Trinity Capital Inc. Q1 FY2021 Earnings Call

Good afternoon. My name is Lisa, and I will be your conference operator today. I would like to welcome everyone to the Trinity Capital's First Quarter 2021 Earnings Conference Call. Our hosts for today's call are Steve Brown, Chairman and Chief Executive Officer; David Lund, Chief Financial Officer; and Sarah Stanton, General Counsel. Kyle Brown, President and Chief Investment Officer; Gerry Harder, Chief Credit Officer; and Michael Testa, Chief Accounting Officer are also present. Today's call is being recorded and will be available for replay beginning at 8:00 p.m. Eastern. The replay dial-in number is 404-537-3406, and the PIN is 4999186. It is now my pleasure to turn the call over to Sarah Stanton. Please go ahead.

Thank you, Lisa, and welcome, everyone, to Trinity Capital's earnings conference call for the first quarter of 2021. Trinity's first quarter 2021 financial results were released just after today's market close and can be accessed from Trinity's Investor Relations website at ir.trincapinvestment.com. We have arranged for a replay of the call at Trinity's web page or by using the telephone number and passcode 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 these 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 information reported on this call speaks only as of today, May 6, 2021. And therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. With that, allow me to introduce Trinity Capital's Chairman and CEO, Steve Brown.

Thank you, Sarah, and thank you to all of those who are joining us today. I hope that you are all healthy and doing well. We're excited to report our earnings for the first time post-IPO, and we're encouraged by both the financial results and the continued progress in different aspects of our business. Trinity continues to build and grow its platform as we serve the emerging growth venture-backed space. Technology and innovation are a top priority for investors in our markets. And as a result, we are seeing expansion in our opportunities, which is the top category we define in our pipeline funnel. Each of our teams from origination to credit to portfolio management to finance are adding talent and improving systems and processes as we scale our business in line with Trinity's plans. The people we have on our team and the relationship-based culture that we prioritize are our most valuable assets. Trinity's goal has always been to differentiate in our space, and our commitment to technology and operational expertise and providing a differentiated product offering is serving us well. Although we've been a public reporting company since January of 2020, this was our first quarter as a publicly listed company on NASDAQ, and we're proud of our Q1 results, which included the closing of our IPO in early February, where we raised over $100 million in equity, and we issued just over 8 million new shares. Investor market support for the emerging growth venture debt niche that we serve in the BDC space appears to be growing, and we believe the timing is just right for Trinity to scale and grow its platform. The following are a few examples and highlights of our accomplishments in the first quarter. We declared a dividend of $0.28 per share, an increase over our prior quarter and in line with our goal of increasing our dividend as we grow our platform. We originated $124 million in new commitments, and we funded $87 million in gross deployments across 19 portfolio companies. Q1 net investment income was $7.3 million or $0.31 per share. This compares to net investment income of $5.3 million or $0.29 per share in Q4 of 2020. Our NAV per share had a meaningful increase of 5%, and we finished the quarter at a NAV of $13.69 per share compared to $13.03 at the end of 2020. Our credit quality in the portfolio remains strong with over 99% of our debt investments at fair value performing. Total liquidity, including cash and availability under our credit facility, was over $108 million. Our debt-to-equity ratio was approximately 0.61 at the end of the quarter as we paid down our credit facility after receiving the IPO proceeds. We'll be using our availability and our cash as we continue to scale and grow with a target ratio back in the desired range of 1.2 to 1.3x. We also expect to declare a dividend for the second quarter of 2021 at the end of June, subject to Board approval. Kyle and Dave will share more detail about our results during the quarter and the strength of the market in general. Again, we're pleased with the progress of our operating results and in particular how we came out of the gate post IPO. We believe we are now well positioned to grow the business and to gain market share within the emerging growth of venture lending and equipment finance space. I'll now turn the call over to Kyle Brown, our President and Chief Investment Officer, for some further thoughts on our progress and more detail on the market. Kyle?

Thank you, Steve. Good afternoon, everyone. Following a record quarter for originations in Q4, Trinity has maintained strong momentum into Q1. This momentum has been building over time, further enhanced by the expansion of our team. We welcomed 6 new members this quarter, including 4 to the investment diligence team. Currently, we have 40 full-time employees, bringing diverse expertise and industry knowledge. We are committed to understanding the technology and markets we operate in, hiring experts and continuously learning about emerging trends. Our dedication to diversification across different industries and a broad range of referral partners has proven effective as we support a variety of portfolio companies. As sectors like agtech, fintech, foodtech, frontiertech, AI, and robotics attract significant venture capital, our portfolio has diversified similarly. Our opportunity pipeline begins with opportunities assessed by our originations team and reviewed by our credit team using our proprietary credit rating system. These opportunities are key indicators of our ability to meet deployment goals. Over the years, we've collected data that correlates a certain volume of top-funnel opportunities with term sheets issued and accepted, serving as a predictive tool for our target funding each quarter. 2020 marked a record year for opportunities at Trinity, and Q1 has also been a record quarter. This serves as an excellent indicator for future funding as we follow up two strong quarters. Our equipment finance sector is expanding, providing unique differentiation and product, industry, and risk diversification. We are continually seeking ways to meet our customers' financial needs in the emerging growth space, beyond what they can obtain through receivable financing and additional resources from tech banks. All of these efforts support our aim of becoming the go-to choice for venture debt and equipment finance in our markets. This quarter, gross deployments reached $87 million across 19 portfolio companies, which included $44 million to 6 new companies and $43 million to 13 existing ones. These gross deployments were somewhat balanced by $67 million in repayments, with $41 million coming from early debt repayments. We ended the quarter with $8.3 million in unfunded commitments to 2 portfolio companies. The structure of our portfolio has remained mostly stable, with $336 million in secured loans, $128 million in equipment financing, and $72 million in equity and equity-related investments, including warrants. In terms of sector distribution, our top 3 allocations were manufacturing at 27%, retail trade at 16%, and professional scientific and technical services at 13%. Geographically, 49% of our portfolio is in the Western region, while about 27% is allocated to the Northeast. Our portfolio credit quality looks solid, and there are emerging liquidity options in the market, particularly in SPAC activity. Notably, we have 3 portfolio companies engaged in a SPAC transaction, and we expect more to consider this route. SPAC activity has generally been positive for Trinity and our portfolio, providing liquidity options to some of our more mature companies. We are pleased with our start this year and remain optimistic about our portfolio's growth. The venture capital industry we serve keeps expanding. Total Q1 venture capital fundraising reached $32.7 billion, setting a new record. Considering the total fundraising for 2020, which was a standout year at $79.8 billion, 2021 is off to a strong start. Regarding venture capital deployment, $69 billion was deployed in Q1 to venture-backed companies, marking a significant year-over-year increase. The combination of increased investment and a healthy IPO market makes the growth-stage company market increasingly attractive. We are well-positioned to leverage this momentum. We believe our established direct origination network benefits from relationships with institutional equity investors, leading technology banks, and entrepreneurs, and this will continue to yield compounding benefits. I will now hand the call over to David Lund for a more detailed discussion of our financial performance. David?

Thank you, Kyle, and thank you, everyone, for joining us on today's call. As Steve and Kyle mentioned, this quarter has been a very strong start to 2021 with the Trinity team. We are very proud of the successful IPO we closed on February 2, where we raised net proceeds of approximately $104 million and the issuance of approximately 8 million shares of our common stock. In addition, we had solid investment activity and portfolio performance, as I will discuss shortly. I will be focusing my remarks on the following key areas: portfolio growth, operating performance, NAV and return performance, credit performance, and liquidity. With that, I will start with portfolio growth. During the first quarter, we entered into $124 million of new commitments and deployed $87 million across 19 portfolio companies. We funded $61.4 million in secured loans to 8 portfolio companies. We funded $14.7 million in equipment loans to 7 companies, and we received $1 million in warrants in connection with this funding activity. We also invested $10 million in direct equity investments in 4 portfolio companies, including the exercise of our warrant in Atieva. As a result of the new investment activity, we continued our goal of transitioning the portfolio to floating rate loans as we ended the quarter with approximately 32% of our debt portfolio in floating rate securities. During the second quarter, we received $67 million in principal repayments, of which $40 million were from early debt repayments, which indicates the quality of our borrowers and their ability to raise additional equity capital or move to more conventional bank lenders to repay our debt. As a result of the $20 million of net investment activity and approximately $7 million of accretive income and realized gains, our portfolio at cost grew by 5.4% to $525 million. On a fair value basis, our portfolio increased from $494 million to $536 million attributed to the increase in costs I just discussed and the $15.5 million of net unrealized appreciation. The increase in net unrealized appreciation of approximately 3.1% was primarily due to valuation changes in our warrant and equity portfolio. I will now turn to our operating results. On a GAAP basis, we recorded total investment income of $17.3 million, comprised of approximately $16.3 million in interest income and $1 million in fee income. This represents a $2 million increase or a 13% increase over the $15.3 million of total investment income in Q4. The increase was primarily related to the increased weighted average balance of our outstanding debt portfolio and higher income from early loan repayments as compared to the prior quarter. Our effective yield on the portfolio for Q1 was 15.5%, which was increased from 14.5% in the prior quarter, driven by accelerated income from early repayments. We incurred $4.6 million of interest and amortization of deferred financing costs on our various debt facilities as compared to $4.3 million in Q4 of 2020. Interest expense under our credit facility was lower in Q1 as we paid down our Credit Suisse facility by $90 million with the proceeds from our IPO. This was offset by higher interest expense on our $50 million of convertible notes, which were outstanding for the full quarter of Q1. Our weighted average cost of debt, including interest and fee amortization, was 7.2%, which increased from the prior quarter due to the higher borrowing costs on the 6% convertible notes and lower debt balance outstanding under our Credit Suisse facility. We expect the cost of debt to decrease in the future as we borrow under our credit facility to fund future obligations. Compensation expense was $4 million in Q1 compared to $4.5 million in Q4. The decrease compared to Q4 2020 was due to lower variable compensation expense offset by higher salary costs incurred in connection with the addition of 6 personnel to the Trinity team during the first quarter. Professional fees were slightly lower at $647,000 in Q1 compared to $731,000 during Q4. This decrease was due to lower accounting and valuation fees in Q1. G&A expense was $808,000 in Q1 compared to $486,000 in Q4. The increase in G&A expense was primarily driven by higher D&O insurance expense now that we are a public company. We expect G&A expense to increase slightly over Q1 commencing in Q2 as we incur higher rent expense for our new headquarters located in Downtown Phoenix. As a result of the activity noted previously, net investment income for the quarter was $7.3 million or $0.31 per share. This compares to $5.3 million or $0.29 per share in Q4 2020. The NII per share would have been meaningfully higher quarter-over-quarter, except for the impact of the 8 million shares of common stock issued in connection with our IPO. During the quarter, we recognized net realized gains of $2.6 million, primarily related to one portfolio company. We recorded net unrealized appreciation of $15.5 million, primarily driven by appreciation in our equity and warrant portfolios. The increase of $5.6 million in our equity investments was principally driven by an increase of $19.2 million in the fair value of our Atieva investment, offset by $12.6 million of depreciation from mark-to-market adjustments in the balance of the equity portfolio and a flip of unrealized appreciation to realized gain of $1 million. The net appreciation of $8.6 million in our warrant portfolio was primarily driven by a $3.4 million fair value increase in the Matterport warrant. The reversal of $3 million of unrealized appreciation on our Atieva warrant that we exercised in Q1 and $2.2 million of net appreciation from mark-to-market adjustments on the balance of the warrant portfolio. Net assets increased by $123 million to $362 million at the end of Q1, primarily due to the net proceeds from our IPO, net realized gains, and net unrealized appreciation. The NAV per share increased by $0.66 per share to $13.69 from $13.03 at the end of Q4, primarily due to the net realized gains and net unrealized appreciation recognized during the quarter. Our credit quality remains strong with over 99% of our portfolio performing. The 3 loans that we had on nonaccrual are the same 3 loans we inherited from the acquired portfolio at the beginning of 2020. So we have had no new nonaccruals. Those 3 loans carry a cost basis of $2.3 million and a fair value of $1.4 million. Turning now to liquidity. Available liquidity as of March 31, 2021, was approximately $108 million, including approximately $36 million in unrestricted cash and cash equivalents and borrowing capacity of $72 million under our credit facility, subject to existing terms and conditions. End-of-period leverage was 61% and our asset coverage ratio was 264%. Lastly, on March 24, 2021, we declared a cash dividend of $0.28 per share for the first quarter of 2021 that was paid on April 16 and which generated 111% coverage by our GAAP NII earnings for the quarter. We anticipate declaring a dividend for the second quarter of 2021 during June, subject to approval by our Board of Directors. With that, I will now open the call for questions. Operator?

Your first question comes from the line of Ryan Lynch with KBW.

First one just has to do with your view of the venture lending market today. Obviously, there's been a lot of capital raised and is flowing into that space from the equity side. I would think that that would help you guys from an exit standpoint as well as to support your current company as they look to raise additional rounds. But I would also think that would be a competitor, the venture equity, compared to as an alternative product to venture lending. So can you talk about what you're seeing from an outlook standpoint, from a competitive standpoint and from a capital deployment standpoint in the venture lending space?

Yes. Ryan, this is Steve. Thanks for the question. No question that a robust market from an equity perspective creates competition. And we've said this before, I'll always say it, our biggest competition is equity, and I think it always will be because we're a solution to help create savings and dilution. But net-net, we think that more equity in the market is good for the venture debt space. And I believe that we don't really see right now a meaningful impact. As Kyle reported, our opportunities are up significantly, all of last year and then another record quarter. And so what you want when you have that kind of capital in the market is to see more opportunities and take advantage of those. So I think net-net, we're seeing that as a positive, but there will always be competition. Kyle, any thoughts on that?

The other thing I'd say is, yes, there's more competition from an equity standpoint, maybe on the debt side as well. Internally, we track term sheet issued, the term sheet accepted ratios and acceptance rates, and we've not seen significant changes quarter-over-quarter over the last few quarters. So there may be more competition, but we're still winning deals at the same rate we're accustomed to.

That's great.

Okay. With that competitive environment in mind, how does it impact your term loan product in the market? Does the increase in venture capital funding present a competitive challenge for your equipment financing, or is that a different area where you operate and compete?

Yes. I don't think it's much different. I mean obviously, most of our equipment financing deals are involved with companies that do have venture investors. So I think it would be similar in the way that we view that. Again, we are seeing a continued sort of uptick in the equipment finance business and the opportunities that we're bringing, and we're excited about growing that piece of the business. It's still a disorganized sort of market in our space. And so we're encouraged by what we're seeing there but don't know that necessarily there's going to be more competition or competition that's going to hurt us relative to our equipment finance business.

Okay. And then you mentioned you guys are looking to continue to scale the platform. I think you said you guys had 40 people. You hired 6 people in the first quarter. Can you talk about the areas that you guys are focusing on for growing your organization's from this point forward?

Yes, we have budgeted for an additional four hires this year, making a total of ten. This expansion is across various areas. As you know, we aim to increase originations, so you can expect to see growth in that aspect. We're not specifically targeting certain markets; instead, we follow where venture capitalists are investing. David, what were you saying?

I was saying 4 of the people that were hired in the first quarter are originations. So clearly, we're looking to build out that team as well as the back-office portfolio team as well.

Yes. On the origination side, two were specifically in originations and two were part of the due diligence support. We have a strong collaborative effort and consider all of these individuals as part of our origination team, so we will continue to expand that segment of the business.

Next question comes from the line of Christopher Nolan with Ladenburg Thalmann.

Most of your loans are fixed rate. Is that a competitive advantage when you are competing for deals in the market?

The fixed rate aspect of our portfolio originates from the period before our IPO when we had fixed SBA debt, which we aligned with that portfolio. Currently, we are transitioning to a more floating rate structure on the loan side. Our leases remain mostly fixed, consisting of a single payment throughout the deal's duration. We're approximately at 32% in this area and are committed to increasing that percentage. The positive aspect is that when we set parameters, we will establish floors based on our initial expectations, leading to significant potential for upside with limited downside as we shift the portfolio from fixed to floating rates on the loan side.

And where does your equipment financing loans sit in seniority relative to other debt? Is it first lien on that equipment?

Yes. Good question. So always first lien on the equipment itself. And the equipment value and security can range deal to deal, but we always get first position on the equipment. And then occasionally, sometimes we'll get a blanket lien as well. So sometimes we'll back that up with a blanket lien or a second blanket lien. Sometimes it's related specifically to the equipment. Gerry and his team, the credit team, do a great job of helping us underwrite the value of that equipment. We'll always take that into account as we're looking at the overall credit and whether or not we should add to the security of our loan relative to an additional lien.

Great. And then are you reiterating your target leverage ratio is 1.25?

Yes. We'll walk back up to that. We're at 0.61 at the end of the quarter. And as we grow the portfolio and put additional funds out, we would target to be back about 1.2 to 1.3.

Great. And final question. David, can you share with us what the repayments are second quarter to date at all?

Second quarter to date, I don't think we've had any early repayments at this point. We did have one.

We did.

Go ahead.

Yes. We had one early repayment within the first week of the quarter.

Yes.

Yes. That makes you unusual in the venture debt area.

Yes.

Yes.

Your next question comes from the line of Sarkis Sherbetchyan with B. Riley Securities.

On the last call, you mentioned achieving $280 million of investment originations in '21 and clearly delivered about $90 million or so in originations here in the first quarter alone. So any updates to this metric? Do you think you'd get a little bit more aggressive or kind of pull back on the cadence of deployments here?

I think we're going to keep doing what we're doing, Sarkis. As we mentioned, we won't be providing specific guidance on the numbers of loans currently on the market. However, Kyle pointed out that a great indicator for funding deals is the number of opportunities we have. We have statistical data on how many opportunities it takes to issue term sheets and then to accept them. We continue to see good performance in this area from last year and into the first quarter. This is a positive sign for our direction. Our goal is to grow, which we started in the first quarter, and we plan to continue that.

And any kind of updates on where the pipeline sits today?

So as I mentioned, Q1 was a record for opportunities, and that trend has continued into Q2. So I would say so far, so good.

Yes. What was the number of opportunities in Q1?

I'd have to get back to you on that.

Okay. And then one final one for me. Just looking at the watch category and the credit matrix you've displayed, it jumped sequentially. Just wanted to see if there's any more color on that. Is there one credit that's sticking out? Or is it just kind of some movement there?

Yes. I'll hand it over to Gerry. Just as a reminder, we monitor the watch category for various reasons, not necessarily negative, and these different reasons prompt us to include them in that category. When they are classified as watch, they are performing. Gerry, would you like to add anything to that?

Sure. Happy to. So we do have 4 credits in the watch category at this quarter. In all 4 cases, these portfolio companies are pursuing equity financing to continue their growth and continue their operations. We've got supportive equity sponsors in all cases and enterprise values and term sheets in excess of Trinity's debt position. So generally speaking, in our watch list, this is often companies that are raising capital, and we're looking at those closely on the portfolio management side. And that's what we're seeing at the end of Q1.

Your next question comes from the line of Finian O'Shea with Wells Fargo Securities.

Just a market question. Would you say that the increased factor of all the VC inflows, presumably to larger firms and larger funds, tilts the demand for venture debt toward the venture banks? Given these firms have much deeper pockets of capital and are able to finance larger companies with a better credit profile, would you say this shifts things away from private venture debt?

Yes, that's a great question. Generally, the banks involved, particularly in their term debt products and receivable products, take on different risks compared to us. We like to think that we don't compete directly with them when we offer additional capital on top of what they provide. We don't see ourselves as direct competitors, as their risk profile differs from ours. That said, in more liquid and robust markets, banks may adjust their credit strategies and become more active in certain markets than in others. However, we typically do not compete with banks offering capital at rates of 4%, 5%, or 6% that come with risks, including covenants and other stipulations tied to their debt facilities, which we may not have. Therefore, there is a clear justification for them to pay a higher price for the more flexible capital we provide compared to the typical offerings from banks. Kyle, do you have any thoughts on this?

No, you hit it.

Yes.

Okay. Very well. I have a market origination question. This quarter, we’ve seen quip moving around in the venture growth area. It seems you have arranged a roughly five-year term loan. Is that typical for the growth stage ventures, or does this indicate a longer-term loan for a private company? Could you elaborate on that? I know it's an individual case, but in general, is this a new area of opportunity?

Yes. No, I would say that that particular financing continues to fall within the realm of what Trinity has historically done and will continue to do. So this is a company that is an omni-channel marketer, and they're expanding their business. So that's the growth that we're finding.

Your next question comes from the line of Brock Vandervliet, UBS. Steven Brown, Chairman and CEO, responded by saying that the particular financing falls within what Trinity has historically done and will continue to do. He noted that the company is an omni-channel marketer and is expanding its business, indicating the growth they are identifying.

Just on Slide 16, in terms of the yield profile, it's interesting. Looking at that pickup, just sequentially about 100 basis points. Is there any sort of mix shift? What's causing that step-up in yield?

Yes. The step-up in the yield really is some of the additional fees that we've been getting upfront. And what will also drive some of that yield is when we do lease financings and we'll have a higher upfront fee to that. So it's pushing up the yield on the core basis. And then obviously, as I mentioned, the early payoffs will also drive yield.

Got it. Okay. That's rolling in through there. Shifting over to funding, I know you paid down the Credit Suisse line at 3.25%. What’s the long-term plan? Will you just continue to draw that down? Can you refinance at better terms than LIBOR plus 3.25%? What does that look like to you?

That facility is out through January of next year, so we'll stay with that facility right now. We'll certainly be in discussions with regards to replacing or enhancing that one. But obviously, we'll be using a facility such as this because there's a lower cost of capital to it and then potentially using the securitizations and so on and rolling some of the assets into it to drive an overall long-term lower cost of debt than some of the facilities we've entered into recently.

Got it. And lastly, I know you have the target leverage level of 1.25. That's quite a bit higher than where you are now. Your earnings profile is just fine at this level of leverage. Just realistically, intermediate term, should we look for you to move to that level or kind of stay down here given your earnings profile seems pretty good?

We are focusing on driving growth in the portfolio, which means we will be looking to make originations and utilizing that facility. As the year progresses and we continue to invest additional funds, I expect we will draw on that facility to reach the 1.2 to 1.3 level.

Your next question comes from the line of Casey Alexander with Compass Point.

Can you explain why you went ahead and exercised the warrants on Atieva even though the SPAC deal hasn't closed? Was that to preserve some sort of rights that you have with the stock as opposed to the warrants? And secondly, can you kind of walk me through the fair value changes of Atieva for the quarter? And lastly, I assume that your position in Atieva has some type of illiquidity discount. I'm curious as to what that discount might be.

Yes, we did exercise our warrants to take advantage of a pro rata opportunity to purchase additional shares at a valuation we considered appropriate before the SPAC deal. We believe this was the right decision, and as a result, we now hold shares instead of warrants. Additionally, we have adjusted the asset's value based on a valuation process that we believe is accurate at this stage. Gerry collaborates closely with our third-party valuation expert, and perhaps he can explain what that specialist examined.

Sure, happy to. Steve mentioned that we utilized a third-party valuation provider for this asset during the March quarter and collaborated closely with our auditors. We have to base this valuation on what is known and knowable at the end of the quarter. There are still some aspects of the transaction that were facts but not evidenced in Q1. The valuation from the specialist considered at least three factors, including the closing price of Churchill on March 31, the price of the PIPE, and the potential for the merger to fail. All of these factors and scenarios were considered, along with a discount for the lack of marketability concerning the Churchill closing price. It was a thorough analysis, and we feel confident about the asset’s valuation. We believe we have identified the fair value.

Okay. Well, the Q isn't out. So can you tell me how much the change in fair value was quarter-over-quarter?

Yes. Our unrealized gain on our position was $19 million in the quarter.

At this time, there are no further questions.

All right. Thank you. Again, we appreciate your support at Trinity. We look forward to working hard on your behalf and reporting to you at the end of the next quarter. Thank you.

This concludes today's conference. You may now disconnect.