Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2018
Business Model: GECC is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). It seeks to generate current income and capital appreciation primarily through debt and equity investments in middle-market companies and small businesses. The company is managed by Great Elm Capital Management, Inc. (GECM).
Key Financial Metrics
| Metric | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 |
|---|---|---|
| Total Investment Income | $14,660 | $13,552 |
| Net Investment Income | $9,944 | $7,572 |
| Net Realized Gains | $1,127 | $3,361 |
| Net Change in Unrealized Appreciation (Depreciation) | $(12,462) | $(10,021) |
| Net Increase (Decrease) in Net Assets from Operations | $(1,391) | $912 |
| Net Asset Value (NAV) per Share | $11.79 | $12.42 (Dec 31, 2017) |
| Total Investments at Fair Value | $278,493 | $230,760 (Dec 31, 2017) |
| Total Debt Outstanding | $79,029 | $32,631 (Dec 31, 2017) |
| Asset Coverage Ratio | 255% | 200% (Prior Requirement) |
| Cash and Cash Equivalents | $3,942 | $2,916 (Dec 31, 2017) |
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased by approximately 8.2% year-over-year, driven primarily by a larger interest-earning portfolio and increased interest income.
- Expense Reduction: Net operating expenses decreased significantly from $5,980 in the prior year period to $4,716. This decrease was primarily due to a reversal of $2,637 in incentive fees related to the restructuring of the Avanti Communications Group plc investment. Excluding this reversal, expenses increased due to higher interest costs from new debt issuances.
- Unrealized Depreciation: The company recorded a net change in unrealized depreciation of $(12,462) for the six months ended June 30, 2018, compared to $(10,021) in the prior year. Significant contributors to this depreciation included Avanti Communications Group plc ($(8,326)), OPS Acquisitions Limited ($(1,736)), and Tru Taj, LLC ($(2,900)).
- Debt Issuance: In January 2018, the company issued $46.4 million in aggregate principal amount of 6.75% notes due 2025 (GECCM Notes), increasing total indebtedness from $32.6 million to $79.0 million.
- Portfolio Composition: The portfolio grew to $278.5 million, with Wireless Telecommunication Services representing the largest industry allocation at 33.40% of net assets.
Guidance, Outlook, Risks, and Unusual Items
- Dividend Policy: The Board declared monthly distributions for the fourth quarter of 2018 at an annual rate of approximately 8.4% of NAV, equating to $0.083 per share per month.
- Regulatory Change: Stockholders approved a reduction in the required minimum asset coverage ratio from 200% to 150% effective May 4, 2018. This allows the company to incur additional leverage, though it increases the risk profile for common stockholders.
- Unusual Item (Avanti Restructuring): In April 2018, GECC's investment in Avanti's third lien notes was converted into common equity. Consequently, the company reversed previously accrued incentive fees associated with the PIK interest from those notes, as they are no longer recognized as a liability until an exit or recovery exceeds the initial cost basis.
- Risks: The company highlights risks associated with increased leverage following the asset coverage ratio reduction, interest rate fluctuations (21 of 29 debt investments are variable rate), and the inherent uncertainty in valuing Level 3 assets (illiquid investments).
- Recent Activity: Subsequent to June 30, 2018, the company made several new investments (including Commercial Barge Line and California Pizza Kitchen) and sold its position in Foresight Energy LP.
Investor Verification Checklist
- Avanti Exposure: Verify the current valuation and recovery prospects of the Avanti Communications Group plc investment, which represents 33.40% of net assets and drove significant unrealized depreciation.
- Leverage Impact: Assess the impact of the new $46.4 million GECCM Notes on interest expense coverage and the company's ability to maintain distributions given the increased fixed costs.
- Asset Coverage Ratio: Monitor the asset coverage ratio (currently 255%) to ensure compliance with the new 150% minimum requirement and evaluate the potential for further leverage deployment.
- Incentive Fee Reversal: Confirm the accounting treatment and future liability status of the reversed incentive fees related to the Avanti restructuring.
- Level 3 Valuations: Review the valuation methodologies and significant unobservable inputs used for Level 3 assets, which comprised $82.3 million of the portfolio.