Solar Senior Capital (NASDAQ:SUNS) Q2 2016 Earnings Conference Call August 3, 2016 11:00 AM ET
Michael Gross - Chairman and Chief Executive Officer
Bruce Spohler - Chief Operating Officer
Richard Peteka - Chief Financial Officer
Mickey Schleien - Ladenburg
Fin O’Shea - Wells Fargo Securities
Good day, ladies and gentlemen and welcome to the Second Quarter 2016 Solar Senior Capital Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Michael Gross, Chairman and Chief Executive Officer. Sir, you may begin.
Thank you very much and good morning everybody. Welcome to Solar Senior Capital’s earnings call for the quarter ended June 30, 2016. I am joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer. Richard, would you please start off by covering the webcast and forward-looking statements?
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 broadcasts 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 would 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 the 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.
Thank you, Richard. The second quarter was a solid quarter for Solar Senior Capital. Amidst global uncertainties and tightened market volatility, SUNS continues to perform well. The credit fundamentals and financial performance of our portfolio companies remains healthy and our portfolio is 100% performing. The comprehensive portfolio grew approximately 4% in the quarter in spite of continued light new issue activity in the middle market. We are making more efficient use of SUNS balance sheet through our strategic initiatives. We expect net investment income continue to grow as we ramp these investment strategies. We have constructed a defensive, broadly diversified portfolio that it’s comprised of predominantly first lien, senior secured floating rate loans issued by upper middle market private companies. We believe loans at the top of the capital structure continue to offer the most attractive risk reward profile.
With a weighted average EBITDA of $78 million of our first-lien issuers at June 30, our portfolio is focused on the larger end of mid-market, where borrowers have the breadth, scale and infrastructure to better withstand challenges compared to their smaller peers. In addition, with 97% of comprehensive portfolio invested in floating rate loans, SUNS provides investors with a hedge against rising interest rates. In spite of muted new issuance and refinance activity, SUNS generated approximately $40 million of gross originations, including our ownership of FLLP. Furthermore, SUNS took advantage of a favorable investment environment in the second quarter to selectively redeploy capital into investments at wider spreads and lower leverage rate levels in the loans we exited.
We continue to favor investments in non-cyclical defensive industries. And as a result, SUNS has no direct exposure energy or commodities. Our priority remains to be disciplined with our new investments, focus on downside protection and importantly, grow net investment income to the continued ramp of FLLP and Gemino. Risk assets rally throughout most of the second quarter although they gave back from the gains in June when the Brexit vote introduced new risks and uncertainties. Based on the combination of improving credits and mark-to-market adjustments, our NAV grew to $16.76 per share at June 30, 2016.
The portfolio did not fully recapture the technical markdowns from market dislocations in the second half of 2015. And as a result, we believe there is additional net asset value upside as the loans are repaid at par. The acquisition of Gemino Healthcare and the creation of FLLP are critical elements of our strategic efforts to gross funds net investment income. We diversified our portfolio with the addition of senior secured asset-backed loans to a healthcare company through Gemino’s lending platform and we have created strategic partnership in our joint venture with VOYA to scale our balance sheet. In an environment of elevated risk and low returns, Gemino and FLLP enhanced our ability to invest in loans that are first-lien, senior secured, have covenant protections and generate high ROEs for SUNS.
In the second quarter, our investments in FLLP and Gemino continue to perform well. For the quarter, FLLP’s annualized distribution yield based on cost was approximately 11%, a healthy increase from the 9.4% in the prior quarter. We are pleased with the measured ramp of our joint venture with VOYA and are confident in our ability to drive increases in our net investment income in the second half of 2016, with the targeted ROE of FLLP in the low teens once fully ramped.
Gemino continued to demonstrate strategic value to its healthcare lending expertise. For the quarter, Gemino’s annualized distribution yield at cost of 11%, consistent with the yield in the first quarter, excluding the special dividend. We expect Gemino will continue to increase contribution to our net investment income in the second half of 2016 and Bruce will provide additional details on FLLP and Gemino. The combination of generating higher return on equity from our strategic investments together with replacing lower yielding investments with new loans at wider spreads resulted in an increase in SUNS weighted average yield to 8.2% from 7.9% in the prior quarter.
At June 30, 2016, SUNS had approximately $33 million of unused capacity under its credit facility. When considering the debt capacity of the FLLP joint venture based as full equity commitment, the expected debt capacity of FLLP combined with the company’s balance sheet is approximately $85 million subject to borrowing base limitations. Lastly, our Board of Directors declared a multi-distribution for the month of August 2016 of $11.75 per share payables on September 1 to shareholders of record of August 18.
At this time, I’d like to turn over the call to our Chief Financial Officer, Richard Peteka.
Thank you, Michael. Solar Senior Capital Limited net asset value at quarter end was $193.3 million or $16.76 per share. This compares to a net asset value of $192.7 million or $16.70 per share at March 31, 2016. SUNS investment portfolio at June 30 had a fair market value of $325.7 million in 52 portfolio companies, operating in 24 industries compared to a fair market value of $312.2 million in 47 portfolio companies operating in 22 industries at March 31. At June 30, the weighted average yields on our income-producing portfolio was 8.2% measured at fair value compared to 7.9% weighted average yield at March 31 and 100% of our portfolio investments were performing.
Investment income for the three months ended June 30 totaled $6.7 million versus $6.3 million for the three months ended March 31. The increase in investment income was primarily related to higher yielding portfolio net portfolio growth, including FLLP’s growing contributions to earnings.
Net expenses for the three months ended June 30 were $2.6 million compared to $2.3 million for the three months ended March 31. In Q2 and Q1, we waived $228,000 and $385,000 respectively of performance-based incentive fees. Accordingly, net investment income for the quarter ended June 30, 2016 was $4.1 million or $0.35 per average share, consistent with $4.1 million or $0.35 per average share for the quarter ended March 31. Below the line, SUNS had net realized and unrealized gains for our second fiscal quarter of $0.6 million compared to net realized and unrealized gains of $4.3 million for the quarter ended March 31.
Ultimately, the company had an increase in net assets resulting from operations of $4.7 million or $0.41 per average share for the three months ended June 30. This compares to an increase in net assets resulting from operations of $8.4 million or $0.73 per average share for the three months ended March 31.
At this time, I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.
Thank you, Richard. Let me begin by providing a portfolio update. At June 30, the credit fundamentals and financial performance of our portfolio companies remained strong, reflecting our disciplined underwriting, seniority in the capital structure and focus on downside protection during the frothy credit markets of the recent couple of years. We are not seeing anything systemic across our portfolio that would suggest an economic slowdown, just a continued steady slow growth environment that remains constructive for prudent lenders. At June 30, the fair value weighted average leverage to our first-lien investments, including our investment through FLLP was approximately 3.9x. And the weighted average cash interest coverage of our first-lien investments was approximately 3x.
At the end of the second quarter, the weighted average revenue and EBITDA of our first lien investments was $377 million of revenues and $72 million of EBITDA. While the portfolio is broadly diversified across multiple issuers and industries, we continue to favor larger mid-market corporate issuers that operate more defensive non-cyclical industries. We feel confident about the prospects of our portfolio companies. As Michael mentioned, at June 30, our portfolio was 100% performing. We continue to have no direct exposure to the oil and gas or commodity sectors. Our internal risk assessments on a weighted average of our loan portfolio remains at approximately two measured at fair market value and based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk.
Also at June 30, the weighted average yield of our portfolio measured at fair value was 8.2% versus 7.9% for the prior quarter. The increase over Q1 reflects a combination of the higher ROE from FLLP, along with recycling some of our lower yielding loans into new investments at higher spreads. At June 30, SUNS $378 million comprehensive portfolio, which includes the loans held in FLLP, have loans to 57 issuers across 27 industries, with an average investment size of just over $6.5 million. Firstly, 100% of this portfolio is invested in senior secured loans, including our investment in Gemino. This portfolio consists entirely senior secured loans. Including our equity investment in Gemino, just over 96% of our income producing portfolio is floating rate. Before I give an overview of our second quarter investment activity, let me provide an update on our strategic investments in both Gemino and FLLP.
As a reminder, Gemino focuses on providing senior secured asset based loans to small and midsize U.S. companies operating in the healthcare sector. Gemino’s healthcare expertise and asset based lending platform creates the unique risk return profile that has a low correlation to SUNS traditional underwriting of senior secured cash flows loans. At the end of the second quarter, Gemino’s portfolio was stable with just over $130 million of funded loans across 38 issuers, with an average loan balance of approximately $3.5 million. All of the commitments at Gemino are floating rate senior secured cash paid loans. For the second quarter, Gemino paid a distribution of just over $900,000 to SUNS, equating to 11 % annualized distribution yield.
Since our acquisition of Gemino in late 2013, Gemino has steadily grown our ROE from 9.5% to 11%, which excludes the special dividend they paid to us in the first quarter of this year. We expect future growth in our ROE from Gemino in the second half of this year. Now let me provide an update on FLLP. As a reminder, our strategic partnership with Voya Investment Management to create FLLP provides incremental long-term capital from a like minded mid-market credit investor that expands our origination capacity and allows us to scale SUNS balance sheet more effectively.
At June 30, FLLP had approximately $92 million of first lien, senior secured floating rate loans across 20 different issuers, with an average investment size of $4.6 million. For the second quarter, FLLP paid distributions to SUNS equating to an 11% annualized distribution yield on the cost of our equity investment. This is up from 9.4% distribution paid to us in the first quarter. We have deployed approximately $30 million of our $50 million equity commitment to FLLP. Once this vehicle is fully ramped, we expect FLLP to earn the low teens ROE for SUNS. In Q2 including our ownership of FLLP, we made investments of approximately $40 million across 14 portfolio companies and we had sales and repayments of approximately $27 million.
Now let me highlight a couple of our second quarter investments. During the quarter, we committed to a stretch senior secured loan to CIBT which is in every portfolio company and it’s one of the largest providers of in the highly fragmented travel document processing services industry. Solar Capital, our sister company has been a junior capital investor into CIBT. SUNS committed approximately $6 million, with evenly between FLLP and SUNS balance sheet, leverage through our investment 4.4x times and the loan carries a yield to maturity of 6.6%.
During the second quarter, SUNS also funded a $9 million investment in the first lien term loan of PGI. PGI is a leading global provider of audio, web and video conferencing solutions. Securus Capital acquired PGI late last year and re-syndicated the debt in April after realizing $40 million of synergies, leverage through our investment of 3.2x and the loan carries a yield of just under 11%. Lastly, we funded a stretch senior-secured term loan to support the merger of Pet Supermarket and Pet Valu. SUNS committed $5.3 million through FLLP leverage through our investment is 4.9x and the loan carries an all-in yield of just under 7%. SUNS and FLLP are incumbent lenders to Pet Supermarket having invested $15 million in the company’s first lien term loan last year when Roark initially acquired the company.
In connection with the recent transaction, SUNS and FLLP were repaid it part on the original investment, which generated an IOR of just under 8%. The acquisition of that value creates a significantly larger company with almost triple the cash flow from when we first invested last year and the return is just under 7% yield that we had last year as well. We also took advantage of favorable market conditions to sell $4 million of our investment in the LIBOR plus 4.25% first lien term loan issued by Healthport at prices above our cost. This enables SUNS to redeploy capital into higher yielding investments.
Finally, we repaid at par on our $4 million second lien term loan investment in Cooper Gay. SUNS realized a return of just over 9% on this investment. Going forward, we intend to continue to access our remaining second lien investments opportunistically and redeploy those proceeds into first lien term loans through both SUNS balance sheet, Gemino and FLLP. Our priority remains to be highly selective with our new investments, focus on capital preservation in growing net investment income through the continued ramps of Gemino and FLLP. While we have seen a slow first half of 2016 for new issue activity, the market disruption has also slowed refinancing transactions, which has resulted in unit repayment activity on our portfolio. Our visibility on repayments for the third quarter to-date is approximately $10 million.
Now I would like to turn the call back over to Michael.
Thank you, Bruce. Solar Senior delivered solid results in the second quarter and we are pleased with our steady performance. Our origination efforts provided modest portfolio growth in the quarter marked by continuing light middle market new issuance and refinance activity.
At June 30, we had a highly diversified defense portfolio comprised predominantly first-lien, senior secured floating rate loans that are 100% performing have no exposure to energy and commodities. Importantly, we continue to deliver a steady monthly distribution to our shareholders. In addition to building a diversified portfolio and taking a prudent approach to new investments, we have taken other important strategic steps to position SUNS to protect net asset value and grow net investment income. We have successfully leveraged the differentiated origination platform, Gemino, to provide recurring cash income from a diversified portfolio of senior secured asset-based floating rate loans, while increasing the return on equity to SUNS and we are optimistic about Gemino’s ability to increase its ROE to SUNS in the second half of 2016. Our first lien loan program joint venture with VOYA has expanded our origination capacity and allows us to scale the SUNS balance sheet.
As we approach our target leverage for FLLP, we anticipate its annualized distribution yield to reach below teens. Through these initiatives and with further deployment of our available debt capacity, we are confident SUNS will increase its ROE, grow net asset value and generate net investment income that will continue to cover our distributions on sustainable basis. At last night’s close, SUNS trades at an 8.5% dividend yield, which represents a significant premium to the 5.3% yield of S&P, LSTA leverage loan 100 Index and a 6.6% yield of representative sample of 14% closed end loan funds.
Given the credit quality of our diversified portfolio, our disciplined investment philosophy and low fee structure, we believe SUNS deserves a premium valuation. Our defensive approach maybe unexciting to some investors, but our experience through multiple credit cycles, such as maintaining a conservative approach. As the second largest shareholder, we demand our team feel tightly in line with our fellow shareholders and we will continue to take the appropriate steps to earn our monthly dividend, reserve capital and take advantage of market dislocations.
Thank you for your time this morning. We look forward to speaking to you next quarter. Operator, at this time, we would like to open up the line for questions.
Thank you. [Operator Instructions] And our first question comes from the line of Mickey Schleien of Ladenburg. Your line is now open.
Yes, good morning Michael and Bruce. So, I just wanted to follow-up your comments on FLLP, if my math is correct, it’s now levered 2 to 1. Are you willing to run that at a higher rate? And if not, what would be the source of the additional equity to inject into FLLP, so you could upsize the line of credit?
Yes, the short answer is we would be willing to run it slightly higher. The facility allows us to take leverage up a little bit, which would obviously pop the ROE into that low-teens that we referenced. And the source of the equity would be the $20 million remaining commitment that SUNS has will be from our balance sheet.
Okay. In other words, you have either cash for unencumbered assets that you could contribute?
Okay. Another question, stocks coincidentally trading right at NAV and we have seen other situations where external managers have paid fees to issue equity, so that is not dilutive. Is that something you would be considering to do for SUNS?
Well, Mickey, as you know, we have always done what we feel are shareholder-friendly actions, including waving an incentive fee to make sure our dividends covered. So, you would expect us if we were to raise equity to do number of things to be shareholder-friendly, including possibly covering underwriting spreads and things of that nature.
Okay. And lastly, perhaps for Bruce, can you give us an update on Global Tel*Link, Miller Heiman and Trident, I am not sure whether these are technical issues or fundamental issues with the credits, but...
Sure. Global Tel, as you may recall is one of the two present telephone companies in that duopoly market, the other one being Securus, which Solar Senior also owns. The short story and I am happy to go deeper with you offline, but as you know, we have been following this one closely, both of them having been invested for a few years now. And they were under review by the FCC to lower the rate caps that they can charge to the prisoners for various telecommunications, callers and so forth. And so far everything has been moving in the company’s direction, which is why you have seen the paper trade up from when we purchased some of the first lien in the low 70s at the trough today’s closure in the low 90s. So, EBITDA continues to perform extremely well. These are low levered businesses, roughly 3.5x senior by four and three quarters second lien, 4.5 second lien, 150, 160 plus EBITDA businesses. The FCC order has been stayed and there is ongoing discussion between the companies and the FCC. And so we continue to have tremendous confidence in the businesses. They have duopoly market position and a reason to exist and are irreplaceable we believe at least in today’s technological environment, focus on security for the prisoners. And so we feel very good that those will eventually be repaid at par and so as you know have improved dramatically over the last couple of quarters.
Trident, we have been in the junior capital, we have been the senior capital, the business is a home healthcare business in large part radiology, ebbs and flows with the flu season, and the business has been doing fine. We marked that down, because there was a technical mark and that’s really all that there was there. We continue to feel very confident. The quotes have been extremely volatile and we feel confident in the business, have been an investor with ODDEX for a number of years in that company. Miller Heiman has also a market that we look to in the public market just because of the large size of the tranche and because that was the lowest of all marks we came up in our valuation process. We decided to use that lower mark of 77.5. The business does have some pressure in some of its segments. But when we look at it in terms of some of the parts, it has a few segments that are doing extremely well and we believe are extremely valuable that would indicate a value in excess of that 77.5, but that is one that is on our watchlist as the company tries to regain its footing.
Terrific. That’s very helpful. I appreciate your time this morning. Thank you.
Thank you, Mickey.
[Operator Instructions] And our next question comes from the line of Jonathan Bock of Wells Fargo Securities. Your line is now open.
Hi, guys. Fin O’Shea in here for Jonathan Buck this morning. How are you?
Good morning, Fin.
Just to kind of segue on Mickey’s questions, a couple of those were helpful explanations of the marks. I saw an interesting funding that your largest funding this quarter on balance sheet was with GenMark and looking at those filings that looked as though is that an agreement you assumed through assets from GE Healthcare and can you just remind us of that and if there are anymore loans like that we should see?
Yes, so very, very good question. So, GenMark did come on platform as part of the Capital One acquisition. The lion’s share of that portfolio as you know resides over Solar Capital. GenMark is a situation where the life science field team had underwritten this deal in their prior life at GE. It has a market cap of $400 million plus as a public company and we felt that this one was of a lower risk profile and therefore more appropriate for Solar Senior. And so I think selectively, you will see some of the lower risk life science deals, but it’s not going to be a big part of the portfolio, but this was a great opportunistic purchase.
Okay, very well. And also listening to the SLRC call and how you consolidated Crystal to smooth out some ‘40 Act nuances, can we expect something like that with Gemino?
I think it’s less likely, because Gemino’s business really does not lend itself to the rest of co-investing with the rest of the platform. Their average loan size is around $3.5 million. They can take all of that on their own balance sheet. So, unlike Crystal that we will see some large deals where it’s a great opportunity for the rest of the solar platform, this less relevant for Gemino.
What’s with Gemino, what are the portfolio yields looked like in that portfolio is we can’t see the income statement there, but it obviously gets pretty good advance rates on leverage, just out of curiosity?
Yes. The asset level yields are closer to 7% to 8%. And then with leverage less the cost, gets us up to that 11% where we think we have some upside beyond that.
Okay, very well. And just finally a more global question as it relates to the waiver, the fee waiver in the dividend. Just kind of looking at SUNS and our model here and accounting for the remaining commitment in FLLP and some a little more yield there may be, it still looks like your – it looks like it tops out at the $0.35 mark, so is there any SLRC like plan to hit a few cents higher and if so, is this going to entail basically what moves the needle, and is it possibly running those assets FLLP and Gemino beyond the 30% bucket?
I think we feel there is a little bit more upside in Gemino. We think that flip, obviously has growth potential, having only put $30 million or $50 million commitment in there. And I think the goal is to get a couple of cents above the existing dividend, but we are obviously exploring other opportunities to add niche asset classes that might take it up a little bit further.
Okay. Guys, well, that’s all for me. And thank you very much, congratulations on the quarter.
Thanks for your time.
Thank you. [Operator Instructions] And I am showing no further questions at this time. I would now like to turn the call over to Mr. Michael Gross for closing remarks.
Thanks everybody for your time. And if you have any further questions, please feel free to follow-up directly. Take care.
Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.
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