Great Elm Capital (GECC) - 2021 Q3 - Quarterly Report

Filing Information This section details Great Elm Capital Corp.'s (GECC) Form 10-Q filing for the quarter ended September 30, 2021, including its registrant status and outstanding common stock Registrant Details Great Elm Capital Corp. (GECC) filed its Form 10-Q for the quarterly period ended September 30, 2021, incorporated in Maryland, operating as a non-accelerated filer and an emerging growth company, with 26,905,668 shares of common stock outstanding as of November 1, 2021 - Great Elm Capital Corp. (GECC) filed its Form 10-Q for the quarterly period ended September 30, 2021[2] | Filer Status | | | | |:---|:---|:---|:---| | Non-accelerated filer | ☒ | Emerging growth company | ☒ | - As of November 1, 2021, the registrant had 26,905,668 shares of common stock, $0.01 par value per share, outstanding[4] Table of Contents This section provides an organized listing of all chapters and sub-sections within the report PART I—FINANCIAL INFORMATION This part presents Great Elm Capital Corp.'s financial data, including statements, management's discussion, market risk disclosures, and controls Cautionary Note Regarding Forward-Looking Information The report contains forward-looking statements that involve risks and uncertainties, including those related to future business, investment returns, market liquidity, interest rate fluctuations, regulatory changes, and the impact of the COVID-19 pandemic, with the company assuming no obligation to update these statements - Forward-looking statements involve a number of risks and uncertainties, including statements concerning future business, operations, operating results or prospects, and the return or impact of current and future investments[9][11] - Key risks include the impact of a protracted decline in credit market liquidity, fluctuations in interest rates, changes in laws or regulations, and serious disruptions like the COVID-19 pandemic[11] - The company assumes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise[10] Item 1. Financial Statements This section incorporates by reference the consolidated financial statements listed in the index immediately following the signature page of the report - The financial statements listed in the index to consolidated financial statements immediately following the signature page to this report are incorporated herein by reference[12] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides an in-depth analysis of Great Elm Capital Corp.'s financial condition and operational results, covering its business overview, investment strategies, revenue and expense drivers, critical accounting policies, portfolio activity, and liquidity and capital resources, also discussing recent developments and the ongoing impact of the COVID-19 pandemic Overview Great Elm Capital Corp. (GECC) operates as a Business Development Company (BDC) focused on generating current income and capital appreciation through debt and income-generating equity investments in middle-market companies, having elected to be treated as a Regulated Investment Company (RIC) for U.S. federal income tax purposes, requiring it to distribute at least 90% of its investment company taxable income annually - GECC is a BDC that seeks to generate both current income and capital appreciation through debt and income generating equity investments in middle-market companies[13] - GECC has elected to be treated as a RIC for U.S. federal income tax purposes, requiring it to annually distribute to its stockholders generally at least 90% of its investment company taxable income on a timely basis[15] Investments The level of GECC's investment activity fluctuates significantly due to various market factors, including the availability of capital for middle-market companies, M&A activity, credit market pricing, and the general economic environment, with the company's investments and portfolio composition subject to specific regulatory requirements as a BDC - Investment activity varies substantially from period to period depending on factors such as debt and equity capital availability, merger and acquisition activity, and pricing in credit markets[16] - As a BDC, GECC's investments and the composition of its portfolio are required to comply with regulatory requirements[17] Revenues GECC generates revenue primarily from interest on debt investments, dividends on equity investments, capital gains from asset dispositions, and various fees, with debt investments typically having an expected maturity of three to five years, paying interest quarterly or semi-annually, and potentially including payment-in-kind (PIK) features, alongside additional revenue from prepayment, origination, due diligence, and exit fees - Revenue is primarily generated from interest on debt investments, dividends on equity investments, capital gains on the disposition of investments, and lease, fee, and other income[18] - Debt investments generally have an expected maturity of three to five years, pay interest quarterly or semi-annually, and may include deferred cash interest or payment-in-kind (PIK) features[18] - Additional revenue sources include prepayment fees, commitment, origination, due diligence fees, end-of-term or exit fees, and fees for providing managerial assistance[18] Expenses GECC's primary operating expenses include a base management fee, administration fees (including allocable overhead), and an incentive fee, all paid to Great Elm Capital Management, Inc. (GECM), compensating GECM for investment advisory and administrative services, with other expenses including interest on outstanding indebtedness and various operational costs - Primary operating expenses include a base management fee, administration fees, and an incentive fee, which remunerate GECM for identifying, evaluating, negotiating, closing, and monitoring investments[19] - The Administration Agreement provides for reimbursement of costs and expenses incurred for office space, equipment, utilities, and non-investment advisory services[19] - GECC also bears all other costs and expenses of its operations and transactions, including interest on outstanding indebtedness[19] Critical Accounting Policies GECC's critical accounting policies cover the valuation of portfolio investments, revenue recognition, and the measurement of realized and unrealized gains/losses, which are crucial for accurately reflecting the company's financial position and performance, especially given the nature of its illiquid investments and diverse revenue streams Valuation of Portfolio Investments Portfolio investments are valued at fair value, defined as the price in an orderly transaction between market participants, with the Board approving valuations quarterly; for investments without readily available market quotations or where quotations are deemed unrepresentative, fair value is determined using market or income approaches, considering factors such as market data, yields, multiples, security covenants, collateral, and the portfolio company's financial performance, with a preference for observable inputs - Portfolio investments are valued at fair value, defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date[20] - For investments without readily available market quotations, fair value is determined using a market approach, an income approach, or both, considering factors like market trading comparables, yields, multiples, security covenants, and the portfolio company's ability to make payments[23] - The Board approves in good faith the valuation of the portfolio as of the end of each quarter, acknowledging the inherent uncertainty and subjectivity in valuing illiquid investments[22] Revenue Recognition Interest and dividend income, including PIK income, are recorded on an accrual basis, while origination, structuring, closing, commitment, and other upfront fees, along with fixed end-of-term or exit fees, are generally amortized or accreted into interest income over the life of the respective debt investment; other fees, such as amendment fees, prepayment fees, and variable end-of-term fees, are recognized as earned, and the collectability of outstanding accrued income receivables is assessed at least quarterly, with reserves or non-accrual status applied if payments are deemed unlikely - Interest and dividend income, including PIK income, is recorded on an accrual basis[27] - Origination, structuring, closing, commitment, and other upfront fees are generally amortized or accreted into interest income over the life of the respective debt investment[27] - The collectability of outstanding accrued income receivables is assessed at least quarterly, with a reserve established or the investment put on non-accrual status if amounts are not likely to be paid[29] Net Realized Gains (Losses) and Net Change in Unrealized Appreciation (Depreciation) Realized gains or losses are measured as the difference between the net proceeds from the repayment or sale of an investment and its amortized cost basis, without regard to previously recognized unrealized appreciation or depreciation, using the specific identification method; the net change in unrealized appreciation or depreciation reflects the net change in portfolio investment fair values and cost bases during the reporting period, including the reversal of prior unrealized amounts when gains or losses are realized - Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale of an investment and the amortized cost basis, computed using the specific identification method[30] - Net change in unrealized appreciation or depreciation reflects the net change in portfolio investment fair values and cost bases during the reporting period, including the reversal of previously recorded unrealized amounts when gains or losses are realized[31] Portfolio and Investment Activity For the nine months ended September 30, 2021, GECC acquired $180.7 million in investments and disposed of $95.5 million, resulting in a weighted average yield of 11.27% at period end, which compares to $101.4 million in acquisitions and $112.0 million in dispositions for the year ended December 31, 2020, with a year-end yield of 11.72% | Period | Acquisitions (in thousands) | Dispositions (in thousands) | Weighted Average Yield (End of Period) | |:---|:---|:---|:---| | Nine months ended Sep 30, 2021 | $180,673 | $(95,491) | 11.27% | | Year ended Dec 31, 2020 | $101,360 | $(111,993) | 11.72% | - Acquisitions include new investments, additional fundings, refinancings, and capitalized PIK income, excluding short-term securities[33] - Dispositions include scheduled principal payments, prepayments, sales, and repayments[36] Portfolio Reconciliation The fair value of GECC's investment portfolio increased from $151.6 million at December 31, 2020, to $246.7 million at September 30, 2021, primarily driven by $180.7 million in new acquisitions and $10.7 million in net unrealized appreciation, partially offset by $95.5 million in repayments/sales and $4.0 million in net realized losses | (in thousands) | For the Nine Months Ended Sep 30, 2021 | For the Year Ended Dec 31, 2020 | |:---|:---|:---|\n| Beginning Investment Portfolio, at fair value | $151,648 | $197,615 | | Portfolio Investments acquired | $180,673 | $101,360 | | Amortization of premium and accretion of discount, net | $3,175 | $4,999 | | Portfolio Investments repaid or sold | $(95,491) | $(111,993) | | Net change in unrealized appreciation (depreciation) on investments | $10,711 | $(29,356) | | Net realized gain (loss) on investments | $(3,981) | $(10,977) | | Ending Investment Portfolio, at fair value | $246,735 | $151,648 | Portfolio Classification As of September 30, 2021, GECC's investment portfolio had a fair value of $246.7 million, with the largest industry concentrations in Specialty Finance (19.67%), Oil & Gas (16.76%), and Wireless Telecommunications Services (13.00%), reflecting a shift from December 31, 2020, where Wireless Telecommunications Services (19.30%) and Internet Media (12.35%) were more prominent, and Specialty Finance had a smaller share (10.39%) | Industry | Sep 30, 2021 Fair Value (in thousands) | Sep 30, 2021 Percentage of Fair Value | Dec 31, 2020 Fair Value (in thousands) | Dec 31, 2020 Percentage of Fair Value | |:---|:---|:---|:---|:---|\n| Specialty Finance | $48,544 | 19.67% | $15,760 | 10.39% | | Oil & Gas | $41,352 | 16.76% | $20,290 | 13.38% | | Wireless Telecommunications Services | $32,076 | 13.00% | $29,270 | 19.30% | | Internet Media | $11,869 | 4.81% | $18,736 | 12.35% | | Apparel | $10,292 | 4.17% | - | -% | | Restaurants | $10,115 | 4.10% | $10,470 | 6.91% | | Construction Materials Manufacturing | $9,914 | 4.02% | $9,676 | 6.38% | | Special Purpose Acquisition Company | $9,257 | 3.75% | - | -% | | Metals & Mining | $7,518 | 3.05% | $3,996 | 2.65% | | Industrial | $7,415 | 3.00% | $4,642 | 3.06% | | Chemicals | $6,454 | 2.62% | - | -% | | Transportation Equipment Manufacturing | $6,084 | 2.47% | $2,948 | 1.95% | | Home Security | $5,831 | 2.36% | - | -% | | Casinos & Gaming | $5,075 | 2.06% | $2,820 | 1.86% | | Software Services | $5,002 | 2.03% | $4,896 | 3.23% | | Retail | $4,884 | 1.98% | $6,145 | 4.05% | | Food & Staples | $4,805 | 1.95% | $8,694 | 5.73% | | Media & Entertainment | $4,540 | 1.84% | - | -% | | Hospitality | $4,080 | 1.65% | - | -% | | Radio Broadcasting | $3,357 | 1.36% | $3,763 | 2.48% | | Services | $3,023 | 1.22% | - | -% | | Wholesale-Apparel, Piece Goods & Notions | $2,862 | 1.16% | $2,762 | 1.82% | | Consumer Services | $2,490 | 1.01% | - | -% | | Hotel Operator | $56 | 0.02% | $1,203 | 0.79% | | Technology | $(160) | (0.06)% | $202 | 0.13% | | Apparel & Textile Products | - | -% | $5,154 | 3.40% | | Real Estate Services | - | -% | $200 | 0.13% | | Building Cleaning and Maintenance Services | - | -% | $162 | 0.11% | | Maritime Security Services | - | -% | $19 | 0.01% | | Telecommunications Services | - | -% | $(160) | (0.11)% | | Total | $246,735 | 100.00% | $151,648 | 100.00% | Results of Operations GECC's results of operations for the three and nine months ended September 30, 2021, show an increase in total investment income driven by higher interest-earning assets and one-time fees, despite a decrease in dividend income, with total expenses also rising due to increased management fees, professional services, and interest expense, reporting net realized gains for the quarter but net realized losses for the nine-month period, alongside a significant shift to net unrealized appreciation Investment Income Total investment income increased to $7.37 million for the three months ended September 30, 2021 (from $5.95 million in 2020) and to $18.90 million for the nine months ended September 30, 2021 (from $17.15 million in 2020), primarily due to an increase in interest-earning assets and certain one-time commitment fees, though dividend income decreased for the three-month period due to lower distributions from Prestige Capital Finance, LLC and reduced holdings in Crestwood Equity Partners, LP | (in thousands) | For the Three Months Ended Sep 30, 2021 | For the Three Months Ended Sep 30, 2020 | For the Nine Months Ended Sep 30, 2021 | For the Nine Months Ended Sep 30, 2020 | |:---|:---|:---|:---|:---|\n| Total Investment Income | $7,373 | $5,951 | $18,901 | $17,148 | | Interest income | $5,872 | $4,375 | $15,143 | $14,546 | | Dividend income | $915 | $1,281 | $2,809 | $2,164 | | Other income | $586 | $295 | $949 | $438 | - Interest income increased due to increases in the interest-earning assets of the portfolio, offsetting impacts from exits from certain high-yielding positions and sharp decreases in LIBOR base rates[43] - Dividend income for the three months ended September 30, 2021, decreased due to a lower current quarter distribution from Prestige Capital Finance, LLC and reductions in holdings of Crestwood Equity Partners, LP[44] - Other income increased primarily due to certain one-time commitment fees earned on the Greenway Health, LLC revolver and PIK commitment and funding fees from Avanti Communications Group, plc[45] Expenses Total expenses increased to $5.80 million for the three months ended September 30, 2021 (from $4.02 million in 2020) and to $13.72 million for the nine months ended September 30, 2021 (from $11.65 million in 2020), mainly driven by higher