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, 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 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.

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

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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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During the three and six months ended June 30, 2018, inclusive of short-term securities, we recorded net change in unrealized depreciation of $(4,240) and $(12,462), respectively, of which $(2,681) and $0, respectively, was related to valuation of interest receivable.

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Interest income included net accretion of OID and market discount of $458 and $1,409 for the three and six months ended June 30, 2018, respectively.  Interest income also included accrued PIK income of $1,725 and $5,002 for the three and six months ended June 30, 2018, respectively.

Total investment income for the three and six months ended June 30, 2018 increased as compared to total investment income for the three and six months ended June 30, 2017 primarily due to increased interest income, as a result of the interest earning investment portfolio growing year over year.

Net expenses for the three and six months ended June 30, 2018 decreased as compared to net expenses for the three and six months ended June 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 note”) 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 six months ended June 30, 2018 increased as compared to net expenses for the three and six months ended June 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 herein) were newly issued in January 2018.  See “ — Liquidity and Capital Resources—Notes Payable” for further information.

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During the three months ended June 30, 2018, we recorded net realized gains of $810, primarily related to the realized gain on the sale of the PR Wireless, Inc. senior secured loan and a partial sale of NANA Development Corp. senior secured bonds.  Realized gains for the six months ended June 30, 2018 also include realized gains in connection with principal amortization of loans that were acquired at a discount and a partial repayment on our PE Facility Solutions, LLC Term B loan.

During the six months ended June 30, 2017 we recorded net realized gains of $3,361 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) for the six months ended June 30, 2017 was $(10,021).  Net change in unrealized appreciation (depreciation) for the three months ended June 30, 2018 and June 30, 2017 was $(4,240) and $(7,326), respectively.  In each of these periods, the change in unrealized appreciation (depreciation) is primarily driven by the performance of a few investments as noted in the table above.

Liquidity and Capital Resources

At June 30, 2018, we had approximately $3,942 of cash and cash equivalents, none of which was restricted in nature.  At June 30, 2018, we also had $4,532 invested in a money market fund that is classified as an investment rather than cash and cash equivalents.

At June 30, 2018, we had investments in 29 debt instruments across 23 companies, totaling approximately $185,418 at fair value and equity investments in five companies, totaling approximately $13,971 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 June 30, 2018, we had approximately $17,572 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 June 30, 2018 balance sheet to satisfy the unfunded commitments.

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For the six months ended June 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 $(35,986), reflecting the purchases and repa yments 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 used for purchases and sales of investments was approxima tely $(36,314), reflecting principal repayments and sales of $56,798, offset by additional investments of $(93,112).  Such amounts included draws and repayments on revolving credit facilities.  Our Board previously set our distribution rate at $0.083 per s hare per month and we intend to re-evaluate our dividend rate from time to time.

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.

Stock Buyback Program

We implemented a stock buyback program pursuant to Rule 10b5‑1 and Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to repurchase our shares in an aggregate amount of up to $15,000 through May 2018 at market prices at any time our shares trade below 90% of net asset value (“NAV”), subject to our compliance with our liquidity, covenant, leverage and regulatory requirements.  Our Board previously increased the overall size of the stock buyback program to a total of $50,000, with $25,000 remaining available under the program.

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.

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On January 11, 2018, we sold $43,000 in aggregate principal amount of 6.75% notes due 2025 (th e "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 aggr egate 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 July 2018, we purchased an additional $2,000 of par value of Commercial Barge Line Company first lien term loan at a price of approximately 72% of par value.

In July 2018, we purchased $478 of par value of PFS Holdings Corp. first lien term loan at a price of approximately 60% of par value.

In July 2018, we purchased an additional $2,500 of par value of Sungard Availability Services Capital, Inc. first lien senior secured term loan at a price of approximately 99% of par value.

In July 2018, we exercised all of our RiceBran Technologies Corporation warrants at a price of $1.60 per share in a cashless exercise.  This transaction resulted in GECC receiving 139,392 shares.  We subsequently sold all of the shares at a weighted average price of $2.43 per share.

In July 2018, in connection with the sale of one of its businesses, DataX, Ltd., The Selling Source, LLC paid down $3,800 of our outstanding $5,689 first lien, senior secured holding.  The remainder of the investment was restructured, with GECC receiving $1,250 of first out term loan bearing interest at a rate of 3-month LIBOR plus 5%, which matures on January 13, 2020.

In August 2018, we purchased an additional $2,647 of par value of SESAC Holdco II LLC second lien senior secured loan at a price of approximately 99% of par value.

In August 2018, we purchased $2,000 of par value of California Pizza Kitchen, Inc. first lien term loan at a price of approximately 98% of par value.

In August 2018, we sold our position in Foresight Energy LP at a price of approximately 100% of par value.

Our Board declared the monthly distributions for the fourth quarter of 2018 at an annual rate of approximately 8.4% of our June 30, 2018 NAV, which equates to $0.083 per month.  The schedule of distribution payments is as follows:

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.

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As of June 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 255%.  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.”