Great Elm Capital Corp. (GECC) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Corp.’s First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference maybe recorded. I would now like to turn the call over to Ms. Meaghan Mahoney. Ma’am, you may begin.

Thank you, Chelsea, and good morning, everyone. Thank you all for joining us for Great Elm Capital Corp.’s first quarter 2018 earnings conference call. As a reminder, this webcast is being recorded on Thursday, May 10, 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 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 the 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 brief overview of our realized position. Please turn to Slide 5 to discuss PR Wireless, Inc. PR Wireless, Inc.’s first lien term loan was a component of the legacy Full Circle portfolio. This loan traded at a discount to par subsequent to the merger closing, and we chose to add to the position at that time; supporting our investment thesis with the company’s significant collateral package, this loan’s seniority and its capital structure, its high current income and our view that there was the potential for a near-term catalyst. In February 2017 that catalyst occurred, PR Wireless announced a joint venture with Sprint in Puerto Rico and the U.S. Virgin Islands, which ultimately closed in Q4 2017. Upon the closing of this JV, Sprint contributed additional collateral as well as a credit enhancing guarantee. During April, we exited this loan at par resulting in a realized gain of approximately $800,000, and IRR of 20.3%, and a cash-on-cash return of 1.28 times of our investment in approximately a 1.5-year time. With that brief overview of PR Wireless, let’s next walk through a review of the quarterly financials, followed by a 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 now turn the call over to Mike Sell, our Chief Financial Officer, to discuss the financial results from the first quarter of 2018.

Thanks, Peter. Please turn to Slide 7 for a snapshot of the financial highlights from the quarter. For the quarter ending March 31, 2018, we generated $0.36 of NII per share as compared to approximately $0.25 per share in base distributions that were paid during the quarter. Turning to Slide 8. As of March 31, our net asset value was $125.6 million versus net assets of $132.3 million at the end of Q4. On a per share basis, this equates to $11.79 NAV versus $12.42 NAV at the end of Q4. This decrease in NAV per share is primarily driven by mark-to-market depreciation from our investment portfolio, most notably Avanti Communications Group PLC, Tru Taj, LLC and OPS Acquisitions Limited. As always, if there are any specific questions on any of these investments, we welcome them during the Q&A portion of this call or in a follow-up call. As of the end of the first quarter, the fair value of our investments was $194.8 million versus $164.9 million at the end of Q4. We also had $29.9 million in cash and cash equivalents, predominantly held in money market mutual fund investments. Now please turn to Slide 9 to walk through the quarterly financial review. Total investment income for the quarter ended March 31 was $7.5 million against net expenses of $3.6 million, resulting in net investment income of $3.9 million or $0.36 per share. This compares to total investment income of $9.7 million for Q4 against net expenses of $3.3 million, which resulted net investment income of $6.4 million and NII per share of $0.60 for the fourth quarter. Our Q1 distribution coverage was approximately 145%, as we earned $0.36 per share in net investment income and paid approximately $0.25 in the form of three monthly $0.083 distributions. Driving this coverage was the solid base of core NII generated from the portfolio, and the portfolio growing by 18% quarter-over-quarter. Net realized gains on investments were approximately $317,000, which equated to approximately $0.03 per share versus $0.02 per share in Q4 on gains of approximately $213,000. Net unrealized depreciation on investments during the quarter was $8.2 million, which equated to $0.77 per share. This compares to $1.6 million or $0.16 per share in Q4 of 2017. This was primarily driven by mark-to-market depreciation on our investment in Avanti, Tru Taj and OPS, while the reminder of the portfolio was slightly up. Now let me turn the call back to Peter to discuss portfolio highlights and activity.

Thanks, Mike. Let’s now turn to Slide 11 to discuss some of the portfolio highlights. Today, we have constructed a portfolio comprised almost entirely of senior secured credit instruments, with a weighted-average current yield of 14.8%. As of March 31, 99.8% of our invested capital was 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 $0.73 on the dollar, highlighting the upside potential in addition to the high current income. Lastly, approximately 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 from our most recent baby bond issuance into new opportunities. Turning to Slide 12, as of March 31, we had 30 debt investments across 23 companies that represented $194.3 million in fair market value and four equity investments representing $442,000 or 0.2% of invested capital. This represents portfolio growth of 18% from the end of the prior quarter. Please turn to Slide 13 to walk through our quarterly portfolio activity. On the investment front, during the first quarter of 2018, we made seven new investments and six add-on investments deploying $63.2 million at a weighted-average price of $0.99 on the dollar and a weighted-average current yield of 10.2% including revolver draws. All of these investments were first lien and/or senior secured instruments. As we’ve noted in prior quarters, given our view on the current state of the credit markets and our keen focus on downside protection, we believe our cautious capital deployment and relatively low balance sheet leverage will be rewarded in the long run. Despite that cautious stance, we’re pleased to report we made seven new investments and three add-on investments during the quarter, deploying nearly $44.8 million of capital into these 10 investments. Please turn to Slide 14. Our new investments in the quarter were the following. First, we acquired $10 million face value of Almonde’s second lien loan of 2025 in the secondary market at a price of 99.5% of par value; this loan bears interest at a rate of LIBOR plus 725 basis points per annual with LIBOR floor of 1%. Next we acquired approximately $2.2 million face value of Aptean second lien loan of 2023 in the secondary market at a price of 101% of par value; this loan bears interest at a rate of LIBOR plus 9.5% with a LIBOR floor of 1%. We also acquired an additional $1.8 million par value of this investment post quarter end. We also acquired $5 million face value of Foresight Energy’s first lien loan in the secondary market at a price of 99% of par value; this loan bears interest at a rate of LIBOR plus 575 basis points with a LIBOR floor of 1%. In addition, we participated in the origination of Full House Resorts, first lien note at a price of 98% of par value; this note bears interest at a rate of LIBOR plus 7% per annum with a LIBOR floor of 1%. Additionally, we acquired $5 million face value of Sungard’s first lien loan of 2021 in the secondary market at a price of 93% of par value; this loan bears interest at a rate of LIBOR plus 7% per annum with a LIBOR floor of 1%. Next funded $250,000 of newly originated first lien term loan at Tallage Davis at par; this loan bears interest at a rate of 11% per annum and its part of $15 million commitment to this Tallage entity. We funded an additional $1.8 million to the Tallage entity post quarter end. And lastly, we acquired approximately $1.7 million face value of Tru Taj’s first lien DIP note in the secondary market at a price of 104% of par value; this note bears interest at a rate of 11% per annum. Also as noted on Slide 15, we’ve made additional investments in three existing portfolio companies. First, we acquired an additional $4.5 million face value of International Wire Group second lien bond in the secondary market at a price of 95% of par value. Next, we acquired an additional approximately $4.5 million face value of Michael Baker’s second lien bond in the secondary market at a price of 98% of par value. And lastly, we acquired an additional $2.6 million face value of SESAC second lien loan in the secondary market at a price of par. We also purchased an additional $500,000 par value of SESAC post quarter end. All in all, an active quarter of deployment of capital into what we view to be attractive risk adjusted investment opportunity. As noted on Slide 13 and 16, we monetized $29.1 million across 12 investments at a weighted-average price of just above par and a weighted-average current yield of 11.1%. Slide 16, 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 maintaining keen focus on structurally senior investment with 100% of our capital deployed into first lien and/or senior secured instruments. We believe this encapsulates what we’re seeking to achieve here at Great Elm Capital Corp, applying the key principles of value investing and building a portfolio of attractive, risk-adjusted, special-situations opportunities that offer both high current yield and the potential for price appreciation. Slides 17 through 20 provide additional detail on the breakdown of the portfolio in terms of where our investments are located in 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 industry breakdown. Lastly, as noted on Slide 17, the weighted-average yields on both the fixed-rate and floating rate instruments in the portfolio at a 11.2% and 10.9% respectively, or well in access of the current distribution rate of approximately 8.45% of March 31 NAV. The next topic we want to cover with 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 21. In the year and a half, 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 nearly 70% of this portfolio at a net gain, exciting 22 positions, across 15 companies and realizing an aggregate total return of $4.2 million on these positions. And although, not all of the positions have been exited at a net gain the larger positions based on our initial cost basis have all had positive outcomes. We wanted to now walk through a brief update on Avanti Communications Group PLC, our largest portfolio position. Please turn to Slide 22. During the quarter, we had some positive news from the company. In December 2017, as referenced on our last earnings call, 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 of 2018, a majority of Avanti shareholders voted in support of this proposed restructuring allowing for Avanti to equitize the third lien notes and exchange for 92.5% of the company’s common equity. Avanti’s existing shareholders retain to remain in 7.5% of the company’s common equity. The restructuring closed in late April and GECC now owns approximately 9.1% of the company’s common equity. Also in April 2018, Kyle White have officially joined Avanti as its new CEO, replacing Alan Harper, who is previously the company’s Interim CEO. With Kyle starting in April, Alan resumed his role as a Non-Executive Director of the company. Kyle brings significant experience working with telecommunications companies in emerging market countries, similar to the ones that Avanti serves. Lastly, also in April, Avanti successfully launched, the much anticipated HYLAS 4 satellite, its largest capacity satellite today with coverage over parts of Europe and Africa. Those are a few of the positive developments at our largest portfolio company in the past month. With that, I will turn the call back over to Mike Sell to discuss recent capital structure activity.

Thanks, Peter. We will brief update this quarter with respect to capital activity. Let’s discuss our distribution policy first. Please turn to Slide 25. In March, our Board of Directors declared our distributions for Q2 of $0.083 per share per month. In our earnings release, we reported that we generated $0.36 per share in NII, which covered our declared base distribution by approximately 1.45 times. Yesterday, we announced our distribution scheduled for Q3 2018 with a plan to continue to distribute $0.083 per share per month or approximately 8.45% at March 31, NAV. Also as noted on our last conference call. In January and February 2018, we achieved $44.9 million, a 6.75% notes of 2025, ticker GECCM plus $1.5 million of the over-allotment option, for a total issue size of $46.4 million. This brings our total debt outstanding to $79 million as of today. 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 wanted to thank our stockholders for your significant support at last week Annual Stockholder Meeting. The majority of our stockholders voted in favor of reducing the asset coverage ratio from 200% to 150% in accordance with the Small Business Credit Availability Act. As of the end of Q1, we had approximately $79 million in par value of debt outstanding with an asset coverage ratio of 255% and debt to equity ratio of 0.63x significantly below the previous debt to equity ratio limit. We intend to continue to be prudent stewards of your capital deploying such leverage as credit market opportunities present. We also 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 one 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 have placed in us. With that, we will turn it over to the operator to open the call for questions.

Thank you. [Operator Instructions] And our first question will come from Owen Lau with Oppenheimer and Company. Your line is open.

Hi, good morning. Thank you for taking my question. I’m just wondering if there are regulatory requirement or any restriction for GECC to sell Avanti shares because GECC owns about 9% of the company and Peter is on the Board. I just want to understand better the regulations on that part. Thank you.

Hi, Owen, thanks for your question. We don’t have a lot of regulatory restrictions on selling those shares from time to time. While I’m on the Board of Avanti Communications, we may have – we may not be able to transact. But as a result of having information that’s not available in the marketplace and we need to transact in accordance with the company’s policies. But for that, we don’t have a lot of regulatory restrictions on our ability to monetize that position.

Okay, great. And regarding the new leverage limit, how would just think about your target leverage ratio going forward?

Sure. Also I think a very good and timely question. Starting, we typically run with meaningfully less leverage than our peer group in the BDC space. And while I don’t know what everyone else is going to do, we intend to take a pretty cautious approach to how and when we utilize the ability to increase leverage. And a chunk of that is going to be driven by the opportunity set that’s available to us in the marketplace, and a chunk of that is going to be driven by what the cost of that incremental debt capital is when we did feel like we’re generating an attractive spread for our stockholders. And since we’re in the – our belief is that we’re in the late innings of a credit cycle right now, we need to feel really good about the incremental assets that we’d be layering on, and we also need to feel that the cost of the incremental debt capital is attractive relative to the opportunity set on the asset side. So I expect that to be cautious and methodical about utilizing that if at all.

Okay, that’s great. Finally, for Tru Taj, I saw there was some marked on and then you put additional money into it. Can you please talk about the reason for that? And also any catalyst you’re seeing from this investment and also the recovery prospect? Thank you.

Sure. So Tru Taj is an interesting position that exhibits price volatility this year. We actually now own two instruments instead of one, one our senior secured notes and one our debtor-in-possession notes which are super priority. The bulk of the price decline or a big chunk of it that we experienced in the first quarter if you were looking on trades today you’d find a market price that is higher than the 3/31 balance sheet date and that’s because the company announced good news post quarter end or what news that the market perceived to be good. So that year we continue to collect our interest on both of those notes. And we continue to believe that that is an attractive investment opportunity. And we’ll have to wait and see, but an inclusion is probably not terribly far in the future given how that investment has played out so far.

Okay, thank you very much. That’s it for me.

Thank you. Our next question comes from Swaraj Chowdhury with Dorchester Capital. Your line is open.

All right, thanks for taking my question. My first question is about Avanti Communications. I went for the restructuring and the second lien is now trading at 8%. What thought process here? Do you think best of course for those extent you can share? Do you think post restructuring the company is self-sufficient, it will grow as HYLAS 4 has been launched and – or you believe the company may need additional money and there could be some more volatility in the immediate future?

Sure. So I’ll take those in pieces. The second part in connection, not terribly – in connection with its restructuring, the company has commented that under certain circumstances it’s possible that it may need more capital that should those circumstances arise, that’s not a surprise to the company’s board or to most of its investors that are close to the company. We believe that the company has levers to address that if those circumstances happen at this point because the company hasn’t put much more information than that in the public domain. I can’t go in – go a lot further into what those circumstances are, how they might play out or how the company might address them. But we believe that that will not be a – if it ends up being an issue to be dealt with, the company will have tools at its disposal to address it. As far as the restructuring, maybe I could take a step back and describe our view of Avanti Communications, which hasn’t changed in a long time, which is – the company has a world-class collection of assets that serve as collateral for our debt instruments. World-class satellites; it has an excellent network, it provides a very high-quality service to its customers, but up until recently the company had been very ineffective from a sales and marketing standpoint. Alan Harper when he became CEO started the process of making the company more effective. And we believe that he and the team have done a very good job. When Kyle Whitehill joined in April, we believed that he will significantly build upon it and accelerate the work that Alan has done. So yes, we do believe that Avanti’s revenues will grow rapidly in the future. I can’t tell you exactly when that will start, but given that the nature of that is relatively fixed operating costs each incremental dollar bandwidth revenue has a very high contribution margin and with a high quality service to sell and a leader with a great experience in turning around telecom companies in emerging markets. Some of which are big, important markets for Avanti, we believe Kyle will accelerate the effects in sales and marketing department and that will show up in the financials and we will eventually have substantial and rapid improvement in the company’s P&L.

Thank you. Thanks, Peter for clarifying. The second position I have a little question on International Wire Group, it’s also a public company and I saw their result year ending 2017. The ten and three quarters you have added the second lien bonds a $0.95, which is from – based on my calculation is about 5.5 times leverage and it’s maturing in August 2019. And it’s also 12.5% yield to maturity size. Is the thought process here as the company will refinance these notes at this time? There is very little market cap below that, but the leverage of 5.5 times are you comfortable with it?

We are comfortable with it. This is a company that we know very well. It has a lot of collateral, it’s probably best thought of as a collection of distinct businesses some of which we believe are extraordinarily valuable not all of that is easy to tease out from the consolidated financial statement.

Okay, that’s good. On Tru Taj, it seems there was asset sales process going on and received up almost $1 billion on the second round. Would the recovery of your debt financing and I understand the Tru Taj 12% notes is best on that, I mean, I was wondering why despite the sales proceeds – expected sales proceeds to be close to $1 billion wider, 12% bonds actually went down. Just wanted to know briefly, when do you think you will monetize these investments and what are the risks here?

So I think after the news of the billion – multiple billion dollar bids for the Asian operations which are gems of Tru Taj but not all of our collateral. The bonds traded up not down, the bonds traded down going into the quarter end and didn’t seem that traded up in response to the company’s counsel saying in an open courtroom they received multiple bid, north of $1 billion to the company’s Asian operations. So that lines up pretty nicely with an increase in trading price from the high 70s into to about $0.90 in trade off slightly since then. But we continue to think that the while the Asian operations in China and in Japan put away the gem there, we continue to think that the market underestimates the quantum and quality of collateral away from that and that – when this is all wound up that will yield a good recovery for our investment.

Okay. This private position which is I think the second largest position in your portfolio called PE Facility Solutions. I know you probably cannot share, but can you tell us what is the level of leverage where this first lien loan A and loan B would add and how this was –

We can’t because it’s private, we’re not sharing that. Maybe qualitatively what I could describe, this position was the biggest position in the legacy Full Circle portfolio or this is related to a company that was the biggest position in the legacy Full Circle portfolio. We now own a boat debt instruments and a control position in the equity at PE Facility Solutions. We’ve helped to enhance the management team. And the company is doing much better than it was then when the merger closed in November 20106. So we’re aware that it’s a big investment, the company’s performing significantly better than it was. And we feel good about where it’s position, we feel good about the company’s future growth and we would – we’re not going to be in the business of owning companies, owning the equity of companies forever. So when someone else in the marketplace recognizes the value that’s been built, we’ll probably monetize it at that time.

Okay, that’s very good. My last question about Almonde, could you be able to share a few words on Almonde, why you find it attractive, why you took $10 million in position?

Sure. Almonde, Inc. is the borrower that’s a subsidiary of a company it’s probably better known as Misys, which makes core bank transaction processing software, that has very high rates of renewal and in a role to the operations of very large banks that we believe are very reluctant to make any sort of changes given how integral it is to the operation, as a result of that we believe that Misys generates very attractive cash flow has a demonstrated ability of raising prices while keeping customer renewals and has a demonstrated ability of making attractive add on acquisitions, that complement it in strength and be getting business. The results of which is a very attractive steady and growing cash flow profile and is backed by the preeminent private equity firm in the enterprise software space this equity partners.

Okay, thank you. Thanks, Peter.

You’re welcome.

[Operator Instructions] I’m showing no further questions at this time. I’d now like to turn the call back to Miss. Meaghan Mahoney for any closing remarks.

Thanks, Chelsea. Thank you, 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 participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.