Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2020
Business Model: GECC is an externally managed, non-diversified closed-end management investment company registered as a Business Development Company (BDC) and a Regulated Investment Company (RIC). It seeks to generate current income and capital appreciation primarily through debt and equity investments in middle-market companies.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 |
|---|---|---|
| Total Investment Income | $11.20 million | $13.02 million |
| Net Investment Income | $3.57 million | $5.78 million |
| Net Realized Gain (Loss) | ($10.38 million) | $1.02 million |
| Net Unrealized Appreciation (Depreciation) | ($23.21 million) | ($3.11 million) |
| Net Increase (Decrease) in Net Assets from Operations | ($30.03 million) | $3.69 million |
| Net Asset Value (NAV) per Share | $5.10 | $8.63 (Dec 31, 2019) |
| Total Portfolio Investments (Fair Value) | $221.22 million | $283.35 million (Dec 31, 2019) |
| Cash and Cash Equivalents | $30.98 million | $4.61 million (Dec 31, 2019) |
| Total Debt Outstanding | $119.54 million | $124.03 million (Dec 31, 2019) |
| Asset Coverage Ratio | 144.5% | 150.0%+ (Dec 31, 2019) |
Material Changes vs. Prior Period
- Investment Income Decline: Total investment income decreased by approximately 14% year-over-year. This was driven by exits from high-income positions (e.g., PE Facility Solutions, Commercial Barge), a general downward trend in LIBOR affecting floating-rate debt, and two investments (Davidzon Radio, PFS Holdings) being placed on non-accrual status.
- Significant Realized Losses: The company reported a net realized loss of $10.38 million for the six months ended June 30, 2020, compared to a gain of $1.02 million in the prior year. Losses were primarily driven by the sale of Commercial Barge ($9.8 million loss) and Full House Resorts ($1.3 million loss).
- Unrealized Depreciation: Net unrealized depreciation of $23.21 million was recorded, largely due to decreases in portfolio company valuations attributed to the COVID-19 pandemic. Notable write-downs included Avanti Communications ($5.0 million), TRU (UK) Asia Limited ($3.3 million), and California Pizza Kitchen ($9.0 million combined).
- Expense Increase: Total expenses increased to $7.63 million from $7.25 million in the prior period. This increase was primarily due to higher interest expense resulting from the issuance of $45.0 million in 6.50% notes in 2019, partially offset by a decrease in incentive fees.
- NAV Decline: NAV per share dropped from $8.63 at year-end 2019 to $5.10 at June 30, 2020, a decrease of approximately 41%.
Guidance, Outlook, Risks, and Unusual Items
- Asset Coverage Ratio Breach: As of June 30, 2020, the Asset Coverage Ratio (ACR) was 144.5%, falling below the minimum requirement of 150% mandated by the Investment Company Act. Consequently, GECC is subject to limitations on incurring additional debt, making cash distributions on junior securities, or repurchasing junior securities until the ratio is restored.
- COVID-19 Impact: Management highlighted significant uncertainty regarding the duration and economic impact of the pandemic. Portfolio companies in sectors like restaurants, retail, and travel have faced operational disruptions, leading to financial distress and potential defaults. The company expects further declines in fair value and investment income if the disruption persists.
- Interest Rate Risk: Approximately $140.6 million of the debt portfolio bears variable interest rates based on LIBOR. Continued low interest rates reduce gross investment income. A 1% decrease in LIBOR would reduce net investment income by approximately $51,000 (annualized impact not fully detailed but sensitivity provided).
- Recent Developments:
- California Pizza Kitchen (CPK): Filed for bankruptcy on July 30, 2020. GECC held $14.2 million in par value of CPK debt as of June 30. The company subsequently purchased $4.2 million in debtor-in-possession term loans in August 2020.
- Distributions: The Board declared monthly distributions for Q4 2020 at an annual rate of approximately 19.5% of NAV ($0.083 per month). Approximately 90% of distributions will be paid in common stock, with a 10% cash limit.
- Legal Proceedings: GECC is involved in ongoing litigation, including a lawsuit regarding a portfolio company (Speedwell Holdings) and a claim from the ITT Educational Services bankruptcy trustee, with an estimated potential exposure of $250,000.
Investor Verification Checklist
- Asset Coverage Ratio: Verify the timeline and strategy for restoring the Asset Coverage Ratio above 150% to lift restrictions on debt and distributions.
- CPK Restructuring: Monitor the outcome of the California Pizza Kitchen bankruptcy proceedings and the valuation of the new debtor-in-possession loan.
- Non-Accrual Status: Review the status of Davidzon Radio and PFS Holdings to determine if they will return to accrual status or require further write-downs.
- LIBOR Sensitivity: Assess the impact of prolonged low interest rates on the company's net investment income given the high exposure to floating-rate debt.
- Portfolio Valuation: Scrutinize the Level 3 fair value measurements for significant unobservable inputs, particularly for distressed assets like Avanti and TRU (UK) Asia Limited.