GECC

Business Context and Reporting Period

Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2021
Business Overview: GECC is a closed-end, externally managed Business Development Company (BDC) and Regulated Investment Company (RIC). It seeks current income and capital appreciation through debt and income-generating equity investments in middle-market companies and specialty finance businesses. The company is managed by Great Elm Capital Management, Inc. (GECM).

Key Financial Metrics

Material Changes vs. Prior Period

• Portfolio Valuation: The portfolio experienced significant unrealized depreciation of $12.9 million in 2021, primarily driven by a $32.0 million write-down on investments in Avanti Communications Group plc (Avanti) and $5.9 million on PFS Holdings Corp. This compares to $29.4 million in unrealized depreciation in 2020.
• Avanti Investment: A significant portion of the Avanti investment was written down to zero fair value and placed on non-accrual status. Consequently, the company reversed $5.0 million in accrued incentive fees related to this investment.
• Realized Losses: Net realized losses were $9.6 million, driven by exits from Davidzon Radio, OPS Acquisitions, Boardriders, and Best Western Luling.
• Expense Reduction: Total expenses decreased to $12.9 million from $15.7 million in 2020. This reduction was largely due to the reversal of $5.3 million in previously recognized incentive fees.
• Debt Issuance: The company issued $57.5 million in 5.875% Notes due 2026 (GECCO Notes) and redeemed all outstanding GECCL Notes ($30.3 million), increasing total indebtedness.
• NAV Decline: NAV per share decreased from $20.74 to $16.63, reflecting the net decrease in net assets from operations and distributions.

Guidance, Outlook, Risks, and Unusual Items

• Management Commentary: Management highlighted the formation of a new subsidiary, Great Elm Specialty Finance, LLC, to oversee specialty finance investments. They noted that while interest rates began to rebound in 2021, the impact of the COVID-19 pandemic on portfolio companies remains uncertain.
• Dividend Policy: Distributions for the quarter ending March 31, 2022, were set at $0.60 per share, and for the quarter ending June 30, 2022, at $0.45 per share (post reverse split). The company intends to distribute from distributable earnings.
• Key Risks:
  • Avanti Concentration: Significant risk of total loss on the Avanti investment, which represented 4% of the portfolio at year-end but contributed significantly to non-cash income.
  • Liquidity and Leverage: The company operates with high leverage (Asset Coverage Ratio of 151.1%, close to the 150% minimum). Rising interest rates could increase borrowing costs and reduce net investment income.
  • Non-Cash Income: A portion of income is non-cash (PIK interest), creating a risk that the company may need to sell assets or raise capital to meet distribution requirements.
  • LIBOR Transition: The phase-out of LIBOR poses uncertainty regarding future reference rates and potential impacts on borrowing costs and asset valuations.
• Unusual Items: The reversal of $5.0 million in accrued incentive fees due to the Avanti write-down is a significant non-recurring item impacting the expense line. Additionally, the company executed a 6-for-1 reverse stock split effective February 28, 2022.

Important Facts for Investor Verification

• Avanti Exposure: Verify the current status and fair value of the Avanti Communications Group investment, as it remains on non-accrual with a fair value of zero for the 2nd Lien bonds and significant impairment on other tranches.
• Asset Coverage Ratio: Monitor the asset coverage ratio, which stood at 151.1% at year-end, leaving minimal buffer above the 150% regulatory minimum required to issue additional senior securities or pay dividends.
• Incentive Fee Waiver: Confirm if the proposed waiver of accrued incentive fees by GECM (contingent on shareholder approval of a reset of hurdle rates) is finalized, as this would impact future expense ratios.
• Reverse Stock Split Impact: Review the impact of the 6-for-1 reverse stock split on share liquidity and trading price, noting that all historical per-share data has been adjusted retroactively.
• Specialty Finance Strategy: Assess the performance and integration of the new specialty finance subsidiary and recent acquisitions (Sterling Commercial Credit, Utica LeaseCo joint venture) announced in 2022.