Great Elm Capital Corp. (GECC) — Q3 2023 Form 10-Q
Business and period. GECC is an externally managed business development company investing primarily in middle-market debt and income-generating equity. This unaudited report covers the quarter and nine months ended September 30, 2023; comparisons are with the corresponding 2022 periods unless stated otherwise.
Financial performance and position
- Investment income: Q3 total investment income was $9.3 million, up from $6.0 million; nine-month income was $26.7 million, up from $17.1 million. Interest income rose with portfolio growth and higher rates. The debt portfolio’s average coupon was 12.5% on approximately $217.8 million of principal, excluding non-accrual positions.
- Net investment income (NII): Q3 NII was $3.1 million ($0.40 per share), versus $1.1 million ($0.14). Nine-month NII was $9.3 million ($1.22 per share), versus $8.2 million ($1.42 per share). Q3 total expenses were $6.2 million, including $0.8 million of incentive fees. Nine-month expenses were $17.3 million; the 2022 comparison included a $4.9 million incentive-fee waiver, making reported prior-period net expenses $8.8 million (or $13.6 million before the waiver).
- Operating results: Q3 net increase in net assets from operations was $7.8 million ($1.02 per share), compared with $1.3 million ($0.18). For nine months, it was $21.1 million ($2.77 per share), versus an $8.3 million decrease ($1.43 loss per share) in 2022. Nine-month 2023 results included $11.3 million of net unrealized appreciation and $0.6 million of realized gains; 2022 included $112.0 million of unrealized appreciation but $128.5 million of realized losses, including large restructuring-related losses.
- Portfolio and valuation: Investments had a reported fair value of $236.4 million, including $204.3 million of debt and $31.1 million of equity/other investments; net assets were $97.9 million. NAV was $12.88 per share, up from $11.16 at December 31, 2022. The portfolio included $126.3 million of Level 3 investments, plus a $3.7 million private-fund investment valued using NAV; fair values are subject to estimation uncertainty.
- Cash flow and liquidity: Nine-month operating cash flow was positive $23.6 million; financing cash flow was negative $22.4 million, including $8.0 million of distributions and debt refinancing activity. Cash and cash equivalents were $1.8 million, with $1.0 million in money-market investments. GECC reported $20.3 million of unfunded loan commitments and said available cash and liquid assets were sufficient to meet them and obligations for at least 12 months.
- Debt and coverage: Notes had $143.1 million aggregate principal outstanding and $140.0 million carrying value; the revolving credit facility had no borrowings. Asset coverage was 168.4%, above the 150% statutory minimum. Notes outstanding were $45.6 million of 6.75% notes due 2025, $57.5 million of 5.875% notes due 2026 and $40.0 million of 8.75% notes due 2028.
- Distributions and trading: GECC declared $0.35 per share for Q3 and set the Q4 2023 distribution at the same amount, payable in cash from distributable earnings. The Q3 share-price range was $7.68–$10.25 against quarter-end NAV of $12.88; the filing reports discounts to NAV of 20.4% at the high and 40.4% at the low.
Material changes, outlook and risks
- On September 1, GECC contributed selected specialty-finance investments and assets to wholly owned Great Elm Specialty Finance, LLC (GESF) for GESF equity and subordinated debt. A strategic investor acquired approximately 12.5% of GESF’s equity interests and subordinated indebtedness. Management expects revenue and cost synergies across GESF’s specialty-finance businesses; the filing does not quantify expected benefits.
- GECC issued $40.0 million of 8.75% notes due 2028 in August and redeemed all $45.0 million of 6.50% notes due 2024 in September. Management cited refinancing-related double interest expense and write-off of deferred offering costs as contributors to higher interest expense. Weighted-average borrowing cost was 8.42% for Q3 versus 7.26% in Q3 2022.
- Approximately $137.7 million of debt principal was floating-rate at quarter-end. GECC estimates a 1% reference-rate increase would raise annual NII by approximately $1.4 million, and a 1% decrease would lower it by approximately the same amount, subject to rate floors and other assumptions.
- No formal earnings guidance is provided. Management believes liquidity is adequate, but flags general credit-market, interest-rate, portfolio-company, valuation, regulatory and RIC-qualification risks. Many investments lack readily available market quotations, and changes in assumptions could materially affect reported values.
- The company reported no material change in risk factors and effective disclosure controls. It disclosed ongoing litigation, including the Intrepid matter, in which some claims survived a motion to dismiss, and claims by Dr. Pumphrey seeking $2–$6 million; GECC says it intends to defend those claims. Outcomes and any resulting exposure are uncertain.
Key facts investors should verify
- Whether NII and cash income support the $0.35 quarterly distribution, particularly given PIK income, accrued incentive fees and portfolio credit performance.
- Performance, valuation, governance and the realized benefits of the GESF contribution and strategic investor’s approximately 12.5% interest.
- Credit quality and recoverability of Level 3 and non-accrual investments, and the assumptions underlying fair values.
- Ability to maintain asset coverage above the 150% requirement and meet debt maturities, interest costs and unfunded commitments.
- Developments in the disclosed litigation and any change in estimated contingencies or potential losses.