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Edited Transcript of GARS earnings conference call or presentation 9-May-19 2:00pm GMT

Q1 2019 Garrison Capital Inc Earnings Call

New York May 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Garrison Capital Inc earnings conference call or presentation Thursday, May 9, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Steven Chase

Garrison Capital Inc. - COO & Director

* Joseph B. Tansey

Garrison Capital Inc. - Chairman & CEO

* Mitchell E. Drucker

Garrison Investment Group LP. - MD and Head of Corporate Finance

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Presentation

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Operator [1]

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Welcome to today's Garrison Capital Inc. first quarter ended March 31, 2019 earnings call. For the first quarter ended March 31, 2019 earnings presentation that we intend to refer to on the earnings call, please visit the Investor Relations link on the home page of our website, www.garrisoncapitalbdc.com and click on the first quarter ended March 31, 2019 earnings presentation under Upcoming Events.

As more fully described in that presentation, words such as anticipates, believes, expects, intends and similar expressions identify forward-looking statements. Actual results could differ materially from those implied or expressed in our forward-looking statements for any reason, and future results could differ materially from historical performance.

You should not rely solely on the matters discussed in today's call as the basis of an investment in Garrison Capital. Please review our publicly available disclosure documents for further information on the risk of an investment in our company. (Operator Instructions)

It is now my pleasure to turn the webcast over to Mr. Joseph Tansey, CEO. You may begin.

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Joseph B. Tansey, Garrison Capital Inc. - Chairman & CEO [2]

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Good morning, everybody, and thank you for joining the call. I'm joined by Brian Chase, our Chief Operating Officer; Mitch Drucker, our Chief Investment Officer; and Dan Hahn, our Chief Financial Officer.

On Tuesday evening, we issued our earnings report and press release for the first quarter ended March 31, 2019. We also posted the supplemental earnings presentation to our website, which is available for reference throughout today's call.

Following my broader comments, Mitch will highlight our investment activity during the quarter and discuss the portfolio in greater detail. Brian will then discuss our financial performance including the change to our incentive fee structure before opening up the lines for Q&A.

The overall credit market rebounded in the first quarter after experiencing a significant volatility in the fourth quarter.

While we have seen spreads largely revert back to the third quarter levels, the fourth quarter volatility did have an impact on M&A activity, which slowed down deal flow during the first half of 2019.

We continue to find the market challenging as supply for direct lending continues to outpace demand. As a result, new opportunities are generally being executed at higher leverage levels with looser credit structures. In light of the current environment, we remain focused on supplementing our secondary purchases with first lien senior secured originations and club investments to strong credit-worthy companies.

Turning now to our first quarter results. We reported net investment income of $0.20 per share as compared to the first quarter dividend of $0.23. Our first quarter NAV was $10.44 per share, down slightly from $10.52 per share in the fourth quarter. The decrease in NAV was driven by unrealized losses on a few of our investments, which Mitch will discuss in further detail. These unrealized losses were largely offset by mark-to-market gains on our syndicated portfolio.

Finally, we have amended our incentive fee structure to reduce our catch-up provision to 50%, which Brian will discuss later. This change effectively halved our incentive fee expense for the first quarter.

Overall, we continue to believe that the company is well positioned to deliver strong, stable returns on a go-forward basis. And we hope that this should result in closing the wide gap between where our stock currently trades and the net asset value of our portfolio.

With that, I'll turn it over to Mitch, who will provide additional color on the loan market and our activity during the quarter.

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Mitchell E. Drucker, Garrison Investment Group LP. - MD and Head of Corporate Finance [3]

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Thanks, Joe. We continue to seek actionable deals across all segments within our market. We characterize our deal flow into 3 buckets: origination business in the lower middle market; club business, which includes deals less than $250 million in size or unrated deals closed by nonbank direct lenders; and purchase credits in the broadly syndicated markets.

Competitive market conditions continue to permeate the lower middle market, resulting in aggressive structures and insufficient spread premiums. While we have not abandoned this market, as a result of the current market conditions, our origination business as a percentage of our overall business continues to decline. On the other hand, while spreads generally tightened in the first quarter as market volatility subsided, we continue to source attractive opportunities in the upper middle market for club deals and broadly syndicated transactions. These larger companies tend to be more durable and resilient in the event of economic volatility. We also continue to service our existing sponsor clients who are seeking acquisition financing, recapitalizations and maturity extensions.

New par additions during the quarter totaled $59 million across 10 new portfolio companies at a weighted average yield of 8.4%. The mix of new business included $7 million in originations, $15 million in club deals, $20 million in purchase credits and $17 million of portfolio add-on investments.

I'd like to highlight a few deals which illustrate the breadth of our market coverage. During the quarter, we originated a lower middle market sponsor acquisition financing for Kane Is Able. The company is a regional 3PL logistics services company providing warehousing, transportation and packaging services. The sponsor capitalized the transaction with 70% equity, and we provided a first lien $15 million term loan leveraged at 2.7x with a 10.7% yield.

We also closed the club deal as part of our first out $125 million term loan for sponsor-owned BJ Services. The company is the largest independent pure-play pressure pumping services provider to E&P companies in North America.

The facility was designed to provide enhanced liquidity to the borrower and was structured as an asset-based loan secured by a 27% advance rate against third-party appraised value of fracking pump units, fracking blenders and tractors and trailers. Unlevered yield on the transaction is 10%.

Additional notable transaction include club deals for Holley Purchaser and [quartz foods] and broadly syndicated transactions for international shareholder services and travel [forward]. In addition to the deals discussed above, we continued our effort to retain exposure to incumbent borrowers that exhibit solid business models and financial performance. Portfolio add-on acquisition financing during the quarter for Keeco and Orion were in line with this strategy. Additions for the quarter were offset by repayments totaling $37 million with a weighted average yield of 8.1%. We received full repayments on Aurora Diagnostics, AP Gaming and FRAM Group.

In addition, we closed out our position in Profusion at our Q4 mark. The balance of the repayments came from ordinary course amortization, excess cash flow and asset sales.

As a result of the modest repayments, total portfolio at fair value increased quarter-over-quarter to $481 million from $454 million. While the average yield of the debt portfolio cost has compressed to 8.9% from 10% over the last year, the repositioning of the portfolio to larger, more stable credits is near completed.

As you can see from Page 6 in the earnings presentation, at quarter end, 94% of the portfolio was originated subsequent to 2016.

With respect to portfolio performance, net realized and unrealized losses totaled $0.8 million or $0.05 a share for the quarter. This was primarily driven by $1 million of unrealized losses due to credit-related adjustments on our investments in Emtec Services and Confluence Outdoor.

For the balance of the portfolio, negative mark-to-market adjustments on 6 investments were largely offset by positive mark-to-market adjustments on our syndicated loan portfolio driven by the loan market rebound in the first quarter. Nonaccruals increased during the quarter to 2.9% of the portfolio based on market value, up from 0.5% in the previous quarter.

While Profusion came off the list due to the sale of our position, we added Emtec and Confluence.

I'll now spend a few minutes discussing the status of the nonaccrual investments.

Emtec is a privately owned provider of information technology services to commercial and public sector customers across the U.S. and Canada. We closed on a lower middle market club deal for unitranche credit facility in 2015. Subsequent to closing, the company experienced a decline in performance due to integration problems associated with certain acquisitions and challenges from its main vendor's migration to cloud computing from on-premise infrastructure solutions. With business performance stabilizing in 2018, the company was put up for sale. While there has been recurring interest in purchasing the whole company or the sum of its parts, no sale has materialized to date. The lenders are currently weighing options, which include a restatement of debt coupled with the transition of ownership to the lender group.

Confluence has been a client since 2014 and is another example of the earlier vintage credits that we discussed in previous quarters. The company is a manufacturer of highly regarded branded kayaks, and over the past couple of years, experienced softness in results due to production and labor issues. Management implemented strategic measures in late 2018, which improved operating and production capabilities. As a result of the liquidity support we provided during the turnaround process, following quarter end, we took possession of the equity through a consensual debt-for-equity conversion process. We remain cautiously optimistic as preseason orders for 2019 are solid and growth dynamics within the outdoor product and kayak categories remain compelling. Although it is taking longer than we would like, the portfolio rotation is largely complete, and we feel good about the credit quality and positioning of the post-2016 vintage within our portfolio. We now have investments in 99 portfolio companies which are diversified across 30 industries. The largest concentrations are in solid defensive sectors such as business services, software and health care with recession-resilient attributes.

The mix has also improved significantly across a number of other metrics. These include lower average hold size per investment, higher concentrations of sponsor deals and larger, better-capitalized companies with lower loan-to-values. This is clearly reflected in the average revenue and EBITDA levels of the companies in our portfolio, which continues to grow quarter-over-quarter.

Aggregate portfolio leverage through our position increased slightly from last quarter to 3.9x EBITDA from 3.8x as a result of executing deals to larger companies with modestly higher leverage. We also utilized a risk grading system that reflects the quality of our portfolio on an ongoing basis. Our risk rating grades ranged from 1 for our highest-rated companies to 4 for the lowest rated. The weighted average risk grading remained flat quarter-over-quarter at 2.4.

Looking back at trends over the previous 4 quarters, the risk grades on our investments have remained stable with approximately 64% of investments assigned a risk grading of 2.

We view this as reflective of the larger, more stable credits that we have been pursuing. With respect to the pipeline, second quarter activity to date has been modest due to weak overall market volume. These conditions appear to be a residual effect of market volatility experienced at the end of last year. Conversely, our first quarter repayment activity has also been moderate, which we believe to be a more normalized level given our relatively young portfolio. As the economic and credit cycles progress, our objectives are to be selective, defensive and focused on downside protection. In seeking out the best quality, we will continue to source a wide funnel of deals across the various size segments of the middle market.

In the near term, we expect the club market to continue to benefit as sponsors look for certainty of execution. In addition, spreads on new transactions in the broadly syndicated market continue to provide attractive opportunities on a selective basis. We're also quick to capitalize on sporadic volatility or even in an economic downturn, which typically leads to secondary purchase opportunities, rescue financings and attractive asset-based lending situations. In the meantime, we'll continue to service and retain our valued existing clients, which often provide us the most attractive risk-adjusted returns.

Now I'd like to pass the discussion to our COO, Brian Chase.

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Brian Steven Chase, Garrison Capital Inc. - COO & Director [4]

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Thanks, Mitch. As Joe noted, our net investment income for the first quarter ending March 31, 2019, was $3.2 million or $0.20 per share, which is unchanged from the fourth quarter of last year. Although overall NII was consistent with the prior quarter, our total investment income increased by approximately $600,000 or $0.04 per share driven primarily by the impact of the full quarter of interest income on the investments made during the fourth quarter. This increase is offset by higher interest expense of $0.02 per share from additional borrowings made under the CLO revolver and $0.02 per share from higher operating expenses.

Looking forward, we expect our operating expenses to revert back to their normal run rate for the rest of 2019. In addition, the Board declared a dividend of $0.23 per share in the second quarter, payable on June 21 to shareholders of record as of June 7. Given that the ramp of our upside CLO is now largely complete, I thought it would be worthwhile to provide a framework for a potential path to covering our dividend with earnings in future quarters.

Based on the size of our portfolio at quarter end and assuming our expenses revert back to previous levels, our current base run rate for net investment income would be around $0.21 per share. If we deploy the remaining $26 million of liquidity in our SBIC, expected NII could increase to between $0.22 and $0.23 per share.

Other variables that may close any remaining gap in a given quarter can include fee income redeployment of nonaccrual assets, further deployment of the CLO, portfolio rotation into higher-yielding assets, and/or investing additional liquidity generated from selling our Class B notes.

In other words, to the extent we are successful in deploying the remaining liquidity from the SBIC over the coming quarters, we should be able to generate net investment income in line with our current dividend payout, assuming all other factors remain equal.

The substantial change that we made to the incentive fee calculation this quarter is a key driver in allowing us to be in a favorable position to earn the current dividend on a sustainable basis. Instead of relying on temporary incentive fee waivers to help earn the dividend in the short term, the board and management decided to implement a permanent change that will perpetually be accretive to shareholders. The change that we made modifies the allocation of profits between what is paid to the advisers in incentive fee and what is retained by the shareholders in such a way that it is now more equitable and provides for a better alignment of interests. As noted on Page 3 of our presentation, this change resulted in a benefit to shareholders of $0.02 per share for the first quarter.

Out of 40 publicly traded BDCs, only 3 others have instituted such an arrangement. The simple result is that the adviser won't earn a full 20% incentive fee until after the $0.23 dividend is covered by net investment income.

In closing, we think deploying the remaining SBIC capacity is achievable while maintaining our disciplined and selective approach to credit.

Prudent deployment of this capacity, along with the other variables previously mentioned, provides us with a variety of achievable paths to generate earnings in line with our current dividend level.

This concludes our prepared remarks for today's call, and I'd like to open the line up for questions.

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Operator [5]

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(Operator Instructions) And at this time, there are no questions in queue.

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Joseph B. Tansey, Garrison Capital Inc. - Chairman & CEO [6]

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Well, great. Then I'll conclude today's call, and we'll talk to you next time.

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Operator [7]

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This concludes today's conference call. You may now disconnect.