Good morning and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2021 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. 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 fourth fiscal quarter 2021 earnings conference call. I'm joined today by Richard Cheung, our Chief Financial Officer. Richard, 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 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 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, Richard. I'm going to spend a few minutes discussing how we fared in the quarter ended September 30, how the portfolio is positioned for the upcoming quarters, our capital structure and liquidity, the financials and then open it up for Q&A. Our core net investment income grew to $0.28 per share, which excludes a one-time expense of $2.9 million in connection with the amendment of our credit facility. Our credit quality generally remains solid. We are poised to significantly grow NII through a three-pronged strategy which includes: one, growing assets on the balance sheet of PFLT as we move towards our target leverage ratio of 1.5 times debt to equity from 1.3 times; number two, growing our PSSL JV with Kemper to about $730 million of assets from approximately $550 million; and three, rotating the equity value in the portfolio that has come from our strong equity co-investment program into cash-paying debt instruments. With regard to the PSSL JV, with the CLO financing we completed earlier this year, as well as additional capital contributions from PFLT and Kemper, the JV will grow over time. The capital contributions from PFLT are targeted to generate a 10% to 12% return. We intend to invest another $42 million over time in order to bring PFLT's investment in PSSL to approximately $243 million. As part of our business model, alongside the debt investments we make, we selectively choose to co-invest in the equity side by side with the financial sponsor. Our returns on these equity co-investments have been excellent over time. Overall, for our platform, from inception through September 30, our $246 million of equity co-investments have generated an IRR of 28% and a multiple on invested capital of 3 times. In a world where investors may want to understand differentiation among middle-market…

Thank you, Art. For the quarter ended September 30, core net investment income was $0.28 per share, which excludes a one-time expense of $2.9 million in connection with the amendment to the credit facility. Looking at some of the expense categories. Management fees and performance-based incentive fee totaled about $3.3 million. Taxes, general and administrative expenses totaled about $450,000 and interest expense totaled about $8.5 million, which includes the credit facility amendment expense. During the quarter ended September 30, net change in unrealized appreciation on investments was a loss of $7.5 million or $0.19 per share. Net realized gains were about $2.5 million or $0.06 per share and changes in the value of our credit facility and notes decreased NAV by $0.01 per share. GAAP investment income was lower than a dividend by $0.05 per share. Consequently, GAAP NAV went from $12.81 to $12.62 per share. Adjusted NAV, excluding the mark-to-market of our liabilities was $12.43 per share, down from $12.62 per share. Our entire portfolio, our credit facility and notes are marked-to-market by our Board of Directors each quarter, using the exit price provided by an independent valuation firm, exchanges on independent broker-dealer quotations, when active markets are available under ASC 820 and 825. In cases where broker-dealer corps are inactive, we use independent valuation firms to value the investments. With ample liquidity and are prudently levered, our GAAP debt-to-equity ratio was 1.3 times, while GAAP net debt to equity after subtracting cash was 1.2 times. Regulatory debt-to-equity ratio was 1.4 times and our regulatory net debt-to-equity ratio after subtracting cash was 1.3 times. With regard to leverage, we have been targeting a debt-to-equity ratio of up to 1.5 times. We have a strong capital structure with diversified funding sources and no near-term maturities. We have a $300 million revolving credit facility maturing in 2026 with $290 million drawn as of September 30. $118 million of unsecured senior notes maturing in 2023, $228 million of asset-backed debt associated with PennantPark CL1, due 2031 and $100 million of unsecured senior notes maturing in 2026. Subsequent to September 30, PFLT issued an additional $85 million of 4.25% 2026 unsecured for notes bringing the total principal to $185 million. The add-on notes were issued at a premium resulting in a yield of 3.875%. The proceeds from this note issuance provide additional capital for investments. Our portfolio remains highly diversified with 110 companies across 45 different industries. 86% is invested in first lien senior secured debt, including 13% in PSSL, 1% in second lien debt, and 13% in equity, including 4% in PSSL. Our overall debt portfolio has a weighted average yield of 7.4%. 99% of the portfolio's folding rate and 81% of the portfolio has a LIBOR floor. The average LIBOR floor is 1%. Now let me turn the call back to Art.

Thanks Richard. To conclude, we want to reiterate our mission. Our goal is a steady stable and 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 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.

Thank you. And our first question today comes from Paul Johnson of KWB – KBW, I'm sorry.

Good morning, guys. Thanks for taking my questions. Sounds like the pipeline is pretty strong, you got some pretty strong growth activity here quarter-to-date is the calendar fourth quarter. I'm just wondering, given the investment opportunities that you guys are looking at, I mean, are you – you're getting up close to the leverage range. Are you compelled to be given, what you're looking at do you have an idea in mind where you would like to be operating at in terms of your leverage range on the low-end versus the high end?

Yeah. Thanks, Paul, and good morning. Yeah. I think we're targeting kind of 1.5 – the zone of 1.5 times for PFLT. That's kind of where we're targeting. Of course, PSSL is a joint venture, kind of side-by-side, and that vehicle we hope and think can over time grow to be over $700 million, $750 million vehicle, which we got a boost from the CLO financing we did there a little while back, and we'll continue to grow that platform. And yes, you're right we're at 1.3. I think 1.5 zone, we kind of top out PFLT.

Great. Appreciate that. And then one thing just on the sort of, I guess, the change quarter-over-quarter in your equity investments. I was wondering, if there was anything particular going on there, if there's any sort of restructuring or new equity investments? It looks like at least on a cost basis, they went-up pretty – quite a bit quarter-over-quarter, but I'm wondering, what's going on there?

Yes, I mean I think part of that is probably PSSL and the growth of PSSL that's probably the main driver of that. Other than that, no, there's no -- and look we do continue to on these deals where we think there's a very good opportunity to participate in the upside. We are gradually and thoughtfully doing these equity co-invests which have worked out well for us over 14 years. We don't say yes to all of them. We declined many of them. But we do say yes to the ones that we think are very attractive. And so I'd imagine the biggest change is the PSSL investment that we keep making in growing that vehicle.

Got it. Thanks for that. And my last question you touched on it a little bit during the call, but any sort of color you can give on the -- your investment in DBI maybe exactly what that business is and just get -- and I'm also curious if there was any overlap with that in the JV as well?

Yes. So, there's -- DBI is in both PFLT and the JV. And when we -- on the transcript, kind of, talked about what it would mean for -- on a consolidated basis between both PFLT and PSSL. The company is a labor services company that does work for municipalities and states. Think about managing vegetation, cutting lawns, managing laboratories, things of that nature. And the issue there and you read about newspapers and inevitably when you have a portfolio of over 100 names, you're going to get -- you're going to one of them -- at least one of them may have some challenges. This is most of their employees are unskilled labor, unskilled labor. So, it's been hard to get unskilled labor and it's when you get unskilled labor it's more expensive on one hand. And on the other hand, they enter into fixed price contracts with the states and cities. So, unfortunately, this company got mismatched between the fixed price contracts they have with the states and the cities and the unskilled labor market where they need to hire. So, that's basically the key reason it's underperformed. As we said, they're looking at a partial sale and a partial liquidation. I don't yet know how that is going to play out. We gave the statistics on the transcript as to in the worst-case scenario if it's zero, what that would look like. It may or may not be the worst case scenario A. And B, obviously, we have a wide range of equity co-invest throughout the portfolio which have had some lift. So, if you look at this last quarter, the quarter ended September 30th, DBI had a negative impact of $0.29 a share, but that was offset to some extent by some of the other co-invests like lash, marketplace events, and SFP. So, we have a diversified book of these co-invests. Some performed well. Over time, they've performed really well, some underperform. DBI is an example of an underperformer. And this is an example of some of the things that are going on in the economy. We think this is not an endemic of our portfolio. This is a one-off the vast, vast, vast majority of our names have 25%, 30% EBITDA margins where they are able to increase their pricing to their customers to hopefully more than cover their costs.

Got it. Appreciate it. Thanks for the color. Very helpful detail. Those were all my questions.

Thanks.

Our next question comes from Mickey Schleien of Ladenburg.

Yes, good morning everyone. Art, in your prepared remarks, you mentioned a lot of the advantages of investing in the lower middle market and I certainly agree. My question is given how intense the competition is higher up in the middle market with so much private debt and private equity capital available. Are you seeing any signs of that trickling down into the middle market and the lower middle market? And are you seeing competitors perhaps idiosyncratically behaving erratically or unrationaly?

Yes. It's a good question. And thankfully we don't see much of the -- what we'll call seeping down into the core middle market. Some of these folks have raised so much money and they are aggressively deploying it, and they're bringing covenant light and low yield and shorter diligence processes into the market. We kind of say core middle market is $50 million and below. Occasionally, you'll see a $40 million EBITDA company kind of falls way to that. One of the big guys will swoop down and pick that one off, and we'll kind of say, god bless, but kind of below $40 million, we're not seeing it. And that could change and we're vigilant about it, but below $40 million we're not seeing it. We really like and where our added value has been. And if you look at our track record, we'll go into it in the PNNT call. Over the last six years, it's where we can start out with these companies that are doing $10 million to $20 million EBITDA. The sponsor has injected a lot of equity, a lot of equity cushion, so we feel very safe about our capital preservation. And there's a real growth plan to take that $10 million or $20 million EBITDA company up to $30 million, $40 million $50 million and higher, where our debt capital can grow with the company we can deploy really attractive capital. We have the front row seat. Obviously, we're the incumbent and there's less competition by definition on the debt. And then, of course, we'll co-invest in the equity occasionally and participate in the upside that our debt is helping to drive. So those deals are kind of where we can add the most value today, where our capital is not commoditized, where we can get a front row seat for the long-term and then when we can get some upside. So that's kind of the prototypical deal for us across our platform. Some of those companies do grow to $40 million, $50 million, $100 million of EBITDA and that's terrific. And sometimes, they leave us on the debt side, and we hold the equity and sometimes that equity is worth a lot of money. So that's kind of where we see our highest value-add today.

Right. Thanks for that, Art. And to follow-up, given the size of those private funds, do you think there's effectively a barrier of entry into the lower middle market where the average deal size just doesn't move the needle for them? And even though the terms may be interesting, it's just not something that they're going to put a lot of time. And does that benefit you?

Yeah. I think that's fair. When you're in the AUM growth business and it's about AUM growth and you're looking at the amount of labor intensity, you need to put against the deal versus how much capital you can deploy I would agree with you. And a long time ago, I was at a big firm. I know how sometimes they think below a certain bite size it just doesn't make sense for the model.

I understand. My last question Art is just a little more philosophical thinking about next year relative to what we've had the last couple of years. This year in particular there's been a lot of tailwinds in the sector apart maybe from high levels of repayments and prepayments. But next year economic growth might decelerate the Fed and might start raising rates. Certainly defaults probably can't go any lower. They've been historically very low and we have an election. So it could be messy. When you think of those issues, how are you considering the right-hand side of your balance sheet both at -- I guess at both of your funds or all of your funds in terms of do you want to take some money off the table and keep leverage perhaps below your long-term targets next year and see how things work out?

Yeah. You're right. Obviously in 2022, we've got supply chain, labor, inflation in any number of different potential challenges as an economy. So how do you think about leverage in light of that? Well, first we have to underwrite companies that can deal with that that have enough cushion in them, so that they can for instance raise prices relatively easily as their costs go up. So we have to underwrite very carefully in this environment. We think we're well-positioned. EBITDA to interest is roughly three times or 3.2 times in this portfolio. So plenty of cushion in the portfolio generally to deal with rising interest rates, but it is something that we think about. In terms of leverage at the vehicles, I mean for PFLT in particular we're saying targets 1.5 times. We know and you know that you can take these same assets and walk them over to another department at S&P called the CLO department, and you could safely get three or four times debt to equity in a box that's very robust and safe and has weathered pandemics and weathered it's global financial crisis, et cetera. So for the assets that we put in PFLT, which we think are among the lowest risk assets in the BDC space, we're very comfortable at that 1.5 times knowing that. Another option we could take move these assets right over and get more leverage if we wanted to still feel safe about those capital structures. And then we can talk about Pennant related. But again, you have to look at the underlying assets. We have a lower target ratio there because the underlying assets are different kind of assets. So, it's something that we -- you've seen us do bonds. We've done unsecured bonds recently. That will continue to be an interesting and important tool for us to manage risk and always have diversified financing sources.

Thank you for that, Art. That's very helpful. And look forward to talking to you later today. Thanks.

Thanks.

The next question comes from Devin Ryan of JMP Securities.

Hi. Good morning. This is Kevin Fultz on for Devin. First question, over the past few quarters you've talked about the three-pronged approach to continue growing operating earnings. And clearly, you've made progress this year in growing NII. This quarter core NII was just shy of covering the dividend. Could you talk about when you expect net investment income to cover the dividend going forward? Thanks.

Yeah. Look we believe that as we continue to execute on this plan that we outlined in the very near future, it's hard for me Kevin to kind of say on February 3rd, so it's kind of -- it's dependent on the deal flow. It's dependent on repayments. It's dependent on rotation of equity. It's dependent on how quickly we can ramp PSSL. We would hope that sometime in 2022, we could safely cover this dividend.

Okay. Makes sense. And then could you provide an update on the current amount of spillover income?

Yes. Richard, do you want to handle that one?

Sure. The current spillover is $0.22 per share. And we should be able to cover that over the -- assuming distribution remains the same we should be able to cover that over the next three quarters.

Okay. And that's as of September 30th, 2021?

Yes, correct. Yes.

Great. Thank you. That's it for me, and thank you for taking my questions.

Kevin, thank you. Appreciate it.

As there are no further questions, I would like to hand the call back to Art for any additional or closing remarks.

Thanks everybody for listening in and giving us your time and attention. Our next quarterly call will be in early February. In the meantime, wishing everybody terrific Thanksgiving, a terrific holiday season and a season fill of health. Speak to you soon.

Ladies and gentlemen, that concludes today's conference call. We thank you for your participation. You may now disconnect.