Business Context and Reporting Period
Company: Great Elm Capital Corp. (GECC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2017
Business Overview: 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 the debt instruments of middle-market companies (enterprise values between $100 million and $2.0 billion). The company is managed by Great Elm Capital Management, Inc. (GECM).
Key Financial Metrics
| Metric | 2017 (in thousands) | 2016 (in thousands) |
|---|---|---|
| Total Investment Income | $29,728 | $5,831 |
| Net Investment Income | $17,575 | $5 |
| Net Realized Gain (Loss) | $3,633 | $(4,424) |
| Net Change in Unrealized Appreciation (Depreciation) | $(23,962) | $(13,455) |
| Net Decrease in Net Assets from Operations | $(2,754) | $(17,874) |
| Total Assets | $239,913 | $236,544 |
| Total Net Assets | $132,287 | $172,984 |
| Net Asset Value (NAV) per Share | $12.42 | $13.52 |
| Outstanding Debt (Notes Payable) | $32,631 | $34,534 |
| Cash and Cash Equivalents | $2,916 | $66,782 |
Expense Ratios (Annualized): Total expenses to average net assets were 8.00% (after waivers). Management fees were 1.51%, and incentive fees were 2.89%.
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased significantly from $5.8 million in 2016 to $29.7 million in 2017, driven by a larger portfolio held for a full year and increased interest income.
- Non-Cash Income: A substantial portion of 2017 income was non-cash, including $11.7 million in Payment-in-Kind (PIK) interest and $5.6 million in accretion of original issue discount (OID) and market discount.
- Unrealized Losses: The company recorded a net unrealized depreciation of $23.9 million in 2017, compared to $13.5 million in 2016. The primary driver was a $19.9 million unrealized loss on the Avanti Communications investment.
- Debt Refinancing: GECC redeemed its 8.25% Notes due 2020 (assumed in the 2016 merger) and issued new 6.50% Notes due 2022 with an aggregate principal of $32.6 million.
- Share Repurchases: The company repurchased 2.14 million shares in 2017 under its buyback program, reducing outstanding shares from 12.79 million to 10.65 million.
Guidance, Outlook, Risks, and Unusual Items
Avanti Communications Restructuring
Avanti Communications, representing approximately 26% of the investment portfolio and 43% of total investment income, is undergoing a significant restructuring. In December 2017, GECC entered an agreement to convert its "Existing Notes" into Avanti common shares and reduce interest rates on "PIK Toggle Notes." Completion is subject to court and shareholder approval. This restructuring poses risks to NAV if the equity value declines and reduces future income due to lower interest rates.
Liquidity and Distributions
Due to high levels of non-cash income (PIK and OID), GECC faces liquidity challenges in meeting distribution requirements to maintain Regulated Investment Company (RIC) status. The company may need to sell assets or raise capital to fund cash distributions. The monthly distribution rate for Q2 2018 was set at $0.083 per share.
Legal Proceedings
GECC is a defendant in Intrepid Investments, LLC v. London Bay Capital regarding a portfolio company (Selling Source). Additionally, the company won a judgment of $3.85 million in FCCC v. Pumphrey in March 2018, though collectability is not guaranteed.
Management Commentary
Management notes that the incentive fees accrued in 2017 ($4.4 million) are expected to be deferred in accordance with the Investment Management Agreement. The company remains focused on generating current income while managing the risks associated with its concentrated portfolio and the Avanti restructuring.
Investor Verification Checklist
- Avanti Restructuring Status: Verify the approval status of the Avanti scheme of arrangement and the valuation of the equity received in exchange for debt.
- Cash Flow vs. Accruals: Analyze the ratio of cash interest received versus total accrued income (PIK/OID) to assess the ability to fund distributions without selling assets.
- Debt Covenants: Confirm compliance with the 200% asset coverage ratio required under the Investment Company Act, especially given the unrealized losses.
- Legal Collectability: Monitor the collection status of the $3.85 million judgment in the Pumphrey case.
- Portfolio Concentration: Review the impact of the top 5 holdings, which represent a significant portion of the portfolio, on overall risk exposure.