The following discussion and analysis should be read in conjunction with our
consolidated 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,” “Logan Ridge,”
or the “Company”, refer to Logan Ridge Finance Corporation.
Forward-Looking Statements
This Quarterly Report on Form 10-Q, 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.
Some of the statements in this Quarterly Report on Form 10-Q constitute
forward-looking statements, which relate to future events or our performance or
financial condition. 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 and the impact of the COVID-19 pandemic thereon;
•
our business prospects and the prospects of our portfolio companies, including
our and their ability to achieve our respective objectives as a result of the
current COVID-19 pandemic;
•
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;
•
our expected financings and 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
and the impact of the COVID-19 pandemic thereon.
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, due to the COVID-19 pandemic or otherwise, 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 and the impact of the
COVID-19 pandemic thereon;
•
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 our Annual Report on Form 10-K for the fiscal year ended December
31, 2021 and 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 U.S. Securities and
Exchange Commission (“SEC”) rule or regulation.
Overview
We are a Maryland corporation that has elected to be regulated as a business
development company (”BDC”) under the Investment Company Act of 1940, as
amended (the ”1940 Act”). Our investment objective is to generate both current
income and capital appreciation through debt and equity investments. We are
managed by Mount Logan Management LLC (the ”Investment Advisor”), and BC
Partners Management LLC (the ”Administrator”) provides the administrative
services necessary for us to operate.
We provide capital to lower and traditional middle-market companies in the
United States (”U.S.”), 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,
products or services with competitive advantages, and industry-appropriate
margins. We primarily invest in companies with between $5.0 million and $50.0
million in trailing twelve-month earnings before interest, tax, depreciation,
and amortization (”EBITDA”).
We invest in first lien loans and, to a lesser extent, second lien loans and
equity securities issued by lower middle-market and traditional middle-market
companies.
As a BDC, we are required to comply with certain regulatory requirements. For
instance, we generally must invest at least 70% of our total assets in
“qualifying assets,” including securities of private or thinly traded public
U.S. companies, cash, cash equivalents, U.S. government securities and
high-quality debt investments that mature in one year or less. In addition, we
are only allowed to borrow money such that our asset coverage, as defined in the
1940 Act, equals at least 150%, if certain requirements are met, after such
borrowing, with certain limited exceptions. As of March 31, 2022, our asset
coverage ratio was 184%. To maintain our regulated
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investment company (“RIC”) status, we must meet specified source-of-income and
asset diversification requirements. To maintain our RIC tax treatment under
subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) for
U.S. federal income tax purposes, we must distribute at least 90% of our net
ordinary income and realized net short-term capital gains in excess of realized
net long-term capital losses, if any, for the taxable year.
Corporate History
We commenced operations on May 24, 2013 and completed our initial public
offering (“IPO”) on September 30, 2013. 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 Fund III, L.P. (f/k/a
CapitalSouth Partners SBIC Fund III, L.P.) (“Fund III”) and CapitalSouth
Partners Florida Sidecar Fund I, L.P. (“Florida Sidecar” and, collectively with
Fund I, Fund II, Fund III and Fund III Parent, the “Legacy Funds”); (ii) raising
capital in the IPO and (iii) continuing and expanding the business of the Legacy
Funds by making additional debt and equity investments in lower middle-market
and traditional middle-market companies.
On September 24, 2013, the Company acquired 100% of the limited partnership
interests in Fund II, Fund III, and Florida Sidecar and each of their respective
general partners, as well as certain assets from Fund I and Fund III Parent, in
exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the
“Formation Transactions”). Fund II, Fund III, and Florida Sidecar became the
Company’s wholly owned subsidiaries. Fund II and Fund III retained their small
business investment company (“SBIC”) licenses issued by the U.S. Small Business
Administration (“SBA”), and continued to hold their existing investments at the
time of IPO and have continued to make new investments after the IPO. The IPO
consisted of the sale of 4,000,000 shares of the Company’s common stock at a
price of $20.00 per share resulting in net proceeds to the Company of $74.25
million, after deducting underwriting fees and commissions totaling $4.0 million
and offering expenses totaling $1.75 million. The other costs of the IPO were
borne by the limited partners of the Legacy Funds. During the fourth quarter of
2017, Florida Sidecar transferred all of its assets to the Company and was
legally dissolved as a standalone partnership. On March 1, 2019, Fund II repaid
its outstanding debentures guaranteed by the SBA (“SBA-guaranteed debentures”)
and relinquished its SBIC license. On June 10, 2021, Fund III repaid its
SBA-guaranteed debentures and relinquished its SBIC license.
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, interest receivable and other assets; and (3) liabilities
of approximately $202.2 million of SBA-guaranteed debentures payable. Fund III,
our subsidiary, is licensed under the Small Business Investment Act, of 1958, as
amended, and has elected to be regulated as BDC under the 1940 Act. Fund II, our
subsidiary, was licensed under the SBIC Act until March 1, 2019 and has elected
to be regulated as a BDC under the 1940 Act.
The Company has formed and expects to continue to form certain consolidated
taxable subsidiaries (the ”Taxable Subsidiaries”), which are taxed as
corporations for U.S. federal income tax purposes. The Taxable Subsidiaries
allow the Company to make equity investments in companies organized as
pass-through entities while continuing to satisfy the requirements of a RIC
under the Code.
Capitala Business Lending, LLC (“CBL”), a wholly-owned subsidiary of ours, was
established on October 30, 2020, for the sole purpose of holding certain
investments pledged as collateral under a senior secured revolving credit
agreement with KeyBank National Association (the “KeyBank Credit Facility”). See
“Financial Condition, Liquidity and Capital Resources” for more details. The
financial statements of CBL are consolidated with those of Logan Ridge Finance
Corporation.
Definitive Agreement
On April 20, 2021, Capitala Investment Advisors, LLC (“Capitala”), the Company’s
former investment adviser, entered into a definitive agreement (the “Definitive
Agreement”) with the Investment Advisor and Mount Logan Capital Inc. (“MLC”),
both affiliates of BC Partners Advisors L.P. (“BC Partners”) for U.S. regulatory
purposes, whereby Mount Logan acquired certain assets related to Capitala’s
business of providing investment management services to the Company (the
“Transaction”), through which the Investment Advisor became the Company’s
investment adviser pursuant to an investment advisory agreement (the “Investment
Advisory Agreement”) with the Company. At a special meeting of the Company’s
stockholders (the “Special Meeting”) held on May 27, 2021, the Company’s
stockholders approved the Investment Advisory Agreement. The transactions
contemplated by the Definitive Agreement closed on July 1, 2021 (the “Closing”).
As part of the Transaction, the Investment Advisor entered into a two-year
contractual fee waiver (the “Fee Waiver”) with the Company to waive, to the
extent necessary, any capital gains fee under the Investment Advisory Agreement
that exceeds what would have been paid to Capitala in the aggregate over such
two-year period under the prior advisory agreement.
On the date of the Closing, the Company changed its name from Capitala Finance
Corp. to Logan Ridge Finance Corporation and on July 2, 2021, the Company’s
common stock began trading on the NASDAQ Global Select Market under the symbol
“LRFC.” The Company’s 5.75% Convertible Notes due 2022 and 6.00% Notes due 2022
continue to trade under the symbols “CPTAG” and “CPTAL,” respectively.
On July 1, 2021, in connection with the Closing, the Company’s then-current
interested directors and the Company’s then-current independent directors
resigned as members of the Board and Ted Goldthorpe, the Chairman and Chief
Executive Officer of the Company, along with Alexander Duka, George Grunebaum,
and Robert Warshauer, were appointed as members of the Board (the “Directors”).
The Directors were appointed by the Board to fill the vacancies created by the
resignations described above and the Directors were appointed to the class of
directors as determined by the Board in accordance with the Company’s
organizational documents. The Company’s stockholders will have the opportunity
to vote for each of the Directors when his class of directors is up for
reelection.
All of the Company’s then-current officers resigned at the Closing and the Board
appointed Ted Goldthorpe as the Company’s Chief Executive Officer and President,
Jason Roos as the Company’s Chief Financial Officer, Treasurer and Secretary,
Patrick Schafer as the Company’s Chief Investment Officer and David Held as the
Company’s Chief Compliance Officer. On November 9, 2021, Jason T. Roos was
replaced as Secretary and Treasurer of the Company by Brandon Satoren, who was
also appointed as Chief Accounting Officer. Mr. Roos continues to serve as Chief
Financial Officer of the Company.
Basis of Presentation
The Company is considered an investment company as defined in Accounting
Standards Codification (“ASC”) Topic 946 – Financial Services – Investment
Companies (“ASC 946”). The accompanying unaudited consolidated financial
statements have been prepared on the accrual basis of accounting in conformity
with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim
financial information and pursuant to the requirements for reporting on Form
10-Q and Article 6 and Article 10 of Regulation S-X. Accordingly, certain
disclosures accompanying our annual consolidated financial statements prepared
in accordance with U.S. GAAP have been omitted. The consolidated financial
statements of the Company include the accounts of the Company and its wholly
owned subsidiaries, including Fund II, Fund III, CBL, and the Taxable
Subsidiaries.
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The Company’s financial statements as of March 31, 2022 and December 31, 2021
and for the periods ended March 31, 2022 and 2021 are presented on a
consolidated basis. The effects of all intercompany transactions between the
Company and its subsidiaries (Fund II, Fund III, CBL, and the Taxable
Subsidiaries) have been eliminated in consolidation. All financial data and
information included in these consolidated financial statements have been
presented on the basis described above. In the opinion of management, the
consolidated financial statements reflect all adjustments that are necessary for
the fair presentation of financial results as of and for the periods presented.
The current period’s results of operations are not necessarily indicative of
results that ultimately may be achieved for the year. Additionally, the
unaudited consolidated financial statements and notes should be read in
conjunction with the audited consolidated financial statements and notes thereto
appearing in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2021, filed with the SEC on March 14, 2022.
Consolidation
As provided under ASC 946, the Company will generally not consolidate its
investment in a company other than an investment company subsidiary or a
controlled operating company whose business consists of providing services to
the Company. Accordingly, the Company consolidated the results of the Company’s
wholly owned investment company subsidiaries (Fund II, Fund III, CBL, and the
Taxable Subsidiaries) in its consolidated financial statements.
Revenues
We generate revenue primarily from the periodic cash interest we 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 gains. Further, we may
generate revenue in the form of commitment fees, origination fees, amendment
fees, 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 Advisor, our allocable portion of overhead and other expenses
incurred by our Administrator in performing its obligations under an
administration agreement between us and the Administrator (the “Administration
Agreement”) and other operating expenses as detailed below. Our investment
advisory fee will compensate our Investment Advisor 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 (such as legal, accounting, and travel expenses incurred in
connection 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 Securities Exchange Act of 1934, as amended (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, our chief
financial officer, and their respective administrative support staff.
Critical Accounting Policies and Use of Estimates
In the preparation of our consolidated financial statements and related
disclosures, we have adopted various accounting policies that govern the
application of 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 consolidated 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 consolidated
financial statements and the reported amounts of revenues and expenses for the
periods covered by such consolidated financial statements. We have identified
investment valuation, revenue recognition, and income taxes 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 judgments
and assumptions we make, actual results could materially differ 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”). ASC 820 defines fair value, establishes a framework
used to measure fair value and requires disclosures for fair value measurements.
In accordance with ASC 820, the Company has categorized its financial
instruments carried at fair value, based on the priority of the valuation
technique, into a three-level fair value hierarchy as discussed in Note 4 to our
consolidated financial statements.
In determining fair value, the Board uses various valuation approaches, and
engages a third-party independent valuation firm, which provides positive
assurance on the investments it reviews. In accordance with U.S. GAAP, a fair
value hierarchy for inputs is used in measuring fair value that maximizes the
use of observable inputs and minimizes the use of unobservable inputs by
requiring that the most observable inputs be used when available.
Observable inputs are those that market participants would use in pricing the
asset or liability based on market data obtained from sources independent of the
Board. Unobservable inputs reflect the Board’s assumptions about the inputs
market participants would use in pricing the asset or liability developed based
upon the best information available in the circumstances. The 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 Company 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.
In estimating the fair value of portfolio investments, the Company starts with
the cost basis of the investment, which includes original issue discount and
payment-in-kind (“PIK”) income, if any. The transaction price is typically the
best estimate of fair value at inception. When evidence supports a subsequent
change to the carrying value from the original transaction price, adjustments
are made to reflect the expected fair value.
Valuation Techniques
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 company. The Company considers a variety of items in
determining a reasonable pricing multiple, including, but not limited to,
operating results, budgeted projections, growth, size, risk, profitability,
leverage, management depth, diversification, market position, supplier or
customer dependence, asset utilization, liquidity metrics, and access to capital
markets. EBITDA of the portfolio company is adjusted for non-recurring items in
order to reflect a normalized level of earnings that is representative of future
earnings. In certain instances, the Company may also utilize revenue multiples
to determine enterprise value. When available, the Company may assign a pricing
multiple or value its investments based on the value of recent investment
transactions in the subject portfolio company or offers to purchase the
portfolio company. The enterprise value is adjusted for financial instruments
with seniority to the Company’s ownership and for the effect of any instrument
which may dilute the Company’s investment in the portfolio company. The adjusted
enterprise value is then apportioned based on the seniority and privileges of
the Company’s investments within the portfolio company.
Income Approach
The income approach utilizes a discounted cash flow methodology in which the
Company estimates fair value based on the present value of expected cash flows
discounted at a market rate of interest. The determination of a discount rate,
or required rate of return, takes into account the portfolio company’s
fundamentals and perceived credit risk. Because the majority of the Company’s
portfolio companies do not have a public credit rating, determining a discount
rate often involves assigning an implied credit rating based on the portfolio
company’s operating metrics compared to average metrics of similar publicly
rated debt. Operating metrics include, but are not limited to, EBITDA, interest
coverage, leverage ratio, return on capital, and debt to equity ratios. The
implied credit rating is used to assign a base discount rate range based on
publicly available yields on similarly rated debt securities. The Company may
apply a premium to the discount rate utilized in determining fair value when
performance metrics and other qualitative information indicate that there is an
additional level of uncertainty about collectability of cash flows.
Asset Approach
The asset approach values an investment based on the value of the underlying
collateral securing the investment.
Revenue Recognition
The Company’s revenue recognition policies are as follows:
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Interest income and paid-in-kind interest income: Interest income is recorded on
the accrual basis to the extent that such amounts are expected to be collected.
The Company has loans in the portfolio that contain a PIK interest provision.
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 investments: Management reviews all loans that become 90 days or
more past due, or when there is reasonable doubt that principal or interest will
be collected, for possible placement on non-accrual status. When the Company
otherwise does not expect the borrower to be able to service its debt and other
obligations, the Company will place the loan on non-accrual status and will
generally cease recognizing interest income and PIK interest on that loan for
financial reporting purposes. Interest payments received on non-accrual loans
may be recognized as income or applied to principal depending upon management’s
judgment. The Company writes off any previously accrued and uncollected cash
interest when it is determined that interest is no longer considered
collectible. Non-accrual loans are returned to accrual status when the
borrower’s financial condition improves such that management believes current
interest and principal payments are expected to be collected.
Gains and losses on investment sales and paydowns: Realized gains and losses on
investments are recognized using the specific identification method.
Dividend income and paid-in-kind dividends: Dividend income is recognized on the
date dividends are declared. The Company holds preferred equity investments in
the portfolio that contain a PIK dividend provision. PIK dividends, which
represent contractually deferred dividends added to the equity balance, are
recorded on the accrual basis to the extent that such amounts are expected to be
collected. The Company will typically cease accrual of PIK dividends when the
fair value of the equity investment is less than the cost basis of the
investment or when it is otherwise determined by management that PIK dividends
are unlikely to be collected. If management determines that a decline in fair
value is temporary in nature and PIK dividends are more likely than not to be
collected, management may elect to continue accruing PIK dividends.
Original issue discount: Discounts received to par on loans purchased are
capitalized and accreted into income over the life of the loan. Any remaining
discount is accreted into income upon prepayment of the loan.
Other income: Origination fees (to the extent services are performed to earn
such income), amendment fees, consent fees and other fees associated with
investments in portfolio companies are recognized as income when they are
earned. Prepayment penalties received by the Company for debt instruments repaid
prior to the maturity date are recorded as income upon receipt.
Income Taxes
Prior to the Formation Transactions, the Legacy Funds were treated as
partnerships for U.S. federal, state and local income tax purposes and,
therefore, no provision has been made in the accompanying consolidated financial
statements for federal, state or local income taxes. In accordance with the
partnership tax law requirements, each partner would include their respective
components of the Legacy Funds’ taxable profits or losses, as shown on their
Schedule K-1 in their respective tax or information returns. The Legacy Funds
are disregarded entities for tax purposes prior to and post the Formation
Transactions.
The Company has elected to be treated for U.S. federal income tax purposes and
intends to comply with the requirement to qualify annually as a RIC under
subchapter M of the Code and, among other things, intends to make the requisite
distributions to its stockholders which will relieve the Company from U.S.
federal income taxes.
In order to qualify as a RIC, among other requirements, the Company is required
to timely distribute to its stockholders at least 90.0% of its investment
company taxable income, as defined by the Code, for each fiscal tax year. The
Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on
undistributed income if it does not distribute at least 98.0% of its ordinary
income in any calendar year and 98.2% of its capital gain net income for each
one-year period ending on October 31.
Depending on the level of taxable income earned in an excise tax year, the
Company may choose to carry forward taxable income in excess of current year
dividend distributions into the next excise tax year and pay a 4.0% excise tax
on such income, as required. To the extent that the Company determines that its
estimated current year annual taxable income will be in excess of estimated
current year dividend distributions for U.S. federal excise tax purposes, the
Company accrues excise tax, if any, on estimated excess taxable income as
taxable income is earned. Since the Company’s IPO, the Company has not accrued
or paid excise tax.
The tax years ended December 31, 2021, 2020, 2019, and 2018 remain subject to
examination by U.S. federal, state, and local tax authorities. No interest
expense or penalties have been assessed for the periods ended March 31, 2022 and
2021. If the Company was required to recognize interest and penalties, if any,
related to unrecognized tax benefits this would be recognized as income tax
expense in the consolidated statements of operations.
The Company’s Taxable Subsidiaries record deferred tax assets or liabilities
related to temporary book versus tax differences on the income or loss generated
by the underlying equity investments held by the Taxable Subsidiaries. As of
March 31, 2022, and December 31, 2021, the Company recorded a net deferred tax
asset of zero. For the three months ended March 31, 2022 and 2021, the Company
recorded a deferred tax provision of zero. As of March 31, 2022 and December 31,
2021, the valuation allowance on the Company’s deferred tax asset was $2.5
million and $2.5 million, respectively. During the three months ended March 31,
2022, there was no change in the valuation allowance recognized by the Company.
During the three months ended March 31, 2021, the Company recognized a decrease
in the valuation allowance of $1.0 million.
In accordance with certain applicable U.S. 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 its entire distribution in either cash or
stock of the RIC, subject to a limitation on the aggregate amount of cash to be
distributed to all stockholders, which limitation must be at least 20.0% of the
aggregate declared distribution. If too many stockholders elect to receive cash,
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 its 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 Topic 740 – Income Taxes (“ASC 740”), provides guidance for how uncertain
tax positions should be recognized, measured, presented, and disclosed in the
consolidated financial statements. ASC 740 requires the evaluation of tax
positions taken or expected to be taken in the course of preparing the Company’s
U.S. federal income 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 March 31, 2022 and
December 31, 2021, there were no uncertain tax positions.
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The Company is required to determine whether a tax position of the Company is
more-likely-than-not to be sustained upon examination by the applicable taxing
authority, including resolution of any related appeals or litigation processes,
based on the technical merits of the position. The tax benefit to be recognized
is measured as the largest amount of benefit that is greater than fifty percent
likely of being realized upon ultimate settlement. De-recognition of a tax
benefit previously recognized could result in the Company recording a tax
liability that could negatively impact the Company’s net assets.
U.S. GAAP provides guidance on thresholds, measurement, de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition that is intended to provide better financial
statement comparability among different entities.
The Company has concluded that it was not necessary to record a liability for
any such tax positions as of March 31, 2022 and December 31, 2021. However, the
Company’s conclusions regarding this policy may be subject to review and
adjustment at a later date based on factors including, but not limited to,
ongoing analyses of, and changes to, tax laws, regulations and interpretations
thereof.
Portfolio and Investment Activity
The Company’s investment objective is to generate both current income and
capital appreciation through debt and equity investments. The Company offers
customized financing to business owners, management teams and financial sponsors
for change of ownership transactions, recapitalizations, strategic acquisitions,
business expansion and other growth initiatives. The Company invests primarily
in first lien loans, and, to a lesser extent, second lien loans and equity
securities issued by lower middle-market companies and traditional middle-market
companies. As of March 31, 2022, our portfolio consisted of investments in 42
portfolio companies with a fair value of approximately $206.9 million.
Most of the Company’s debt investments are structured as first lien loans. First
lien loans may contain some minimum amount of principal amortization, excess
cash flow sweep feature, prepayment penalties, or any combination of the
foregoing. First lien loans are secured by a first priority lien in existing and
future assets of the borrower and may take the form of term loans, delayed draw
facilities, or revolving credit facilities. Unitranche debt, a form of first
lien loan, typically involves issuing one debt security that blends the risk and
return profiles of both senior secured and subordinated debt, bifurcating the
loan into a first-out tranche and last-out tranche. As of March 31, 2022, 8.2%
of the fair value of our first lien loans consisted of last-out loans. As of
December 31, 2021, 8.5% of the fair value of our first lien loans consisted of
last-out loans. In some cases, first lien loans may be subordinated, solely with
respect to the payment of cash interest, to an asset based revolving credit
facility.
The Company also invests in debt instruments structured as second lien loans.
Second lien loans are loans which have a second priority security interest in
all or substantially all of the borrower’s assets, and in some cases, may be
subject to the interruption of cash interest payments upon certain events of
default, at the discretion of the first lien lender.
During the three months ended March 31, 2022, we made approximately $16.4
million of investments and had approximately $8.4 million in repayments and
sales, resulting in net deployment of approximately $8.0 million for the period.
During the three months ended March 31, 2021, we made no investments and had
approximately $29.9 million in repayments and sales, resulting in net repayments
and sales of approximately $29.9 million for the period.
As of March 31, 2022, our debt investment portfolio, which represented 68.1% of
the fair value of our total portfolio, had a weighted average annualized yield
of approximately 8.3% (excluding non-accruals and collateralized loan
obligations). As of March 31, 2022, 24.3% of the fair value of our debt
investment portfolio was bearing a fixed rate of interest. As of December 31,
2021, our debt investment portfolio, which represented 67.4% of the fair value
of our total portfolio, had a weighted average annualized yield of approximately
8.1% (excluding non-accruals and collateralized loan obligations). As of
December 31, 2021, 22.8% of the fair value of our debt investment portfolio was
bearing a fixed rate of interest.
The weighted average annualized yield is calculated based on the effective
interest rate as of period end, divided by the fair value of our debt
investments. The weighted average annualized yield of our debt investments is
not the same as a return on investment for our stockholders but, rather, relates
to a portion of our investment portfolio and is calculated before the payment of
all of our fees and expenses. There can be no assurance that the weighted
average annualized yield will remain at its current level.
As of March 31, 2022, the Board approved the fair value of our investment
portfolio of approximately $206.9 million in good faith in accordance with our
valuation procedures. The Board approved the fair value of our investment
portfolio as of March 31, 2022 with input from a third-party valuation firm and
the Investment Advisor based on information known or knowable as of the
valuation date, including trailing and forward-looking data.
As of March 31, 2022, we had debt investments in two portfolio companies on
non-accrual status with an aggregate amortized cost of $12.7 million and an
aggregate fair value of $7.0 million, which represented 6.4% and 3.4% of the
investment portfolio, respectively. As of December 31, 2021, we had debt
investments in two portfolio companies on non-accrual status with aggregate
amortized cost of $12.7 million and an aggregate fair value of $7.6 million,
which represented 6.7% and 3.8% of the investment portfolio, respectively.
The following table summarizes the amortized cost and the fair value of
investments as of March 31, 2022 (dollars in thousands):
Amortized Cost Fair Value
Investments at Percentage of
Investments at Percentage of
Amortized Cost Total Portfolio Fair Value Total Portfolio
First Lien Debt $ 106,929 53.7 % $ 100,663 48.7 %
Second Lien Debt 33,168 16.7 % 33,220 16.1 %
Subordinated Debt 7,117 3.6 % 7,115 3.4 %
Collateralized Loan
Obligations 8,106 4.1 % 7,199 3.5 %
Equity and Warrants 43,649 21.9 % 58,708 28.3 %
Total $ 198,969 100.0 % $ 206,905 100.0 %
The following table summarizes the amortized cost and the fair value of
investments as of December 31, 2021 (dollars in thousands):
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Amortized Cost Fair Value
Investments at Percentage of
Investments at Percentage of
Amortized Cost Total Portfolio Fair Value Total Portfolio
First Lien Debt $ 103,667 54.4 % $ 98,251 49.6 %
Second Lien Debt 30,048 15.8 % 30,190 15.2 %
Subordinated Debt 5,050 2.6 % 5,050 2.6 %
Equity and Warrants 51,717 27.2 % 64,698 32.6 %
Total $ 190,482 100.0 % $ 198,189 100.0 %
The following table shows the portfolio composition by industry grouping at fair
value as of March 31, 2022 and December 31, 2021 (dollars in thousands):
March 31, 2022 December 31, 2021
Percentage Percentage
Investments at of Total Investments at of Total
Fair Value Portfolio Fair Value Portfolio
Healthcare $ 35,509 17.2 % $ 28,852 14.6 %
Business Services 32,456 15.7 % 32,819 16.6 %
Information Technology 25,605 12.4 % 24,066 12.1 %
Financials 19,679 9.5 % 17,162 8.7 %
Consumer Discretionary 12,809 6.2 % 11,017 5.6 %
Industrials 10,062 4.9 % 14,640 7.4 %
Entertainment 8,643 4.2 % 8,894 4.5 %
Electronic Machine Repair 8,395 4.1 % 8,465 4.3 %
QSR Franchisor 8,178 4.0 % 8,007 4.0 %
Financial Services 7,498 3.6 % 7,430 3.7 %
Healthcare Management 6,247 3.0 % 7,002 3.5 %
Online Merchandise Retailer 5,954 2.9 % 5,951 3.0 %
Textile Equipment
Manufacturer 5,107 2.5 % 5,050 2.5 %
Medical Device Distributor 4,961 2.4 % 4,961 2.5 %
Automobile Part Manufacturer 4,402 2.1 % 2,722 1.4 %
Advertising & Marketing
Services 4,390 2.1 % 4,579 2.3 %
Home Repair Parts
Manufacturer 3,055 1.5 % 3,062 1.5 %
Testing Laboratories 986 0.5 % 1,113 0.6 %
Consumer Products 803 0.4 % 623 0.3 %
Household Product
Manufacturer 758 0.4 % 287 0.1 %
General Industrial 645 0.3 % 645 0.3 %
Data Processing & Digital
Marketing 509 0.3 % 509 0.3 %
Oil & Gas Engineering and
Consulting Services 254 0.1 % 333 0.2 %
Total $ 206,905 100.0 % $ 198,189 100.0 %
Results of Operations
Operating results for the three months ended March 31, 2022 and 2021 were as
follows (dollars in thousands):
For the Three Months Ended March 31,
2022 2021
Total investment income $ 3,337 $ 4,926
Total expenses, net of incentive fee waiver 4,388 5,709
Net investment loss (1,051 ) (783 )
Net realized loss on investments (36 ) (14,023 )
Net change in unrealized appreciation on investments 229 27,160
Net (decrease) increase in net assets resulting from
operations $ (858 ) $ 12,354
Investment income
The composition of our investment income for the three months ended March 31,
2022 and 2021 was as follows (dollars in thousands):
For the Three Months Ended March 31,
2022 2021
Interest income $ 3,197 $ 4,592
Other income 8 9
Payment-in-kind interest and dividend income 132 170
Dividend income – 155
Total investment income $ 3,337 $ 4,926
The income reported as interest income, PIK interest, and PIK dividend income is
generally based on the stated rates as disclosed in our consolidated schedules
of investments. Accretion of discounts received for purchased loans are included
in interest income as an adjustment to yield. As a general rule, our interest
income, PIK interest, and PIK dividend income are recurring in nature.
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We also generate fee income primarily through origination fees charged for new
investments, and secondarily via amendment fees, consent fees, prepayment
penalties, and other fees. While fee income is typically non-recurring for each
investment, most of our new investments include an origination fee; as such, fee
income is dependent upon our volume of directly originated investments and the
fee structure associated with those investments.
We earn dividends on certain equity investments within our investment portfolio.
As noted in our consolidated schedules of investments, some investments are
scheduled to pay a periodic dividend, though these recurring dividends do not
make up a significant portion of our total investment income. We may receive,
and have received, more substantial one-time dividends from our equity
investments.
For the three months ended March 31, 2022, total investment income decreased by
$1.6 million, or 32.3%, compared to the three months ended March 31, 2021. The
decrease from the prior period was driven by a decrease in interest income from
$4.6 million for the three months ended March 31, 2021 to $3.2 million for the
three months ended March 31, 2022. The decline in interest income is primarily
due to lower average outstanding debt investments for the three months ended
March 31, 2022 compared to the three months ended March 31, 2021. PIK income
declined from $0.2 million for the three months ended March 31, 2021 to $0.1
million for the three months ended March 31, 2022. The decrease in PIK income
was due to a decline in investments with a contractual PIK rate. Dividend income
decreased from $0.2 million for the three months ended March 31, 2021 to zero
for the three months ended March 31, 2022, primarily due to non-recurring
dividends received from portfolio companies during the three months ended March
31, 2021
Operating expenses
The composition of our expenses for the three months ended March 31, 2022 and
2021 was as follows (dollars in thousands):
For the Three Months Ended March
31,
2022 2021
Interest and financing expenses $ 2,188 $ 3,037
Base management fee 1,027 1,398
Directors’ fees 103 103
Administrative service fees 120 350
General and administrative expenses 950 821
Total expenses $ 4,388 $ 5,709
For the three months ended March 31, 2022, operating expenses decreased by $1.3
million, or 23.2%, compared to the three months ended March 31, 2021. Interest
and financing expenses decreased from $3.0 million for the three months ended
March 31, 2021 to $2.2 million for the three months ended March 31, 2022 due
primarily to lower average outstanding debt during the three months ended March
31, 2022 compared to the three months ended March 31, 2021. Base management fees
declined from $1.4 million for the three months ended March 31, 2021 to $1.0
million for the three months ended March 31, 2022, due to lower average assets
under management. Administrative services fees declined from $0.4 million for
the three months ended March 31, 2021 to $0.1 million for the three months ended
March 31, 2022, due to efficiencies generated by the size and scale of the
Investment Advisor’s platform. General and administrative expenses increased
from $0.8 million for the three months ended March 31, 2021 to $1.0 million for
the three months ended March 31, 2022, primarily due to accelerated one-time
prepaid financing costs during the three months ended March 31, 2022 as well as
higher professional fees.
Net realized loss on sales of investments
During the three months ended March 31, 2022, we recognized $36 thousand of net
realized losses on our portfolio investments. During the three months ended
March 31, 2021 we recognized $14.0 million of net realized losses on our
portfolio investments.
Net unrealized appreciation (depreciation) on investments
Net change in unrealized (depreciation) appreciation on investments reflects the
net change in the fair value of our investment portfolio. For the three months
ended March 31, 2022 and 2021, we recognized $0.2 million and $27.2 million of
net change in unrealized appreciation investments, respectively.
Changes in net assets resulting from operations
For the three months ended March 31, 2022, we recorded a net decrease in net
assets resulting from operations of $0.9 million. Based on the weighted average
shares of common stock outstanding for the three months March 31, 2022, our per
share net decrease in net assets resulting from operations was $0.32.
For the three months ended March 31, 2021, we recorded a net increase in net
assets resulting from operations of $12.4 million. Based on the weighted average
shares of common stock outstanding for the three months ended March 31, 2021,
our per share net increase in net assets resulting from operations was $4.56.
Financial Condition, Liquidity and Capital Resources
We use and intend to use existing cash primarily to originate investments in new
and existing portfolio companies, pay distributions to our stockholders, and
repay indebtedness.
Since our IPO, we have raised approximately $136.0 million in net proceeds from
equity offerings through March 31, 2022.
KeyBank Credit Facility
On October 30, 2020, Capitala Business Lending, LLC (“CBL”), a direct, wholly
owned, consolidated subsidiary of the Company, entered into a senior secured
revolving credit agreement (the “KeyBank Credit Facility”) with the Company’s
investment adviser at the time (as collateral manager), the lenders from time to
time parties thereto (each, a “Lender”), KeyBank National Association (as
administrative agent), and U.S. Bank National Association (as custodian). Under
the KeyBank Credit Facility, the Lenders have agreed to extend credit to CBL in
an aggregate principal amount of up to $25.0 million. On January 1, 2021, the
KeyBank Credit Facility was amended to replace the collateral manager with the
Company’s Investment Advisor. CBL may, on any business day prior to October 28,
2022, request an increase in the aggregate principal amount from $25.0 million
to $100.0 million in accordance with the terms and in the manner described in
the KeyBank Credit Facility. The period during which the Lenders may make loans
to CBL under the KeyBank Credit Facility commenced on October 30, 2020 and will
continue through October 28, 2022, unless there is an earlier termination or
event of default. The KeyBank Credit Facility matures on October 28, 2023,
unless there is an earlier termination or event of
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default. Borrowings under the KeyBank Credit Facility bear interest at one-
month LIBOR plus 3.5%. The KeyBank Credit Facility includes customary
affirmative and negative covenants, including certain limitations on the
incurrence of additional indebtedness and liens, as well as usual and customary
events of default for revolving credit facilities of this nature. As of March
31, 2022, there were no outstanding draws on the KeyBank Credit Facility.
2026 Notes
On October 29, 2021, we issued $50.0 million in aggregate principal amount of
5.25% fixed rate notes due October 30, 2026 (the “2026 Notes”) at 98.00%
pursuant to a supplemental indenture with U.S. Bank National Association (the
“Trustee”), which supplements that certain base indenture, dated as of June 16,
2014. The 2026 Notes were issued in a private placement exempt from registration
under the Section 4(a)(2) of the Securities Act of 1933, as amended (the
“Securities Act”). The net proceeds to the Company were approximately $48.8
million, after deducting estimated offering expenses. The Notes will mature on
October 30, 2026 and may be redeemed in whole or in part at the Company’s option
at any time or from time to time at the redemption prices set forth in the
Indenture. The Notes bear interest at a rate of 5.25% per year payable
semi-annually on April 30 and October 30 of each year, commencing on April 30,
2022. The Notes are general unsecured obligations of the Company that rank
senior in right of payment to all of the Company’s existing and future
indebtedness that is expressly subordinated in right of payment to the Notes,
rank pari passu with all existing and future unsecured unsubordinated
indebtedness issued by the Company, rank effectively junior to any of the
Company’s secured indebtedness (including unsecured indebtedness that the
Company later secures) to the extent of the value of the assets securing such
indebtedness, and rank structurally junior to all existing and future
indebtedness (including trade payables) incurred by the Company’s subsidiaries,
financing vehicles or similar facilities.
In connection with the offering, the Company entered into a Registration Rights
Agreement, dated as of October 29, 2021 (the “Registration Rights Agreement”),
with the purchasers of the 2026 Notes. Pursuant to the Registration Rights
Agreement, the Company is obligated to file with the Securities and Exchange
Commission a registration statement relating to an offer to exchange the 2026
Notes for new notes issued by the Company that are registered under the
Securities Act and otherwise have terms substantially identical to those of the
2026 Notes, and to use its commercially reasonable efforts to cause such
registration statement to be declared effective.
As of March 31, 2022, the Company had approximately $50.0 million in aggregate
principal amount of 2026 Notes outstanding.
2022 Notes
On May 16, 2017, we issued $70.0 million in aggregate principal amount of 6.0%
fixed-rate notes due May 31, 2022 (the “2022 Notes”). On May 25, 2017, we issued
an additional $5.0 million in aggregate principal amount of the 2022 Notes
pursuant to a partial exercise of the underwriters’ overallotment option. The
2022 Notes will mature on May 31, 2022 and may be redeemed in whole or in part
at any time or from time to time at our option on or after May 31, 2019 at a
redemption price equal to 100% of the outstanding principal, plus accrued and
unpaid interest. Interest on the 2022 Notes is payable quarterly. The 2022 Notes
are listed on the NASDAQ Global Select Market under the trading symbol “CPTAL”
with a par value of $25.00 per share.
On November 1, 2021, the Company notified the Trustee for the Company’s 2022
Notes, of the Company’s election to redeem $50.0 million aggregate principal
amount of the 2022 Notes outstanding. The redemption was completed on December
6, 2021. As of March 31, 2022, the Company had approximately $22.8 million in
aggregate principal amount of 2022 Notes outstanding.
2022 Convertible Notes
On May 26, 2017, we issued $50.0 million in aggregate principal amount of 5.75%
fixed-rate convertible notes due May 31, 2022 (the “2022 Convertible Notes”). On
June 26, 2017, we issued an additional $2.1 million in aggregate principal
amount of the 2022 Convertible Notes pursuant to a partial exercise of the
underwriters’ overallotment option. Interest on the 2022 Convertible Notes is
payable quarterly. The 2022 Convertible Notes are listed on the NASDAQ Capital
Market under the trading symbol “CPTAG” with a par value of $25.00 per share. As
of March 31, 2022, the Company had approximately $52.1 million in aggregate
principal amount of 2022 Convertible Notes outstanding.
Bond Repurchase Program
On July 30, 2020, the Board approved a bond repurchase program which authorizes
the Company to repurchase up to an aggregate of $10.0 million worth of the
Company’s outstanding 2022 Notes and/or 2022 Convertible Notes (the “Bond
Repurchase Program”). The Bond Repurchase Program expired on July 30, 2021.
During the three months ended March 31, 2021, the Company did not purchase any
of the 2022 Notes or the 2022 Convertible Notes.
Asset Coverage Ratio
We are only allowed to borrow money such that our asset coverage, as defined in
the 1940 Act, equals at least 150% if certain requirements are met, after such
borrowing, with certain limited exceptions. As of March 31, 2022, our asset
coverage ratio was 184%. If our asset coverage ratio falls below 150% due a
decline in the fair market of our portfolio, we may be limited in our ability to
raise additional debt.
Cash and Cash Equivalents
As of March 31, 2022, we had $15.8 million in cash and cash equivalents.
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 Administration Agreement are each
terminable by either party without penalty upon 60 days’ written notice to the
other. If either of these agreements is terminated, the costs we incur under new
agreements may increase. In addition, we will likely incur significant time and
expense in locating alternative parties to provide the services we expect to
receive under both our Investment Advisory Agreement and our Administration
Agreement. Any new investment advisory agreement would also be subject to
approval by our stockholders.
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A summary of our significant contractual payment obligations as of March 31,
2022 are as follows (dollars in millions):
Contractual Obligations Payments Due by Period
Less More
Than 1 – 3 3 – 5 Than
1 Year Years Years 5 Years Total
2022 Notes $ 22.8 $ – $ – $ – $ 22.8
2022 Convertible Notes 52.1 – – – 52.1
2026 Notes – – 50.0 – 50.0
Total Contractual Obligations $ 74.9 $ – $
50.0 $ – $ 124.9
Distributions
In order to qualify as a RIC and to avoid corporate-level U.S. federal income
tax on the income we timely distribute to our stockholders, we are required to
distribute at least 90% of our net ordinary income and our net short-term
capital gains in excess of net long-term capital losses, if any, to our
stockholders on an annual basis. Additionally, we must distribute an amount at
least equal to the sum of 98% of our net ordinary income (during the calendar
year) plus 98.2% of our net capital gain income (during each 12-month period
ending on October 31) plus any net ordinary income and capital gain net income
that we recognized for preceding years, but were not distributed during such
years, and on which we paid no U.S. federal income tax to avoid a U.S. federal
excise tax. We made quarterly distributions to our stockholders for the first
four full quarters subsequent to our IPO. To the extent we had income available,
we made monthly distributions to our stockholders from October 30, 2014 until
March 30, 2020. As announced on April 1, 2020, distributions, if any, will be
made on a quarterly basis effective for the second quarter of 2020. Our
stockholder distributions, if any, will be determined by our Board on a
quarterly basis. Any distributions to our stockholders will be declared out of
assets legally available for distribution. The Company’s Board determined not to
declare a distribution for the first quarter of 2022 and 2021.
We may not be able to achieve operating results that will allow us to make
distributions at a specific level or to increase the amount of our distributions
from time to time, and from time to time we may decrease the amount of our
distributions. In addition, we may be limited in our ability to make
distributions due to the asset coverage requirements applicable to us as a BDC
under the 1940 Act. If we do not distribute a certain percentage of our income
annually, we will suffer adverse tax consequences, including the possible loss
of our qualification as a RIC. We cannot assure stockholders that they will
receive any distributions.
To the extent our taxable earnings fall below the total amount of our
distributions for that fiscal year, a portion of those distributions may be
deemed a return of capital to our stockholders for U.S. federal income tax
purposes. Thus, the source of a distribution to our stockholders may be the
original capital invested by the stockholder rather than our income or gains.
Stockholders should read any written disclosure accompanying any stockholder
distribution carefully and should not assume that the source of any distribution
is our ordinary income or capital gains.
We have adopted an “opt out” dividend reinvestment plan (“DRIP”) for our common
stockholders. As a result, if we declare a distribution, then stockholders’ cash
distributions will be automatically reinvested in additional shares of our
common stock unless a stockholder specifically “opts out” of our DRIP. If a
stockholder opts out, that stockholder will receive cash distributions. Although
distributions paid in the form of additional shares of our common stock will
generally be subject to U.S. federal, state, and local taxes in the same manner
as cash distributions, stockholders participating in our DRIP will not receive
any corresponding cash distributions with which to pay any such applicable
taxes.
The Company’s Board determined not to declare a distribution for any quarter of
2021 and through March 31, 2022.
Tax characteristics of all distributions paid are reported to stockholders on
Form 1099 after the end of the calendar year. There were no distributions for
the year ended December 31, 2021. Distributions may be subject to
reclassification based on future dividends and operating results and will not be
determined until the end of the year.
Related Parties
On July 1, 2021, we entered into the Investment Advisory Agreement with the
Investment Advisor. The Company is externally managed by the Investment Advisor,
an affiliate of BC Partners, pursuant to the Investment Advisory Agreement. Mr.
Goldthorpe, an interested member of the Board, has a direct or indirect
pecuniary interest in the Investment Advisor. The Investment Advisor is a
registered investment adviser under the Investment Advisers Act of 1940, as
amended. The Investment Advisor is an affiliate of BC Partners Advisors L.P. for
U.S. regulatory purposes. Mount Logan Capital Inc. is the ultimate control
person of the Investment Advisor.
Under the Investment Advisory Agreement, fees payable to the Investment Advisor
equal (i) the Base Management Fee and (ii) the Incentive Fee. Unless earlier
terminated as described below, the Investment Advisory Agreement will remain in
effect from year-to-year if approved annually by a majority of the Board or by
the holders of a majority of the outstanding shares, and, in each case, a
majority of the independent directors.
Pursuant to the Administration Agreement, the Administrator provides
administrative services to the Company necessary for the operations of the
Company, which include providing to the Company office facilities, equipment and
clerical, bookkeeping and record keeping services at such facilities and such
other services as the Administrator, subject to review by the Board, shall from
time to time deem to be necessary or useful to perform its obligations under the
applicable Administration Agreement. The Administrator also provides to the
Company portfolio collection functions for and is responsible for the financial
and other records that the Company is required to maintain and prepares, prints
and disseminates reports to the Company’s stockholders and reports and all other
materials filed with the SEC.
For providing these services, facilities and personnel, the Company reimburses
the Administrator the allocable portion of overhead and other expenses incurred
by the Administrator in performing its obligations under the Administration
Agreement, including the Company’s allocable portion of the costs of
compensation and related expenses of its chief financial officer and chief
compliance officer and their respective staffs.
On October 23, 2018, the SEC issued an order granting an application for
exemptive relief to an affiliate of our Investment Advisor that allows BDCs
managed by the Investment Advisor, including Logan Ridge, to co-invest, subject
to the satisfaction of certain conditions, in certain private placement
transactions, with other funds managed by the Investment Advisor or its
affiliates and any future funds that are advised by the Investment Advisor or
its affiliated investment advisers. Under the terms of the exemptive order, in
order for Logan Ridge to participate in a co-investment transaction, a “required
majority” (as defined in Section 57(0) of the 1940 Act) of Logan Ridge’s
independent directors; must conclude that (i) the terms of the proposed
transaction, including the consideration to be paid, are reasonable and fair to
Logan Ridge and its stockholders and do not involve overreaching with respect of
Logan Ridge or its stockholders on the part of any person concerned, and (ii)
the proposed transaction is consistent with the interests of Logan Ridge’s
stockholders and is consistent with Logan Ridge’s investment objectives and
strategies and certain
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criteria established by the Board. We believe this relief may not only enhance
our ability to further our investment objectives and strategies, but may also
increase favorable investment opportunities for us, in part by allowing us to
participate in larger investments, together with our co-investment affiliates,
than would be available to us in the absence of such relief.
Prior to July 1, 2021, we were party to an administration agreement with our
then administrator, Capitala Advisors Corp. As administrator, Capitala Advisors
Corp. provided us with the office facilities and administrative services
necessary to conduct our day-to-day operations. On July 1, 2021, we entered into
a new Administration Agreement with our current Administrator, BC Partners
Management LLC. Pursuant to the terms of the Administration Agreement, our
Administrator provides us with the office facilities and administrative services
necessary to conduct our day-to-day operations.
Off-Balance Sheet Arrangements
As of March 31, 2022, the Company had outstanding unfunded commitments related
to debt investments in existing portfolio companies of $0.4 million to American
Academy Holdings, LLC, $4.7 million to Accordion Partners LLC, $0.9 million to
Bradshaw International, Inc., $3.1 million to Critical Nurse Staffing, LLC, $0.9
million to Keg Logistics LLC, $1.5 million to Premiere Imaging, LLC, and $3.0
million to Wealth Enhancement Group, LLC. As of December 31, 2021, the Company
had outstanding unfunded commitments related to debt investments in existing
portfolio companies of $9.0 million to Accordion Partners LLC, $0.7 million to
Bradshaw International, Inc., $3.1 million to Critical Nursing Staffing, Inc.,
$3.5 million to J5 Infrastructure Partners, LLC, $0.9 million to Keg Logistics
LLC, $2.5 million to Marble Point Credit Management LLC, $1.9 million to
Premiere Imaging, LLC, and $3.5 million to Wealth Enhancement Group, LLC.
We have no other off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.
Recent Developments
On April 1, 2022, the Company entered into a Note Purchase Agreement (the
“Purchase Agreement”) governing the issuance of $15.0 million in aggregate
principal amount of 5.25% Convertible Notes due 2032 (the “Convertible Notes”)
in a transaction exempt from registration pursuant to Section 4(a)(2) of the
Securities Act. The Convertible Notes have not been registered under the
Securities Act or any state securities laws and may not be reoffered or resold
in the United States absent registration or an applicable exemption from such
registration requirements. The Convertible Notes were delivered and paid for on
April 1, 2022. The Convertible Notes will mature on April 1, 2032 (the “Maturity
Date”). The net proceeds to the Company were $13,650,000, after deducting
estimated offering expenses. Capitalized terms used but not defined herein have
the meanings ascribed to them in the Purchase Agreement.
The Company obtained an Investment Grade rating from a Nationally Recognized
Statistical Rating Organization (“NRSRO”) with respect to the Convertible Notes.
The Convertible Notes have a fixed interest rate of 5.25% per annum payable
semi-annually on March 31 and September 30 of each year, commencing on September
30, 2022, subject to a step up of 0.75% per annum to the extent that the
Convertible Notes are downgraded below Investment Grade by an NRSRO or the
Convertible Notes no longer maintain a rating from an NRSRO. The Company will
also be required to pay an additional interest rate of 2.0% per annum (x) on any
overdue payment of interest and (y) during the continuance of an Event of
Default. The Company intends to use the net proceeds from the offering of the
Convertible Notes for general corporate purposes, which may include repaying
outstanding indebtedness, making opportunistic investments and paying corporate
expenses. In addition, on the occurrence of a Change in Control Repurchase Event
or Delisting Event, the Company will generally be required to make an offer to
purchase the outstanding Convertible Notes at a price equal to 100% of the
principal amount of such Convertible Notes plus accrued and unpaid interest to
the repurchase date.
On May 10, 2022, CBL, a direct, wholly owned, consolidated subsidiary of the
Company, amended its existing senior secured revolving credit agreement (the
“Amended KeyBank Credit Facility”), dated as of October 30, 2020 (and amended as
of July 1, 2021) with the Investment Advisor as collateral manager, the lenders
from time to time parties thereto (each a “Lender”), KeyBank National
Association, as administrative agent, and U.S. Bank National Association, as
custodian. Under the Amended KeyBank Credit Facility, the Lender agreed to
extend credit to CBL in an initial commitment equal to an aggregate principal
amount of $75.0 million. CBL may borrow up to an additional $125.0 million
through an incremental uncommitted accordion feature in accordance with the
terms and in the manner described in the Amended KeyBank Credit Facility.
The period during which the Lender may make loans to CBL under the Amended
KeyBank Credit Facility and will continue through May 12, 2025, unless there is
an earlier termination or event of default (the “Commitment Termination Date”).
The Amended KeyBank Credit Facility will mature on May 10, 2027, unless there is
an earlier termination or event of default. Borrowings under the Amended KeyBank
Credit Facility will bear interest at a floating forward-looking term rate equal
to term SOFR plus an applicable margin of 2.90% until the Commitment Termination
Date and 3.25% thereafter. The Company will also pay an unused commitment fee,
depending on the level of utilization, at a rate of 1.00%, 0.65%, or 0.35% per
annum on the unutilized portion of the aggregate commitments under the Amended
KeyBank Credit Facility.
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