UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended March 31, 2017

OR

 

For the transition period from _______ to _________

 

Commission File Number: 814-01211

 

Great Elm Capital Corp.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Registrant's telephone number, including area code: (617) 375-3006

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

 

The registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 or Rule 12b-2 of the Securities Exchange Act of 1934    ☒ 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.     ☐ 

 

As of May 10, 2017, the registrant had 11,641,186 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

 

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Table of Contents

 

 

 

 

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PART I—FINANCIAL INFORMATION

Unless the context otherwise requires, all references to “GECC,” “we,” “us,” “our,” the “Company” and words of similar import are to Great Elm Capital Corp. and/or its subsidiaries.  We reference materials on our website, www.greatelmcc.com, but nothing on our website shall be deemed incorporated by reference or otherwise contained in this report.  All dollar amounts, other than per share amounts, are disclosed in thousands unless otherwise noted.

Item 1. Financial Statements.

The financial statements listed in the index to financial statements immediately following the signature page to this report are incorporated herein by reference.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We are a business development company (“BDC”) that seeks to generate both current income and capital appreciation through debt and equity investments. Our investment focus is on debt obligations of middle-market companies.  We invest primarily in the debt of middle-market companies as well as small businesses, generally in the form of senior secured and unsecured notes, as well as in senior secured loans, junior loans and mezzanine debt. We will from time to time make equity investments as part of restructuring credits and in rare instances reserve the right to make equity investments directly.

On September 27, 2016, we and Great Elm Capital Management, Inc. (“GECM”) entered into the Investment Management Agreement and the Administration Agreement, and, upon closing the Merger, we began to accrue obligations to our external investment manager under those agreements.

Beginning with our tax year starting October 1, 2016, we intend to elect to be treated as a Regulated Investment Company (“RIC”) for U.S. federal income tax purposes. As a RIC, we will not be taxed on our income to the extent that we distribute such income each year and satisfy other applicable income tax requirements. To qualify as a RIC, we must, among other things, meet source-of-income and asset diversification requirements and annually distribute to our stockholders generally at least 90% of our investment company taxable income on a timely basis. If we qualify as a RIC, we generally will not have to pay corporate level taxes on any income that we distribute to our stockholders.

Formation Transactions

On June 23, 2016, we entered into the Subscription Agreement, under which:

For financial reporting purposes, we have accounted for the contribution of the Initial GECC Portfolio as an asset acquisition per Topic 805, Business Combinations, of the Accounting Standards Codification (“ASC”).  For tax purposes, we recorded our basis in the Initial GECC Portfolio at the fair market value of the Initial GECC Portfolio as of the date of contribution.

Under the Subscription Agreement, upon consummation of the Merger, we became obligated to reimburse the costs incurred by GEC and the MAST Funds in connection with the Merger and the transactions contemplated by the Subscription Agreement.

Following the closing of the Merger, we entered into a registration rights agreement with GEC and the MAST Funds.

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Full Circle Merger

On June 23, 2016, we entered into the Merger Agreement with Full Circle.  Following approval on October 31, 2016 of the Merger by Full Circle’s stockholders, on November 3, 2016:

We accounted for the Merger as a business combination under ASC Topic 805 and Regulation S-X’s purchase accounting guidance. GECC was designated as the acquirer for accounting purposes. The difference between the fair value of Full Circle’s net assets and the consideration was recorded as a purchase accounting loss because the fair value of the assets acquired and liabilities assumed, as of the date of the Merger, was less than that of the merger consideration paid.

Investments

Our level of investment activity can and does vary substantially from period to period depending on many factors, including, among others, the amount of debt and equity capital available from other sources to middle-market companies, the level of merger and acquisition activity, pricing in the high yield credit markets, our expectations of future investment opportunities, the general economic environment as well as the competitive environment for the types of investments we make.

As a BDC, our investments and the composition of our portfolio are required to comply with regulatory requirements.

Revenues

We generate revenue primarily in the form of interest on the debt investments that we hold. We also may generate revenue from dividends on the equity investments that we hold, capital gains on the disposition of investments, and certain lease, fee, and other income. Our investments in fixed income instruments generally have an expected maturity of three to five years, although we have no lower or upper constraint on maturity. Our debt investments generally pay interest quarterly or semi-annually. Payments of principal of our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments and preferred stock investments may defer payments of cash interest or dividends or pay in kind (“PIK”). In addition, we may generate revenue in the form of prepayment fees, commitment, origination, due diligence fees, end-of-term or exit fees, fees for providing significant managerial assistance, consulting fees and other investment related income.

Expenses

Our primary operating expenses include the payment of a base management fee, administration fees (including the allocable portion of overhead under the administration agreement), and, depending on our operating results, an incentive fee. The base management fee and incentive fee remunerates the Investment Manager for work in identifying, evaluating, negotiating, closing and monitoring our investments. Our administration agreement provides for reimbursement of costs and expenses incurred for office space rental, office equipment and utilities allocable to us under the Administration Agreement, as well as certain costs and expenses incurred relating to non-investment advisory, administrative or operating services provided by GECM or its affiliates to us. We also bear all other costs and expenses of our operations and transactions. Our expenses include interest on our outstanding indebtedness.

Critical Accounting Policies

Valuation of Portfolio Investments

We value our portfolio investments at fair value based upon the principles and methods of valuation set forth in policies adopted by our board of directors (our “Board”). Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. Market participants are buyers and sellers

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in the principal (or most advantageous) market for the asset that (1) are independent of us; (2) are knowledgeable, having a reasonable understanding about the asset based on all available information (including information that might be obtained through due diligence efforts that are usual and customary); (3) are able to transact for the asset; and (4) are willing to transact for the asset (that is, they are motivated but not forced or otherwise compelled to do so).

Investments for which market quotations are readily available are valued at such market quotations unless the quotations are deemed not to represent fair value. We generally obtain market quotations from recognized exchanges, market quotation systems, independent pricing services or one or more broker-dealers or market makers. However, short term debt investments with remaining maturities within ninety days are generally valued at amortized cost, which approximates fair value.

Debt and equity securities for which market quotations are not readily available or for which market quotations are deemed not to represent fair value, are valued at fair value using a consistently applied valuation process in accordance with our valuation policy that has been reviewed and approved by our Board, who also approves in good faith the valuation of such securities as of the end of each quarter. Due to the inherent uncertainty and subjectivity of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments and may differ materially from the values that we may ultimately realize. In addition, changes in the market environment and other events may have differing impacts on the market quotations used to value some of our investments than on the fair values of our investments for which market quotations are not readily available.

The valuation process approved by our Board with respect to investments for which market quotations are not readily available or for which market quotations are deemed not to represent fair value is as follows:

Those investments for which market quotations are not readily available or for which market quotations are deemed not to represent fair value are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in determining the fair value of our investments include, as relevant and among other factors: available current market data, including relevant and applicable market trading and transaction comparables; applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral; the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, merger and acquisition comparables; and enterprise values.

We strive to maximize the use of observable inputs and minimize the use of unobservable inputs in our valuation process. Inputs refer broadly to the assumptions that market participants would use in pricing an asset, including assumptions about risk. Observable inputs are inputs that reflect the assumptions market participants would use in pricing an asset developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the assumptions market participants would use in pricing an asset developed based on the best information available in the circumstances.

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Our investments may be categorized based on the types of inputs used in their valuation. The level in the GAAP valuation hierarchy in which an investment falls is based on the lowest level input that is significant to the valuation of the investment in its entirety. Investments are classified by GAAP into the three broad levels as follows:

Revenue Recognition

Interest and dividend income, including income paid in kind, is recorded on an accrual basis. Origination, structuring, closing, commitment and other upfront fees, including original issue discounts, earned with respect to capital commitments are generally amortized or accreted into interest income over the life of the respective debt investment, as are end-of-term or exit fees receivable upon repayment of a debt investment if such fees are fixed in nature. Other fees, including certain amendment fees, prepayment fees and commitment fees on broken deals, and end-of-term or exit fees that have a contingency feature or are variable in nature are recognized as earned. Prepayment fees and similar income due upon the early repayment of a loan or debt security are recognized when earned and are included in interest income.

We may purchase debt investments at a discount to their face value. Discounts on the acquisition of corporate debt instruments are generally amortized using the effective-interest or constant-yield method, unless there are material questions as to collectability. For debt instruments where we are amortizing original issue discounts, when principal payments on the debt instrument are received in an amount in excess of the debt instrument’s amortized cost, the excess principal payments are recorded as interest income.

Net Realized Gains (Losses) and Net Change in Unrealized Appreciation (Depreciation)

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale of an investment and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Realized gains and losses are computed using the first in first out method. Net change in unrealized appreciation or depreciation reflects the net change in portfolio investment values and portfolio investment cost bases during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

Portfolio and Investment Activity

The following is a summary of our investment activity since our inception in April 2016:

 

 

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Portfolio Reconciliation

The following is a reconciliation of the investment portfolio for the period from inception through March 31, 2017:

 

 

During the three months ended March 31, 2017, we recorded net unrealized appreciation (depreciation) of $(2,695).

During the three months ended March 31, 2017, we recorded net realized gains of $1,980, primarily in connection with our disposition of our investment in JN Medical, which resulted in a $1,007 gain.  We also realized gains of $281 on our sale of our Trilogy International bonds and $354 on the sale of a portion of our Everi Payments bonds.

Portfolio Classifications

The following table shows the fair value of our portfolio of investments by asset class as of March 31, 2017:

 

 

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Results of Operations for the three months ended March 31, 2017

 

 

Total Investment Income

 

 

 

Total Investment Income for the three months ended March 31, 2017 was $7,315, which included $6,826 of interest income.  Interest income included net accretion of OID and market discount of $1,178 and total investment income included PIK income of $1,142.

We also generated $443 of fee income.  

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Expenses

 

 

Total expenses for the three months ended March 31, 2017 were $3,226.

Total advisory fees were $1,616, with $593 of management fees and $1,023 of incentive fees accrued during the period.  The incentive fees are currently expected to be deferred in accordance with our investment management agreement.

Total administration fees were $495, which includes direct costs deemed reimbursable under our administration agreement and fees paid for sub-administration services.  We have accrued $5 as of March 31, 2017 under the reimbursement provision of the administration agreement, based on expenses accrued from November 4, 2016 through March 31, 2017. The cap on costs will be determined after completion of the year ending November 4, 2017.

Interest expense for the period was $631.

Net Investment Income

Net investment income for the three months ended March 31, 2017 was $4,094.

Realized Gain (Loss) on Investments

During the three months ended March 31, 2017, we recorded net realized gains of $1,980, primarily in connection with our disposition of our investment in JN Medical, which resulted in a $1,007 gain.  We also realized gains of $281 on the sale of our Trilogy International bonds and $354 on the sale of a portion of our Everi Payments bonds.

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Change in Unrealized Gain (Loss) on Investments

Net change in unrealized appreciation (depreciation) on investments was $(2,695) for three months ended March 31, 2017. The following table summarizes the significant changes in unrealized appreciation (depreciation) of the Company’s investment portfolio, for the three months ended March 31, 2017 by portfolio company.

 

 

Liquidity and Capital Resources

At March 31, 2017, we had approximately $66,763 of cash and cash equivalents, none of which was restricted in nature.

At March 31, 2017, we had investments in debt securities of 20 companies, totaling approximately $149,601 at fair value and equity investments in seven companies, totaling approximately $2,633 at fair value. The debt investment amount includes $526 in accrued PIK income earned for the three months ended March 31, 2017, and $526, cumulatively, which is included in carrying value of our investments.

For the three months ended March 31, 2017, cash provided by operating activities, consisting primarily of net purchases of investments and the items described in “Results of Operations,” was approximately $6,989, reflecting the purchases and repayments of investments, net investment income resulting from operations, offset by non-cash income related to OID and PIK income, changes in working capital and accrued interest receivable. Net cash provided by purchases and sales of investments was approximately $2,906, reflecting principal repayments and sales of $78,758, offset by additional investments of $75,852. Such amounts included draws and repayments on revolving credit facilities.  Our Board previously set our distribution rate at $0.083 per share per month and we intend to re-evaluate our dividend rate from time to time.

Stock Buyback Program

We have implemented a stock buyback program through May 2018 pursuant to Rule 10b5‑1 of the Exchange Act to repurchase our shares in an aggregate amount of up to $15,000 at market prices at any time the shares trade below 90% of NAV, subject to our compliance with our liquidity, covenant, leverage and regulatory requirements.  Our Board has increased the overall size of the stock buyback program by a further $35,000.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.

Notes Payable.

On November 3, 2016, we assumed approximately $33,646 in aggregate principal amount of Full Circle’s 8.25% Notes due June 30, 2020 (the “Notes”).  The Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of

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payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the Notes is paid quarterly in arrears at a rate of 8.25% per annum. The Notes mature on June 30, 2020 and may be redeemed in whole or in part at any time or from time to time at our option. The Notes are listed on the NASDAQ Global Market under the trading symbol “FULLL” with a par value of $25.00 per share.

Recent Developments

During April 2017, we sold our position in Chester Downs & Marina LLC for approximately $6.3 million, including accrued interest.  We realized approximately $0.3 million of gains on the disposition of the investment

During April and May 2017, we sold the remaining $6.3 million of our position in Everi Payments, Inc. for approximately $6.8 million, including accrued interest.  We realized approximately $0.6 million of gains on the disposition of the investment.

During May 2017, we received approximately $2.8 million in proceeds from the disposition of the primary asset of Double Deuce Lodging, LLC.

Our self-tender offer expired at on May 5, 2017.  We purchased 869,565 shares of our common stock, representing approximately 7 percent of our outstanding shares at a price of $11.50 per share on a pro rata basis for a total cost of approximately $10,000, excluding fees and expenses relating to the self-tender offer.  The purchase price represented approximately 85% of net asset value per share as of March 31, 2017.

Our board of directors declared the monthly distributions for the third quarter of 2017 at an annual rate of approximately 7.37% of NAV, which equates to $0.083 per month. The schedule of distribution payments is as follows:

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are subject to financial market risks, including changes in interest rates. As of March 31, 2017, 8 debt investments in our portfolio bore interest at a fixed rate, and the remaining 15 debt investments were at variable rates, representing approximately $79,484 and $70,117 in principal debt, respectively. The variable rates are based upon LIBOR.

To illustrate the potential impact of a change in the underlying interest rate on our net investment income, we have assumed a 1%, 2%, and 3% increase and 1%, 2%, and 3% decrease in the underlying Prime Rate or LIBOR, and no other change in our portfolio as of March 31, 2017. We have also assumed there are no outstanding floating rate borrowings by the Company. See the below table for the effect the rate changes would have on net investment income.

 

 

This analysis does not adjust for changes in the credit quality, size and composition of our portfolio, and other business developments that could affect the net increase in net assets resulting from operations. Accordingly, no assurances can be given that actual results would not differ materially from the results under this hypothetical analysis.

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We may in the future hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contracts. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to the investments in our portfolio with fixed interest rates.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of March 31, 2017, we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Changes in Internal Controls Over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we, our investment adviser or administrator may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. .  See Note 6 to our unaudited consolidated financial statements.

Item 1A. Risk Factors.

There have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K (File No. 814-01211).

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

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Issuer Purchases of Equity Securities

In the prospectus for the Merger, we announced that we would initiate a stock buyback program. For the three months ended March 31, 2017, we purchased 245,729 shares under our stock buyback program at a weighted average price of $11.35 per share. As of May 10, 2017 we have cumulatively purchased 378,301 shares under our stock buyback program at a weighted average price of $11.17 per share, resulting in $4,227 of cumulative cash paid, under the program since November 4, 2016.

 

 

Item 3. Defaults Upon Senior Securities.

Not applicable

Item 4. Mine Safety Disclosures.

Not applicable

Item 5. Other Information.

Not applicable

Item 6. Exhibits.

The exhibit index following the financial statements is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized as of May 12, 2017.

 

 

 

 

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GREAT ELM CAPITAL CORP.

INDEX TO FINANCIAL STATEMENTS

MARCH 31, 2017

 

 

 

 

F-1

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GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

MARCH 31, 2017

Dollar amounts in thousands (except per share amounts)

 

 

The accompanying notes are an integral part of these financial statements.

F-2

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GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENT OF OPERATIONS (unaudited)

THREE MONTHS ENDED MARCH 31, 2017

Dollar amounts in thousands (except per share amounts)

 

 

The accompanying notes are an integral part of these financial statements.

F-3

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GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS (unaudited)

THREE MONTHS ENDED MARCH 31, 2017

Dollar amounts in thousands

 

 

The accompanying notes are an integral part of these financial statements.

F-4

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GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)

THREE MONTHS ENDED MARCH 31, 2017

Dollar amounts in thousands

 

 

The accompanying notes are an integral part of these financial statements.

 

 

F-5

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GREAT ELM CORP.

CONSOLIDATED SCHEDULE OF INVESTMENTS (unaudited)

MARCH 31, 2017

Dollar amounts in thousands