Great Elm Capital Corp (GECC) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Corp. Third Quarter 2017 Financial Results Conference Call. (Operator Instructions) I would now like to introduce your host for this conference call, Ms. Meaghan Mahoney. You may begin, ma'am.

Thank you, Kevin, and good morning, everyone. Thank you all for joining us for Great Elm Capital Corp's Third Quarter 2017 Earnings Conference Call. As a reminder, this webcast is being recorded on Tuesday, November 7, 2017. If you would like to be added to our distribution list, you can either e-mail investorrelations@greatelmcap.com or you can sign up for alerts directly on our website. The slide presentation accompanying this morning's conference call and webcast can be found on Great Elm Capital Corp's website under Financial Information Quarterly Results at www.greatelmcc.com as can a copy of our earnings release and Form 10-Q. A link to the webcast is also available on the Great Elm Capital Corp website. I'd like to call your attention to the customary safe harbor statement regarding forward-looking information. Also, please note that nothing in today's call constitutes an offer to sell or solicitation of offers to purchase our securities. Today's conference call includes forward-looking statements and projections and we ask that you refer to Great Elm Capital Corp's filings with the SEC for important factors that could cause actual results to differ materially from these projections.

Great Elm Capital Corp does not undertake to update its forward-looking statements unless required by law. To obtain copies of the SEC filings, please visit Great Elm Capital Corp's website under Financial Information SEC Filings or by visiting the SEC's website. Hosting the call this morning is Peter Reed, Great Elm Capital Corp's President and Chief Executive Officer. I'll now turn the call over to Peter.

Thank you, Meaghan. Good morning, and thank you, everyone, for joining us today. I'm joined this morning by our investment committee comprised of me; John Ehlinger, Adam Yates and Adam Kleinman as well as Michael Sell, our Chief Financial Officer; and Meaghan Mahoney, our Head of Investor Relations.

During our last 2 quarterly calls, we started with an update on the realized investments from the prior quarter to provide tangible examples of our special situations investment approach. As noted in our press release, this quarter was characterized by more capital deployment than monetization activity. As such, we have no full realizations to discuss during this quarterly call.

Let's start our call with a review of the quarterly financials, followed by portfolio highlights and investment activity. And then we will provide an update on our capital structure activity. We will then conclude the call with Q&A.

Where relevant in our prepared remarks, we will point you to the corresponding slide number in the deck that Meaghan referenced, which is available on our website as well as through the webcast. I will turn the call over to Mike Sell, our Chief Financial Officer, to discuss the financial results from Q3.

Thanks, Peter. Please turn to Slide 5 for a snapshot of the financial and portfolio highlights from the quarter. As of September 30, our net asset value was $132.8 million versus net assets of $153.7 million at the end of Q2. On a per share basis, this equates to $12.38 NAV versus $13.29 NAV at the end of Q2. This decrease in NAV per share was driven primarily by unrealized mark-to-market depreciation in our investment portfolio. As of the end of the third quarter, the fair value of our investments was $153.1 million versus $131.6 million at the end of Q2 and we had $60.3 million in cash and cash equivalents, predominantly held in money market funds.

Now please turn to Slide 6 to walk through the quarterly financial review. Total investment income for the quarter ended September 30 was $6.5 million against net expenses of $2.9 million, resulting in net investment income of $3.6 million or $0.32 per share. This compares to total investment income of $6.2 million for Q2 against net expenses of $2.8 million, which resulted in net investment income of $3.5 million and NII per share of $0.29 for the second quarter. Our Q3 distribution coverage was approximately 128% as we earned $0.32 per share of net investment income and paid $0.25 in the form of 3 monthly $0.083 distributions. Net realized gains in the portfolio were approximately $59,000, which equated to approximately $0.01 per share versus $0.11 per share in Q2 on gains of approximately $1.4 million. As noted by Peter earlier on this call, this quarter was slower than Q2 on the realization front.

Now unrealized depreciation on investments during the quarter was $12.4 million, which equated to $1.16 per share versus unrealized depreciation of $0.60 per share. In Q2, our net unrealized depreciation was $7.3 million. This was primarily driven by mark-to-market on our investments in Avanti Communications Group plc, our largest portfolio acquisition. Now let me turn the call back to Peter to discuss portfolio highlights and activity.

Thanks, Mike. Let's now turn to Slide 8 to discuss some of the portfolio highlights and what we view as reflective of our total return, special situations investment approach.

Today, despite the debtor-friendly state of the credit markets, we have constructed a portfolio comprised almost entirely of senior secured credit instruments with a weighted average current yield of 13.4%. That compares to a weighted average current yield of 13.2% as of the end of Q2.

As of September 30, 99.8% of our invested capital was invested at the top of the capital structure in positions that are classified as first lien and/or senior secured credit instruments. Our overall credit portfolio had a weighted average valuation of approximately 70.5 cents on the dollar, highlighting the potential for significant price appreciation in addition to the high current income. That compares to an average price at the end of Q2 of 73 cents on the dollar. This decrease in average prices is a result of the GECC portfolio rotating into more total return opportunities as noted in the deployment/monetization figures and from the mark-to-market depreciation on portfolio investments.

Lastly, in a significant uptick versus the end of last quarter, approximately 75% of the portfolio was comprised of positions that are representative of the way in which we intend to invest going forward. Having exited, in whole or in part, a number of Full Circle, MAST-contributed and newer GECC positions since the merger closed a year ago, we allocated a significant amount of capital to new opportunities during Q3.

Turning to Slide 9. As of September 30, we had 24 debt investments across 20 companies that represented $152.8 million in fair market value and 7 equity investments representing $349,000 or 0.2% of invested capital.

Turning to Slide 10 to walk through our quarterly portfolio activity. On the investment front, during the third quarter of 2017, we made 3 new investments and 2 add-on investments, deploying $49.5 million at a weighted average price of 96 cents on the dollar and a weighted average current yield of 10.6%. We'd like to note that again these capital deployments come at a lower average dollar price in our recent monetizations. As we have noted in prior quarters, given our view on the current state of the credit markets and our keen focus on downside protection, we believe this cautious stance in capital deployment will be rewarded in the long run as we will have ample dry powder to deploy into market dislocations. Despite that cautious stance, I'm pleased to report we made 3 new investments during the quarter. We deployed nearly $30 million of capital into these 3 new investments.

Our new investments in the quarter were the following: 1, International Wire Group. During the quarter, we acquired approximately $10 million in face value of the senior secured second lien bonds of International Wire Group in the secondary market at an average price just shy of $0.93 despite carrying a 10.75% rate of interest. These notes mature in August of 2021. 2, TRU Taj. We also acquired approximately $10 million in face value of the first lien notes of TRU Taj, LLC, a subsidiary of Toys "R" Us at an average price of approximately 95% of par value. These notes also mature in August of 2021 and bear interest at a rate of 12% per annum. 3, Geo Specialty Chemicals. Lastly, we purchased approximately $10.5 million of face value of the loans of this chemical company in a negotiated transaction from a bank seller at a price representing approximately 94% of par value. In conjunction with this acquisition, we and the other lenders extended the maturity of this loan to April of 2019 in October.

On the monetization front, we monetized in part 6 investments at a weighted average price of par and a weighted average current yield of 11.2%. While this was a slower quarter with respect to realizations, we are pleased with the progress we've made during the past year. Since the closing of the full merger, on monetizing both the legacy Full portfolio as well as monetizing a number of the MAST-contributed positions and subsequent acquisitions at attractive returns.

Slides 11 and 12 provide additional detail on the breakdown of the portfolio in terms of where our investments are located in their respective issuers capital structures, floating versus fixed rate in industry breakdown. Similar to the end of Q2, nearly all of our invested capital is in top of the capital structure instruments with 99.8% of the portfolio in first lien and/or senior secured debt instruments.

During the past quarter, we have increased our exposure to floating-rate instruments from 48.6% at the end of Q2 to 50.3% at the end of Q3. Lastly, the weighted average yield on the fixed-rate instruments in the portfolio is 10.48%, a significant margin above the current distribution rate of approximately 8% of September 30th NAV. With that, I'll turn the call back over to Mike Sell to discuss our recent capital activity.

Thanks, Peter. We have a couple of updates that we would like to discuss with respect to capital activity. First, with respect to our distribution policy, let's turn to Slide 15. In August, our Board of Directors declared our distributions for Q4 of $0.083 per share per month. In our earnings release, we reported that we generated $0.32 per share in NII, which covers our third quarter declared distribution by approximately 1.28x. Yesterday, we announced our distribution schedule amount for Q1 2018 with plans to continue to distribute at the level from 2017 of $0.083 per share per month, or approximately 8% of our September 30th NAV. As noted on our last quarterly call, it is our intent to supplement our monthly distributions with special distributions from NII generated in excess of the declared distributions. We expect to announce a special distribution later in Q4 subsequent to the completion of our analysis and we will update the market in due course.

Next with respect to our stock buyback program, let's turn to Slide 16. During Q3, we purchased over 838,000 shares of our stock through our 10b5-1 program at an average discounts on our September 30th NAV at 12.5% utilizing $9.2 million or a $15 million 10b5-1 program. From the commencement of the 10b5-1 stock buyback program in November 2016 through November 6, 2017, we've purchased an aggregate of approximately 1.35 million shares at a weighted average price of $10.98 per share resulting in approximately $14.9 million of cumulative cash paid to purchase shares at approximately 88.7% of September 30th NAV. Including the tender offer, we've purchased in aggregate of over 2.2 million shares to date spending approximately $24.9 million in a share buyback in tender activity. For the first 9 months of 2017, our stock buyback and tender offer activity has added approximately $0.30 in per share accretion to our NAV.

Lastly, turning to Slide 18, as referenced on our last quarterly call, on July 31, 2017, we filed a registration statement with the SEC for a baby bond offering. The intended use of proceeds for this offering was to repay the Full Circle 8.25% notes that were assumed in the merger and to make new investments consistent with our investment objectives. On September 13, 2017, we priced the deal at approximately $28.4 million in newly issued 6.5% notes due September 2022. With a fully subscribed over-allotment option, we had a total issue size of approximately $32.6 million. These notes trade under the ticker GECCL. This allowed us to reduce the coupon rate on our debt by 175 basis points resulting in annual cash savings of approximately $721,000. Concurrent with the settlement of the new GECCL notes, we provided a notice of redemption to the existing FULLL noteholders and the notes were redeemed on October 20, 2017.

With that capital activity update, let me turn the call back over to Peter for closing remarks and then Q&A.

Thank you all for joining us this morning. We continue to be excited about the current portfolio, the investments we've made to date and the progress we have made in rotating out of the legacy Full Circle portfolio and into new investments. We believe that we have created a significant alignment of interest with you and hope to have displayed this through our share repurchase and stock tender activity. We look forward to growing both our NAV and distribution rate per share. Thank you, again, for the support and confidence that you've placed in us. With that, we will turn it over to the operator to open the call for questions.

(Operator Instructions) Our first question comes from Josh Findler with (inaudible)

I just want to ask a little bit on Avanti because there is obviously a lot of movement in the bonds during the quarter, but not a lot of -- heard a lot of news from the chief seats. So maybe you guys could just kind of walk us through how you are currently thinking about that investment? And what kind of developments. There has been some -- obviously some positive developments with the new CEO and all that, but what kind of caused that kind of sell off in the bonds during the quarter?

Thanks, Josh, and good question. You're right. There are a lot of moving pieces and maybe we'll take a minute to walk through those and then share at least what we're able to share at this point about our view on our investment in Avanti. What I would call unfortunate trading in the third -- Avanti third lien position going into quarter end caused us to have a significant unrealized loss in the quarter. The trading price of that instrument at the end of the quarter was $0.195, which is down from $0.37 at the end of Q2. Today, that price is back up to $0.285 and so the timing of that trading was unfortunate for the timing of the close of our portfolio. Where we closed it -- have we closed the portfolio on 9 30 at today's price, the unrealized loss would have been reduced by $4.87 million or about $0.46 per share.

With that out of the way, I think it's maybe useful to make a couple further comments about Avanti understanding that from time-to-time there are things that we can't share publicly about the company. But this is a very asset-rich company. Those assets serve as collateral for our position and we remain confident in the underlying value of that collateral and by extension what that means for the investment that we have in the company. As you pointed out, we have a new interim CEO, Alan Harper, has been appointed and we are very encouraged by the progress that the Avanti management team is making under Alan's leadership. And we believe that this appointment will ultimately turn out to be a meaningful turning point in the history of the company.

And maybe just one follow-up in terms of, I think, the sort of strategic alternatives. I think you're now passed the U.K. takeover cooling-off period now. So can you just walk us through -- or tell us what you can about sort of the strategic alternatives process?

Sure. There is no formal strategic alternatives process going on at Avanti. You can imagine the board and the company are very focused on maximizing the value of the assets in the business that they have. So I presume that should anyone have something another company or investor have a proposal that could drive value for Avanti that the board would take that very seriously.

The next question comes from Brian Alexitch with Greenwich Investment.

My question is also related to Avanti. The progress though sound encouraging, but -- I mean, just by virtue of the bonds trading in distress levels, they look like they will be unbankrupt to what would be the human equivalent of Avanti. It's a bit of an uncomfortable overweight in the portfolio and it appears to be generating a substantial amount of the portfolio's total investment income. But the problem with that is it looks to be paying pick income, can you confirm, one, if that's the case, and if it is, that means you're paying out a substantial amount of cash income as you're not collecting new cash at the same time, while the investment is depreciating. Can you just -- understanding little bit more on your thesis on Avanti now, can you just comment a little bit on the flow-through to the portfolio, particularly the -- how cash income does not match to cash distribution?

Sure. Thanks for your question. I think that you've -- the instruments so far have been receiving pick interest because the company has been making pick elections that have been available to it. So you are correct that we have pick income and that's different than cash income, while that presents something to be navigated, I think the fact that we had cash on the balance sheet and we have one of the least leveraged balance sheets of any of the BDC peer group. We have ample ability to pay our current dividend, which is covered from income as you've pointed out, a chunk of that is noncash income. But we're not particularly worried about a mismatch between pick income and cash distribution payments.

Okay. Understood. I suppose what does it look like on the other end assuming that a portion of what you have paid out, say, we get to the point where these bonds mature, they're still in the portfolio. And the assets might not provide for everything that has been paid out in the pick. I mean, it presents a substantial problem potentially down the line. How do you think about that?

We are aware of that issue. I guess -- and we're -- given our position on the company's Board of Directors were relatively limited with what we can say publicly, but I would point you back to that this is a very asset-rich company. Those asset serve as collateral for these bonds, we're confident in the value of that collateral and what that ultimately means for our investment.

Our next question comes from Phillip Goldstein with Bulldog.

1 more question about Avanti about the valuation itself. From past discussions you've indicated that the trading is pretty scarce in these bonds. And obviously, the volatility is very high. How does the company and the board value these, I mean, do you just take the market price or do you take into account -- do you adjust that in anyway because as you've indicated, I've got what you said, the price was on September 30, and that it's up substantially today, but you just turned -- are you blind to the fact that there could be a huge tick up or down and just say whatever the market is that's where we're going to fare -- that's what our value is or is there something else that goes into the mix?

Philip, this is Mike Sell. I think given that there is an active market trading here....

But you said active market, but it's not that active, right?

There is trading on a somewhat regular basis, particularly running into quarter end. On this issue, there was almost daily trading for the last couple of days. Our default position, if there is volume, is to take the last traded price, the last traded price as adjusted by a pricing service provider, an IDC or the like that provides data on traded issues. If there is a scale issue, we would have to reevaluate that, but that hasn't been the case in this particular issue. And at 9 30 we took the last traded price, part of being in a traded issue, you're going to see more volatility than in a nontraded one based on market dynamics.

All right. Okay. The other question is regarding the prospect for special dividend. Also it's like a 2-part question. So #1 is, would that special dividend be expected to be paid this year? And 2, while you can't give us an exact number, can you give us a range like or rough idea where you think the range of that dividend would be?

Yes, I'll feel that one as well. I think in regards to the first question, that's a bit of a board-level decision. Though for our excise tax purposes, we would expect to have a record date at least in the current year depending on the time period for closing down the analysis on it. In terms of the range, I think, the best place to look is going to be the capital section of our balance sheet. We have undistributed net investment income on a GAAP basis of $3.6 million at 9 30. So that's probably a reasonable proxy for where we stood in terms of what we needed to distribute on an excess basis to avoid excise tax at 9 30. There is obviously going to be income over the fourth quarter that we will have to take into account as well as put tax differences. But from a put your finger in the air what's a good estimate, that's probably a decent one to start with.

Okay. We don't want to pay any excess taxes.

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host.

Thanks, Kevin. I just want to make one point of clarification before we conclude, is that the accretion from share buyback and tender activity for the first 9 months of the year was $0.37 per share. I believe we misspoke earlier in the call. Thank you, again, for joining us this morning. We look forward to our continued dialogue and please do let us know if we could be helpful with anything in follow-up. Have a great day.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.