Great Elm Capital (GECC) - 2018 Q4 - Annual Report

PART I Business GECC is an externally managed BDC investing in middle-market debt to generate current income and capital appreciation, managed by GECM and operating as a RIC - GECC is an externally managed BDC focused on generating current income and capital appreciation by investing mainly in the debt of middle-market companies with enterprise values of $100 million to $2.0 billion[16] - The company's investment strategy primarily targets secured and senior unsecured debt instruments purchased in the secondary markets, but may also include originating investments directly and investing in subordinated debt, mezzanine debt, and equity instruments[17] - To maintain its status as a Regulated Investment Company (RIC), GECC must derive at least 90% of its gross income from specific sources (like dividends and interest) and meet certain asset diversification tests quarterly[93] Key Portfolio Holdings (as of Dec 31, 2018) | Company | Description | | :--- | :--- | | Avanti Communications Group plc | A leading provider of satellite-enabled data communications services in Europe, the Middle East, and Africa | | Commercial Barge Line Company | One of the largest providers of barge transportation in the United States | | Finastra Group Holdings, Ltd. | The world's third-largest financial technology company, providing financial software solutions | | Full House Resorts, Inc. | An owner, operator, and developer of regional casinos in the United States | | International Wire Group, Inc. | The largest bare copper wire and copper wire products manufacturer in the United States | | Michael Baker International, LLC | A leading provider of engineering and consulting services in the United States | | PE Facility Solutions, LLC | Provides facilities maintenance services for commercial real estate owners across North America | | SESAC Holdco II LLC | A performance rights organization in the United States | | TRU Taj LLC | A leading global retailer of toys and juvenile products, operating under the "Toys R Us" and "Babies R Us" banners internationally | Management & Incentive Fee Structure | Fee Type | Rate/Structure | | :--- | :--- | | Base Management Fee | 1.50% annually on average total assets (excluding cash), payable quarterly | | Income Incentive Fee | 20% of pre-incentive fee net investment income over a 7.0% annualized hurdle rate, with a catch-up provision | | Capital Gains Incentive Fee | 20% of cumulative realized capital gains, net of cumulative realized losses and unrealized depreciation | Risk Factors The company faces significant investment and business risks, including a concentrated, highly leveraged portfolio, market volatility, and potential conflicts of interest - A significant risk is the investment in Avanti, which represented approximately 19% of the investment portfolio as of December 31, 2018; Avanti is highly leveraged, and a default could lead to a total loss of the investment[125][127] - The company's portfolio is concentrated in a limited number of companies and industries, making it more susceptible to significant losses if a single investment fails or a specific industry experiences a downturn[136][137] - Investing in companies experiencing financial distress, such as TRU Taj LLC which underwent Chapter 11 restructuring, exposes the company to significant risks, including the potential loss of the entire investment[144][145] - The company uses leverage, which magnifies the potential for loss; upon stockholder approval, the minimum asset coverage ratio was reduced from 200% to 150%, permitting the company to incur additional debt and potentially increasing investment risk[179][244][245] - The recognition of non-cash income, such as Payment-In-Kind (PIK) interest, may create difficulty in meeting the cash distribution requirements to maintain RIC status, potentially forcing the company to sell assets at inopportune times[214][215] - Potential conflicts of interest exist with the investment adviser, GECM; the management fee is based on gross assets (incentivizing leverage), and the incentive fee structure may encourage riskier investments to generate higher returns[231][267] Unresolved Staff Comments The company reported no unresolved staff comments from the SEC - None[291] Properties The company's executive offices are located in Waltham, MA, and are provided by its administrator, GECM, under the Administration Agreement - Executive offices are located at 800 South Street, Suite 230, Waltham, MA 02453, and are provided by GECM[292] Legal Proceedings The company is involved in several legal proceedings, including a lawsuit related to a portfolio investment, a counterclaim from a loan guarantor, and a claim related to a bankruptcy - GECC is a defendant in a lawsuit, Intrepid Investments, LLC v. London Bay Capital, related to its portfolio investment in Speedwell Holdings, with claims of aiding and abetting breaches of fiduciary duty[294] - The company is defending against counterclaims from Willis Pumphrey seeking $2 million to $6 million in damages related to a loan transaction originated by its predecessor, Full Circle[295] - GECC is named as a defendant in a claim brought by the Chapter 7 trustee in the ITT Educational Services bankruptcy, related to a senior secured facility purchased by its predecessor[296] Mine Safety Disclosures This item is not applicable to the company - Not applicable[297] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities GECC common stock trades on NASDAQ, with 2018 distributions from net investment income, and a performance graph is included - The company's common stock trades on the NASDAQ Global Market under the symbol "GECC"[300] - For the year ended December 31, 2018, distributions were made from undistributed net investment income; the company cautions that future distributions may be a tax-free return of capital if they exceed taxable earnings[301][302] Selected Financial Data This section provides a summary of key financial data for the fiscal years ended December 31, 2018 and 2017, and for the period from inception through December 31, 2016 Selected Financial Data (in thousands, except per share amounts) | | For the year ended Dec 31, 2018 | For the year ended Dec 31, 2017 | For the period ended Dec 31, 2016 | | :--- | :--- | :--- | :--- | | Total Investment Income | $27,754 | $29,728 | $5,831 | | Net Investment Income | $15,334 | $17,575 | $5 | | Net Decrease in Net Assets from Operations | $(9,005) | $(2,754) | $(17,874) | | Total Assets | $281,563 | $239,913 | $236,544 | | Total Net Assets | $110,116 | $132,287 | $172,984 | | Net Investment Income Per Share | $1.44 | $1.52 | $0.28 | | Dividends Declared Per Share | $1.24 | $1.20 | $0.17 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial condition, investment activities, and operational results, noting decreased investment income, Avanti restructuring impacts, and increased interest expense Portfolio Investment Activity (in thousands) | Time Period | Acquisitions | Dispositions | | :--- | :--- | :--- | | For the year ended Dec 31, 2018 | $174,965 | $(134,817) | | For the year ended Dec 31, 2017 | $199,877 | $(174,984) | | For the period ended Dec 31, 2016 | $207,158 | $(41,738) | - As of December 31, 2018, the portfolio's largest industry concentrations by fair value were Wireless Telecommunications Services (19.35%), Building Cleaning and Maintenance Services (10.01%), and Software Services (8.66%)[342] - Incentive fees decreased significantly in 2018 to $0.2 million from $4.4 million in 2017, primarily due to a $2.6 million reversal of previously accrued fees related to the restructuring of the Avanti investment[350] - The company recorded net unrealized depreciation of $26.8 million in 2018, largely driven by a $16.8 million decrease related to the Avanti restructuring and a $5.8 million decrease on the TRU Taj investment[362] - In January 2018, the company issued $46.4 million of 6.75% notes due 2025 (the "GECCM Notes"), which increased liquidity but also raised interest expense for the year[379] Results of Operations Comparison (in thousands) | Metric | 2018 | 2017 | | :--- | :--- | :--- | | Total Investment Income | $27,754 | $29,728 | | PIK Income Component | $8,200 | $11,700 | | Net Operating Expenses | $12,240 | $12,029 | | Net Investment Income | $15,334 | $17,575 | | Net Realized Gain (Loss) | $2,419 | $3,633 | | Net Change in Unrealized Depreciation | $(26,758) | $(23,962) | Quantitative and Qualitative Disclosures About Market Risk The company is exposed to interest rate risk, with a significant portion of its debt portfolio tied to variable LIBOR rates - As of December 31, 2018, the company's debt portfolio consisted of approximately $103.2 million in variable-rate investments and $74.8 million in fixed-rate investments[389] Interest Rate Sensitivity Analysis (as of Dec 31, 2018) | LIBOR Change | Impact on Net Investment Income | | :--- | :--- | | +3.00% | $3,453,000 | | +2.00% | $2,302,000 | | +1.00% | $1,151,000 | | -1.00% | $(1,145,000) | | -2.00% | $(2,094,000) | | -3.00% | $(2,626,000) | Financial Statements and Supplementary Data This section incorporates the company's audited consolidated financial statements for the fiscal year ended December 31, 2018 - The company's audited consolidated financial statements and supplementary data are included in the report, as indexed on page F-1[393][425] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure This item is not applicable to the company - Not applicable[394] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2018 - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[396] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2018, based on the framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)[400] - No material changes in the company's internal control over financial reporting occurred during the fourth quarter of 2018[404] Other Information This item is not applicable to the company - Not applicable[405] PART III Directors, Executive Officers and Corporate Governance The information required for this item is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[407] Executive Compensation The information required for this item is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[408] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required for this item is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[409] Certain Relationships and Related Transactions, and Director Independence The information required for this item is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[410] Principal Accounting Fees and Services The information required for this item is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[411] PART IV Exhibits, Financial Statement Schedules This section lists financial statements and exhibits filed as part of the Form 10-K, with financial statements incorporated by reference - The financial statements are incorporated by reference, and an exhibit index is included in the filing[413][414] Form 10-K Summary This item is not applicable to the company - Not applicable[416]