Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2018
Business Model: GECC is an externally managed, non-diversified closed-end management investment company registered as a Business Development Company (BDC). It seeks to generate current income and capital appreciation primarily through debt investments (senior secured/unsecured, mezzanine) in middle-market companies and small businesses. It also makes limited equity investments.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total Investment Income | $7,498,000 | $7,315,000 |
| Net Investment Income (NII) | $3,866,000 | $4,094,000 |
| Net Realized Gains | $317,000 | $1,980,000 |
| Net Unrealized Depreciation | $(8,222,000) | $(2,695,000) |
| Net Increase (Decrease) in Net Assets from Operations | $(4,039,000) | $3,379,000 |
| Net Asset Value (NAV) per Share | $11.79 | $13.59 |
| Total Portfolio Investments (Fair Value) | $194,750,000 | $152,234,000 |
| Total Debt Outstanding | $79,029,000 | $33,646,000 (2020 Notes only) |
| Asset Coverage Ratio | 255% | N/A |
| Cash and Cash Equivalents | $6,030,000 | $66,763,000 |
Material Changes vs. Prior Period
- Portfolio Growth: The investment portfolio grew from $152.2 million in Q1 2017 to $194.8 million in Q1 2018, driven by acquisitions of $63.2 million against dispositions of $29.1 million.
- Net Income Decline: While Total Investment Income increased slightly ($7.5M vs $7.3M), Net Investment Income decreased by $228,000 due to higher operating expenses, specifically interest expense which doubled to $1.275 million from $631,000 following new debt issuances.
- Unrealized Losses: Net unrealized depreciation increased significantly to $8.2 million in Q1 2018 compared to $2.7 million in Q1 2017. This was primarily driven by valuation adjustments on Avanti Communications Group plc and Tru Taj, LLC.
- Leverage Increase: Total indebtedness rose to approximately $79.0 million in Q1 2018, compared to roughly $33.6 million in the prior year period, due to the issuance of new senior notes (GECCL and GECCM Notes).
Guidance, Outlook, and Risks
- Distributions: The Board declared monthly distributions for Q3 2018 at $0.083 per share, representing an annualized rate of approximately 8.45% of the March 31, 2018 NAV.
- Asset Coverage Ratio Change: Stockholders approved a reduction in the required minimum asset coverage ratio from 200% to 150%, effective May 4, 2018. This permits the Company to incur additional leverage.
- Recent Developments:
- Avanti Communications: A restructuring plan closed in April 2018, converting third lien debt to equity. GECC now owns approximately 9.1% of Avanti's common equity.
- Investment Activity: In April/May 2018, the Company purchased additional loans in Aptean Holdings and SESAC Holdco II, sold a loan to PR Wireless (realizing ~$800k gain), and funded commitments to Tallage Davis.
- Risks:
- Leverage Risk: Increased debt magnifies potential gains and losses. A decline in asset values would cause NAV to decline more sharply due to leverage.
- Interest Rate Risk: Approximately 54% of the debt portfolio is at variable rates (LIBOR-based). A 1% increase in LIBOR would increase net investment income by approximately $817,000 annually, while a 1% decrease would reduce it by $1.172 million.
- Valuation Uncertainty: A significant portion of the portfolio (Level 3 assets) relies on unobservable inputs, creating subjectivity in fair value measurements.
Investor Verification Checklist
- Avanti Restructuring Impact: Verify the valuation methodology and future cash flow expectations for the new 9.1% equity stake in Avanti Communications following the debt-for-equity swap.
- Debt Service Coverage: Confirm the Company's ability to service the new $79 million debt load, particularly given the increase in interest expense to $1.275 million in Q1 2018.
- Unrealized Depreciation Drivers: Review the specific valuation adjustments for Avanti Communications and Tru Taj, LLC, which contributed significantly to the $8.2 million unrealized loss.
- Liquidity Position: Assess the sufficiency of cash ($6.0M) and liquid assets ($23.9M in money market funds) to meet the $22.4 million in unfunded loan commitments.
- Asset Coverage Compliance: Monitor the asset coverage ratio post-May 4, 2018, to ensure compliance with the new 150% minimum threshold as leverage potentially increases.