Great Elm Capital Corp. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Great Elm is an externally managed business development company investing in middle-market debt and income-generating equity, including specialty finance. Amounts below are in U.S. dollars; financial statement amounts are in thousands unless stated otherwise.
Key financial results and position
| Metric | Three months ended Sept. 30, 2022 | Three months ended Sept. 30, 2021 | Nine months ended Sept. 30, 2022 | Nine months ended Sept. 30, 2021 |
|---|---|---|---|---|
| Investment income | $6.033 million | $7.373 million | $17.104 million | $18.901 million |
| Net investment income | $1.062 million | $1.573 million | $8.204 million | $5.180 million |
| Net realized gain (loss) | $1.171 million | $1.660 million | $(128.513) million | $(3.984) million |
| Net unrealized appreciation (depreciation) | $(0.902) million | $(6.364) million | $112.013 million | $10.706 million |
| Net increase (decrease) from operations | $1.331 million | $(3.131) million | $(8.296) million | $11.902 million |
| Earnings (loss) per share | $0.18 | $(0.79) | $(1.43) | $3.02 |
The reported nine-month net investment income includes a $4.854 million reversal of previously accrued incentive fees following the adviser’s waiver; this one-time item materially affects comparison. Net investment income before taxes for the nine months was $8.327 million, compared with $5.180 million a year earlier.
- Balance sheet at Sept. 30: total assets $293.128 million; total liabilities $197.612 million; net assets $95.516 million; NAV $12.56 per share, versus $16.63 at Dec. 31, 2021.
- Portfolio: investments at fair value totaled $286.689 million, including $173.440 million of debt, $43.573 million of equity and $69.676 million of short-term investments. Excluding short-term investments, the portfolio was $217.013 million across 50 debt instruments and 116 equity investments. Specialty finance was the largest industry exposure at $51.347 million, or 23.66% of portfolio fair value.
- Cash and liquidity: $1.502 million cash and cash equivalents and $19.784 million in money market funds; the portfolio also included $49.892 million fair value of Treasury bills. The company reported $21.6 million of unfunded loan commitments and said available cash and liquid assets were sufficient to meet them.
- Cash flow, nine months: operating activities used $34.260 million; financing activities provided $26.617 million. Financing included $37.507 million gross proceeds from a rights offering and $9.603 million of distributions paid. Ending cash and cash equivalents were $1.502 million.
- Debt and coverage: notes payable had $145.933 million principal outstanding and $142.862 million carrying value. The reported asset coverage ratio was 165.5%, above the 150% statutory minimum. No borrowings were outstanding under the $25 million City National Bank revolving facility.
- Distributions: $0.45 per share was declared for each of Q2 and Q3 2022, down from $0.60 per quarter in 2021 and Q1 2022.
Material changes versus comparable periods
- Q3 investment income fell 18% year over year; nine-month investment income fell 9%. Lower interest income, including the exit and non-accrual treatment of Avanti positions, was partly offset by new investments and specialty-finance income.
- For the nine months, realized losses were dominated by the April 2022 Avanti Communications restructuring, which generated approximately $110 million of realized loss from previously recognized unrealized losses. Additional realized losses included $15.9 million on Tru Taj common stock and $4.2 million on California Pizza Kitchen common stock. Unrealized appreciation largely reflects reversals of prior unrealized losses as these investments were restructured or sold.
- Portfolio fair value excluding short-term investments increased to $217.013 million from $212.149 million at year-end, despite $92.167 million of repayments and sales, reflecting acquisitions and valuation movements. Investment activity for the first nine months included $112.540 million of acquisitions and $92.167 million of dispositions.
- Net assets rose from $74.556 million at year-end to $95.516 million, supported in part by the rights offering, but NAV per share declined. The common stock’s Q3 trading range was $8.04–$12.70 versus quarter-end NAV of $12.56.
Outlook, risks, contingencies and unusual items
- Management stated it believed liquidity was sufficient for obligations over at least the next 12 months; no specific earnings, investment or distribution guidance was provided.
- Interest-rate exposure is meaningful: $87.2 million principal of debt investments bore variable rates at quarter-end. The filing estimates a 1% reference-rate increase would raise annual net investment income by $0.909 million, while a 1% decrease would reduce it by the same amount; larger changes are affected by rate floors. These are hypothetical sensitivities, not forecasts.
- Valuation uncertainty is material: $129.593 million of investments were classified as Level 3, relying on significant unobservable inputs. The filing cautions that realized proceeds may differ materially from estimated fair values. Avanti Space debt positions were on non-accrual; they had a combined low or zero fair value, and the company recognized no related Q3 interest income.
- The May 2022 amendment to the bank revolver replaced LIBOR with SOFR and set a 150% quarterly asset-coverage covenant, with specified exceptions for the first two quarters of 2022. The company reported covenant compliance.
- Stockholders approved an amendment resetting the capital-gains incentive-fee and mandatory-deferral periods to begin April 1, 2022 and excluding $163.2 million of pre-April 2022 realized and unrealized losses from future capital-gains fee calculations.
- Legal matters include a stayed Delaware action alleging claims related to a portfolio investment and a Texas dispute in which a plaintiff seeks $2 million to $6 million in damages; the company says it intends to defend the claims. The filing does not quantify a probable loss or reserve for these matters.
- The company identified continuing uncertainty from COVID-19 and related economic effects, including supply-chain and labor disruption, inflation and market instability. It reported no material changes to risk factors and no material control changes during the quarter.
Important facts for investors to verify
- How much of reported 2022 net investment income is recurring after excluding the $4.854 million incentive-fee waiver.
- Credit performance, non-accrual status and recovery prospects for Avanti Space and other stressed or Level 3 portfolio investments.
- Portfolio fair-value assumptions and the potential impact of weaker credit markets, higher rates or lower borrower cash flows.
- Liquidity available after considering the $21.6 million unfunded commitments, debt service and the revolver’s borrowing-base and covenant restrictions.
- Ability to sustain distributions given lower recent per-share distributions, the decline in NAV per share and the company’s RIC distribution requirements.
- Developments in the disclosed legal proceedings and any resulting financial exposure.