Great Elm Capital Corp. (NASDAQ:GECC) Q1 2024 Earnings Call Transcript

Great Elm Capital Corp. (NASDAQ:GECC) Q1 2024 Earnings Call Transcript May 3, 2024

Great Elm Capital Corp.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, ladies and gentlemen and welcome to the Great Elm Capital Corp First Quarter 2024 Financial Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, May 2, 2024. I would now like to turn the conference over to Garrett Edson, representative of the company. Please go ahead.

Garrett Edson: Good morning, and thank you everyone for joining us for Great Elm Capital Corp’s first quarter 2024 earnings conference call. 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, www.greatelmcc.com. I’d like to note the slide presentation posted on our website accompanying today’s call. The slide presentation can be found on our website under Financial Information, Quarterly Results. On our website, you can also find our earnings release and SEC filings. 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 solicitation of offers to purchase our securities.

Today’s conference call includes forward-looking statements, 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 statements. 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 Matt Kaplan, Great Elm Capital Corp’s Chief Executive Officer who will be joined by Chief Financial Officer, Keri Davis; Chief Compliance Officer, Adam Kleinman; and Mike Keller, President of Great Elm Specialty Finance. I will now turn the call over to GECC’s CEO, Matt Kaplan.

Matt Kaplan: Thanks, Garrett. Good morning and thank you all for joining us today. We had a solid start to 2024 making further significant strides in our growth strategy as reflected in strategic initiatives we have undertaken in the beginning of the year increasing our asset base by over 20% as well as expanding our reach into structured products. In February, we raised $24 million of equity at net asset value from a special purpose vehicle supported by a $6 million investment by Great Elm Group. This capital raise not only strengthened our financial position, but also provided a template for future capital raises and investment opportunities. The successful completion of this non-dilutive equity raise is a testament to our portfolio repositioning efforts over the past two years further empowering us to grow Great Elm, while enabling us to execute on our robust investment pipeline at greater scale.

Subsequent to quarter end, we also successfully completed an underwritten public offering of $34.5 million of 8.5% notes due in June 2029. We were pleased to issue these notes at a more than 50 basis point spread to treasury improvement as compared to the August 2023 note offering. We believe this financing rate improvement was driven by our strong earnings, fresh equity capital and the Egan-Jones rating upgrade to BBB flat from BBB minus since our August offer. Our timing was also prudent in hindsight with the five year treasury increasing over 30 basis points in the week after all the offering on higher for longer interest rate expectations, which we believe will benefit our business. The notes provide us with additional capital to deploy into compelling investments that offer attractive risk-adjusted returns for our shareholders.

In aggregate, these efforts have resulted in us raising nearly $60 million of fresh capital in the past few months. In addition to our successful capital raising efforts last week, we formed a new joint venture focused on investing in CLO entities and related to warehouse facilities. Given the structure of these investments, we expect to receive sizable distributions from the JV beginning in the second half of the year and continuing into 2025 and beyond. Over time, we expect to generate mid-teens to low 20% returns from our investments in CLO structure. We are excited for this new joint venture as it further diversifies Great Elm through exposure to structured vehicles that have historically generated strong returns throughout economic cycles.

Shifting back to our first quarter performance, NAV per share declined in the quarter ending at $12.57 per share on March 31 down from $12.99 as of year end 2023. This decline is concentrated in illiquid, Level 3 investments originated by prior management in two portfolio companies, Research Now and PFS Holdings. As shown on the NAV walk on slide 9, the impact from these inherited positions adversely affected NAV by approximately $0.55 per share in the quarter. We continue to actively monitor these investments as well as one other position we placed on non-accrual in the quarter. Total non-accruals as of quarter end totaled $4.7 million of portfolio fair value or less than 2% of the portfolio. Away from these investments, our portfolio is otherwise performing well overall.

In fact, holding the marks from these inherited investment costs from the prior quarter, NAV otherwise would have increased sequentially to $13.07 per share. In the first quarter, we generated $0.37 per share of NII exceeding the base dividend of $0.35 per share. Sequentially, our NII per share declined due to cash drag related to the additional share issuance from our equity offering in February as well as from the timing of cash flows from certain newly made investments and the impact from the previously discussed inherited investments. With the successful notes offering last month and the expected additional cash drag from that issuance as we seek to deploy capital, we expect our NII in dollar terms in the second quarter to be relatively consistent with our first quarter performance.

Overall, we put up a solid quarter of results in addition to executing on our strategic initiatives, enhancing both our capital structure and overall operations while positioning us for sustainable long-term growth. With the expected ramp-up of distributions from our JV in the back half of the year, coupled with income from the prudent deployments from the capital raises in 1Q and 2Q, we expect NII in the second half of the year to meaningfully outpace the first half. As a result, we believe we remain well positioned to continue covering our dividend and expect our Board will be in a position to evaluate a special distribution again around year-end. With that, I’d like to hand the call over to Keri Davis to discuss our first quarter 2024 performance.

A financial planner carefully scrutinizing company’s investment portfolio.

Keri Davis: Thanks, Matt. I’ll go over our financial highlights now, but we invite all of you to review our press release, accompanying presentation and SEC filings for greater detail. During the first quarter, GECC generated NII of $3.2 million or $0.37 per share as compared to $3.3 million or $0.43 per share in the fourth quarter of 2023. The sequential decline is largely attributed to cash drag and the increased share count from our February equity issuance at NAV. Despite this, we exceeded our quarterly base dividend for the fifth consecutive quarter. Our net assets as of March 31, 2024, rose to $119 million compared to $99 million at December 31, 2023. Our NAV per share was $12.57 as of March 31 versus $12.99 as of December 31.

The decline attributable to the write-down of certain inherited investments, which impacted NAV by approximately $0.55 per share in the quarter. Details for the quarter-over-quarter change in NAV can be found on slide 9 of the investor presentation. As of March 31, GECC’s asset coverage ratio improved to approximately 180.2% as compared to 169% as of December 31. Pro forma for the April bond issuance and pay down of the revolver, our asset coverage would be approximately 166.9%. As of March 31, total debt outstanding was approximately $148 million, which includes $5 million outstanding on our $25 million revolver. Cash and money market securities totaled approximately $9 million. Pro forma for the April bond issuance and subsequent pay down of our outstanding revolver balance, the total debt outstanding was approximately $178 million.

Our Board of Directors has authorized a $0.35 per share cash distribution for the quarter ending June 30, 2024. The second quarter cash distribution will be payable on June 28, 2024 to stockholders of record as of June 14. The distribution equates to an 11% annualized dividend yield on our March 31 NAV of $12.57 per share. With that, I’ll turn the call back over to Matt.

Matt Kaplan: Thanks, Keri. In the first quarter, we continued to rotate into higher-yielding investments, taking advantage of the ongoing, higher for longer environment and deploying approximately $64 million into new investments at average yields of approximately 13%. Meanwhile, we opportunistically monetized $29 million of assets in the quarter at average yields of approximately 11%. Our rotation into more floating rate investments continued with 69% of our debt investment portfolio at quarter end comprised of floating rate debt, compared to 67% last quarter. Notably, along with our portfolio yield profile, which stood at 13.1% at quarter end, the majority of the capital deployed in the quarter was into first lien investments continuing to strengthen the overall credit quality of our portfolio.

Despite the impact of the inherited investments, we are pleased with the composition and return profile of the portfolio and are excited to begin receiving distributions from our recent CLO JV investment starting in the third quarter. Given the ongoing volatility in the macro environment, we remain disciplined in our approach to deploying capital, directing it toward investments that are well suited to perform both in the current elevated rate environment and through economic cycles. As always, we are focused on credit quality and investments with limited risk of permanent capital loss. By maintaining this approach, we are well positioned to further grow Great Elm Capital Corp. and deliver compelling risk-adjusted returns for our shareholders.

We remain excited about the future of GECC. And with that, I would like to turn the call over to Mike Keller to provide an update on Specialty Finance.

Mike Keller: Thanks, Matt. Despite a sluggish start to 2024 for new deal originations across all our Specialty Finance platforms, GESF began to experience a positive uptick in deal activity as the first quarter drew to a close. The pipelines remain robust thus far in the second quarter, and we are laser-focused on closing deals and streamlining operations. In support of these initiatives, I’m pleased to announce Jason Schwartz, a seasoned banking executive, joined GESF in February as Chief Credit Officer, adding significant experience in underwriting finance and operations to our platform. Additionally, in February, we exited our position in lenders funding revolver at par plus accrued. Further simplifying our specialty finance vertical.

Touching on our platform companies, Prestige started the first quarter with lower invoice financing volumes, but has seen a pickup in activity in March and April. At Sterling, groundwork late in January paved the way to close deals in February and March, and the business has a strong foundation in place to further convert the pipeline into earning assets over the coming months. Finally, at Great Elm Healthcare Finance, while deal volume has lagged projections, management remains focused on implementing strategic refinements to further position the platform for success. In summary, while the year got off to a slow start, we are excited for the opportunities in front of us, and we’ll seek to execute on our pipeline over the coming months.

Matt Kaplan: Thanks, Mike. To sum it up, it was a good start through year for GECC. The strategic initiatives undertaken over the past few months are evidence of our commitment to further strengthen and build our platforms and portfolio. Looking ahead, we believe we remain well positioned to continue to cover our quarterly base distribution throughout 2024. With that, I’ll turn the call over to the operator for questions. Operator?

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jim Fowler of Kingsbarn Capital Management. Your line is already open.

Jim Fowler: Thank you. Hello Matt. How are you?

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Q&A Session

Matt Kaplan: Good. How are you doing Jim?

Jim Fowler: Very well thank you. I wanted to — just a couple of things that caught my eye after Raj just a quick perusal of the deck. On Page 13, could you characterize of the 29 investments that were made in the quarter, the type of investments those were made by category?

Matt Kaplan: By category, I believe over half of them are in first lien secured debt. So, that’s a big chunks. And then about $10.8 million, you’ll see is into CLO subordinated notes, also colloquially known as CLO equity, which is part of our focus and jumping into that structured product arena, which we believe will pay a lot of dividends going forward for us. There is a timing lag in terms of cash flows, so we do expect a ramp of our NII, kind of, starting in the third quarter here based on that.

Jim Fowler: On that specifically I wanted to ask a question how is that initiative exactly structured if you might?

Matt Kaplan: It is a joint venture that we formed the strategic partner. We are 25%. They are — we are 75%, they are 25%. And we are looking to invest in both CLO securities as well as warehouse facilities to start the formation called CLO formation JV.

Jim Fowler: Okay. A lot of capital is now engaged in CLO equity. How will Great Elm go about accessing attractive investment opportunities given the significant amount of capital that’s been targeting that asset class for some time?

Matt Kaplan: So, this initial investment as I said was about $10.8 million which is pro forma for our asset mix. I think we have about $300 million after the round numbers — after the bond deal done in April. So, that’s yes sub 4%. We could see that grow over time. Of course, as we identify attractive opportunities and in warehouses ramp, this is an attractive way for us to get access to the loan market with attractive funding sources on and continue to generate significant kind of ROEs and returns to continue to pay solid distributions and access the broadly syndicated loan market, which on a look-through basis, these entities is largely a first-lien secured loans.

Jim Fowler: That’s right. And what is your JV partner the 25% owner, what is their role in the venture?

Matt Kaplan: They are involved in the CLO business and have developed a strategic relationship with us over time and we look forward to continue to grow it with them.

Jim Fowler: But is that a name that will be disclosed in the queue?

Matt Kaplan: At this point in time are limited when we compare to an institutional investor on them as I have to support that.

Jim Fowler: Got it. Last question if I may jump in January in — or squeeze it in here. On page 24, the boxes on specialty finance Great Elm specialty finance real estate and junior capital still white. Are you continuing to move forward with initiatives building out that those three boxes?

Matt Kaplan: I know we’ll continue to evaluate many deal opportunities and have a high bar key partners partnering with management teams and continue to look and evaluate transactions all the time. We just haven’t done any of them that fit in that box.

Jim Fowler: Got it. Okay. I lied. I have one more if I could. Page 27 on healthcare finance, other direct lenders to health care have talked about reimbursement issues, labor costs, et cetera across a number of these categories. What are you seeing in that area? Are you seeing at the at the operating entity level are things going okay? Or you do you also see some pressures across some of these categories?

Matt Kaplan: So before turning it over to Mike Keller for a quick discussion on health care finance, again these are our asset based loans focused on the receivables, primarily of these businesses. And it’s a very specialized entry and our partner Berkadia alongside us. And overall I think, we are not just making unsecured loans or enterprise value loans here. So, there’s a little bit of a new nuance there and I’ll let Mike turn it up — I’ll turn it over to Mike.

Jim Fowler: So even though even though in the use of funds on that page you states a lot of those things. You’re really just focusing right now on asset-backed versus receivable financing?

Mike Keller: Yes. Asset backed financing. Yes that’s correct. And we’re very judicious in the healthcare space and how we deploy capital. There has been a lot of turmoil. But as Matt mentioned we’re focused on the asset-based side of the equation. So we are very keenly aware of cash flows in and out of business. And we’re able to monitor literally on a daily basis. So we don’t get out over our skis.

Jim Fowler: Got it. Good. Okay guys. Thank you so much and really appreciate taking the questions and congrats on good quarter.

Matt Kaplan: Thank you very much Jim.

Operator: There are no further questions at this time. I would hand over the call to Matt Kaplan, CEO. Please proceed for closing comments.

Matt Kaplan: Thank you again for joining us today everyone. We are pleased with another quarter of solid performance as we continue to execute on our growth strategy. We look forward to continued investor dialogue. Please let us know if we can help with any follow-up questions that you may have. Thank you.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation and you may now disconnect.