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Solar Senior Capital Ltd (NASDAQ:SUNS)

Q1 2014 Earnings Conference Call

May 06, 2014 11:00 AM ET

Executives

Michael S. Gross – Chairman, President & Chief Executive Officer

Richard L. Peteka – Chief Financial Officer, Secretary & Treasurer

Bruce J. Spohler – Chief Operating Officer & Director

Analysts

Jonathan G. Bock – Wells Fargo Securities LLC

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2014 Solar Senior Capital Limited Earnings Conference Call. My name is Ian, I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Chairman and CEO, Mr. Michael Gross. Please proceed, sir.

Michael S. Gross

Thank you, and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended March 31, 2014. I’m joined here today by Bruce Spohler, our Chief Operating Officer; and Rich Peteka, our Chief Financial Officer.

Rich, would you please start off by covering the webcast and forward-looking statements?

Richard L. Peteka

Of course. Thanks, Michael. I would like to remind everyone that today’s call and webcast are being recorded. Please note that they are the property of Solar Senior Capital Limited, and that any unauthorized broadcast, in any form are strictly prohibited. This conference call is being webcast on our website at www.solarseniorcap.com. Audio replays of this call will be made available later today as disclosed in our press release.

I’d also like to call your attention to the customary disclosures in our press release regarding forward-looking information. Statements made in today’s conference call and webcast may constitute forward-looking statements, which relate to future events or our future performance or financial condition. These statements are not guarantees of our future performance, financial condition or results and involve a number of risks and uncertainties. Actual results may differ materially as a result of a number of factors including those described from time to time in our filings with the SEC. Solar Senior Capital Limited undertakes no duty to update any forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit our website or call us at 212-993-1670.

At this time, I would like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Michael S. Gross

Thank you, Rich. The first quarter of 2014 marked the anniversary of Solar Senior’s third year as a public company. As you may recall, we launched Solar Senior to provide investors with what we believed would be a lower risk, floating rate, senior secured alternative to the traditional junior capital BDCs. Immediately, we were able to leverage our investment and credit experience at Solar Capital. Since our inception, we have now invested approximately $660 million in over 60 portfolio companies.

The track record of Solar Senior speaks to our conservative approach to portfolio management. The main investment objective of this fund is preservation of principal and in the continued heated market environment, we take that mandate very seriously. As owners of 6% of our common stock, we are investing alongside our fellow public shareholders.

During the first quarter, we had modest portfolio growth, which was slowed by continued significant redemptions. Our net debt to equity ratio at March 31 was 0.23 times. Our target leverage remains 0.8 times and given that leverage target, we have approximately $150 million of available capacity for new investment opportunities subject to borrowing base limitations.

However, we are not willing to compromise our credit standards in order to achieve our target leverage. We remain focused on increasing the efficiency of our capital structure by increasing our leverage, be it portfolio growth and highly attractive investments. Given this focus on funding and prudent portfolio growth with our existing credit capacity, we do not anticipate raising additional equity capital until we approach our target leverage level.

At March 31, our net asset value was $18.04 per share consistent with our net asset value at year-end. For this first quarter, net investment income was $0.33 per share versus $0.32 per share in the fourth quarter of 2013. The weighted average yield of the portfolio based on fair value was 7.7% at March 31.

In comparison, the implied yield of the LTDX, which represents the liquid loan market was just 4.8% at March 31, 2014. Our strategic investment in Gemino Secured Healthcare Finance at the end of the third quarter 2013 is proving out our original investment thesis with 100% performing senior secured floating rate portfolio.

During the first quarter, Gemino upsized its credit facility to $105 million and added two new lenders. Not only is Gemino providing us with an attractive recurring cash dividend, but during the first quarter 2014, it demonstrated both growth and strategic value for our franchise. The credit quality of our diversified portfolio remains strong and was 100% performing at March 31, 2014.

Bruce will provide additional information on our first-quarter investment activity. Lastly, our Board of Directors declared a monthly dividend for May 2014 of $0.1175 per share payable on May 30 to stockholders of record on May 22, 2014.

At this time, I will turn the call back over to our Chief Financial Officer, Rich Peteka.

Richard L. Peteka

Solar Senior Capital’s net asset value at March 31, 2014 was $208 million, or $18.04 per share consistent with our net asset value at December 31, 2013. Our investment portfolio at March 31, 2014 had a fair market value of $274.9 million as compared to $267.9 million at December 31.

At March 31, 2014, we had investments in 37 portfolio companies in 22 industries versus 36 portfolio companies in 23 industries at December 31. The weighted average yield on our income-producing portfolio of investments was 7.7% at March 31 measured at fair value. This compares to 7.5% at year-end.

For the three months ended March 31, 2014, gross investment income totaled $5.7 million consistent with Q4 2013. Expenses totaled $1.9 million for our first quarter, compared to $2.0 million at Q4 2013.

The Company’s net investment income for the three months ended March 31, 2014 totaled $3.9 million or $0.33 per average share versus $3.6 million or $0.32 per average share for Q4 2013.

Net realized and unrealized gains for Q1 2014 totaled $0.1 million. For Q4 2013, net realized and unrealized gains totaled $2.0 million. The three months ended March 31, 2014, the Company had a net increase in net assets resulting from operations of $4.0 million or $0.35 per average share.

For the three months ended December 31, 2013, the company had a net increase in net assets resulting from operations of $5.6 million or $0.49 per average share.

At this time, I would like to turn the floor over to our Chief Operating Officer, Bruce Spohler.

Bruce J. Spohler

Thank you, Rich. Let me begin by providing a portfolio update. Overall, the financial performance of our portfolio of companies continues to be steady to modestly improving. Given that we primarily invest in defensive non-cyclical industries, the general credit strength of our portfolio was not significantly impacted by the harsh winter weather that hurt many businesses.

At March 31, our portfolio was 100% performing and we feel confident about the prospects of our portfolio of companies operating performance. At quarter end, the weighted average yield of our portfolio was 7.7% based on fair value. Our internal risk assessments on a weighted average of our portfolio remained at approximately 2 at 331 based on our 1 to 4 risk rating scale with 1 representing the least amount of risk.

Our portfolio ended the quarter with investments in 37 distinct issuers across 22 industry groups. The average position is approximately $7.4 million. Our portfolio was invested 86% in senior secured loans, 12% in Gemino, our strategic specialty finance company, which also has a highly diversified portfolio of senior secured loans, and less than 2% in unsecured loans when measured at fair value. Before I give an overview of Q1’s activity, I would like to give you an update on Gemino.

At quarter end Gemino had approximately $175 million of commitments in senior secured revolving or term loans with approximately $103 million funded. The highly diversified commitments are across 33 separate issuers having an average loan balance of approximately $3 million.

The Company’s origination efforts, which had been put on hold during the sale process last year, are now ramping with two new commitments this quarter and one add-on commitment totaling $16 million.

During the quarter, $11 million of commitments were extinguished. For the first quarter, Gemino paid distributions of approximately $820,000 to SUNS, which equates to a 10% annualized dividend yield on our cost, up from 9.5% distribution in Q4 of 2013, which had been our first quarter of ownership. In addition, Gemino has $75 million outstanding under its $105 million credit facility at 331.

During the first quarter, SUNS made investment of approximately of $50 million across nine portfolio companies consistent with our historical average pace. Now let me highlight couple of those investments, We invested just over $17 million in the first lien term loan of Embarcadero Technologies, which is a provider of database management tool software and an application development software. It is owned by Thoma Bravo which is a leading private equity investor in the software sector. This transaction refinanced existing debt and enabled the company to fund a new acquisition.

Leverage to our security is approximately four times and the all-in yield exceeds 9.5%. We also made an approximately $10 million investment in the new first lien term loan of Material Handling services, which is a portfolio company of CI capital. PFS minor is a leading provider of facilities and asset management services focused on the maintenance of mission-critical equipment in the retail distribution and manufacturing footprint of Fortune 2000 businesses.

We also invested $5 million in an add-on first lien term loan for KODA Distribution, which increased our total investment in the credit to approximately $10 million. The company is a leading US specialty chemical distributor owned by Odex Partners. The proceeds of the add-on term loan helped fund the acquisition of the DeWolf Chemical, a specialty distributor to the personal care end-markets. The all-in yield for our investment exceeds 6%.

We also invested $2.5 million in the new second lien term loan for Asurion. In conjunction with the company’s refinancing, our $3 million existing investment in Asurion was repaid at a premium to par. The Solar Capital platform with Solar Capital had been an original investor in Madison Dearborn’s acquisition of this company back in 2007 and to date, we have invested over $150 million combined across the five different transactions since 2007.

The Solar Capital platform has been redeemed on or sold approximately $135 million of this invested amount at a weighted average sale price exceeding 101. Our experience with Asurion serves as a great example of our ability to leverage our experience with a credit across both Solar Capital and Solar Senior to achieve duration in companies that we like.

During Q1, we had repayments and sales of approximately $43.5 million. We were repaid on our $9.7 million investment in National Vision’s first lien term loan, which resulted in an IRR exceeding 8.5%.

During the quarter our $10 million first lien term loan investment in Shield Finance was also redeemed. The IRR on this investment was just over 7.5% and our $5 million second lien investment in TriNet was repaid at a premium to par resulting in an IRR exceeding 17% given the short duration. Similar to our investment in Asurion, which we first diligenced back when we made our first investment for Solar Capital, we continue to find opportunities to benefit from our team’s credit experience with both previous Solar Senior and Solar Capital investments.

In today’s competitive market, our familiarity with credits and our role as an incumbent lender is providing us with a competitive advantage, which we expect will continue to provide us with attractive investment opportunities.

Now, I will turn the call back to Michael.

Michael S. Gross

Thank you, Bruce. In conclusion, over the past three years, we have constructed a highly diversified portfolio of predominantly floating rate investments. 98% of our portfolio consists of senior secured loans. Collectively, our over $340 million of investment exits during that time were accretive to earnings, given prepayment premiums, we received an acceleration of OID.

These repayments and sales, however, have slowed our efforts to reach our target leverage of 0.8 to 0.85 times, which we remain committed to achieving via a prudent, highly selective investment approach. Although the duration of many of our investments has been shorter than we would have preferred, we have been able to realize duration and credits we like by reinvesting in those companies.

We continue to believe that the senior secured middle-market asset class remains attractive on both a relative and absolute basis. The risk reward value proposition of an investment in Solar Senior Capital with its diversified portfolio of middle market senior secured loans is compelling when compared to the liquid syndicated high yield and bank loan markets, particularly given the recent selloff in the BDC sector resulting from the announcements by the S&P and Russell Indices that BDCs will be able to – no longer be eligible for index inclusion.

We view this as a short-term type of a factor that presents a buying opportunity. At a yield of approximately 8.6% as of yesterday’s close, SUNS compared favorably to the 5% yield of the Barclays high-yield corporate index and a 6.2% weighted average yield on a representative sample of closed-end bank loan funds.

Thank you for your time this morning. We look forward to speaking to you next quarter. Operator, please open the line for questions at this time.

Question-and-Answer Session

Certainly, sir. (Operator Instructions) First question comes from the line of Chris York of JMP Securities. Please go ahead.

Hannah Kim – JMP Securities

Hi, this is actually Hannah Kim calling in for Chris York. Thanks for taking my question this morning. I was wondering if you can comment on the expected level of excess in repayments for the rest of year 2014.

Bruce J. Spohler

Yes, I think, as you know, it is always a little bit difficult to project out beyond sort of the existing quarter. I think it’s fair to say that we’ve seen a rather consistent investment pace of around $50 million per quarter. We don’t see any reason why that won’t continue to be our go-forward investment pace.

I think the thing that’s more difficult to project is really the pace of repayments. And we feel as if that has abated not because of anything other than so much of our portfolio has churned. So I think that our expectation is it should slow a little bit just given the recency of many of our investments. But again, we don’t get a lot of visibility, unless it’s a business being sold that we are an investor into, then we know ahead of time that it’s being put up for sale, because that process takes a few months. But if somebody is just doing a refinancing, we may not get a lot of visibility on that. But we are cautiously optimistic that the pace of repayment will abate.

Hannah Kim – JMP Securities

Great, thank you. That is all from me today.

Michael S. Gross

Thank you.

Operator

Thank you. (Operator Instructions) And we have another question this was from Jon Bock of Wells Fargo Securities. Please go ahead Jon.

Jonathan G. Bock – Wells Fargo Securities LLC

Hi, good afternoon. Again, thank you for taking my questions. So, maybe looking back at historically for a moment, I know you mentioned Michael and Bruce that an equity raise at 0.8 or kind of approaching that optimum leverage level is kind of your target. And as we look back over history, I mean, I see that there were some raises done at even 0.2, 0.22 times and particularly the one in March of 2013.

Can you walk us through that even if this stock is above book value, it could kind of your focus on – or maybe reiterate a point that you will choose not to raise equity as you get to that point – until you get to that 0.7 or 0.8 level or do you see it more as, if you are above book, it just makes sense in light of the fact that you need more liquidity for the stock? How would you look at the two?

Bruce J. Spohler

Just to be clear, since our IPO, we have done one equity raise in our history and that was above book. But, no, I think given where we are today, you’re not going to see us raise equity until we see our way clear to getting very close to our target debt to equity.

Jonathan G. Bock – Wells Fargo Securities LLC

Okay, great. And then, Bruce, talking about Gemino, and I want to make sure I got these numbers correct, I think you said – how much available capacity do they have effectively to grow as of 3/31? I think it was 75?

Bruce J. Spohler

Yes, but, remember, the facility was upsized to 1.05

Jonathan G. Bock – Wells Fargo Securities LLC

Got it, okay.

Bruce J. Spohler

And their average investment is $3 million. So, we think that they’ve got ample capital for their growth plan through this year. Although, we do have capital reserved to invest to support additional growth. As you know, we just don’t want them to feel the pressure to put that capital to work. So, we are going to be disciplined as they are. But I do think one thing worth noting, Jon, is that they act pretty much as the working capital provider to their issuers. And so what that means is, unlike some of our other asset classes on the platform, they tend to be a little bit stickier and have longer duration. So, we have been patient as they revamped their origination activities, but we don’t face the same repayment level that you might in other asset classes in this credit environment.

Jonathan G. Bock – Wells Fargo Securities LLC

So, trying to model that forward, and everybody appreciates prudent growth, Bruce, which is good to hear. How should we try to model that portfolio’s growth bit-by-bit over time because, as we look at it, that is a major determinant of dividend growth in the future and it would be helpful to kind of see how you’re looking at maybe increasing the size of that portfolio over the next 12 months in a measured way?

Bruce J. Spohler

I think slow and steady. I can try to fine-tune some numbers with you, but I would keep it more as a nominal growth as we’ve seen in Q1.

Jonathan G. Bock – Wells Fargo Securities LLC

Okay.

Bruce J. Spohler

But I think importantly you are able to see us take our dividend rate from 9.5% to 10% versus Q4. So, we do think that there is upside there, particularly as they will be using additional cost-effective debt capital to fund their growth.

Jonathan G. Bock – Wells Fargo Securities LLC

Got it. That’s all my questions. Thank you.

Bruce J. Spohler

Great, Jonathan.

Operator

Thank you. (Operator Instructions) Thank you. We have received no further questions, so I would now like to turn the call over to Michael Gross for closing remarks. Please go ahead, sir.

Michael S. Gross

Thank you. At this time, we have no closing remarks, but we appreciate everyone’s attendance this morning. And we look forward to talking to you in the future.

Operator

Thank you ladies and gentlemen for joining today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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