Earnings Call Transcript - SSSS Q1 2020

Operator, Operator

Good day, ladies and gentleman and thank you for standing by. Welcome to the Sutter Rock Capital First Quarter 2020 Earnings Call. During today’s presentation all parties will be in a listen-only mode. This call is being recorded today. And I will now turn the conference over to Claire Councill. Please go ahead.

Claire Councill, Speaker

Thank you for joining us on today’s call. I’m joined today by the Chief Executive Officer of Sutter Rock Capital, Mark Klein, and Chief Financial Officer, Allison Green. Please note that a slide presentation that corresponds to today’s prepared remarks by management is available on our website at www.sutterrock.com under Investor Relations Events & Presentations. Today’s call is being recorded and broadcast live on our website, www.sutterrock.com. Replay information is included in our press release issued today. This call is the property of Sutter Rock Capital, and the unauthorized reproduction of this call in any form is strictly prohibited. I would also like to call your attention to customary disclosures in today’s earnings press release regarding forward-looking information. Statements made in today’s conference call and webcast may constitute forward-looking statements, which relate to future events or our future performance or financial conditions. These statements are not guarantees of our future performance or future financial condition or results, and involve a number of risks, estimates and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including but not limited to, those described from time to time in the company’s filings with the SEC. Management does not undertake to update such forward-looking statements unless required to do so by law. To obtain copies of Sutter Rock Capital’s latest SEC filings, please visit our website at www.sutterrock.com or the SEC’s website at sec.gov. Now I would like to turn the call over to Mark Klein.

Mark Klein, CEO

Thank you, Claire. We are pleased to announce the results of Sutter Rock Capital’s first quarter 2020. These are obviously unprecedented times we’re living through, and society is facing tremendous challenges. We at Sutter Rock Capital would like to thank the frontline workers and first responders who have put themselves at risk throughout the COVID-19 pandemic to help others. We are fortunate to report that our employees and their families are healthy, and our companies continue to function remotely like many other firms. Our portfolio has held up relatively well compared to the broader market indices, which experienced one of their worst quarters since the financial crisis. Our portfolio company valuations were priced as of March 31, 2020, which was one week within the bottom of the market sell-off. And as you all know, since that time most of the major indices have recovered to pre-COVID levels. I will discuss how our portfolios fared during the onset of the COVID-19 pandemic and highlight how a few of our larger positions have experienced degrees of business acceleration during this time. To conclude, I will hand the call over to Allison Green for a brief overview. At the conclusion of our remarks, we will open the call for questions. Let's start with Slide 3. As of March 31, 2020, our net asset value was $10.22 per share, a decrease from $11.38 per share at December 31, 2019. Please turn to Slides 4 and 5 to review notable developments in our investment portfolio in the first quarter and to date. Sutter Rock Capital's top five positions as of March 31 were Coursera, Palantir, Course Hero, Nextdoor, and Aussie Media. These positions accounted for approximately 69% of the investment portfolio at fair value. As of March 31, our top 10 positions accounted for approximately 91% of the portfolio. I would now like to walk through notable developments in a few of our largest positions. In particular, I would like to highlight our investments in online learning through our positions in Coursera and Course Hero, which represent about one-third of our invested portfolio. From recent media and public company earnings reports, it is evident the COVID-19 pandemic has sparked surges in demand for online and distance learning as governments and major institutions close. We believe the effects of the COVID-19 related school closures will spark a fundamental shift in how education is and will be consumed with a clear shift to online and distance learning. As previously announced, our largest position, Coursera, last raised $103 million in April 2019 at a $1.56 billion pre-money valuation. And in an April 2020 interview with Axios, Coursera CEO, Jeff Maggioncalda highlighted how 1.6 billion students around the world have had their schools closed due to COVID-19, with 56 million learners globally, partnerships with 165 of the world's top universities, and 4,200 courses in disciplines like data science, computer science, arts and humanities, and social science. Coursera offers online courses that allow students to learn for free or at a low cost. Further, in response to COVID-19, Coursera has expanded access for its Coursera for Campus product. Coursera for Campus allows colleges, universities, and high schools to provide online Coursera-created educational content to their students. As a result of the program, 400,000 students have enrolled in 1.4 million courses for free. Finally, Coursera is working with multiple state governments to offer Coursera’s content catalog to unemployed individuals in those states. Our third largest position, Course Hero, led by CEO Andrew Grauer, recently raised a Series B round. In February 2020, EdSurge reported that Course Hero raised a $10 million Series B round led by NewView Capital at a $1.1 billion valuation. NewView Capital also contributed $30 million to the company's employee tender program. This financing round marks Course Hero’s first financing since Sutter Rock Capital led its Series A in 2014. As a result of COVID-19 related school closures, students have had less access to teachers and study groups and are increasingly turning to online learning supplements, including Course Hero’s online document library for their studies. In response to the increased reliance on distance learning at this time, Course Hero has offered educators on its platform three months of free access to the Course Hero document library of more than 40 million teaching and learning resources. Additionally, Course Hero is facilitating peer review between educators who would like feedback on their remote teaching resources. Our fourth largest position, Nextdoor, has gained noticeable traction during the COVID-19 pandemic. In a March 2020 CNBC interview with Nextdoor CEO Sarah Friar, she indicated that the neighborhood-based social networking platform experienced an 80% month-over-month increase in daily active users since the global spread of COVID-19. In response, Nextdoor launched Nextdoor Groups and the Nextdoor Help Map to provide healthy individuals an opportunity to support neighbors in need. Nextdoor serves over 210,000 neighborhoods across 11 countries. With extended mandates for social distancing, we believe Nextdoor will become an increasingly relied upon tool for the communities and neighborhoods it serves. Ultimately, Nextdoor has tremendous upside as it expands internationally and is able to further monetize its hyper-localized user base. Our second largest position, Palantir, is a leading data analytics company that continues to show positive momentum. In April 2020, the Wall Street Journal reported that Palantir's models and analysis surrounding the COVID-19 outbreak have provided critical data and information to numerous government entities, including those in the United States, the United Kingdom, Greece, and others. Also, in April, Bloomberg and CNBC reported that Palantir anticipates generating $1 billion in 2020 revenue, allowing the company to break even for the first time in its history. Recent media reports imply Palantir is preparing for an IPO, although timing will be subject to market conditions. We currently hold our Palantir investment at an implied equity value of approximately $12 billion. Within our current investment portfolio, we are continuing to see ongoing M&A activity at a few of our portfolio companies. If these transactions are consummated, they would likely result in a meaningful increase to our net asset value in the second quarter. To put our investment portfolio into perspective, the combined value of our top five positions as of March 31 was $110 million, or approximately 111% of Sutter Rock’s market capitalization at quarter’s end. We believe this dynamic emphasizes a significant risk-reward opportunity for our investors. Please turn to Slide 6. Segmented by six general investment themes, the top allocation of our investment portfolio is to education technology, representing approximately 45% of the investment portfolio at fair value. Big data and cloud is the second largest category, representing approximately 19% of the portfolio. Our financial technology and services category accounted for approximately 50% of our portfolio at fair value, our social and media category accounted for approximately 13% of our portfolio, and marketplaces accounted for approximately 9% of our investment portfolio at fair value. In February, we announced an expansion of our investment strategy to include private credit investments spearheaded by Keri Findley as Senior Managing Director and senior member of the Investment Committee. Since then, our team has continued to expand our sourcing network in order to evaluate a wide array of equity and private credit investment opportunities in top VC and institutionally backed companies that demonstrate strong operating fundamentals. Due to ongoing market dislocation, we are seeing tremendous investment opportunities in high-quality companies at significantly lower valuations compared to just a month ago. This dislocation is presenting attractive opportunities in both equity and in private credit. We continue to target businesses that have shown to prove scaled valuation growth before a potential IPO or strategic exit. A few industries of focus include e-commerce and retail, financial technology, food technology, and transportation and logistics. Please turn to Page 7. We have committed to invest approximately $500,000 in a follow-on investment in Lime. Yesterday, Uber announced it has closed a $170 million financing round in Lime. As part of the transaction, Uber will transfer JUMP, Uber's bike and scooter business, to Lime. We have committed to invest our pro-rata share of approximately $500,000 into this financing round. Given the attractive valuation at which the follow-on investment is being made, we are confident that a modest improvement of Lime's business from present levels will generate a profit on our total investment. With the support of Uber, we believe Lime is financially and strategically positioned to further establish a stronghold in the micro-mobility market, particularly after social distancing requirements are reduced or limited. As the global ride-sharing leader, Uber is a natural fit for Lime’s business. And we believe this partnership can accelerate the success Lime experienced prior to the spread of COVID-19. Although it is impossible to determine the long-term impact that the COVID-19 pandemic will have on the world at large, looking ahead, we believe Sutter Rock Capital is well positioned to continue to deliver long-term shareholder value as we execute against a disciplined growth investment strategy with strong talent and attractive investment opportunities ahead of us. Thank you for your attention. And with that, I will hand it over to Allison.

Allison Green, CFO

Thank you, Mark. I would like to follow Mark’s update with a more detailed review of our financial results as of March 31, 2020, our share repurchase program, our transition to an internally managed BDC and other ongoing expense reduction initiatives, and our current liquidity positions. Before I review the financial results for the quarter, I do want to echo our March 19, 2020 press release and confirm that today and for the foreseeable future, Sutter Rock has been working remotely and adhering to state-ordered social distancing and stay-at-home mandates. We have not experienced and do not anticipate any operational disruptions during this time. We ended the first quarter with an NAV per share of $10.22. A breakdown of NAV per share as of quarter end is shown on Slide 8 and is consistent with our financial reporting. In sum, the decrease in NAV per share during the first quarter was largely driven by approximately $1.59 per share of net unrealized depreciation of our portfolio investments and a decrease of $0.17 per share of net investment loss. These decreases to NAV per share were offset by $0.40 per share in net realized gain on investment and a net $0.20 per share increase due to the accretive effects of common stock repurchase during the quarter through the share repurchase program. During the first quarter, we paid the second of two dividends declared in late 2019. On December 20, 2019, our Board of Directors declared a dividend of $0.12 per share that was subsequently paid on January 15, 2020, to shareholders of record as of December 31, 2019. The first 2019 dividend of $0.20 per share was declared on November 5, 2019, by our Board of Directors and paid on December 12, 2019, to shareholders of record as of December 2, 2019. The dividends declared and paid have been categorized as net realized capital gains for tax purposes. These realized gains are generally attributable to the monetization of shares held in our portfolio companies that went public and other successful exits in 2019. Please refer to Slide 9 as I review the current state of our share repurchase program. During the first quarter, the company repurchased 689,928 shares for approximately $3.7 million. As announced on our previous earnings calls, on March 9th, our Board of Directors authorized an additional $5 million allocation to the share repurchase program. This brought the total allocation by our Board of Directors to the share repurchase program to $30 million since the program's inception in August 2017. Subsequent to quarter end and pursuant to 10b5-1 plan through May 8, 2020, we have purchased an additional 594,637 shares for approximately $3.6 million. Since the inception of the share repurchase program in August 2017, we have repurchased a total of 4,452,049 shares of our common stock for approximately $27.3 million, excluding the modified Dutch Auction Tender offer effectuated in the fourth quarter of 2019. Considering share repurchases to date, this leaves approximately $2.7 million for further repurchases under the program. Including the Q4 2019 modified Dutch Auction Tender offer, Sutter Rock Capital has repurchased 5,901,324 shares of common stock for approximately $37.3 million since the inception of the share repurchase program in August 2017. This represents nearly 27% of the shares outstanding at that time. During the first quarter, we reached the one-year anniversary of the internalization of the management of Sutter Rock Capital, and we continue to see the cost-saving effects from the internalization. As previously discussed, as an internally managed BDC, we have a significantly reduced cost structure. Upon termination of the investment advisory agreement on March 12, 2019, we no longer pay management fees each month as management is now employed directly by the BDC, and we no longer accrue incentive fees. Total operating expenses decreased over 23% from $4.3 million in the first quarter of 2019 to $3.3 million in the first quarter of 2020. The decrease was primarily due to the elimination of management fees, incentive fees, and costs under the prior administration agreement and further supported by ongoing expense reduction initiatives separate from the inherent savings of the internalized management structure. This overall cost savings continues our years-long rigorous focus on expense reduction. To add some perspective, operating expenses for the first quarter of 2020 were approximately 40% lower than operating expenses for the first quarter of 2018 before waivers. We anticipate seeing the full cost savings for the internalization in 2020. Together, we believe our ongoing meticulous efforts to reduce operating expenses and the meaningful cost savings we are realizing as an internally managed BDC will positively impact NAV. We remain diligent about managing our expense base moving forward. Finally, I would like to review Sutter Rock Capital’s current liquidity. We ended the quarter with approximately $51.3 million of cash and cash equivalents. We did not hold any public securities during the quarter or at quarter end. Our cash balance of $46.1 million as of March 31, 2020, consisted primarily of proceeds generated by the monetization of various portfolio positions from the fourth quarter of 2017 through quarter end, and remaining proceeds from the issuance of $40 million or 4.75% convertible senior notes due in 2023 during the first quarter of 2018. Our exit of Parchment Inc. upon the January 31, 2020 closing of their merger with Credential Solutions resulted in net cash proceeds of approximately $10.8 million and a realized gain of $6.9 million during the first quarter. Major cash outflows during the quarter include the continuation of an increase in allocation to the share purchase program, the semi-annual interest payment on our 4.75% convertible senior notes due 2023, and final payments under consulting and licensing agreements agreed to upon our internalization. That concludes my comments. We would like to thank you for your interest and support of Sutter Rock Capital, and most importantly at this time, would like to wish you and your families health and safety as we work together globally to overcome COVID-19. Now I will turn the call over to the operator to start the Q&A session.

Operator, Operator

Thank you. For our first question, we'll go to Alex Paris.

Alex Paris, Analyst

Hi, Mark and Allison, I hope you and your families are well. Congratulations on the quarter. You had a decline in NAV, but the decline was less than I think most people feared. My question is related to your portfolio of companies. In your prepared comments, you mentioned that Palantir is the subject of IPO talk, although that's going to require obviously a more stable market environment. I'm wondering what other companies in your portfolio are likely to pursue an IPO track and maybe comment on your new investment pipeline? In the press release, you talked a bit about some potential exciting investments that you hope to close by the end of the second quarter. Thank you.

Mark Klein, CEO

Thank you, Alex. I hope you and your family are doing well during these challenging times, and I appreciate your continued support for the organization. Regarding Palantir, we are all aware of the recent updates about the company and its revenue projections. They seem to be preparing for a public offering, whether it happens this year or next. Our online education companies are performing exceptionally well. For instance, public companies like Chegg have seen positive market reactions due to their strong performance. The pandemic has influenced student learning, and when we assess our portfolio for potential public offerings, Coursera stands out because of its size and scale. The two cannabis REITs in our portfolio have publicly stated their intentions to go public in 2020, although the situation has become more complex. Currently, only IIPR is listed, but these two remain solid candidates for future listings. In terms of mergers and acquisitions, we have notable activity in our portfolio, and I expect these transactions to finalize soon. This could lead to gains and markups for us, which is exciting given the current remote work environment. Although our pipeline isn't closed yet, we are seeing a significant amount of opportunities for both secondary and primary investments. We are monitoring several names we've researched for over a year, and I anticipate that we will finalize one investment soon. We are in the right of first refusal period for one secondary transaction and are reviewing a couple of primary debt opportunities that are progressing well. While the Lime transaction has gained attention recently, it represents a lower valuation than what was achieved months ago. However, participating in this deal gives us the chance to benefit if the valuation improves from this level, though it won't reach the heights of our initial investment. Overall, we are very active corporately and have a broad array of opportunities. We are carefully considering how to use our capital, which, while substantial, is limited, and we aim to invest in the best opportunities available. Thank you, Alex.

Operator, Operator

And we will take our next question from Andrew Hart.

Unidentified Analyst, Analyst

It'd be nice to hear how the pandemic has changed the environment and your outlook for private credit investments. Are you still targeting around 20% of assets under private credit, and maybe what new opportunities could arise as a result of the pandemic?

Mark Klein, CEO

And while those who are focused on the credit market as opposed to the equity market understand that the credit market is far more in disarray than the equity markets, which is sort of hard to fathom given the equity market plummeted through March and then rebounded since the third or fourth week in March. So the broadly defined private credit market, I think, is an interesting situation. There are billions and billions of dollars that are out there to be raised to deploy against that. And it's really in a part of the credit market that we really hadn't anticipated participating in. I still don't think we will. Again, our view on the private credit side is to look at venture-backed companies that need financing on more of an asset base side that, for lack of a better word, would be off-balance sheet. So not your traditional BDC private credit side, but a bit of a niche that Keri identified prior to joining the organization. And it is one that we are executing against, which we have an opportunity to lend against in asset of a company and then get some sort of equity participation from the venture-backed company. So we’re seeing, as you can imagine, we're seeing an awful lot of that right now. We are progressing fairly deeply against a couple of them right now. And as we suggested in our prepared remarks, we anticipate announcing something certainly as we get into the end of Q2. So thank you. I appreciate the call and the support of your firm.

Operator, Operator

There are no further questions in the queue at this time. Ladies and gentlemen, that does conclude today's conference. We appreciate your participation today.

Mark Klein, CEO

Again, thank you everybody. Thank you all for attending our call. I hope this call finds you and your families healthy, and that we all continue to remain safe. Thank you all very much.