Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2019
Business Overview: GECC is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). Its investment objective is to generate current income and capital appreciation by investing predominantly in the debt instruments of middle-market companies (enterprise values between $100 million and $2.0 billion). The company is managed by Great Elm Capital Management, Inc. (GECM).
Key Financial Metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Total Investment Income | $27.0 million | $27.8 million |
| Net Investment Income | $10.9 million | $15.3 million |
| Net Realized Gain | $1.3 million | $2.4 million |
| Net Unrealized Depreciation | ($19.8 million) | ($26.8 million) |
| Net Decrease in Net Assets from Operations | ($7.5 million) | ($9.0 million) |
| Total Assets | $291.0 million | $281.6 million |
| Total Net Assets | $86.9 million | $110.1 million |
| Net Asset Value (NAV) per Share | $8.63 | $10.34 |
| Total Debt Outstanding | $124.0 million | $79.0 million |
| Asset Coverage Ratio | 170% | 150% (approx.) |
| Cash and Short-Term Investments | $90.3 million | $82.3 million |
Material Changes vs. Prior Period
- Net Investment Income Decline: Net investment income decreased by approximately 29% from $15.3 million in 2018 to $10.9 million in 2019. This was primarily driven by a decrease in interest income due to the restructuring of the Avanti Communications Group plc investment (conversion of third lien notes to non-income producing equity) and the conversion of TRU (UK) Asia Limited notes to equity.
- Expense Increases: Total expenses rose to $15.9 million from $12.2 million. This increase was largely due to higher interest expense ($7.6 million vs. $5.6 million) resulting from the issuance of $45.0 million in new notes (GECCN Notes) in mid-2019, and a significant increase in accrued incentive fees ($2.7 million vs. $0.2 million) due to the reversal of prior period accruals related to Avanti.
- Unrealized Depreciation: Net unrealized depreciation improved slightly to $19.8 million in 2019 compared to $26.8 million in 2018. Significant depreciation in 2019 was driven by investments in Avanti, Commercial Barge, TRU Taj, and PFS Holdings.
- Debt Issuance: The company increased its leverage, issuing $45.0 million in 6.50% notes due 2024 in June and July 2019, bringing total indebtedness to approximately $124.0 million.
- Share Repurchases: The company executed a $5.0 million stock buyback program, repurchasing 589,719 shares at a weighted average price of $8.54 per share.
Guidance, Outlook, Risks, and Unusual Items
- Avanti Communications Risk: Avanti remains the largest investment (approx. 21% of the portfolio). The company faces significant risk of loss due to Avanti's high leverage and the conversion of debt to equity, which is currently non-income producing. The Avanti common stock was delisted in September 2019.
- Distressed Lending Risks: The portfolio includes investments in companies experiencing financial difficulties, such as TRU (UK) Asia Limited (Toys "R" Us), which underwent bankruptcy restructuring. The company holds equity securities in the reorganized entity and a liquidating trust.
- Non-Cash Income (PIK): A significant portion of income is derived from Payment-in-Kind (PIK) interest, particularly from Avanti. This creates a risk where the company must recognize taxable income without receiving cash, potentially requiring asset sales or additional borrowing to fund distributions and maintain Regulated Investment Company (RIC) status.
- COVID-19 Impact: The filing notes that the global outbreak of COVID-19 has disrupted economic markets and may significantly impact the operational and financial performance of portfolio companies, affecting investment valuations.
- Legal Proceedings: The company is involved in ongoing litigation, including a lawsuit by Intrepid Investments, LLC regarding a portfolio company (Speedwell Holdings) and a claim by a Chapter 7 trustee in the ITT Educational Services bankruptcy.
- Management Commentary: Management highlighted that the decrease in interest income was offset by increases from investments in Commercial Barge Line Company and PFS Holdings Corp. The company maintains sufficient liquidity to meet unfunded loan commitments of approximately $29.8 million.
Key Facts for Investor Verification
- Concentration Risk: Verify the current status and valuation of the Avanti Communications Group plc investment, which represents a significant portion of the portfolio and carries high default risk.
- Liquidity and Distributions: Confirm the company's ability to fund distributions given the high level of non-cash (PIK) income and the requirement to distribute 90% of taxable income to maintain RIC status.
- Debt Covenants: Review the asset coverage ratio (currently 170%) against the 150% regulatory minimum to assess the company's capacity to incur additional debt or make distributions.
- Portfolio Valuation: Scrutinize the fair value determinations for Level 3 assets (illiquid investments), which comprised a significant portion of the portfolio and experienced substantial unrealized depreciation.
- Legal Exposure: Monitor the outcomes of the Intrepid Investments and ITT Educational Services bankruptcy proceedings for potential financial impact.