UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2018

 

¨      Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission
File Number
  Exact name of registrant as specified in its charter, 
address of principal executive office, telephone number and
state or other jurisdiction of incorporation or organization
  I.R.S. Employer
Identification Number
814-01022  

Capitala Finance Corp.

4201 Congress St., Suite 360

Charlotte, North Carolina

Telephone: (704) 376-5502

State of Incorporation: Maryland

  90-0945675

 

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.

 

  Capitala Finance Corp. Yes   x 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

  Capitala Finance Corp. 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. (Check one):

 

Capitala Finance Corp. Large accelerated filer   ¨ Accelerated filer x
         
  Non-accelerated filer ¨ Smaller reporting company ¨
         
      Emerging growth company   x

 

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.           ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

  Capitala Finance Corp. Yes  ¨ No   x

 

The number of shares of Capitala Finance Corp.’s common stock, $0.01 par value, outstanding as of May 7, 2018 was 15,981,224.

 

 

   

 

 

TABLE OF CONTENTS

 

      Page
       
PART I. FINANCIAL INFORMATION   3
       
Item 1. Consolidated Financial Statements   3
       
  Consolidated Statements of Assets and Liabilities as of March 31, 2018 (unaudited) and December 31, 2017   3
       
  Consolidated Statements of Operations for the three months ended March 31, 2018 and 2017 (unaudited)   4
       
  Consolidated Statements of Changes in Net Assets for the three months ended March 31, 2018 and 2017 (unaudited)   5
       
  Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017 (unaudited)   6
       
  Consolidated Schedules of Investments as of March 31, 2018 (unaudited) and December 31, 2017   7
       
  Notes to Consolidated Financial Statements as of March 31, 2018 (unaudited)   23
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   49
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk   68
       
Item 4. Controls and Procedures   70
       
PART II.    OTHER INFORMATION   71
       
Item 1. Legal Proceedings   71
       
Item 1A. Risk Factors   71
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   72
       
Item 3. Defaults Upon Senior Securities   72
       
Item 4. Mine Safety Disclosures   72
       
Item 5. Other Information   72
       
Item 6. Exhibits   73
     
Signatures   74

 

 2 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

 

Capitala Finance Corp.

 

Consolidated Statements of Assets and Liabilities

(in thousands, except share and per share data)

 

   As of 
   March 31, 2018   December 31, 2017 
   (unaudited)     
ASSETS        
Investments at fair value          
Non-control/non-affiliate investments (amortized cost of $278,716 and $298,132, respectively)  $271,092   $288,374 
Affiliate investments (amortized cost of $99,167 and $77,336, respectively)   125,012    103,957 
Control investments (amortized cost of $91,319 and $89,559, respectively)   107,618    107,608 
Total investments at fair value (amortized cost of $469,202 and $465,027, respectively)   503,722    499,939 
Cash and cash equivalents   25,720    31,221 
Interest and dividend receivable   3,090    2,976 
Due from related parties   -    95 
Prepaid expenses   275    309 
Other assets   57    55 
Total assets  $532,864   $534,595 
           
LIABILITIES          
SBA debentures (net of deferred financing costs of $2,146 and $2,300, respectively)  $168,554   $168,400 
2022 Notes (net of deferred financing costs of $2,371 and $2,496, respectively)   72,629    72,504 
2022 Convertible Notes (net of deferred financing costs of $1,504 and $1,583, respectively)   50,584    50,505 
Credit Facility (net of deferred financing costs of $1,186 and $1,293, respectively)   10,814    7,707 
Management and incentive fees payable   2,446    2,172 
Interest and financing fees payable   1,479    3,141 
Trade settlement payable   -    175 
Deferred tax liability, net   1,339    1,289 
Written call option at fair value (proceeds of $20 and $20, respectively)   6,815    6,815 
Total liabilities  $314,660   $312,708 
           
Commitments and contingencies (Note 2)          
           
NET ASSETS          
Common stock, par value $.01, 100,000,000 common shares authorized, 15,974,218 and 15,951,231 common shares  issued and outstanding, respectively  $160   $160 
Additional paid in capital   241,191    241,027 
Undistributed net investment income   16,304    15,854 
Accumulated net realized losses from investments   (65,837)   (61,982)
Net unrealized appreciation on investments, net of deferred taxes   33,181    33,623 
Net unrealized depreciation on written call option   (6,795)   (6,795)
Total net assets  $218,204   $221,887 
Total liabilities and net assets  $532,864   $534,595 
           
Net asset value per share  $13.66   $13.91 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

Capitala Finance Corp.

 

Consolidated Statements of Operations

(in thousands, except share and per share data)

(unaudited)

 

   For the Three Months Ended March 31 
   2018   2017 
INVESTMENT INCOME          
Interest and fee income:          
Non-control/non-affiliate investments  $7,356   $9,638 
Affiliate investments   1,941    1,044 
Control investments   1,849    1,988 
Total interest and fee income   11,146    12,670 
Payment-in-kind interest and dividend income:          
Non-control/non-affiliate investments   705    1,178 
Affiliate investments   486    231 
Control investments   166    246 
Total payment-in-kind interest and dividend income   1,357    1,655 
Dividend income:          
Non-control/non-affiliate investments   -    168 
Affiliate investments   29    29 
Control investments   25    280 
Total dividend income   54    477 
Interest income from cash and cash equivalents   15    13 
Total investment income   12,572    14,815 
           
EXPENSES          
Interest and financing expenses   4,364    4,653 
Base management fee   2,303    2,514 
Incentive fees   244    1,308 
General and administrative expenses   1,223    1,107 
Expenses before incentive fee waiver   8,134    9,582 
Incentive fee waiver (See Note 6)   -    (958)
Total expenses, net of fee waivers   8,134    8,624 
           
NET INVESTMENT INCOME   4,438    6,191 
           
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND WRITTEN CALL OPTION:          
Net realized gain (loss) from investments:          
Non-control/non-affiliate investments   (4,579)   4,831 
Affiliate investments   724    15 
Net realized gain (loss) from investments   (3,855)   4,846 
Net unrealized appreciation (depreciation) on investments:          
Non-control/non-affiliate investments   2,134    (6,395)
Affiliate investments   (776)   225 
Control investments   (1,750)   1,499 
Net unrealized depreciation from investments   (392)   (4,671)
Net unrealized depreciation on written call option   -    (1,485)
Net loss on investments and written call option   (4,247)   (1,310)
Tax provision   (50)   - 
Total net realized and unrealized loss on investments and written call option, net of taxes   (4,297)   (1,310)
           
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS  $141   $4,881 
           
NET INCREASE IN NET ASSETS PER SHARE RESULTING FROM OPERATIONS – BASIC AND DILUTED  $0.01   $0.31 
           
WEIGHTED AVERAGE COMMON STOCK OUTSTANDING - BASIC AND DILUTED   15,959,215    15,873,655 
           
DISTRIBUTIONS PAID PER SHARE  $0.25   $0.39 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

Capitala Finance Corp.

 

Consolidated Statements of Changes in Net Assets

(in thousands, except share data)

(unaudited)

 

   Common Stock   Additional Paid  

Undistributed Net

   Accumulated Net
Realized Gains
   Net Unrealized
Appreciation (Depreciation)
on Investments,
net of Deferred
   Net Unrealized
Depreciation on
     
   Number of Shares   Par Value   in Capital  

Investment Income

  (Losses)   Taxes   Written Call Option   Total 
                                 
BALANCE, December 31, 2016   15,868,045   $159   $240,184   $22,973   $(37,881)  $27,863   $(2,716)  $     250,582 
Net investment income   -    -    -    6,191    -    -    -    6,191 
Net realized gain from investments   -    -    -    -    4,846    -    -    4,846 
Net change in unrealized depreciation on investments   -    -    -    -    -    (4,671)   -    (4,671)
Net change in unrealized depreciation on written call option   -    -    -    -    -    -    (1,485)   (1,485)
Distributions to Shareholders:                                        
Stock issued under dividend reinvestment plan   15,447    -    207    -    -    -    -    207 
Distributions declared   -    -    -    (6,191)   -    -    -    (6,191)
BALANCE, March 31, 2017  15,883,492   $159   $240,391   $22,973   $(33,035)  $23,192   $(4,201)  $249,479 
                                         
BALANCE, December 31, 2017   15,951,231   $160   $241,027   $15,854   $(61,982)  $33,623   $(6,795)  $221,887 
Net investment income   -    -    -    4,438    -    -    -    4,438 
Net realized loss from investments   -    -    -    -    (3,855)   -    -    (3,855)
Net change in unrealized depreciation on investments   -    -    -    -    -    (392)   -    (392)
Tax provision   -    -    -    -    -    (50)   -    (50)
Distributions to Shareholders:                                        
Stock issued under dividend reinvestment plan   22,987    -    164    -    -    -    -    164 
Distributions declared   -    -    -    (3,988)   -    -    -    (3,988)
BALANCE, March 31, 2018   15,974,218   $160   $241,191   $16,304   $(65,837)  $33,181   $(6,795)  $218,204 

  

See accompanying notes to consolidated financial statements.

 

 5 

 

 

Capitala Finance Corp.

 

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

   For the Three Months Ended March 31 
   2018   2017 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net increase in net assets resulting from operations  $141   $4,881 
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities:          
Purchase of investments   (27,800)   (21,708)
Repayments and sales of investments   21,400    33,049 
Net realized (gain) loss on investments   3,855    (4,846)
Net unrealized depreciation on investments   392    4,671 
Payment-in-kind interest and dividends   (1,357)   (1,655)
Accretion of original issue discount on investments   (273)   (350)
Net unrealized depreciation on written call option   -    1,485 
Amortization of deferred financing fees   465    534 
Tax provision   50    - 
Changes in assets and liabilities:          
Interest and dividend receivable   (114)   (259)
Due from related parties   95    39 
Trade settlement receivable   -    (990)
Prepaid expenses   34    65 
Other assets   (2)   5 
Due to related parties   -    (35)
Management and incentive fees payable   274    (2,539)
Interest and financing fees payable   (1,662)   (1,691)
Accounts payable and accrued expenses   -    (389)
Trade settlement payable   (175)   - 
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES   (4,677)   10,267 
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Proceeds from Credit Facility   16,000    - 
Payments to Credit Facility   (13,000)   - 
Distributions paid to shareholders   (3,824)   (5,984)
NET CASH USED IN FINANCING ACTIVITIES   (824)   (5,984)
           
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   (5,501)   4,283 
CASH AND CASH EQUIVALENTS, beginning of period   31,221    36,281 
CASH AND CASH EQUIVALENTS, end of period  $25,720   $40,564 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Cash paid for interest  $5,196   $5,582 
           
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING TRANSACTIONS          
Distributions paid through dividend reinvestment plan share issuances  $164   $207 

 

See accompanying notes to consolidated financial statements.

 

 6 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Non-control/non-affiliated investments - 124.2%                          
                           
Non-control/non-affiliated investments - United States                          
                           
3 Bridge Solutions, LLC  IT Consulting  First Lien Debt (10.67% Cash (1 month LIBOR + 9.0%, 1% Floor), Due 12/4/22)  $11,180   $11,180   $11,180    5.1%
                           
3 Bridge Solutions, LLC  IT Consulting  Preferred Units (965,250 units, 8% PIK) (5)        990    990    0.4%
                           
3 Bridge Solutions, LLC  IT Consulting  Membership Units (39,000 units)        10    147    0.1%
                           
               12,180    12,317    5.6%
                           
Alternative Biomedical Solutions, LLC  Healthcare  First Lien Debt (11.91% Cash, Due 12/18/22) (6)   13,000    13,000    13,000    6.0%
                           
Alternative Biomedical Solutions, LLC  Healthcare  Membership Units (20,092 units)        800    410    0.2%
                           
               13,800    13,410    6.2%
                           
American Clinical Solutions, LLC  Healthcare  First Lien Debt (10.5% Cash, 1% PIK, Due 6/11/20)   9,091    9,091    6,731    3.1%
                           
               9,091    6,731    3.1%
                           
AmeriMark Direct, LLC  Consumer Products  First Lien Debt (12.75% Cash, Due 9/8/21)   18,950    18,590    18,950    8.7%
                           
               18,590    18,950    8.7%
                           
B&W Quality Growers, LLC  Farming  Membership Unit Warrants (91,739 Units)        -    5,609    2.6%
                           
               -    5,609    2.6%
                           
BigMouth, Inc.  Consumer Products  First Lien Debt (13.6% Cash, Due 11/14/21) (6)   9,616    9,616    9,616    4.4%
                           
BigMouth, Inc.  Consumer Products  Series A Preferred Stock (350,000 shares, 8% PIK) (5)        389    727    0.3%
                           
               10,005    10,343    4.7%
                           
Bluestem Brands, Inc.  Online Merchandise Retailer  First Lien Debt (9.38% Cash (1 month LIBOR + 7.5%, 1% Floor), Due 11/7/20)   3,967    3,915    3,615    1.7%
                           
               3,915    3,615    1.7%
                           
Burke America Parts Group, LLC  Home Repair Parts Manufacturer  Membership Units (14 units)        5    2,767    1.3%
                           
               5    2,767    1.3%

 

 7 

 

  

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
California Pizza Kitchen, Inc.  Restaurant  Second Lien Debt (11.88% Cash (1 month LIBOR + 10%, 1% Floor), Due 8/23/23)   5,000   4,886   4,886   2.2%
                           
               4,886    4,886    2.2%
                           
Caregiver Services, Inc.  In-Home Healthcare Services  Common Stock (293,186 shares)        258    80    0.0%
                           
Caregiver Services, Inc.  In-Home Healthcare Services  Common Stock Warrants (655,908 units) (7)        264    178    0.1%
                           
               522    258    0.1%
                           
Cedar Electronics Holding Corp.  Consumer Electronics  Subordinated Debt (12% Cash, Due 12/26/20) (8)(9)   21,550    21,550    958    0.4%
                           
               21,550    958    0.4%
                           
CIS Secure Computing, Inc.  Government Services  First Lien Debt (10.17% Cash (1 month LIBOR + 8.5%, 1% Floor), 1% PIK, Due 9/14/22) (10)   9,015    9,015    9,015    4.1%
                           
CIS Secure Computing, Inc.  Government Services  Common Stock (46,163 shares)        1,000    1,541    0.7%
                           
               10,015    10,556    4.8%
                           
Corporate Visions, Inc.  Sales & Marketing Services  Subordinated Debt (9% Cash, 2% PIK, Due 11/29/21)   18,250    18,250    17,431    8.0%
                           
Corporate Visions, Inc.  Sales & Marketing Services  Common Stock (15,750 shares)        1,575    640    0.3%
                           
               19,825    18,071    8.3%
                           
Currency Capital, LLC  Financial Services  First Lien Debt (12.67% Cash (1 month LIBOR + 11%, 0.50% Floor) Due 1/20/22) (11)   17,000    17,000    17,000    7.8%
                           
Currency Capital, LLC  Financial Services  Class A Preferred Units (2,000,000 units) (11)        2,000    2,000    0.9%
                           
               19,000    19,000    8.7%
                           
Flavors Holdings, Inc.  Food Product Manufacturer  First Lien Debt (8.05% Cash (3 month LIBOR + 5.75%, 1% Floor), Due 4/3/20)   6,600    6,503    6,023    2.8%
                           
Flavors Holdings, Inc.  Food Product Manufacturer  Second Lien Debt (12.30% Cash (3 month LIBOR + 10%, 1% Floor), Due 10/3/21)   12,000    11,757    10,923    5.0%
                           
               18,260    16,946    7.8%
                           
MC Sign Lessor Corp.  Advertising & Marketing Services  First Lien Debt (8.66% Cash (1 month LIBOR + 7.0%, 1% Floor), Due 12/22/22)(12)   3,935    3,935    3,935    1.8%

 

 8 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
MC Sign Lessor Corp.  Advertising & Marketing Services  First Lien Debt (8.66% Cash (1 month LIBOR + 7.0%, 1% Floor), Due 12/22/22)(13)   -   -   -   0.0%
                           
               3,935    3,935    1.8%
                           
Nth Degree, Inc.  Business Services  First Lien Debt (13.19% Cash (1 month LIBOR + 11.5%, 1% Floor), 2% PIK, Due 12/14/20)   7,236    7,236    7,236    3.3%
                           
Nth Degree, Inc.  Business Services  Preferred Stock (2,400 Units, 10% PIK dividend) (5)        3,011    11,401    5.2%
                           
               10,247    18,637    8.5%
                           
Sequoia Healthcare Management, LLC  Healthcare Management  First Lien Debt (12% Cash, 4% PIK, Due 7/17/19)   8,706    8,668    8,706    4.0%
                           
               8,668    8,706    4.0%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  First Lien Debt (10% Cash, 4% PIK, Due 12/27/22)   7,525    7,525    7,525    3.4%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  Class A Units (1,283,824 units, 4% Cash dividend, 11% PIK dividend) (5)        1,321    1,560    0.7%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  Class B Units (257 units)        -    -    0.0%
                           
               8,846    9,085    4.1%
                           
Sur La Table, Inc.  Retail  First Lien Debt (12% Cash, Due 7/28/20)   15,000    15,000    15,000    6.9%
                           
               15,000    15,000    6.9%
                           
Taylor Precision Products, Inc.  Household Product Manufacturer  Series C Preferred Stock (379 shares)        758    758    0.3%
                           
               758    758    0.3%
                           
Vintage Stock, Inc.  Specialty Retail  First Lien Debt (14.16% Cash (1 month LIBOR + 12.5%, 0.5% floor), 3% PIK, Due 11/3/21)   19,494    19,494    19,494    8.9%
                           
               19,494    19,494    8.9%
                           
Vology, Inc.  Information Technology  Subordinated Debt (15% Cash (3 month LIBOR + 14%, 1% Ceiling), 4% PIK Due 6/30/20)   8,458    8,458    8,458    3.9%
                           
               8,458    8,458    3.9%
                           
Western Windows Systems, LLC  Building Products  First Lien Debt (12.5% Cash, Due 7/31/20) (6)   10,500    10,500    10,500    4.8%

 

 9 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Western Windows Systems, LLC  Building Products  Membership Units (39,860 units)       3,000   8,209   3.8%
                           
               13,500    18,709    8.6%
                           
Xirgo Technologies, LLC  Information Technology  Subordinated Debt (11.5% Cash, Due 3/1/22)   15,750    15,750    15,750    7.2%
                           
Xirgo Technologies, LLC  Information Technology  Membership Units (600,000 units)        600    569    0.3%
                           
               16,350    16,319    7.5%
                           
Sub Total Non-control/non-affiliated investments - United States              266,900    263,518    120.7%
                           
Non-control/non-affiliated investments - Brazil                          
Velum Global Credit Management, LLC  Financial Services  First Lien Debt (15% PIK, Due 12/31/17) (8) (11) (14) (15)   12,741    11,816    7,574    3.5%
                           
               11,816    7,574    3.5%
                           
Sub Total Non-control/non-affiliated investments - Brazil              11,816    7,574    3.5%
                           
Sub Total Non-control/non-affiliated investments             $278,716   $271,092    124.2%
                           
Affiliate investments - 57.3%                          
                           
Affiliate investments - United States                          
AAE Acquisition, LLC  Industrial Equipment Rental  Second Lien Debt (8% Cash, 4% PIK, Due 8/24/19) (14)  $16,004   $16,004   $15,952    7.3%
                           
AAE Acquisition, LLC  Industrial Equipment Rental  Membership Units (2.19% fully diluted)        17    -    0.0%
                           
AAE Acquisition, LLC  Industrial Equipment Rental  Warrants (37.78% fully diluted)        -    -    0.0%
                           
               16,021    15,952    7.3%
                           
Burgaflex Holdings, LLC  Automobile Part Manufacturer  First Lien Debt (12% Cash, 1% PIK, Due 3/23/21)   14,688    14,688    14,688    6.7%
                           
Burgaflex Holdings, LLC  Automobile Part Manufacturer  Common Stock Class A (1,253,198 shares)        1,504    -    0.0%
                           
Burgaflex Holdings, LLC  Automobile Part Manufacturer  Common Stock Class B (900,000 shares)        300    300    0.1%
                           
               16,492    14,988    6.8%
                           
City Gear, LLC  Footwear Retail  Subordinated Debt (13% Cash, Due 10/20/19) (14)   8,231    8,231    8,231    3.8%

 

 10 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
City Gear, LLC  Footwear Retail  Preferred Membership Units (2.78% fully diluted, 9% Cash Dividend) (5)       1,269   1,269   0.6%
                           
City Gear, LLC  Footwear Retail  Membership Unit Warrants (11.38% fully diluted)        -    7,631    3.5%
                           
               9,500    17,131    7.9%
                           
GA Communications, Inc.  Advertising & Marketing Services  Series A-1 Preferred Stock (1,998 shares, 8% PIK Dividend) (5)        2,968    3,286    1.5%
                           
GA Communications, Inc.  Advertising & Marketing Services  Series B-1 Common Stock (200,000 shares)        2    1,678    0.8%
                           
               2,970    4,964    2.3%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Subordinated Debt (13% Cash, Due 6/16/19) (14)   6,406    6,406    6,313    2.9%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Common Stock (8,182 shares)        818    -    0.0%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Common Stock Warrants (6,369 shares)        -    -    0.0%
                           
               7,224    6,313    2.9%
                           
LJS Partners, LLC  QSR Franchisor  Common Stock (1,500,000 shares)        896    7,662    3.5%
                           
               896    7,662    3.5%
                           
MMI Holdings, LLC  Medical Device Distributor  First Lien Debt (12% Cash, Due 1/31/19) (14)   2,600    2,600    2,600    1.2%
                           
MMI Holdings, LLC  Medical Device Distributor  Subordinated Debt (6% Cash, Due 1/31/19) (14)   400    388    400    0.2%
                           
MMI Holdings, LLC  Medical Device Distributor  Preferred Units (1,000 units, 6% PIK Dividend) (5)        1,405    1,542    0.7%
                           
MMI Holdings, LLC  Medical Device Distributor  Common Membership Units (45 units)        -    174    0.1%
                           
               4,393    4,716    2.2%
                           
MTI Holdings, LLC  Retail Display & Security Services  Membership Units (2,000,000 units) (16)        -    100    0.0%
                           
               -    100    0.0%
                           
Sierra Hamilton Holdings Corporation  Oil & Gas Engineering and Consulting Services  Common Stock (15,068,000 shares)        6,958    8,891    4.1%
                           
               6,958    8,891    4.1%

 

 11 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Source Capital Penray, LLC  Automotive Chemicals & Lubricants  Membership Units (11.3% ownership) (16)       -   101   0.0%
                           
               -    101    0.0%
                           
US Bath Group, LLC  Building Products  First Lien Debt (10.67% Cash (1 month LIBOR + 9.0%, 1% Floor), Due 1/2/23)   14,688    14,688    14,688    6.7%
                           
US Bath Group, LLC  Building Products  Membership Units (500,000 units)        500    500    0.2%
                           
               15,188    15,188    6.9%
                           
U.S. Well Services, LLC  Oil & Gas Services  First Lien Debt (7.65% Cash (1 month LIBOR + 6%, 1% floor), Due 2/2/22) (17)   2,299    2,299    2,299    1.1%
                           
U.S. Well Services, LLC  Oil & Gas Services  First Lien Debt (10.65% Cash (1 month LIBOR + 9%, 1% floor), Due 2/2/22)   9,713    9,713    9,713    4.5%
                           
U.S. Well Services, LLC  Oil & Gas Services  Class A Units (5,680,688 Units)        6,259    15,004    6.9%
                           
U.S. Well Services, LLC  Oil & Gas Services  Class B Units (2,076,298 Units)        441    955    0.4%
                           
               18,712    27,971    12.9%
                           
V12 Holdings, Inc.  Data Processing & Digital Marketing  Subordinated Debt (18)        813    1,035    0.5%
                           
               813    1,035    0.5%
                           
Sub Total Affiliate investments - United States             $99,167   $125,012    57.3%
                           
Control investments- 49.3%                          
                           
Control investments - United States                          
CableOrganizer Acquisition, LLC  Computer Supply Retail  First Lien Debt (12% Cash, 4% PIK, Due 5/24/18)  $12,497   $12,497   $11,306    5.2%
                           
CableOrganizer Acquisition, LLC  Computer Supply Retail  Common Stock (21.3% fully diluted)        1,394    -    0.0%
                           
CableOrganizer Acquisition, LLC  Computer Supply Retail  Common Stock Warrants (10% fully diluted )        -    -    0.0%
                           
               13,891    11,306    5.2%
                           
Eastport Holdings, LLC  Business Services  Subordinated Debt (15.02% Cash (3 month LIBOR + 13%, 0.5% Floor), Due 4/29/20)   16,500    14,926    16,500    7.6%

 

 12 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Eastport Holdings, LLC  Business Services  Membership Units (33.3% ownership) (19)       4,733   26,449   12.1%
                           
               19,659    42,949    19.7%
                           
Kelle's Transport Service, LLC  Transportation  First Lien Debt (4% Cash, Due 2/15/20) (20)   2,227    2,227    2,227    1.0%
                           
Kelle's Transport Service, LLC  Transportation  First Lien Debt (1.46% Cash, Due 2/15/20) (14)   13,674    13,669    9,933    4.6%
                           
Kelle's Transport Service, LLC  Transportation  Membership Units (27.5% fully diluted)        -    -    0.0%
                           
               15,896    12,160    5.6%
                           
Micro Precision, LLC  Conglomerate  Subordinated Debt (10% Cash, Due 9/15/18) (14)   1,862    1,862    1,862    0.9%
                           
Micro Precision, LLC  Conglomerate  Subordinated Debt (14% Cash, 4% PIK, Due 9/15/18) (14)   4,195    4,195    4,195    1.9%
                           
Micro Precision, LLC  Conglomerate  Series A Preferred Units (47 units)        1,629    1,177    0.5%
                           
               7,686    7,234    3.3%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  First Lien Debt (15% Cash, Due 10/30/20) (14)   7,500    7,500    7,500    3.4%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  Class A Preferred Stock (1,000 shares, 10% Cash Dividend) (5)        1,000    1,000    0.5%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  Common Stock (300,000 shares)        1    5,258    2.4%
                           
               8,501    13,758    6.3%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Subordinated Debt (18% Cash, Due 12/19/18) (8) (14)   14,778    11,020    11,647    5.3%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Series A Preferred Stock (32,782 shares)        3,278    -    0.0%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Series B Preferred Stock (23,648 shares)        2,365    -    0.0%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Common Stock (33,058 shares)        33    -    0.0%
                           
               16,696    11,647    5.3%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  First Lien Debt (8.69% Cash (1 month LIBOR + 7%, 1% floor, 2% ceiling), Due 12/31/22) (21)   2,040    2,040    2,040    0.9%

 

 13 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

March 31, 2018

(unaudited)

 

Portfolio Company, Country (1), (2), (3), (4)  Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Portrait Studio, LLC  Professional and Personal Digital Imaging  First Lien Debt (8.69% Cash (1 month LIBOR + 7%, 1% floor, 5% ceiling), Due 12/31/22)   4,500    4,500    4,500    2.1%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  Preferred Units (4,350,000 Units)        2,450    2,024    0.9%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  Membership Units (150,000 Units)        -    -    0.0%
                           
               8,990    8,564    3.9%
                           
Sub Total Control investments - United States             $91,319   $107,618    49.3%
                           
TOTAL INVESTMENTS - 230.8%             $469,202   $503,722    230.8%
                         
Derivatives - (3.1)%                          
                           
Derivatives - United States                          
Eastport Holdings, LLC  Business Services  Written Call Option (19)       $(20)  $(6,815)   (3.1%)
                           
Sub Total Derivatives - United States             $(20)  $(6,815)   (3.1%)
                           
TOTAL DERIVATIVES- (3.1)%             $(20)  $(6,815)   (3.1%)

 

(1) All investments valued using unobservable inputs (Level 3).

(2) All investments valued by the Board of Directors.

(3) All debt investments are income producing, unless otherwise noted. Equity and warrant investments are non-income producing, unless otherwise noted.

(4) Percentages are based on net assets of $218,204 as of March 31, 2018.

(5) The equity investment is income producing, based on rate disclosed.

(6) The cash rate equals the approximate current yield on our last-out portion of the unitranche facility.

(7) The equity investment has an exercisable put option.

(8) Non-accrual investment.

(9) On April 2, 2018, the debt investment was converted to equity as part of a restructuring. The investment was valued based on the new capital structure of the company.

(10) The investment has a $2.0 million unfunded commitment.

(11) Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company's total assets at the time of acquisition of any additional non-qualifying assets. As of March 31, 2018, 5.0% of the Company's total assets were non-qualifying assets.

(12) The investment has a $0.6 million unfunded commitment.

(13) The investment has a $0.5 million unfunded commitment.

(14) The maturity date of the original investment has been extended.

(15) The company is headquartered in Brazil.

(16) The company has been exited. The residual value reflects estimated escrow to be settled post-closing.

(17) The investment has a $0.7 million unfunded commitment.

(18) The investment has been exited. The residual value reflects estimated escrow and earnout to be settled post-closing.

(19) The Company has written a call option that enables CapitalSouth Partners Florida Sidecar Fund II, L.P. to purchase up to 31.25% of the Company's interest at a strike price of $1.5 million. As of March 31, 2018, the fair value of the written call option is approximately $6.8 million. See Note 4 to the consolidated financial statements for further detail on the written call option transaction.

(20) The investment has a $0.8 million unfunded commitment.

(21) The investment has a $3.0 million unfunded commitment.

 

See accompanying notes to consolidated financial statements. 

 

 14 

 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Non-control/non-affiliated investments - 130.0%                          
                           
Non-control/non-affiliated investments - United States                          
                           
3 Bridge Solutions, LLC  IT Consulting  First Lien Debt (10.38% Cash (1 month LIBOR + 9.0%, 1% Floor), Due 12/4/22)  $11,250   $11,250   $11,250   5.1%
                           
3 Bridge Solutions, LLC  IT Consulting  Preferred Units (965,250 units, 8% PIK) (5)        971    971    0.4%
                           
3 Bridge Solutions, LLC  IT Consulting  Membership Units (39,000 units)        10    10    0.0%
                           
               12,231    12,231    5.5%
                           
Alternative Biomedical Solutions, LLC  Healthcare  First Lien Debt (11.74% Cash, Due 12/18/22) (6)   13,000    13,000    13,000    5.9%
                           
Alternative Biomedical Solutions, LLC  Healthcare  Membership Units (20,092 units)        800    800    0.4%
                           
               13,800    13,800    6.3%
                           
American Clinical Solutions, LLC  Healthcare  First Lien Debt (10.5% Cash, 1% PIK, Due 6/11/20)   9,068    9,068    7,568    3.4%
                           
               9,068    7,568    3.4%
                           
American Exteriors, LLC  Replacement Window Manufacturer  First Lien Debt (10% PIK, Due 1/1/19) (7)(8)   8,287    5,679    1,880    0.8%
                           
American Exteriors, LLC  Replacement Window Manufacturer  Common Stock Warrants (10% fully diluted)        -    -    0.0%
                           
               5,679    1,880    0.8%
                           
AmeriMark Direct, LLC  Consumer Products  First Lien Debt (12.75% Cash, Due 9/8/21)   19,100    18,713    19,100    8.6%
                           
               18,713    19,100    8.6%
                           
B&W Quality Growers, LLC  Farming  Membership Unit Warrants (91,739 Units)        -    5,581    2.5%
                           
               -    5,581    2.5%
                           
BigMouth, Inc.  Consumer Products  First Lien Debt (13.3% Cash, Due 11/14/21) (6)   9,790    9,790    9,790    4.4%
                           
BigMouth, Inc.  Consumer Products  Series A Preferred Stock (350,000 shares, 8% PIK) (5)        382    722    0.3%
                           
               10,172    10,512    4.7%

 

 15 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Bluestem Brands, Inc.  Online Merchandise Retailer  First Lien Debt (9.07% Cash (1 month LIBOR + 7.5%, 1% Floor), Due 11/7/20)   4,029   3,965   3,755   1.7%
                           
               3,965    3,755    1.7%
                           
Brunswick Bowling Products, Inc.  Bowling Products  First Lien Debt (8% Cash (1 month LIBOR + 6%, 2% Floor), Due 5/22/20)   1,600    1,600    1,600    0.7%
                           
Brunswick Bowling Products, Inc.  Bowling Products  First Lien Debt (16.25% Cash (1 month LIBOR + 14.25%, 2% Floor), Due 5/22/20)   5,586    5,586    5,586    2.5%
                           
               7,186    7,186    3.2%
                           
Burke America Parts Group, LLC  Home Repair Parts Manufacturer  Membership Units (14 units)        5    2,767    1.2%
                           
               5    2,767    1.2%
                           
California Pizza Kitchen, Inc.  Restaurant  Second Lien Debt (11.57% Cash (1 month LIBOR + 10%, 1% Floor), Due 8/23/23)   5,000    4,880    4,880    2.2%
                           
               4,880    4,880    2.2%
                           
Caregiver Services, Inc.  In-Home Healthcare Services  Common Stock (293,186 shares)        258    54    0.0%
                           
Caregiver Services, Inc.  In-Home Healthcare Services  Common Stock Warrants (655,908 units) (9)        264    120    0.1%
                           
               522    174    0.1%
                           
Cedar Electronics Holding Corp.  Consumer Electronics  Subordinated Debt (12% Cash, Due 12/26/20) (7)   21,550    21,550    3,498    1.6%
                           
               21,550    3,498    1.6%
                           
CIS Secure Computing, Inc.  Government Services  First Lien Debt (9.88% Cash (1 month LIBOR + 8.5%, 1% Floor), 1% PIK, Due 9/14/22) (10)   9,116    9,116    9,116    4.1%
                           
CIS Secure Computing, Inc.  Government Services  Common Stock (46,163 shares)        1,000    1,204    0.5%
                           
               10,116    10,320    4.6%
                           
Corporate Visions, Inc.  Sales & Marketing Services  Subordinated Debt (9% Cash, 2% PIK, Due 11/29/21)   18,159    18,159    16,995    7.7%
                           
Corporate Visions, Inc.  Sales & Marketing Services  Common Stock (15,750 shares)        1,575    393    0.2%
                           
               19,734    17,388    7.9%
                           
Currency Capital, LLC  Financial Services  First Lien Debt (12.38% Cash (1 month LIBOR + 11%, 0.50% Floor) Due 1/20/22) (11)   17,000    17,000    17,000    7.7%

 

 16 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Currency Capital, LLC  Financial Services  Class A Preferred Units (2,000,000 units) (11)       2,000   1,905   0.9%
                           
               19,000    18,905    8.6%
                           
Flavors Holdings, Inc.  Food Product Manufacturer  First Lien Debt (7.44% Cash (3 month LIBOR + 5.75%, 1% Floor), Due 4/3/20)   6,700    6,589    5,911    2.7%
                           
Flavors Holdings, Inc.  Food Product Manufacturer  Second Lien Debt (11.69% Cash (3 month LIBOR + 10%, 1% Floor), Due 10/3/21)   12,000    11,740    10,311    4.6%
                           
               18,329    16,222    7.3%
                           
Nth Degree, Inc.  Business Services  First Lien Debt (8.38% Cash (1 month LIBOR + 7%, 1% Floor), 1% PIK, Due 12/14/20)   8,833    8,833    8,833    4.0%
                           
Nth Degree, Inc.  Business Services  First Lien Debt (12.88% Cash (1 month LIBOR + 11.5%, 1% Floor), 2% PIK, Due 12/14/20)   7,200    7,200    7,200    3.2%
                           
Nth Degree, Inc.  Business Services  Preferred Stock (2,400 Units, 10% PIK dividend) (5)        2,938    11,140    5.0%
                           
               18,971    27,173    12.2%
                           
Sequoia Healthcare Management, LLC  Healthcare Management  First Lien Debt (12% Cash, 4% PIK, Due 7/17/19)   9,014    8,964    9,014    4.1%
                           
               8,964    9,014    4.1%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  First Lien Debt (10% Cash, 4% PIK, Due 12/27/22)   7,450    7,450    7,450    3.4%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  Class A Units (1,283,824 units, 4% Cash dividend, 11% PIK dividend) (5)        1,286    1,286    0.6%
                           
Spectra Services Holdings, LLC  Refrigeration / HVAC services  Class B Units (257 units)        -    -    0.0%
                           
               8,736    8,736    4.0%
                           
Sur La Table, Inc.  Retail  First Lien Debt (12% Cash, Due 7/28/20)   15,000    15,000    15,000    6.8%
                           
               15,000    15,000    6.8%
                           
Taylor Precision Products, Inc.  Household Product Manufacturer  Series C Preferred Stock (379 shares)        758    1,316    0.6%
                           
               758    1,316    0.6%
                           
Vintage Stock, Inc.  Specialty Retail  First Lien Debt (13.86% Cash (1 month LIBOR + 12.5%, 0.5% floor), 3% PIK, Due 11/3/21)   20,713    20,713    20,713    9.3%
                           
               20,713    20,713    9.3%

 

 17 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Vology, Inc.  Information Technology  Subordinated Debt (15% Cash (3 month LIBOR + 14%, 1% Ceiling), 4% PIK Due 6/30/20)   8,374   8,374   8,374   3.8%
                           
               8,374    8,374    3.8%
                           
Western Windows Systems, LLC  Building Products  First Lien Debt (11.9% Cash, Due 7/31/20) (6)   10,500    10,500    10,500    4.7%
                           
Western Windows Systems, LLC  Building Products  Membership Units (39,860 units)        3,000    7,379    3.3%
                           
               13,500    17,879    8.0%
                           
Xirgo Technologies, LLC  Information Technology  Subordinated Debt (11.5% Cash, Due 3/1/22)   15,750    15,750    15,750    7.1%
                           
Xirgo Technologies, LLC  Information Technology  Membership Units (600,000 units)        600    637    0.3%
                           
               16,350    16,387    7.4%
                           
Sub Total Non-control/non-affiliated investments - United States              286,316    280,359    126.4%
                           
Non-control/non-affiliated investments - Brazil                          
Velum Global Credit Management, LLC  Financial Services  First Lien Debt (15% PIK, Due 12/31/17) (7) (8) (11) (12)   12,275    11,816    8,015    3.6%
                           
               11,816    8,015    3.6%
                           
Sub Total Non-control/non-affiliated investments - Brazil              11,816    8,015    3.6%
                           
Sub Total Non-control/non-affiliated investments             $298,132   $288,374    130.0%
                           
Affiliate investments - 46.8%                          
                           
Affiliate investments - United States                          
AAE Acquisition, LLC  Industrial Equipment Rental  Second Lien Debt (8% Cash, 4% PIK, Due 8/24/19) (8)  $15,846   $15,846   $15,603    7.0%
                           
AAE Acquisition, LLC  Industrial Equipment Rental  Membership Units (2.19% fully diluted)        17    -    0.0%
                           
AAE Acquisition, LLC  Industrial Equipment Rental  Warrants (37.78% fully diluted)        -    -    0.0%
                           
               15,863    15,603    7.0%
                           
Burgaflex Holdings, LLC  Automobile Part Manufacturer  Subordinated Debt (14% Cash, Due 8/9/19) (13)   3,000    3,000    3,000    1.4%

 

 18 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Burgaflex Holdings, LLC  Automobile Part Manufacturer  Subordinated Debt (12% Cash, Due 8/9/19) (13)   5,828   5,828   5,828   2.6%
                           
Burgaflex Holdings, LLC  Automobile Part Manufacturer  Common Stock (1,253,198 shares)        1,504    457    0.2%
                           
               10,332    9,285    4.2%
                           
City Gear, LLC  Footwear Retail  Subordinated Debt (13% Cash, Due 10/20/19) (8)   8,231    8,231    8,231    3.7%
                           
City Gear, LLC  Footwear Retail  Preferred Membership Units (2.78% fully diluted, 9% Cash Dividend) (5)        1,269    1,269    0.6%
                           
City Gear, LLC  Footwear Retail  Membership Unit Warrants (11.38% fully diluted)        -    8,248    3.7%
                           
               9,500    17,748    8.0%
                           
GA Communications, Inc.  Advertising & Marketing Services  Series A-1 Preferred Stock (1,998 shares, 8% PIK Dividend) (5)        2,902    3,225    1.5%
                           
GA Communications, Inc.  Advertising & Marketing Services  Series B-1 Common Stock (200,000 shares)        2    1,932    0.9%
                           
               2,904    5,157    2.4%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Subordinated Debt (6% Cash, 7% PIK, Due 6/16/19) (8)   6,368    6,368    6,170    2.8%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Common Stock (8,182 shares)        818    -    0.0%
                           
J&J Produce Holdings, Inc.  Produce Distribution  Common Stock Warrants (6,369 shares)        -    -    0.0%
                           
               7,186    6,170    2.8%
                           
LJS Partners, LLC  QSR Franchisor  Common Stock (1,500,000 shares)        896    7,650    3.4%
                           
               896    7,650    3.4%
                           
MMI Holdings, LLC  Medical Device Distributor  First Lien Debt (12% Cash, Due 1/31/19) (8)   2,600    2,600    2,600    1.2%
                           
MMI Holdings, LLC  Medical Device Distributor  Subordinated Debt (6% Cash, Due 1/31/19) (8)   400    388    400    0.2%
                           
MMI Holdings, LLC  Medical Device Distributor  Preferred Units (1,000 units, 6% PIK dividend) (5)        1,381    1,520    0.7%
                           
MMI Holdings, LLC  Medical Device Distributor  Common Membership Units (45 units)        -    193    0.1%
                           
               4,369    4,713    2.2%

 

 19 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
MTI Holdings, LLC  Retail Display & Security Services  Membership Units (2,000,000 units) (14)       -   100   0.0%
                           
               -    100    0.0%
                           
Sierra Hamilton Holdings Corporation  Oil & Gas Engineering and Consulting Services  Common Stock (15,068,000 shares)        6,958    8,528    3.8%
                           
               6,958    8,528    3.8%
                           
Source Capital Penray, LLC  Automotive Chemicals & Lubricants  Membership Units (11.3% ownership) (14)        -    101    0.0%
                           
               -    101    0.0%
                           
STX Healthcare Management Services, Inc.  Dental Practice Management  Common Stock (1,200,000 shares) (14)        -    93    0.0%
                           
               -    93    0.0%
                           
U.S. Well Services, LLC  Oil & Gas Services  First Lien Debt (7.35% Cash (1 month LIBOR + 6%, 1% floor), Due 2/2/22) (15)   2,299    2,299    2,299    1.0%
                           
U.S. Well Services, LLC  Oil & Gas Services  First Lien Debt (12.35% PIK (1 month LIBOR + 11%, 1% floor), Due 2/2/22)   9,516    9,516    9,516    4.3%
                           
U.S. Well Services, LLC  Oil & Gas Services  Class A Units (5,680,688 Units)        6,259    15,004    6.8%
                           
U.S. Well Services, LLC  Oil & Gas Services  Class B Units (2,076,298 Units)        441    955    0.4%
                           
               18,515    27,774    12.5%
                           
V12 Holdings, Inc.  Data Processing & Digital Marketing  Subordinated Debt (19)        813    1,035    0.5%
                           
               813    1,035    0.5%
                           
Sub Total Affiliate investments - United States             $77,336   $103,957    46.8%
                           
Control investments- 48.5%                          
                           
Control investments - United States                          
CableOrganizer Acquisition, LLC  Computer Supply Retail  First Lien Debt (12% Cash, 4% PIK, Due 5/24/18)  $12,373    12,373    12,373    5.6%
                           
CableOrganizer Acquisition, LLC  Computer Supply Retail  Common Stock (21.3% fully diluted)        1,394    118    0.1%

 

 20 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
CableOrganizer Acquisition, LLC  Computer Supply Retail  Common Stock Warrants (10% fully diluted )       -   60   0.0%
                           
               13,767    12,551    5.7%
                           
Eastport Holdings, LLC  Business Services  Subordinated Debt (14.49% Cash (3 month LIBOR + 13%, 0.5% Floor), Due 4/29/20)   16,500    14,738    16,500    7.4%
                           
Eastport Holdings, LLC  Business Services  Membership Units (33.3% ownership) (16)        4,733    26,449    11.9%
                           
               19,471    42,949    19.3%
                           
Kelle's Transport Service, LLC  Transportation  First Lien Debt (4% Cash, Due 2/15/20) (17)   2,000    2,000    2,000    0.9%
                           
Kelle's Transport Service, LLC  Transportation  First Lien Debt (1.46% Cash, Due 2/15/20) (8)   13,674    13,669    9,560    4.3%
                           
Kelle's Transport Service, LLC  Transportation  Membership Units (27.5% fully diluted)        -    -    0.0%
                           
               15,669    11,560    5.2%
                           
Micro Precision, LLC  Conglomerate  Subordinated Debt (10% Cash, Due 9/15/18) (8)   1,862    1,862    1,862    0.8%
                           
Micro Precision, LLC  Conglomerate  Subordinated Debt (14% Cash, 4% PIK, Due 9/15/18) (8)   4,154    4,154    4,154    1.9%
                           
Micro Precision, LLC  Conglomerate  Series A Preferred Units (47 units)        1,629    1,629    0.7%
                           
               7,645    7,645    3.4%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  First Lien Debt (15% Cash, Due 10/30/20) (8)   6,500    6,500    6,500    2.9%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  Class A Preferred Stock (1,000 shares, 10% Cash Dividend) (5)        1,000    1,000    0.5%
                           
Navis Holdings, Inc.  Textile Equipment Manufacturer  Common Stock (300,000 shares)        1    5,005    2.3%
                           
               7,501    12,505    5.7%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Subordinated Debt (18% Cash, Due 12/19/18) (7) (8)   14,072    11,020    11,588    5.2%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Series A Preferred Stock (32,782 shares)        3,278    -    0.0%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Series B Preferred Stock (23,648 shares)        2,365    -    0.0%
                           
On-Site Fuel Services, Inc.  Fuel Transportation Services  Common Stock (33,058 shares)        33    -    0.0%
                           
               16,696    11,588    5.2%

 

 21 

 

 

Capitala Finance Corp.

 

Consolidated Schedule of Investments

(in thousands, except for units/shares)

December 31, 2017

 

Portfolio Company, Country (1), (2), (3), (4)   Industry  Type of Investment  Principal
Amount
   Cost   Fair Value   % of
Net Assets
 
                       
Portrait Studio, LLC  Professional and Personal Digital Imaging  First Lien Debt (8.56% Cash (1 month LIBOR + 7%, 1% floor, 2% ceiling), Due 12/31/22) (18)   1,860    1,860    1,860   0.9%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  First Lien Debt (8.56% Cash (1 month LIBOR + 7%, 1% floor, 5% ceiling), Due 12/31/22)   4,500    4,500    4,500    2.0%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  Preferred Units (4,350,000 Units)        2,450    2,450    1.1%
                           
Portrait Studio, LLC  Professional and Personal Digital Imaging  Membership Units (150,000 Units)        -    -    0.0%
                           
               8,810    8,810    4.0%
                           
Sub Total Control investments - United States             $89,559   $107,608    48.5%
                           
TOTAL INVESTMENTS - 225.3%             $465,027   $499,939    225.3%
                         
Derivatives - (3.1)%                          
                           
Derivatives - United States                          
Eastport Holdings, LLC  Business Services  Written Call Option (16)       $(20)  $(6,815)   (3.1)%
                           
Sub Total Derivatives - United States             $(20)  $(6,815)   (3.1)%
                           
TOTAL DERIVATIVES- (3.1)%             $(20)  $(6,815)   (3.1)%

 

(1) All investments valued using unobservable inputs (Level 3).

(2) All investments valued by the Board of Directors.

(3) All debt investments are income producing, unless otherwise noted. Equity and warrant investments are non-income producing, unless otherwise noted.

(4) Percentages are based on net assets of $221,887 as of December 31, 2017.

(5) The equity investment is income producing, based on rate disclosed.

(6) The cash rate equals the approximate current yield on our last-out portion of the unitranche facility.

(7) Non-accrual investment.

(8) The maturity date of the original investment has been extended.

(9) The equity investment has an excercisable put option.

(10) The investment has a $2.0 million unfunded commitment.

(11) Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company's total assets at the time of acquisition of any additional non-qualifying assets. As of December 31, 2017, 5.0% of the Company's total assets were non-qualifying assets.

(12) The company is headquartered in Brazil.

(13) In addition to the stated rate, the Company is charging 3% default interest on the investment.

(14) The investment has been exited. The residual value reflects estimated escrow to be settled post-closing.

(15) The investment has a $0.7 million unfunded commitment.

(16) The Company has written a call option that enables CapitalSouth Partners Florida Sidecar Fund II, L.P. to purchase up to 31.25% of the Company's interest at a strike price of $1.5 million. As of December 31, 2017, the fair value of the written call option is approximately $6.8 million. See Note 4 to the consolidated financial statements for further detail on the written call option transaction.

(17) The investment has a $1.0 million unfunded commitment.

(18) The investment has a $3.1 million unfunded commitment.

(19) The investment has been exited. The residual value reflects estimated escrow and earnout to be settled post-closing.

 

See accompanying notes to consolidated financial statements.

 

 

 22 

 

 

CAPITALA FINANCE CORP.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

March 31, 2018

 

(Unaudited)

 

Note 1. Organization

 

Capitala Finance Corp. (the ‘‘Company’’, ‘‘we’’, ‘‘us’’, and ‘‘our’’) is an externally managed non-diversified closed-end management investment company incorporated in Maryland that has elected to be regulated as a business development company (‘‘BDC’’) under the Investment Company Act of 1940, as amended (the ‘‘1940 Act’’). The Company is an ‘‘emerging growth company’’ within the meaning of the Jumpstart Our Business Startups Act of 2012 (the ‘‘JOBS Act’’), and as such, is subject to reduced public company reporting requirements. The Company commenced operations on May 24, 2013 and completed its initial public offering (‘‘IPO’’) on September 30, 2013. The Company is managed by Capitala Investment Advisors, LLC (the ‘‘Investment Advisor’’), an investment adviser that is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the ‘‘Advisors Act’’), and Capitala Advisors Corp. (the ‘‘Administrator’’) provides the administrative services necessary for the Company to operate. For United States (“U.S.”) federal income tax purposes, the Company has elected to be treated, and intends to comply with the requirements to continue to qualify annually, as a regulated investment company (‘‘RIC’’) under subchapter M of the Internal Revenue Code of 1986, as amended (the ‘‘Code’’).

 

The Company’s investment objective is to generate both current income and capital appreciation through debt and equity investments. Both directly and through our subsidiaries that are licensed by the U.S. Small Business Administration (‘‘SBA’’) under the Small Business Investment Company (‘‘SBIC’’) Act, the Company offers customized financing to business owners, management teams and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. The Company invests in first lien loans, second lien loans, subordinated loans, and, to a lesser extent, equity securities issued by lower middle-market companies and traditional middle-market companies.

 

The Company was formed for the purpose of: (i) acquiring, through a series of transactions, an investment portfolio from the following entities: CapitalSouth Partners Fund I Limited Partnership (‘‘Fund I’’); CapitalSouth Partners Fund II Limited Partnership (‘‘Fund II’’); CapitalSouth Partners Fund III, L.P. (‘‘Fund III Parent’’); CapitalSouth Partners SBIC Fund III, L.P. (‘‘Fund III’’) and CapitalSouth Partners Florida Sidecar Fund I, L.P. (‘‘Florida Sidecar’’ and, collectively with Fund I, Fund II, Fund III and Fund III Parent, the ‘‘Legacy Funds’’); (ii) raising capital in the IPO and (iii) continuing and expanding the business of the Legacy Funds by making additional debt and equity investments in lower middle-market and traditional middle-market companies.

 

On September 24, 2013, the Company acquired 100% of the limited partnership interests in Fund II, Fund III and Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I and Fund III Parent, in exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the ‘‘Formation Transactions’’). Fund II, Fund III and Florida Sidecar became the Company’s wholly owned subsidiaries. Fund II and Fund III retained their SBIC licenses, continued to hold their existing investments at the time of the IPO and have continued to make new investments. The IPO consisted of the sale of 4,000,000 shares of the Company’s common stock at a price of $20.00 per share, resulting in net proceeds to the Company of $74.25 million, after deducting underwriting fees and commissions totaling $4.0 million and offering expenses totaling $1.75 million. The other costs of the IPO were borne by the limited partners of the Legacy Funds.

 

During the fourth quarter of 2017, Florida Sidecar transferred all of its assets to Capitala Finance Corp. and was legally dissolved as a standalone partnership.

 

The Company has formed and expects to continue to form certain consolidated taxable subsidiaries (the ‘‘Taxable Subsidiaries’’), which are taxed as corporations for income tax purposes. These Taxable Subsidiaries allow the Company to make equity investments in companies organized as pass-through entities while continuing to satisfy the requirements of a RIC under the Code.

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Company is considered an investment company as defined in Accounting Standards Codification (‘‘ASC’’) Topic 946 — Financial Services — Investment Companies (‘‘ASC 946’’). The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles (‘‘U.S. GAAP’’) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 6 and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying our annual consolidated financial statements prepared in accordance with U.S. GAAP have been omitted. The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries, including Fund II, Fund III, Florida Sidecar, and the Taxable Subsidiaries.

 

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The Company’s financial statements as of March 31, 2018 and December 31, 2017 are presented on a consolidated basis. The effects of all intercompany transactions between the Company and its subsidiaries (Fund II, Fund III, Florida Sidecar, and the Taxable Subsidiaries) have been eliminated in consolidation. All financial data and information included in these consolidated financial statements have been presented on the basis described above. In the opinion of management, the consolidated financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of and for the periods presented.

 

The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. Additionally, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the U.S. Securities and Exchange Commission (“SEC”) on February 27, 2018.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates under different assumptions and conditions. The most significant estimates in the preparation of the consolidated financial statements are investment valuation, revenue recognition, and income taxes.

 

Consolidation

 

As provided under Regulation S-X and ASC 946, the Company will generally not consolidate its investment in a company other than a substantially wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company consolidated the results of the Company’s wholly owned investment company subsidiaries (Fund II, Fund III, Florida Sidecar, and the Taxable Subsidiaries) in its consolidated financial statements.

 

Segments

 

In accordance with ASC Topic 280 — Segment Reporting (‘‘ASC 280’’), the Company has determined that it has a single reporting segment and operating unit structure. While the Company invests in several industries and geographic locations, all investments share similar business and economic risks. As such, all investment activities have been aggregated into a single segment.

 

Cash and Cash Equivalents

 

The Company considers cash equivalents to be highly liquid investments with original maturities of three months or less at the date of purchase. The Company deposits its cash in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation insurance limits.

 

Investment Classification

 

In accordance with the provisions of the 1940 Act, the Company classifies its investments by level of control. As defined in the 1940 Act, ‘‘Control Investments’’ are investments in those companies that the Company is deemed to ‘‘Control.’’ ‘‘Affiliate Investments’’ are investments in those companies that are ‘‘Affiliated Companies’’ of the Company, as defined in the 1940 Act, other than Control Investments. ‘‘Non-Control/Non-Affiliate Investments’’ are those investments that are neither Control Investments nor Affiliate Investments. Generally under the 1940 Act, the Company is deemed to control a company in which it has invested if the Company owns more than 25% of the voting securities of such company and/or has greater than 50% representation on its board or has the power to exercise control over management or policies of such portfolio company. The Company is deemed to be an affiliate of a company in which the Company has invested if it owns between 5% and 25% of the voting securities of such company.

 

Valuation of Investments

 

The Company applies fair value accounting to all of its financial instruments in accordance with the 1940 Act and ASC Topic 820 — Fair Value Measurements and Disclosures (‘‘ASC 820’’). ASC 820 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements. In accordance with ASC 820, the Company has categorized its financial instruments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy, as discussed in Note 4.

 

In determining fair value, the Company’s board of directors (the ‘‘Board’’) uses various valuation approaches, and engages a third-party valuation firm, which provides an independent valuation of certain investments it reviews. In accordance with U.S. GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

 

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Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Board. Unobservable inputs reflect the Board’s assumptions about the inputs market participants would use in pricing the asset or liability developed based upon the best information available in the circumstances.

 

The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a market for the securities existed. Accordingly, the degree of judgment exercised by the Board in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement.

 

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many securities. This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.

 

In estimating the fair value of portfolio investments, the Company starts with the cost basis of the investment, which includes original issue discount and payment-in-kind (‘‘PIK’’) income, if any. The transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from the original transaction price, adjustments are made to reflect the expected fair values.

 

The valuation methodologies summarized below are utilized by the Company in estimating fair value.

 

Enterprise Value Waterfall Approach

 

The enterprise value waterfall approach determines an enterprise value based on earnings before interest, tax, depreciation and amortization (‘‘EBITDA’’) multiples of publicly traded companies that are considered similar to the subject portfolio company. The Company considers a variety of items in determining a reasonable pricing multiple, including, but not limited to, operating results, budgeted projections, growth, size, risk, profitability, leverage, management depth, diversification, market position, supplier or customer dependence, asset utilization, liquidity metrics, and access to capital markets. EBITDA of the portfolio company is adjusted for non-recurring items in order to reflect a normalized level of earnings that is representative of future earnings. In certain instances, the Company may also utilize revenue multiples to determine enterprise value. When available, the Company may assign a pricing multiple or value its equity investments based on the value of recent investment transactions in the subject portfolio company or offers to purchase the portfolio company. The enterprise value is adjusted for financial instruments with seniority to the Company’s ownership and for the effect of any instrument which may dilute the Company’s investment in the portfolio company. The adjusted enterprise value is then apportioned based on the seniority and privileges of the Company’s investments within the portfolio company.

 

The enterprise value waterfall approach is primarily utilized to value the Company’s equity securities, including warrants. However, the Company may utilize the enterprise value waterfall approach to value certain debt securities.

 

Income Approach

 

The income approach utilizes a discounted cash flow methodology in which the Company estimates fair value based on the present value of expected cash flows discounted at a market rate of interest. The determination of a discount rate, or required rate of return, takes into account the portfolio company’s fundamentals and perceived credit risk. Because the majority of the Company’s portfolio companies do not have a public credit rating, determining a discount rate often involves assigning an implied credit rating based on the portfolio company’s operating metrics compared to average metrics of similar publicly rated debt. Operating metrics include, but are not limited to, EBITDA, interest coverage, leverage ratios, return on capital, and debt to equity ratios. The implied credit rating is used to assign a base discount rate range based on publicly available yields on similarly rated debt securities. The Company may apply a premium to the discount rate utilized in determining fair value when performance metrics and other qualitative information indicate that there is an additional level of uncertainty about collectability of cash flows.

 

Asset Approach

 

The asset approach values an investment based on the value of the underlying collateral securing the investment. This approach is used when the Company has reason to believe that it will not collect all principal and interest in accordance with the contractual terms of the debt agreement.

 

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Revenue Recognition

 

The Company’s revenue recognition policies are as follows:

 

Interest income and paid-in-kind interest income: Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company has loans in the portfolio that contain a payment-in-kind interest (‘‘PIK interest’’) provision. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at maturity, is recorded on an accrual basis to the extent that such amounts are expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay all principal and interest when due.

 

Non-accrual investments: Management reviews all loans that become 90 days or more past due, or when there is reasonable doubt that principal or interest will be collected, for possible placement on non-accrual status. When the Company otherwise does not expect the borrower to be able to service its debt and other obligations, the Company will place the loan on non-accrual status, and will generally cease recognizing interest income and PIK interest on that loan for financial reporting purposes. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. The Company writes off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. The Company may elect to cease accruing PIK interest and continue accruing interest income in cases where a loan is currently paying its interest income but, in management’s judgment, there is a reasonable likelihood of principal loss on the loan. Non-accrual loans are returned to accrual status when the borrower’s financial condition improves such that management believes current interest and principal payments are expected to be collected.

 

Gains and losses on investment sales and paydowns: Realized gains and losses on investments are recognized using the specific identification method.

 

Dividend income and paid-in-kind dividends: Dividend income is recognized on the date dividends are declared. The Company holds preferred equity investments in the portfolio that contain a payment-in-kind dividend (‘‘PIK dividends’’) provision. PIK dividends, which represent contractually deferred dividends added to the equity balance, are recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company will typically cease accrual of PIK dividends when the fair value of the equity investment is less than the cost basis of the investment or when it is otherwise determined by management that PIK dividends are unlikely to be collected. If management determines that a decline in fair value is temporary in nature and the PIK dividends are more likely than not to be collected, management may elect to continue accruing PIK dividends.

 

Original issue discount: Discounts received to par on loans purchased are capitalized and accreted into income over the life of the loan. Any remaining discount is accreted into income upon prepayment of the loan.

 

Other income: Origination fees (to the extent services are performed to earn such income), amendment fees, consent fees, and other fees associated with investments in portfolio companies are recognized as income when the investment transaction closes. Prepayment penalties received by the Company for debt instruments repaid prior to maturity date are recorded as income upon receipt.

 

Loan Sales

 

The Company follows the guidance in ASC Topic 860 — Transfers and Servicing (‘‘ASC 860’’) when accounting for loan participations and partial loan sales as it relates to concluding on sales accounting treatment for such transactions. Based on the Company’s analysis of all loan participations and partial sales completed, the Company believes that all such transactions meet the criterion required by ASC 860 to qualify for sales accounting treatment.

 

General and Administrative Expenses

 

General and administrative expenses are paid as incurred. The Company’s administrative expenses include personnel and overhead expenses allocable to the Company paid by and reimbursed to the Administrator under an administration agreement between the Company and the Administrator (the ‘‘Administration Agreement’’). Other operating expenses such as legal and audit fees, director fees, and director and officer insurance are generally paid directly by the Company.

 

Deferred Financing Fees

 

Costs incurred to issue the Company’s debt obligations are capitalized and are amortized over the term of the debt agreements under the effective interest method.

 

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Commitments and Contingencies

 

As of March 31, 2018, the Company had outstanding unfunded commitments related to debt investments in existing portfolio companies of $3.0 million (Portrait Studio, LLC), $2.0 million (CIS Secure Computing, Inc.), $1.1 million (MC Sign Lessor Corp), $0.8 million (Kelle’s Transport Service, LLC) and $0.7 million (U.S. Well Services, LLC). As of December 31, 2017, the Company had outstanding unfunded commitments related to debt investments in existing portfolio companies of $3.1 million (Portrait Studio, LLC), $2.0 million (CIS Secure Computing, Inc.), $1.0 million (Kelle’s Transport Service, LLC), and $0.7 million (U.S. Well Services, LLC).

 

In addition to unfunded commitments related to debt investments, the Company also has extended a guaranty on behalf of one of our portfolio companies, whereby we have guaranteed $1.9 million of obligations of Kelle’s Transport Service, LLC. As of March 31, 2018 we have not been required to make payments on this or any previous guaranties, and we consider the credit risks to be remote and the fair value of this guaranty to be immaterial.

 

In the ordinary course of business, the Company may enter into contracts or agreements that contain indemnifications or warranties. Future events could occur that could lead to the execution of these provisions against the Company. Based on its history and experience, management believes that the likelihood of such an event is remote.

 

On December 28, 2017, an alleged stockholder filed a putative class action lawsuit complaint, Paskowitz v. Capitala Finance Corp., et al., in the United States District Court for the Central District of California (case number 2:17-cv-09251-MWF-AS) (the “Paskowitz Action”), against the Company and certain of its current officers on behalf of all persons who purchased or otherwise acquired the Company’s common stock between January 4, 2016 and August 7, 2017. On January 3, 2018, another alleged stockholder filed a putative class action complaint, Sandifer v. Capitala Finance Corp., et al., in the United States District Court for the Central District of California (case number 2:18-cv-00052-MWF-AS) (the “Sandifer Action”), asserting substantially similar claims on behalf of the same putative class and against the same defendants. The complaints in the Paskowitz Action and the Sandifer Action allege certain violations of the securities laws, including, inter alia, that the defendants made certain materially false and misleading statements and omissions regarding the Company’s business, operations, and prospects. On February 2, 2018, the Sandifer Action was transferred, on stipulation of the parties, to the United States District Court for the Western District of North Carolina. The Sandifer Action was voluntarily dismissed on February 28, 2018. On March 1, 2018, the Paskowitz Action was transferred, on stipulation of the parties, to the United States District Court for the Western District of North Carolina (case number 3:18-cv-00096-RJC-DSC). While the Company intends to vigorously defend itself in this litigation, the outcome of these legal proceedings cannot be predicted with certainty.

 

Estimating an amount or range of possible losses resulting from litigation proceedings is inherently difficult and requires an extensive degree of judgment, particularly where the matters involve indeterminate claims for monetary damages, are in the early stages of the proceedings, and are subject to appeal. In addition, because most legal proceedings are resolved over extended periods of time, potential losses are subject to change due to, among other things, new developments, changes in legal strategy, the outcome of intermediate procedural and substantive rulings and other parties’ settlement posture and their evaluation of the strength or weakness of their case against us. For these reasons, we are currently unable to predict the ultimate timing or outcome of, or reasonably estimate the possible losses or a range of possible losses resulting from, the matters described above. Based on information currently available, the Company does not believe that any reasonably possible losses arising from the currently pending legal matters described above will be material to the Company’s results of operations or financial condition. However, in light of the inherent uncertainties involved in such matters, an adverse outcome in this litigation could materially and adversely affect the Company’s financial condition, results of operations or cash flows in any particular reporting period.

 

In the ordinary course of business, the Company may directly or indirectly be a defendant or plaintiff in legal actions with respect to bankruptcy, insolvency or other types of proceedings. Such lawsuits may involve claims that could adversely affect the value of certain financial instruments owned by the Company or result in direct losses to the Company. In management’s opinion, no direct losses with respect to litigation contingencies were probable as of March 31, 2018 and December 31, 2017. Management is of the opinion that the ultimate resolution of such claims, if any, will not materially affect the Company’s business, financial position, results of operations or liquidity. Furthermore, in management’s opinion, it is not possible to estimate a range of reasonably possible losses with respect to litigation contingencies.

 

Income Taxes

 

The Company has elected to be treated for U.S. federal income tax purposes, and intends to comply with the requirements to qualify annually as a RIC under subchapter M of the Code and, among other things, intends to make the requisite distributions to its stockholders which will relieve the Company from U.S. federal income taxes.

 

In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its stockholders at least 90.0% of its investment company taxable income, as defined by the Code, for each fiscal tax year. The Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on undistributed income if it does not distribute at least 98.0% of its ordinary income in any calendar year and 98.2% of its capital gain net income for each one-year period ending on October 31.

 

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Depending on the level of taxable income earned in an excise tax year, the Company may choose to carry forward taxable income in excess of current year dividend distributions into the next excise tax year and pay a 4.0% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions for excise tax purposes, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. Since the Company’s IPO, the Company has not accrued or paid excise tax.

 

For U.S. federal income tax purposes, as of March 31, 2018, the aggregate net unrealized appreciation for all securities was $27.7 million. As of March 31, 2018, gross unrealized appreciation was $82.0 million and gross unrealized depreciation was $54.3 million. The aggregate cost of securities for U.S. federal income tax purposes was $476.0 million.

 

The Company’s Taxable Subsidiaries record deferred tax assets or liabilities related to temporary book versus tax differences on the income or loss generated by the underlying equity investments held by the Taxable Subsidiaries. As of March 31, 2018 and December 31, 2017, the Company recorded a net deferred tax liability of $1.3 million and $1.3 million, respectively. For the three months ended March 31, 2018, the Company recorded a tax provision of $50 thousand. For the three months ended March 31, 2017, no tax provision was recorded.

 

In accordance with certain applicable U.S. Treasury regulations and guidance issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive its entire distribution in either cash or stock of the RIC, subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution. If too many stockholders elect to receive cash, the cash available for distribution must be allocated among the stockholders electing to receive cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive the lesser of (a) the portion of the distribution such stockholder has elected to receive in cash or (b) an amount equal to his or her entire distribution times the percentage limitation on cash available for distribution. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. For income tax purposes, the Company has paid distributions on its common stock from ordinary income in the amount of $25.2 million, $24.5 million, and $25.1 million during the tax years ended August 31, 2017, 2016 and 2015, respectively.

 

ASC Topic 740 — Income Taxes (‘‘ASC 740’’), provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are ‘‘more-likely-than-not’’ to be sustained by the applicable tax authority. Tax positions deemed to meet a ‘‘more-likely-than-not’’ threshold would be recorded as a tax benefit or expense in the current period. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the consolidated statements of operations. As of March 31, 2018 and December 31, 2017, there were no uncertain tax positions.

 

The Company is required to determine whether a tax position of the Company is more likely-than-not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that could negatively impact the Company’s net assets.

 

U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial statement comparability among different entities.

 

The tax years ended August 31, 2017, 2016 and 2015 remain subject to examination by U.S. federal, state, and local tax authorities. No interest expense or penalties have been assessed for the three months ended March 31, 2018 and March 31, 2017. If the Company was required to recognize interest and penalties, if any, related to unrecognized tax benefits this would be recognized as income tax expense in the consolidated statements of operations.

 

The Company has elected to amend its tax year end from August 31 to December 31 and will file a tax return for the four months ended December 31, 2017. The election to change the tax year end is not expected to have a material impact on the Company’s consolidated statements of operations, the Company’s tax status as a RIC, or the nature of distributions paid to our stockholders. 

 

On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act, which significantly changes the existing U.S. tax laws, including a reduction in the corporate tax rate from 35% to 21%, a move from a worldwide tax system to a territorial system, as well as other changes. The Taxable Subsidiaries’ provisional tax is based on the new lower blended federal and state corporate tax rate of 25%. This estimate incorporates assumptions made based on the Taxable Subsidiaries’ current interpretation of the Tax Act and may change, possibly materially, as we complete our analysis and receive additional clarification and implementation guidance.

 

Distributions

 

Distributions to common stockholders are recorded as payable on the declaration date. The amount to be paid out as a dividend is determined by the Board. Net capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for reinvestment.

 

The Company has adopted an ‘‘opt out’’ dividend reinvestment plan (‘‘DRIP’’) for the Company’s common stockholders. As a result, if the Company declares a distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of the Company’s common stock unless a stockholder specifically ‘‘opts out’’ of our DRIP. If a stockholder opts out, that stockholder will receive cash distributions. Although distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, stockholders participating in the Company’s DRIP will not receive any corresponding cash distributions with which to pay any such applicable taxes.

 

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Company Investment Risk, Concentration of Credit Risk, and Liquidity Risk

 

The Investment Advisor has broad discretion in making investments for the Company. Investments will generally consist of debt and equity instruments that may be affected by business, financial market or legal uncertainties. Prices of investments may be volatile, and a variety of factors that are inherently difficult to predict, such as domestic or international economic and political developments, may significantly affect the results of the Company’s activities and the value of its investments. In addition, the value of the Company’s portfolio may fluctuate as the general level of interest rates fluctuate.

 

The value of the Company’s investments may be detrimentally affected to the extent, among other things, that a borrower defaults on its obligations, there is insufficient collateral and/or there are extensive legal and other costs incurred in collecting on a defaulted loan, observable secondary or primary market yields for similar instruments issued by comparable companies increase materially or risk premiums required in the market between smaller companies, such as our borrowers, and those for which market yields are observable increase materially.

 

The Investment Advisor may attempt to minimize this risk by maintaining low debt-to-liquidation values with each debt investment and the collateral underlying the debt investment.

 

The Company’s assets may, at any time, include securities and other financial instruments or obligations that are illiquid or thinly traded, making purchase or sale of such securities and financial instruments at desired prices or in desired quantities difficult. Furthermore, the sale of any such investments may be possible only at substantial discounts, and it may be extremely difficult to value any such investments accurately.

 

Note 3. Recent Accounting Pronouncements

 

In October 2016, the SEC adopted new rules and amended existing rules (together, ‘‘final rules’’) intended to modernize the reporting and disclosure of information by registered investment companies. In part, the final rules amend Regulation S-X and require standardized, enhanced disclosures about derivatives in investment company financial statements, as well as other amendments. The compliance date for the amendments to Regulation S-X was August 1, 2017. Management has adopted the amendments to Regulation S-X and included required disclosures in the Company’s consolidated financial statements and related disclosures.

 

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (ASC Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements under ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The new guidance significantly enhances comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized. The new guidance became effective for the annual reporting period beginning January 1, 2018, including interim periods within that reporting period. The Company completed its assessment in evaluating the potential impact on its consolidated financial statements and based on its assessment, determined that its financial contracts are excluded from the scope of ASU 2014-09. As a result of the scope exception for financial contracts, the Company’s management has determined that there will be no material changes to the recognition timing and classification of revenues and expenses; additionally, the Company’s management determined that the adoption of ASU 2014-09 does not have a significant impact on its consolidated financial statement disclosures.

 

Note 4. Investments and Fair Value Measurements

 

The Company’s investment objective is to generate both current income and capital appreciation through debt and equity investments. Both directly and through the Company’s subsidiaries that are licensed by the SBA under the SBIC Act, the Company offers customized financing to business owners, management teams and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. The Company invests in first lien loans, second lien loans, and subordinated loans. Most of the Company’s debt investments are coupled with equity interests, whether in the form of detachable ‘‘penny’’ warrants or equity co-investments made pari-passu with our borrowers’ financial sponsors. As of March 31, 2018, our portfolio consisted of investments in 46 portfolio companies with a fair value of approximately $503.7 million.

 

Most of the Company’s debt investments are structured as first lien loans. First lien loans may contain some minimum amount of principal amortization, excess cash flow sweep feature, prepayment penalties, or any combination of the foregoing. First lien loans are secured by a first priority lien in existing and future assets of the borrower and may take the form of term loans or delayed draw facilities. Unitranche debt, a form of first lien loan, typically involves issuing one debt security that blends the risk and return profiles of both senior secured and subordinated debt in one debt security, bifurcating the loan into a first-out tranche and last-out tranche. As of March 31, 2018, 12.9% of the fair value of our first lien loans consisted of last-out loans. In some cases, first lien loans may be subordinated, solely with respect to the payment of cash interest, to an asset based revolving credit facility.

 

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The Company also invests in debt instruments structured as second lien loans. Second lien loans are loans which have a second priority security interest in all or substantially all of the borrower’s assets, and which are not subject to the blockage of cash interest payments to the Company at the first lien lender’s discretion.

 

In addition to first and second lien loans, the Company may also invest in subordinated loans. Subordinated loans typically have a second lien on all or substantially all of the borrower’s assets, and unlike second lien loans, may be subject to the interruption of cash interest payments upon certain events of default, at the discretion of the first lien lender.

 

During the three months ended March 31, 2018, the Company made approximately $27.8 million of investments and had approximately $21.4 million in repayments and sales resulting in net investments of approximately $6.4 million for the period. During the three months ended March 31, 2017, the Company made approximately $21.7 million of investments and had approximately $33.0 million in repayments and sales resulting in net repayments and sales of approximately $11.3 million for the period.

 

During the three months ended March 31, 2018, the Company funded $1.0 million of previously committed capital to existing portfolio companies. During the three months ended March 31, 2018, the Company funded $26.8 million of investments in portfolio companies for which it was not previously committed to fund. During the three months ended March 31, 2017, the Company funded $1.2 million of previously committed capital to existing portfolio companies. During the three months ended March 31, 2017, the Company funded $20.5 million of investments in portfolio companies for which it was not previously committed to fund. In addition to investing directly in portfolio companies, the Company may assist portfolio companies in securing financing from other sources by introducing portfolio companies to sponsors or by leading a syndicate of investors to provide the portfolio companies with financing. During the three months ended March 31, 2018 and March 31, 2017, the Company did not lead any syndicates and did not assist any portfolio companies in obtaining indirect financing.

 

On August 31, 2016, the Company sold a portion of 14 securities across 10 portfolio companies to CapitalSouth Partners Florida Sidecar Fund II, L.P. (‘‘FSC II’’), including granting an option to acquire a portion of the Company’s equity investment in Eastport Holdings, LLC (the ‘‘Written Call Option’’), in exchange for 100% of the partnership interests in FSC II. Concurrent with the sale of these assets to FSC II, the Company received cash consideration of $47.6 million from an affiliated third-party purchaser in exchange for 100% of the partnership interests of FSC II. These assets were sold to FSC II at their June 30, 2016 fair market values, resulting in a net realized gain of $0.1 million. The Company’s Board pre-approved this transaction pursuant to Section 57(f) of the 1940 Act.

 

The Company collected and will periodically collect principal and interest payments related to certain of the securities purchased by FSC II. Such principal and interest payments will be remitted timely to FSC II based on its proportionate share of the security. FSC II does not have any recourse to the Company related to the non-payment of principal or interest by the underlying issuers of the securities.

 

The Written Call Option granted FSC II the right to purchase up to 31.25% of the Company’s equity investment in Eastport Holdings, LLC. The Written Call Option has a strike price of $1.5 million and a termination date of August 31, 2018. The fair value of the Written Call Option, which has been treated as a derivative liability and is recorded in the financial statement line item Written Call Option at fair value in the Company’s consolidated statements of assets and liabilities, was approximately $6.8 million and $6.8 million as of March 31, 2018 and December 31, 2017, respectively. For purposes of determining the fair value of the Written Call Option, the Company calculated the difference in the fair value of the underlying equity investment in Eastport Holdings, LLC and the strike price of the Written Call Option, or intrinsic value. The time value of the Written Call Option as of March 31, 2018 was determined to be insignificant. The Written Call Option is classified as a Level 3 financial instrument.

 

The composition of our investments as of March 31, 2018, at amortized cost and fair value was as follows (dollars in thousands):

 

   Investments
at
Amortized Cost
   Amortized Cost
Percentage of
Total Portfolio
   Investments
at
Fair Value
   Fair Value
Percentage of
Total Portfolio
 
First Lien Debt  $268,504    57.2%  $256,594    51.0%
Second Lien Debt   32,647    7.0    31,761    6.3 
Subordinated Debt   111,849    23.8    92,780    18.4 
Equity and Warrants   56,202    12.0    122,587    24.3 
Total  $469,202    100.0%  $503,722    100.0%

 

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The composition of our investments as of December 31, 2017, at amortized cost and fair value was as follows (dollars in thousands):

 

   Investments
at
Amortized Cost
   Amortized Cost
Percentage of
Total Portfolio
   Investments
at
Fair Value
   Fair Value
Percentage of
Total Portfolio
 
First Lien Debt  $257,147    55.3%  $243,489    48.7%
Second Lien Debt   32,465    7.0    30,794    6.1 
Subordinated Debt   120,235    25.8    103,385    20.7 
Equity and Warrants   55,180    11.9    122,271    24.5 
Total  $465,027    100.0%  $499,939    100.0%

 

As noted above, the Company values all investments in accordance with ASC 820. ASC 820 requires enhanced disclosures about assets and liabilities that are measured and reported at fair value. As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

 

ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.

 

Based on the observability of the inputs used in the valuation techniques, the Company is required to provide disclosures on fair value measurements according to the fair value hierarchy. The fair value hierarchy ranks the observability of the inputs used to determine fair values. Investments carried at fair value are classified and disclosed in one of the following three categories:

 

Level 1 — Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 

Level 2 — Valuations based on inputs other than quoted prices in active markets, which are either directly or indirectly observable.

 

Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

 

In addition to using the above inputs in investment valuations, the Company continues to employ the valuation policy approved by the Board that is consistent with ASC 820 (see Note 2). Consistent with the Company’s valuation policy, the Company evaluates the source of inputs, including any markets in which its investments are trading, in determining fair value.

 

In estimating fair value of portfolio investments, the Company starts with the cost basis of the investment, which includes amortized original issue discount and PIK income, if any. The transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from the original transaction price, adjustments are made to reflect the expected fair values.

 

The following table presents the fair value measurements of investments, by major class, as of March 31, 2018 (dollars in thousands), according to the fair value hierarchy:

 

   Fair Value Measurements 
   Level 1   Level 2   Level 3   Total 
First Lien Debt  $   $   $256,594   $256,594 
Second Lien Debt           31,761    31,761 
Subordinated Debt           92,780    92,780 
Equity and Warrants           122,587    122,587 
Total  $   $   $503,722   $503,722 

 

The following table presents fair value measurements of the Written Call Option as of March 31, 2018 (dollars in thousands), according to the fair value hierarchy:

 

   Fair Value Measurements 
   Level 1   Level 2   Level 3   Total 
Written Call Option  $   $   $(6,815)  $(6,815)
Total  $   $   $(6,815)  $(6,815)

 

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The following table presents fair value measurements of investments, by major class, as of December 31, 2017 (dollars in thousands), according to the fair value hierarchy:

 

   Fair Value Measurements 
   Level 1   Level 2   Level 3   Total 
First Lien Debt  $   $   $243,489   $243,489 
Second Lien Debt           30,794    30,794 
Subordinated Debt           103,385    103,385 
Equity and Warrants           122,271    122,271 
Total  $   $   $499,939   $499,939 

 

The following table presents fair value measurements of the Written Call Option as of December 31, 2017 (dollars in thousands), according to the fair value hierarchy:

 

   Fair Value Measurements 
   Level 1   Level 2   Level 3   Total 
Written Call Option  $   $   $(6,815)  $(6,815)
Total  $   $   $(6,815)  $(6,815)

 

 The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the three months ended March 31, 2018 (dollars in thousands):