GECC

Business Context and Reporting Period

Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2016 (Operations commenced November 4, 2016 following a merger with Full Circle Capital Corporation).
Business Model: GECC is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). It seeks current income and capital appreciation by investing primarily in secured and senior unsecured debt instruments of middle-market companies (enterprise values $100 million to $2.0 billion). The company is managed by Great Elm Capital Management, Inc. (GECM).

Key Financial Metrics

Material Changes and Operational Highlights

• Formation and Merger: The company was formed in April 2016 and completed a merger with Full Circle Capital Corporation on November 3, 2016. This transaction resulted in a purchase accounting loss of $4.7 million, significantly impacting the net decrease in net assets for the period.
• Portfolio Composition: As of December 31, 2016, the portfolio consisted of 21 debt investments ($154.2 million) and 4 equity investments ($0.5 million). The largest holding was Avanti Communications Group plc (24.29% of NAV).
• Unrealized Losses: The company recorded a net change in unrealized depreciation of $13.5 million, primarily driven by the Avanti Communications position, which saw a decrease in fair value of $13.3 million during the period.
• Expenses: Total expenses were $5.8 million, heavily influenced by $3.5 million in non-recurring professional services related to the merger and formation transactions. Recurring advisory fees totaled $1.3 million.
• Stock Buyback: The company initiated a stock buyback program, purchasing 98,172 shares in Q4 2016 at a weighted average price of $10.73 per share.

Guidance, Outlook, and Risks

• Distributions: The Board declared monthly distributions of $0.083 per share for the first quarter of 2017 (annualized rate of approximately 7.39% of NAV). Distributions are intended to be paid from assets legally available for distribution.
• Avanti Communications Restructuring: A significant risk factor involves the company's largest investment, Avanti Communications. In January 2017, Avanti completed a refinancing involving "PIK Toggle Notes" (payment-in-kind interest). GECC participated by exchanging existing notes and purchasing new notes. While this provided Avanti with new liquidity, it increased the risk of future non-cash income and potential default if Avanti cannot meet obligations.
• Regulatory Status: GECC intends to maintain its status as a Regulated Investment Company (RIC) to avoid corporate-level taxation, requiring the distribution of at least 90% of investment company taxable income.
• Interest Rate Sensitivity: Approximately 59% of the debt portfolio is at variable rates (LIBOR-based). A 1% increase in LIBOR would increase net investment income by approximately $0.5 million, while a 1% decrease would reduce it by $0.1 million.
• Legal Proceedings: Several shareholder lawsuits regarding the merger were filed in late 2016. An agreement in principle for settlement was reached in October 2016, pending court approval.

Investor Verification Checklist

• Avanti Exposure: Verify the current status of the Avanti Communications restructuring and the impact of the new PIK Toggle Notes on GECC's cash flow and credit risk.
• Non-Recurring Costs: Confirm that the $3.5 million in merger-related expenses are one-time costs and do not reflect ongoing operational inefficiencies.
• Unrealized Losses: Assess the likelihood of the $13.5 million in unrealized losses becoming realized losses, particularly regarding the Avanti position.
• Capital Loss Carryforwards: Note the $41.8 million in capital loss carryforwards for tax purposes, which may limit future taxable distributions.
• Stock Buyback Program: Monitor the execution of the $50 million stock buyback program (increased from $15 million) and its impact on share count and NAV.