Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2018
Business Overview: 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 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 | Three Months Ended Sep 30, 2018 | Nine Months Ended Sep 30, 2018 |
|---|---|---|
| Total Investment Income | $6,181,000 | $20,841,000 |
| Net Investment Income | $2,686,000 | $12,629,000 |
| Net Realized Gains | $898,000 | $2,025,000 |
| Net Change in Unrealized Appreciation (Depreciation) | $1,275,000 | $(11,187,000) |
| Net Increase in Net Assets from Operations | $4,859,000 | $3,467,000 |
| Earnings Per Share (Basic & Diluted) | $0.46 | $0.33 |
| Net Asset Value (NAV) Per Share | $12.00 (End of Period) | $12.00 (End of Period) |
| Total Investments at Fair Value | $279,119,000 | $279,119,000 |
| Total Debt Outstanding | $79,029,000 | $79,029,000 |
| Asset Coverage Ratio | 258% | 258% |
| Cash and Cash Equivalents | $4,060,000 | $4,060,000 |
Material Changes vs. Prior Period
- Net Investment Income: For the nine months ended September 30, 2018, net investment income increased to $12.6 million compared to $11.1 million in the prior year period. This was driven by higher interest income ($20.5 million vs. $19.3 million), partially offset by higher interest expense due to increased leverage.
- Expenses: Net operating expenses for the nine months ended September 30, 2018, were $8.2 million, a decrease from $8.9 million in the prior year. This decrease was primarily due to a reversal of $2.6 million 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 portfolio experienced a net change in unrealized depreciation of $(11.2) million for the nine months ended September 30, 2018, compared to $(22.4) million in the prior year. The improvement was largely driven by the performance of the Avanti investment, which saw a reduction in unrealized depreciation compared to the prior year.
- Debt Structure: In January 2018, the company issued $46.4 million in aggregate principal amount of 6.75% notes due 2025 (GECCM Notes), increasing total indebtedness to approximately $79 million.
Guidance, Outlook, Risks, and Unusual Items
- Avanti Communications Restructuring: A significant unusual item involved the restructuring of Avanti Communications Group plc. The company's third lien senior secured notes were converted into common equity. Consequently, the company reversed previously accrued incentive fees associated with the PIK interest from these notes, as they are no longer recognized as a liability until an exit or recovery results in proceeds exceeding the initial cost basis.
- Asset Coverage Ratio Reduction: 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. As of September 30, 2018, the ratio was 258%.
- Legal Proceedings:
- Intrepid Investments, LLC v. London Bay Capital: GECC is a defendant in a lawsuit regarding its portfolio investment, Selling Source, LLC. The company joined a motion to dismiss in September 2018.
- ITT Educational Services Bankruptcy: GECC was named as a defendant in a claim by the Chapter 7 trustee in the ITT Educational Services bankruptcy regarding the PEAKS Trust 2009-1 facility. A motion to stay litigation was filed in November 2018 to facilitate settlement.
- Market Risk: The company is exposed to interest rate risk. Approximately $107.7 million of its debt portfolio is at variable rates based on LIBOR. A 1% increase in LIBOR would increase net investment income by approximately $2.1 million annually, while a 1% decrease would reduce it by approximately $2.1 million.
- Distributions: The Board declared monthly distributions for the first quarter of 2019 at an annual rate of approximately 8.3% of the September 30, 2018 NAV ($0.083 per month), all from net investment income.
Important Facts for Investors to Verify
- Avanti Investment Valuation: Verify the current fair value and recovery prospects of the Avanti Communications Group plc investment, which represents a significant portion of the portfolio (33.46% of net assets) and has experienced substantial unrealized depreciation.
- Leverage and Interest Expense: Monitor the impact of the increased debt load ($79 million outstanding) on net investment income, particularly given the fixed interest rates on the GECCM Notes (6.75%) and GECCL Notes (6.50%).
- Incentive Fee Reversal: Understand the implications of the $2.6 million incentive fee reversal on future expense recognition and the conditions under which these fees may become payable again.
- Legal Contingencies: Track the status of the Intrepid Investments lawsuit and the ITT Educational Services bankruptcy proceedings, as adverse outcomes could impact the valuation of related portfolio assets.
- Asset Coverage Ratio: Confirm the company's ability to maintain the required 150% asset coverage ratio, especially if asset values decline or if further leverage is utilized.