10-Q
Table of Contents

 

 

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 Quarter Ended September 30, 2013

 

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

 

 

 

Commission
File Number

  

Exact name of registrants as specified in their charters, addresses of principal  executive

offices, telephone numbers and states or other jurisdictions 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
814-01021   

CapitalSouth Partners Fund II Limited Partnership

4201 Congress St., Suite 360

Charlotte, North Carolina

Telephone: (704) 376-5502

State of Formation: North Carolina

  55-0793325
814-01023   

CapitalSouth Partners SBIC Fund III, L.P.

4201 Congress St., Suite 360

Charlotte, North Carolina

Telephone: (704) 376-5502

State of Formation: Delaware

  20-8426667

 

 

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  ¨            No  x  

CapitalSouth Partners Fund II Limited Partnership

  Yes  ¨            No  x  

CapitalSouth Partners SBIC Fund III, L.P.

  Yes  ¨            No  x  

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  ¨  

CapitalSouth Partners Fund II Limited Partnership

  Yes  ¨            No  ¨  

CapitalSouth Partners SBIC Fund III, L.P.

  Yes  ¨            No  ¨  

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

 

Capitala Finance Corp.

  Large accelerated filer   ¨    Accelerated filer   ¨
  Non-accelerated filer   x    Smaller reporting company   ¨

 

CapitalSouth Partners Fund II Limited Partnership

  Large accelerated filer   ¨    Accelerated filer   ¨
  Non-accelerated filer   x    Smaller reporting company   ¨

 

CapitalSouth Partners SBIC Fund III, L.P.

  Large accelerated filer   ¨    Accelerated filer   ¨
  Non-accelerated filer   x    Smaller reporting company   ¨

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  

CapitalSouth Partners Fund II Limited Partnership

  Yes  ¨            No  x  

CapitalSouth Partners SBIC Fund III, L.P.

  Yes  ¨            No  x  

The number of shares of Capitala Finance Corp.’s common stock, $0.01 par value, outstanding as of November 14, 2013 was 12,974,420.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

 

 

          Page  

PART I

  

FINANCIAL INFORMATION

     3   

Item 1.

  

Financial Statements

     3   
  

Consolidated Statements of Assets and Liabilities as of September 30, 2013 (unaudited) and December 31, 2012

     3   
  

Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012 (unaudited)

     4   
  

Consolidated Schedules of Investments as of September 30, 2013 (unaudited) and December 31, 2012

     5   
  

Consolidated Statements of Changes in Net Assets for the nine months ended September 30, 2013 and 2012 (unaudited)

     14   
  

Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (unaudited)

     15   
  

Notes to Consolidated Financial Statements as of September 30, 2013 (unaudited)

     16   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     28   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     39   

Item 4.

  

Controls and Procedures

     39   

PART II

  

OTHER INFORMATION

     39   

Item 1.

  

Legal Proceedings

     39   

Item 1A.

  

Risk Factors

     40   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     58   

Item 3.

  

Defaults upon Senior Securities

     58   

Item 4.

  

Mine Safety Disclosures

     58   

Item 5.

  

Other Information

     58   

Item 6.

  

Exhibits

     59   

Signatures

     60   

 

2


Table of Contents

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

Capitala Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except share and per share data)

 

     As of  
     September 30, 2013      December 31, 2012  
     (unaudited)      (combined)  

ASSETS

     

Investments at fair value

     

Non-control/non-affiliate investments (amortized cost of $63,469 and $61,609, respectively)

   $ 79,008       $ 78,769   

Affiliate investments (amortized cost of $145,591 and $122,655, respectively)

     168,143         136,809   

Control investments (amortized cost of $59,242 and $43,434, respectively)

     83,826         68,353   
  

 

 

    

 

 

 

Total investments at fair value (amortized cost of $268,302 and $227,698, respectively)

     330,977         283,931   

Cash and cash equivalents

     133,525         30,467   

Interest and dividend receivable

     2,315         1,917   

Due from related parties

     1,782         1,494   

Deferred financing fees (net of accumulated amortization of $2,420 and 1,898, respectively)

     4,667         4,583   

Other assets

     2         —     
  

 

 

    

 

 

 

Total assets

   $ 473,268       $ 322,392   
  

 

 

    

 

 

 

LIABILITIES

     

SBA debentures payable

   $ 202,200       $ 177,200   

Due to related parties

     503         197   

Accounts payable and accrued expenses

     843         2,562   
  

 

 

    

 

 

 

Total liabilities

   $ 203,546       $ 179,959   
  

 

 

    

 

 

 

NET ASSETS

     

General partner’s capital

   $ —         $ 282   

Limited partners’ capital

     —           77,358   

Common stock, par value $.01, 100,000,000 common shares authorized, 12,974,420 and 0 common shares issued and outstanding, respectively

     130         —     

Additional paid in capital

     190,158         —     

Accumulated net realized earnings

     16,759         8,560   

Net unrealized appreciation on investments

     62,675         56,233   
  

 

 

    

 

 

 

Total net assets

     269,722         142,433   
  

 

 

    

 

 

 
     
  

 

 

    

 

 

 

Total liabilities and net assets

   $ 473,268       $ 322,392   
  

 

 

    

 

 

 

Net asset value per share

   $ 20.79         N/A   

See accompanying notes to consolidated financial statements.

N/A – Not Applicable

 

3


Table of Contents

Capitala Finance Corp.

Consolidated Statements of Operations

(in thousands, except share and per share data)

(unaudited)

 

                                                                           
     For the three months ended September 30      For the nine months ended September 30  
             2013                     2012                      2013                     2012          

INVESTMENT INCOME

         

Loan interest, fee and dividend income:

         

Non-control/Non-affiliate investments

   $ 2,063      $ 2,094       $ 6,112      $ 6,425   

Affiliate investments

     2,825        2,815         9,067        6,987   

Control investments

     3,215        1,247         5,305        3,126   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total loan interest, fee and dividend income

     8,103        6,156         20,484        16,538   
  

 

 

   

 

 

    

 

 

   

 

 

 

Payment-in-kind interest income:

         

Non-control/Non-affiliate investments

     45        42         132        143   

Affiliate investments

     114        148         268        376   

Control investments

     263        235         692        595   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total payment-in-kind interest income

     422        425         1,092        1,114   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income from pass-through entities:

         

Non-control/Non-affiliate investments

     —          —           5        —     

Affiliate investments

     210        —           1,543        171   

Control investments

     —          —           23        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income from pass-through entities

     210        —           1,571        171   

Interest income from cash and cash equivalents

     66        33         141        112   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total investment income

     8,801        6,614         23,288        17,935   
  

 

 

   

 

 

    

 

 

   

 

 

 

EXPENSES

         

Interest expense and amortization of deferred financing fees

     2,237        2,029         6,527        5,794   

Management fees

     980        1,314         2,994        2,992   

Other expenses

     147        1         382        118   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     3,364        3,344         9,903        8,904   
  

 

 

   

 

 

    

 

 

   

 

 

 

NET INVESTMENT INCOME

     5,437        3,270         13,385        9,031   
  

 

 

   

 

 

    

 

 

   

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:

         

Net realized gain (loss) from investments

         

Non-control/Non-affiliate investments

     6,011        196         6,011        528   

Affiliate investments

     (4,140     —           (4,140     —     

Control investments

     —          —           364        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total realized gain from investments

     1,871        196         2,235        528   

Net unrealized appreciation on investments

     601        7,312         6,442        21,315   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net gain on investments

     2,472        7,508         8,677        21,843   
  

 

 

   

 

 

    

 

 

   

 

 

 

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

   $ 7,909      $ 10,778       $ 22,062      $ 30,874   
  

 

 

   

 

 

    

 

 

   

 

 

 

NET INCREASE IN NET ASSETS PER SHARE RESULTING FROM OPERATIONS – BASIC AND DILUTED

   $ 0.61        N/A       $ 1.70        N/A   

WEIGHTED AVERAGE COMMON STOCK OUTSTANDING - BASIC AND DILUTED

     12,974,420        N/A         12,974,420        N/A   

See accompanying notes to consolidated financial statements.

N/A – Not Applicable

 

4


Table of Contents

Capitala Finance Corp.

Consolidated Schedule of Investments

(in thousands, except for units)

September 30, 2013

(unaudited)

 

Company (4, 5)

  

Industry

  

Investment Interest Rate /
Maturity

   Principal
Amount
     Cost      Fair
Value
     % of
Net Assets
 

Non-control/Non-affiliated investments - 29.3%

              

AAE Acquisition, LLC

  

Industrial Equipment Rental

   Senior Secured Term Debt (12% Cash, Due 5/6/15)    $ 19,000       $ 18,992       $ 19,000         7.0

AAE Acquisition, LLC

  

Industrial Equipment Rental

   Membership Units (10,964 units)      —           25         3,500         1.3
           

 

 

    

 

 

    

 

 

 
              19,017         22,500         8.3
           

 

 

    

 

 

    

 

 

 

American Exteriors, LLC

  

Replacement Window Manufacturer

   Senior Secured Debt (14.0% Cash, Due 6/30/14)      4,565         3,365         4,565         1.7

American Exteriors, LLC (1)

  

Replacement Window Manufacturer

   Jr. Convertible Note (10.0% Cash, Due 6/30/15)      600         416         600         0.2

American Exteriors, LLC

  

Replacement Window Manufacturer

   Common Stock Warrants (15% fully diluted)      —           —           1,394         0.5
           

 

 

    

 

 

    

 

 

 
              3,781         6,559         2.4
           

 

 

    

 

 

    

 

 

 

Boot Barn Holding Corporation

  

Western Wear Retail

   Common Stock (2,400 shares)      —           2,400         5,071         1.9
           

 

 

    

 

 

    

 

 

 
              2,400         5,071         1.9
           

 

 

    

 

 

    

 

 

 

Caregiver Services, Inc.

  

In-Home Healthcare Services

   Common Stock (293,186 shares)      —           258         270         0.1

Caregiver Services, Inc.

  

In-Home Healthcare Services

   Common Stock Warrants (2.98% fully diluted)      —           264         604         0.2
           

 

 

    

 

 

    

 

 

 
              522         874         0.3
           

 

 

    

 

 

    

 

 

 

Immersive Media Tactical Solutions, LLC

  

Specialty Defense Contractor

   Senior Secured Term Debt (13% Cash, Due 10/6/16)      2,000         2,000         1,956         0.7

Immersive Media Tactical Solutions, LLC

  

Specialty Defense Contractor

   Common Unit Warrants (12% fully diluted)      —           —           766         0.3
           

 

 

    

 

 

    

 

 

 
              2,000         2,722         1.0
           

 

 

    

 

 

    

 

 

 

Medical Depot, Inc.

  

Medical Device Manufacturer

   Subordinated Debt (14% Cash, Due 10/11/16)      4,667         4,667         4,667         1.7

Medical Depot, Inc.

  

Medical Device Manufacturer

   Series C Convertible Preferred Stock (740 shares)      —           1,333         1,788         0.7
           

 

 

    

 

 

    

 

 

 
              6,000         6,455         2.4
           

 

 

    

 

 

    

 

 

 

Naples Lumber & Supply Co (1)

  

Building Supplies

   Subordinated Debt (6% cash, Due 2/15/14)      1,969         1,309         1,969         0.7

Naples Lumber & Supply Co

  

Building Supplies

   Common Stock Warrants (10% fully diluted)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              1,309         1,969         0.7
           

 

 

    

 

 

    

 

 

 

Precision Manufacturing, LLC

  

Industrial Boiler Manufacturer

   Senior Secured Term Debt (13% Cash, Due 2/10/17)      2,500         2,500         2,447         0.9

Precision Manufacturing, LLC

  

Industrial Boiler Manufacturer

   Membership Unit Warrants (6.65% fully diluted)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              2,500         2,447         0.9
           

 

 

    

 

 

    

 

 

 

Southern Pump & Tank Company, LLC (1)

  

Petroleum Equipment Supplier

   Senior Secured Term Debt (13% Cash, 6% PIK, Due 6/15/14)      3,974         3,213         3,481         1.3

Southern Pump & Tank Company, LLC

  

Petroleum Equipment Supplier

   Common Stock Warrants (10% fully diluted)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              3,213         3,481         1.3
           

 

 

    

 

 

    

 

 

 

Stoddard Hill Media Holdings, LLC

  

IT Hosting Services

   Class D Preferred Units (132,159 shares)      —           300         587         0.2
           

 

 

    

 

 

    

 

 

 
              300         587         0.2
           

 

 

    

 

 

    

 

 

 

 

5


Table of Contents

Company (4, 5)

  

Industry

  

Investment Interest Rate /
Maturity

   Principal
Amount
     Cost      Fair
Value
     % of
Net Assets
 

Tenere, Inc.

  

Industrial Manufacturing

   Senior Secured Term Debt (11% Cash, 2% PIK, Due 5/30/18)      3,396         3,396         3,396         1.3
           

 

 

    

 

 

    

 

 

 
              3,396         3,396         1.3
           

 

 

    

 

 

    

 

 

 

Worklife America, Inc.

  

Professional Employer Organization

   Senior Secured Debt (12% Cash, Due 12/28/16)      19,031         19,031         19,031         7.1

Worklife America, Inc.

  

Professional Employer Organization

   Common Unit Warrants (3.84% ownership)      —           —           3,351         1.3

Worklife America, Inc.

  

Professional Employer Organization

   Preferred Unit Warrants (3.84% ownership)      —           —           565         0.2
           

 

 

    

 

 

    

 

 

 
              19,031         22,947         8.6
           

 

 

    

 

 

    

 

 

 
                 
           

 

 

    

 

 

    

 

 

 

Sub Total Non-control/Non-affiliated investments

           63,469         79,008         29.3
           

 

 

    

 

 

    

 

 

 

Affiliate investments - 62.3%

              

Chef’N Corporation

  

Culinary Products

   Subordinated Debt (15% Cash, 3% optional PIK, Due 5/16/18)    $ 6,300       $ 6,300       $ 6,300         2.3

Chef’N Corporation

  

Culinary Products

   Series A Preferred Stock (1,000,000 shares)      —           1,000         3,893         1.5
           

 

 

    

 

 

    

 

 

 
              7,300         10,193         3.8
           

 

 

    

 

 

    

 

 

 

City Gear, LLC

  

Footwear Retail

   Subordinated Debt (13% Cash, Due 9/28/16)      8,231         8,231         8,231         3.0

City Gear, LLC (6)

  

Footwear Retail

   Preferred Membership Units (scheduled 9% dividend)      —           1,269         1,412         0.5

City Gear, LLC

  

Footwear Retail

   Membership Unit Warrants (14.152% fully diluted)      —           —           1,803         0.7
           

 

 

    

 

 

    

 

 

 
              9,500         11,446         4.2
           

 

 

    

 

 

    

 

 

 

Corporate Visions, Inc.

  

Sales & Marketing Services

   Subordinated Debt (14% Cash, 2% PIK, Due 3/22/18)      11,117         11,117         11,117         4.1

Corporate Visions, Inc.

  

Sales & Marketing Services

   Common Stock (2,206,463 shares)      —           2,576         8,140         3.0

Corporate Visions, Inc.

  

Sales & Marketing Services

   Common Stock Warrant (302,534 shares)      —           —           1,641         0.6
           

 

 

    

 

 

    

 

 

 
              13,693         20,898         7.7
           

 

 

    

 

 

    

 

 

 

GA Communications, Inc.

  

Advertising & Marketing Services

   Series A-1 Preferred Stock (1,998 shares)      —           1,998         2,324         0.9

GA Communications, Inc.

  

Advertising & Marketing Services

   Series B-1 Common Stock (200,000 shares)      —           2         2,746         1.0
           

 

 

    

 

 

    

 

 

 
              2,000         5,070         1.9
           

 

 

    

 

 

    

 

 

 

Impresa Aerospace Holdings, LLC (2, 3)

  

Aerospace Parts Manufacturer

   Subordinated Debt (9% Cash, 6% PIK, Due 4/28/16)      12,320         12,299         7,910         2.9

Impresa Aerospace Holdings, LLC

  

Aerospace Parts Manufacturer

   Class A Membership Units (1,006,621 shares)      —           900         —           0.0

Impresa Aerospace Holdings, LLC

  

Aerospace Parts Manufacturer

   Class C Membership Units (362,416 shares)      —           362         —           0.0

Impresa Aerospace Holdings, LLC

  

Aerospace Parts Manufacturer

   Class F Membership Units (257,235 shares)      —           262         —           0.0
           

 

 

    

 

 

    

 

 

 
              13,823         7,910         2.9
           

 

 

    

 

 

    

 

 

 

J&J Produce Holdings, Inc.

  

Produce Distribution

   Subordinated Debt (13% Cash, Due 7/16/18)      5,182         5,182         5,182         1.9

J&J Produce Holdings, Inc.

  

Produce Distribution

   Common Stock (8,182 shares)      —           818         1,096         0.5

J&J Produce Holdings, Inc.

  

Produce Distribution

   Common Stock Warrants (4,318 shares)      —           —           604         0.2
           

 

 

    

 

 

    

 

 

 
              6,000         6,882         2.6
           

 

 

    

 

 

    

 

 

 

LJS Partners, LLC

  

QSR Franchisor

   Common Stock (1,500,000 shares)      —           1,500         14,904         5.5
           

 

 

    

 

 

    

 

 

 
              1,500         14,904         5.5
           

 

 

    

 

 

    

 

 

 

MJC Holdings, LLC

  

Specialty Clothing

   Subordinated Debt (12% Cash, 2% PIK, Due 1/16/18)      7,500         7,500         7,500         2.8

 

6


Table of Contents

Company (4, 5)

  

Industry

  

Investment Interest Rate /
Maturity

   Principal
Amount
     Cost      Fair
Value
     % of
Net Assets
 

MJC Holdings, LLC

  

Specialty Clothing

   Series A Preferred Units (2,000,000 shares)      —           2,000         3,673         1.3
           

 

 

    

 

 

    

 

 

 
              9,500         11,173         4.1
           

 

 

    

 

 

    

 

 

 

MMI Holdings, LLC

  

Medical Device Distributor

   Subordinated Debt (6% Cash, Due 8/15/15)      400         388         400         0.1

MMI Holdings, LLC

  

Medical Device Distributor

   Senior Secured Debt (12% Cash, Due 10/17/14)      2,600         2,600         2,600         1.0

MMI Holdings, LLC

  

Medical Device Distributor

   Preferred Units (1,000 shares)      —           1,052         1,200         0.5

MMI Holdings, LLC

  

Medical Device Distributor

   Common Units (120 shares)      —           —           128         0.0
           

 

 

    

 

 

    

 

 

 
              4,040         4,328         1.6
           

 

 

    

 

 

    

 

 

 

MTI Holdings, LLC

  

Retail Display & Security Services

   Subordinated Debt (12% Cash, Due 11/1/18)      8,000         8,000         8,000         3.0

MTI Holdings, LLC

  

Retail Display & Security Services

   Capital Units (2,000,000 units)      —           2,000         2,000         0.7
           

 

 

    

 

 

    

 

 

 
              10,000         10,000         3.7
           

 

 

    

 

 

    

 

 

 

Pickaway Plains Ambulance Services, Inc. (1, 2)

  

Medical Transportation Services

   Senior Secured Term Debt (13.0% Cash, Due 12/31/15)      1,548         —           —           0.0

Pickaway Plains Ambulance Services, Inc.

  

Medical Transportation Services

   Common Stock Warrants (5% fully diluted)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              —           —           0.0
           

 

 

    

 

 

    

 

 

 

Source Capital ABUTEC, LLC

  

Oil & Gas Services

   Senior Secured Debt (10% Cash, Due 12/28/17)      1,000         1,000         998         0.4

Source Capital ABUTEC, LLC

  

Oil & Gas Services

   Subordinated Debt (12% Cash, 3% PIK, Due 12/28/17)      4,093         4,093         4,021         1.4

Source Capital ABUTEC, LLC

  

Oil & Gas Services

   Preferred Membership Units (15.5% ownership)      —           1,239         500         0.2
           

 

 

    

 

 

    

 

 

 
              6,332         5,519         2.0
           

 

 

    

 

 

    

 

 

 

Source Capital Penray, LLC

  

Automotive Chemicals & Lubricants

   Subordinated Debt (13% Cash, Due 2/17/17)      2,500         2,500         2,447         0.9

Source Capital Penray, LLC

  

Automotive Chemicals & Lubricants

   Membership Units (136.12 units)      —           750         446         0.2

Source Capital Penray, LLC

  

Automotive Chemicals & Lubricants

   Common Stock Warrants (6.65% fully diluted)      —           —           247         0.1
           

 

 

    

 

 

    

 

 

 
              3,250         3,140         1.2
           

 

 

    

 

 

    

 

 

 

Source Capital SSCR, LLC

  

Suntan Lotion Manufacturer

   Senior Secured Term Debt (12% Cash, Due 7/6/17)      15,000         15,000         15,000         5.6

Source Capital SSCR, LLC

  

Suntan Lotion Manufacturer

   Preferred Membership Units (14.44% interest)      —           1,770         37         0.0

Source Capital SSCR, LLC

  

Suntan Lotion Manufacturer

   Membership Unit Warrants (1.37% interest)      —           —           2         0.0
           

 

 

    

 

 

    

 

 

 
              16,770         15,039         5.6
           

 

 

    

 

 

    

 

 

 

Source Recycling, LLC (2)

  

Metal Recycler

   Subordinated Debt (13% Cash, Due 9/2/16)      5,000         5,000         3,031         1.1

Source Recycling, LLC

  

Metal Recycler

   Membership Units (68,658 shares)      —           1,540         —           0.0

Source Recycling, LLC

  

Metal Recycler

   Membership Unit Warrants (.97% fully diluted)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              6,540         3,031         1.1
           

 

 

    

 

 

    

 

 

 

Sparus Holdings

  

Energy Services

   Subordinated Debt (12% Cash, Due 3/18/14)      7,150         7,150         7,150         2.7

Sparus Holdings

  

Energy Services

   Series B Preferred Stock (5,704 shares)      —           1,173         1,415         0.5

Sparus Holdings

  

Energy Services

   Common Stock Warrants (3,491 shares)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              8,323         8,565         3.2
           

 

 

    

 

 

    

 

 

 

STX Healthcare Management Services, Inc. (1)

  

Dentistry Services

   Subordinated Debt (14% Cash, Due 7/31/15)      7,425         7,425         7,425         2.8

 

7


Table of Contents

Company (4, 5)

  

Industry

  

Investment Interest Rate /
Maturity

   Principal
Amount
     Cost      Fair
Value
     % of
Net Assets
 

STX Healthcare Management Services, Inc.

  

Dentistry Services

   Common Stock (1,200,000 shares)      —           1,200         926         0.3

STX Healthcare Management Services, Inc.

  

Dentistry Services

   Common Stock Warrants (1,154,254 shares)      —           218         983         0.4
           

 

 

    

 

 

    

 

 

 
              8,843         9,334         3.5
           

 

 

    

 

 

    

 

 

 

Take 5 Oil Change, LLC

  

Quick Lube Services

   Common Stock (10,692 shares)      —           1,069         1,523         0.6
           

 

 

    

 

 

    

 

 

 
              1,069         1,523         0.6
           

 

 

    

 

 

    

 

 

 

TCSafety, Inc.

  

Oil & Gas Services

   Subordinated Debt (12% Cash, 2% PIK, Due 11/22/18)      12,027         12,027         12,027         4.5

TCSafety, Inc.

  

Oil & Gas Services

   Class A Common Stock (2,100 shares)      —           2,100         2,100         0.8
           

 

 

    

 

 

    

 

 

 
              14,127         14,127         5.2
           

 

 

    

 

 

    

 

 

 

V12 Holdings

  

Data Processing & Digital Marketing

   Bridge Note (0% Cash, Due 12/31/14)      663         361         663         0.2

V12 Holdings

  

Data Processing & Digital Marketing

   Tier 2 Note (0% Cash, Due 12/31/14)      81         44         81         0.0

V12 Holdings

  

Data Processing & Digital Marketing

   Senior Subordinated Note (0% Cash, Due 12/31/14)      3,598         2,369         3,598         1.3

V12 Holdings

  

Data Processing & Digital Marketing

   Tier 3 Note (0% Cash, Due 12/31/14)      314         207         314         0.1

V12 Holdings

  

Data Processing & Digital Marketing

   Jr. Subordinated Note (0% Cash, Due 12/31/14)      2,750         —           405         0.2

V12 Holdings

  

Data Processing & Digital Marketing

   Tier 4 Note (0% Cash, Due 12/31/14)      243         —           —           0.0

V12 Holdings

  

Data Processing & Digital Marketing

   Series A-1 Preferred Stock (11,025 shares)      —           —           —           0.0

V12 Holdings

  

Data Processing & Digital Marketing

   Series A-3 Preferred Stock (204,082 shares)      —           —           —           0.0

V12 Holdings

  

Data Processing & Digital Marketing

   Series A-5 Preferred Stock (8,409 shares)      —           —           —           0.0

V12 Holdings

  

Data Processing & Digital Marketing

   Common Stock Warrants (880,541 shares)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              2,981         5,061         1.9
           

 

 

    

 

 

    

 

 

 
                 
           

 

 

    

 

 

    

 

 

 

Sub Total Affiliate investments

         $ 145,591       $ 168,143         62.3
           

 

 

    

 

 

    

 

 

 

Control investments - 31.1%

              

Best In Class

  

Corporate Fulfillment

   Subordinated Debt (12.5% Cash, Due 12/31/13)    $ 1,455       $ 1,413       $ 1,455         0.5

Best In Class

  

Corporate Fulfillment

   Class A Preferred Units (178 shares)      —           626         647         0.3

Best In Class

  

Corporate Fulfillment

   Class B Preferred Units (91 shares)      —           50         91         0.0
           

 

 

    

 

 

    

 

 

 
              2,089         2,193         0.8
           

 

 

    

 

 

    

 

 

 

CableOrganizer Acquisition, LLC

  

Computer Supply Retail

   Senior Secured Term Debt (12% Cash, 4% PIK, Due 5/24/18)      6,518         6,518         6,518         2.4

CableOrganizer Acquisition, LLC

  

Computer Supply Retail

   Common Stock (193,333 shares)      —           1,125         1,031         0.4
           

 

 

    

 

 

    

 

 

 
              7,643         7,549         2.8
           

 

 

    

 

 

    

 

 

 

KBP Investments, LLC (6)

  

QSR Franchisee

   Class A Preferred Stock (scheduled 10% dividend)      —           8,269         8,269         3.1

KBP Investments, LLC

  

QSR Franchisee

   Class A Common Stock (380,413 shares)      —           —           20,701         7.7
           

 

 

    

 

 

    

 

 

 
              8,269         28,970         10.8
           

 

 

    

 

 

    

 

 

 

Market E, Inc.

  

Online Travel Sales & Marketing

   Senior Secured Debt (10% Cash, 9% PIK, Due 12/31/13)      3,014         2,897         2,504         0.9

Market E, Inc.

  

Online Travel Sales & Marketing

   Class A Preferred Stock (540 shares)      —           240         —           0.0

 

8


Table of Contents

Company (4, 5)

  

Industry

  

Investment Interest Rate /
Maturity

   Principal
Amount
     Cost      Fair
Value
     % of
Net Assets
 

Market E, Inc.

  

Online Travel Sales & Marketing

   Class B Preferred Stock (2,170 shares)      —           965         —           0.0

Market E, Inc.

  

Online Travel Sales & Marketing

   Class A Common Stock (540 shares)      —           —           —           0.0
           

 

 

    

 

 

    

 

 

 
              4,102         2,504         0.9
           

 

 

    

 

 

    

 

 

 

Micro Precision, LLC

  

Conglomerate

   Subordinated Debt (10% Cash, Due 9/16/16)      1,862         1,862         1,862         0.7

Micro Precision, LLC

  

Conglomerate

   Subordinated Debt (14% Cash, 4% PIK, Due 9/16/16)      3,525         3,525         3,525         1.3

Micro Precision, LLC

  

Conglomerate

   Common Stock (47 shares)      —           1,629         2,164         0.8
           

 

 

    

 

 

    

 

 

 
              7,016         7,551         2.8
           

 

 

    

 

 

    

 

 

 

Navis Holdings, Inc.

  

Textile Equipment Manufacturer

   Senior Secured Term (14% Cash, 3% PIK, Due 2/1/16)      6,735         6,735         6,735         2.5

Navis Holdings, Inc.

  

Textile Equipment Manufacturer

   Class A Preferred Stock (1,000 shares)      —           1,000         1,154         0.4

Navis Holdings, Inc.

  

Textile Equipment Manufacturer

   Common Stock (300,000 shares)      —           1         1,412         0.5
           

 

 

    

 

 

    

 

 

 
              7,736         9,301         3.4
           

 

 

    

 

 

    

 

 

 

On-Site Fuel Services, Inc.

  

Fuel Transportation Services

   Subordinated Debt (14% Cash, 4% PIK, Due 12/19/16)      4,799         4,799         4,799         1.8

On-Site Fuel Services, Inc.

  

Fuel Transportation Services

   Series A Preferred Stock (32,797 shares)      —           3,278         3,022         1.1

On-Site Fuel Services, Inc. (6)

  

Fuel Transportation Services

   Series B Preferred Stock (14% scheduled cash dividend, 4% PIK dividend)      —           2,365         2,365         0.9

On-Site Fuel Services, Inc.

  

Fuel Transportation Services

   Common Stock (33,107 shares)      —           33         —           0.0
           

 

 

    

 

 

    

 

 

 
              10,475         10,186         3.8
           

 

 

    

 

 

    

 

 

 

Print Direction, Inc. (1)

  

Printing Services

   Subordinated Debt (12% Cash, 6% PIK, Due 7/25/2018)      4,356         4,322         4,356         1.6

Print Direction, Inc. (1)

  

Printing Services

   Subordinated Debt (14% Cash, Due 7/31/18)      4,600         4,600         4,600         1.7

Print Direction, Inc.

  

Printing Services

   Common Stock (19,363 shares)      —           2,990         6,336         2.4

Print Direction, Inc.

  

Printing Services

   Common Stock Warrants (3% fully diluted)      —           —           280         0.1
           

 

 

    

 

 

    

 

 

 
              11,912         15,572         5.8
           

 

 

    

 

 

    

 

 

 
                 
           

 

 

    

 

 

    

 

 

 

Sub Total Control investments

         $ 59,242       $ 83,826         31.1
           

 

 

    

 

 

    

 

 

 

TOTAL INVESTMENTS - 122.7%

         $ 268,302       $ 330,977         122.7
           

 

 

    

 

 

    

 

 

 

 

(1) The maturity date of the original investment has been extended
(2) Due to deterioration in credit quality, this investment is on non-accrual status
(3) Due to deterioration in credit quality, the subordinated debt interest rate has been amended from its original 14% cash and 3% PIK
(4) All debt investments are income producing. Equity and warrant investments are non-income producing, unless otherwise noted.
(5) Percentages are based on net assets of $269,722 as of September 30, 2013.
(6) The equity investment is income producing.

See accompanying notes to consolidated financial statements.

 

9


Table of Contents

Capitala Finance Corp.

Consolidated Schedule of Investments

(in thousands, except for units)

December 31, 2012

 

Company (3, 4)

  

Industry

  

Investment Interest Rate / Maturity

   Principal
Amount
    Cost     Fair
Value
    % of
Net
Assets
 

Non-control/Non-affiliated investments - 55.3%

           

AAE Acquisition, LLC

   Industrial Equipment Rental    Senior Secured Term Debt (13% Cash, Due 5/6/15)    $ 14,500      $ 14,488      $ 14,500        10.2

AAE Acquisition, LLC

   Industrial Equipment Rental    Membership Units (10,964 units)      —          25        3,501        2.4
          

 

 

   

 

 

   

 

 

 
             14,513        18,001        12.6
          

 

 

   

 

 

   

 

 

 

American Exteriors, LLC (1, 2)

   Replacement Window Manufacturer    Senior Secured Debt (14.0% Cash, Due 6/30/14)      4,565        3,365        5,137        3.6

American Exteriors, LLC

   Replacement Window Manufacturer    Jr. Convertible Note (10.0% Cash, Due 6/30/15)      125        —          125        0.1

American Exteriors, LLC

   Replacement Window Manufacturer    Common Stock Warrants (15% fully diluted)      —          —          323        0.2
          

 

 

   

 

 

   

 

 

 
             3,365        5,585        3.9
          

 

 

   

 

 

   

 

 

 

Boot Barn Holding Corporation

   Western Wear Retail    Subordinated Debt (12.5% Cash, Due 12/12/16)      15,000        15,000        15,000        10.5

Boot Barn Holding Corporation

   Western Wear Retail    Common Stock (2,400 shares)      —          2,400        4,928        3.5
          

 

 

   

 

 

   

 

 

 
             17,400        19,928        14.0
          

 

 

   

 

 

   

 

 

 

Caregiver Services, Inc.

   In-Home Healthcare Services    Common Stock (146,593 shares)      —          140        116        0.1

Caregiver Services, Inc.

   In-Home Healthcare Services    Common Stock Warrants (1.49% fully diluted)      —          —          259        0.2
          

 

 

   

 

 

   

 

 

 
             140        375        0.3
          

 

 

   

 

 

   

 

 

 
              

Highwinds Capital, Inc.

   Usenet Hosting Services    Common Stock (33,176 shares)      —          —          4,739        3.3

Highwinds Capital, Inc.

   Usenet Hosting Services    Common Stock Warrants (1,087 shares)      —          —          1,475        1.0
          

 

 

   

 

 

   

 

 

 
             —          6,214        4.3
          

 

 

   

 

 

   

 

 

 

Immersive Media Tactical Solutions, LLC

   Specialty Defense Contractor    Senior Secured Term Debt (13% Cash, Due 10/6/16)      1,300        1,300        467        0.3

Immersive Media Tactical Solutions, LLC

   Specialty Defense Contractor    Common Unit Warrants (12% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             1,300        467        0.3
          

 

 

   

 

 

   

 

 

 

Medical Depot, Inc.

   Medical Device Manufacturer    Subordinated Debt (14% Cash, Due 10/11/16)      4,667        4,667        4,667        3.3

Medical Depot, Inc.

   Medical Device Manufacturer    Series C Convertible Preferred Stock (740 shares)      —          1,333        1,619        1.1
          

 

 

   

 

 

   

 

 

 
             6,000        6,286        4.4
          

 

 

   

 

 

   

 

 

 

Naples Lumber & Supply Co

   Building Supplies    Subordinated Debt (6% Cash, Due 2/15/14)      984        394        972        0.7

Naples Lumber & Supply Co

   Building Supplies    Common Stock Warrants (5% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             394        972        0.7
          

 

 

   

 

 

   

 

 

 

Precision Manufacturing, LLC

   Industrial Boiler Manufacturer    Senior Secured Term Debt (13% Cash, Due 2/10/17)      2,500        2,500        2,447        1.7

Precision Manufacturing, LLC

   Industrial Boiler Manufacturer    Membership Unit Warrants (6.65% fully diluted)      —          —          213        0.2
          

 

 

   

 

 

   

 

 

 
             2,500        2,660        1.9
          

 

 

   

 

 

   

 

 

 

Southern Pump & Tank Company, LLC (1, 2)

   Petroleum Equipment Supplier    Senior Secured Term Debt (13% Cash, 6% PIK, Due 6/15/14)      1,679        1,679        1,679        1.2

Southern Pump & Tank Company, LLC (1, 2)

   Petroleum Equipment Supplier    Senior Secured Term Debt (4% Cash, 6% PIK, Due 6/15/14)      877        644        877        0.6

Southern Pump & Tank Company, LLC (1, 2)

   Petroleum Equipment Supplier    Senior Secured Term Debt (13% Cash, 6% PIK, Due 6/15/14)      124        124        124        0.1

Southern Pump & Tank Company, LLC

   Petroleum Equipment Supplier    Common Stock Warrants (8% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             2,447        2,680        1.9
          

 

 

   

 

 

   

 

 

 

Stoddard Hill Media Holdings, LLC

   IT Hosting Services    Class D Preferred Units (132,159 shares)      —          300        372        0.3
          

 

 

   

 

 

   

 

 

 
             300        372        0.3
          

 

 

   

 

 

   

 

 

 

Worklife America, Inc.

   Professional Employer Organization    Senior Secured Debt (12% Cash, Due 12/28/16)      13,250        13,250        13,250        9.3

Worklife America, Inc.

   Professional Employer Organization    Common Unit Warrants (3% fully diluted)      —          —          1,909        1.4

 

10


Table of Contents

Company (3, 4)

  

Industry

  

Investment Interest Rate / Maturity

   Principal
Amount
    Cost     Fair
Value
    % of
Net
Assets
 

Worklife America, Inc.

   Professional Employer Organization    Preferred Unit Warrants (3% fully diluted)      —          —          70        0.0
          

 

 

   

 

 

   

 

 

 
             13,250        15,229        10.7
          

 

 

   

 

 

   

 

 

 

Sub Total Non-control/Non-affiliated investments

        $ 61,609      $ 78,769        55.3
          

 

 

   

 

 

   

 

 

 

Affiliate investments - 96.1%

              

Chef'N Corporation

   Culinary Products    Subordinated Debt (15% Cash, 3% optional PIK, Due 5/16/18)    $ 6,300      $ 6,300      $ 6,300        4.4

Chef'N Corporation

   Culinary Products    Series A Preferred Stock (1,000,000 shares)      —          1,000        2,469        1.7
          

 

 

   

 

 

   

 

 

 
             7,300        8,769        6.1
          

 

 

   

 

 

   

 

 

 

City Gear, LLC

   Footwear Retail    Subordinated Debt (13% Cash, Due 9/28/16)      4,231        4,231        4,231        3.0

City Gear, LLC (5)

   Footwear Retail    Preferred Membership Units (scheduled 9% dividend)      —          1,269        1,825        1.3

City Gear, LLC

   Footwear Retail    Membership Unit Warrants (9.817% fully diluted)      —          —          1,074        0.7
          

 

 

   

 

 

   

 

 

 
             5,500        7,131        5.0
          

 

 

   

 

 

   

 

 

 

Corporate Visions, Inc.

   Sales & Marketing Services    Common Stock (2,000,000 shares)      —          2,000        5,928        4.2

Corporate Visions, Inc.

   Sales & Marketing Services    Common Stock Warrants (302,534 shares)      —          —          1,079        0.7
          

 

 

   

 

 

   

 

 

 
             2,000        7,008        4.9
          

 

 

   

 

 

   

 

 

 

Fresh Food Concepts, Inc.

   Salsa Manufacturer    Subordinated Debt (13% Cash, 4% PIK, Due 11/30/15)      3,240        3,240        —          0.0

Fresh Food Concepts, Inc.

   Salsa Manufacturer    Class A Common Units (1,500 units)      —          1,500        —          0.0

Fresh Food Concepts, Inc.

   Salsa Manufacturer    Class C Common Unit Warrants (165 units)      —          43        —          0.0
          

 

 

   

 

 

   

 

 

 
             4,783        —          0.0
          

 

 

   

 

 

   

 

 

 

GA Communications, Inc.

   Advertising & Marketing Services    Subordinated Debt (12.5% Cash, Due 4/14/17)      13,000        13,000        13,000        9.2

GA Communications, Inc.

   Advertising & Marketing Services    Series A-1 Preferred Stock (1,998 shares)      —          1,998        2,194        1.5

GA Communications, Inc.

   Advertising & Marketing Services    Series B-1 Common Stock (200,000 shares)      —          2        3,260        2.3
          

 

 

   

 

 

   

 

 

 
             15,000        18,454        13.0
          

 

 

   

 

 

   

 

 

 

Impresa Aerospace Holdings, LLC (3)

   Aerospace Parts Manufacturer    Subordinated Debt (12% Cash, 3% PIK, Due 4/28/16)      8,699        8,699        5,219        3.7

Impresa Aerospace Holdings, LLC

   Aerospace Parts Manufacturer    Class A Membership Units (900,000 units)      —          900        —          0.0

Impresa Aerospace Holdings, LLC

   Aerospace Parts Manufacturer    Class C Membership Units (317,114 shares)      —          317        —          0.0
          

 

 

   

 

 

   

 

 

 
             9,916        5,219        3.7
          

 

 

   

 

 

   

 

 

 

J&J Produce Holdings, Inc.

   Produce Distribution    Subordinated Debt (13% Cash, Due 7/16/18)      5,182        5,182        5,182        3.6

J&J Produce Holdings, Inc.

   Produce Distribution    Common Stock (8,182 shares)      —          818        1,005        0.7

J&J Produce Holdings, Inc.

   Produce Distribution    Common Stock Warrants (4,318 shares)      —          —          535        0.4
          

 

 

   

 

 

   

 

 

 
             6,000        6,722        4.7
          

 

 

   

 

 

   

 

 

 

LJS Partners, LLC

   QSR Franchisor    Common Stock (1,500,000 units)      —          1,500        15,112        10.6
          

 

 

   

 

 

   

 

 

 
             1,500        15,112        10.6
          

 

 

   

 

 

   

 

 

 

MJC Holdings, LLC

   Specialty Clothing    Subordinated Debt (12% Cash, 2% PIK, Due 1/16/18)      7,571        7,571        7,571        5.4

MJC Holdings, LLC

   Specialty Clothing    Series A Preferred Units (2,000,000 units)      —          2,000        2,762        1.9
          

 

 

   

 

 

   

 

 

 
             9,571        10,333        7.3
          

 

 

   

 

 

   

 

 

 

MMI Holdings, LLC

   Medical Device Distributor    Subordinated Debt (6% Cash, Due 8/15/15)      200        200        200        0.1

MMI Holdings, LLC

   Medical Device Distributor    Senior Secured Debt (12% Cash, Due 10/17/14)      2,600        2,600        2,600        1.9

MMI Holdings, LLC

   Medical Device Distributor    Preferred Units (500 units)      —          500        575        0.4

MMI Holdings, LLC

   Medical Device Distributor    Common Units (45 shares)      —          —          187        0.1
          

 

 

   

 

 

   

 

 

 
             3,300        3,562        2.5
          

 

 

   

 

 

   

 

 

 

Pickaway Plains Ambulance Services, Inc. (1, 2)

   Medical Transportation Services    Senior Secured Term Debt (13.0% Cash, Due 12/31/15)      1,248        —          —          0.0

Pickaway Plains Ambulance Services, Inc.

   Medical Transportation Services    Common Stock Warrants (4% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             —          —          0.0
          

 

 

   

 

 

   

 

 

 

Source Capital ABUTEC, LLC

   Oil & Gas Services    Senior Secured Debt (10% Cash, Due 12/28/17)      1,000        1,000        1,000        0.7

 

11


Table of Contents

Company (3, 4)

  

Industry

  

Investment Interest Rate / Maturity

   Principal
Amount
    Cost     Fair
Value
    % of
Net
Assets
 

Source Capital ABUTEC, LLC

   Oil & Gas Services    Subordinated Debt (12% Cash, 3% PIK, Due 12/28/17)      4,000        4,000        4,000        2.8

Source Capital ABUTEC, LLC

   Oil & Gas Services    Preferred Membership Units (15.5% ownership)      —          1,240        1,240        0.9
          

 

 

   

 

 

   

 

 

 
             6,240        6,240        4.4
          

 

 

   

 

 

   

 

 

 

Source Capital Penray, LLC

   Automotive Chemicals & Lubricants    Subordinated Debt (13% Cash, Due 2/17/17)      2,500        2,500        2,447        1.7

Source Capital Penray, LLC

   Automotive Chemicals & Lubricants    Membership Units (136.12 units)      —          750        539        0.4

Source Capital Penray, LLC

   Automotive Chemicals & Lubricants    Common Stock Warrants (6.65% fully diluted)      —          —          297        0.2
          

 

 

   

 

 

   

 

 

 
             3,250        3,283        2.3
          

 

 

   

 

 

   

 

 

 

Source Capital SSCR, LLC

   Suntan Lotion Manufacturer    Senior Secured Term Debt (12% Cash, Due 7/6/17)      12,000        12,000        11,777        8.3

Source Capital SSCR, LLC

   Suntan Lotion Manufacturer    Preferred Membership Units (14.91% fully diluted)      —          1,425        1,116        0.8

Source Capital SSCR, LLC

   Suntan Lotion Manufacturer    Membership Unit Warrants (1.0% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             13,425        12,893        9.1
          

 

 

   

 

 

   

 

 

 

Source Recycling, LLC

   Metal Recycler    Subordinated Debt (13% Cash, Due 9/2/16)      4,900        4,900        2,931        2.1

Source Recycling, LLC

   Metal Recycler    Membership Units (68,658 shares)      —          1,391        —          0.0

Source Recycling, LLC

   Metal Recycler    Common Unit Warrants (1.0% fully diluted)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             6,291        2,931        2.1
          

 

 

   

 

 

   

 

 

 

Sparus Holdings

   Energy Services    Subordinated Debt (12% Cash, Due 3/18/14)      7,000        7,000        7,000        4.9

Sparus Holdings

   Energy Services    Series B Preferred Stock (5,704 shares)      —          500        287        0.2

Sparus Holdings

   Energy Services    Common Stock Warrants (3,491 shares)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             7,500        7,287        5.1
          

 

 

   

 

 

   

 

 

 

STX Healthcare Management Services, Inc.

   Dentistry Services    Subordinated Debt (14% Cash, Due 7/31/15)      6,625        6,593        6,625        4.6

STX Healthcare Management Services, Inc.

   Dentistry Services    Common Stock (1,200,000 shares)      —          1,200        680        0.5

STX Healthcare Management Services, Inc.

   Dentistry Services    Common Stock Warrants (845,784 shares)      —          218        680        0.5
          

 

 

   

 

 

   

 

 

 
             8,011        7,984        5.6
          

 

 

   

 

 

   

 

 

 

Take 5 Oil Change, LLC

   Quick Lube Services    Senior Secured Debt (10% Cash, Due 11/28/16)      12,000        12,000        12,000        8.4

Take 5 Oil Change, LLC

   Quick Lube Services    Common Stock (10,692 shares)      —          1,069        1,248        0.9
          

 

 

   

 

 

   

 

 

 
             13,069        13,248        9.3
          

 

 

   

 

 

   

 

 

 

V12 Holdings

   Data Processing & Digital Marketing    Bridge Note (0% Cash, Due 12/31/14)      280        —          280        0.2

V12 Holdings

   Data Processing & Digital Marketing    Tier 2 Note (0% Cash, Due 12/31/14)      34        —          34        0.0

V12 Holdings

   Data Processing & Digital Marketing    Senior Subordinated Note (0% Cash, Due 12/31/14)      2,200        —          —          0.0

V12 Holdings

   Data Processing & Digital Marketing    Tier 3 Note (0% Cash, Due 12/31/14)      380        —          297        0.2

V12 Holdings

   Data Processing & Digital Marketing    Jr. Subordinated Note (0% Cash, Due 12/31/14)      33        —          26        0.0

V12 Holdings

   Data Processing & Digital Marketing    Tier 4 Note (0% Cash, Due 12/31/14)      194        —          —          0.0

V12 Holdings

   Data Processing & Digital Marketing    Series A-1 Preferred Stock (11,025 shares)      —          —          —          0.0

V12 Holdings

   Data Processing & Digital Marketing    Series A-3 Preferred Stock (204,082 shares)      —          —          —          0.0

V12 Holdings

   Data Processing & Digital Marketing    Series A-5 Preferred Stock (8,409 shares)      —          —          —          0.0

V12 Holdings

   Data Processing & Digital Marketing    Common Stock Warrants (880,541 shares)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             —          637        0.4
          

 

 

   

 

 

   

 

 

 

Sub Total Affiliate investments

        $ 122,655      $ 136,809        96.1
          

 

 

   

 

 

   

 

 

 

Control investments - 47.9%

              

Best In Class

   Corporate Fulfillment    Subordinated Debt (12.5% Cash, Due 12/31/13)    $ 728      $ 728      $ 728        0.5

Best In Class

   Corporate Fulfillment    Class A Preferred Units (89 units)      —          272        381        0.3

Best In Class

   Corporate Fulfillment    Class B Preferred Units (45 units)      —          —          56        0.0
          

 

 

   

 

 

   

 

 

 
             1,000        1,165        0.8
          

 

 

   

 

 

   

 

 

 

 

12


Table of Contents

Company (3, 4)

  

Industry

  

Investment Interest Rate / Maturity

   Principal
Amount
    Cost     Fair
Value
    % of
Net
Assets
 

KBP Investments, LLC (5)

   QSR Franchisee    Class A Preferred Stock (10% scheduled dividend)      —          7,938        7,938        5.6

KBP Investments, LLC

   QSR Franchisee    Class A Common Stock (380,413 shares)      —          331        22,011        15.4
          

 

 

   

 

 

   

 

 

 
             8,269        29,949        21.0
          

 

 

   

 

 

   

 

 

 

Market E, Inc.

   Online Travel Sales & Marketing    Senior Secured Debt (10% Cash, 9% PIK, Due 12/31/13)      921        1,178        1,178        0.8

Market E, Inc.

   Online Travel Sales & Marketing    Class A Preferred Stock (240 shares)      —          240        —          0.0

Market E, Inc.

   Online Travel Sales & Marketing    Class B Preferred Stock (964 shares)      —          965        243        0.2

Market E, Inc.

   Online Travel Sales & Marketing    Class A Common Stock (240 shares)      —          —          —          0.0
          

 

 

   

 

 

   

 

 

 
             2,383        1,421        1.0
          

 

 

   

 

 

   

 

 

 

Micro Precision, LLC

   Conglomerate    Subordinated Debt (10% Cash, Due 9/16/16)      1,862        1,862        1,862        1.3

Micro Precision, LLC

   Conglomerate    Subordinated Debt (14% Cash, 4% PIK, Due 9/16/16)      3,427        3,427        3,427        2.4

Micro Precision, LLC

   Conglomerate    Series A Preferred Units (47 shares)      —          1,629        3,276        2.3
          

 

 

   

 

 

   

 

 

 
             6,918        8,565        6.0
          

 

 

   

 

 

   

 

 

 

Navis Holdings, Inc.

   Textile Equipment Manufacturer    Senior Secured Term (14% Cash, 3% PIK, Due 2/1/16)      6,602        6,600        6,602        4.6

Navis Holdings, Inc.

   Textile Equipment Manufacturer    Class A Preferred Stock (1,000 shares)      —          1,000        1,101        0.8

Navis Holdings, Inc.

   Textile Equipment Manufacturer    Common Stock (300,000 shares)      —          1        731        0.5
          

 

 

   

 

 

   

 

 

 
             7,601        8,434        5.9
          

 

 

   

 

 

   

 

 

 

On-Site Fuel Services, Inc.

   Fuel Transportation Services    Subordinated Debt (14% Cash, 4% PIK, Due 12/19/16)      4,656        4,656        4,656        3.3

On-Site Fuel Services, Inc.

   Fuel Transportation Services    Series A Preferred Stock (32,797 shares)      —          3,302        2,309        1.6

On-Site Fuel Services, Inc. (5)

   Fuel Transportation Services    Series B Preferred Stock (14% scheduled cash dividend, 4% PIK dividend)      —          2,341        587        0.4

On-Site Fuel Services, Inc.

   Fuel Transportation Services    Common Stock (33,107 shares)      —          33        1,492        1.1
          

 

 

   

 

 

   

 

 

 
             10,332        9,044        6.4
          

 

 

   

 

 

   

 

 

 

Print Direction, Inc.

   Printing Services    Subordinated Debt (12% Cash, 6% PIK, Due 9/27/13)      2,549        2,549        2,550        1.8

Print Direction, Inc.

   Printing Services    Subordinated Debt (7.75% Cash, Due 9/27/13)      454        454        454        0.3

Print Direction, Inc.

   Printing Services    Subordinated Debt (12% Cash, 6% PIK, Due 9/27/13)      763        763        763        0.5

Print Direction, Inc.

   Printing Services    Common Stock (14,603 shares)      —          1,575        4,418        3.1
          

 

 

   

 

 

   

 

 

 
             5,341        8,185        5.7
          

 

 

   

 

 

   

 

 

 

Vita Nonwovens

   Textile Manufacturer    Subordinated Debt (14% Cash, 4% PIK, Due 8/31/17)      1,115        1,115        1,115        0.8

Vita Nonwovens

   Textile Manufacturer    Class A Preferred United (475,000 units)      —          475        475        0.3
          

 

 

   

 

 

   

 

 

 
             1,590        1,590        1.1
          

 

 

   

 

 

   

 

 

 

Sub Total Control investments

        $ 43,434      $ 68,353        47.9
          

 

 

   

 

 

   

 

 

 

TOTAL INVESTMENTS - 199.3%

           $ 227,698      $ 283,931        199.3
          

 

 

   

 

 

   

 

 

 

 

(1) The maturity date of the original investment has been extended
(2) Due to deterioration in credit quality, this investment is on non-accrual status
(3) All debt investments are income producing. Equity and warrant investments are non-income producing, unless otherwise noted.
(4) Percentages are based on net assets of $142,433 as of December 31, 2012.
(5) The equity investment is income producing.

See accompanying notes to consolidated financial statements.

 

13


Table of Contents

Capitala Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands)

(unaudited)

 

                 Common Stock      Additional      Accumulated     Net Unrealized         
     General     Limited     Number of      Par      Paid in      Net Realized     Appreciation on         
     Partner     Partners     Shares      Value      Capital      Earnings     Investments      Total  

BALANCE, January 1, 2012

   $ 209      $ 70,366        —         $ —         $ —         $ 7,783      $ 21,176         99,535   

Partners’ capital contributions

     73        6,992        —           —           —           —          —           7,065   

Distribution to partners

     —          —          —           —           —           (11,121     —           (11,121

Net investment income

     —          —          —           —           —           9,031        —           9,031   

Net realized gain on portfolio investments

     —          —          —           —           —           528        —           528   

Net change in unrealized appreciation on portfolio investments

     —          —          —           —           —           —          21,315         21,315   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

BALANCE, September 30, 2012

   $ 282      $ 77,358        —         $ —         $ —         $ 6,221      $ 42,491       $ 126,352   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

BALANCE, January 1, 2013

   $ 282      $ 77,358        —         $ —         $ —         $ 8,560      $ 56,233       $ 142,433   

Partners’ capital contributions

     —          24,852        —           —           —           —          —           24,852   

Distribution to partners

     —          —          —           —           —           (7,421     —           (7,421

Formation transactions

     (282     (102,210     8,974,420         90         114,198         —          —           11,796   

Public offering of common stock

     —          —          4,000,000         40         75,960         —          —           76,000   

Net investment income

     —          —          —           —           —           13,385        —           13,385   

Net realized gain on portfolio investments

     —          —          —           —           —           2,235        —           2,235   

Net change in unrealized appreciation on portfolio investments

     —          —          —           —           —           —          6,442         6,442   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

BALANCE, September 30, 2013

   $ —        $ —          12,974,420       $ 130       $ 190,158       $ 16,759      $ 62,675       $ 269,722   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

14


Table of Contents

Capitala Finance Corp.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     Nine Months     Nine Months  
     Ended     Ended  
     September 30, 2013     September 30, 2012  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net increase in net assets resulting from operations

   $ 22,062      $ 30,874   

Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:

    

Purchase of portfolio investments

     (75,817     (45,027

Repayments of portfolio investments

     50,209        12,056   

Net realized gain on portfolio investments

     (2,235     (528

Increase in net unrealized appreciation on portfolio investments

     (6,442     (21,315

Payment-in-kind interest accrued, net of payments received

     (930     (1,057

Accretion of original issue discount on portfolio investments

     (35     (56

Amortization of deferred financing fees

     522        472   

Changes in assets and liabilities:

    

Interest and dividends receivable

     (398     (1,216

Due from related parties

     (288     (38

Accounts payable and accrued expenses

     (1,719     (1,290

Due to related parties

     306        388   

Other assets

     (2     —     
  

 

 

   

 

 

 

NET CASH USED IN OPERATING ACTIVITIES

     (14,767     (26,737
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from issuance of SBA-guaranteed debentures

     25,000        35,000   

Partners’ capital contributions

     24,852        7,065   

Proceeds from IPO, net of underwriting expense

     76,000        —     

Distributions paid

     (7,421     (11,121

Deferred financing fees paid

     (606     (849
  

 

 

   

 

 

 

NET CASH PROVIDED BY FINANCING ACTIVITIES

     117,825        30,095   
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     103,058        3,358   

CASH AND CASH EQUIVALENTS, beginning of period

     30,467        24,181   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 133,525      $ 27,539   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

    

Cash paid for interest

   $ 7,828      $ 4,350   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING TRANSACTIONS

    

In-kind contribution of assets

   $ 11,796      $ —     
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

15


Table of Contents

CAPITALA FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(unaudited)

Note 1. Organization

Capitala Finance Corp. (the “Company”, “we”, “us”, and “our”) is a newly formed, externally managed non-diversified closed-end management investment company incorporated in Maryland that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). We commenced operations on May 24, 2013 and completed our 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 “Advisers Act”), and Capitala Advisors Corp. (the “Administrator”) provides the administrative services necessary for us to operate. In addition, for U.S. federal income tax purposes, the Company intends to elect to be treated as a regulated investment company (“RIC”) commencing with our tax year ending December 31, 2013, under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

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 smaller and lower middle market companies.

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, we offer customized financing to business owners, management teams and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We invest primarily in traditional mezzanine, senior subordinated and unitranche debt, as well as senior and second-lien loans and, to a lesser extent, equity securities issued by smaller and lower 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 Fund’s wholly-owned subsidiaries. Fund II and Fund III retained their SBIC licenses, continue to hold their existing investments and continue 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 $76,000,000, after deducting underwriting fees and commissions totaling $4,000,000. The other costs of the IPO were borne by the limited partners of the Legacy Funds. As of September 30, 2013, the Company had 12,974,420 shares of common stock outstanding.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”). Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. The financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries as described in the Formation Transactions presented in Note 1. The transactions related to Fund II, Fund III, and the Florida Sidecar constitute an exchange of shares between entities under common control and will be accounted for in accordance with ASC 805, Business Combinations. As such, the Company’s results of operations and cash flows for the three and nine month periods ended September 30, 2013 are presented as if the aforementioned transactions had occurred as of January 1, 2013. In addition, the results of the Company’s operations and cash flows for the three and nine month periods ended September 30, 2012 and the Company’s financial position as of December 31, 2012 have been presented on a combined basis in order to provide comparative information with respect to prior periods. The Formation Transactions also included an asset acquisition of certain assets in Fund I and Fund III Parent. In accordance with ASC 805, Business Combinations, the assets acquired were recorded at fair value at the date of acquisition, September 24, 2013.

 

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The Company’s financial position as of September 30, 2013 is presented on a consolidated basis. The effects of all intercompany transactions between the Company and its subsidiaries (Fund II, Fund III, and the Florida Sidecar) have been eliminated in consolidation. All financial data and information included in these financial statements have been presented on the basis described above. In the opinion of management, the financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of and for the periods presented.

Use of Estimates in the Preparation of Financial Statements

The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

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. Cash and cash equivalents include deposits in money market accounts. The Company deposits its cash in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits.

Investment Classification

In accordance with the provisions of the 1940 Act, the Company classifies investment 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 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 3.

In determining fair value, our board of directors uses various valuation approaches, and engages a third-party valuation firm, which provides an independent review of certain investments. 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.

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 of directors. Unobservable inputs reflect the board of directors’ 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 of directors in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair

 

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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. We use 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.

Valuation Techniques

Senior and Subordinated Secured Loans

The Company’s portfolio primarily consists of private debt instruments (“Level 3 debt”). We consider our Level 3 debt to be performing loans if the borrower is not in default, the borrower is remitting payments in a timely manner, the loan is in covenant compliance or is otherwise not deemed to be impaired. In determining the fair value of the performing Level 3 debt, the Company’s board of directors considers fluctuations in current interest rates, the trends in yields of debt instruments with similar credit ratings (if applicable), the financial condition of the borrower, economic conditions and other relevant factors, both qualitative and quantitative. In the event that a Level 3 debt instrument is not performing, as defined above, the board of directors will evaluate the value of the collateral utilizing the same framework described above for a performing loan to determine the value of the Level 3 debt instrument.

This evaluation will be updated no less than quarterly for Level 3 debt instruments that are not performing, and more frequently for time periods where there are significant changes in the collateral or significant changes in the perceived performance of the underlying portfolio company. The collateral value will be analyzed on an ongoing basis using internal metrics, appraisals, third-party valuation agents and other data as may be acquired and analyzed by our management and board of directors.

Equity Investments in Private Companies

Our board of directors determines the fair value of its investments in private companies by incorporating valuations that consider the evaluation of financing and sale transactions with third-parties, expected cash flows and market-based information, including comparable transactions, and performance multiples, among other factors, and may use third-party valuation agents. Such non-public investments are included in Level 3 of the fair value hierarchy.

Warrants

Our board of directors will ascribe value to warrants based on the fair value of holdings to which they are associated that can include discounted cash flow analyses, option pricing models, comparable analyses and other techniques as deemed appropriate. Such warrants are included in Level 3 of the fair value hierarchy to the extent issued by non-public companies.

Revenue Recognition

The Company’s revenue recognition policies are as follows:

Interest Income and Paid-in Kind Interest: 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 (“PIK”) provision. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at maturity, is recorded on the 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 income: Generally, when interest and/or principal payments on a loan become past due, or if 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 on that loan for financial reporting purposes, until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. The Company writes off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. Non-accrual loans are returned to accrual status when all past due principal and interest are current and, in management’s judgment, are likely to remain current.

 

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

Dividend Income: Dividend income is recognized on the date dividends are declared.

Other Income: Origination, amendment, closing and/or commitment 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.

Deferred Financing Fees

Costs incurred to issue the SBA-guaranteed debentures payable are capitalized and are amortized over the term of the debt agreements under the straight-line method, which does not differ materially from the effective interest method.

Commitments and Contingencies

As of September 30, 2013 and December 31, 2012, the Company had no outstanding unfunded commitments.

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

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.

Income Taxes

The Company intends to elect to be treated for federal income tax purposes, and intends to qualify annually thereafter, 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 federal income taxes. Therefore, no provision has been recorded for 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.

Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year dividend distributions into the next 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.

In accordance with certain applicable Treasury regulations and private letter rulings 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 his or her 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, each stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20.0% of his or her entire distribution in cash. 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.

ASC 740, Income Taxes, 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” of being 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 September 30, 2013 and December 31, 2012, there were no uncertain tax positions.

 

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Dividends

Dividends to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the board of directors. Net capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for reinvestment.

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a cash dividend or other distribution, each stockholder that has not “opted out” of our dividend reinvestment plan will have its dividends automatically reinvested in additional shares of our common stock rather than receiving cash dividends. Stockholders who receive distributions in the form of shares of common stock will be subject to the same federal, state and local tax consequences as if they received cash distributions.

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 in loans 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 loan-to-liquidation values with each loan and the collateral underlying the loan.

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. Investments

The composition of our investments as of September 30, 2013, at amortized cost and fair value were 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
 

Senior Secured Debt

   $ 87,247         32.5   $ 88,232         26.7

Subordinated Debt

     127,104         47.4        123,633         37.3   

Equity and Warrants

     53,951         20.1        119,112         36.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 268,302         100.0   $ 330,977         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The composition of our investments as of December 31, 2012, at amortized cost and fair value were 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
 

Senior Secured Debt

   $ 72,728         32.0   $ 73,638         25.9

Subordinated Debt

     109,030         47.9        101,659         35.8   

Equity and Warrants

     45,940         20.1        108,634         38.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 227,698         100.0   $ 283,931         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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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 of directors that is consistent with ASC 820 (See Note 2). Consistent with our Company’s valuation policy, we evaluate the source of inputs, including any markets in which our 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 the amortized OID and payment-in-kind 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 valuation methodologies are utilized by the company in estimating fair value and are summarized as follows:

Enterprise Value Waterfall Approach

The enterprise value waterfall approach determines an enterprise value based on EBITDA multiples of publicly traded companies that are considered similar to the subject portfolio companies. The Company considers a variety of items in determining a reasonable pricing multiple, including 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. 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.

Income Approach

The income approach utilizes a discounted cash flow methodology in which the Company estimates fair value based on the present value of a stream of contractual 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. The income approach is typically utilized for debt-only investments in which the Company determines it is reasonably likely that all cash flows will be collected in accordance with the debt agreement.

 

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Asset Approach

The asset approach values an investment based on the greater of the enterprise value or the underlying collateral securing the investment. See discussion of determining enterprise value above. This approach is used when the debt is not performing in accordance with its contractual terms or 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. As of September 30, 2013, there were three portfolio companies with securities valued at $10.9 million using the asset approach.

The following table presents fair value measurements of investments, by major class, as of September 30, 2013 (dollars in thousands), according to the fair value hierarchy:

 

     Fair Value Measurements  
     Level 1      Level 2      Level 3      Total  

Senior Secured Debt

   $ —         $ —         $ 88,232       $ 88,232   

Subordinated Debt

     —           —           123,633         123,633   

Equity and Warrants

     —           —           119,112         119,112   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ 330,977       $ 330,977   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents fair value measurements of investments, by major class, as of December 31, 2012 (dollars in thousands), according to the fair value hierarchy:

 

     Fair Value Measurements  
     Level 1      Level 2      Level 3      Total  

Senior Secured Debt

   $ —         $ —         $ 73,638       $ 73,638   

Subordinated Debt

     —           —           101,659         101,659   

Equity and Warrants

     —           —           108,634         108,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ 283,931       $ 283,931   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended September, 2013 (dollars in thousands):

 

     Senior
Secured
Debt
    Subordinated
Debt
    Equity
and
Warrants
    Total  

Balance as of January 1, 2013

   $ 73,638      $ 101,659      $ 108,634      $ 283,931   

Change in classification due to restructure

     6,735        (6,735     —          —     

Repayments

     (22,958     (20,004     (7,247     (50,209

Purchases

     24,775        44,459        6,583        75,817   

Purchase related to asset acquisition

     5,601        2,353        3,842        11,796   

Payment in-kind interest accrued, net of payments received

     362        568        —          930   

Accretion of original issue discount

     4        31        —          35   

Gain/(loss) on sale

     —          (2,597     4,832        2,235   

Increase in net unrealized appreciation

     75        3,899        2,468        6,442   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2013

   $ 88,232      $ 123,633      $ 119,112      $ 330,977   
  

 

 

   

 

 

   

 

 

   

 

 

 

The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended September 30, 2012 (dollars in thousands):

 

     Senior
Secured
Debt
    Subordinated
Debt
    Equity
and
Warrants
    Total  

Balance as of January 1, 2012

   $ 40,357      $ 114,736      $ 57,638      $ 212,731   

Change in classification due to restructure

     14,520        (14,520     —          —     

Repayments

     (8,650     (2,694     (712     (12,056

Purchases

     15,920        21,019        8,088        45,027   

Payment in-kind interest accrued, net of payments received

     271        786        —          1,057   

Accretion of original issue discount

     3        53        —          56   

Gain/(loss) on sale

     —          —          528        528   

Increase in net unrealized appreciation

     2,363        2,723        16,229        21,315   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2012

   $ 64,784      $ 122,103      $ 81,711      $ 268,658   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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The net change in unrealized appreciation on investments held as of September 30, 2013 and 2012, was $4.2 million and $20.8 million, respectively, and is included in net unrealized appreciation on investments in the consolidated statements of operations.

The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of September 30, 2013 were as follows (dollars in thousands, except EBITDA amounts):

 

     Fair Value      Valuation Approach   

Level 3 Input

  

Range of Inputs

  

Weighted
Average

Subordinated debt and second lien notes

   $ 106,631       Income    

Required Rate of Return

Leverage Ratio

Adjusted EBITDA

  

8.0% - 19.0%

1.3x – 5.1x

$1.7 million-$23.5 million

  

14.4%

3.2x

$7.9 million

Subordinated debt and second lien notes

     17,002       Asset and
Enterprise Value
Waterfall 
  

Adjusted EBITDA Multiple

Adjusted EBITDA

  

4.9x – 5.0x

$1.6 million - $4.0 million

  

5.0x

$3.1 million

Senior debt and first lien notes

     82,247       Income   

Required Rate of Return

Leverage Ratio

Adjusted EBITDA

  

11.0% - 17.0%

0.1x – 5.2x

$1.5 million- $16.9 million

  

13.0%

3.2x

$8.3 million

Senior debt and first lien notes

     5,985       Asset and
Enterprise Value
Waterfall
  

Adjusted EBITDA Multiple

Adjusted EBITDA

  

5.0x – 6.8x

$0.8 million - $1.3 million

  

6.0x

$1.1 million

Equity shares and warrants

     119,112       Asset and
Enterprise Value
Waterfall
  

Adjusted EBITDA Multiple

Adjusted EBITDA

  

2.5x – 9.5x

$1.6 million -$36.3 million

  

6.9x

$13.4 million

The significant unobservable inputs used in the valuation of the Company’s debt and equity investments are required rate of return, adjusted EBITDA, EBITDA multiples, and leverage. Changes in any of these unobservable inputs could have a significant impact on the Company’s estimate of fair value. An increase (decrease) in required rate of return or leverage will result in a lower (higher) estimate of fair value while an increase (decrease) in adjusted EBITDA or EBITDA will result in a higher (lower) estimate of fair value.

Note 4. Agreements

On September 24, 2013, the Company entered into an investment advisory agreement (the “Investment Advisory Agreement”) with our Investment Advisor, which was approved by the Board of Directors of the Company on June 10, 2013. The initial term of the Investment Advisory Agreement is two years, with automatic, one-year renewals at the end of each year subject to certain approvals by our board of directors and/or our stockholders. Subject to the overall supervision of our Board of Directors, our investment adviser manages our day-to-day operations, and provides investment advisory and management services to us. Under the terms of our Investment Advisory Agreement, The Investment Advisor:

 

    determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

 

    identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio companies);

 

    closes and monitors the investments we make; and

 

    provides us with other investment advisory, research and related services as we may from time to time require.

The Investment Advisor’s services under the Investment Advisory Agreement are not exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired.

Pursuant to the Investment Advisory Agreement, we have agreed to pay the Investment Advisor a fee for investment advisory and management services consisting of two components — a base management fee and an incentive fee.

 

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The base management fee is calculated at an annual rate of 1.75% of our gross assets, which is our total assets as reflected on our Statements of Assets and Liabilities and includes any borrowings for investment purposes. Although we do not anticipate making significant investments in derivative financial instruments, the fair value of any such investments, which will not necessarily equal their notional value, will be included in our calculation of gross assets. For services rendered under the Investment Advisory Agreement, the base management fee is payable quarterly in arrears. The base management fee will initially be calculated based on the value of our gross assets at the end of the first calendar quarter subsequent to our IPO, and thereafter based on the average value of our gross assets at the end of the two most recently completed calendar quarters, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter. For the first twelve months following our IPO, the Investment Advisor has agreed to waive the portion of the base management fee payable on cash and cash equivalents held at the Company level, excluding cash and cash equivalents held by the Legacy Funds that were acquired by the Company in connection with the Formation Transactions.

Prior to the formation transaction, the management fee charged by each Legacy Fund for each fiscal quarter was the lesser of (a) an amount equal to an annual rate of .625% of the sum of (i) the Legacy fund’s regulatory capital and (ii) the amount of an assumed two tiers of outstanding leverage based on such regulatory capital, or (b) an amount negotiated between the General Partner and the Management Company. The management fee was reduced by certain fees ultimately received by the Management Company from the portfolio companies. Payments of the management fee were made quarterly in advance. Certain direct expenses such as legal, audit, tax, and limited partner expense were the responsibility of the Legacy Fund.

The incentive fee consists of the following two parts:

The first part of the incentive fee is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the Administration Agreement to our Administrator, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any realized capital gains, computed net of all realized capital losses or unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding calendar quarter, is compared to a hurdle of 2.0% per quarter (8.0% annualized). Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to calculate the 1.75% base management fee. We pay the Investment Advisor an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:

 

    no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle of 2.0%;

 

    100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle but is less than 2.5% in any calendar quarter (10.0% annualized). We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle but is less than 2.5%) as the “catch-up.” The “catchup” is meant to provide our investment adviser with 20% of our pre-incentive fee net investment income as if a hurdle did not apply if this net investment income exceeds 2.5% in any calendar quarter; and

 

    20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter (10.0% annualized) is payable to Capitala Investment Advisors (once the hurdle is reached and the catch-up is achieved, 20% of all preincentive fee investment income thereafter is allocated to the Investment Advisor).

The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date), commencing with the 2013 calendar year, and will equal 20% of our realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees with respect to each of the investments in our portfolio, provided that, the incentive fee determined as of December 31, 2013 will be calculated for a period of shorter than twelve calendar months to take into account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation from the inception of the Company.

 

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We will defer cash payment of the portion of any incentive fee otherwise earned by our Investment Advisor that would, when taken together with all other incentive fees paid to our Investment Advisor during the most recent 12 full calendar month period ending on or prior to the date such payment is to be made, exceed 20% of the sum of (a) our pre-incentive fee net investment income during such period, (b) our net unrealized appreciation or depreciation during such period and (c) our net realized capital gains or losses during such period. Any deferred incentive fees will be carried over for payment in subsequent calculation periods to the extent such payment is payable under the Investment Advisory Agreement. Such deferred amounts will be calculated using a period of shorter than 12 full calendar months until 12 full calendar months have passed since completion of our IPO.

For the three months ended September 30, 2013 and 2012 we incurred $1.0 million and $1.3 million in base management fees, respectively. For each of the nine month periods ending September 30, 2013 and 2012 we incurred $3.0 million in base management fees, respectively.

On September 24, 2013, the Company entered into a separate administration agreement (the “Administration Agreement”) with Capitala Advisors Corp., our Administrator, pursuant to which our Administrator has agreed to furnish us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Our Administrator also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records that we are required to maintain and preparing reports to our stockholders. In addition, our Administrator assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others.

Payments under the Administration Agreement are equal to an amount based upon our allocable portion of our Administrator’s overhead in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions and our allocable portion of the compensation of our chief financial officer, chief compliance officer and our allocable portion of the compensation of any administrative support staff. Under the Administration Agreement, our Administrator will also provide on our behalf managerial assistance to those portfolio companies that request such assistance. The Administration Agreement will have an initial term of two years and may be renewed with the approval of our Board of Directors. The Administration Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that our Administrator outsources any of its functions, we will pay the fees associated with such functions on a direct basis without any incremental profit to our Administrator. Stockholder approval is not required to amend the Administration Agreement.

The Administration Agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, our Administrator and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from the Company. for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our Administrator’s services under the Administration Agreement or otherwise as Administrator for the Company.

Note 5. Related Party Transactions

At September 30, 2013 and December 31, 2012, the Company had the following receivables from (payables to) related parties relating to certain capital contributions, management fees, and reimbursable expenses:

 

     September 30,
2013
    December 31,
2012
 

CapitalSouth Corporation

   $ 256      $ 256   

Phoenix Holdings-NC, Inc.

     (486     (161

Shareholders/Limited Partners

     275        138   

Capital South Fund III, L.P.

     1,046        1,062   

Other

     188        2   
  

 

 

   

 

 

 

Total

   $ 1,279      $ 1,297   
  

 

 

   

 

 

 

These amounts are reflected in the accompanying statements of financial position under the captions, “Due from related parties” and “Due to related parties.”

At times, the Company maintains deposit accounts and certificates of deposit with financial institutions that are shareholders of the Company or were limited partners of a legacy fund prior to the formation transaction. Total deposits with these financial institutions were approximately $13.7 million and $30.3 million at September 30, 2013 and December 31, 2012, respectively.

 

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Note 6. Borrowings

SBA Debentures

The Company, through its two wholly-owned subsidiaries, uses debenture leverage provided through the SBA to fund a portion of its investment portfolio. As of September 30, 2013, the Company has issued $202.2 million of SBA-guaranteed debentures. The Company has issued all SBA-guaranteed debentures that were permitted under each of the Legacy Funds’ respective SBIC licenses (as applicable), and there are no unused SBA debenture commitments remaining.

For the three and nine months ended September 30, 2013, we recorded $2.2 million and $6.5 million, respectively, of interest and financing expenses related to the SBA guaranteed debenture, of which $2.0 million and $6.0 million, respectively, was attributable to interest expense and $0.2 million and $0.5 million, respectively, of amortization of commitment and upfront fees. For the three and nine months ended September 30, 2012, we recorded $2.0 million and $5.8 million, respectively, of interest and financing expenses related to the SBA guaranteed debenture, of which $1.8 million and $5.3 million, respectively, was attributable to interest expense and $0.2 million and $0.5 million, respectively, of amortization of commitment and upfront fees. The weighted average interest rate for all SBA-guaranteed debentures as of September 30, 2013 and December 31, 2012 was 3.57% and 3.74%, respectively.

As of September 30, 2013 and December 31, 2012, the Company’s issued and outstanding SBA-guaranteed debentures mature as follows (dollars in thousands):

 

Date of Pooling

  

Fixed Maturity Date

   Interest Rate     September 30,
2013
     December 31,
2012
 

September 1, 2004

   September 1, 2014      4.120   $ 2,000       $ 2,000   

September 1, 2004

   September 1, 2014      4.684     8,000         8,000   

September 1, 2005

   September 1, 2015      4.941     8,000         8,000   

September 1, 2005

   September 1, 2015      5.524     2,000         2,000   

September 1, 2006

   September 1, 2016      5.535     11,500         11,500   

March 1, 2009

   March 1, 2019      4.620     5,000         5,000   

September 1, 2010

   September 1, 2020      3.215     3,000         3,000   

September 1, 2010

   September 1, 2020      3.215     4,000         4,000   

September 1, 2010

   September 1, 2020      3.215     4,000         4,000   

September 1, 2010

   September 1, 2020      3.215     4,000         4,000   

September 1, 2010

   September 1, 2020      3.215     4,000         4,000   

March 1, 2011

   March 1, 2021      4.084     15,700         15,700   

March 1, 2011

   March 1, 2021      4.084     5,000         5,000   

March 1, 2011

   March 1, 2021      4.084     5,000         5,000   

March 1, 2011

   March 1, 2021      4.084     4,000         4,000   

March 1, 2011

   March 1, 2021      4.084     18,000         18,000   

March 1, 2011

   March 1, 2021      4.084     14,000         14,000   

March 1, 2012

   March 1, 2022      2.766     25,000         25,000   

March 1, 2012

   March 1, 2022      2.766     35,000         35,000   

March 1, 2013

   March 1, 2023      2.351     25,000         —     
       

 

 

    

 

 

 
        $ 202,200       $ 177,200   
       

 

 

    

 

 

 

ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. The Company estimates that the fair value of its SBA-guaranteed debentures is approximately $209.1 million and $185.8 million as of September 30, 2013 and December 31, 2012, respectively. The fair value estimate was based on future contractual cash payments discounted at market interest rates to borrow from the SBA as of the measurement date. Because the market interest rate is considered an unobservable input, SBA-guaranteed debentures are considered a level 3 financial instrument in the fair value hierarchy.

Note 7. Directors Fees

Our independent directors receive an annual fee of $50,000. They also receive $5,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board meeting, and also receive $5,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting. In addition, the chairman of the audit committee receives an annual fee of $10,000 and each chairman of any other committee receives an annual fee of $5,000 for their additional services, if any, in these capacities. No compensation is expected to be paid to directors who are “interested persons” of the Company, as such term is defined in Section 2(a)(19) of the 1940 Act.

 

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Note 8. Stockholders’ Equity

On September 24, 2013, we issued 8,974,420 shares of common stock to the limited partners of the Legacy Funds, in exchange for 100% of their membership interests or certain investment assets of such Legacy Fund, as the case may be. On September 30, 2013, we issued 4,000,000 shares of common stock in connection with the closing of our IPO. The shares issued in the IPO were priced at $20.00 per share. We received proceeds of $76.0 million in the IPO, net of underwriters’ discounts and commissions of $4.0 million. The limited partners of the Legacy Funds bore the other $1.75 million in out of pocket expenses associated with the offering.

Note 9. Earnings Per Share

In accordance with the provisions of ASC 260, Earnings per Share, basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. As of September 30, 2013, there were no dilutive shares.

The following information sets forth the computation of the weighted average basic and diluted net increase in net assets per share from operations for the three and nine months ended September 30, 2013 and 2012 (dollars in thousands except share and per share data):

 

     For the three months ended      For the nine months ended  

Basic and diluted

   September 30,
2013
     September 30,
2012
     September 30,
2013
     September 30,
2012
 

Net increase in net assets from operations

   $ 7,909       $ 10,778       $ 22,062       $ 30,874   

Weighted average common shares outstanding

     12,974,420         N/A         12,974,420         N/A   

Net increase in net assets per share from operations-basic and diluted

   $ 0.61         N/A       $ 1.70         N/A   

Note 10. Dividend

The Company’s dividends and distributions are recorded on the record date. Shareholders have the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and common stock.

Note 11. Financial Highlights

The following is a schedule of financial highlights for the nine months ended September 30, 2013 (dollars in thousands, except share and per share data):

 

     September 30, 2013  

Per share data:

  

Net asset value at beginning of period(1)

   $ 17.74   

Net investment income(2)

     1.03   

Net realized gain on investments

     0.17   

Net unrealized appreciation on investments

     0.50   
  

 

 

 

Net increase in stockholders’ equity

     1.70   
  

 

 

 

Capital contributions from partners

     1.92   

Capital distributions to partners

     (0.57

Net asset value at end of period

   $ 20.79   

Net assets at end of period

   $ 269,722   

Shares outstanding at end of period

     12,974,420   

Per share market value at end of period

   $ 19.20   

Total return based on market value(3)

     (4.00 )% 

Ratio/Supplemental data:

  

Ratio of net investment income to average, net assets(1)(5)

     7.14

Ratio of operating expenses to average net assets(1)(5)

     1.80

Ratio of incentive management fees to average net assets(1)(5)

    

Ratio of debt related expenses to average net assets(1)(5)

     3.48

Ratio of total expenses to average net assets(1)(5)

     5.29

Portfolio turnover rate(4)

     2.27

 

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(1) Net asset value as of January 1, 2013 and average net assets for the nine months ended September 30, 2013 are presented as if the Offering and Formation Transactions had occurred on January 1, 2013. See Note 2 for a further description of the basis of presentation of the Company’s financial statements
(2) Net investment income per share is calculated using the weighted average shares outstanding during the period.
(3) Total investment return is calculated assuming a purchase of common shares at the IPO offering price per share at September 25, 2013 of $20.00 and a sale at the current market value on the last day of the period reported. Dividends and distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Company’s dividend reinvestment plan. Total investment return does not reflect brokerage commissions. Total investment returns covering less than a full period are not annualized.
(4) Portfolio turnover rate is calculated using the lesser of year-to-date sales or year-to-date purchases over the average of the invested assets at fair value.
(5) Ratios are annualized.

Note 12. Subsequent Events

Management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. There have been no subsequent events that occurred during such period that would be required to be recognized in the consolidated financial statements as of and for the three and nine month periods ended September 30, 2013.

On October 28, 2013, the Company invested $6.0 million in Crowley Holdings Inc. in Series A Preferred Equity, secured by underlying subordinated debt, earning 10% cash and 2% PIK.

On October 28, 2013, the Company invested $2.06 million in Source Capital SSCR, LLC in subordinated debt, earning 14% cash and 5% PIK.

On November 1, 2013, the Company invested $11.1 million in TCE Holding Company, with $9.6 million in subordinated debt, earning 12% cash and 2% PIK, and $1.5 million in common stock.

On November 11, 2013, the Company’s Board of Directors declared a quarterly dividend of $0.47 per share payable on December 30, 2013 to holders of record as of December 10, 2013.

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

The following discussion and analysis should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q.

Except as otherwise specified, references to “we,” “us,” “our” or the “Company”, refer to Capitala Finance Corp.

This Quarterly Report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about the Company, our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “will,” “may,” “continue,” “believes,” “seeks,” “estimates,” “would,” “could,” “should,” “targets,” “projects,” and variations of these words and similar expressions are intended to identify forward-looking statements.

The forward-looking statements contained in this Quarterly Report on Form 10-Q involve risks and uncertainties, including statements as to:

 

    our future operating results;

 

    our business prospects and the prospects of our portfolio companies;

 

    the impact of investments that we expect to make;

 

    our contractual arrangements and relationships with third parties;

 

    the dependence of our future success on the general economy and its impact on the industries in which we invest;

 

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    the ability of our portfolio companies to achieve their objectives;

 

    our expected financings and investments;

 

    our ability to obtain exemptive relief from the SEC to co-invest and to engage in joint restructuring transactions or joint follow-on investments;

 

    the adequacy of our cash resources and working capital; and

 

    the timing of cash flows, if any, from the operations of our portfolio companies.

These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation:

 

    an economic downturn could impair our portfolio companies’ ability to continue to operate or repay their borrowings, which could lead to the loss of some or all of our investments in such portfolio companies;

 

    a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities;

 

    interest rate volatility could adversely affect our results, particularly if we use leverage as part of our investment strategy; and

 

    the risks, uncertainties and other factors we identify in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. Important assumptions include our ability to originate new loans and investments, certain margins and levels of profitability and the availability of additional capital. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or Securities and Exchange Commission (“SEC”) rule or regulation.

OVERVIEW

We are a Maryland corporation that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We are managed by Capitala Investment Advisors (the “Investment Advisor”), and Capitala Advisors Corp. (the “Administrator”) provides the administrative services necessary for us to operate.

We provide capital to smaller and lower middle-market companies in the United States, with a non-exclusive emphasis on the Southeast, Southwest and Mid-Atlantic regions. We invest primarily in companies with a history of earnings growth and positive cash flow, proven management teams, product or service with competitive advantages and industry-appropriate margins. We primarily invest in companies with between $5 million and $30 million in trailing twelve month EBITDA.

We invest in mezzanine and senior subordinated debt investments that are secured by subordinated liens on all of our borrowers’ assets and, to a lesser extent, in senior, cash flow-based “unitranche” securities. Most of our 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.

Corporate History

Immediately prior to our initial public offering (“IPO”), through a series of transactions (the “Formation Transactions”), we acquired all the equity interests in CapitalSouth Partners Fund II Limited Partnership (“Fund II”), CapitalSouth Partners SBIC Fund III, L.P. (“Fund III”), CapitalSouth Partners Florida Sidecar Fund I, L.P. (“Florida Sidecar”) and each such fund’s respective general partners, as well as certain assets from CapitalSouth Partners Fund I Limited Partnership (“Fund I”) and CapitalSouth Partners Fund III, L.P. (“Fund III Parent”, and together with Fund I, Fund II, Fund III and Florida Sidecar, the “Legacy Funds”), which collectively constitute our portfolio. The investments included in our portfolio had a collective fair value of approximately $315.6 million as of June 30, 2013, as determined by our board of directors based on management’s internal analysis and positive assurance from a third-party independent valuation firm. At the time of the Formation Transactions, our portfolio consisted of: (1) approximately $326.3 million in investments; (2) an aggregate of approximately $67.1 million in cash,

 

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interest receivable and other assets; and (3) liabilities of approximately $202.2 million of SBA-guaranteed debt payable. In connection with our acquisition of our portfolio, we issued an aggregate of approximately 9.0 million shares of our common stock to the investors in the Legacy Funds. We have two SBIC-licensed subsidiaries that have elected to be treated as BDCs under the 1940 Act. We may also seek other forms of leverage and borrow funds to make investments, including before we have fully invested the proceeds of this offering.

Revenues

We generate revenue primarily from the periodic cash interest we will collect on our debt investments. In addition, most of our debt investments offer the opportunity to participate in a borrower’s equity performance through warrant participation, direct equity ownership or otherwise, which we expect to result in revenue in the form of dividends and/or capital gain. Further, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. These fees will be recognized as they are earned.

Expenses

Our primary operating expenses include the payment of investment advisory fees to our investment adviser, Capitala Investment Advisors, LLC, our allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the Administration Agreement and other operating expenses as detailed below. Our investment advisory fee will compensate our investment adviser for its work in identifying, evaluating, negotiating, closing, monitoring and servicing our investments. We will bear all other expenses of our operations and transactions, including (without limitation):

 

    the cost of our organization;

 

    the cost of calculating our net asset value, including the cost of any third-party valuation services;

 

    the cost of effecting sales and repurchases of our shares and other securities;

 

    interest payable on debt, if any, to finance our investments;

 

    fees payable to third parties relating to, or associated with, making investments, including fees and expenses associated with performing due diligence reviews of prospective investments and advisory fees;

 

    transfer agent and custodial fees;

 

    fees and expenses associated with marketing efforts;

 

    costs associated with our reporting and compliance obligations under the 1940 Act, the Exchange Act, other applicable federal and state securities laws and ongoing stock exchange listing fees;

 

    federal, state and local taxes;

 

    independent directors’ fees and expenses;

 

    brokerage commissions;

 

    costs of proxy statements, stockholders’ reports and other communications with stockholders;

 

    fidelity bond, directors’ and officers’ liability insurance, errors and omissions liability insurance and other insurance premiums;

 

    direct costs and expenses of administration, including printing, mailing, telephone and staff;

 

    fees and expenses associated with independent audits and outside legal costs; and

 

    all other expenses incurred by either our Administrator or us in connection with administering our business, including payments under the Administration Agreement that will be based upon our allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions, and our allocable portion of any costs of compensation and related expenses of our chief compliance officer and our chief financial officer and any administrative support staff.

Critical Accounting Policies and Use of Estimates

In the preparation of our unaudited financial statements and related disclosures, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States (“U.S. GAAP”). Our significant accounting policies are described in Note 2 to the Consolidated Financial Statements. While all of these policies are important to understanding our financial statements, certain accounting policies and estimates are considered critical due to their impact on the reported amounts of assets and liabilities at the date of the unaudited financial statements and the reported amounts of revenues and expenses for the periods covered by such financial statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. Because of the nature of the judgment and assumptions we make, actual results could differ material from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

 

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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 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements. In accordance with ASC 820, the Fund 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 3.

In determining fair value, our board of directors uses various valuation approaches, and engages a third-party independent valuation firm, which provides positive assurance on the investments they review. 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.

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 of directors. Unobservable inputs reflect the board of directors’ 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 fair value hierarchy is categorized into three levels based on the inputs as follows:

Level 1 – Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 securities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

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

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 of directors 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. We use 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.

Valuation Techniques

Senior and Subordinated Secured Loans

The Fund’s portfolio primarily consists of private debt instruments (“Level 3 debt”). We consider our Level 3 debt to be performing loans if the borrower is not in default, the borrower is remitting payments in a timely manner, the loan is in covenant compliance or is otherwise not deemed to be impaired. In determining the fair value of the performing Level 3 debt, the Company’s board of directors considers fluctuations in current interest rates, the trends in yields of debt instruments with similar credit ratings (if applicable), the financial condition of the borrower, economic conditions and other relevant factors, both qualitative and quantitative. In the event that a Level 3 debt instrument is not performing, as defined above, the board of directors will evaluate the value of the collateral utilizing the same framework described above for a performing loan to determine the value of the Level 3 debt instrument.

 

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This evaluation will be updated no less than quarterly for Level 3 debt instruments that are not performing, and more frequently for time periods where there are significant changes in the collateral or significant changes in the perceived performance of the underlying portfolio company. The collateral value will be analyzed on an ongoing basis using internal metrics, appraisals, third-party valuation agents and other data as may be acquired and analyzed by our management and board of directors.

Equity Investments in Private Companies

Our board of directors determines the fair value of its investments in private companies by incorporating valuations that consider the evaluation of financing and sale transactions with third-parties, expected cash flows and market-based information, including comparable transactions, and performance multiples, among other factors, and may use third-party valuation agents. Such non-public investments are included in Level 3 of the fair value hierarchy.

Warrants

Our board of directors will ascribe value to warrants based on fair value holdings that can include discounted cash flow analyses, option pricing models, comparable analyses and other techniques as deemed appropriate. Such warrants are included in Level 3 of the fair value hierarchy to the extent issued by non-public companies.

Revenue Recognition

The Company’s revenue recognition policies are as follows:

Interest Income and Paid-in Kind Interest: 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 (“PIK”) provision. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at maturity, is recorded on the 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 income: Generally, when interest and/or principal payments on a loan become past due, or if 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 on that loan for financial reporting purposes, until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. The Company writes off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. Non-accrual loans are returned to accrual status when all past due principal and interest are current and, in management’s judgment, are likely to remain current.

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

Dividend Income: Dividend income is recognized on the date dividends are declared.

Other Income: Origination, amendment, closing and/or commitment 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.

Portfolio and Investment Activity

As of September 30, 2013, our portfolio consisted of investments in 40 portfolio companies with a fair value of approximately $331.0 million.

During the three months ended September 30, 2013, we made approximately $34.2 million of investments in new or existing portfolio companies and had approximately $23.1 million in aggregate amount of exits and repayments resulting in net investments of approximately $11.1 million for the period. During the three months ended September 30, 2012, we made approximately $23.3 million of investments in new or existing portfolio companies and had approximately $3.3 million in aggregate amount of exits and repayments resulting in net investments of approximately $20.0 million for the period.

 

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During the nine months ended September 30, 2013, we made approximately $75.8 million of investments in new or existing portfolio companies and had approximately $50.2 million in aggregate amount of exits and repayments resulting in net investments of approximately $25.6 million for the period. During the nine months ended September 30, 2012, we made approximately $45.0 million of investments in new or existing portfolio companies and had approximately $12.1 million in aggregate amount of exits and repayments resulting in net investments of approximately $32.9 million for the period.

As of September 30, 2013, our average portfolio company investment and our largest portfolio company investment at amortized cost and fair value was approximately $6.7 million and $8.3 million, and $19.0 million and $29.0 million, respectively. As of September 30, 2013, the Company had approximately $133.5 million of cash and cash equivalents. As of December 31, 2012, our average portfolio company investment and our largest portfolio company investment at amortized cost and fair value was approximately $6.0 million and $7.5 million, and $17.4 million and $29.9 million, respectively. As of December 31, 2012, the Company had $30.5 million of cash and cash equivalents

The following table summarizes the amortized cost and the fair value of investments and cash and cash equivalents as of September 30, 2013 (dollars in thousands):

 

     Investments at
Amortized Cost
     Amortized Cost
Percentage of
Total Portfolio
    Investments at
Fair Value
     Fair Value
Percentage of
Total Portfolio
 

Senior Secured Debt

   $ 87,247         21.7   $ 88,232         19.0

Subordinated Debt

     127,104         31.7        123,633         26.6   

Equity and Warrants

     53,951         13.4        119,112         25.6   

Cash and Cash Equivalents

     133,525         33.2        133,525         28.8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 401,827         100.0   $ 464,502         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table summarizes the amortized cost and the fair value of investments and cash and cash equivalents as of December 31, 2012 (dollars in thousands):

 

     Investments at
Amortized Cost
     Amortized Cost
Percentage of
Total Portfolio
    Investments at
Fair Value
     Fair Value
Percentage of
Total Portfolio
 

Senior Secured Debt

   $ 72,728         28.2   $ 73,638         23.4

Subordinated Debt

     109,030         42.2        101,659         32.3   

Equity and Warrants

     45,940         17.8        108,634         34.6   

Cash and Cash Equivalents

     30,467         11.8        30,467         9.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 258,165         100.0   $ 314,398         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

As of September 30, 2013, our income-bearing investment portfolio, which represented nearly 64.0% of our total portfolio, had a weighted average yield based upon cost of our portfolio investments of approximately 13.8% all bearing a fixed rate of interest. As of December 31, 2012, our income-bearing investment portfolio, which represented nearly 62% of our total portfolio, had a weighted average yield based upon cost of our portfolio investments of approximately 13.5% all bearing a fixed rate of interest.

 

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The following table shows the portfolio composition by industry grouping at fair value (dollars in thousands):

 

     September 30, 2013     December 31, 2012  
     Investments
at
Fair Value
     Percentage
of
Total
Portfolio
    Investments
at
Fair Value
     Percentage
of
Total
Portfolio
 

QSR Franchisee

   $ 28,970         8.8   $ 29,950         10.5

Professional Employer Organization

     22,948         6.9        15,229         5.4   

Industrial Equipment Rental

     22,500         6.8        18,001         6.4   

Sales & Marketing Services

     20,898         6.3        7,008         2.5   

Oil & Gas Services

     19,646         5.9        6,240         2.2   

Printing Services

     15,572         4.7        8,185         2.9   

Suntan Lotion Manufacturer

     15,040         4.5        12,892         4.5   

QSR Franchisor

     14,904         4.5        15,112         5.3   

Footwear Retail

     11,445         3.5        7,131         2.5   

Specialty Clothing

     11,173         3.4        10,333         3.6   

Culinary Products

     10,194         3.1        8,769         3.1   

Fuel Transportation Services

     10,185         3.1        9,043         3.2   

Retail IT & Security Solutions

     10,000         3.0        —           —     

Dentistry Services

     9,334         2.8        7,984         2.8   

Textile Equipment Manufacturer

     9,301         2.8        8,433         3.0   

Energy Services

     8,566         2.6        7,287         2.6   

Aerospace Parts Manufacturer

     7,910         2.4        5,219         1.8   

Conglomerate

     7,551         2.3        8,565         3.0   

Computer Supply Retail

     7,549         2.3        —           —     

Produce Distribution

     6,881         2.1        6,722         2.4   

Replacement Window Manufacturer

     6,559         2.0        5,585         2.0   

Medical Device Manufacturer

     6,454         2.0        6,286         2.2   

Western Wear Retail

     5,071         1.5        19,928         7.0   

Advertising & Marketing Services

     5,070         1.5        18,453         6.5   

Data Processing & Digital Marketing

     5,061         1.5        637         0.2   

Medical Device Distributor

     4,328         1.3        3,561         1.3   

Petroleum Equipment Supplier

     3,481         1.0        2,681         0.9   

Industrial Manufacturing

     3,396         1.0        —           —     

Automotive Chemicals & Lubricants

     3,140         0.9        3,283         1.2   

Metal Recycler

     3,031         0.9        2,931         1.0   

Specialty Defense Contractor

     2,722         0.8        467         0.2   

Online Travel Sales & Marketing

     2,504         0.8        1,421         0.5   

Industrial Boiler Manufacturer

     2,447         0.7        2,660         0.9   

Corporate Fulfillment

     2,193         0.7        1,165         0.4   

Building Supplies

     1,969         0.6        972         0.3   

Quick Lube Services

     1,523         0.5        13,248         4.7   

In-Home Healthcare Services

     874         0.3        374         0.1   

IT Hosting Services

     587         0.2        372         0.1   

Usenet Hosting Services

     —           —          6,214         2.2   

Textile Manufacturer

     —           —          1,590         0.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 330,977         100.0   $ 283,931         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

All investments made by the Company as of September 30, 2013 and December 31, 2012 were made in portfolio companies located in the U.S. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business. The following table shows the portfolio composition by geographic region at fair value at September 30, 2013 and December 31, 2012 (dollars in thousands):

 

     At September 30, 2013     At December 31, 2012  
     Investments
at
Fair Value
     Percentage
of
Total
Portfolio
    Investments
at
Fair Value
     Percentage
of
Total
Portfolio
 

South

   $ 225,255         68.0   $ 202,429         71.3

West

     63,135         19.1        47,931         16.9   

Northeast

     22,097         6.7        18,419         6.5   

Midwest

     20,490         6.2        15,152         5.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 330,977         100.0   $ 283,931         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The Investment Advisor regularly assesses the risk profile of each of our investments and rates each of them based on the following categories, which we refer to as the Investment Advisor’s investment credit rating:

 

Credit Rating

  

Definition

1    Investments that are performing above expectations.
2   

Investments that are performing within expectations, with risks that are neutral or favorable compared to risks at the time of origination.

 

All new loans are rated ‘2’.

3   

Investments that are performing below expectations and that require closer monitoring, but where no loss of interest, dividend or principal is expected.

 

Companies rated ‘3’ may be out of compliance with financial covenants, however, loan payments are generally not past due.

 

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Credit Rating

  

Definition

4   

Investments that are performing below expectations and for which risk has increased materially since origination.

 

Some loss of interest or dividend is expected but no loss of principal.

 

In addition to the borrower being generally out of compliance with debt covenants, loan payments may be past due (but generally not more than 180 days past due).

5   

Investments that are performing substantially below expectations and whose risks have increased substantially since origination.

 

Most or all of the debt covenants are out of compliance and payments are substantially delinquent.

 

Some loss of principal is expected.

The following table shows the distribution of our investments on the 1 to 5 investment performance rating scale at fair value as of September 30, 2013 (dollars in thousands):

 

Investment Performance Rating

   Investments
at Fair
Value
     Percentage
of Total
Investments
 

1

   $ 159,969         48.3

2

     124,046         37.5   

3

     33,517         10.1   

4

     13,445         4.1   

5

     —           —     
  

 

 

    

 

 

 

Total

   $ 330,977         100.0

The following table shows the distribution of our investments on the 1 to 5 investment performance rating scale at fair value as of December 31, 2012 (dollars in thousands):

 

Investment Performance Rating

   Investments
at Fair
Value
     Percentage
of Total
Investments
 

1

   $ 172,598         60.8

2

     80,676         28.4   

3

     21,870         7.7   

4

     8,787         3.1   

5

     —           —     
  

 

 

    

 

 

 

Total

   $ 283,931         100.0

The Company had non-accrual loans outstanding with a fair market value of $10.9 million and $5.1 million as of September 30, 2013 and December 31, 2012, respectively.

Results of Operations

Operating results for the three and nine months ended September 30, 2013 and 2012 are as follows (dollars in thousands):

 

     For the three months ended  
     September 30,
2013
     September 30,
2012
 

Total investment income

   $ 8,801       $ 6,614   

Total expenses, net

     3,364         3,344   
  

 

 

    

 

 

 

Net investment income

     5,437         3,270   

Net realized gains

     1,871         196   

Net unrealized gains (losses)

     601         7,312   
  

 

 

    

 

 

 

Net increase (decrease) in net assets resulting from operations

   $ 7,909       $ 10,778   
  

 

 

    

 

 

 

 

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     For the nine months ended  
     September 30,
2013
     September 30,
2012
 

Total investment income

   $ 23,288       $ 17,935   

Total expenses, net

     9,903         8,904   
  

 

 

    

 

 

 

Net investment income

     13,385         9,031   

Net realized gains

     2,235         528   

Net unrealized gains (losses)

     6,442         21,315   
  

 

 

    

 

 

 

Net increase in net assets resulting from operations

   $ 22,062       $ 30,874   
  

 

 

    

 

 

 

Investment income

The composition of our investment income for the three and nine months ended September 30, 2013 and 2012 was as follows (dollars in thousands):

 

     For the three months ended  
     September 30,
2013
     September 30,
2012
 

Loan interest, fee and dividend income

   $ 8,103       $ 6,156   

Payment-in-kind interest income

     422         425   

Interest from cash and cash equivalents

     66         33   

Income from pass-through entities

     210         —     
  

 

 

    

 

 

 

Total Investment Income

   $ 8,801       $ 6,614   
  

 

 

    

 

 

 

 

     For the nine months ended  
     September 30,
2013
     September 30,
2012
 

Loan interest, fee and dividend income

   $ 20,484       $ 16,538   

Payment-in-kind interest income

     1,092         1,114   

Interest from cash and cash equivalents

     141         112   

Income from pass-through entities

     1,571         171   
  

 

 

    

 

 

 

Total Investment Income

   $ 23,288       $ 17,935   
  

 

 

    

 

 

 

Operating expenses

The composition of our expenses for the three and nine months ended September 30, 2013 and 2012 was as follows (dollars in thousands):

 

                                                 
     For the three months ended  
     September 30,
2013
     September 30,
2012
 

Interest expense

   $ 2,237       $ 2,029   

Management fees

     980         1,314   

Other Expenses

     147         1   
  

 

 

    

 

 

 

Total expenses

   $ 3,364       $ 3,344   
  

 

 

    

 

 

 

 

                                                 
     For the nine months ended  
     September 30,
2013
     September 30,
2012
 

Interest expense

   $ 6,527       $ 5,794   

Management fees

     2,994         2,992   

Other Expenses

     382         118   
  

 

 

    

 

 

 

Total expenses

   $ 9,903       $ 8,904   
  

 

 

    

 

 

 

 

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Net realized gains/losses on sales of investments

During the three and nine months ended September 30, 2013, we recognized $1.9 million and $2.2 million of net realized gains on our portfolio investments, respectively. During the three and nine months ended September 30, 2012, we recognized $0.2 million and $0.5 million of net realized gains, respectively, on portfolio investments.

Net unrealized appreciation/depreciation on investments

Net change in unrealized appreciation on investments reflects the net change in the fair value of our investment portfolio. For the three and nine months ended September 30, 2013, we had $0.6 million and $6.4 million of unrealized appreciation, respectively, on portfolio investments. For the three and nine months ended September 30, 2012, we had $7.3 million and $21.3 million of unrealized appreciation, respectively, on portfolio investments.

Changes in net assets resulting from operations

For the three and nine months ended September 30, 2013, we recorded a net increase in net assets resulting from operations of $7.9 million and $22.1 million, respectively. Based on the weighted average shares of common stock outstanding for the three and nine months ended September 30, 2013 our per share net increase in net assets resulting from operations was $0.61 and $1.70, respectively. For the three and nine months ended September 30, 2012, we recorded a net increase in net assets resulting from operations of $10.8 million and $30.9 million, respectively.

Financial Condition, Liquidity and Capital Resources

In addition to the $76.0 million of net proceeds from our initial public offering, we intend to continue to generate cash from future offerings of securities and cash flows from operations, including earnings on investments in our portfolio and future investments, as well as interest earned from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less. In addition to our existing SBA-guaranteed debentures, we may, if permitted by regulation, seek to issue additional SBA-guaranteed debentures as well as other forms of leverage and borrow funds to make investments, including before we have fully invested the proceeds of this offering.

As of September 30, 2013, we had $133.5 million in cash and cash equivalents, and our net assets totaled $269.7 million. We believe that our current cash and cash equivalents on hand, and our anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations for at least the next 12 months.

Contractual obligations

We have entered into two contracts under which we have material future commitments, the Investment Advisory Agreement, pursuant to which the Investment Advisor serves as our investment adviser, and the Administration Agreement, pursuant to which our Administrator agrees to furnish us with certain administrative services necessary to conduct our day-to-day operations. Payments under the Investment Advisory Agreement in future periods will be equal to: (1) a percentage of the value of our gross assets; and (2) an incentive fee based on our performance. Payments under the Administration Agreement will occur on an ongoing basis as expenses are incurred on our behalf by our Administrator.

The Investment Advisory Agreement and the Adminis