Great Elm Capital Corp. (GECC) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Great Elm Capital Corp's Second Quarter 2019 Financial Results. 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, this conference is being recorded. I'd now like to turn the conference over to Adam Yates. Mr. Yates, you may begin.

Thank you, Tiffany, and good morning, everyone. Thank you for joining us for Great Elm Capital Corp's second quarter 2019 earnings conference call. As a reminder, this webcast is being recorded on Tuesday, August 13, 2019. 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 Web site www.greatelmcc.com. The slide presentation accompanying this morning's conference call and webcast can be found on our Web site under Financial Information, Quarterly Results. On the Web site, you can also find a copy of our earnings release, Form 10-Q and the link to the webcast. 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 Web site under Financial Information, SEC filings or visit the SEC's Web site. 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, Adam. Good morning and thank you for joining us today. I'm joined this morning by our COO, Adam Kleinman; Portfolio Managers, Adam Yates and John Ehlinger; and our CFO, Keri Davis. Where relevant, in our prepared remarks, we will point you to the corresponding slide number in the deck that Adam referenced, which is available on our website as well as through the webcast. Please turn to slide 3 for an overview of GECC. GECC is an externally managed special situations-focused BDC. GECC seeks to generate both current income and capital appreciation from its portfolio of investments composed primarily of secured loans, secured bonds and specialty finance investments. As of June 30, 2019, GECC had total assets of approximately $334.6 million, a portfolio fair value of $204.2 million and a net asset value of $103.6 million, equating to $10.30 per share. The weighted average current yield on our debt holdings was approximately 11.4%. GECC pays an $0.083 per share base monthly distribution that equates to approximately $1 per share on an annual basis. Importantly, greater than 20% of GECC's shares are held amongst GECC insiders creating a very clear alignment of interest between management and our shareholders. Let's turn to slide 4 to go over a few highlights and recent achievements. I'm pleased to report that GECC's net investment income has covered its declared distributions every quarter since inception in 2016. Over the trailing 12 months, GECC has paid $1.24 in total distributions consisting of an $0.083 monthly base distribution and a $0.24 special distribution. Based on June 30's NAV and closing market price that total distribution equates to an annual distribution yield of 12.0% and 14.2%, respectively. During the quarter, we deployed capital at a weighted average price of 98% of par and we monetized investments at a weighted average price of par. On slide 6, we highlight a few high level characteristics of the portfolio. The weighted average current yield on our secured debt holdings, which comprise approximately 85% of the fair value of the portfolio, is approximately 11.4%. The weighted average price of the debt investments in our portfolio is approximately 90% of par providing for significant potential capital appreciation. Moreover, as we have monetized legacy full circle positions and redeployed the proceeds into new and existing Great Elm investments, the portfolio continues to better reflect our investing style and approach. As of June 30, roughly 84% of the portfolio was comprised of investments that are representative of the diversified manner, in which we intend to invest going forward. Slide 7 describes additional portfolio characteristics. The portfolio contains 34 investments, 27 of which are secured debt and seven are equity. The 27 debt investments account for $173.2 million of fair value and the seven equity investments account for approximately $31 million of fair value. Of our total debt holdings, roughly 74% are floating rate instruments and 26% accrue at fixed rates. Please turn to slide 8 to review our capital activity during the fourth quarter. We deployed almost $62 million into 15 investments at a weighted average price of 98% of par and a weighted average current yield of 10.9%. We monetized in part or in full, 16 investments at a weighted average dollar price of par and a weighted average current yield of 10.8%. Slide 9 and 10 review our capital deployment in greater detail. We purchased investments in five new and four existing portfolio companies during the quarter, deploying approximately $40.4 million. The new investments were $12 million of Research Now, the second-lien term loan, $5.4 million of Avanti's new 1.5 lien secured term loan. $5 million of Shearer's Foods secured term loan $2.3 million of Peninsula Pacific Entertainment secured term-loan and $500,000 of Tensar secured term loan. Additions to our existing investments included $6 million of Boardriders secured term loan, $4.5 million of APTIM secured notes, $4 million of California Pizza Kitchen's secured loan and $2 million of SESAC second-lien term loan. Please turn to slide 11 to breakdown the quarter end portfolio by asset and interest rate type. Approximately 85% of the fair value of the portfolio is invested in secured debt with the balance in equity investments. That's roughly $173.2 million of debt and $31 million of equity. Of the $173.2 million of debt holdings, roughly $128.8 million is invested in floating rate debt with a weighted average current yield of 11.2%. Roughly $44.4 million is invested in fixed rate debt with a weighted average current yield of 11.9%. On slide 12, we highlight how the composition of the portfolio has changed over time. Today the portfolio has no unsecured debt as we continue to source and purchase attractive secured opportunities. In addition, the acquisition of a majority of Prestige Capital Corporation's equity interest in the first quarter expanded our equity holdings. Given Prestige's encouraging performance, over time, we seek to increase our exposure to similar specialty finance businesses with little correlation to our broader secured credit portfolio. Turning to slide 13. I'd like to note that floating rate debt has encompassed a growing percentage of the portfolio quarter-after-quarter. Specifically, our team has been focusing on leverage loan opportunities that are uncovering in the secondary market. Recently, we found greater opportunity in the leverage loan market than in the more transparent high-yield bond market and we anticipate that this trend may continue. On slide 14, we break down the portfolio by industry. Wireless telecommunication services comprised of our investments in Avanti is still the largest industry leading. Nevertheless, we continue to maintain a diversified portfolio of investments as indicated by the 20 different industries represented. Please turn to slide 15 to take a historical look at GECC's portfolio rotation. During each of the past 11 quarters since inception, we've monetized higher dollar priced investments and deployed capital into lower dollar priced investments, contributing to GECC's total return. Most recently in the second quarter of 2019, we deployed capital at a weighted average price of approximately 98% of par and we realized investments at a weighted average price of par. Again, substantially all of the debt capital deployed was invested in first lien and/or secured debt. Turning to slide 16, we get a more granular picture of what GECC's investment activity looks like quarter-over-quarter. We've been able to find interesting debt investment opportunities at prices below par in each of the past five quarters. This past quarter, we were able to invest capital at a 10.9% average current yield, higher than last quarter's current yield and largely in line with our recent trend. Please turn to slide 17 for an update on Avanti. When we formed GECC, Avanti was struggling to monetize the capacity of its satellite network. As Avanti encountered financial difficulty, we worked with other key creditors to improve the company through deleveraging its balance sheet, launching its biggest satellite to date and identifying and recruiting new Board members who brings stability and strategic insight into company. These improvements paved the way to hire Kyle Whitehill as the new CEO in April of 2018. Since Kyle's start, he has dramatically overhauled sales and marketing, resulting in large contract wins and rapidly growing recurring core bandwidth revenue. With the business heading in an exciting direction, Great Elm and other significant Avanti stakeholders were given the unique opportunity to participate in the new 1.5 lien delayed draw term loan facility. As you can see from the tables on the bottom of the slide, the debt carries not only an attractive interest rate, but also a significant fee that accretes to GECC's benefit. On its current trajectory and with minimal required capital expenditure, we expect that Avanti will have visibility into generating positive unlevered free cash flow. Turning to slide 18. Let's review our investment in Prestige Capital Corporation. It's been six months since our acquisition of Prestige and the company continues to exceed our expectations. Prestige is ahead of budget with annualized fiscal year 2019 pretax income of approximately $3.8 million versus our expectation in February of approximately $2.4 million. Stuart Rosenthal, President and Alan Eliasof, CEO have done terrific job of continuing to grow the business at an impressive rate, while maintaining extremely low credit loss frequency. In June, GECC received its second distribution from Prestige, totaling $400,000 and annualizing to a greater than 20% yield on GECC's initial investment. Prestige generates meaningful earnings with little correlation to GECC's corporate credit portfolio. We're certainly interested in expanding and diversifying GECC's investments in the specialty finance channel. On slide 20, we detail our activities since quarter end. In particular, I would note, our sale of PE Facility Solutions assets to Kellermeyer Bergensons Services for $23.75 million. Proceeds from the sale paid down the entirety of GECC's revolving loan and term loan A and a portion of GECC's term loan B to PEFS. This substantial repayment represents a big win for our team, who worked hard over the past few years to rehabilitate this troubled company related to the largest Full Circle Capital Corp. contributed investment. As you can see from August month-to-date activity on slide 21, we're already hard at work at reinvesting the proceeds from the sale. Let's turn to slide 23 to review financial highlights from the quarter. Net loss per share was $0.43 in the first quarter. NII per share came in at an impressive $0.29 covering our $0.25 quarterly base distribution by a wide margin. We expect – we experienced net realized gains of approximately $0.04 and net unrealized losses of $0.76, primarily the result of fluctuations in the fair value of our Avanti investments. Net asset value or NAV was $10.30 per share at period end. Please turn to slide 24 for a financial overview of the portfolio. At period end, total assets were $334.6 million total fair value of investments was $204.2 million, and our $10.30 per share NAV equated to an aggregate NAV of $103.6 million. Total debt outstanding increased to $121.5 million, as we issued a new senior unsecured note under NASDAQ ticker GECCN. Cash and money market investments were a healthy $52.8 million at period end. Slide 25 details select financial performance during the quarter. Total investment income was approximately $6.7 million or $0.66 per share. Net expenses were approximately $3.7 million or $0.36 per share. NII was approximately $3.0 million, or $0.29 per share. Net realized gains were approximately $0.4 million or $0.04 per share. Net unrealized depreciation from investments was $7.8 million, or $0.76 per share. Turning to slide 26, let's discuss the quarterly operating results. Total investment income of $6.7 million or $0.66 per share compares to the first quarter $6.3 million, or $0.59 per share. Net operating expenses of $3.7 million, or $0.36 per share were marginally greater than the first quarter's $3.5 million or $0.33 per share. Importantly, NII of $3.0 million or $0.29 per share was greater than the first quarter's $2.8 million or $0.26 per share as we increased the size of our portfolio and repurchased shares during the quarter. Let's turn to slide 28. Let's discuss GECC's distribution policy and declared distributions to date. GECC continues to pay an $0.083 per share monthly base distribution that sums to $1 per share per year. In December, we announced a special distribution of $0.24 per share bringing the past 12 months' total distributions to $1.24 per share. The past 12 months total distributions represent a 12% dividend yield on the June 30, 2019 NAV and approximately 14.2% dividend yield on the quarter end market value. Slide 29 shows GECC's full distribution history and overlays what the annual distribution yield was as a percentage of the market price. GECC's substantial special distributions in each of the past two years when combined with the monthly base distributions have driven annual distribution yields well north of 10% in each full year since inception. Slide 30 illustrates our historical distribution coverage. Again it's important to emphasize that NII has covered the base distribution every quarter since inception in 2016. Finally, please turn to slide 32 for a GECC summary. Our Board has set fourth quarter 2019 distributions at $0.083 per share per month. Also importantly, GECC insiders own greater than 20% of GECC's outstanding shares fostering it through alignment of interest between insiders and other shareholders. Furthering that alignment of interest to-date, GECC has repurchased approximately 22% of its initial share count. The weighted average current yield on our diversified portfolio of secured loans and bonds is greater than 11% and the IRR on our growing pool of realized investments is a substantial 21%. Thank you 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 monetizing legacy positions. We believe that we have created a significant alignment of interest with you our shareholders. Thank you again for the support and confidence that you have placed in us. With that we will turn the call over to the operator to open for questions.

Thank you. [Operator Instructions] And our first question comes from Mickey Schleien with Ladenburg Thalmann. Please proceed.

Good morning, everyone. Peter, could you please walk us through the Board's assessment of the Avanti second lien's valuation which was at 74 versus some trades during the quarter in the sort of 33 to 43 price range?

Sure. Hi, Mickey. So what we go through our normal valuation policy and our outside independent valuation firm in this case Lincoln International goes through and assesses any trading activity to determine if they believe there's significant enough liquidity to take the market prices indicative of value. In this case as has been the same for a number of quarters in a row, they have determined that there wasn't enough liquidity to take that market price. So as they have done for a number of different quarters, Lincoln did a full valuation of the -- of all of our bond -- of our two debt positions. Included in their full valuation is information that we provided then that is nonpublic on the basis of having access to that information by virtue of having Board representation. So Lincoln went through their methodology, which does take into account any Bloomberg valuation for example and any reported trades as part of it. And the output of that is what you see in our financial results.

Peter, do you have any sense as to the nature of the sellers of those positions? In other words were they distressed in some fashion and perhaps that led to the pricing that we saw?

Mickey, well, one of the tough things about that market is it -- pretty significant opacity. So, what I can tell you is largely hearsay and rumor. But the market hearsay and rumor is that -- probably the largest seller of that was in -- was probably in a distressed position or fund liquidation mode.

Okay. Switching gears Peter what's the outlook for monetizing the TRU Taj equity?

Outlook for monetizing the TRU Taj equity is I'd say as follows. Obviously, that having at the moment non-yield-producing equity is not optimal for our portfolio, so we are looking to monetize that at some point. That will depend upon the valuation. The company has emerged from bankruptcy as a debt-free or largely debt-free business and generates significant free cash flow. So, I don't know it will be non-yield-producing equity forever. But at the moment, we aren't receiving any dividend distributions on it. We own a not particularly big percentage of the company, so I would think there will be a point in time when we would be able to monetize that at a reasonable value. That being said the company's sort of clean separation from its troubled parent which went through one of the messiest bankruptcies in memory really just completed in April with being sort of standalone. So, it's still early days and that company's standing on its feet and I think the marketplace there's been no trading that I can think of in the equity. And so I think market participants are trying to figure out how things are shaking out after an involved process to separate itself from its very troubled former parent. But we'll be evaluating that for opportunities to monetize.

Yes, that's helpful. I want to ask about Prestige Capital. I see that they provide many types of financing. Can you give us a sense of their main businesses, particularly how much is cash flow lending versus ABL lending?

Sure. Mickey, there's no cash flow lending and there's really no ABL lending either. It's primarily a spot factoring business.

Okay. And what's the average EBITDA sort of their typical borrower?

I don't know but I would think that there's little to no EBITDA as they're not in the spot factoring business. They are largely evaluating the credit risk of the -- what they would call the account debtors or the receivables that they're buying from a borrower who is not particularly creditworthy and they are taking on credit risk of highly creditworthy companies, which is why I think their realized credit losses over a 25-year history are very, very low.

Okay. So, if I could summarize these are borrowers that in some fashion might be distressed or not profitable, but they have a package of decent inventory receivables that Prestige lends against in probably a short-term basis, is that right?

So, it's close. And to nitpick on details because Alan and Stuart will yell at me if I describe the business as lending, because they're very clear that it's not lending, it's factoring. But a decent profile would be on earlier stage fast-growing company that is not all that creditworthy on its own. Prestige advances funds to that company and buys their receivables from large creditworthy companies, think of like a Costco, for example. They purchase those receivables at a discount then collect the receivables as the account debtors pay them. And so, that's how they make money.

So that's an interesting business and we've seen other BDCs going to that business. I'm curious about your thoughts about how that sort of business could perform in an economic downturn and how sustainable do you think this sort of 20-plus-percent return you're getting is.

So, we believe, it's very sustainable. The Prestige had a very long multi-decade history of operating, so they've been through a number of economic downturns. And since you're taking very little fundamental credit risk, because you're predominantly buying receivables of large creditworthy companies, usually your losses come from fraud not from inability of our account debtors to pay. So as a result of that, one of the things that we like about it is, we would expect in a downturn with the strength of our balance sheet that they -- there would be more demand for their services and we can, on an as-needed basis, provide them more capital to grow the business. We have very little concern about their ability to underwrite credit and how that will perform in a downturn. And so, we're pretty enthusiastic about the business and our long-term ownership prospects. And we do believe that the yield that we've received so far is sustainable and representative of how we underwrote the deal.

Okay. And from the prepared remarks it sounds like you're looking to do more investing in this space. Would that be other portfolio companies, or are you looking for tuck-in acquisitions that you can add to Prestige?

The answer to that is both. Prestige is in dialogue with relative frequency about tuck-in or add-on acquisitions. And we have also, both independently and with Prestige management team, looked at other specialty finance operations, which would include factoring, but also might include an ABL lender.

All right. And just a couple of more simple questions and I'll finish. Any background you can give us on the outlook for mass capital unwinding for the rest of its shares?

I really don't know. I'm observing the same things that you probably are through the 13D and the Form 4. It's been a number of years since I was an employee there, so I really don't have any insight into the operations or motivations of those sales. I'm just observing the trades as they are reported on SEC filings.

Okay. Finally, you've reported some nice supplemental dividends the last couple of years. Can you give us an estimate of where your current spillover taxable income is?

I don't have that at the moment, but I'm happy to follow up offline with our best estimate of where we stand today.

Do you think it's conceivable to pay another supplemental in this $0.20 $0.25 range at some point?

I think it is conceivable that we will pay another special distribution. I think that as far -- it's too early to say on the amount. We're very pleased with the income we've generated in the quarter and year-to-date. As you can imagine, we have a fair bit of redeployment activity. So the open question in all of our minds and risk to our forecast in either direction, up or down, is the deployment of those proceeds from PE Facility Solutions and other payoffs that we've had recently.

Understood. That’s really helpful. Those are my questions. I very much appreciate your time today.

Thank you, Mickey.

Thank you. [Operator Instructions] Our next question comes from David Sheridan with Boenning & Scattergood. Please proceed.

Hey, Pete. Thanks for taking my call. Just two questions. One, the $45 million you just raised in the preferred offering, what are your initial plans for that -- those funds?

Sure. Hey David, and thanks for participating on the call, and thanks for your questions. We are deploying those proceeds and we're not fully deployed. But consistent with how we have been deploying for the last few quarters, which is largely in performing secured loans, I think the weighted average current yield of that is just a touch under 11%, and I would expect that the deployment of the rest of the proceeds would more or less approximate that kind of statistic.

And would you use any of these proceeds to continue to share buybacks?

We've repurchased a healthy amount of shares. We -- at the moment, we don't have any plans, but we certainly will update the market as that happens. And we're pretty aware of the recent trading price activity, which makes it more appealing than it was a month ago that's for sure. But at current, we don't have plans.

All right. Thank you, and congratulations on another great quarter.

Thank you.

Thank you. I'm currently showing no further questions in queue. This concludes the Q&A session. I'd like to turn the call back over to Adam Yates for closing remarks.

Thank you, again, for joining us this morning. We look forward to continued dialogue, and please do let us know if we can be helpful with anything in follow-up.

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