Trinity Capital Inc. (TRIN) Earnings Call Transcript & Summary

Good afternoon. My name is Chelsea, and I will be your conference operator today. At this time, I would like to welcome everyone to Trinity Capital's Second Quarter 2023 Earnings Conference Call. Our host for today's call are Steve Brown, Chairman and Chief Executive Officer; Kyle Brown, President and Chief Investment Officer; David Lund, Chief Financial Officer; Michael Testa, Chief Accounting Officer; and Ben Malcolmson, Director of Investor Relations. Gerry Harder, Chief Operating Officer; Ron Kundich, Chief Credit Officer; and Sarah Stanton, Chief Compliance Officer and General Counsel, are also present. Today's call is being recorded and will be made available for replay at 3:00 p.m. Eastern Time. The replay dial number is 800-839-5490 and no conference ID is required for access. [Operator Instructions] It is now my pleasure to turn the call over to Ben Malcolmson. Please go ahead.

Thank you, Chelsea, and welcome, everyone, to Trinity Capital's Earnings Conference Call for the Second Quarter of 2023. Trinity's second quarter financial results were released earlier this morning and can be accessed from Trinity's Investor Relations website at ir.trinitycap.com. A replay of the call will be available on Trinity's website or by using the telephone number provided in today's earnings release. Before we begin, I would like to remind everyone that certain statements that are not based on historical facts made during this call, including any statements relating to financial guidance, may be deemed forward-looking statements under federal securities laws. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by those forward-looking statements. We encourage you to refer to our most recent SEC filings for information on some of these risk factors. Trinity Capital assumes no obligation or responsibility to update any forward-looking statements. Please note that the information reported on this call speaks only as of today, August 2, 2023. Therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Now please allow me to introduce Trinity Capital's Chairman and CEO, Steve Brown.

Thank you, Ben, and thank you to everyone joining us today. We finished the first half of the year with a strong operating performance and we are pleased with the results achieved in the second quarter with the most notable highlights, including growth in our net asset value, a 41% year-over-year improvement in net investment income and the increase in our regular dividend for the tenth consecutive quarter. Digging a bit further into our highlights in Q2, NAV increased by $0.08 to $13.15 per share. Due in part to the stability of our portfolio, out earning our distributions and accretive stock issuances under our ATM program. We believe our consistent track record of delivering solid returns combined with a portfolio that is proving resilient even in a disrupted market is leading to a stable NAV. Second quarter net investment income was $22.1 million or NII per share of $0.61, providing a 127% coverage on our regular dividend. Last month, we increased our quarterly regular dividend to $0.48 per share, furthering Trinity's consistent track record of increasing our dividend since our IPO. We also announced a supplemental dividend of $0.05 per share to comply with tax regulations. We will further evaluate our tax position in Q3 and determine if additional supplemental dividends are required. We continue to outearn our regular dividend and in addition to the undistributed income from 2022, we are always looking for new ways to strategically invest in our platform to provide greater returns for our shareholders. We look forward to providing more updates on this front in the quarters to come. Our focus continues to be on execution as we build a business that serves our customers with uncommon care and delivers accretive value to our shareholders. I'll now turn the call over to our President and Chief Investment Officer, Kyle Brown, who will dive deeper into Trinity's competitive positioning, reviewing our growing platform and provide a portfolio update. Kyle?

Great. Thanks, Steve. Looking at the macro environment, the VC industry is finding solid footing as the disruption caused by the recent banking crisis continues to be absorbed by the financial community. Venture capital dry powder in the U.S. remains at record levels with experts estimating there's more than $0.5 trillion of capital ready to be deployed. In the second quarter, total VC industry investments were $40 billion, which is higher than pre-2021 investment levels. We're seeing the companies with the right team, technology and market continue to receive financing, albeit many at lower valuations. Even though we prefer that our portfolio of companies receive higher valuations, equity support at any valuation is an overall positive for Trinity and its portfolio. As a proof point, year-to-date, 30 of our portfolio companies have received more than $1.4 billion of new equity fundings. Net financing such as Trinity's provides a crucial solution to the current market for venture-backed companies that want to continue to fund growth without major dilution. The evolving competitive landscape has been a real favorable for Trinity, with volatility in the banking industry creating outsized opportunities for nonbank solutions like us. We're seeing more opportunities at the top of the pipeline, but a smaller percentage of deals are being approved as we remain vigilant in adhering to our proven underwriting process. We are committed to continuing to execute the rigorous diligence process that is foundational to our business model. We've had a very exciting first half of the year. And as part of our growth strategy, we announced several important updates in the second quarter, including many new items surrounding our life science vertical. We believe that the life science industry holds immense potential for growth as we continue to make investments to capitalize on the opportunities we see in this sector. In early 2022, Trinity brought on Rob Lake, a seasoned professional with more than 2 decades of experience as Senior Managing Director to spearhead our growth efforts in the Life Science sector. Since then, the proportion of our assets under management dedicated life science investments has continued to grow, with a portfolio now totaling over $100 million. This quarter, we added to the team with the appointment of Igor Dacruz as Managing Director, who brings more than 12 years of experience in the industry. We also announced a new office location in San Diego designed to support the company's ongoing expansion in the sector, a city known for its disruptive research and innovation, the strategic hub now places Trinity at the heart of major life science hub. Additionally, we're expanding our tech lending platform's presence on the East Coast with the addition of Andrew Ghannam as Managing Director based in Manhattan. Andrew brings more than a decade of experience lending to venture-backed technology companies with $31 billion of Venture Capital investment last year. New York is a key market for Trinity for a go-forward basis. We're building a unique internally managed BDC platform and executing initiatives that support our ability to grow and deploy capital both on and off balance sheet. In the second quarter, we continued to realize the benefits of our direct lending joint venture and expanded our lending capacity with the addition of the credit facility with KeyBank. This off-balance sheet growth provides incremental returns that flow to our shareholders. During the second quarter, we added $0.02 per share to our net investment income from our joint venture fees, and that's just the beginning. We intend to significantly ramp up our off-balance sheet activity and deployment and assets under management. Trinity's newly formed RIA has also engaged with several potential investment partners, and we expect to have more to announce on that strategy over the next several quarters. Gross fundings in Q2 were approximately $155 million. The proceeds received from repayments and the company's debt investments during Q2 totaled approximately $104 million. The composition of our portfolio remains consistent with prior quarters and shows diversification across 19 different industries. We have intentionally constructed a portfolio with varied industry segmentation with our largest industry exposure, representing only 12% of the portfolio at cost. Additionally, our pipeline is robust. We finished the quarter with $345 million of unfunded commitments, all of which are subject to milestones, ongoing diligence and approval by our investment committee. In addition, we had signed term sheets in the quarter of $157 million at the end of Q2. As we look to the second half of the year, we believe companies will continue to seek alternative lending solutions. We intend to be the go-to solution and lender for growth-stage companies providing all financing solutions with the exception of the inexpensive receivable financing that they can get from banks. Our team has built an attractive platform to support the needs of growth stage companies and the unique partnerships we maintain with current and prospective portfolio companies is unmatched. We are well positioned to continue to profitably grow this business. As we increase our off-balance sheet activity, we will see new ways to improve returns for our shareholders. As an internally managed BDC, we are focused on return on equity and delivering a steady dividend to our shareholders. We've been really consistent with that messaging from day 1. Our efforts on and off balance sheet are to generate outsized ROE for our shareholders. Trinity will continue to seek opportunities to further diversify our capital base with access to both public and private markets as we drive value for our shareholders. Our CFO, David Lund, will now discuss our operating performance in more detail. David?

Thank you, Kyle, and welcome to everyone joining us today. As you saw in our earnings release issued this morning, in the first half of the year, we maintained a flexible balance sheet and generated strong operational performance. In Q2, we recorded total investment income of $46 million, a 37.6% increase over the same period in 2022. This increase was attributable to interest earned on the higher average loan balances in our debt investment portfolio, the benefit of increases in the prime rate since Q2 of '22 and OID acceleration. Our effective yield on the portfolio for Q2 was 16.2% compared to 15% in the first quarter. Our core yield, which excludes nonrecurring fee income increased to 14.8% from 14.3% in the prior quarter. This yield growth has contributed to our solid NII performance in the quarter. Our debt portfolio remains well positioned against the recent interest rate hikes with 72% of our debt investments at floating rates. While on the borrowing side, 35% of our outstanding debt at the end of the second quarter was at a variable silver rate, contributing to a solid net interest margin or NIM of 12.1% for the quarter. Total operating expenses, including interest expense, were $22.9 million in the second quarter compared to $17.7 million in the comparable period in the prior year. The increase was primarily related to higher interest expense on higher debt outstanding and a higher weighted average cost of debt. Net investment income for the second quarter was $22.1 million or $0.61 per basic share, an increase of 41% compared to $15.7 million or $0.51 per basic share in the same period of the prior year. We recorded unrealized appreciation of $24.4 million and realized losses of $26.6 million. This investment activity was primarily related to the flip of [indiscernible] that was written down in prior quarters and became a realized loss in the current quarter. Our operating activities generated strong returns for our shareholders with ROAE based on NII over average equity of 18.4% and ROAA based on NII over average total assets of 7.6%. Lastly, as of June 30, 2023, a NAV increased 2.6% to $482 million and NAV per share increased to $13.15 compared to $13.07 in Q1. Increase in NAV per share was primarily the result of net investment income that exceeded the company's declared dividend and accretive ATM activity. I will now hand the call over to Mike Testa, our Chief Accounting Officer, who will discuss our credit performance, liquidity and capital allocation.

Thanks, Dave. The credit quality of our portfolio remains strong and stable with approximately 98% of our portfolio performing at fair value. Our average internal credit rating for the second quarter stood at 2.8% based on our 1 to 5 rating system with 5 indicating very strong performance. This rating is in line with our average credit rating of 2.8% in Q1. When you look at historical loss rates, Trinity has been consistent over its 15-year history. And when factoring realized gains from warrant and equity positions, loss rates are a net positive. We take a proactive approach to managing our portfolio to mitigate risk. Trinity's dedicated portfolio management team monitors our investments on a day-to-day basis, regularly communicates with all our portfolio companies and participate in our core evaluation process. We currently have 3 portfolio companies on nonaccrual, a decrease from prior quarter. The total fair value of these investments were approximately $22.5 million, representing just 2% of the total debt portfolio. Moving to liquidity. As of June 30, 2023, we had total liquidity of approximately $130 million, comprised of approximately $118 million of undrawn capacity under our credit facility and $12 million in unrestricted cash and cash equivalents. Additionally, we continue to co-invest with our joint venture, which provides additional investment liquidity and as of Q2 had $100 million of assets under management. During the quarter, we expanded our liquidity through the JV with execution of a $75 million credit facility with KeyBank, bringing the total investment capacity through the joint venture to $226 million. Our net leverage ratio, which represents principal debt outstanding less cash on hand, increased slightly to 1.35x this quarter as a result of net portfolio growth. Subsequent to June 30, Trinity received early loan repayments of $69 million, thereby reducing our debt-to-equity ratio significantly. As of June 30, 2023, total debt principal outstanding was $664.5 million and had a weighted average cost of debt of 7.2%, up slightly from the first quarter due to higher base rates on our credit facility. With the majority of our investment portfolio and floating rate investments in the majority of our corporate debt at fixed rates, we are well positioned in a rising rate environment. We also utilized our ATM offering program during the quarter, raising approximately $10 million in gross proceeds, further supporting the long-term growth of Trinity. We are focused on our capital structure and balance sheet, especially with the successful execution of the joint venture and potential investment partner discussions on the ROAA. These vehicles provide accretive earnings to our -- to the BDC, while providing additional liquidity to the platform. And with that, I'll now open the line up for questions. Operator?

[Operator Instructions] Our first question will come from Finian O'Shea with Wells Fargo Securities.

A question on Life Sciences. Is there experience at the CIO level? And if not, how does the investment committee sort of organize around those opportunities brought by the LifeSci deal teams?

Finian, we are starting that business and have kicked off the majority of that portfolio is really focused on commercialized products and execution risk, which is what we're very familiar with. So first and foremost, the portfolios, it's not going to be filled with a lot of biotech deals. A lot of FDA approved and we're really kind of focused on a company that's ramping up production and sales. So that's the first thing. And then Gerry, you can pick up there.

Yes. I mean, Kyle referenced it in his prepared remarks. Rob Lake, who is running that vertical market for us as 20-plus years of experience with different organizations, sourcing and underwriting and managing these types of companies. We're obviously going to be expanding our credit team there as we grow that team. But as Kyle said, we're starting out with that same sort of execution risk that we historically take with our tech lending practice.

That's helpful. And just a follow-up on the joint venture. It looks like the partner took on something close to its 40% allocation this quarter on origination. Does that mean a quarter like this, would it be unprofitable for the BDC after you account for your G&A compensation and so forth.

Yes. Fin, this is Mike. I just want to point out. What we do have? You'll see some actually benefit in the quarter where there's a quite a bit more JV sales given how the fee structure is set up at the joint venture with a lot of that 100 basis points of [indiscernible]. So you'll see that come through and you saw in this quarter in the results about $700,000 of fee income from the joint venture, which helps to offset that portfolio's -- the sales to the JV and the income from those positions.

It's all incremental, though. I think it's...

Yes. I mean it's all incremental to the BDC. The other thing I would say, Fin, is the sale to a JV is going to lag our funding by about 45 days in general. And so looking at the cohort of what we add to the portfolio at the BDC level in any given quarter and looking with the JV adds, it's time shifted by about half a quarter. So just something to be cognizant of as you're modeling.

Our next question will come from Bryce Rowe with B. Riley.

I wanted to ask about just growth of the platform and any commentary you can add on taking advantage of hiring opportunities, et cetera, that you've seen from fall out in Silicon Valley? I mean it looked like you had the employee count or at least the professional account goes from 55 to 61 quarter-over-quarter. And so again, is that tied to what you've seen here in the first half of the year? Or was that planned?

So we've been really opportunistic with a lot of volatility in the banking space. We have decades of experience working with seasoned veterans, and we took a bit of a sniper approach to -- and for talent, and we're really excited to talk about some of the people that we've added to the team who are bringing their network and incredible knowledge and value. And we expect you'll see some more announcements in the future about that as well.

Okay. That's helpful. And then maybe a related question. Just around appetite for equity raises, especially considering the stock being up as much as it is year-to-date, and now with a nice premium over NAV and obvious opportunities to build out the platform. Just kind of curious what your appetite might be above and beyond using the ATM from an equity perspective?

So we are really focused on building the platform, both on and off balance sheet to the extent that it's accretive and good for investors. We've proven that from day 1 when we raise equity, we put to work and we out our -- and we just -- we're going to continue doing that. And so what the off-balance sheet business does, both on the JV and the RIA, it really gives us the ability to grow and make sure that any time we do grow, it's accretive and good for investors. So we're going to be opportunistic. And we're excited to see some of the positive momentum. But again, we're -- as an internally managed BDC, we're just really hyper focused on ROE.

Our next question will come from Christopher Nolan with Ladenburg Thalmann.

Three quick questions. Any change in terms of your leverage limit or threshold, which sort of follows on Bryce's question, given your leverage levels are sort of high?

Chris, it's Mike. Yes, as I mentioned in my prepared remarks, we were slightly above the top end of the range. But when you take into account the cash on hand, we're right there. And as I mentioned also, we have some significant payoffs that pushed from June to July. So that does help. And at the point in time, yes, we are at the high end of the range. But yes, I think with the JV having that liquidity, those sales also will help. And again, another quarter of low repayments and portfolio growth that's driving that number.

We're honed in on making sure that NII is up and the right dividend is up into the right, and our off-balance sheet activity there helps us really manage that debt to equity.

Great. And I didn't see was the increase in compensation related to the amortization of restricted stock grants.

That's right. Yes. This was a full quarter of that.

Final question, big picture. In today's Wall Street Journal, there's an article talking about private equity and hedge funds braced for coming SEC overhaul. Does that touch the BDC sector at all?

I don't know the article that you're referencing. So I couldn't speak to it. But we -- big picture, we are seeing a lot of opportunities for growth, nonbank solutions, banks lending less and looking to alternative solutions, and we intend to be that solution.

Our next question will come from Casey Alexander with Compass Point.

There seems to be kind of a mix shift in the portfolio from with a higher percentage of secured loans and a lower percentage of equipment finance making up the portfolio. So I'm just wondering, as rates have risen, have those who are seeking to finance equipment found more competitive solutions and maybe the mandates that you're seeing for equipment finance have declined some simply because they're a fully collateralized loan solution and perhaps there's more competition in that sleeve?

So 21% of the portfolio is equipment. That's consistent year-over-year. Deployment-wise, that might just be a lag in some fundings. But I think we're actually going to stay really consistent with the idea that equipment is somewhere around 1/4 of our deployment and we'll continue to be -- and we have the ability to grow that business. The other part of that question?

Yes. I think, Casey, as we add the life sciences business, right? It's becoming more relevant at over $100 million. And so those are going to be loans. And so if you look at the historical mix of equipment versus term loans, it used to be equipment financing and tech lending. Now it's equipment financing, tech lending and life sciences lending, right? So I do think if you look across historical numbers, you might see what looks like a shift in less equipment. But I think it's just more opportunity in new areas where we were growing.

Hence, there being a shift.

There's a difference between a shift between existing business units and a change in denominator due to adding business units. So I disagree with that.

Yes. All right. The -- any further color on the payoffs that shifted from June to July? And can you help us with how much we might be seeing in terms of payoffs in the third quarter? Because the last 2 quarters obviously have been some of the lowest that you've ever had in history.

Yes, for sure. The last 3, as a matter of fact, I think going back to Q4 of '22. So as Mike mentioned, we got $69 million in early repayments in July that was 3 credits. And I don't know that I would read a broader trend into that in terms of more of that within the quarter. In general, we are seeing a bit more activity in the marketplace. So I think clearly, even with that July result, we're coming off those historical ways. But I wouldn't declare it open season yet. It was just idiosyncratic that we got those 3 within July.

Last question, unless I missed it. Any reason that you didn't give the details of the ATM program in the quarter in the press release?

No, there should have been $10 million of gross proceeds that we see from ATM. So we did tap that on pace this quarter.

Yes. Okay. Just it would be helpful if you threw that into future quarters.

Our next question will come from Ryan Lynch with KBW.

First question I had, the roughly $700,000 in fee income from the JV. You have a rough breakdown of what percentage of that was structuring fees versus loan servicing fees? And I'm just also trying to get a sense of if this JV kind of ramps to roughly the max capacity over whatever time frame that takes, what sort of level of fee income do you think the JV can generate once fully ramped?

Yes. I mean I think this benefit -- you saw the benefit this quarter mostly in origination fee, I think of $600 000 of that $700,000. And as this stage, as it's ramping, you see more sales, that will probably continue for the next couple of quarters until it's fully deployed. And then you'll see more on the AUM and management base, administrative base fee component and then you'll see, again, start to see our dividends. But as well, we have our debt investment that is -- has the current coupon associated with it and is also pulling in income from the JV [indiscernible].

Do you have a sense of the $700,000? Obviously, there's going to be a period where you'll keep ramping up. So structuring fees will be high over that period of time. And then like you said, it will sort of shift where then once this starts to get fully ramped on structuring fees will go down, but the loan servicing fees will go up. Is this sort of a good run rate then for the foreseeable future, the $700,000? Or do you expect it to expand to any higher levels?

Yes, I think in the next 2 quarters, that's probably around that level, but we do expect those to increase over time.

And then the other question I had was just surrounding kind of your existing portfolio companies receiving funding. And this is maybe a broader question. But obviously, out there, the term AI has sort of captured a lot of mind share from certainly the media as well as, I think, VCs. Has there, to any extent, been sort of shift away from VCs? Any sort of pullback in funding companies out there that don't have a specific AI bent to them, which would -- could hurt really well companies out there who maybe aren't directly in that AI field from receiving additional funding given that we all know capital raising is down, investments are down, exits are down in the VC space. So capital is already a little limited. And I'm just wondering if you're having kind of an outsized funding towards AI-related investments, does that pull away from existing investments in other businesses?

Ryan, this is Ron Kundich Chief Credit Officer. I'll take that question. The quick answer is no. We're still seeing a very diversified mix of companies entering the top of our pipeline. AI is obviously a category of interest as you alluded to, whether it's in the press or in reality, we are seeing more AI, broadly speaking, companies hit the portfolio -- I'm sorry, hit the pipeline, but that is not taking away from the other industries and industry segments that have been within our pipeline for the last several years.

[Operator Instructions] Our next question will come from Kyle Joseph with Jefferies.

Just want to get a sense for, obviously, good yield expansion on the portfolio. Is that primarily 100% base rate? Or what are you seeing in terms of spreads in your market?

We are and have continued to push this, Kyle. We've continued to push pricing, and we continue to see it increase. And so some of that is rates going up and then some of it is demand for our products. And I'd say less liquidity out there from a supply perspective. And so we're pushing pricing. We're still pushing pricing. And you've seen that gradually increase over the last 1.5 years, right?

Got it. And then with the IPO market showing signs of life, you highlighted kind of near-term repayment activity, but kind of give us a kind of intermediate longer-term outlook? Do you expect repayments to go towards historical levels and how the rates that impact that as well?

So historically, the majority of our exits are coming through refinances, amortization, M&A type activity. And then IPOs are certainly just -- it's a positive thing. So to the extent there are more IPOs, that is only a good thing for us in some of our more mature companies, right, and giving them another liquidity option. So there's nothing on the horizon and nothing we can point to right now. Certainly, some candidates. Hopefully, that's a great option for some of them.

Got it. And then one last one for me. Obviously, credit appears stable. I see nonaccruals come down. But just give us a sense for kind of the revenue growth trends you've been seeing at the portfolio level and how that is compared to recent quarters?

Yes. This is Ron again, Chief Credit Officer. Quarter-over-quarter over the past several quarters, I mean, yes, revenues are -- some companies have been impacted on the revenue growth side, but I'll circle back to our rigorous underwriting we do. Any company we led into the portfolio is on a growth path, is a growing top line story. And we've seen that our portfolio is just the test of time over the last couple of quarters. Our companies are growing. They're raising capital when they need to and we're supporting them along the way.

Yes. I would say there's just less focus on the explosive growth rate than we saw prior to about a year ago, right? Our portfolio companies are making their cash less. They're growing at more modest levels. They're focusing on reaching cash flow positivity versus that grow at all costs.

Yes. And that began Q1, Q2 of 2022, right? So I think our industry in general, was a little bit ahead of the curve because they have to be, right? And so a lot of these adjustments, reduction of burn, we sell that across the portfolio, and we've seen that for the last 6 quarters, right? So they acted quick and they've continued to be a little more prudent.

Next, we have Vilas Abraham with UBS.

Just one for me. Just on the supplemental dividend. It sounds like your hand was forced a little bit here recently with that. And just wondering if we are going to see, say, NII per share kind of consistent with what we saw for Q2, is it fair to expect that the supplemental dividend will keep coming here?

This is Dave. The supplemental dividend had more to do with the '22 spillover than it does with the current operations. So I mean we're continuing to grow our dividend, have done so over the last 10 quarters. So we will take a look during the third quarter and determine whether or not we need to do another supplemental dividend simply to pay out the balance of the '22 spill over.

At this time, we have no further questions in the queue. So I would like to turn the call back over to Steve Brown, Chairman and CEO, for closing remarks.

Thank you. We really appreciate everybody's participation today. We appreciate your support and we look forward to reporting on Q3 in the fall. Thank you so much.

Thank you, ladies and gentlemen. This concludes today's call, and we appreciate your participation. You may disconnect at any time.