PennantPark Floating Rate Capital Ltd. ($PFLT)

Good morning, and welcome to the PennantPark Floating Rate Capital's Second Fiscal Quarter 2026 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. Welcome to PennantPark Floating Rate Capital's Second Fiscal Quarter 2026 Earnings Conference Call. I'm joined today by Jose Briones, Senior Partner at PennantPark. Rick Allorto, our CFO, is unable to be with us today due to a prior commitment. Jose, 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 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 the latest SEC filings, please visit our website, 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, Jose. I'll begin with an overview of our second quarter results, including our dividend adjustment and an outlook for net investment income. I'll then discuss the current market environment and how we believe PFLT is positioned going forward. Jose will follow up with a detailed review of our financial results, after which we will open up the call for questions. We are pleased with the continued strong performance and quality of our portfolio in what remains a challenging market environment. The risk/reward profile of the core middle market remains meaningfully more attractive than that of the upper market. NAV was flat quarter-over-quarter. Median portfolio company leverage remains moderate at 4.6x. Last 12 months PIK interest is only 2.2% of total interest and nonaccruals are less than 1% of the portfolio, and we do not have material software exposure. The substantial growth of the PSSL II JV this past quarter provides a solid base and positions us for growth in NII over time as the JV ramps. Let me now walk through our quarterly results. For the quarter ended March 31, core net investment income was $0.27 per share. During the quarter, we continued to scale our new joint venture, PSSL II, investing $148 million in new and existing investments. At quarter end, the portfolio totaled $340 million. We are encouraged by the pace of deployment and remain focused on methodically scaling PSSL II to over $1 billion of assets, consistent with our existing joint venture. Based upon the current market environment, we expect this ramp to occur over the next 12 to 18 months while maintaining our disciplined underwriting standards. In light of the current market dynamics and in consultation with our Board, we are updating our dividend framework to better align with net investment income. Beginning with the July dividend, we will set a base monthly dividend at $0.08 per share, a level we believe is well supported by current earnings. In addition, we will introduce a variable supplemental dividend equal to 50% of the excess NII above the base dividend. The supplement will be declared and paid monthly along with the base dividend. Let me now turn to the broader market environment. M&A activity has increased over the last 6 to 9 months and although overall conditions remain uneven. Private equity sponsors remain active, and we are seeing a growing pipeline of attractive opportunities across both new originations and add-on investments. However, activity levels remain below the unusually strong levels observed in 2024 as the market transitions toward a more normalized backdrop. We expect increased transaction activity to drive repayments across the portfolio, including opportunities to monetize equity co-investments and redeploy capital into income-generating investments. Notably, we expect a meaningful realization from our equity co-investment in Aechelon this quarter. Aechelon is a leading defense technology company sponsored by Sagewind Capital, our long-term sponsor relationship. Aechelon announced that it has agreed to be acquired by Shield AI, another cutting-edge defense technology company. Upon closing, we expect our $3.2 million equity co-investment to generate approximately $47 million in total proceeds. Proceeds will consist of $40 million of cash and $7 million of value in Shield AI stock. This represents nearly a 15x multiple on invested capital and demonstrates the value of our equity co-investment program. Given the current geopolitical environment and the Aechelon news, it is important to highlight that approximately 20% of our portfolio is exposed to government services and defense. In the core middle market, pricing for high-quality first lien term loans remains attractive, typically ranging from SOFR plus 500 to 550 basis points with leverage of approximately 4.5x EBITDA. Importantly, these structures continue to include meaningful covenant protections in contrast to the covenant-like structures prevalent in the upper middle market. We believe that the current environment favors lenders with strong private equity sponsor relationships and disciplined underwriting, areas where we have a clear competitive advantage. During the quarter, we invested $295 million at a weighted average yield of 9.3%, including $117 million invested in 6 new platform portfolio companies with a median debt-to-EBITDA ratio of 3x, interest coverage of 3.4x and a loan-to-value of only 44%. Our portfolio remains conservatively positioned. PIK income represents just 2.5% of total interest income among the lowest levels in the industry. Median leverage was 4.6x, median interest coverage was 2x and median loan-to-value was 44%. We ended the quarter with 3 nonaccrual investments, representing just 0.8% of the portfolio at cost and 0.5% at market value. These results reflect the rigor of our underwriting process and the discipline of our investment approach. Turning to software exposure, which has been an area of recent market focus. Our exposure remains limited at approximately 4.3% of the portfolio and is structured consistently with our core middle market strategy. These investments are primarily cash pay, covenant-protected loans with moderate leverage and shorter durations. Importantly, they are concentrated in mission-critical enterprise software serving regulated industries such as defense, health care and financial institutions. We believe this represents a meaningful point of differentiation relative to our peers. We continue to believe that our focus on the core middle market provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. Core middle market companies, those typically 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 process and package of terms we receive is attractive. We have many weeks to do our diligence. We thoughtfully structure transactions with sensible leverage, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity co-investment. Additionally, from a monitoring perspective, we received monthly financial statements to help us stay informed on the performance of our portfolio 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 $9 billion in 551 companies, and we have experienced only 27 nonaccruals. Since inception, our loss ratio on invested capital is only 12 basis points annually. As a provider of strategic capital that fuels 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 March 31, we've invested over $618 million in equity co-investments and have generated an IRR of 25% and a multiple on invested capital of 2x. Looking ahead, our experienced team and broad origination platform position us well to generate attractive deal flow. Our mission remains consistent to deliver a stable and well-covered dividend while preserving capital. Everything we do is aligned to that objective. We continue to focus on investing in high-quality middle market companies with strong free cash flow generation. We capture that value through first lien senior secured loans, 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 Jose for a more detailed review of our financial results.

Thank you, Art. For the quarter ended March 31, GAAP net investment income was $0.26 per share and core net investment income was $0.27 per share. Core net investment income includes the add-back of $1.1 million of debt issuance costs related to the refinancing of our securitization due 2038. Our operating expenses for the quarter were as follows: interest expense on the debt were $24.1 million, base management and performance-based incentive fees were $12.8 million, general and administrative expenses were $2.1 million, credit facility amendment and debt issuance costs were $1.1 million and provision for taxes was less than $0.1 million. For the quarter ended March 31, net realized and unrealized change of investments, including the provision for taxes was a gain of $3 million. As of March 31, NAV was $10.47 per share, essentially flat from $10.49 per share last quarter. As of March 31, 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 paid down our revolving credit facility and reduced our debt-to-equity ratio to 1.5x, which is within the target range of 1.4x to 1.6x. As of March 31, our key portfolio statistics were as follows: the portfolio remains well diversified, comprising 162 companies across 51 industries. The weighted average yield on our debt investment was 9.8% and approximately 99% of our debt portfolio is floating rate. LTM PIK income equal to 2.2% of total interest income. The portfolio is comprised of 87% first lien senior secured debt, 1% in second lien and subordinated debt, 3% in equity of PSSL I and PSSL II and 9% in equity co-investments. Debt-to-EBITDA in the portfolio is 4.6 and interest coverage was 2.0. With that, I'll turn the call back to Art for closing remarks.

Thanks, Jose. In conclusion, I'd like to thank our exceptional team for their continued dedication and our shareholders for their trust and partnership. We remain focused on delivering durable earnings, 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.

[Operator Instructions] And we'll take our first question from Brian McKenna of Citizens.

So NAV per share was roughly flat in the quarter. That's a pretty notable standout here within the group for the first quarter. What's driving the resiliency here? You do have the forthcoming pretty sizable realization event, I believe, coming in the next quarter or so. So I'm assuming that drove some incremental gains across the portfolio. But anything else just to note across the rest of the portfolio?

Thanks, Brian. Yes, Aechelon is a big piece of the equation there, really showing the value of equity co-invest. And we also have a few other equity co-invests that are percolating along nicely, and you'll see those in the SOI. We have one called Guild Garage, which is an equity co-invest, which has already been exited. And we have some others that are certainly not the size of Aechelon, but are percolating along and provided some nice singles and doubles. And that's really -- just to zoom out, that's really part of the reason we do equity co-invest. Many of our peers do it. Some of our peers do not. It's nice to have something in the portfolio that can give you some lift that can offset the inevitable nonaccruals that you're going to have in a broadly diversified loan portfolio. So the program in this quarter is certainly meeting its mission and providing a stable NAV.

Got it. That's helpful. And then when you look at your pipeline of new originations today, I mean, where are you leaning in? Is it a lot of the same sectors? I know you've been active in defense and government services. But kind of what's the mix of the pipeline there? And then how does spreads compare on these transactions versus spreads that are really tied to the prepayments that have come in over the last quarter or 2? Just trying to gauge where the spreads are coming in today versus maybe some of the recent prepays.

Yes. Jose, do you want to answer that one?

Sure. With regards to areas of opportunities and what we're seeing, defense and government services is a big part of our investment philosophy as well as health care and some business services. And so we're quite active with our private equity sponsors looking at those type of deals in the industries, and you saw the benefit of our exposure to defense with Aechelon. With regards to spreads, by and large, in our market, we're in that 500 to 550 over SOFR. And our view is that that's pretty consistent over the last couple of quarters.

Yes. I'll also add in on the industry focus. Obviously, government services and defense, a big one. We also have substantial exposure to health care, which we think is a resilient and can be a resilient area of the economy, certainly a big part of the GDP. Some of our peers have stumbled a little bit in health care over time. Thankfully, for us, by and large, we've done very well with it. And it's just -- I think, basically, we keep leverage low. We don't get out over our skis, we keep leverage low, keep it reasonable. I think where you've seen stumbles in health care, it's kind of higher leverage situation. So when you have higher leverage, you just don't have the cushion to be able to withstand bumps in the road. So we're pleased with health care. Obviously, we have a big business services. Consumer services are a big area. We've been doing quite a bit in kind of services around the home. That's been an active area. So those are kind of some of the areas where we focus.

[Operator Instructions]

Okay. We do have an extra question here, please.

We'll go next to Christopher Nolan with Ladenburg Thalmann.

Apologies if I missed part of the call. Art, on your comments earlier on the dividend adjustment, should we look at that as a proxy for the run rate direction for PFLT?

Yes. It's a great question as we -- look, we still believe that as we ramp this joint venture, this JV II that we can earn over time north of $0.30 a share per quarter. And if you were to model it out, Chris, I think you'd see that. Just with what was going on in the M&A market, which was not quite as robust as we would have hoped, we said, hey, let's not force it. Let's take our time in this more muted M&A market. The deals will be -- forcing investment usually doesn't pay off. So we said, look, let's take this time, adjust the dividend to be more comfortable. We clearly want to position ourselves as a prudent, stable BDC. BDCs today are kind of a little bit out of favor. And as the market turns, and we hope they will be in favor again, we want to come out of it well positioned as a BDC that easily covers its dividend, comfortably covers its dividend and also has dividend upside. So this was an opportunity for us to kind of clear the table a bit, align the dividend comfortably to the NII, which is why we've chosen the $0.24 a quarter, $0.08 a month, plus 50% of the difference between the base and GAAP NII. And then we will pay that out monthly. So we've already stated that for the month of July, there'll be an $0.08 per share base dividend and a $0.0033 supplemental dividend for July, August, September. We'll announce earnings in August. We'll be back here in a few months. We'll see what GAAP NII was, and we will adjust -- the supplemental will be adjusted to whatever that was. So we just thought it was a good time given what's going on to kind of reset the table, make sure our investors know that we can comfortably cover it and not force the issue on ramping the JV in a more muted M&A market. I hope that makes sense.

Yes. No, it does. And I guess from a broader perspective, I mean, you guys see a lot of deals. And for this quarter, at least from my chair, it looks like asset quality for BDCs in general seems to be deteriorating. And I just want to -- and I'm not isolating PFLT or any PennantPark entity. But in general, where do you see us in the cycle for credit for these market companies.

Yes. So for us, as you missed the first part of the call, but our nonaccruals are under 1%. So for us, that's pretty good. We'll take below 1% in any environment. But let me comment on the broader picture. Obviously, those BDCs that have significant software exposure, by definition, had to mark those loans down, right? Now they still hopefully will perform well. Hopefully, it will pay off, all good. But by definition, there was a mark-to-market, particularly for those who have a big software exposure. We have very limited software exposure. So we did not get hung up on that. I will highlight that, theory that where we do have our minimal nonaccruals and where everyone in the industry has some nonaccruals is, I'll call it the post-COVID vintage of '21, '22 deals where right post-COVID, there was a lot of money flowing around and there was a perception that the era that we were in, for instance, consumer products were doing well, other areas of the economy that were more of an at-home economy, there was a perception by everybody that things would be kind of for the long term in that space. Guess what? Here we are in 2026, there's been a reversion to the mean. Some of those companies that were doing really well in 2022 or 2023 are doing less well. So for us, in our below 1% nonaccruals, and you see -- I think you see it elsewhere in the industry, that's -- I kind of think that's where you're seeing some of the nonaccruals hit. Does that answer your question, Chris?

Yes, it does.

And at this time, there are no further questions. I'll turn the call back to Art for any closing remarks.

Thank you. Thanks, everybody, for being on the call today. We look forward to speaking with you in early August after our next earnings release. In the meantime, we're wishing all the mothers out there a great Mother's Day. Have a great summer, and we'll speak to you in August. Thank you very much.

This does conclude today's conference. We thank you for your participation.