Great Elm Capital Corp. quarterly report, Q1 FY2023

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Great Elm Capital Corp. — Q1 2023 Form 10-Q

Business context and reporting period

Great Elm Capital Corp. (GECC) is an externally managed business development company that invests in middle-market debt and income-producing equity, including specialty finance businesses. This unaudited report covers the three months ended March 31, 2023; balance-sheet comparisons are to December 31, 2022.

Financial and portfolio highlights

  • Investment income: $8.41 million, up 51% from $5.56 million in Q1 2022. Interest income rose to $6.63 million from $4.04 million, while dividend income fell to $0.93 million from $1.27 million. GECC attributed higher interest income mainly to portfolio growth and rising rates.
  • Net investment income: $2.84 million ($0.37 per share), versus $5.95 million ($1.31 per share) in Q1 2022. The prior-year comparison benefited from a $4.85 million reversal of accrued incentive fees under a non-recapturable waiver; Q1 2023 included $0.71 million of incentive fees. Net investment income before taxes was $2.87 million.
  • Operating result: Net increase in net assets from operations was $8.16 million ($1.07 per share), versus a $5.11 million decrease in Q1 2022. Q1 2023 included $1.85 million of realized gains and $3.48 million of net unrealized appreciation. The prior-year period had $19.93 million of realized losses, partly offset by $8.87 million of unrealized appreciation.
  • Net assets and NAV: Net assets were $90.31 million, up from $84.81 million at year-end; NAV was $11.88 per share, up from $11.16. Q1 2023 distributions were $0.35 per share. The Q1-end closing share price was $9.00, below NAV.
  • Investments: Total investments at fair value were $307.50 million, including $80.56 million of short-term investments; the portfolio excluding short-term investments was $226.94 million. Debt investments were $184.05 million and equity/other investments $42.89 million. Specialty finance was the largest stated industry exposure at $56.59 million, or 24.94% of the non-short-term portfolio.
  • Investment activity and yield: Acquisitions were $53.29 million and dispositions/paydowns $57.18 million. The reported weighted-average yield on debt securities at period-end was 13.06%, compared with 12.43% at December 31, 2022 and 10.38% at March 31, 2022. GECC reported an average coupon of 11.8% on approximately $204.2 million of debt principal, excluding non-accrual positions.
  • Cash flow and liquidity: Cash from operating activities was $8.72 million; financing activities used $7.66 million, including $5.0 million of net revolver repayments and $2.66 million of distributions. Period-end cash and cash equivalents were $1.64 million, in addition to $80.56 million of short-term investments. GECC said available liquidity was sufficient for its obligations for at least the next 12 months.
  • Debt and coverage: Balance-sheet notes payable were $143.44 million net of unamortized discount, and revolver borrowings were $5.0 million. Notes had $145.93 million aggregate principal outstanding. Asset coverage was approximately 159.8%, above the 150% statutory minimum, but with limited headroom. The revolver has a $25 million maximum subject to its borrowing base and matures May 5, 2024.

Material changes versus the comparable period

  • Investment income increased, primarily as the debt portfolio expanded and floating-rate income benefited from higher rates; dividend income declined with lower distributions and exits from certain preferred equity positions.
  • Net investment income fell year over year, but comparison is substantially affected by the $4.85 million incentive-fee waiver recorded in Q1 2022. Excluding that waiver, expenses rose to $5.54 million from $4.36 million, with higher management, administration, incentive, professional-service and interest costs.
  • Realized results improved from a $19.93 million loss to a $1.85 million gain. The prior-year losses were principally tied to Tru Taj and California Pizza Kitchen stock sales; current-period gains included sales and paydowns of several debt and preferred-equity positions.
  • Net unrealized appreciation was $3.48 million, compared with $8.87 million in Q1 2022. Current-quarter gains included United Insurance Holdings bonds and Prestige Capital Finance equity; decreases in Maverick Gaming and First Brands values partly offset them.
  • Variable-rate debt principal increased to approximately $117.3 million from $100.8 million at year-end 2022, while fixed-rate debt principal declined to approximately $112.8 million from $129.3 million.

Outlook, risks, and unusual items

  • The Board set the distribution for the quarter ending June 30, 2023 at $0.35 per share, payable in cash and expected to be from distributable earnings. The filing provides no broader earnings or investment guidance.
  • GECC stated that higher interest rates may increase investment income, but results depend on portfolio spreads, expenses, credit performance and borrowing. Its sensitivity analysis estimates that a 1% reference-rate increase would raise annual net investment income by approximately $1.22 million, and a 1% decrease would reduce it by approximately $1.22 million, subject to floors and stated assumptions.
  • Valuations are materially judgmental: $119.15 million of investments were Level 3 at March 31, 2023. The filing cautions that actual realizable values may differ from estimated fair values. Avanti Space debt positions were on non-accrual and valued at zero.
  • GECC had approximately $20.98 million of unfunded loan commitments and said available cash and other liquid assets were sufficient to meet them. The filing also identifies non-qualifying assets at 24.91% of total assets.
  • Two disclosed legal matters remain: the Intrepid Investments lawsuit involving a portfolio investment, and claims by Dr. Pumphrey seeking $2 million to $6 million in damages. GECC says it intends to defend the matters; the filing does not provide a clear estimate of any probable loss or liability.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. GECC reported no material changes to its risk factors.

Important facts for investors to verify

  • Review asset coverage and covenant headroom, particularly the 159.8% ratio against the 150% minimum, alongside upcoming note maturities: GECCN in June 2024, GECCM in January 2025 and GECCO in June 2026.
  • Assess cash versus non-cash income, including PIK accruals, deferred incentive fees and the sustainability of portfolio-company dividends.
  • Examine credit quality, non-accruals, Level 3 assumptions and valuation changes in larger or stressed positions, including Avanti, Maverick Gaming and First Brands.
  • Confirm the composition and accessibility of short-term investments and liquidity available for unfunded commitments, operating costs and distributions.
  • Compare the declared $0.35 distribution with future distributable earnings and taxable income; the filing does not provide forward earnings guidance.