Great Elm Capital Corp (GECC) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Third Quarter 2018 Financial Results Call. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Ms. Meaghan Mahoney. Ma'am, you may begin.

Thank you, Jimmy, and good morning, everyone. Thank you all for joining us for Great Elm Capital Corp.'s Third Quarter 2018 Earnings Conference Call. As a reminder, this webcast is being recorded on Tuesday, November 13, 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 continued to be quite active this quarter on the capital deployment, monetization and restructuring fronts. I would specifically like to highlight the continued progress with Avanti in Q3, which we will discuss later in the deck. We will start this morning's call by walking through the complete monetizations from the quarter, followed by a review of the quarterly financials, portfolio highlights and investment activity. We will then provide an update on our capital structure activity before concluding the call with Q&A.

Please turn to Slide 5 to discuss Foresight Energy. Foresight is a thermal coal producer that is based here in the U.S. and focuses exclusively on the Illinois Basin. We made our initial investment into Foresight's first lien loan in the first quarter of 2018, acquiring approximately $4.6 million of par value in the secondary market at a slight discount to par. We believe that the strong business trends, coupled with the company's restrictive debt covenants, would result in an earlier refinancing than its stated maturity in 2022. With the strength in the underlying business, the credit traded tighter, allowing us to exit our position in August at par, resulting in an IRR of 11.3% and a cash-on-cash return of 1.04x our investment in approximately 6 months' time.

Please now turn to Slide 6. The next realization we are going to discuss is NANA Development Corp. NANA is an Alaska-based diversified holding company that operates across 3 segments: its federal segment, which provides consulting services to the federal government; its mining segment, which receives royalties from a zinc mine; and its commercial segment, which provides engineering, construction, security and hospitality services.

We made our initial investment in NANA's first lien bonds in January of 2017, building a position size at peak of $8 million of par value at a weighted average price of 97.5% of par value. We believe that the bonds had significant downside protection from the robust cash flow profile of the business and anticipated that several catalysts would drive earnings improvement, allowing us to either exit in the secondary market or be refinanced prior to maturity. We made our last sales of this investment in August at a premium to par, resulting in an IRR of 12.4% and a cash-on-cash return of 1.15x our investment in approximately 18 months from what we viewed to be a well-covered first lien bond.

Lastly, for realizations, let's turn to Slide 7 to discuss RiceBran. In 2017, we had sold our position in RiceBran's revolver and term loan A, leaving our remaining exposure in the company's warrants. As a refresher, this was a position that was part of the legacy Full Circle portfolio. On the heels of positive news in June and July, shares were up nearly 60%. In July, we exercised all of our warrants in a cashless exercise at a price of $1.60 per share. We subsequently sold all of the shares at $2.43 per share, resulting in an IRR of 63.1%. All in, our IRR on the RiceBran investment was 91.6% with a cash-on-cash return of 1.08x.

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

Thanks, Peter. Please turn to Slide 9 for a snapshot on the financial highlights from the quarter. For the quarter ending September 30, 2018, we generated $0.25 of NII per share, covering the $0.25 per share base distributions that were paid during the quarter. On a year-to-date basis, we have generated $1.19 per share in NII, significantly in excess of the approximately $0.75 of distributions paid per share.

During each quarter, since the GECC-Full Circle merger closed just over 2 years ago, NII generated by the GECC portfolio has met or exceeded the distributions paid to shareholders.

Turning to Slide 10. As of September 30, our net asset value was $127.8 million, an increase from our net asset value of $125.6 million in Q2 and Q1. On a per-share basis, this equated to a $12 NAV, also up quarter-over-quarter from the Q1 and Q2 NAV per share valuations of $11.79.

This increase quarter-over-quarter was driven primarily by both realized and unrealized appreciation in the investment portfolio.

As of the end of the third quarter, the fair value of our investment portfolio was $203.3 million versus $199.3 million at the end of Q2, representing modest growth of approximately 2% in our investment portfolio during the quarter and approximately 23% portfolio growth during the 9 months ended September 30, 2018.

We also had $5.3 million in cash and cash equivalents as of the same date.

Now please turn to Slide 11 to walk through the quarterly financial review. Total investment income for the quarter ended September 30 was $6.2 million against net expenses of $3.5 million, resulting in net investment income of $2.7 million or $0.25 per share. This compares to total investment income of $7.2 million for Q2 against net expenses of $1.1 million, which resulted in net investment income of $6.1 million and NII per share of $0.57 for the second quarter.

Our Q3 distribution coverage was approximately 100% as we earned $0.25 per share in net investment income and paid approximately $0.25 in the form of the 3 monthly $0.083 distributions. Driving this coverage was the solid base of core NII generated from the portfolio and portfolio growth year-to-date.

Net realized gains on investments were approximately $898,000, which equated to approximately $0.08 per share versus $0.08 per share in Q2 on gains of approximately $810,000.

Net unrealized appreciation on investments during the third quarter was $1.3 million, which equated to $0.12 per share. This compares to net unrealized depreciation of $4.2 million or $0.40 per share in Q2 of 2018.

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

Thanks, John. Let's now turn to Slide 13 to discuss some of the portfolio highlights. We've constructed a portfolio comprised almost entirely of senior secured credit instruments with a weighted average current yield of 11.6%. As of September 30, 93.6% 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 $0.875 on the dollar, highlighting the upside potential in addition to the high current income.

Lastly, approximately 83% 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 14. As of September 30, we had 29 debt investments across 23 companies that represented $190.2 million in fair market value and 4 equity investments representing $13 million or 6.4% of the fair value of all investments.

Please turn to Slide 15 to walk through our quarterly portfolio activity. On the investment front, during the third quarter of 2018, we deployed capital into 8 investments, investing $39 million at a weighted average price of $0.89 on the dollar and a weighted average current yield of 10.99%, including revolver draws. All of these investments were first lien and/or senior secured instruments. We monetized $38 million across 17 investments at a weighted average price of par and a weighted average current yield of 8.99%. Approximately 99% of the monetization activity was in first lien and/or senior secured instruments.

Let's walk through briefly where we have been deploying capital. Please turn to Slide 16. First, on the new investment front, we acquired $2 million of face value of California Pizza Kitchen's first lien loan in the secondary market at a price of approximately 98% of par. This loan bears interest at a rate of LIBOR plus 6% and matures in 2022.

Next, also in new investment, we acquired approximately $9.2 million of face value of PFS Holding Corp. first lien loan at a price of approximately 60% of par. This loan bears interest at a rate of approximately LIBOR plus 350 basis points.

Next on the additional investment front, turning to Slide 17. We acquired an additional $5 million of face value of Commercial Barge Line's first lien loan in the secondary market at a price of approximately 76% of par. We also acquired an additional $2.6 million of face value of SESAC's second lien loan in the secondary market at a price of 99% of par.

Next, we acquired an additional $2.5 million of 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 acquired an additional $4.5 million of face value of Tru Taj's DIP note of 2019 in the secondary market at a price of 104% of par value.

Slide 18 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 through each quarter for the past 5 quarters.

This quarter represented the greatest potential for total return on new investments with a weighted average price of $0.89 on the dollar of our capital deployed. We believe this encapsulates what we are seeking to achieve here at Great Elm, applying the key principles of value investing and building a portfolio of attractive risk-adjusted opportunities that offer both high current yield and the potential for price appreciation.

Slides 19 through 22 provide additional detail on the breakdown of the portfolio in terms of where our investments are located and the respective issuers 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.

Lastly, as noted on Slide 19, the weighted average yields on both the fixed rate and floating rate instruments in the portfolio at 12% and 11.9%, respectively, are well in excess of the current distribution rate of approximately 8.3% of September 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 23. In the 2 years since the closing of the merger with Full Circle, we've been focused on working out and monetizing what was largely viewed as a challenged portfolio. 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 $4.6 million on these positions. The IRRs of each company are presented on the right-hand side of this slide. And 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.

Now I would like to walk through a brief update on Avanti Communications Group, our largest portfolio position. Please turn to Slide 24. We've had a number of positive developments from the company over the past 6 months since Kyle Whitehill joined the company as its new CEO. Despite the long sales cycle in the telecom space, Kyle has signed 3 large potentially highly profitable and long-term new contracts. We believe that each of these contracts would be amongst the largest in the company's history.

First, in June, Avanti signed a $10 million 2-year contract with Viasat for its HYLAS 4 satellite. Next, in August 2018, Avanti signed a 7-year master distribution agreement for HYLAS 4 with COMSAT, providing Avanti access to the U.S. government. Lastly, in September, Avanti announced a 7-year wholesale capacity lease agreement for $84 million with a major player in the satellite space. With these contract wins in place, we would expect to see significant revenue growth from Avanti going forward. That, coupled with its largely fixed operating costs, could ultimately translate into significant and recurring cash flow.

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 27. 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 $0.25 per share in NII, which covered our declared base distributions. This morning, we announced our distribution amount for Q1 2019 with a plan to continue to distribute $0.083 per share per month or approximately 8.3% of the September 30 NAV. The distribution schedule, including record date and payment date, will be set by GECC and communicated to shareholders in December.

Please turn to Slide 28 to discuss the recent significant block trade in our shares. As you may have seen, on October 22, MAST Capital Management LLC sold approximately 2.28 million shares of our stock in a block trade at a price of $7.55 per share to the seller and a price of $7.70 paid by the buyer. Neither GECC nor GEC or its subsidiaries were involved with this transaction. Given MAST's concentrated ownership of GECC, we would expect this trade would result in a more diversified shareholder base and enhanced liquidity in our shares going forward.

With that capital activity update, let me turn the call back over to Peter for closing remarks and 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 of the portfolios. 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) Our first question comes from Mickey Schleien with Ladenburg.

I'd like to ask what sort of opportunities, if any, you're seeing in the credit markets that are being caused by the volatility and dislocations in the equity markets and how that's affecting your investment strategy.

Mickey, thanks for that question. I would say what we're observing is sort of a bifurcated response to market volatility. There is -- the high-yield bond market seems to have responded more to that than has the leverage loan market. And certainly, any originations that we are looking at or considering at this point seem to have not responded much at all. So I think it depends upon the nature of the opportunity, ranging from some significant response to broader market volatility to none at all.

Okay. And how about within the energy sector? Are you seeing value in any energy credits that may be driven by the volatility we've seen there in the last few weeks?

There may be value in certain of those credits, but I can tell you that we don't have any in our -- we have a decent backlog of opportunities to fund. It's been a while since we raised incremental debt capital. We don't have any energy opportunities presently in our backlog, there very well may be value, which is -- those aren't on our list at the moment.

And our next question comes from Chris Kotowski with Oppenheimer.

Not sure to what extent you can comment on this, but these contracts that you noted for Avanti, and do you anticipate that that will generate sufficient revenue for them to meet their near-term debt and other obligations?

I think that those contracts, when coupled with the other contract wins and other business wins they've had but haven't announced publicly, position the company very well for revenue growth, ultimately cash flow and the ability to meet all of their obligations. So I think in totality, the business is on the right track to meaningfully improve its financial performance and deal with all of those obligations.

Okay. And then on your -- one of your other large positions, the PE Facility Solutions, I noticed those were marked up this quarter. And does that reflect the potential of a liquidity event there?

Sure. So PE Facility Solutions is valued by our third-party valuation firm, and that valuation is largely a reflection of excellent financial performance by the company. John Ehlinger on our team has a lot of time into rehabilitating the company, enhancing management, enhancing that company's board, and it's performing at a very high level right now.

We do -- we have been receiving for some time, as that investment has continued to improve its financial performance, a significant amount of inbound inquiries to acquire the company. I don't think at this point -- we don't have anything that we can say about that further at this point, but we do get a lot of interest in that. And to the extent that that interest matches a price that we think is fair, that probably would move us closer to a monetization event there.

Okay. And then could you also just briefly discuss the right-hand side of the balance sheet and your plans there? I mean, your balance sheet is modestly levered, but your liquidity position is tight at present or your cash position is relatively low. Can you just kind of discuss your outlook there?

Sure. So we filed for a registration statement for another baby bond issuance with the SEC staff. And once that registration statement is effective, and if the market is still attractive, we'd expect to be raising more debt capital. And candidly, we've had a backlog of investment opportunities for multiple months. So we continue to believe that they're -- that issuing a bond like that, at where we believe the market is, would drive meaningful incremental spread income for our stockholders. So that's something that we are excited to do if market conditions sort of hold constant.

(Operator Instructions) And speakers, I'm showing no further questions in the queue at this time. I'd like to turn the call back over to Meaghan Mahoney for any closing remarks.

Thank you, Jimmy, and thank you all again 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 in follow-up. Have a great day.

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