Sunrise Realty Trust, Inc. (SUNS) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2016 Solar Senior Capital Ltd Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session; instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host for today, Michael Gross, Chairman and Chief Executive Officer. You may begin.

Thank you very much and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended September 30, 2016. I am joined here today by Bruce Spohler, our Chief Operating Officer, and Richard Peteka, our Chief Financial Officer. Rich, would you please start off by covering the webcast and forward-looking statements?

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 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 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.

Thank you very much, Rich. The successful running of a marathon requires both a plan and a solid training foundation. Similarly as conservative credit managers, we consider a strong strategic plan built on the foundation of a healthy investment portfolio to be a prerequisite for growing Solar Senior Capital’s portfolio and earnings. This quarter we are pleased to report that on both these fronts we are well-positioned to grow our net investment income over the coming year. In fact, because we are so optimistic about Sun’s growth opportunities, we raised additional equity at book value during the quarter via a very shareholder friendly share offering. While we are focused on the long-term benefits we expect to realize from this incremental capital, we also fully appreciate the importance of preserving full net investment income coverage of our distributions during the ramp period. So we have committed to waiving our earned incentive and management fees as needed to support distribution to shareholders through June 30, 2017. This quarter we waived over $500,000 of performance-based incentive fees to do so. As a result of our waiver commitment, we believe in our ability to deliver a multi-distribution of $0.1175 per share per month as we seek to grow our portfolio and associated earnings. Before updating you on our strategic initiatives which pave the way for earnings growth, I will touch on our strong financial performance year to date which positions us to deliver growth in the future. For the third quarter, SUNS earned net investment income per average share of $0.37 which fully covered our monthly distributions. Additionally, our net asset value per share increased modestly to $16.78 and our portfolio remains 100% performing. Given a solid foundation, we are able to focus our efforts on prudent growth and during the third quarter we made several advancements on this front. First, we increased our FLLP credit facility to $100 million and extended its maturity to August 2021. With a $25 million incremental bond capacity, we intend to complete the ramp of FLLP’s portfolio and achieve our low to mid teens return on equity. Second, Gemino Healthcare Finance inked another quarter of strong earnings. For the quarter, Gemino paid Solar Senior a distribution equating to an $0.1125% annualized yield at cost, up from 11% in the prior quarter and 9.5% at the time of our acquisition of the company. Given Gemino’s positive earnings momentum, we believe there is additional upside to our return on equity on this investment. We believe these strategic initiatives will enable us to grow net investment income over the coming year while maintaining our emphasis on investing in first lien senior secured loans. Finally, our $75 million common equity raise completed in September provides us with additional capital to deploy into our strategic initiatives with their low double-digit ROEs as well as into new strategic initiatives in the future. In addition to the high potential return on capital we expect to achieve in these proceeds, Solar Senior Capital should also benefit from its larger market capitalization, increased liquidity in our stock, increased portfolio diversification and greater scale. To facilitate the capital raise, Solar Capital Partners, our investment advisor took several shareholder friendly actions. First, Solar Capital Partners made a supplemental payment to the underwriter that cover the 2.1% gap between the offering price and estimated book value per share so that Solar Senior received proceeds equal to book value. Second, the investment advisor paid the full gross spread to the underwriters. Even though Solar Senior has received authority to issue shares below book value at its annual meeting again this past June, the advisor covered all the costs totaling $4.2 million because we believed it was the right thing to do. Third, as I previously mentioned, to preserve shareholder value during the deployment of proceeds, Solar Capital Partners committed to waiving incentive and management fees as needed to support GAAP net investment income and monthly distribution through June 30, 2017. At September 30, 2016, SUNS had $132 million of unused capacity under its revolving credit facility. When considering the unused debt capacity of the FLLP credit facility as well as anticipated leverage on the $75 million of new equity raise in September, available capital is approximately $200 million subject to borrowing base limitations. As we allocate the majority of our available capital to our strategic initiatives, we anticipate growth in investment income over the coming quarters. Lastly, our Board of Directors declared a monthly distribution for November 2016 of $0.1175 per share payable on December 1, 2016 to shareholders of record on November 23, 2016. At this time, I would like to turn the call over to our Chief Financial Officer, Richard Peteka.

Thanks, Michael. Solar Senior Capital Limited’s net asset value at September 30 was $268.9 million or $16.78 per share. This compares to a net asset value of $193.3 million or $16.76 per share at June 30. SUNS’ investment portfolio at September 30, 2016 had a fair market value of $327.9 million in 49 portfolio companies operating in 22 industries compared to a fair market value of $325.7 million and 52 portfolio companies operating in 24 industries at June 30. At September 30, the weighted average yield on our income producing portfolio was 8.2% measured at fair value consistent with the prior quarter and that 100% of our portfolio of investments was performing. Investment income for the three months ended September 30, 2016 totaled $7 million versus $6.7 million for the three months ended June 30. The continued growth and dividend income from Gemino and the FLLP contributed to the increase in investment income for the quarter. Net expenses for the three months ended September 30 were $2.5 million compared to $2.6 million for the three months ended June 30. In Q3 as well as Q2, we waived $518,000 and $228,000 respectively of performance-based incentive fees earned. Accordingly, net investment income for the quarter ended September 30, 2016 was $4.5 million or $0.37 per average share compared to $4.1 million or $0.35 per average share for the quarter ended June 30. Below the line, SUNS had net realized and unrealized gains for our third fiscal quarter of $0.6 million compared to net realized and unrealized gains of $0.6 million for the quarter ended June 30. Ultimately the Company had an increase in net assets resulting from operations of $5.2 million or $0.42 per average share for the three months ended September 30. This compares to 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. At this time I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich. Let me begin by providing a portfolio update. At September 30, the credit fundamentals and financial portfolio performance of our portfolio companies remained strong reflecting our disciplined underwriting, the seniority in the capital structure of our investments and focus on downside protection during the frothy credit markets of the recent few years. We are seeing a continuing steady slow growth environment that remains constructive for prudent lenders. At the end of the third quarter, the weighted average EBITDA of our first lien investments in SUNS portfolio including our ownership of FLLP was just over $77 million of EBITDA. While the portfolio was broadly diversified across multiple borrowers and industries, we continue to favor the larger, midmarket borrowers which operate in more defensive, non-cyclical industries. As Michael mentioned, at the end of the third quarter our portfolio was 100% performing. We also continue to have no direct exposure to the oil and gas or commodity sectors. Our internal risk assessments on a weighted average of our portfolio remains at approximately 2 at September 30, based on our 1 to 4 risk rating scale with 1 representing the least amount of risk. Also at September 30, the weighted average yield on our portfolio at fair value was 8.2% consistent with the prior quarter. At September 30, SUNS approximately $390 million portfolio had loans to 57 different borrowers across 26 industry groups. Our average investment size was just under $7 million or 1.8% of our portfolio representing a high degree of diversification. Virtually 100% of our portfolio is invested in senior secured loans including our investment in Gemino whose portfolio consists entirely of senior secured loans. Including our investment in Gemino, roughly 97% of our income producing portfolio is floating rate. Given that the investing community is increasingly focused on the potential value destruction that is expected to occur in long-duration fixed-rate assets as interest rates rise, we feel particularly good about the floating rate structure of our portfolio. Before I give an overview of our third-quarter activity, let me provide an update on our strategic investments. As a reminder, Gemino focuses on providing senior secured asset based loans to small and midsized U.S. companies exclusively in the healthcare industry. Gemino’s expertise and asset-based lending platform creates a risk return profile that has a very low correlation to SUNS traditional underwriting of sponsor backed senior secured cash flow loans. At quarter end, Gemino’s portfolio consisted of approximately $120 million of funded loans across 37 issuers with an average loan balance of just over $3 million. All of the commitments at Gemino are floating rate senior secured cash paid loans. For the third quarter, Gemino paid a distribution of $924,000 to SUNS which equates to an 11.25% annualized distribution yield. This is up from 11% in the prior quarter. We are extremely pleased that since our acquisition of Gemino in 2013, Gemino has steadily grown its ROE from an additional 9.5% to the current 11.25%. We believe there is further upside to Gemino’s ability to drive higher ROEs. Now let me provide an update on FLLP. At quarter end, FLLP had approximately $107 million of first lien senior secured floating rate loans across 23 different borrowers. The average loan balance was approximately $4.7 million. Importantly, FLLP’s portfolio is 100% performing. For the third quarter, FLLP paid distributions to SUNS equating to an annualized yield on the average cost of our investment of 11.3%. To date, we have deployed approximately $31 million of our $50 million equity commitment to FLLP. During the quarter, we upsized FLLP’s credit facility to $100 million which will enable us to efficiently fund the remainder of our equity commitment. Once this vehicle is fully ramped, we expect FLLP to continue to earn a low teens ROE. During the third quarter, we made investments of approximately $33 million across six portfolio companies and had sales and repayments of approximately $21 million. Now let me touch on a couple of our investments. We originated a $15 million investment in the First Lien Loan of Polycom, which is a manufacturer of voice and video communication equipment. Across the Solar platform, we invested just under $40 million in this loan which carries a yield of approximately 8.5%. This loan backs a take private of this company by Siris Capital which has a proven expertise in the telecommunications sector. EBITDA for the company is just over $275 million and leverage through our investment is only 2.5 times. We also funded a $5.5 million investment in the First Lien Term loan of Data Bank, which is a leading datacenter provider. We were able to leverage our expertise in the datacenter industry with this being our seventh investment in the sector. The loan carries a yield of just over 6%. We also originated a $5 million investment in the First Lien Loan to finance Golden Gate Capital’s acquisition of Tronair. Tronair is a manufacturer of ground support equipment and replacement parts into the aircraft sector catering to business, commercial and military aircraft. Net leverage through our investment is 4.5 times and our yield is approximately 6%. Now I would like to highlight a couple of our third-quarter exits. We have been focused on reducing our second lien exposure at SUNS and cycling out of these investments at attractive prices in order to redeploy the proceeds into First Lien Loans. This past quarter we continued to make progress in this effort. At the end of September, only $28 million or 7% of our portfolio was invested in second lien loans. Now to highlight a few of our repayments. We were repaid at par on our $3 million investment in the second lien loan to Landslide Holdings. Rather than rolling our proceeds into the company’s new covenant light refinancing, we intend to allocate the proceeds to our strategic initiatives which we believe offer more attractive risk-reward profiles. The IRR on our investment in LANDesk was just over 8.75%. Additionally, the remainder of our investment in Filtration Group’s second lien loan was sold at par. Our IRR in this investment was 9.7%. Finally, we sold approximately $1 million of our investment in Asurion’s second lien loan at an average price exceeding par which resulted in an IRR on our investment of over 11%. As we look forward, we are confident that through our multiple origination engines we will grow the portfolio through investments with attractive risk-reward characteristics. As a result of our diversified investment platform, we are not reliant on the sponsor back segment of the middle-market which has been somewhat muted this year. However, we are expecting an increase in sponsor finance activity during both Q4 and into 2017. Now I would like to turn the call back to Michael.

Thank you, Bruce. In Q3, Solar Senior delivered another solid quarter of results. With a comprehensive investment portfolio that is 100% performing, almost 100% senior secured and 97% floating rate, we believe we are positioned for future strong performance. Importantly, our strong foundation coupled with the earnings potential of our strategic initiatives provides us with a clear path to generating incremental shareholder value. As we deploy our approximately $200 million of available capital, we should achieve growth and return on equity and investment income. We are confident that once we fully invested the proceeds from our September equity raise over the next couple of quarters, our portfolio would generate quarterly net investment income that exceeds our current distributions. In the meantime, we have agreed to waive incentive and management fees through June 30, 2017 as necessary to ensure that quarterly GAAP net investment income fully covers the distribution. We view this waiver as a shareholder friendly action that protects our shareholders during the ramping of our strategic initiatives with the proceeds from the recent equity raise. At last night’s close, Solar Senior trades at 89.3% yield which represents a significant discount to the 5.2% implied yield of the S&P/LSTA Leveraged Loan 100 Index and the 6.4% yield of a representative sample of 14 closed end loan funds. Given the credit quality of our diversified portfolio, our disciplined investment philosophy and our low fee structure, we believe SUNS deserves a premium valuation. As the second-largest shareholder, we the management team feel closely aligned with our fellow shareholders as evidenced by the actions Solar Capital Partners took to net Solar Senior Capital $75 million of incremental capital at book value. We believe our ongoing efforts to responsibly steward our shareholders capital will result both in NAV preservation and net investment income growth. Thank you very much for your time this morning. We look forward to speaking to you next quarter. Operator, could you please open up the line for questions?

[Operator Instructions] And our first question comes from Jonathan Bock of Wells Fargo Securities. Your line is now open.

Hi, guys. Jamie Sirockman filling in for Jonathan. First, with the equity offering, how should be kind of think about the portfolio going forward? Are we thinking a similar strategy, just larger hold sizes?

Yes.

Okay.

Very good question and concise answer. I think you hit the nail on the head. The relevance for lenders such as Solar Senior is to be able to speak for larger hold sizes in the same loans. It obviously offers us tremendous economies as we are already seeing these transactions but it allows us to drive better terms and better pricing across these investments. So historically while we might have invested in $10 million loan hold size, you will now see us taking our hold sizes $15 million to $20 million. And then I think additionally it offers us obviously additional capital to deploy both Gemino and into the FLLP.

Great, thanks. And just kind of related to Gemino and the FLLP, are they going to kind of grow in proportion with the rest of the portfolio? Right now I think you are utilizing a good bit of the 30% nonqualified asset bucket. Do you intend to continue to use about that proportion?

Yes.

That is great. Thanks for the color. Appreciate the help there. That is all the questions for me.

Thank you. [Operator Instructions] And our next question comes from Robert Schweich from Burnham. Your line is now open.

I certainly appreciate what you are doing for shareholders and want to be sure that comes across. I also noticed that there is a substantial increase in performance-based incentive fees that is going on this year even though you are waiving a significant number and an increased amount in the third quarter. I wonder if you could elaborate on why this increase is occurring? And I believe that when you waive the fees that has tended to allow the profits to cover the dividends. Could you discuss this in a little bit more detail?

Sure. First of all, in Q3 we actually earned meaningful incentive fees because that is what the formula kicks out. If you look at the income statement and the 10-Q, you will see that below the line of total expenses you will see that we waived a significant portion of it to make sure the dividend is covered. So they net incentive fees after the waiver of $500,000 is fairly de minimis. To be specific on the income statement on the income statement if you look at the 10-Q, we earned according to our management contract, $636,000 of incentive fees and then below the line you will see that we waved $518,000 of it and that allowed us to fully cover the dividend.

Right, I see that.

So that is about $118,000 of incentive fee to the house.

And the $636,000 is because of the contractual arrangement you have on your loans?

Because we exceeded the 7% hurdle.

I see that is due to exceeding the 7% hurdle. Thank you.

But again we only took just over $100,000 of it.

Right. Thank you.

Have pleasure.

Thank you. [Operator Instructions] I am showing no further questions at this time. This does conclude our question-and-answer session. I would now like to turn the call back over to Michael Gross for any further remarks.

We thank you for your continued support and your time and attention this morning. We look forward to talking to you next quarter or earlier if you have any follow-up questions. Thank you.