contemplating any other kind of credit quality changes? And then what other kind of core assumptions are in that?

Yes, we can run models together. The current market suggests there is potential for SOFR to move lower, and even if we consider the market's expectations for SOFR a year from now, I believe that based on our analysis, we are adequately covering the dividend.

We will take our next question from Doug Harter with UBS.

Thanks. Can you just talk about kind of where you're seeing new loan spreads and sort of kind of any stabilization there? And then how that compares to what you're seeing on new financing costs?

Yes. So I think we talked about our new JV guide credit facility at the SOFR plus 175. So that's kind of our most recent comparable kind of loan that we can access. I think we said in our stated remarks that we've seen it kind of in the 4.75% to 5.25% range on average in our world now. In our world, a little bit lower risk, i.e., our average debt to EBITDA is in the mid-4s. We're not stretching for yield. Our loan to values are kind of 40-ish percent. So in our box, we're okay taking a little lower yield if the credit is really, really solid. So we will do a $475 million or $500 million if we really feel good about the credit, the value, and the low leverage. Again, that shows up in the PIK percentage 1.8%; we're probably among the lowest in the industry in terms of the amount of PIK. Obviously, if you have higher leverage in your book, whether it's 6x, 7x ARR loans, whatever you want to call them, PIK is more of a requirement because of the higher leverage.

We will take our next question from Arren Cyganovich with Truist Securities.

Following up on the prior questions. The portfolio acquisition boosted leverage to around 1.6x and then subsequently to that, so it went back down to 1.4x. Is that 1.4x? Does that run rate cover the dividend? And how much if you were just to exclude PSSL, does that cover the dividend? I'm just trying to kind of have the puts and takes and put those to your comments.

We'd be glad to discuss the model inputs. Our typical leverage range is between 1.4x and 1.6x. As you've observed, we sometimes increase it to 1.6x and then move assets into our two joint ventures, which brings us back down to 1.4x. If you want to model at 1.5x, which is the midpoint, that would be reasonable. We believe that at 1.5x, with growth in the joint venture over time, we should be able to easily cover our dividend, even factoring in a reduction in SOFR. We're open to going through scenarios with you as we explore the ramping of the second joint venture. We also anticipate some equity rotation as mergers and acquisitions occur, which should further support our position. If you model this joint venture similarly to our other two, that's where we think we will land.

Got it. That's helpful. And then the credit quality has been solid, really for the industry. Here, you have some small one-offs here and there. Maybe you could talk a little bit about the strength of your underlying portfolio companies and what you're seeing in terms of trends and average EBITDA and revenues for your portfolios?

Yes. I don't know if we put it in prepared remarks, we are seeing kind of double-digit growth in revenues and probably single-digit growth and mid-single-digit growth. Again, kind of what we chatted about earlier, it's industry and company-specific, of course. Logistics we talked about; there are a couple of choppier credits there. We're focused a lot on the consumer and kind of how the consumer is faring in this environment. So we're focused on that. By and large, the portfolio is healthy. To have all the names that we had well over 100 and have a handful of choppier names is totally expected; it's what we model. Of course, in any of these portfolios, you're going to have a handful of names that are one way, experiencing issues. Sometimes they rebound, sometimes they don't. But we think the number of choppier credits is relatively minor at this point. And the watch list of things that we're kind of looking at is nothing really unusual about what's going on right now. We're not seeing any systemic issues with credit at this point in the economy or direct lending.

We will take our next question from Paul Johnson with KBW.

What happened with your investment in Bilight quarter-over-quarter? It looked like maybe there was a little bit of a payoff there some sort of realization. But just curious what happened in that company?

Yes. There was a dividend recapitalization and we were in the equity. That's one where we have an equity co-invest. There was a realized gain of about $0.04 a share.

And that's $0.04 in terms of dividend income this quarter? Or is that just the realized gain that was taken?

That was not an income element. That was an NAV element. So we had some realized gains. We had some realized losses. Walker Edison was the big realized loss that was already written down. It was unrealized; it became realized. Something called LAV gear was realized and went through a restructuring. So it was a realized $0.05. So Walker Edison was realized at $0.12 per share, LAV gear was realized at $0.05 per share, and then this Bilight was a realized positive of $0.04 a share.

We will take our next question from Christopher Nolan with Ladenburg Thalmann.

Is it correct here that the EBITDA coverage was 4.5x, 4.4x?

4.4x would be the debt to EBITDA, yes.

Am I correct that it sort of seems like either the leverage is going down on these portfolio companies or the EBITDA is going up? I presume your EBITDA is going up. Is that a fair assumption?

Well, it could be both. It depends on the company. As we just said, EBITDA is going up a bit in the portfolio. And also if we're underwriting correctly, the companies are deleveraging and paying debt down, which is our goal. We'd love to see pay down, and then on the new deals, the new deals that come in are again relatively low leverage and kind of in the low to mid-4s.

The stock price is trading 17% below book. Any consideration in terms of buybacks? Or does all the joint ventures restrict your abilities to do that given the leverage ratio?

The Board of Directors always considers all options including buybacks. Insiders are continual buyers of our portfolios, both public funds and private funds. So it does appear to be a good value right now.

There are no further questions at this time. I will now turn the conference back to Mr. Penn for any additional or closing remarks.

Thanks, everybody, for your participation in this Thanksgiving season. We are certainly grateful for the trust that our shareholders have given us. We wish everyone a terrific Thanksgiving and holiday season, and we'll speak to you in early February.

This concludes today's call. Thank you for your participation. You may now disconnect.