Great Elm Capital Corp (GECC) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Corp. Fourth Quarter 2017 Financial Results Conference Call. (Operator Instructions)

As a reminder, this conference is being recorded. I would now like to hand the floor over to Meaghan Mahoney, Head of Investor Relations. Please go ahead.

Thank you, Karen, and good morning, everyone. Thank you all for joining us for Great Elm Capital Corp.'s Fourth Quarter and 2017 Earnings Conference Call. As a reminder, this webcast is being recorded on Monday, March 12, 2018. If you'd like to be added to our distribution list, you can 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-K. 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 a 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 will 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 by Michael Sell, our Chief Financial Officer; and Meaghan Mahoney, our Head of Investor Relations. 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 throughout the webcast.

I would like to start this quarter's call with a reflection on some key highlights and accomplishments from 2017, our first full year managing Great Elm Capital Corp. Please turn to Slide 4. First, let's discuss distributions. During each quarter of 2017, we out-earned our $0.25 per share quarterly distribution that is comprised of 3 monthly $0.083 per share distributions. Each quarter, we generated net investment income that ranged from $0.29 per quarter on the low end to $0.60 per share on the high end. For the year, we generated, in total, $1.52 per share in NII and paid out approximately $1 per share in base distributions, a 1.52x base distribution coverage. Furthermore, we supplemented our base distribution yield with a special distribution of $0.20 per share. In aggregate, we distributed approximately 9.63% of December 31 NAV, a strong distribution level at NAV and an even more compelling one at the current trading levels.

Next, let's discuss highlights from our portfolio activity. We've been diligently working on deploying capital into attractive, risk-adjusted opportunities as we've been rotating out of the legacy Full Circle portfolio as well as contributed positions and postmerger investments. On the capital deployment front, during 2017, we deployed $186.6 million into 20 investments across 17 issuers, including 9 new investments. This investment activity was executed at a weighted average price of $0.97 on the dollar and a weighted average current yield of 11.49%.

On the monetization front, across the portfolio during 2017, we monetized $175 million across 32 investments and 27 issuers at a weighted average price of par and a weighted average current yield of 11.84%. This includes the complete exit of 15 positions, including 9 legacy Full Circle positions. In the year plus since the merger closed, we've exited 21 of the legacy Full Circle positions across 15 portfolio companies, and in aggregate, we have exited those positions at a net gain of approximately $1.775 million.

In terms of capital structure activity, in the fall of 2017, we called the legacy Full Circle notes that we assumed in this merger, which were paying 8.25% in annual interest, with the proceeds from the issuance of the GECCL notes of 2022 that are paying 6.50%, allowing us to save 175 basis points per annum in coupon payments. In January 2018, we issued the GECCM notes of 2025, paying 6.75% per annum on the 7-year notes. Between these 2 baby bond debt issuances, we have approximately $79 million in debt outstanding as of today and have laddered and extended our maturities while locking in attractive fixed rates in the current low-rate environment.

Lastly, during 2017, we repurchased approximately 2.1 million shares of our stock, which represented approximately 16% of the shares outstanding as of the end of 2016. These share repurchases were completed at a discount of approximately 10% of our December 31, 2017, NAV and in aggregate, resulted in $0.40 per share in accretion to our stockholders.

As we reflect on what we set forth to do when this merger closed 1.5 years ago, we said our intent was to focus on investing well, to extract value from the legacy Full Circle portfolio, to deliver a competitive distribution yield and to create a strong alignment of interest with our shareholders. We're proud of the progress we have made with each of these goals.

Having taken a moment to reflect on the year, let's now discuss realization activity from Q4 and Q1 quarter-to-date. Please turn to Slide 6 to discuss Optima Specialty Steel. As you may recall from our Q1 earnings call, our original investment in Optima was in its pre-petition debt, which was a component of the initial contributed portfolio. The notes were scheduled to mature about a month after our merger with Full Circle closed, and we expected this maturity might be a catalyst for a bankruptcy. As expected, Optima filed for bankruptcy protection in December 2016. We then worked to structure, and participated in, a debtor-in-possession, or DIP, loan that refinanced the pre-petition notes at par in Q1 2017.

This DIP loan was an attractive investment opportunity for us, as it was a senior secured instrument carrying with it a LIBOR plus 1,000 basis point rate of interest, with a maturity in October 2017. Like with our original investment in the notes, we expected the DIP maturity to be the catalyst for a par financing upon the company's exit from Chapter 11 bankruptcy. We also believe the DIP loan had robust downside protection, given our view of the value of the company's business and assets. The company ultimately exited bankruptcy in November 2017, and we were repaid in cash and full, generating an IRR of 12% with a cash-on-cash return of 1.08x in approximately 9 months.

The next investment we would like to discuss is Sonifi Solutions. Please turn to Slide 7. We made our initial investment in Sonifi at a price of $0.51 on the dollar, shortly after our merger closed with Full Circle in Q4 2016. This was a company that we knew very well and had been integrally involved in leading its restructuring in 2014. Post-restructuring, we had seen improved company performance that was supportive of our view that its near-term maturity would prove to be a catalyst for a refinancing at par. Ultimately, it was refinanced in November at par, resulting in an IRR of 229% and a cash-on-cash return of 1.9x our investment in under a year.

We had several other small realized investments and write-offs during the quarter, including realizations in Almonde, Inc. post quarter-end, Modular Process Controls and Texas Westchester. We also recognized write-offs in our investments in PR Wireless warrants, Ads Direct and Pristine Environments.

With that review of recent accomplishments and monetization activity, let's next walk through a review of the quarterly financials, followed by portfolio highlights and investment activity. We will then provide an update on our capital structure activity before concluding the call with Q&A.

I will turn the call over to Mike Sell, our Chief Financial Officer, to discuss the financial results from Q4.

Thanks, Peter. Please turn to Slide 12 for a snapshot of the financial highlights from the quarter. For the quarter ending December 31, 2017, we generated $0.60 of NII per share as compared to approximately $0.25 per share in base distributions and $0.45 per share in total distributions paid -- declared, when include our -- when including our $0.20 per share special distribution.

Turning to Slide 13. As of December 31, our net asset value was $132.3 million versus net assets of $132.8 million at the end of Q3. On a per-share basis, this equates to $12.42 of NAV versus a $12.38 NAV at the end of Q3. This increase in NAV per share was primarily due to earnings in excess of declared distributions and accretion from our share repurchase activity. As of the end of the fourth quarter, the fair value of our investments was $164.9 million versus $153.1 million at the end of Q3. We also had $18.9 million in cash and cash equivalents, predominantly held in money market mutual fund investments.

Now please turn to Slide 14 to walk through the quarterly financial review. Total investment income for the quarter ended December 31 was $9.7 million against net expenses of $3.3 million, resulting in net investment income of $6.4 million or $0.60 per share. This compares to total investment income of $6.5 million for Q3 against net expenses of $2.9 million, which resulted in net investment income of $3.6 million and NII per share of $0.32 for the third quarter. Our Q4 distribution coverage was approximately 240%, as we earned $0.60 per share of net investment income and paid $0.25 in the form of 3 monthly $0.083 distributions. Including our special distribution of $0.20 per share, our distribution coverage was approximately 133%.

Driving this coverage were a large uptick in interest income from Avanti's PIK toggle election, a one-time reduction in interest expense from our prepayment of the Full Circle baby bonds that were previously held at a premium and a solid base of core NII generated from the balance of the portfolio. Net realized gains in the portfolio were approximately $213,000, which equated to approximately $0.02 per share versus $0.01 per share in Q3 on gains of approximately $59,000. Net unrealized depreciation on investments during the quarter was $1.6 million, which equated to $0.16 per share versus unrealized depreciation of $1.16 per share in Q3 on net unrealized depreciation of $12.4 million. This was primarily driven by mark-to-market depreciation on our investment in Commercial Barge Line Company and the reversal of previously unrealized gains on our holding in Sonifi. Offsetting these declines was an improvement in the valuation of our PR Wireless term loan, subsequent to the successful transaction with Sprint.

Now let me turn the call back to Peter to discuss portfolio highlights and activity.

Thanks, Mike. Let's now turn to Slide 16 to discuss some of the portfolio highlights and what we view is reflective of our investment philosophy: applying the key principles of value investing to the capital structures of middle market companies.

To date, we have constructed a portfolio comprised almost entirely of senior secured credit instruments, with a weighted average yield of 15.3%. That compares to a weighted average current yield of 13.4% as of the end of Q3. As of December 31, 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 $0.71 on the dollar, highlighting the potential for significant price appreciation in addition to the high current income. That was in line with the average price of the debt investments in the portfolio as of the end of Q3. Lastly, in a slight uptick versus the end of last quarter, approximately 77% of the portfolio was comprised of positions that are representative of the way in which we intend to invest going forward, as we continue to monetize legacy positions and redeploy capital into new opportunities.

Turning to Slide 17. As of December 31, we had 24 debt investments across 19 companies that represented $164.5 million in fair market value and 4 equity investments representing $349,000 or 0.2% of invested capital.

Turning to Slide 18 to walk through our quarterly portfolio activity. On the investment front, during the fourth quarter of 2017, we made 4 new investments and 7 add-on investments, deploying $46.1 million at a weighted average price of $0.97 on the dollar and a weighted average current yield of 11.4%. All of these investments were first lien and/or senior secured instruments. We'd also like to note that these capital deployments come at a lower average dollar price as well as a higher weighted average current yield than our recent monetizations.

As we have noted in prior quarters, given our view of this current state of the credit markets and our keen focus on downside protection, we believe this cautious stance in capital deployment and balance sheet leverage will be rewarded in the long run. Despite that cautious stance, we're pleased to report we made 4 new investments during the quarter, deploying nearly $20 million into these 4 new investments. Our new investments in the quarter were the following. First, we acquired $5 million at face value of Almonde's second lien loan at 101% of par that bears interest at LIBOR plus 725 basis points. We ultimately chose to exit this position in early Q1, as noted earlier in the call.

The next new investment was in a government services company called Michael Baker. We acquired $5 million at face value of this senior secured bond at approximately $0.98 on the dollar. This bond carries with it an 8.75% interest rate and matures in 2023. The third new position in the portfolio during the quarter was in SESAC, a performance rights organization. We acquired approximately $4.2 million at face value of this second lien loan in the secondary market at a price of $0.99 on the dollar. This loan matures in 2025 and bears interest at a rate of LIBOR plus 725 basis points. And the last investment was in Sungard Availability Services, a technology services company. We acquired $6 million face value of this first lien loan at a price of $0.95 on the dollar. This loan matures in 2022 and carries with it a LIBOR plus 1,000 basis point rate of interest.

Turning to the monetization front. We monetized, in whole or in part, 16 investments at a weighted average price of par and a weighted average current yield of 10.4%. Slide 19 provides a snapshot of our portfolio rotation quarter-by-quarter since inception. Here you can see how we have rotated out of higher dollar-priced instruments into greater total return opportunities while staying structurally senior in the capital structure. I believe this really encapsulates what we're seeking to achieve here at Great Elm Capital Corp., apply the key principles of value investing in building a portfolio of attractive, risk-adjusted, special situations opportunities that offer both attractive yield and the potential for price appreciation.

Slides 20 through 23 provide additional detail on the breakdown of the portfolio in terms of where our investments are located and the respective issuer's capital structures, how this has trended over time, floating versus fixed rate, and how this has trended over time, as well as industry breakdown. Similar to the end of Q3, 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. Lastly, the weighted average yield on the fixed rate instruments in the portfolio is 11.3%, a significant margin above the current distribution rate of approximately 8% of December 31 NAV.

We wanted to now walk through a brief update on Avanti Communications Group PLC, our largest portfolio position. Please turn to Slide 24. During the past few months, we've had some significant and positive news from the company. In December 2017, the company announced a proposed restructuring plan to amend the terms of the second lien PIK toggle notes and to equitize the third lien notes. They have proposed the following changes to the second lien notes: reduce the interest rate to 9%, allow Avanti to pay its interest in kind for the remaining life of the security and to extend its maturity by a year. The company has received significant support from its second lien note holders as well as from its third lien note holders and received the required consents for the restructuring. Next week, the company will hold a meeting for its third lien note holders to approve this scheme of arrangement.

Additionally, as you may recall, Avanti's cofounder and former CEO, David Williams, stepped down as CEO in August 2017. Alan Harper, previously serving as a Non-Executive Director, stepped up to the CEO role at that time on an interim basis, allowing the company to run a thorough process to find a replacement for David. In February, the company announced a conclusion to that process, hiring Kyle Whitehill as its new CEO. We're excited for the company to bring Kyle on board, given his extensive experience working with telecom companies in emerging markets. Kyle starts in April, at which time Alan will resume his role as a Non-Executive Director.

Lastly, Avanti has set its launch date for HYLAS 4, its largest satellite to date, which will be launching later this month. This will significantly increase the capacity for Avanti across Africa and Europe, with steerable beams offering coverage of a much larger territory. Slide 25 has a map illustrating the coverage potential for HYLAS 4's steerable beams.

With that, I will turn the call back over to Mike Sell to discuss recent capital structure 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 28. In November, our Board of Directors declared our distributions for Q1 of $0.083 per share per month. In our earnings release, we reported that we generated $0.60 per share in NII, which covered our declared base distribution by approximately 2.4x. Including the special distribution we announced in December of $0.20 per share, NII covered the total quarterly distribution by approximately 1.3x.

Today, we announced our distribution scheduled amount for Q2 2018 with a plan to continue to distribute at the level of 2017 and Q1 2018 of $0.083 per share per month or approximately 8% of December 31 NAV. Also during Q4, we prepaid the Full Circle legacy baby bonds that we assumed in the merger, resulting in approximately $0.05 per share in NII accretion, as these were previously held at a premium.

Next, with respect to our stock buyback program, let's turn to Slide 29. During Q4, we purchased approximately 77,000 shares of our stock through our 10b5-1 program at an average discount to our December 31 NAV of 18%, utilizing $790,000 of our $15 million 10b5-1 program. From the commencement of the 10b5-1 stock buyback program in November 2016 through today, we have purchased an aggregate of over 1.3 million shares at a weighted average price of $10.97 per share, resulting in approximately $15 million of cumulative cash paid to purchase shares at approximately 88% of December 31 NAV. Including the tender offer, we've purchased an aggregate of over 2.2 million shares to date, spending approximately $25 million on share buyback and tender offer activity. For 2017, our stock buyback and tender offer activity added approximately $0.40 in per-share accretion to our NAV.

Lastly, turning to Slide 31. In January 2018, we completed a baby bond offering of $44.9 million under the ticker GECCM. Including the over-allotment option, the total issue size was $46.4 million. The notes mature in January 2025 and are callable after January 31, 2021, and bear interest at a rate of 6.75% per annum.

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 have made to date and the progress we have made in rotating out of the legacy portfolio and into new total return investments. We believe that we have created a significant alignment of interest with you and hope to have displayed this. 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 the line of Barry Bergman with Alba Investments.

I'd like to ask about the satellite company whose name escapes me right now. And excuse me, I came on the call a little bit late. Can you just give us an update on what the company's up to, if anything? And I know some of their management turned over, and I think, at some point, you would've been excited about that. Maybe you can kind of give us an update on that.

Sure. Avanti.

Avanti, Avanti, yes.

Yes. So I think there are a number of things that we can share with you about Avanti today. One of the things, as you've alluded to, is management. So last summer, David Williams, Avanti's Founder and CEO, stepped down, and a Non-Executive Director named Alan Harper stepped up into the CEO role on an interim basis. The company ran a very fulsome replacement process, culminating with the announcement of the hiring of Kyle Whitehill. Kyle has deep experience in the telecom space in emerging markets and in -- particularly, in Africa. We're excited about all of that, and Kyle starts in April. So the company and as we, as investors, are very excited about that. Alan Harper will resume his role as a Non-Executive Director once Kyle starts.

Second thing that we should discuss on the call is that Avanti's restructuring process is well underway with a number of dates coming up. And we are hopeful that, that will be concluded in the second quarter of this year. But in December, it announced it was seeking a restructuring out of court. In February, it announced the consent solicitations necessary for that to happen, and since February has been crossing procedural milestones for that to happen. So we believe that, that will occur probably in April of this year. And then the third thing worth talking about is HYLAS 4, which is the satellite that we, as investors, have funded and are anxiously awaiting its launch. And that is scheduled to launch later this month. So there is a collection of pieces of good news about Avanti, and those are what we're able to share this morning.

Could you talk about the underlying business, and how pricing is in the marketplace or -- for the satellite, sort of, markets that these guys participate in?

As a result of our board seat, there is not a lot of that kind of information that I can share, but we continue to believe that the company has a high-quality service offering that's very competitively priced. And as a result of this restructuring, arguably, the company can be even more aggressive on pricing than it was before. So we think that the future for revenue and cash flow generation at Avanti is very bright.

Can I just ask you, when you guys talk about your interest coverage and things like that, do you include the cash as well as the PIK interest from Avanti? Or is it -- just trying to understand that. I think these guys...

Do you mean our NII coverage of dividend?

Yes, exactly. Exactly.

Yes. Yes, we do, we include -- we include all of the interest income in there.

(Operator Instructions) Our next question comes from the line of Chris Kotowski with Oppenheimer.

Just as a follow up on Avanti, I'm wondering, can -- was it on full [TIK] in the fourth quarter? And can you just flesh out for us, roughly, how much investment income it generated in the fourth quarter? And then going forward, I assume that's -- that would step down to just $35 million times 9%, right? And when does that happen? Does that happen in 2Q or in 1Q?

Sure. Good morning, Chris. So I'll take sort of the back story about what drove that high amount of income in the quarter as well as going forward, and Mike will give you the specific number in Q4. So in Q4, one of the things that we benefited from is Avanti's third lien bond is a PIK toggle instrument. And the way that our accounting works is, at the lower of those 2 rates is the base level on which we accrue over the year. And then, in the two coupon dates, where we actually receive PIK interest, should Avanti elect that option, then we catch up to -- for all of the higher rate of interest that we've not been accruing for. That coupon date occurred in the fourth quarter, so as a result of that, we had a catch up from the lower of the two PIK toggle rates to the higher, when we received a PIK election from Avanti. And Mike, that number in the fourth quarter was...

In the fourth quarter, that toggle election brought in an incremental about $2.5 million of interest income or, net of fees, approximately $0.19 per share.

And for your last question on what happens going forward, neither we nor Avanti are in control of the timing, but we would guess that in about April of this year, the entirety of our third lien position would be converted into common equity, presuming that this schedule holds. So our $54 million and change principal amount of notes would receive an incremental -- a little bit shy of 200 million incremental shares of Avanti Communications Group. And in case you're looking to Avanti's publicly listed equity price, there is a pretty significant disparity presently between the fair value of that position as implied by the third lien trading price and the common equity trading price.

And that concludes our question-and-answer session. I'd like to turn the conference back over to Meaghan Mahoney for any closing comments.

Thank you. Thank you again, all, for joining us this morning. We look forward to our continued dialogue and appreciate your support, and please do let us know if we can be helpful with anything in follow-up. Have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.