Great Elm Capital Corp. - Quarter Report: 2018 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2018

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 every Interactive Data File required to be submitted 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 such files).    Yes  ☐    No  ☐

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

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 13(a) 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  ☒

As of November 5, 2018, the registrant had 10,652,401 shares of common stock, $0.01 par value per share, outstanding.

Table of Contents

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “Form 10-K”).

The information contained herein may contain “forward-looking statements” based on our current expectations, assumptions and estimates about us and our industry.  These forward-looking statements involve risks and uncertainties.  Words such as “anticipate,” “believe,” “expect,” “intend,” “will,” “should,” “could,” “may,” “plan” and other similar expressions identify forward-looking statements.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements that are subject to risks, uncertainties and assumptions.  Our actual results could differ materially from those we express in the forward-looking statements as a result of several factors more fully described in “Risk Factors” and elsewhere in our Form 10-K and in this Quarterly Report on Form 10-Q (the “Form 10-Q”).  The forward-looking statements made in this Form 10-Q relate only to events as of the date on which the statements are made.  We undertake no obligation to update publicly any forward-looking statements for any reason, whether as a result of new information, future events or otherwise, except as required by law.

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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 consolidated 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 as well as small businesses.  We invest primarily in senior secured and senior unsecured debt instruments as well as in junior loans and mezzanine debt of middle-market companies and small businesses.  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”), our external manager, entered into an investment management agreement (the “Investment Management Agreement”) and an administration agreement (the “Administration Agreement”), and we began to accrue obligations to GECM under those agreements.

We have elected 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.

Investments

Our level of investment activity varies substantially from period to period depending on many factors, including, among others, the amount of debt and equity capital available to middle-market companies from other sources, the level of merger and acquisition activity, pricing in the high yield and leveraged loan credit markets, our expectations of future investment opportunities, the general economic environment and 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 from interest on the debt investments that we hold.  We may also generate revenue from dividends on the equity investments, capital gains on the disposition of investments, and lease, fee, or 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.  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 GECM 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 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.

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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.

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.  Short-term debt investments with remaining maturities within 90 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 valuation process consistent with our Board-approved policy.  Our Board approves in good faith the valuation of our portfolio 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 impact the market quotations used to value some of our investments.

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 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.  In following these approaches, the types of factors that we may take into account in determining the fair value of our investments include, 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, and 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, and merger and acquisition comparables; and enterprise values.

We prefer 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.  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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Investments are classified in accordance with accounting principles generally accepted in the United States of America into the three broad levels as follows:

All Level 3 investments that comprise more than 5% of the investments of GECC are valued by independent third parties.

Revenue Recognition

Interest and dividend income, including payment-in-kind (“PIK”) income, is recorded on an accrual basis.  Origination, structuring, closing, commitment and other upfront fees, including original issue discounts (“OID”), 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 OID, 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 fair value 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.

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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 nine months ended September 30, 2018 and the year ended December 31, 2017.  Investments in short-term securities, including U.S. Treasury Bills and money market mutual funds, were excluded from the table below.

During the three and nine months ended September 30, 2018, inclusive of short-term securities, we recorded net change in unrealized depreciation of $1,275 and $(11,187), respectively.

Portfolio Classification

The following table shows the fair value of our portfolio of investments by industry as of September 30, 2018:

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Results of Operations

Total Investment Income

Interest income included net accretion of OID and market discount of $797 and $2,206 for the three and nine months ended September 30, 2018, respectively.  Interest income also included accrued PIK income of $1,932 and $6,934 for the three and nine months ended September 30, 2018, respectively.

Expenses

Net expenses for the nine months ended September 30, 2018 decreased as compared to net expenses for the nine months ended September 30, 2017 primarily due to the reversal of $2,637 of incentive fees recorded in prior periods.  Our largest investment, Avanti Communications Group plc (“Avanti”), has generated significant non-cash income in the form of PIK interest.  In connection with the recent restructuring of Avanti, which closed on April 26, 2018, our investment in Avanti’s third lien senior secured notes (the “third lien notes”) was converted into Avanti common equity.  As a result of this debt-for-equity conversion, we have determined that the accrued incentive fees payable associated with the portion of such PIK interest generated by the third lien notes should not at this time be recognized as a liability and as such we have reversed for prior periods.  Notwithstanding this reversal, such incentive fees remain payable under the Investment Management Agreement (subject to achievement of return hurdles) and will be recognized as an expense to the extent that an exit or recovery results in gross proceeds to us in excess of our initial cost basis in the third lien notes.

Excluding the impact of the incentive fee reversal described above, net expenses for the three and nine months ended September 30, 2018 increased as compared to net expenses for the three and nine months ended September 30, 2017 primarily due to increased interest expense, as a result of having a greater amount of debt outstanding compared to the prior year.  The GECCM Notes (as defined below) were newly issued in January 2018.  See “—Liquidity and Capital Resources—Notes Payable” for further information.

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Net Realized Gains (Losses) on Investments

During the three months ended September 30, 2018, we recorded net realized gains of $898, which primarily consist of approximately $702 in acceleration of original issue discount in connection with the restructuring of our investment in Speedwell Holdings (formerly known as The Selling Source, LLC) and net realized gain of $190 on the exercise of the RiceBran Technologies Corporation warrants and subsequent sale of the common stock received in that exercise.

Realized gains for the nine months ended September 30, 2018 also include realized gains in connection with principal amortization of loans that were acquired at a discount, and realized gains on the sale of the PR Wireless, Inc. senior secured loan, sales of NANA Development Corp. senior bonds and a partial repayment on our PE Facility Solutions, LLC Term Loan B.

Realized gains for the three months ended September 30, 2017 primarily consisted of principal amortization of loans acquired at a discount.  During the nine months ended September 30, 2017 we recorded net realized gains of $3,420 primarily in connection with the disposition of several investments and the prepayment of a portion of our loan to Sonifi Solutions.

Net Change in Unrealized Appreciation (Depreciation) on Investments

The following table summarizes the significant changes in unrealized appreciation (depreciation) of our investment portfolio, excluding the impact of unrealized appreciation (depreciation) on short-term securities such as U.S. Treasury Bills and money market mutual funds, for the nine months ended September 30, 2018.

The following table summarizes the significant changes in unrealized appreciation (depreciation) of our investment portfolio, excluding the impact of unrealized appreciation (depreciation) on short-term securities such as U.S. Treasury Bills and money market mutual funds, for the three months ended September 30, 2018.

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Net change in unrealized appreciation (depreciation) for the nine months ended September 30, 2017 was $(22,382).  Net change in unrealized appreciation (depreciation) for the three months ended September 30, 2017 was $(12,361).  In each of these periods, the change in unrealized appreciation (depreciation) was primarily driven by the performance of the investment in Avanti.

Liquidity and Capital Resources

At September 30, 2018, we had approximately $4,060 of cash and cash equivalents, none of which was restricted in nature.  At September 30, 2018, we also had $1,252 invested in a money market fund that is classified as an investment rather than cash and cash equivalents.

At September 30, 2018, we had investments in 29 debt instruments across 23 companies, totaling approximately $190,216 at fair value and equity investments in four companies, totaling approximately $13,041 at fair value.

In the normal course of business, we may enter into investment agreements under which we commit to make an investment in a portfolio company at some future date or over a specified period of time.  As of September 30, 2018, we had approximately $17,360 in unfunded loan commitments, subject to our approval in certain instances, to provide debt financing to certain of our portfolio companies.  We had sufficient cash and other liquid assets on our September 30, 2018 balance sheet to satisfy the unfunded commitments.

For the nine months ended September 30, 2018, net cash used for operating activities, consisting primarily of net purchases of investments and the items described in “—Results of Operations,” was approximately $(33,216), reflecting the purchases and repayments of investments offset by net investment income, including non-cash income related to OID and PIK income and proceeds from sales of investments and principal payments received.  Net cash used for purchases and sales of investments was approximately $(37,035), reflecting principal repayments and sales of $94,789, offset by additional investments of $(131,824).  Such amounts included draws and repayments on revolving credit facilities.

For the nine months ended September 30, 2018, net cash provided by financing activities was $34,360, which consisted primarily of $44,448 in cash proceeds from the issuance of the GECCM Notes partially offset by $(10,088) in distributions to investors.

Contractual Obligations

A summary of our significant contractual payment obligations as of September 30, 2018 is as follows:

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We have certain contracts under which we have material future commitments.  Under the Investment Management Agreement, GECM provides investment advisory services to us.  For providing these services, we pay GECM a fee, consisting of two components: (1) a base management fee based on the average value of our total assets and (2) an incentive fee based on our performance.

We are also party to the Administration Agreement with GECM.  Under the Administration Agreement, GECM furnishes us with, or otherwise arranges for the provision of, office facilities, equipment, clerical, bookkeeping, finance, accounting, compliance and record keeping services at such office facilities and other such services as our administrator.

If any of the contractual obligations discussed above are terminated, our costs under any new agreements that we enter into may increase.  In addition, we would likely incur significant time and expense in locating alternative parties to provide the services we expect to receive under our Investment Management Agreement and our Administration Agreement.  Any new investment management agreement would also be subject to approval by our stockholders.

Both the Investment Management Agreement and the Administration Agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other.

Inflation

Inflation has not had a significant effect on our results of operations in any of the reporting periods presented in our financial statements.  However, from time to time, inflation may impact the operating results of our portfolio companies.  

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 September 18, 2017, we sold $28,375 in aggregate principal amount of 6.50% notes due 2022 (the "GECCL Notes").  On September 29, 2017, we sold an additional $4,256 of the GECCL Notes upon full exercise of the underwriters’ over-allotment option.  As a result of the issuance of these additional GECCL Notes, the aggregate principal balance of GECCL Notes outstanding is $32.6 million.

The GECCL Notes are our unsecured obligations and rank equal with all of our outstanding and future unsecured unsubordinated indebtedness.  The GECCL Notes are effectively subordinated, or junior in right of payment, to any future secured indebtedness that we may incur and structurally subordinated to all future indebtedness and other obligations of our subsidiaries.  We pay interest on the GECCL Notes on January 31, April 30, July 31 and October 31 of each year.  The GECCL Notes will mature on September 18, 2022 and can be called on, or after, September 18, 2019.  Holders of the GECCL Notes do not have the option to have the GECCL Notes repaid prior to the stated maturity date.  The GECCL Notes were issued in minimum denominations of $25 and integral multiples of $25 in excess thereof.

On January 11, 2018, we sold $43,000 in aggregate principal amount of 6.75% notes due 2025 (the "GECCM Notes").  On January 19, 2018 and February 9, 2018, we sold an additional $1,898 and $1,500 of the GECCM Notes upon partial exercise of the underwriters’ over-allotment option.  As a result of the issuance of these additional GECCM Notes, the aggregate principal balance of GECCM Notes outstanding is $46.4 million.

The GECCM Notes are our unsecured obligations and rank equal with all of our outstanding and future unsecured unsubordinated indebtedness.  The GECCM Notes are effectively subordinated, or junior in right of payment, to any future secured indebtedness that we may incur and structurally subordinated to all future indebtedness and other obligations of our subsidiaries.  We pay interest on the GECCM Notes on March 31, June 30, September 30 and December 31 of each year.  The GECCM Notes will mature on January 31, 2025 and can be called on, or after, January 31, 2021. Holders of the GECCM Notes do not have the option to have the GECCM Notes repaid prior to the stated maturity date.  The GECCM Notes were issued in minimum denominations of $25 and integral multiples of $25 in excess thereof.

Recent Developments

In October 2018, we purchased an additional $5,813 of par value of PFS Holdings Corp. first lien term loan at a price of approximately 60% of par value.

In October 2018, we purchased approximately $2,000 of par value of Viasat, Inc. receivable at a price of 85% of par value.

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In November 2018, $1,256 of par value of Geo Specialty Chemicals, Inc. first lien term loan was paid down at 100% of par value.

In November 2018, we funded an additional $329 of par value to PR Wireless, Inc. first lien, delayed draw.

On October 22, 2018, based on the Form 4 filed by MAST Capital, a related party, with the Securities and Exchange Commission, MAST Capital executed a trade to sell 2,276,279 shares of GECC at $7.55 per share.  After this transaction, MAST Capital has 2,711,874 shares of GECC representing approximately 25.5% of the outstanding shares.

Our Board declared the monthly distributions for the first quarter of 2019 at an annual rate of approximately 8.3% of our September 30, 2018 net asset value, which equates to $0.083 per month.  All of the monthly distributions are from net investment income.  The schedule of distribution payments will be established by GECC pursuant to authority granted by our Board.

Reduction in Required Minimum Asset Coverage Ratio

On March 23, 2018, the Consolidated Appropriations Act of 2018, which includes the Small Business Credit Availability Act (the “Act”), was signed into law.  The Act amends the Investment Company Act of 1940, as amended (the “Investment Company Act”) to permit a BDC to reduce the required minimum asset coverage ratio applicable to it from 200% to 150%, subject to certain requirements described therein.  This reduction significantly increases the amount of debt that BDCs may incur.  

Prior to the enactment of the Act, BDCs were required to maintain an asset coverage ratio of at least 200% in order to incur debt or to issue other senior securities.  Generally, for every $1.00 of debt incurred or in senior securities issued, a BDC was required to have at least $2.00 of assets immediately following such incurrence or issuance.  For those BDCs that satisfy the Act’s disclosure and approval requirements, the minimum asset coverage ratio is reduced such that for every $1.00 of debt incurred or in senior securities issued, a BDC must now have at least $1.50 of assets.

At our 2018 annual meeting of stockholders, which was held on May 3, 2018 (the “Annual Meeting”), a majority of our stockholders approved the application of the modified minimum asset coverage requirements set forth in Section 61(a)(2) of the Investment Company Act, to the Company.  As a result of such approval, and subject to satisfying certain ongoing disclosure requirements, effective May 4, 2018 the asset coverage ratio test applicable to the Company was decreased from 200% to 150%, permitting us to incur additional leverage.

As of September 30, 2018, we had approximately $79 million of total outstanding indebtedness under two series of senior securities (unsecured senior notes)—the GECCL Notes and the GECCM Notes—and our asset coverage ratio was 258%.  For risks associated with the reduction in our required minimum asset coverage ratio from 200% to 150%, see “Risk Factors—Risks Resulting from the Reduction in Required Minimum Asset Coverage Ratio.”

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

We are subject to financial market risks, including changes in interest rates.  As of September 30, 2018, eight debt investments in our portfolio bore interest at a fixed rate, and the remaining 21 debt investments were at variable rates, representing approximately $82,619 and $107,681 in debt at fair value, respectively.  The variable rates are based upon the London Interbank Offered Rate (“LIBOR”).

To illustrate the potential impact of a change in the underlying interest rate on our interest income, we have assumed a 1%, 2%, and 3% increase and 1%, 2%, and 3% decrease in the underlying LIBOR, and no other change in our portfolio as of September 30, 2018.  We have also assumed that we have no outstanding floating rate borrowings.  The below table illustrates the effect such assumed rate changes would have on an annual basis.

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 assurance can be given that actual results would not differ materially from the results under this hypothetical analysis.

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Item 4.  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of September 30, 2018, 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 filings with the Securities and Exchange Commission (“SEC”) 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 Exchange Act) during the quarter ended September 30, 2018 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 or GECM 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.  The following items update the legal proceedings previously disclosed in our Form 10-K.

We are named as a defendant in a lawsuit captioned Intrepid Investments, LLC v. London Bay Capital, which is pending in the Delaware Court of Chancery. This lawsuit was brought by a member of Selling Source, LLC, one of our portfolio investments, against various members of and lenders to Selling Source.  The plaintiff asserts claims of aiding and abetting, breaches of fiduciary duty, and tortious interference against us. As of September 30, 2018, we held $1.25 million in principal amount, or approximately 6%, of Selling Source’s outstanding senior bank debt. The lawsuit was filed on March 5, 2016 and the plaintiff immediately agreed to stay the action in light of an ongoing mediation among parties other than us. In June 2018, Intrepid sent notice to the court and defendants effectively lifting the stay and triggering defendants’ obligation to respond to the Intrepid complaint.  In September 2018, we joined the other defendants in a motion to dismiss on various grounds.  We intend to continue to monitor the matter and will assess the need to defend the matter further as necessary.

We were named in two related complaints, captioned Daniel Saunders, on behalf of himself and all others similarly situated, v. Full Circle Capital Corporation, et al., filed on September 23, 2016 (the “Saunders Action”), and William L.  Russell, Jr., individually and on behalf of all others similarly situated, v.  Biderman, et al., filed on September 12, 2016 and amended on September 22, 2016 (the “Russell Action”), in the United States District Court for the District of Maryland and in the Circuit Court for Baltimore City, (the “Circuit Court”), respectively.  On October 7, 2016, a complaint captioned David Speiser, individually and on behalf of all others similarly situated v.  Felton, et al., was filed in the Circuit Court (the “Speiser Action,” and together with the Russell Action, the “State Court Actions”) (the State Court Actions, together with the Saunders Action, the “Actions”).

On October 24, 2016, we, along with Full Circle, GECC, MAST Capital, certain directors of Full Circle and the plaintiffs in the Actions reached an agreement in principle providing for the settlement of the Actions on the terms and conditions set forth in a memorandum of understanding (the “MOU”).  Pursuant to the terms of the MOU, without agreeing that any of the claims in the Actions have merit or that any supplemental disclosure was required under any applicable statute, rule, regulation or law, Full Circle and GECC agreed to and did make the supplemental disclosures with respect to the Merger.  The MOU further provides that, among other things, (a) the parties to the MOU will enter into a definitive stipulation of settlement (the “Stipulation”) and will submit the Stipulation to the Circuit Court for review and approval; (b) the Stipulation will provide for dismissal of the Actions on the merits; (c) the Stipulation will include a general release of defendants of claims relating to the transactions contemplated by the merger agreement between GECC and Full Circle; and (d) the proposed settlement is conditioned on final approval by the Circuit Court after notice to Full Circle's stockholders. In March 2018, the Saunders Action was voluntarily dismissed by the plaintiff without prejudice. In August 2018, the State Court Actions were dismissed by the Circuit Court without prejudice for failure to prosecute.

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In September 2018, we, the other lenders, and the lender trustee under PEAKS Trust 2009-11, were named as defendants in a claim brought by the chapter 7 trustee in the ITT Educational Services bankruptcy.  Full Circle Capital Corporation (“Full Circle”), predecessor by merger to GECC, purchased via assignment a portion of the PEAKS Trust 2009-1 senior secured facility from Deutsche Bank Trust Company Americas in December 2016.  The PEAKS Trust 2009-1 senior secured facility was supported by an underlying portfolio of student loans and guaranteed by ITT Educational Services, Inc.  In September 2016, ITT and its affiliates filed for relief under chapter 7 of the bankruptcy code.  Following the chapter 7 filing, a trustee was appointed who initiated a proceeding against certain Deutsche Bank entities and the investors in the PEAKS Trust, including Great Elm Capital Corporation, successor by merger to Full Circle.  On November 2, 2018, the trustee filed a motion seeking to stay the litigation in order to facilitate settlement.  We are continuing to monitor these proceedings.

Item 1A.  Risk Factors.

In addition to the risk factors set forth below and the other information set forth in this report, you should carefully consider the “Risk Factors” discussed in our Form 10-K, which could materially affect our business, financial condition and/or operating results.

Risks Resulting from the Reduction in Required Minimum Asset Coverage Ratio

Incurring additional indebtedness could increase the risk in investing in our Company.  Pursuant to the Act, at the Annual Meeting our stockholders approved of the reduction of our required minimum asset coverage ratio from 200% to 150%, permitting us to incur additional leverage.  The use of leverage magnifies the potential for gain or loss on amounts invested.  The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. If we incur such additional leverage, you may experience increased risks of investing in our common stock.

As of September 30, 2018, we had approximately $79 million of total outstanding indebtedness under two series of senior securities (unsecured senior notes)—the GECCL Notes and the GECCM Notes—and our asset coverage ratio was 258%.  Holders of our GECCL Notes and GECCM Notes have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and such holders may seek to recover against our assets in the event of a default.

If we are unable to meet the financial obligations under the GECCL Notes or the GECCM Notes, the holders of such indebtedness would have a superior claim to our assets over our common stockholders in the event of a default by us.  If the value of our assets decreases, leveraging would cause our net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses.  Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed.  Such a decline would also negatively affect our ability to make distributions with respect to our common stock.  Our ability to service any debt depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures.  Moreover, as the base management fee payable to GECM, our investment adviser, is payable based on the average value of our total assets, including those assets acquired through the use of leverage, GECM will have a financial incentive to incur leverage, which may not be consistent with our stockholders’ interests.  In addition, our common stockholders bear the burden of any increase in our fees or expenses as a result of our use of leverage, including interest expenses and any increase in the base management fee payable to GECM.

If our asset coverage ratio falls below the required limit, we will not be able to incur additional debt until we are able to comply with the asset coverage ratio applicable to us.  This could have a material adverse effect on our operations, and we may not be able to make distributions to stockholders.  The actual amount of leverage that we employ will depend on GECM’s and our Board’s assessment of market and other factors at the time of any proposed borrowing.  We cannot assure you that we will be able to obtain credit at all or on terms acceptable to us.

Incurring additional leverage may magnify our exposure to risks associated with changes in interest rates, including fluctuations in interest rates which could adversely affect our profitability.  If we incur additional leverage, general interest rate fluctuations may have a more significant negative impact on our investments and investment opportunities than they would have absent such additional incurrence, and, accordingly, may have a material adverse effect on our investment objectives and rate of return on investment capital.  A portion of our income will depend upon the difference between the rate at which we borrow funds and the interest rate on the debt securities in which we invest.  Because we may borrow money to make investments and may issue debt securities, preferred stock or other securities, our net investment income is dependent upon the difference between the rate at which we borrow funds or pay interest or dividends on such debt securities, preferred stock or other securities and the rate at which we invest these borrowed funds.

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We expect that a majority of our investments in debt will continue to be at floating rates with a floor.  However, in the event that we make investments in debt at variable rates, a significant increase in market interest rates could also result in an increase in our non-performing assets and a decrease in the value of our portfolio because our floating-rate loan portfolio companies may be unable to meet higher payment obligations.  In periods of rising interest rates, our cost of funds would increase, resulting in a decrease in our net investment income.  Incurring additional leverage will magnify the impact of an increase to our cost of funds.  In addition, a decrease in interest rates may reduce net income, because new investments may be made at lower rates despite the increased demand for our capital that the decrease in interest rates may produce.  To the extent our additional borrowings are in fixed-rate instruments, we may be required to invest in higher-yield securities in order to cover our interest expense and maintain our current level of return to stockholders, which may increase the risk of an investment in our securities.

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

Not applicable.

Item 3.  Defaults Upon Senior Securities.

Not applicable.

Item 4.  Mine Safety Disclosures.

Not applicable.

Item 5.  Other Information.

Not applicable.

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Item 6.  Exhibits.

Unless otherwise indicated, all references are to exhibits to the applicable filing by Great Elm Capital Corp. (the “Registrant”) under File No.  814-01211 with the Securities and Exchange Commission.

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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.

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GREAT ELM CAPITAL CORP.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1

GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES (unaudited)

Dollar amounts in thousands (except per share amounts)

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

F-2

GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

Dollar amounts in thousands (except per share amounts)

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

F-3

GREAT ELM CAPITAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (unaudited)

Dollar amounts in thousands