Great Elm Capital Corp. (GECC) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Great Elm Capital Corp. Fourth Quarter 2020 Financial Results Call. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions] I would now like to hand the conference over to a representative of the company. Please go ahead.

Thank you, and good morning, everyone. Thank you for joining us today for Great Elm Capital Corp.'s fourth quarter earnings conference call. If you would 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, www.greatelmcc.com. In addition to our comments for today's call, we'll be utilizing investor presentation as an accompaniment. While we will not be directly referring to the slides, our comments today will generally follow the formal structure of the presentation. The slide presentation accompanying this morning's call and webcast can be found on our website under Financial Information, Quarterly Results. On the website, you can also find a copy of this presentation, our earnings release, Form 10- K and a link to the webcast. I would like to call your attention to the customary safe harbor language regarding forward-looking information. Also, please note that nothing in today's call constitutes an offer to sell or 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 SEC filings, please visit Great Elm Capital Corp.'s website under Financial Information, SEC Filings or visit the SEC's website. Hosting the call this morning is Peter Reed, Great Elm Capital Corp.'s President and Chief Executive Officer. As a reminder, this webcast is being recorded on Tuesday, March 16, 2021. With that, I'd now like to turn the call over to Peter. Please go ahead, Peter.

Thank you, Adam. Good morning, and thank you for joining us today. On today's call, we have our COO, Adam Kleinman; and our CFO, Keri Davis. I will begin with an overview of GECC's investment performance during the quarter, discuss the challenges that we face and the impact on the period and explain where we are subsequent to year-end. Keri will then discuss our capital position in greater detail, and then I'll return for closing remarks. Overall, despite the uncertainty of the pandemic on the economy, credit markets in general and specifically on our portfolio companies, we are pleased to exit 2020 in a solid financial position and with dry powder to continue the progress made in repositioning our portfolio. GECC is an externally managed total return-focused BDC. We seek to generate both current income and capital appreciation from its portfolio of investments comprised primarily of secured loans, secured bonds and specialty finance investments. The business currently has total assets of $283.3 million with $79.6 million of net asset value or $3.46 per share and pay a quarterly dividend of $0.10 per share. The weighted average current yield on our debt holdings was approximately 11.7%. Directors of GECC, employees of GECM and officers and directors of GECM's parent, including investment funds managed by directors of GECM's parent, own approximately 42.5% of GECC's outstanding shares. As we discussed during our second quarter 2020 conference call, our management team and Board made the determination to reposition our portfolio, which we believe was necessary in order to better strengthen GECC's ability to compete in the market. We've had success in our specialty finance business, Prestige Capital. It's impossible to conduct a thorough analysis of our operations to date without first discussing the rights offering that the company completed in October 2020. Throughout our history, we have sought to increase liquidity in a manner that is most advantageous to our shareholders including, where appropriate, fixed rate debt. As we evaluated our needs going forward, our Board of Directors determined that a nontransferable rights offering would further strengthen GECC's balance sheet and allow GECC to take advantage of being nimble in a period of market dislocation. We received aggregate gross proceeds of $31.7 million, strengthened our ability to grow the BDC significantly. Our asset coverage ratio at year-end was 167.1%. We are in an excellent position to pursue new investment opportunities, compelling values on a risk-adjusted return basis. NII for the quarter ended December 31, 2020, was approximately $1.6 million or $0.07 per share as compared to NII of $1.9 million or $0.18 per share for the quarter ended September 30, 2020. NII was impacted by slower-than-anticipated deployment of capital following the completion of the company's rights offering, repayments and higher-than-anticipated legal expenses. The biggest impact on our fourth quarter was further depreciation on certain legacy portfolio companies, offset by strong performance from our more recent loans and securities as we have continued to reposition the portfolio. This included Davidzon Radio, Luling Lodging and TRU Asia, although we saw encouraging financial results from TRU subsequent to year-end. As many of you know, a long time legacy investment of Great Elm is Avanti Communications Group, which is a U.K.-based satellite operator selling wholesale satellite broadband and satellite connectivity services. On a cost basis, Avanti is the largest individual company investment that we hold. Prior to quarter end, Avanti had uncertainty around the maturity of its first lien debt. Subsequent to year-end, the company did refinance and extend this facility while also securing a number of new business wins. However, due to this uncertainty at December 31, we reported higher-than-expected unrealized depreciation for the position in the fourth quarter that served to negatively impact investment income for the quarter. The impact of this depreciation served to overshadow strong performance at recent investments such as Crestwood, APTIM and Tensar. We expect over time to exit legacy positions in favor of more strategic deployments of our capital. Our goal is to work to build our portfolio coming out of this restructuring in a gradual and impactful manner that better represents the strategic direction of Great Elm. To that end, I want to discuss our capital deployment during the fourth quarter. While the pace of new investments was not as robust as we would have liked early in the fourth quarter, we are seeing an excellent pipeline of opportunities in the early part of 2021. We closed the transaction during the quarter with a company called Lenders' Funding and are participating in one of their factoring participations. This transaction has performed exceptionally well to date, and we intend to be do -- to do more business with Lenders' Funding in the future. Our criteria remain strict in that we want to avoid end-market concentration and are utilizing a number of sourcing channels as we redeploy the capital that we have raised over the past few months. Again, our focus has been on specialty finance, partially because of the favorable returns and opportunities generated from our investment in Prestige Capital and generally, a higher amount of demand in that sector. More specifically, our time has been concentrated in the following subsectors: asset-based lenders, equipment-leasing companies, factoring businesses and merchant cash advance providers. Prestige is a New Jersey-based company that for over 34 years has been a provider of spot-factoring services, growing into a leader throughout the market. With more than 30 years in business and through greater than $6 billion of transactions factored, Prestige has a track record of strong credit underwriting with minimal losses. In 2019, the company's pretax income was approximately $2.8 million. In 2020, Prestige's pretax income increased to approximately $4 million on a preliminary unaudited basis. The company's growing profitability and new business pipeline continue to exceed our internal expectations. It has been an ideal relationship to date. GECC's balance sheet enables Prestige to increase the size of the transactions it can pursue, and our investment in Prestige may create opportunities that would allow GECC to participate in certain of Prestige's larger factoring transactions directly. This would be at potentially higher rates of return and stronger underlying credit quality than more traditional leverage credit investments, and we completed 3 of these investments in 2020 at a rate of 13% per annum. Unlike investments sourced in the secondary market or as part of a syndicate, these transactions would be proprietary to GECC and unique to our portfolio. We expect to close more of these in 2021. With that, I would like to turn it over to Keri to discuss our portfolio performance for the quarter.

Thanks, Pete. I'll provide a basic overview of the Great Elm BDC portfolio and close with investment activity during the period. Our December 31 portfolio contained 41 investments, 31 of which are debt, and 10 of which are equity. The 31 debt investments account for $108 million or approximately 71% of the fair value, and 10 equity investments account for approximately $44 million of fair value in the portfolio. The weighted average current yield on our debt investments was 11.7%, while the weighted average current yield of our income-generating equity investments in Prestige and Crestwood Equity Partners is approximately 15.2%. We intend to grow the yield-generating equity portion of our portfolio as we target income-generating specialty finance investments to expand and diversify our holdings. We increased our equity investments from last quarter, and it's important to note that 3 of the 10 equity investments totaling approximately $27.4 million of fair value at December 31 are income-generating equity investments. Of the $108 million of debt holdings, roughly $59 million is invested in floating rate debt with a weighted average current yield of 9.4%. Roughly $50 million is invested in fixed rate debt with a weighted average current yield of 14.7%. Our portfolio is currently heavily weighted in the wireless telecommunications service business due to our largest holding, Avanti. However, as we grow our investments in the specialty finance space and further diversify our holdings, we expect the portfolio to generally be less concentrated with additional focus in the specialty finance sector. As Peter noted earlier, we saw higher-than-normal number of prepayments during the period and exited 12 positions. We've been able to successfully find compelling debt investment opportunities at prices below par in each of the last 6 quarters with this past quarter's weighted average price of new debt investments at a recent low. This past quarter, we were able to deploy capital at a weighted average price of 92% of par and monetize investments at 100% of par. In the fourth quarter, we monetized a considerable portion of capital, nearly $44 million. We continue the process of repositioning this capital with $35.3 million in new investments. More importantly, we continue to see stability in our weighted average current yield, which was 11.7% at the end of the fourth quarter. Moving to financial highlights. I'll go through these quickly but invite all of you to review our press release, accompanying presentation and, of course, our SEC filings. Total weighted average shares outstanding increased to 22.2 million for the quarter from 10.7 million in the prior quarter. Net loss per share was $0.43 per share in the quarter compared to net income of $0.72 per share in the prior quarter, largely due to the increased unrealized depreciation Peter noted earlier. NII per share came in at $0.07 compared to $0.18 in the prior quarter. Net asset value, or NAV, was $3.46 per share at the end of the period, which reflects the increased shares outstanding following our rights offering and stock distribution. At December 31, total assets grew to approximately $283 million compared to $265 million in the prior quarter. Total fair value of investments was $151.7 million compared to $169.5 million in the prior quarter. And NAV equated to $79.6 million, up from $60.5 million in the prior quarter. Total debt outstanding was approximately $118.7 million and was comprised entirely of our unsecured baby bonds. Our outstanding debt balances decreased quarter-over-quarter throughout the year as we repurchased baby bonds at a significant discount to par, reducing both interest expense and our future obligations. Currently, we are looking at varying options given the favorable refinancing market surrounding BDCs in general, while always seeking areas in which to improve the spread between our yield and our cost of capital. Cash was $52.6 million at the end of period, a significant increase over the prior quarter. And with that, I'll turn it back to Pete for closing remarks.

Thanks, Keri. I'd like to close with our dividend and capital deployment and then discuss the positive and impactful change at GECC in general. We declared a $0.10 cash distribution to shareholders of record on March 15, 2021, with a payable date of March 31, 2021. We also announced this morning that we will be paying a $0.10 per share cash distribution to shareholders for the quarter ending June 30, 2021. This represents an indicated yield of 11.5% on NAV at year-end and an 11.0% yield on our common stock price as of Friday's close. Moreover, we feel this positions the company favorably where it can examine the dividend on a quarter-by-quarter basis with the potential for increasing as conditions warrant. We've made considerable progress since our announcement of the restructuring of our portfolio in the second quarter. We had difficult and challenging decisions to make during a period of economic uncertainty, and we made them. Throughout the process, we strengthened our balance sheet, have conducted a sizable turnover in our portfolio in a short amount of time at a favorable yield and now have the leveraging capacity to grow. Finally, as an externally managed BDC, Great Elm Capital Management, or GECM, is responsible for the day-to-day investment decisions impacting the BDC, and we are pleased to have added 2 new members to our Investment Committee from Imperial Capital Asset Management; Jason Reese and Matt Kaplan. Jason has been Executive Co-Chairman of Great Elm Group's Board of Directors since February of 2020 and is the Co-Founder, Chairman and Chief Executive Officer of Imperial Capital Asset Management. Matt joined ICAM in 2020 after spending 4 years at Citadel from 2015 through 2019, investing in special situations and event-driven credit and equities. This is a significant development for the BDC. Our goal has been to both strengthen and broaden GECM's reach and financial acumen. We've worked with ICAM for several periods now. We show the same philosophy about investment opportunities in credit markets. We are very pleased to have the benefit of Jason and Matt's expertise, and look forward to working closely for the benefit of all shareholders in the future. With that, we will turn the call over to the operator to open it for questions.

[Operator Instructions] Our first question comes from the line of Nat Stewart of N.A.S. Capital.

It's interesting. I've kind of followed along with the repositioning. The question I have, just I was curious what else you can tell us about how you're going about the search for more businesses like Prestige. Obviously, that was a big win. If you could find a few more like that, that would be great. I assume there are pretty niche businesses with that type of return, probably hard to find, and also, a lot of people wouldn't really want to sell it. So I'm just curious, is there anything else you can tell us about that process or what you're finding as you search for more specialty finance businesses?

Sure. So Nat, I think that's a great question. I think there's a lot of truth in what you've just said. There definitely tend to be niche businesses. Each kind of sub-niche has its own dynamics. That being said, getting the first one done, Prestige is probably the hardest part. And I think the quality of the relationship that we've built there has led to warm introductions with other people that they know. And so we've had an awful lot of conversations with a variety of different companies that fit a similar profile. They aren't all-in factoring, but what we're looking for is a team that's been together for quite some time, has a really good credit underwriting history, has a very profitable niche business and then ideally, on top of that, like Prestige, is able to benefit from an institutional-sized balance sheet for those few instances a year where they have a very interesting transaction opportunity, but the size of that opportunity is bigger than they would stomach on their own. So that's a bit of the profile. We have a lot of conversations ongoing. It was disappointing to not get more done in the quarter. We did close a participation opportunity with a group called Lenders' Funding, and we're very pleased with that and believe that we will have more of those transactions in the coming quarters.

That sounds good. I think that could give the BDC a really nice focus if you're able to execute on this repositioning. And I wish you luck.

Thanks, Nat. Appreciate it.

[Operator Instructions] And at this time, I'd like to turn the call back over to management for closing remarks.

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

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.