SLR Investment Corp (SLRC) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Solar Capital third-quarter 2010 earnings conference call.

My name is Tuanda and I will be your coordinator for today.

At this time, all participants are in listen-only mode.

Later, we will facilitate a question-and-answer session.

(Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr.

Michael Gross, CEO.

Please proceed.

Thank you and good morning.

Welcome to Solar Capital's earnings conference call for the third quarter of 2010.

I am joined here today by Bruce Spohler, our Chief Operating Officer, and Nick Radesca, our Chief Financial Officer.

Nick, before we begin, would you please start off by covering the webcast and forward-looking statements.

Of course.

Thanks, Michael.

I'd like to remind everyone that today's call and webcast are being recorded.

Please note that they are the property of Solar Capital Ltd.

and that any unauthorized broadcasts in any form are strictly prohibited.

This conference call is being webcast on our website, www.solarcapltd.com.

A replay of this call will be made available on our website later today.

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, condition, or results and involve a number of risks and uncertainties.

Actual results may differ materially from those in the forward-looking statements as a result of a number of factors including those described from time to time in our filings with the SEC.

Solar Capital Ltd.

undertakes no duty to update any forward-looking statements made herein 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'd like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Thank you, Nick.

During the third quarter of 2010 we continued to deliver on the strategic objectives that we set out at the time of the IPO.

First, we delivered earnings per share of $0.63 per share for the quarter ended September 30, 2010 bringing our year-to-date total to $3.02 per share.

We continue to expect to generate taxable income in excess of our anticipated total 2010 dividends.

Our year-to-date realized gains and call premiums have provided a significant source of distributable income that will allow us to patiently ramp our portfolio.

Our NAV per share of $22.09 was slightly above prior quarter and up 7% year to date.

Second, we committed to more than $74 million of investments in four companies.

The improving economic climate, [assets] capital markets and substantial funds available to financial sponsors for new acquisitions continue to provide us with a robust pipeline of new opportunities to evaluate.

Despite the frothy liquid markets, we are maintaining our stringent underwriting standards and thus have not chased deals with terms that do not meet our risk-reward hurdles.

During the quarter, our pace of realizations slowed down from that during the first half of the year.

We had realizations of approximately $10 million compared to over $210 million received in the first half of the year.

However, we do expect additional realizations over the next couple of quarters.

Approximately 99% of the face value of our realizations this year were at par or at a premium to par.

Our portfolio is extremely healthy, with over 99% of our assets performing at a fair value basis.

The fair value weighted average mark on our credit portfolio of 94.6%, which is in conjunction with expected realizable value in our equity positions, will provide additional NAV appreciation potential as we move forward.

Third, in September, we entered into a $35 million term loan with a new lender which diversified our borrowings and increased our total secure borrowing capacity to $390 million.

We remain in active dialogue with potential new lenders, expect to continue to expand our credit facilities as we increase our assets to debt capital.

As of October 31, 2010, the revolver was undrawn; however we expect to access the facility to fund investments as we continue to ramp.

And finally, our Board of Directors declared a quarterly dividend of $0.60 per share.

The [fourth] quarter 2010 dividend will be paid out of taxable earnings on December 30, 2010 to holders of record as of December 17, 2010.

The $2.14 of total dividends declared for 2010 represents nearly 11 months as a public company and is more than fully covered by our taxable earnings.

At this time, I will turn the call over to Nick to take you through the financial highlights.

Thanks, Michael.

The NAV at June 30 was $732.6 million or $22.09 per share compared to $728.8 million or $22.07 per share at June 30.

Earnings of $0.63 per share for the quarter exceeded our dividend payable of $0.60 per share resulting in an increase in our equity value.

Our total investment portfolio had a fair market value of $906 million on September 30 as compared to $819.3 million on June 30.

The portfolio value increase for the quarter was primarily attributable to new investment activity and unrealized portfolio appreciation, partially offset by the repayment of assets.

At quarter end, investable capital totaled $390 million.

For the third quarter of 2010 gross investment income was $29.4 million compared to $28.3 million the prior quarter and $27.8 million for the period ended September 30, 2009.

Improvements in investment income were driven by a higher invested balance, the return to full accrual status of a cost-recovery investment and dividends received during the period.

Net investment income totaled $15.6 million for the third quarter, consistent with the $15.2 million in Q2 2010.

Net realized and unrealized gains totaled $5.5 million compared to $1.3 million for the prior quarter.

Net gain/loss for the third quarter of 2010 reflects steadily improving stable portfolio values.

As of September 30, 2010, there were two non-accrual assets with a total market value of $5.1 million and there were no longer any performing assets on a cost-recovery basis.

We expect realizable value for these assets to be in excess of their September 30 marks.

The weighted average investment risk rating of our portfolio has remained steady at just below 2 measured at fair value at September 30, 2010.

Quarterly, we rate our assets on a scale from 1 to 4, with 1 representing the least amount of risk and 4 representing assets that are materially underperforming our underwritten expectations.

New investments are typically rated at 2.

At this time, I'd like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Nick.

I'd like to start by giving you an update on our portfolio.

At quarter end, the total investment portfolio at fair market value was $906 million, of which 99.5% was performing.

We had investments in securities of 34 different portfolio companies in 23 industries, with approximately 20% senior secured investments, 73% in mezzanine debt, and 7% in equity.

As of September 30, the fair value weighted average yield on our income-producing investments was approximately 14.1% which is consistent with the level we saw at June 30.

We continue to have positive developments within our portfolio.

Overall, the credit quality of our underlying companies demonstrated further improvement during the quarter.

We are pleased with both the current leverage levels and interest coverage ratios and are encouraged by the trends across our portfolio of companies.

Three of our portfolio companies recently filed public offering registration statements, one of which has since gone public.

NXP successfully completed its IPO this past August at a valuation above our June 30 mark.

Booz Allen and AMC Theaters are still in the registration process.

Upon successful completion of these two public offerings, we anticipate realizations to be in excess of the 9/30 marks.

In response to the positive business momentum and improved liquidity, National Specialty Alloys or NSA declared and paid a cash dividend of 12% per annum on our common stock investment during Q3.

In addition, Birds Eye Iglo food group also had a positive development during the quarter.

The frozen foods company acquired Findus Italy which is the market leader in the Italian frozen food space.

Our investment tranche received 100 basis points consent fee as well as an increase in our coupon of 275 basis points in conjunction with permitting the acquisition.

Importantly, the pro forma leverage through our tranche remains modest at around the mid four times.

Additionally, we have returned ProSieben to full accrual status.

The Company has capitalized on the strong improvement in the German advertising market.

Due to its improving cash flow, we anticipate realizable value to be in excess of the September 30 mark, which was held at 61.

As of yesterday, the public quote for this investment was in the low 70s.

During the third quarter, we received approximately $7 million face value from a partial repayment of our mezzanine investment in Booz Allen defense services at a premium to par.

Additionally, we sold $3 million of our Asurion second lien position.

The proceeds from each of these realizations were in excess of their June 30 marks.

Year-to-date realizations total in excess of $210 million all in values at or above the prior quarter mark.

We view these exits validation of our original investment theses.

Let's talk about originations.

During Q3, we originated $74 million face value in new investments resulting in net portfolio growth of approximately $65 million.

Just to highlight a few -- first would be Shoes For Crews, where we invested $16 million in the mezzanine notes for AEA Investors' acquisition of this company.

It's a manufacturer of slip-resistant shoes primarily sold into the fast food restaurant industry.

It performed extremely well since closing and has a nice recession-resistant quality.

Additionally, we originated a $4.5 million follow-on investment into ViaWest second lien notes that we had held consistent with our $25-million investment made in the second quarter.

The super-regional provider of data services centers which is owned by Oak Hill is using the proceeds to fund a tuck-in acquisition and the business continues to perform well.

As you may recall, during Q2 we provided MidCap Financial, which is a mid-market secured lender to the healthcare industry, with a $25 million mezzanine loan investment.

We funded that shortly after quarter end.

Given the strength of the Company's performance, we were very pleased to commit to an additional $50 million investment during Q3, $15 million of which was funded during this quarter.

We expect to remain -- to fund the remaining $35 million over the next few quarters.

For the credit investments that we funded year to date, our initial weighted average yield based on cost is just over 14% and our current leverage through our security averages approximately 3.5 times.

This leverage statistic includes MidCap Financial, which as a finance company is evaluated on metrics other than debt to EBITDA.

We view these mid-teen yields on such modest leverage as an extremely attractive on a risk/return basis.

Now I would like to turn the call back over to Michael.

Thank you, Bruce.

As we discussed, we are pleased that the portfolio continued to remain fundamentally strong.

Both a solid financial performance for investments and the $210 million of realizations year to date and potential future realizations reaffirm the recession-resilient nature of our portfolio.

We currently have a very promising pipeline and are in various stages of due diligence on several prospective investments.

As we had mentioned before, our underwriting process can take several months for a single investment.

We are continuing to evaluate new opportunities which we source through our sponsor and intermediary relationships.

Additionally, we are in [the structuring] stage on several deals which our team first begin [diligencing] during Q2 or Q3.

Due to the positive market dynamics as well as the strength of our origination efforts and established presence in the sponsor community, we anticipate our pipeline of new opportunities will remain strong for the foreseeable future.

The high yield market has been seeing significant funding flows this year, which has driven pricing tighter and leverage higher on new issues in that market.

However, the market for private middle market debt has not experienced the same capital influx, and thus the spread between the two asset classes has continued to widen.

We are continuing to see attractive pricing and conservative leverage ratios.

In short, this is a great investing environment for our business model.

We are pleased with the results we delivered for the third quarter.

With the declaration of our fourth-quarter dividend and a surplus of taxable earnings to support future dividends, we are confident that we will be able to continue to deliver strong financial performance for investors as we patiently deploy our capital.

Thank you for your time.

Operator, would you please open up the line for questions?

(Operator Instructions).

John Stilmar, Suntrust.

Good morning, gentlemen.

Just a quick question for you.

Philosophically as you think about your balance sheet, you have done a great job this quarter of expanding the amount of bank capacity, both with your term loan as well as increased capacity on your revolver, which certainly should pay dividends in the future.

But how do you balance the cost of acquiring that financing today versus how we should think about sort of the long term?

How do you balance the cost of bringing that leverage on today versus the ability to leverage that seemingly beyond what your -- potentially your current equity base already has the capacity to hold?

That's a good question, John.

As you know, our target debt-to-equity leverage is about 0.6 to 1.

And what we are trying to do is gradually put in place facilities to accommodate that target.

The (inaudible) cost to put these facilities in place is really not that much.

We are paying typically a point or less on the capital, and it is being amortized over the life of the loan.

So in the case of the term loan, it's three years; in revolver, three years; in new facility, (inaudible) it'll be longer.

So the cost to carry it is really not that much money, in the scheme of things, and so we're happy to do it.

And we are very confident that you'll see us going to that leverage in the near-term and start to really use that capacity.

Great.

And then on the asset side you've certainly referenced the divergence between the liquid markets and the illiquid markets in your ability to extract the liquidity premium.

Are there any differences now, I would say in the third quarter?

Because that trend has certainly been in place for the past several quarters -- what would you say is the difference?

Are the liquid markets trying to creep in to the larger companies just in the search for yield?

Are you seeing BDCs have been successful at raising capital?

Are you seeing competition start to increase or changes?

How would you characterize any sort of inflection relative to the trend that has certainly been in place for a little bit?

Yes.

That is a good question.

The high-yield market, as you talk about, has really enjoyed quite a resurgence and they are financing companies very cheaply and with higher leverage.

The quid pro quo, though, to get into that market, you have to have size.

And so to get the liquidity investors need, the typical high yield deal is at least $200 million.

The companies we are focusing on are looking to raise sub debt more in the range of $50 million to $150 million.

And so they are not able to tap that market.

And as a result, since there hasn't been a lot of influx of capital into our market, you are not seeing terms change that dramatically at all.

The fact that there has been a couple of small IPOs or BDCs has really had no impact on us whatsoever, because they tend to trap in companies that are much more smaller than what we do and it hasn't changed the competitive dynamics at all.

Perfect.

Thank you, guys.

Thanks, John.

Vernon Plack, BB&T Capital Markets

Thanks very much.

You talk a lot about the promising pipeline and just curious in terms of the opportunities that you are looking at.

Is it anything outside, say, the typical investment profile?

In other words, are there perhaps maybe some things in the 30% bucket that you are looking at or something different just in terms of trying to be opportunistic, given what is going on in the market?

I would say two things, Vernon.

One, yes, it is at least of the 30% bucket.

As you know, with our investment in MidCap Financial, for example, that is an area where we think specialty finance provides some very promising opportunities, and not many of our peers really have dug in there.

And so that's an important area for us and we feel very good about what we've done with MidCap and are open to other specialty finance opportunities.

So I think that's really the primary opportunity set.

Additionally, beyond our traditional mezzanine investing, we are seeing more opportunities on the unitranche side, where we are moving up the capital structure to try to satisfy the sponsors' need for additional senior capital, given the dearth of bank capital out there for leverage companies.

And so I think you will continue to see unitranche investments like the deal we invested in in Q2 for Paradies, the CNBC airport-based retailer, I think you'll see that increase as the mix of our investment as we do more senior secured investing.

Okay.

And regarding international exposure, any thoughts in terms of potential changes there?

I don't know if you're looking at more international deals or less international deals or --.

No, I think that that market has not really opened up the way the mid-market has here.

We are still open, but we haven't really seen anything that attractive relative to the opportunity set here in the States.

Okay, thanks, Bruce.

[Aaron Sigonovich], Evercore.

Hi, good morning.

Hi Aaron.

In relation to the second investments in your portfolio of companies, do you earn any origination or structuring fees on any of those investments?

We do, we typically get between two and three points; and for GAAP purposes, we amortize it over the life of the loan.

So these weren't the secondary-market purchases?

No.

Okay.

And then looking at your portfolio, I guess, talking about seeing some improvements in your portfolio of companies, what are some of the trends that you're seeing?

Is it more broad-based or in certain sectors in terms of improving EBITDAs or leverage levels for your portfolio of companies?

Sure.

I would say that it is broad-based, with the exception -- we don't have much -- but the little bit of the consumer discretionary exposure we have tends to be more flat-line.

The good news for us is given the leverage levels or the modest leverage levels, they still generate meaningful excess free cash flow and are able to derisk the credit for us without having any substantial growth.

But I would say broadly across the portfolio, we still see sort of low single-digit top-line growth and a little bit higher earnings growth, all of which is leading to better deleveraging for us.

But I would say that our underlying managers are cautiously optimistic, have better ability and visibility, but no real willingness to make long-term commitments yet.

But generally, things feel better.

Okay, that's helpful.

And then finally, in relation to sponsor activity, how is the dialogue going with many of the private equity sponsors that you're working with?

And I guess, kind of relating back to the question about the differences between high-yield and middle market.

There seems to be still a lot of private equity capital available.

Why hasn't that been chasing the middle markets as much as the high yield?

The answer are they are chasing the market, and what you've seen is a lot more activity on I'd say, week over week, we see more and more investment opportunities in the middle market from sponsors, but you also see prices creep up for them.

But the good news is that the leverage rate does not.

So what it means is we're seeing bigger equity cushions in the deals we are doing.

Thank you.

David Chiaverini, BMO Capital Markets.

Good morning, guys.

My question relates to the net asset value and potential upside from here.

By my calculation, I come up with a dollar plus of performing loans that are marked below cost.

I was wondering over what time frame could we expect to see that accrete back into book value?

I'd say a reasonable time here would be 12 to 18 months.

That could change in the event companies choose to refinance or go public or sell the company prior to that, which we have no control over.

And are there any other sources of upside to net asset value in your opinion?

Yes, I think, we believe relative to where our marks are both on the underlying credit portfolio and the equity portfolio, we have additional upside beyond that.

We mark -- our equity portfolio is above $50 million on an expected return basis of mid 20% to 30%.

So we expect good appreciation across that portfolio over time.

We've seen that happen, for example, in something like NXP, that has gone from being marked at $0.05 to the $1, having gone public this year, is now $0.50 on the $1.

So we expect some of those types of things to happen in the future.

And then lastly, I would say that the three assets we've had on non-accrual or cost recovery basis, we continue to believe that there's recovery potential in excess of marks there.

And ProSieben, I think, highlights that.

At the trough, we had that marked close to $0.03 and today it is quoted in the low 70s, and our mark at September was 61.

So I think all three of those we hope to see realizable value above their September 30 marks.

Great.

Thank you.

Thanks, Dave.

[Eric Cohen], Guggenheim.

Hey, guys.

Quick question on the non-accruals.

Just wanted to see if there was a specific game plan for them and how you plan on, I guess, getting rid of them from your books?

Yes, I'm not sure we're going to get rid of them because I think, as Bruce mentioned, we think there's meaningful upside; we have them marked for recovery.

It's two assets, it's [Weights Equip], which we have marked at zero, which we actually are still collecting cash interest on, but we expect more recovery there.

And then it's Graycon that we've marked at $5 million or $0.25 on the $1.

That company is in the midst of restructuring discussions as we speak, and we expect a recovery meaningful in excess of that $5 million, and eventually have a loan that goes back down to a performing basis.

Okay, great.

And one follow-up on the ForEx and your hedging strategies.

I was wondering if you could provide a little more color on that.

Sure.

We do provide currency hedges on the foreign currency assets, as you know, and those currencies go quarter to quarter, and so we do have realized gains and losses on a cash basis.

But those are offset on an unrealized basis based on the underlying appreciation or depreciation in the asset to match that on a quarterly basis.

Anything changing in your strategies moving forward?

I think that as we continue to draw under the revolver as we ramp our investment portfolio, you will see us migrate the hedging to the revolver, because we do have the flexibility to draw in local currencies.

It is a multi-currency facility.

So I think you'll see us begin to match that way.

Okay, great.

Thank you very much.

Michael Kaye, Citigroup.

Good morning.

I'm wondering if you could share some of your recent dialogue with some of your original shareholders and perhaps their appetite to sell.

Yes, I think that --

As you know, the lock-up came off this past June, and we did see some pressure on the stock.

I think some of the smaller holders who had been locked up for the last three plus years took advantage of the opportunity to realize some liquidity.

And what we found is that between that, as well as the secondary we did this past spring, that it appears that the overhang has substantially disappeared.

So we feel very good about the core investor base and their continued commitment to the Company.

Okay.

Thank you.

A follow-up question.

You have a lot of excess capacity.

Would you perhaps be interested in maybe purchasing like a large portfolio of loans if something became available?

Sure.

At the right value and as long as it's a portfolio of things that we think we would otherwise invest in, given our business strategy, absolutely.

I'm not sure, given where we are in the market today, that that opportunity is out there today.

I think the distressed dollars have been cleaned up, so I wouldn't -- that's not something I would count on as part of our investment strategy in the near term.

Okay.

Thank you.

And with no further questions in queue, I would now like to turn the conference over to Mr.

Michael Gross for closing remarks.

We appreciate all your time and look forward to speaking to you in early February when we announce our fourth quarter.

Thank you.

: Thanks, everybody.

Thank you for joining today's conference.

That concludes the presentation.

You may now disconnect and have a great day.