Great Elm Capital Corp (GECC) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Corp.'s Second Quarter 2018 Financial Results Conference Call. (Operator Instructions)

And at this time, I would now like to introduce your host for today's conference, Ms. Meaghan Mahoney. Ma'am, you may begin.

Thank you, Sandra, and good morning, everyone. Thank you all for joining us for Great Elm Capital Corp.'s Second Quarter 2018 Earnings Conference Call.

As a reminder, this webcast is being recorded on Friday, August 10, 2018.

If you'd like to be added to our distribution list, you can email 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, www.greatelmcc.com, under Financial Information, Quarterly Results, 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 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 John Ehlinger, Adam Yates, Adam Kleinman and me. As well as by John Woods, 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 through the webcast.

As noted in our press release, we were very active this quarter on the capital deployment, monetization and restructuring fronts. I would specifically like to highlight the restructuring of Avanti Communications Group plc, a significant pay down of our loan to the selling source and the continued deployment of capital into existing portfolio companies.

We will start this morning's call by walking 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.

Before I turn the call over to John Woods, our Chief Financial Officer, to discuss the financial results from the second quarter of 2018, I would officially like to welcome John Woods to the team.

By way of background, John Woods recently joined the Great Elm Capital Corp. team as CFO but has been a member of the broader Great Elm organization since early 2017. In addition to his role as the CFO of GECC, John also serves as the CFO of Great Elm Capital Management, our external manager, and Great Elm Capital Group, the parent company of Great Elm Capital Management.

Now let's turn the call over to John to discuss financial results from the quarter.

Thanks, Peter. Please turn to Slide 5 for a snapshot of the financial highlights from the quarter.

For the quarter ended June 30, 2018, we generated $0.57 of NII per share, significantly in excess of the $0.25 per share in base distributions that were paid during the quarter.

Turning to Slide 6. As of June 30, our net asset value was $125.6 million, which was flat quarter-over-quarter. On a per-share basis, this equated to an $11.79 NAV, also flat quarter-over-quarter. While NII significantly exceeded our distribution for the quarter, this impact to NAV was offset by mark-to-market depreciation in the portfolio. The mark-to-market depreciation in the portfolio was driven predominantly by our investments in Avanti Communications Group plc.

As of the end of the second quarter, the fair value of our investment portfolio was $199.3 million versus $194.8 million at the end of Q1, representing modest growth of approximately 2% in our investment portfolio during the quarter and approximately 20% portfolio growth during the 6 months ended June 30, 2018. We also had $8.5 million in cash and cash equivalents predominantly held in money market mutual fund investments as of the same date.

Now please turn to Slide 7 to walk through the quarterly financial review. Total investment income for the quarter ended June 30 was $7.2 million against net expenses of $1.1 million, resulting in net investment income of $6.1 million or $0.57 per share. This compares to total investment income of $7.5 million for Q1 against net expenses of $3.6 million, which resulted in net investment income of $3.9 million and NII per share of $0.36 for the first quarter. Net investment income of $6.1 million generated in the quarter was driven in part by the $2.6 million reversal of previously accrued but unpaid incentive fees associated with the Avanti third lien position.

Our Q2 distribution coverage was nearly 230% as we earned $0.57 per share in net investment income and paid approximately $0.25 in the form of 3 monthly $0.083 distributions. Driving this coverage was the solid base of core NII generated from the portfolio, portfolio growth year-to-date and the aforementioned reversal of the previously accrued but unpaid incentive fee.

Net realized gains on investments were approximately $810,000, which equated to approximately $0.08 per share versus $0.03 per share in Q1 on gains of approximately $317,000. Net unrealized depreciation on investments during the quarter was $4.2 million, which equated to $0.40 per share. This compares to net unrealized depreciation of $8.2 million or $0.77 per share in Q1 of 2018. Again, this was primarily driven by the mark-to-market depreciation on our investments in Avanti.

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

Thanks, John. Let's now turn to Slide 9 to discuss some of the portfolio highlights.

We have constructed a portfolio comprised almost entirely of senior secured credit instruments with a weighted average current yield of 11.1%. As of June 30, 93% of the fair value of our investments 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 $0.87 on the dollar, highlighting the upside potential in addition to the high current income.

Lastly, 81% of the portfolio was comprised of positions that are representative of the way in which we intend to invest going forward as we have been actively deploying capital into new opportunities while continuing to focus on monetizing the legacy Full Circle positions.

Turning to Slide 10. As of June 30, we had 29 debt investments across 23 companies that represented $185.4 million in fair market value and 5 equity investments representing $14 million or 7% of the fair value of all investments.

Please turn to Slide 11 to walk through our quarterly portfolio activity. On the investment front, during the second quarter of 2018, we added to 8 existing investments deploying $37.9 million at a weighted average price of $0.99 on the dollar and a weighted average current yield of 10.9%, including revolver draws. All of these investments were first lien and/or senior secured instruments.

Let's walk through briefly where we have been deploying capital. Please turn to Slide 12. First, we acquired an additional $1.8 million face value of Aptean's second-lien loan in the secondary market at a price of 101% of par value.

Next, we acquired an additional $5 million face value of Michael Baker's second-lien bond in the secondary market at a price of approximately 95% of par value. We also acquired an additional $500,000 face value of SESAC second-lien loan in the secondary market at a price just below par.

Next, we acquired an additional $3 million face value of Sungard's first-lien loan of 2022 in the secondary market at a price of approximately 99% of par value.

Lastly, we funded $3.75 million to Tallage Davis in originated first-lien term loan at par.

As noted on Slides 11 and 13, we monetized $27.7 million across 12 investments at a weighted average price of par and a weighted average current yield of 10.4%.

Slide 13 provides a snapshot of our portfolio rotation quarter-by-quarter for the trailing 5 quarters. Here, you can see how we have rotated out of higher dollar-priced instruments into greater total return opportunities while maintaining a keen focus on structurally senior investments with 100% of our capital deployed into first lien and/or senior secured instruments during the quarter.

We believe this encapsulates what we are seeking to achieve here at Great Elm, applying the key principles of value investing to build a portfolio of attractive risk-adjusted opportunities that offer both high current yield and the potential for price appreciation.

Slides 14 through 17 provide additional detail on the breakdown of the portfolio in terms of where our investments are located and their respective issuer's capital structures, how this has trended over time, floating versus fixed rate accruals and how this has trended over time, as well as an industry breakdown.

For clarity, the portfolio's equity exposure increased quite significantly quarter-over-quarter in connection with the equitization of the previously held third-lien debt investment in Avanti.

Lastly, as noted on Slide 14, the weighted average yields on both the fixed rate and floating rate instruments in the portfolio at 11.05% and 11.15%, respectively, are well in excess of the current distribution rate of approximately 8.4% of June 30 NAV.

The next topic I would like to cover is the success we have had with the monetization of the legacy Full Circle portfolio, as this is a frequent topic of conversation with our shareholders. Please turn to Slide 18.

In the 21 months since the closing of the merger with Full Circle, we've been focused diligently on working out and monetizing what was largely viewed as a challenged portfolio. After spending meaningful time, we have managed to date to monetize approximately 73% of this portfolio at a net gain, exiting 23 positions across 15 companies and realizing an aggregate total return of $4.4 million on these positions.

Although not all of the positions have been exited at a net gain, the larger realized positions, based on our initial cost basis, have all had positive outcomes.

Additionally, subsequent to the close of the quarter, we received a significant pay down on our investment in The Selling Source, LLC, further reducing our exposure to the legacy Full Circle portfolio. Our remaining exposure was also rolled up into a super senior first out loan position that matures in January 2020.

Additionally, subsequent to the close of the quarter, we monetized our warrants in RiceBran Technologies Corporation, another legacy Full Circle position, at a small gain.

I want to now walk through a brief update on Avanti Communications Group, our largest portfolio position. Please turn to Slide 19. As noted, during the quarter, we had a number of positive developments from the company. Recall, 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.

In April 2018, a majority of Avanti shareholders voted in support of this proposed restructuring. The restructuring closed in late April, and GECC now owns approximately 9.1% of Avanti's common equity.

Post the close of the restructuring, with a more sustainable capital structure in place, Avanti announced a new contract with Viasat for $10 million for its newly launched HYLAS 4 satellite. With in-orbit testing for HYLAS 4 nearing its conclusion, we expect to continue to see more contract wins for its newest -- its largest and newest satellite as well as for the balance of the fleet.

Additionally, Avanti announced that it will be awarded up to $20.075 million from arbitration proceedings against the Ministry of Defence of the Republic of Indonesia to recover money owed to it under a contract for Avanti's Artemis satellite. We expect this will be paid by mid-August.

With that, I will turn the call back over to John Woods to discuss recent capital structure activity.

Thanks, Peter. We have a brief update this quarter with respect to capital activity. Let's discuss our distribution policy first. Please turn to Slide 23. In May, our Board of Directors declared our distributions for Q3 of $0.083 per share per month. In our earnings release, we reported that we generated $0.57 per share in NII, which covered our declared base distributions by approximately 2.3x. This morning, we announced our distribution schedule for Q4 2018 with the plan to continue to distribute $0.083 per share per month or approximately 8.4% of June 30's NAV.

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 upside potential in the portfolio as well as with the progress we have made with both the legacy Full Circle and other day 1 investments. We believe that we have created a significant alignment of interest with you, our shareholders, and we hope to have displayed this. Thank you again for the support and confidence that you have placed in us.

With that, we will turn it over to the operator to open the call for questions.

(Operator Instructions) And our first question comes from the line of Chris Kotowski with Oppenheimer.

So I guess, in the time you've been public, it's been kind of an unusual time in that you've been winding down the Full Circle legacy portfolio. But when I look at your activity this quarter, it seems like there's an extraordinary amount of churn in there looking at the deployments and the monetizations. And then, I guess, I thought it's -- on Page 13, that it's an interesting exhibit that shows every quarter, you're buying a bunch of positions at $0.96 to $0.99 and selling them at $1.00. So -- I mean, is that what we should expect going forward, that this is kind of -- there's -- but there isn't a lot of portfolio growth, right, in, at least, the most recent 3-month period. And should we expect that level of churn? Or is this really kind of an unusual period?

Chris, so one of the things about that statistic that could potentially be misleading is, it does include both draws and pay-downs on revolving credit facilities that we provide to certain of our portfolio companies. And as you might imagine, within the course of the quarter, the amount of activity that a company might be utilizing on both sides of that could be significant. And as a result, I think there's probably less actual churn of portfolio positions than that statistic implies. So for example, on Slide 12, the -- away from revolver positions -- funding revolvers, we've -- we show all of the additions to the portfolio, whether new position or funding more of existing positions. And I think, if you look at that, that is meaningfully less than the total amount of capital deployed.

All right. Okay, fair enough. Then on that page, the one name that's jumped out at me is, kind of, Aptean. I know it's a small position but it's the first time I recall having seen you bought anything at a premium to par. Can you -- I'm just curious on the rationale there.

Sure. Aptean has a pretty -- we think it's a very high-quality enterprise software company backed by Vista Equity Partners, who we consider to be the premier private equity firm dedicated to that space. And this particular loan has an attractive coupon, and from time to time, has had call protection so that it wasn't necessarily callable by the company at par. So the LIBOR plus 9.50% coupon, coupled with the -- what we consider to be the attractive characteristics of the business and demonstrated history of growing cash flow, we thought, all things considered, that's a pretty attractive investment.

Okay. And then I mean, you have a fair amount of liquidity, I guess, do you have an ideal or targeted level of debt investments over a, say, 12-, 18-month period? Or is kind of the level that we're at now, what we should expect going forward?

I think that we do intend to be growing the portfolio. I think we had $8 million of cash and equivalents at the quarter end, which is not all that much. And within the course of a quarter, we can have deployments or pay-downs that can impact our level of liquidity. We do intend to grow the portfolio. Our leverage is less than most of our peer group so we do think that, as the opportunity set warrants, both as far as our ability to deploy and where we might raise incremental debt capital that we do expect over time, that we'd be expanding the portfolio and raising incremental debt capital to fund that. And so I do expect continued portfolio growth.

You also have the $75 million treasury bill portfolio, right?

There's a -- if you look, there's an offsetting liability that almost exactly matches that asset number so...

(Operator Instructions) And I'm showing no further questions at this time. I would like to return the call to Ms. Meaghan Mahoney for any closing remarks.

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

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