CAPITALA FINANCE CORP. 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 Annual Report on Form 10-K. Except as otherwise specified, references to "we," "us," "our," "Capitala," or the "Company", refer toCapitala Finance Corp. Forward-Looking Statements This Annual Report on Form 10-K, 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 Annual Report on Form 10-K constitute forward-looking statements, which relate to future events or our performance or financial condition. The forward-looking statements contained in our Annual Report on Form 10-K involve risks and uncertainties, including statements as to: • our future operating results and the impact of the COVID-19 pandemic thereon;
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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;
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the impact of investments that we expect to make;
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our contractual arrangements and relationships with third parties;
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the dependence of our future success on the general economy and its impact on the industries in which we invest;
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our expected financings and investments;
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the adequacy of our cash resources and working capital; and
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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;
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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;
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interest rate volatility could adversely affect our results, particularly if we use leverage as part of our investment strategy; and
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the risks, uncertainties and other factors we identify in "Risk Factors" and elsewhere in this Annual Report on Form 10-K.
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
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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 Annual Report on Form 10-K 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. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. 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 orU.S. Securities and Exchange Commission ("SEC") rule or regulation. Overview We are aMaryland 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 byCapitala Investment Advisors, LLC (the "Investment Advisor"), andCapitala Advisors Corp. (the "Administrator") provides the administrative services necessary for us to operate. We provide capital to lower and traditional middle-market companies inthe 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$4.5 million and$30.0 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 publicU.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. The Small Business Credit Availability Act (the "SBCA") allows BDCs to decrease their asset coverage requirement from 200% to 150% (i.e. the amount of debt may not exceed 66.7% of the value of our total assets), if certain requirements are met. OnNovember 1, 2018 , our board of directors (the "Board"), including a "required majority"
(as
such term is defined in Section 57(o) of the 1940 Act) approved the application of the modified asset coverage, and as a result, our asset coverage requirements for senior securities was changed from 200% to 150%, effectiveNovember 1, 2019 . As ofDecember 31, 2020 , our asset coverage ratio was 187.2%. To maintain our regulated 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") forU.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 onMay 24, 2013 and completed our initial public offering ("IPO") onSeptember 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 Partners SBIC Fund III, L.P. ("Fund III") andCapitalSouth 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. 80
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OnSeptember 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 theU.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. OnMarch 1, 2019 , Fund II repaid its outstanding debentures guaranteed by the SBA ("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 untilMarch 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 forU.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 onOctober 30, 2020 , for the sole purpose of holding certain investments pledged as collateral under a senior secured revolving credit agreement withKeyBank 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 ofCapitala Finance Corp. Reverse Stock Split OnJuly 30, 2020 , the Company's board of directors (the "Board") approved a one-for-six reverse stock split of shares of the Company's common stock. Accordingly, onAugust 3, 2020 , the Company filed Articles of Amendment (the "Articles of Amendment") to its Articles of Amendment and Restatement with theState Department of Assessments and Taxation of the State of Maryland to effectuate a one-for-six reverse stock split (the "Reverse Stock Split") of the Company's shares of common stock, par value$0.01 per share (the "Shares"). The Reverse Stock Split became effective at5:00 p.m. Eastern Time onAugust 21, 2020 (the "Effective Time"). At the Effective Time, every six (6) issued and outstanding Shares were converted into one (1) Share. The Articles of Amendment also provided that there was no change in the par value of$0.01 per Share as a result of the Reverse Stock Split. No fractional shares of common stock were issued in connection with the Reverse Stock Split and fractional shares of common stock were eliminated by paying cash for the fair value of a fractional portion of Shares. The Reverse Stock Split applied to all of the Company's outstanding Shares and therefore did not affect any shareholder's relative ownership percentage. Retroactive Adjustments for Reverse Stock Split The share amount and per share amount of our common stock in the consolidated financial statements and notes have been retroactively adjusted for the Reverse Stock Split effected onAugust 21, 2020 for all periods presented. See Note 1 for more information regarding the Reverse Stock Split. 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 81
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consolidated financial statements have been prepared on the accrual basis of accounting in conformity withU.S. generally accepted accounting principles ("U.S. GAAP") and pursuant to the requirements for reporting on Form 10-K and Article 6 of Regulation S-X. The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries. The Company's financial statements as ofDecember 31, 2020 and 2019, and for the years endedDecember 31, 2020 , 2019, and 2018 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. 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. The Company did not consolidate its interest inCapitala Senior Loan Fund II, LLC ("CSLF II") during the periods it was in existence because the investment was not considered a substantially wholly owned investment company subsidiary. Further, CSLF II was a joint venture for which shared power existed relating to the decisions that most significantly impact the economic performance of the entity. See Note 4 to the consolidated financial statements for a description of the Company's investment in CSLF II. 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;
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the cost of effecting sales and repurchases of our shares and other securities;
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interest payable on debt, if any, to finance our investments;
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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;
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transfer agent and custodial fees;
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fees and expenses associated with marketing efforts;
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•
costs associated with our reporting and compliance obligations under the 1940 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act") other applicable federal and state securities laws and ongoing stock exchange listing fees;
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federal, state and local taxes;
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independent directors' fees and expenses;
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brokerage commissions;
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costs of proxy statements, stockholders' reports and other communications with stockholders;
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fidelity bond, directors' and officers' liability insurance, errors and omissions liability insurance and other insurance premiums;
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direct costs and expenses of administration, including printing, mailing, telephone and staff;
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fees and expenses associated with independent audits and outside legal costs; and
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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 ofU.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. 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 withU.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: 83
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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.
As a practical expedient, the Company used net asset value ("NAV") as the fair
value for its equity investment in CSLF II. CSLF II recorded its underlying
investments at fair value on a quarterly basis in accordance with the 1940 Act
and ASC 820.
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
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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:
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. The Company may elect to cease accruing PIK interest and continue
accruing interest income in cases where a loan is currently paying its interest
but, in management's judgment, there is a reasonable likelihood of principal
loss on the loan. Non- accrual loans are returned to accrual status when the
borrower's financial condition improves such that management believes current
interest and principal payments are expected to be collected.
Gains and losses on investment sales and paydowns: Realized gains and losses on
investments are recognized using the specific identification method.
Dividend income and paid-in-kind dividends: Dividend income is recognized on
the date dividends are declared. The Company holds preferred equity investments
in the portfolio that contain a 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.
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Original issue discount: Discounts received to par on loans purchased are capitalized and accreted into income over the life of the loan. Any remaining discount is accreted into income upon prepayment of the loan. Other income: Origination fees (to the extent services are performed to earn such income), amendment fees, consent fees, and other fees associated with investments in portfolio companies are recognized as income when the investment transaction closes. Prepayment penalties received by the Company for debt instruments repaid prior to the maturity date are recorded as income upon receipt. Income Taxes Prior to the Formation Transactions, the Legacy Funds were treated as partnerships forU.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 forU.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 fromU.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 nondeductibleU.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 onOctober 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 forU.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 endedDecember 31, 2020 , 2019, 2018, and 2017 remain subject to examination byU.S. federal, state, and local tax authorities. No interest expense or penalties have been assessed for the years endedDecember 31, 2020 , 2019, and 2018. 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 ofDecember 31, 2020 and 2019, the Company recorded a net deferred tax asset of$0.0 . For the years endedDecember 31, 2020 , 2019 and 2018, the Company recorded a deferred tax benefit (provision) of$0.0 ,$(0.6) million , and$1.9 million , respectively. As ofDecember 31, 2020 and 2019, the valuation allowance on the Company's deferred tax asset was$4.6 million and$3.2 million , respectively. During the years endedDecember 31, 2020 , 2019, and 2018 the Company recognized an increase in the valuation allowance of$1.4 million ,$2.8 million , and$0.0 respectively. In accordance with certain applicableU.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 86
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its entire distribution in cash. If these and certain other requirements are met, forU.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'sU.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 ofDecember 31, 2020 and 2019, there were no uncertain tax positions. The Company is required to determine whether a tax position of the Company is more likely-than-not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that could negatively impact the Company's net assets.U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial statement comparability among different entities. The Company has concluded that it was not necessary to record a liability for any such tax positions as ofDecember 31, 2020 or 2019. 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 ofDecember 31, 2020 , our portfolio consisted of investments in 36 portfolio companies with a fair value of approximately$274.7 million . Most of the Company's debt investments are structured as first lien loans. First lien loans may contain some minimum amount of principal amortization, excess cash flow sweep feature, prepayment penalties, or any combination of the foregoing. First lien loans are secured by a first priority lien in existing and future assets of the borrower and may take the form of term loans, 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 ofDecember 31, 2020 , 14.5% of the fair value of our first lien loans consisted of last-out loans. As ofDecember 31, 2019 , 18.1% 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 year endedDecember 31, 2020 , we made approximately$21.1 million of investments and had approximately$75.8 million in repayments and sales of investments resulting in net repayments and sales of approximately$54.7 million for the year. During the year endedDecember 31, 2019 , we made approximately 87
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$77.8 million of investments and had approximately$128.1 million in repayments and sales resulting in net repayments and sales of approximately$50.3 million for the year. As ofDecember 31, 2020 , our debt investment portfolio, which represented 75.2% of the fair value of our total portfolio, had a weighted average annualized yield of approximately 10.0%. As ofDecember 31, 2020 , 48.9% of the fair value of our debt investment portfolio was bearing a fixed rate of interest. As ofDecember 31, 2019 , our debt investment portfolio, which represented 78.6% of the fair value of our total portfolio, had a weighted average annualized yield of approximately 11.5%. As ofDecember 31, 2019 , 37.2% 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 ofDecember 31, 2020 , the Board approved the fair value of our investment portfolio of approximately$274.7 million in good faith in accordance with our valuation procedures. The Board approved the fair value of our investment portfolio as ofDecember 31, 2020 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. The COVID-19 pandemic is an unprecedented circumstance that materially impacts the fair value of our investments. As a result, the fair value of our portfolio investments may be further negatively impacted afterDecember 31, 2020 by circumstances and events that are not yet known. The COVID-19 pandemic may also impact our portfolio companies' ability to pay their respective contractual obligations, including principal and interest due to us, and some portfolio companies may require interest or amortization deferrals in order to fulfill short-term liquidity needs in response to the COVID-19 pandemic. We are working with each of our portfolio companies to help them access short-term liquidity through interest deferrals, funding on unused lines of credit, and other sources of liquidity. As ofDecember 31, 2020 , we had debt investments in four portfolio companies on non-accrual status with an aggregate amortized cost of$37.5 million and an aggregate fair value of$20.8 million , which represented 13.5% and 7.6% of the investment portfolio, respectively. As ofDecember 31, 2019 , we had no investments on non-accrual status. The increase in non-accrual investments fromDecember 31, 2019 toDecember 31, 2020 was largely driven by the economic impact of the COVID-19 pandemic. The following table summarizes the amortized cost and the fair value of investments as ofDecember 31, 2020 (dollars in thousands): Investments at Percentage of Investments at Percentage of Amortized Cost Total Fair Value Total First Lien Debt$ 185,108 66.7%$ 167,418 60.9% Second Lien Debt 39,026 14.0 39,209 14.3 Equity and Warrants 53,518 19.3 68,065 24.8 Total$ 277,652 100.0%$ 274,692 100.0%
The following table summarizes the amortized cost and the fair value of
investments as of
Investments at Percentage of Investments at Percentage of
Amortized Cost Total Fair Value Total
First Lien Debt $ 235,646 66.6% $ 231,203 63.8%
Second Lien Debt 54,079 15.3 53,857 14.8
Equity and Warrants 50,556 14.3 63,841 17.6
Capitala Senior Loan Fund II, LLC 13,600 3.8 13,631 3.8
Total $ 353,881 100.0% $ 362,532 100.0%
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The following table shows the portfolio composition by industry grouping at fair
value as of
December 31, 2020 December 31, 2019
Investments at Percentage of Investments at Percentage of
Fair Value Total Portfolio Fair Value Total Portfolio
Business Services $ 36,794 13.4% $ 40,410 11.2%
Healthcare 23,899 8.7 27,928 7.7
Sales & Marketing Services 20,947 7.6 19,291 5.3
Financial Services 15,721 5.7 29,517 8.1
Consumer Products 15,649 5.7 25,118 6.9
Automobile Part Manufacturer 14,935 5.5 15,056 4.2
Security System Services 14,727 5.4 16,063 4.4
IT Consulting 13,199 4.8 13,773 3.8
Multi-platform media and consumer products 13,000 4.7 13,000 3.6
Textile Equipment Manufacturer 11,868 4.3 11,564 3.2
Government Services 11,381 4.1 11,279 3.1
Information Technology 11,154 4.1 10,009 2.8
Healthcare Management 10,673 3.9 12,607 3.5
Entertainment 10,241 3.7 10,912 3.0
Electronic Machine Repair 8,759 3.2 6,100 1.7
Wireless Deployment Services 6,948 2.5 7,000 1.9
Testing laboratories 6,449 2.4 7,026 1.9
Medical Device Distributor 5,019 1.8 4,904 1.4
QSR Franchisor 4,707 1.7 1,881 0.5
Advertising & Marketing Services 4,212 1.5 4,262 1.2
Data Services 3,856 1.4 4,749 1.3
Home Repair Parts Manufacturer 2,461 0.9 2,489 0.7
Online Merchandise Retailer 2,253 0.8 2,877 0.8
Footwear Retail 2,011 0.7 3,326 0.9
Oil & Gas Engineering and Consulting Services 1,418 0.5 5,908 1.6
Household Product Manufacturer 758 0.3 758 0.2
General Industrial 670 0.3 838 0.2
Oil & Gas Services 493 0.2 2,273 0.6
Data Processing & Digital Marketing 490 0.2 708 0.2
Food Product Manufacturer - - 17,609 4.9
Investment Funds - - 13,631 3.8
Retail - - 10,045 2.8
Restaurant - - 4,697 1.3
Logistics - - 2,924 0.8
Computer Supply Retail - - 1,490 0.4
Professional and Personal Digital Imaging - - 510 0.1
Total $ 274,692 100.0% $ 362,532 100.0%
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All investments made by the Company as ofDecember 31, 2020 and 2019 were made in portfolio companies located in theU.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 as ofDecember 31, 2020 and 2019 (dollars in thousands): AtDecember 31, 2020 At
Investments at Percentage of Investments at Percentage of
Fair Value Total Portfolio Fair Value Total Portfolio
South $ 140,048 51.0% $ 165,963 45.8%
West 50,212 18.3 70,102 19.3
Midwest 48,255 17.6 55,283 15.3
Northeast 36,177 13.1 71,184 19.6
Total $ 274,692 100.0% $ 362,532 100.0%
In addition to various risk management tools, our Investment Advisor uses an
investment rating system to characterize and monitor our expected level of
return on each investment in our portfolio.
As part of our valuation procedures, we risk rate all of our investments. In
general, our investment rating system uses a scale of 1 to 5, with 1 being the
lowest probability of default and principal loss. Our internal rating is not an
exact system, but it is used internally to estimate the probability of:
(i) default on our debt securities and (ii) loss of our debt principal, in the
event of a default. In general, our internal rating system may also assist our
valuation team in its determination of the estimated fair value of equity
securities or equity-like securities. Our internal risk rating system generally
encompasses both qualitative and quantitative aspects of our portfolio
companies.
Our internal investment rating system incorporates the following five
categories:
Investment
Rating Definition1 In general, the investment may be performing above our internal expectations. Full return of principal and interest is expected. Capital gain is expected.
2 In general, the investment may be performing within our internal expectations, and potential risks to the applicable investment are considered to be neutral or favorable compared to any potential risks at the time of the original investment. All new investments are initially given this rating.
3 In general, the investment may be performing below our internal expectations and therefore, investments in this category may require closer internal monitoring; however, the valuation team believes that no loss of investment return (interest and/or dividends) or principal is expected. The investment also may be out of compliance with certain financial covenants.
4 In general, the investment may be performing below internal expectations and quantitative or qualitative risks may have increased substantially since the original investment. Loss of some or all principal is expected.
5 In general, the investment may be performing substantially below our internal expectations and a number of quantitative or qualitative risks may have increased substantially since the original investment. Loss of some or all principal is expected.
Our Investment Advisor will monitor and, when appropriate, change the investment
ratings assigned to each investment in our portfolio. In connection with our
valuation process, our Investment Advisor will review these investment ratings
on a quarterly basis. The investment rating of a particular investment should
not, however, be deemed to be a guarantee of the investment's future
performance.
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The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as ofDecember 31, 2020 and 2019 (dollars in thousands): As of December 31, 2020 As of December 31, 2019 Percentage of Percentage of Investments at Total Investments at Total Investment Rating Fair Value Investments Fair Value Investments 1$ 96,703 35.2%$ 85,688 23.6% 2 140,111 51.0 219,855 60.7 3 17,111 6.2 56,989 15.7 4 20,767 7.6 - - 5 - - - - Total$ 274,692 100.0%$ 362,532 100.0%Capitala Senior Loan Fund II, LLC OnDecember 20, 2018 , the Company andTrinity Universal Insurance Company ("Trinity"), a subsidiary of Kemper Corporation, entered into a limited liability company agreement (the "LLC Agreement") to co-manage CSLF II. The purpose and design of the joint venture was to invest primarily in senior secured first-out loans. The Company and Trinity committed to provide$25.0 million of equity to CSLF II, with the Company providing$20.0 million and Trinity providing$5.0 million . The Company and Trinity each appointed two members to CSLF II's four-person board of directors and investment committee. All material decisions with respect to CSLF II, including those involving its investment portfolio, required approval of a member on the board of directors and investment committee of at least one member representing the Company and Trinity, respectively. InMay 2020 , the Company and Trinity elected to wind-down operations of CSLF II. OnJune 1, 2020 , CSLF II sold its existing assets with the Company and Trinity each purchasing approximately 50% of CSLF II's debt investments at their par value. OnJune 12, 2020 , CSLF II declared final distributions and returned all remaining capital of$13.1 million and$3.3 million to the Company and Trinity, respectively. For the years endedDecember 31, 2020 and 2019, the Company received$0.0 and$1.0 million , respectively, in dividend income from its equity interest in CSLF II. As ofDecember 31, 2019 ,$13.6 million and$3.4 million in equity capital had been contributed by the Company and Trinity, respectively. As ofDecember 31, 2019 , the Company and Trinity had$6.4 million and$1.6 million of unfunded equity capital commitments outstanding, respectively. The Company's equity investment in CSLF II was not redeemable. OnJune 12, 2020 , the capital commitments for the Company and Trinity were terminated. OnSeptember 3, 2019 , CSLF II entered into a senior secured revolving credit facility (the "CSLF II Credit Facility") with KeyBank Specialty Finance Lending, an affiliate of KeyCorp. The CSLF II Credit Facility provided for borrowings up to$60.0 million , subject to certain borrowing base restrictions. Borrowings under the CSLF II Credit Facility bore interest at a rate of one-month LIBOR + 2.25%. Prior to the termination of the CSLF II Credit Facility, CSLF II incurred unused fees of .35% when utilization of the CSLF II Credit Facility exceeded 50% and .65% when utilization of the CSLF II Credit Facility was less than 50%. OnJune 5, 2020 , CSLF II terminated the CSLF II Credit Facility and repaid all amounts outstanding. As ofDecember 31, 2019 ,$12.7 million was outstanding under the CSLF II Credit Facility. For the years endedDecember 31, 2020 and 2019, CSLF II incurred interest and financing expenses of$1.1 million and$0.2 million , respectively. OnSeptember 3, 2019 , the Company and Trinity committed to provide$25.0 million of subordinated debt (the "Subordinated Notes") to CSLF II, with the Company providing$5.0 million and Trinity providing$20.0 million . The Subordinated Notes were scheduled to mature onSeptember 3, 2024 , however, the Subordinated Notes were terminated onJune 12, 2020 . As ofDecember 31, 2019 ,$0.0 were outstanding on the Subordinated Notes. As ofDecember 31, 2019 , the Company and Trinity had$5.0 million and$20.0 million of unfunded commitments related to the 91
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Subordinated Notes, respectively. For the years endedDecember 31, 2020 and 2019, CSLF II did not incur any interest and financing expenses related to the Subordinated Notes. Below is a summary of CSLF II's portfolio as ofDecember 31, 2019 (dollars in thousands): December 31, 2019 First lien loans(1)$ 28,396 Weighted average current interest rate on first lien loans
6.4%
Number of portfolio companies
5
Largest portfolio company investment(1) $
7,443
Total of five largest portfolio company investments(1)$ 28,396 (1)
Based on principal amount outstanding at period end.
Below is CSLF II's schedule of investments as ofDecember 31, 2019 (dollars in thousands): Principal Portfolio Company Industry Type of Investment Amount Cost Fair Value Investments at Fair Value Freedom Electronics, Electronic First Lien Debt (7.0% Cash LLC Machine (1 month LIBOR + 5.0%, Repair 2.0% Floor), Due 12/20/23)$ 5,445 $ 5,445 $ 5,445 Installs, LLC Logistics First Lien Debt (5.8% Cash (1 month LIBOR + 4.0%, 1.8% Floor), Due 6/20/23) 7,443 7,443 7,443 RAM Payment, LLC Financial First Lien Debt (6.7% Cash Services (1 month LIBOR + 5.0%, 1.5% Floor), Due 1/4/24) 6,653 6,653 6,653
System (1 month LIBOR + 3.8%,
Services 1.8% Floor), Due 11/22/24) 4,400 4,400 4,400
U.S. BioTek Testing First Lien Debt (7.0% Cash
2.0% Floor), Due 12/14/23) 4,455 4,455 4,455
TOTAL
INVESTMENTS $ 28,396 $ 28,396 $ 28,396
(1)
The investment has a
Below are the statements of assets and liabilities for CSLF II as of
As of
December 31, 2020 December 31, 2019
ASSETS
Investments at fair value (amortized cost of $0 and $28,396 , respectively) $ - $ 28,396
Cash and cash equivalents - 704
Interest receivable - 151
Other assets - 7
Total assets $ - $ 29,258
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As of
$ - $ 12,079
Interest and financing fees payable - 113
Accounts payable - 27
Total liabilities $ - $ 12,219
NET ASSETS
Members' capital $ - $ 17,039
Total net assets $ - $ 17,039 Below are the statements of operations for CSLF II (dollars in thousands):
For the Year Ended For the Year Ended
December 31, 2020 December 31, 2019
INVESTMENT INCOME
Interest income $ 650 $ 1,372
Fee income 5 175
Total investment income $ 655 $ 1,547
EXPENSES
Interest and financing expenses $ 1,135 $ 151
General and administrative expenses 164 176
Total expenses $ 1,299 $ 327
NET INVESTMENT (LOSS) INCOME $ (644) $ 1,220
NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (644) $ 1,220
Results of Operations
Our operating results for the years ended December 31, 2020 and 2019 were as
follows (dollars in thousands):
For the Years Ended December 31,
2020 2019
Total investment income $ 26,446 $ 44,035
Total expenses, net of incentive fee waiver 26,388 30,992
Net investment income 58 13,043
Net realized loss on investments (24,049) (19,756)
Net unrealized depreciation on investments (11,611) (20,306)
Tax provision - (628)
Net realized gain on extinguishment of debt 155 -
Net decrease in net assets resulting from operations
$ (27,647) 93
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Investment income The composition of our investment income for the years endedDecember 31, 2020 and 2019 was as follows (dollars in thousands): For the Years Ended December 31, 2020 2019 Interest income$ 23,669 $ 36,106 Fee income 778 1,470 Payment-in-kind interest and dividend income 1,923
2,962
Dividend income 25
3,299
Interest from cash and cash equivalents 51 198 Total investment income$ 26,446 $ 44,035 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. 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 year endedDecember 31, 2020 , total investment income decreased by$17.6 million , or 39.9%, compared to the year endedDecember 31, 2019 . The decrease from the prior year was driven primarily by a decrease in interest income, from$36.1 million for the year endedDecember 31, 2019 to$23.7 million for the year endedDecember 31, 2020 . The decline in interest income is primarily due to lower average outstanding debt investments for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . PIK income declined from$3.0 million for the year endedDecember 31, 2019 to$1.9 million for the year endedDecember 31, 2020 . The decrease in PIK income was due to a decline in investments with a contractual PIK rate. For the year endedDecember 31, 2020 , we generated$0.2 million in origination fees from new deployments and$0.6 million in other fees. Comparatively, for the year endedDecember 31, 2019 , we generated$1.2 million in origination fees from new deployments and$0.3 million in other fees. Dividend income decreased from$3.3 million for the year endedDecember 31, 2019 to$25.0 thousand for the year endedDecember 31, 2020 due to$1.0 million in dividends from our investment in CSLF II and several one-time dividends received from portfolio companies during the year endedDecember 31, 2019 . 94
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Operating expenses The composition of our expenses for the years endedDecember 31, 2020 and 2019 was as follows (dollars in thousands): For the Years Ended
2020 2019
Interest and financing expenses$ 15,144 $ 17,121 Base management fee 6,428
7,967
Incentive fees, net of incentive fee waiver -
1,209
Administrative service fees 1,400
1,400
General and administrative expenses 3,416
3,295
Total expenses, net of fee waiver$ 26,388
For the year endedDecember 31, 2020 , operating expenses decreased by$4.6 million , or 14.9%, compared to the year endedDecember 31, 2019 . Interest and financing expenses declined from$17.1 million for the year endedDecember 31, 2019 to$15.1 million for the year endedDecember 31, 2020 due primarily to lower average debt outstanding during the period, offset in part by$1.1 million in accelerated deferred financing expenses from the termination of the ING Credit Facility during the year endedDecember 31, 2020 . Our base management fee declined from$8.0 million for the year endedDecember 31, 2019 to$6.4 million for the year endedDecember 31, 2020 due to lower average assets under management. Incentive fees, net of incentive fee waiver, decreased from$1.2 million to$0.0 primarily due to better net investment income returns in relation to our net asset value for the year endedDecember 31, 2019 . Administrative services fees were the same for the years endedDecember 31, 2020 and 2019 at$1.4 million . General and administrative expenses increased from$3.3 million for the year endedDecember 31, 2019 to$3.4 million for the year endedDecember 31, 2020 . Net realized losses on sales of investments During the years endedDecember 31, 2020 and 2019, we recognized$(24.0) million and$(19.8) million of net realized losses on our portfolio investments, respectively. Net unrealized depreciation on investments Net change in unrealized depreciation on investments reflects the net change in the fair value of our investment portfolio. For the years endedDecember 31, 2020 and 2019, we had$(11.6) million and$(20.3) million of unrealized depreciation on investments, respectively. Tax provision For the years endedDecember 31, 2020 and 2019, we recorded a tax provision of$0.0 and$(0.6) million , respectively. Changes in net assets resulting from operations For the years endedDecember 31, 2020 and 2019, we recorded a net decrease in net assets resulting from operations of$(35.4) million and$(27.6) million , respectively. Based on the weighted average shares of common stock outstanding for the years endedDecember 31, 2020 and 2019, our per share net decrease in net assets resulting from operations was$(13.08) and$(10.29) , respectively. Per share data has been adjusted for the periods shown to reflect the one-for-six reverse stock split effected onAugust 21, 2020 on a retroactive basis. For the years endedDecember 31, 2019 and 2018 The comparison of the fiscal years endedDecember 31, 2019 and 2018 can be found in our annual report on Form 10-K for the fiscal year endedDecember 31, 2019 located within Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, which is incorporated by reference herein. 95
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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 throughDecember 31, 2020 . ING Credit Facility OnOctober 17, 2014 , the Company entered into a senior secured revolving credit agreement (as amended, the "ING Credit Facility") withING Capital, LLC , as administrative agent, arranger, and bookrunner, and the lenders party thereto. The ING Credit Facility was set to mature onApril 30, 2022 . OnJune 19, 2020 , the Company unilaterally terminated the ING Credit Facility. KeyBank Credit Facility OnOctober 30, 2020 , CBL, a direct, wholly owned, consolidated subsidiary of the Company, entered into the KeyBank Credit Facility with the Investment Adviser, as collateral manager, the lenders from time to time parties thereto (each a "Lender"),KeyBank National Association , as administrative agent, andU.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 as ofOctober 30, 2020 . CBL may, on any business day prior toOctober 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 onOctober 30, 2020 and will continue throughOctober 28, 2022 , unless there is an earlier termination or event of default. The KeyBank Credit Facility matures onOctober 28, 2023 , unless there is an earlier termination or event of default. Borrowings under the KeyBank Credit Facility bear interest at one-month LIBOR plus 3.5%. As ofDecember 31, 2020 , the Company had$0 outstanding and$25.0 million available under the KeyBank Credit Facility. 2022 Notes OnMay 16, 2017 , we issued$70.0 million in aggregate principal amount of 6.0% fixed-rate notes dueMay 31, 2022 (the "2022 Notes"). OnMay 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 onMay 31, 2022 and may be redeemed in whole or in part at any time or from time to time at our option on or afterMay 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. As ofDecember 31, 2020 , the Company had approximately$72.8 million in aggregate principal amount of 2022 Notes outstanding. 2022 Convertible Notes OnMay 26, 2017 , we issued$50.0 million in aggregate principal amount of 5.75% fixed-rate convertible notes dueMay 31, 2022 (the "2022 Convertible Notes"). OnJune 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 theNASDAQ Capital Market under the trading symbol "CPTAG" with a par value of$25.00 per share. As ofDecember 31, 2020 , the Company had approximately$52.1 million in aggregate principal amount of 2022 Convertible Notes outstanding. Bond Repurchase Program OnJuly 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 will terminate upon 96
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the earlier of (i)July 30, 2021 or (ii) the repurchase of an aggregate of$10.0 million worth of 2022 Notes and/or 2022 Convertible Notes. During the year endedDecember 31, 2020 , the Company purchased approximately$2.2 million of outstanding principal of the 2022 Notes under the Bond Repurchase Program, resulting in a net realized gain of$0.2 million . During the year endedDecember 31, 2020 , the Company did not purchase any of the 2022 Convertible Notes. SBA-guaranteed debentures As ofDecember 31, 2020 , Fund III had$75.0 million in regulatory capital and$91.0 million in SBA-guaranteed debentures outstanding. 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. OnJune 10, 2014 , we received an exemptive order from theSEC exempting us, Fund II and Fund III from certain provisions of the 1940 Act (including an exemptive order granting relief from the asset coverage requirements for certain indebtedness issued by Fund II and Fund III as SBICs) and from certain reporting requirements mandated by the 1934 Act, with respect to Fund II and Fund III. We intend to comply with the conditions of the order. ATM Program OnDecember 31, 2019 , we entered into an open market sale agreementSM withJefferies LLC pursuant to which we may issue and sell up to$50.0 million in aggregate amount of shares of our common stock in amounts, and at times, to be determined by us (the "ATM Program"). Actual sales in this ATM Program will depend on a variety of factors to be determined by us including market conditions, the trading price of our common stock and determinations by us of the appropriate sources of funding. We may issue shares of our common stock at a price below the then current NAV per share pursuant to the ATM Program. There were no sales of shares of our common stock under the ATM Program during the year endedDecember 31, 2020 . 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. The SBCA allows BDCs to decrease their asset coverage requirement from 200% to 150% (i.e. the amount of debt may not exceed 66.7% of the value of total assets), if certain requirements are met. OnNovember 1, 2018 , the Board, including a "required majority" (as such term is defined in Section 57(o) of the 1940 Act) approved the application of the modified asset coverage and as a result, our asset coverage requirements for senior securities was changed from 200% to 150%, effectiveNovember 1, 2019 . As ofDecember 31, 2020 , our asset coverage ratio was 187.2%. If our asset coverage ratio falls below 150% due a decline in the fair market of our portfolio, including as the result of the economic impact caused by the COVID-19 pandemic, we may be limited in our ability to raise additional debt. As ofDecember 31, 2020 , we had$49.9 million in cash and cash equivalents, and our net assets totaled$108.9 million . 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. 97
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A summary of our significant contractual payment obligations as of
Contractual Obligations Payments Due by Period
Less Than 1 - 3 3 - 5 More Than
1 Year Years Years 5 Years Total
SBA-guaranteed debentures $ 6,000 $ 85,000 $ - $ - $ 91,000
2022 Notes - 72,833 - - 72,833
2022 Convertible Notes - 52,088 - - 52,088
KeyBank Credit Facility - - - - -
Total Contractual Obligations
$ -
Senior Securities Information about the Company's senior securities as ofDecember 31, 2020 , 2019, 2018, 2017, 2016, 2015, 2014 and 2013, and information about Fund II's and Fund III's senior securities as ofDecember 31, 2012 and 2011 are shown in the following table. Assets Involuntary Average Total Amount Coverage Liquidation Market Class and Year Outstanding(1) Per Unit(2)(7) Preference per Unit(3) Value per Unit(4) (in thousands)Capitala Finance Corp. KeyBank Credit Facility(5) 2020 $ -$ 1,900 - N/A ING Credit Facility(6) 2019 - 2,200 - N/A 2018 10,000 2,400 - N/A 2017 9,000 2,600 - N/A 2016 44,000 2,600 - N/A 2015 70,000 2,500 - N/A 2014 - 1,800 - N/A 2022 Notes 2020$ 72,833 $ 1,900 - $ 867 2019 75,000 2,200 - 1,000 2018 75,000 2,400 - 996 2017 75,000 2,600 - 1,014 2022 Convertible Notes 2020$ 52,088 $ 1,900 - $ 856 2019 52,088 2,200 - 994 2018 52,088 2,400 - 984 2017 52,088 2,600 - 1,001 SBA-guaranteed debentures 2020$ 91,000 $ N/A - N/A 2019 150,000 N/A - N/A 2018 165,700 N/A - N/A 2017 170,700 N/A - N/A 2016 170,700 N/A - N/A 98
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Assets Involuntary Average
Total Amount Coverage Liquidation Market
Class and Year Outstanding(1) Per Unit(2)(7) Preference per Unit(3) Value per Unit(4)
(in thousands)
2015 184,200 N/A - N/A
2014 192,200 1,800 - N/A
2013 202,200 2,300 - N/A
Fund II SBA-guaranteed debentures
2012 $ 52,200 $ 2,000 - N/A
2011 52,200 1,600 - N/A
Fund III SBA-guaranteed debentures
2012 $ 125,000 $ 1,700 - N/A
2011 90,000 1,700 - N/A
(1)Total amount of each class of senior securities outstanding at the end of the period presented.
(2)
Asset coverage per unit is the ratio of the carrying value of our total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per$1,000 of indebtedness. Amounts are rounded to the nearest$1,000 .
(3)
The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The "- " indicates information that theSEC expressly does not require to be disclosed for certain types of senior securities.
(4)
Not applicable except for the 2021 Notes, the 2022 Notes and the 2022 Convertible Notes which are publicly traded. The Average Market Value Per Unit is calculated by taking the daily average closing price during the period and dividing it bytwenty-five dollars per share and multiplying the result by one thousand to determine a unit price per thousand consistent with Asset Coverage Per Unit.
(5)
As ofDecember 31, 2020 , there was no outstanding balance on the KeyBank Credit Facility. As ofMarch 5, 2021 there was no outstanding balance on theKeyBank Credit Facility.
(6)
On
(7)
We have excluded our SBA-guaranteed debentures from the asset coverage calculation as ofDecember 31, 2020 , 2019, 2018, 2017, 2016, and 2015 pursuant to the exemptive relief granted by theSEC inJune 2014 that permits us to exclude such debentures from the definition of senior securities in the asset coverage ratio we are required to satisfy under the 1940 Act.
Distributions
In order to qualify as a RIC and to avoid corporate-levelU.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 onOctober 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 noU.S. federal income tax to avoid aU.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 fromOctober 30, 2014 untilMarch 30, 2020 . As announced onApril 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. OnApril 30, 2020 ,July 30, 2020 , andOctober 29, 2020 the Company's Board determined not to declare a distribution for the second quarter, third quarter, or fourth quarter, respectively, due to the impact of the COVID-19 pandemic on the Company's expected net investment income. 99
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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 forU.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 toU.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 following tables summarize our distributions declared fromJanuary 1, 2018 throughDecember 31, 2020 : Amount Date Declared Record Date Payment Date Per Share(1) January 2, 2020 January 24, 2020 January 30, 2020$ 0.50 January 2, 2020 February 20, 2020 February 27, 2020 0.50 January 2, 2020 March 23, 2020 March 30, 2020 0.50 Total Distributions Declared and Distributed for 2020$ 1.50 Amount Date Declared Record Date Payment Date Per Share(1)
January 2, 2019 January 24, 2019 January 30, 2019$ 0.50 January 2, 2019 February 20, 2019 February 27, 2019 0.50 January 2, 2019 March 21, 2019 March 28, 2019 0.50 April 1, 2019 April 22, 2019 April 29, 2019 0.50 April 1, 2019 May 23, 2019 May 30, 2019 0.50 April 1, 2019 June 20, 2019 June 27, 2019 0.50 July 1, 2019 July 23, 2019 July 30, 2019 0.50 July 1, 2019 August 22, 2019 August 29, 2019 0.50 July 1, 2019 September 20, 2019 September 27, 2019 0.50 October 1, 2019 October 22, 2019 October 29, 2019 0.50 October 1, 2019 November 22, 2019 November 29, 2019 0.50 October 1, 2019 December 23, 2019 December 30, 2019 0.50 Total Distributions Declared and Distributed for 2019$ 6.00 100
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Amount
Date Declared Record Date Payment Date Per Share(1)
January 2, 2018 January 22, 2018 January 30, 2018 $ 0.50
January 2, 2018 February 20, 2018 February 27, 2018 0.50
January 2, 2018 March 23, 2018 March 29, 2018 0.50
April 2, 2018 April 19, 2018 April 27, 2018 0.50
April 2, 2018 May 22, 2018 May 30, 2018 0.50
April 2, 2018 June 20, 2018 June 28, 2018 0.50
July 2, 2018 July 23, 2018 July 30, 2018 0.50
July 2, 2018 August 23, 2018 August 30, 2018 0.50
July 2, 2018 September 20, 2018 September 27, 2018 0.50
October 1, 2018 October 23, 2018 October 30, 2018 0.50
October 1, 2018 November 21, 2018 November 29, 2018 0.50
October 1, 2018 December 20, 2018 December 28, 2018 0.50
Total Distributions Declared and Distributed
for 2018 $ 6.00
(1)
Amount per share has been adjusted for the periods shown to reflect the
one-for-six reverse stock split effected on August 21, 2020 on a retroactive
basis, as described in Note 1 to our consolidated financial statements included
in this Annual Report on Form 10-K.
Tax characteristics of all distributions paid are reported to stockholders on
Form 1099 after the end of the calendar year. For the year ended December 31,
2020 , we estimate that total distributions of $4.1 million were comprised of
approximately $0.7 million from ordinary income and $3.4 million from return of
capital. For the year ended December 31, 2019 , total distributions of
$16.1 million were comprised of approximately $13.4 million from ordinary income
and $2.7 million from return of capital. For the year ended December 31, 2018 ,
total distributions of $16.0 million , were comprised 100% of ordinary income.
Related Parties
We have entered into the Investment Advisory Agreement with the Investment
Advisor. Joseph B. Alala , our chief executive officer and chairman of our Board,
is the managing partner and chief investment officer of the Investment Advisor,
and M. Hunt Broyhill , a member of our Board, has an indirect controlling
interest in the Investment Advisor.
In addition, an affiliate of the Investment Advisor also manages CapitalSouth
Partners SBIC Fund IV, L.P. ("Fund IV"), a private investment limited
partnership which provides financing solutions to smaller and lower
middle-market companies that had its first closing in March 2013 and obtained
SBA approval for its SBIC license in April 2013 . In addition to Fund IV,
affiliates of the Investment Advisor may manage several affiliated funds whereby
institutional limited partners in Fund IV have the opportunity to co-invest with
Fund IV in portfolio investments. An affiliate of the Investment Advisor also
manages Capitala Private Credit Fund V, L.P. ("Fund V"), a private investment
limited partnership, and a private investment vehicle (referred to herein as
"Capitala Specialty Lending Corp " or "CSLC"), both of which provide financing
solutions to lower middle-market and traditional middle-market companies. The
Investment Advisor and its affiliates may also manage other funds in the future
that may have investment mandates that are similar, in whole and in part, with
ours. To the extent permitted by the 1940 Act and interpretation of the SEC
staff, the Investment Advisor and its affiliates may determine that an
investment is appropriate for us and for one or more of those other funds. In
such event, depending on the availability of such investment and other
appropriate factors, the Investment Advisor or its affiliates may determine that
we should invest side-by-side with one or more other funds. Any such investments
will be made only to the extent permitted by applicable law and interpretive
positions of the SEC and its staff, and consistent with the Investment Advisor's
allocation procedures. We expect to make, and have made, co-investments with
Fund IV, Fund V, and/or CSLC to the extent their respective investment
strategies align with ours.
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OnSeptember 10, 2015 , we, Fund II, Fund III, Fund V, and the Investment Advisor filed an application for exemptive relief with theSEC to permit an investment fund and one or more other affiliated investment funds, including future affiliated investment funds, to participate in the same investment opportunities through a proposed co-investment program where such participation would otherwise be prohibited under the 1940 Act. OnJune 1, 2016 , theSEC issued an order (the "Order") permitting this relief. Pursuant to the Order, we are permitted to co-invest in such investment opportunities with our affiliates if a "required majority" (as defined in Section 57(o) of the 1940 Act) of our directors each of which is not considered an "interested person", as such term is defined under the 1940 Act (the "independent directors") make certain conclusions in connection with a co-investment transaction, including, but not limited to, that (1) the terms of the potential co-investment transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching in respect of us or our stockholders on the part of any person concerned, and (2) the potential co-investment transaction is consistent with the interests of our stockholders and is consistent with our then-current investment objective and strategies. We have entered into a license agreement with the Investment Advisor, pursuant to which the Investment Advisor has agreed to grant us a non-exclusive, royalty-free license to use the name "Capitala." We have entered into the Administration Agreement with our Administrator. 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.Mr. Alala , our chief executive officer, and chairman of our Board, is the chief executive officer, president and a director of our Administrator. Off-Balance Sheet Arrangements As ofDecember 31, 2020 , the Company had outstanding unfunded commitments related to debt investments in existing portfolio companies of$4.3 million (Rapid Fire Protection, Inc. ),$3.5 million (J5 Infrastructure Partners, LLC ),$1.0 million (Freedom Electronics, LLC ), and$1.0 million (U.S. BioTek Laboratories, LLC ). As ofDecember 31, 2019 , the Company had outstanding unfunded commitments related to debt and equity investments in existing portfolio companies of$11.4 million (CSLF II),$4.5 million (Rapid Fire Protection, Inc. ),$3.5 million (J5 Infrastructure Partners, LLC ),$2.6 million (BigMouth, Inc. ),$1.0 million (Freedom Electronics, LLC ),$1.0 million (U.S. BioTek Laboratories, LLC ), and$0.5 million (Jurassic Quest Holdings, 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 Portfolio Activity OnJanuary 28, 2021 , the Company's first lien debt investment inBurgaflex Holdings, LLC was repaid at par. Borrowings OnFebruary 24, 2021 , the Company repaid$20.0 million in outstanding SBA-guaranteed debentures,$6.0 million that was scheduled to mature onMarch 1, 2021 and$14.0 million that was scheduled to mature onMarch 1, 2022 . 102
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ITEM 7A.
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