FIDUS INVESTMENT CORPORATION The following discussion and analysis of our financial condition and results of operations should be read in conjunction withFidus Investment Corporation's consolidated financial statements and related notes appearing in our annual report on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 3, 2022 . The information contained in this section should also be read in conjunction with our unaudited consolidated financial statements and related notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
Except as otherwise specified, references to "we," "us," "our," "Fidus" and
"FIC" refer to
Forward Looking Statements
This Quarterly Report on Form 10-Q 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 aboutFidus Investment Corporation , our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as "anticipates," "expects," "intends," "plans," "will," "may," "continue," "believes," "seeks," "estimates," "would," "could," "should," "targets," "projects" and variations of these words and similar expressions are intended to identify forward-looking statements. The forward-looking statements contained in this Quarterly Report on Form 10-Q involve risks and uncertainties, including statements as to:
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our future operating results and the uncertainties associated with the continued impact of the COVID-19 pandemic thereon; • changes in the financial and lending markets; • 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 ongoing 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 and the impact of the COVID-19 pandemic thereon; • the ability of our portfolio companies to achieve their objectives; • our expected financing and investments; • the adequacy of our cash resources and working capital; • the timing of cash flows, if any, from the operations of our portfolio companies and the impact of the COVID-19 pandemic thereon; • the ability of the Investment Advisor to locate suitable investments for us and to monitor and administer our investments and the impacts of the COVID-19 pandemic thereon; • the ability of our investment advisor to attract and retain highly talented professionals; • our regulatory structure and tax treatment; • our ability to operate as a BDC and a RIC and each of the Funds to operate as an SBIC; • the timing, form and amount of any dividend distributions; • the impact of interest rate volatility, including the decommissioning of LIBOR and rising interest rates, and the elevated level of inflation on our business and portfolio companies; • the valuation of any investments in portfolio companies, particularly those having no liquid trading market; and • our ability to recover unrealized losses. 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:
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an economic downturn, including as a result of the current COVID-19 pandemic,
and significant disruptions to our portfolio companies, including supply chain
disruptions and labor shortages, could impair our portfolio companies' ability
to continue to operate, 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, including as a result of the COVID-19 pandemic, could impair our
lending and investment activities;
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interest rate volatility, including the decommissioning of LIBOR and rising
interest rates, could adversely affect our results, particularly because we use
leverage as part of our investment strategy;
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the elevated level of inflation could adversely affect our business, results of
operations and financial condition of our portfolio companies, which may, in
turn, impact the valuation of such portfolio companies; and
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the risks, uncertainties and other factors we identify in Item 1A. - Risk
Factors contained in our Annual Report on Form 10-K for the year ended
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 debt 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 Item 1.A - Risk Factors contained in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 3, 2022 . 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. 39 --------------------------------------------------------------------------------
Overview
General and Corporate Structure
We provide customized debt and equity financing solutions to lower middle-market companies, which we define asU.S. based companies having revenues between$10.0 million and$150.0 million . Our investment objective is to provide attractive risk-adjusted returns by generating both current income from our debt investments and capital appreciation from our equity related investments. Our investment strategy includes partnering with business owners, management teams and financial sponsors by providing customized financing for ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We seek to maintain a diversified portfolio of investments in order to help mitigate the potential effects of adverse economic events related to particular companies, regions or industries. FIC was formed as aMaryland corporation onFebruary 14, 2011 . We completed our initial public offering, or IPO, inJune 2011 . OnJune 20, 2011 , FIC acquired all of the limited partnership interests of Fund I and membership interests ofFidus Mezzanine Capital GP, LLC , its general partner, resulting in Fund I becoming our wholly-owned SBIC subsidiary. Immediately following the acquisition, we and Fund I elected to be treated as business development companies, or BDCs, under the 1940 Act and our investment activities have been managed byFidus Investment Advisors, LLC , our investment advisor, and supervised by our board of directors, a majority of whom are independent of us. OnMarch 29, 2013 , we commenced operations of a second wholly-owned subsidiary, Fund II. OnApril 18, 2018 , we commenced operations of a third wholly-owned subsidiary, Fund III. Fund II and Fund III received their SBIC licenses onMay 28, 2013 , andMarch 21, 2019 , respectively. We plan to continue to operate the Funds as SBICs, subject to SBA approval, and to utilize the proceeds of the sale of SBA-guaranteed debentures to enhance returns to our stockholders. As ofSeptember 9, 2019 , Fund I completed a wind-down plan, relinquished its SBIC license, and can no longer issue additional SBA debentures. We have also made, and continue to make, investments directly through FIC. We believe that utilizing FIC and the Funds as investment vehicles provides us with access to a broader array of investment opportunities. We have certain wholly-owned taxable subsidiaries (the "Taxable Subsidiaries"), each of which generally holds one or more of our portfolio investments listed on the consolidated schedules of investments. The Taxable Subsidiaries are consolidated for financial reporting purposes, such that our consolidated financial statements reflect our investment in the portfolio company investments owned by the Taxable Subsidiaries. The purpose of the Taxable Subsidiaries is to permit us to hold equity investments in portfolio companies that are taxed as partnerships forU.S. federal income tax purposes (such as entities organized as limited liability companies ("LLCs") or other forms of pass through entities) while complying with the "source-of-income" requirements contained in the RIC tax provisions. The Taxable Subsidiaries are not consolidated with us forU.S. federal corporate income tax purposes, and each Taxable Subsidiary will be subject toU.S. federal corporate income tax on its taxable income. Any such income or expense is reflected in the consolidated statements of operations.
COVID-19 Update
OnMarch 11, 2020 , theWorld Health Organization declared the novel coronavirus, or COVID-19, as a pandemic, and onMarch 13, 2020 the United States declared a national emergency with respect to COVID-19. The outbreak of COVID-19 has severely impacted global economic activity and caused significant volatility and negative pressure in financial markets. We have been closely monitoring, and will continue to monitor, the impact of the COVID-19 pandemic, including the Delta and Omicron variants and any new variants, and its impact on all aspects of our business, including how it will impact our portfolio companies, employees, due diligence and underwriting processes, and financial markets. Given the fluidity of the pandemic, we cannot estimate the long-term impact of COVID-19 on our business, future results of operations, financial position or cash flows at this time. Further, the operational and financial performance of the portfolio companies in which we make investments may be significantly impacted by COVID-19, which may in turn impact the valuation of our investments. We believe our portfolio companies have taken, and continue to take, immediate actions to effectively and efficiently respond to the challenges posed by COVID-19 and related orders imposed by state and local governments and private businesses, including developing liquidity plans supported by internal cash reserves, and shareholder support. The COVID-19 pandemic and preventative measures taken to contain or mitigate its spread have caused, and are continuing to cause, business shutdowns and cancellations of events, restrictions on travel, significant reduction in demand for certain goods and services, reductions in business activity and financial transactions, supply chain disruptions, labor difficulties and shortages, commodity inflation and elements of economic and financial market instability inthe United States and globally. Such effects will likely continue for the duration of the pandemic, which is uncertain, and for some period thereafter. 40 --------------------------------------------------------------------------------
Investments
We seek to create a diversified investment portfolio that primarily includes debt investments and, to a lesser extent, equity securities. Our investments typically range between$5.0 million to$35.0 million per portfolio company, although this investment size may vary proportionately with the size of our capital base. Our investment objective is to provide attractive risk-adjusted returns by generating both current income from our debt investments and capital appreciation from our equity related investments. We may invest in the equity securities of our portfolio companies, such as preferred stock, common stock, warrants and other equity interests, either directly or in conjunction with our debt investments. First Lien Debt. We structure some of our investments as senior secured or first lien debt investments. First lien debt investments are secured by a first priority lien on existing and future assets of the borrower and may take the form of term loans or revolving lines of credit. First lien debt is typically senior on a lien basis to other liabilities in the issuer's capital structure and has the benefit of a first-priority security interest in assets of the issuer. The security interest ranks above the security interest of any second lien lenders in those assets. Our first lien debt may include stand-alone first lien loans, "last out" first lien loans, or "unitranche" loans. Stand-alone first lien loans are traditional first lien loans. All lenders in the facility have equal rights to the collateral that is subject to the first-priority security interest. "Last out" first lien loans have a secondary priority behind super-senior "first out" first lien loans in the collateral securing the loans in certain circumstances. The arrangements for a "last out" first lien loan are set forth in an "agreement among lenders," which provides lenders with "first out" and "last out" payment streams based on a single lien on the collateral. Since the "first out" lenders generally have priority over the "last out" lenders for receiving payment under certain specified events of default, or upon the occurrence of other triggering events under intercreditor agreements or agreements among lenders, the "last out" lenders bear a greater risk and, in exchange, receive a higher effective interest rate, through arrangements among the lenders, than the "first out" lenders or lenders in stand-alone first lien loans. Agreements among lenders also typically provide greater voting rights to the "last out" lenders than the intercreditor agreements to which second lien lenders often are subject. Many of our debt investments also include excess cash flow sweep features, whereby principal repayment may be required before maturity if the portfolio company achieves certain defined operating targets. Additionally, our debt investments typically have principal prepayment penalties in the early years of the debt investment. The majority of our debt investments provide for a variable interest rate, generally with a LIBOR floor. Second Lien Debt. Some of our debt investments take the form of second lien debt, which includes senior subordinated notes. Second lien debt investments obtain security interests in the assets of the portfolio company as collateral in support of the repayment of such loans. Second lien debt typically is senior on a lien basis to other liabilities in the issuer's capital structure and has the benefit of a security interest over assets of the issuer, though ranking junior to first lien debt secured by those assets. First lien lenders and second lien lenders typically have separate liens on the collateral, and an intercreditor agreement provides the first lien lenders with priority over the second lien lenders' liens on the collateral. These loans typically provide for no contractual loan amortization, with all amortization deferred until loan maturity, and may include payment-in-kind ("PIK") interest, which increases the principal balance over the term and, coupled with the deferred principal payment provision, increases credit risk exposure over the life of the loan. Subordinated Debt. These investments are typically structured as unsecured, subordinated notes. Structurally, subordinated debt usually ranks subordinate in priority of payment to first lien and second lien debt and may not have the benefit of financial covenants common in first lien and second lien debt. Subordinated debt may rank junior as it relates to proceeds in certain liquidations where it does not have the benefit of a lien in specific collateral held by creditors (typically first lien and/or second lien)who have a perfected security interest in such collateral. However, subordinated debt ranks senior to common and preferred equity in an issuer's capital structure. These loans typically have relatively higher fixed interest rates (often representing a combination of cash pay and PIK interest) and amortization of principal deferred to maturity. The PIK feature (meaning a feature allowing for the payment of interest in the form of additional principal amount of the loan instead of in cash), which effectively operates as negative amortization of loan principal, coupled with the deferred principal payment provision, increases credit risk exposure over the life of the loan.Equity Securities . Our equity securities typically consist of either a direct minority equity investment in common or preferred stock or membership/partnership interests of a portfolio company, or we may receive warrants to buy a minority equity interest in a portfolio company in connection with a debt investment. Warrants we receive with our debt investments typically require only a nominal cost to exercise, and thus, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. Our equity investments are typically not control-oriented investments, and in many cases, we acquire equity securities as part of a group of private equity investors in which we are not the lead investor. We may structure such equity investments to include provisions protecting our rights as a minority-interest holder, as well as a "put," or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and "piggyback" registration rights. Our equity investments typically are made in connection with debt investments to the same portfolio companies. 41 -------------------------------------------------------------------------------- Revenues: We generate revenue in the form of interest and fee income on debt investments and dividends, if any, on equity investments. Our debt investments, whether in the form of second lien, subordinated or first lien loans, typically have terms of five to seven years and most bear interest at fixed or variable rates. In some instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we may receive repayments of some of our debt investments prior to their scheduled maturity dates, which may include prepayment penalties. The frequency or volume of these repayments fluctuates significantly from period to period. Our portfolio activity may reflect the proceeds of sales of securities. In some cases, our investments provide for deferred interest payments or PIK interest. The principal amount of debt investments and any accrued but unpaid interest generally become due at the maturity date. In addition, we may generate revenue in the form of commitment, origination, amendment, or structuring fees and fees for providing managerial assistance. Debt investment origination fees, OID and market discount or premium, if any, are capitalized, and we accrete or amortize such amounts into interest income. We record prepayment penalties on debt investments as fee income when earned. Interest and dividend income is recorded on the accrual basis to the extent that we expect to collect such amounts. Interest is accrued daily based on the outstanding principal amount and the contractual terms of the debt investment. Dividend income is recorded as dividends are declared or at the point an obligation exists for the portfolio company to make a distribution, and is generally recognized when received. Distributions of earnings from portfolio companies are evaluated to determine if the distribution is a distribution of earnings or a return of capital. Distributions of earnings are included in dividend income while a return of capital is recorded as a reduction in the cost basis of the investment. Estimates are adjusted as necessary after the relevant tax forms are received from the portfolio company. Debt investments or preferred equity investments (for which we are accruing PIK dividends) are placed on non-accrual status when principal, interest or dividend payments become materially past due, or when there is reasonable doubt that principal, interest or dividends will be collected. Interest and dividend payments received on non-accrual investments may be recognized as interest or dividend income or may be applied to the investment principal balance based on management's judgment. Non-accrual investments are restored to accrual status when past due principal, interest or dividends are paid and, in management's judgment, payments are likely to remain current. See "Critical Accounting Policies and Use of Estimates - Revenue Recognition." We recognize realized gains or losses on investments based on the difference between the net proceeds from the disposition and the cost basis of the investment, without regard to unrealized gains or losses previously recognized. We record current period changes in fair value of investments that are measured at fair value as a component of the net change in unrealized appreciation (depreciation) on investments in the consolidated statements of operations. Expenses: All investment professionals of the Investment Advisor and/or its affiliates, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses allocable to personnelwho provide these services to us, are provided and paid for by the Investment Advisor and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to:
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organization;
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calculating our net asset value (including the cost and expenses of any independent valuation firm); • fees and expenses incurred by the Investment Advisor under the Investment Advisory Agreement or payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments, including "dead deal" costs; • interest payable on debt, if any, incurred to finance our investments; • offerings of our common stock and other securities; • investment advisory fees and management fees; • administration fees and expenses, if any, payable under the Administration Agreement (including payments under the Administration Agreement between us and the Investment Advisor based upon our allocable portion of the Investment Advisor's overhead in performing its obligations under the Administration Agreement, including rent and the allocable portion of the cost of our officers, including our chief compliance officer, our chief financial officer, and their respective staffs); • transfer agent, dividend agent and custodial fees and expenses; • federal and state registration fees; • all costs of registration and listing our shares on any securities exchange; •U.S. federal, state and local taxes; • Independent Directors' fees and expenses; • costs of preparing and filing reports or other documents required by theSEC or other regulators including printing costs; • costs of any reports, proxy statements or other notices to stockholders, including printing and mailing costs; • our allocable portion of any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; • direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs; 42 --------------------------------------------------------------------------------
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proxy voting expenses; and • all other expenses reasonably incurred by us or the Investment Advisor in connection with administering our business.
Portfolio Composition, Investment Activity and Yield
During the nine months endedSeptember 30, 2022 and 2021, we invested$268.0 million and$245.5 million , respectively, in debt and equity investments including fifteen and twelve new portfolio companies, respectively. During the nine months endedSeptember 30, 2022 and 2021, we received proceeds from sales or repayments, including principal, return of capital dividends and net realized gains (losses), of$128.3 million and$319.0 million , respectively, including exits of five and six portfolio companies, respectively. The following table summarizes investment purchases and sales and repayments of investments by type for the nine months endedSeptember 30, 2022 and 2021 (dollars in millions). Purchases of Investments
Sales and Repayments of Investments
Nine Months Ended September 30,
2022 2021 2022 2021
First Lien
Debt(1) $ 166.3 62.1 % $ 172.5 70.3 % $ 31.5 24.5 % $ 61.0 19.1 %
Second Lien
Debt 49.5 18.4 43.9 17.8 18.8 14.7 177.8 55.8
Subordinated
Debt 44.5 16.6 18.4 7.5 - - 56.8 17.8
Equity 7.7 2.9 10.7 4.4 78.0 60.8 23.4 7.3
Warrants - - - - - - - -
Total $ 268.0 100.0 % $ 245.5 100.0 % $ 128.3 100.0 % $ 319.0 100.0 %
(1) For the nine months ended September 30, 2022 and 2021, includes unitranche
securities, which account for 39.8% and 66.4% of purchases, respectively. For
the nine months ended September 30, 2022 and 2021, includes unitranche
securities, which account for 21.6% and 12.7% of repayments, respectively.
As of September 30, 2022 , the fair value of our investment portfolio totaled
$856.9 million and consisted of 75 active portfolio companies and thirteen
portfolio companies that have sold their underlying operations. As of September
30, 2022 , 43 portfolio companies' debt investments bore interest at a variable
rate, which represented $538.1 million , or 72.0%, of our debt investment
portfolio on a fair value basis, and the remainder of our debt investment
portfolio was comprised of fixed rate investments. Overall, the portfolio had
net unrealized appreciation of $29.5 million as of September 30, 2022 . As of
September 30, 2022 , our average active portfolio company investment at amortized
cost was $11.0 million , which excludes investments in the thirteen portfolio
companies that have sold their underlying operations.
As of December 31, 2021 , the fair value of our investment portfolio totaled
$719.1 million and consisted of 70 active portfolio companies and eight
portfolio companies that have sold their underlying operations. As of December
31, 2021 , 32 portfolio companies' debt investments bore interest at a variable
rate, which represented $376.0 million , or 68.4%, of our debt investment
portfolio on a fair value basis, and the remainder of our debt investment
portfolio was comprised of fixed rate investments. Overall, the portfolio had
net unrealized appreciation of $97.3 million as of December 31, 2021 . As of
December 31, 2021 , our average active portfolio company investment at amortized
cost was $8.8 million , which excludes investments in the eight portfolio
companies that have sold their underlying operations.
The weighted average yield on debt investments as of September 30, 2022 and
December 31, 2021 was 12.9% and 12.3%, respectively. The weighted average 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 and our subsidiaries' fees and
expenses. The weighted average yields were computed using the effective interest
rates for debt investments at cost including the accretion of OID and debt
investment origination fees, but excluding investments on non-accrual status, if
any.
The following table shows the portfolio composition by investment type at fair value and cost and as a percentage of total investments (dollars in millions):
Fair Value Cost
September 30, December 31, September 30, December 31,
2022 2021 2022 2021
First Lien
Debt(1) $ 488.3 57.0 % $ 354.9 49.4 % $ 488.0 59.0 % $ 353.3 56.8 %
Second Lien
Debt 177.2 20.7 158.8 22.1 200.0 24.2 168.6 27.1
Subordinated
Debt 81.8 9.5 36.1 5.0 80.5 9.7 36.0 5.8
Equity 107.0 12.5 166.1 23.1 55.6 6.7 60.6 9.8
Warrants 2.6 0.3 3.2 0.4 3.3 0.4 3.3 0.5
Total $ 856.9 100.0 % $ 719.1 100.0 % $ 827.4 100.0 % $ 621.8 100.0 %
(1) Includes unitranche investments, which account for 43.1% and 44.4% of our
portfolio on a fair value and cost basis as of September 30, 2022 , respectively.
Includes unitranche investments, which account for 40.2% and 46.3% of our
portfolio on a fair value and cost basis as of December 31, 2021 , respectively.
All investments made by us as of September 30, 2022 and December 31, 2021 were
made in portfolio companies headquartered in the United States . The following
table shows portfolio composition by geographic region at fair value and cost
and as a percentage of total investments (dollars in millions). 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.
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Fair Value Cost
September 30, December 31, September 30, December 31,
2022 2021 2022 2021
Midwest $ 186.0 21.7 % $ 157.2 21.9 % $ 140.7 17.0 % $ 89.9 14.5 %
Southeast 250.5 29.2 220.0 30.6 252.2 30.5 197.4 31.7
Northeast 123.9 14.5 126.6 17.6 128.2 15.5 127.8 20.6
West 154.9 18.1 105.9 14.7 161.0 19.4 100.1 16.1
Southwest 141.6 16.5 109.4 15.2 145.3 17.6 106.6 17.1
Total $ 856.9 100.0 % $ 719.1 100.0 % $ 827.4 100.0 % $ 621.8 100.0 %
The following table shows the detailed industry composition of our portfolio at fair value and cost as a percentage of total investments:
Fair Value Cost
September 30, December 31, September 30, December 31,
Name 2022 2021 2022 2021
Information Technology
Services 34.4 % 27.0 % 36.4 % 30.6 %
Business Services 11.3 13.3 11.5 14.3
Healthcare Products 11.3 11.2 6.4 3.6
Component Manufacturing 8.6 4.1 8.8 4.0
Specialty Distribution 6.1 8.0 5.6 8.2
Aerospace & Defense
Manufacturing 5.4 7.9 5.6 8.4
Transportation Services 3.3 2.9 3.4 3.3
Promotional Products 3.0 3.1 3.1 4.1
Retail 2.7 1.6 3.7 1.8
Building Products
Manufacturing 2.6 3.7 3.5 4.8
Healthcare Services 2.6 3.6 2.5 4.2
Environmental Industries 2.5 3.0 2.6 3.5
Consumer Products 1.9 2.6 2.0 3.0
Oil & Gas Services 1.7 2.9 1.8 0.5
Utilities: Services 1.4 1.9 1.4 1.8
Industrial Cleaning &
Coatings 1.2 1.5 1.6 2.1
Restaurants 0.0 (1) 0.0 (1) 0.1 0.1
Specialty Chemicals 0.0 (1) - - 0.0 (1)
Utility Equipment
Manufacturing - 1.5 - 1.4
Vending Equipment
Manufacturing 0.0 (1) 0.2 - 0.3
Total 100.0 % 100.0 % 100.0 % 100.0 %
(1) Percentage is less than 0.1% of respective total.
Portfolio Asset Quality
In addition to various risk management and monitoring tools, the Investment Advisor uses an internally developed investment rating system to characterize and monitor the credit profile and our expected level of returns on each investment in our portfolio. We use a five-level numeric rating scale. The following is a description of the conditions associated with each investment rating:
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Investment Rating 1 is used for investments that involve the least amount of risk in our portfolio. The portfolio company is performing above expectations, the debt investment is expected to be paid in the near term and the trends and risk factors are favorable, and may include an expected capital gain on the equity investment. • Investment Rating 2 is used for investments that involve a level of risk similar to the risk at the time of origination. The portfolio company is performing substantially within our expectations and the risk factors are neutral or favorable. Each new portfolio investment enters our portfolio with Investment Rating 2. • Investment Rating 3 is used for investments performing below expectations and indicates the investment's risk has increased somewhat since origination. The portfolio company requires closer monitoring, but we expect a full return of principal and collection of all interest and/or dividends. • Investment Rating 4 is used for investments performing materially below expectations and the risk has increased materially since origination. The investment has the potential for some loss of investment return, but we expect no loss of principal. • Investment Rating 5 is used for investments performing substantially below our expectations and the risks have increased substantially since origination. We expect some loss of principal.
As the COVID-19 pandemic continues to evolve, we are maintaining close communications with our portfolio companies to proactively assess and manage risks across our investment portfolio. We have also increased oversight and analysis of credits in vulnerable industries in an attempt to improve performance and reduce credit risk.
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The following table shows the distribution of our investments on the 1 to 5
investment rating scale at fair value and cost as of
Fair Value Cost
September 30, December 31, September 30, December 31,
Investment
Rating 2022 2021 2022 2021 1$ 95.1 11.1 %$ 119.8 16.7 %$ 38.9 4.7 %$ 19.1 3.1 % 2 674.9 78.7 566.7 78.8 664.9 80.4 556.1 89.4 3 74.8 8.7 31.7 4.4 91.0 11.0 40.4 6.5 4 7.4 0.9 0.9 0.1 10.7 1.3 3.0 0.5 5 4.7 0.6 - - 21.9 2.6 3.2 0.5 Total$ 856.9 100.0 %$ 719.1 100.0 %$ 827.4 100.0 %$ 621.8 100.0 %
Based on our investment rating system, the weighted average rating of our
portfolio as of
Non-Accrual As ofSeptember 30, 2022 , we had debt investments in three portfolio companies on non-accrual status. As ofDecember 31, 2021 , we had a debt investment in one portfolio company on non-accrual status (dollars in millions). September 30, 2022 December 31, 2021 Fair Fair Portfolio Company Value Cost Value Cost EBL, LLC (EbLens)$ 2.4 $ 9.3 $ - (1) $ - (1) US GreenFiber, LLC - 5.2 - (2) 5.2 (2)K2 Merger Agreement Agent, LLC (fka K2 Industrial Services, Inc.) 2.2 2.4 - (1) - (1) Total$ 4.6 $ 16.9 $ -$ 5.2 (1) Portfolio company debt investment was not on non-accrual status atDecember 31, 2021 . (2) Portfolio company was on PIK-only non-accrual status atDecember 31, 2021 , meaning we ceased recognizing PIK interest income on the investment.
Discussion and Analysis of Results of Operations
Comparison of three and nine months ended
Investment Income
Below is a summary of the changes in total investment income for the three months endedSeptember 30, 2022 as compared to the same period in 2021 (dollars in millions, percent change calculated based on underlying dollar amounts in thousands): Three Months Ended September 30, 2022 2021 $ Change % Change (1)(2) Interest income $ 21.5 $ 17.9$ 3.6 20.4 % Payment-in-kind interest income 0.4 1.2 (0.8 ) (67.2 %) Dividend income 0.7 0.5 0.2 41.1 % Fee income 2.4 1.6 0.8 46.6 % Interest on idle funds and other income - - - NM Total investment income $ 25.0 $ 21.2$ 3.8 17.7 % (1) NM = Not meaningful (2) Percent change calculated based on underlying dollar amounts in thousands as presented on the consolidated statements of operations. For the three months endedSeptember 30, 2022 , total investment income was$25.0 million , an increase of$3.8 million or 17.7%, from the$21.2 million of total investment income for the three months endedSeptember 30, 2021 . As reflected in the table above, the increase is primarily attributable to the following:
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•
•
$0.8 million increase in fee income resulting from an increase in origination and amendment fees, partially offset by a decrease in prepayment fees, during 2022 as compared to 2021. 45 -------------------------------------------------------------------------------- Below is a summary of the changes in total investment income for the nine months endedSeptember 30, 2022 as compared to the same period in 2021 (dollars in millions): Nine Months Ended September 30, 2022 2021 $ Change % Change (1)(2) Interest income $ 58.0 $ 54.8$ 3.2 5.8 % Payment-in-kind interest income 1.3 3.3 (2.0 ) (60.2 %) Dividend income 1.4 1.4 - NM Fee income 6.0 6.8 (0.8 ) (13.0 %) Interest on idle funds and other income - - - NM Total investment income $ 66.7 $ 66.3$ 0.4 0.5 % (1) NM = Not meaningful (2) Percent change calculated based on underlying dollar amounts in thousands as presented on the consolidated statements of operations. For the nine months endedSeptember 30, 2022 , total investment income was$66.7 million , an increase of$0.4 million or 0.5%, from the$66.3 million of total investment income for the nine months endedSeptember 30, 2021 . As reflected in the table above, the increase is primarily attributable to the following:
•
$1.2 million increase in total interest income (which includes a$2.0 million decrease in PIK income) resulting from an increase in average debt investment balances outstanding and an increase in weighted average yield on debt investment balances outstanding, partially offset by repayments of PIK debt investments and an increase in PIK investments on non-accrual, during 2022 as compared to 2021.
•
$0.8 million decrease in fee income resulting from a decrease in prepayment and amendment fees, partially offset by an increase in origination fees during 2022 as compared to 2021. Expenses
Below is a summary of the changes in total expenses, including income tax
provision, for the three months ended
Three Months Ended September 30,
2022 2021 $ Change % Change (1)(2)
Interest and financing expenses $ 4.7 $ 4.7 $ - NM
Base management fee 3.8 3.3 0.5 15.1 %
Incentive fee - income 3.0 2.4 0.6 25.6 %
Incentive fee (reversal) - capital
gains (0.3 ) 4.7 (5.0 ) (105.5 %)
Administrative service expenses 0.5 0.4 0.1 9.6 %
Professional fees 0.3 0.5 (0.2 ) (33.1 %)
Other general and administrative
expenses 0.4 0.2 0.2 41.6 %
Total expenses, before base
management and income incentive fee
waivers 12.4 16.2 (3.8 ) (23.6 %)
Base management and income
incentive fee waivers (0.1 ) (0.1 ) - NM
Total expenses, before income tax
provision 12.3 16.1 (3.8 ) (23.8 %)
Income tax provision (benefit) - - - NM
Total expenses, including income
tax provision $ 12.3 $ 16.1 $ (3.8 ) (23.8 %)
(1) NM = Not meaningful
(2) Percent change calculated based on underlying dollar amounts in thousands as
presented on the consolidated statements of operations.
For the three months ended September 30, 2022 , total expenses, including income
tax provision, were $12.3 million , a decrease of $3.8 million or (23.8%), from
the $16.1 million of total expenses for the three months ended September 30,
2021 . As reflected in the table above, changes across periods were primarily
attributable to the following:
•
•
•
$5.0 million decrease in the accrued capital gains incentive fee due to a$24.6 million decrease in net gain on investments (net realized gains (losses), plus net change in unrealized appreciation (depreciation) on investments) plus realized losses on extinguishment of debt, during 2022 as compared to the same period in 2021. 46 --------------------------------------------------------------------------------
•
Below is a summary of the changes in total expenses, including income tax
provision, for the nine months ended
Nine Months Ended September 30,
2022 2021 $ Change % Change (1)(2)
Interest and financing expenses $ 13.7 $ 14.4 $ (0.7 ) (4.7 %)
Base management fee 10.7 9.7 1.0 11.0 %
Incentive fee - income 5.3 7.6 (2.3 ) (30.9 %)
Incentive fee - capital gains (0.6 ) 8.6 (9.2 ) (106.9 %)
Administrative service expenses 1.4 1.3 0.1 10.2 %
Professional fees 1.5 1.5 - NM
Other general and administrative
expenses 0.8 0.6 0.2 16.9 %
Total expenses, before base
management and income incentive fee
waivers 32.8 43.7 (10.9 ) (24.9 %)
Base management and income
incentive fee waivers (0.2 ) (0.1 ) (0.1 ) 132.7 %
Total expenses, before income tax
provision 32.6 43.6 (11.0 ) (25.3 %)
Income tax provision (benefit) - 0.1 (0.1 ) (106.3 %)
Total expenses, including income
tax provision $ 32.6 $ 43.7 $ (11.1 ) (25.4 %)
(1) NM = Not meaningful
(2) Percent change calculated based on underlying dollar amounts in thousands as
presented on the consolidated statements of operations.
For the nine months ended September 30, 2022 , total expenses, including income
tax provision, were $32.6 million , a decrease of $11.1 million or (25.4%), from
the $43.7 million of total expenses for the nine months ended September 30,
2021 . As reflected in the table above, changes across periods were primarily
attributable to the following:
•
•
•
•
$9.2 million decrease in the accrued capital gains incentive fee due to a$46.2 million decrease in net gain on investments (net realized gains (losses), plus net change in unrealized appreciation (depreciation) on investments), plus realized losses on extinguishment of debt during 2022 as compared to the same period in 2021. Net Investment Income Net investment income increased by$7.6 million , or 148.5%, to$12.7 million during the three months endedSeptember 30, 2022 as compared to the same period in 2021, as a result of the$3.8 million decrease in total expenses, including base management fee waivers and income tax provision, and the$3.8 increase in total investment income. Net investment income increased by$11.5 million , or 50.3%, to$34.1 million during the nine months endedSeptember 30, 2022 as compared to the same period in 2021, as a result of the$11.1 million decrease in total expenses, including base management waivers and income tax provision, and the$0.4 increase in total investment income. 47 --------------------------------------------------------------------------------
For the three and nine months endedSeptember 30, 2022 , the total net realized gain/(loss) on investments, before income tax (provision)/benefit, was$40.0 million and$65.2 million , respectively. Income tax (provision) benefit from realized gains on investments was zero and$(0.1) million for the three and nine months endedSeptember 30, 2022 , respectively. We realize a gain/(loss) on our equity investments primarily when we either sell our equity investment or the underlying portfolio company is sold. Significant realized gains (losses) for the three and nine months endedSeptember 30, 2022 are summarized below (dollars in millions): Period Ended September 30, 2022 Three Nine Realization Event Portfolio Company (1) Months MonthsFrontline Food Services, LLC (f/k/a Accent Food Services, LLC) Escrow distribution $ - $ 0.2 Revenue Management Solutions, Exit of portfolio LLC company - 0.1 SpendMend LLC Escrow distribution - 6.3 Escrow liability FDS Avionics Corp. release 0.6 0.2 Sale of portfolio Mesa Line Services, LLC company (0.2 ) 0.1 Mirage Trailers LLC Escrow distribution - 0.3 Sale of portfolio TransGo, LLC company - 1.9 Sale of portfolio AVC Investors, LLC (dba Auveco) company - 0.8 CRS Solutions Holdings, LLC Sale of portfolio (dba CRS Texas) company - 0.4 Sale of portfolio Pinnergy, Ltd. company - 15.3 Exit of portfolio Palisade Company, LLC company 1.9 1.9 Sale of portfolio The Tranzonic Companies company 1.4 1.4 Exit of portfolio Bandon Fitness (Texas), Inc. company 3.2 3.2 SES Investors, LLC (dba SES Sale of portfolio Foam) company 8.8 8.8 Partial sale of Pfanstiehl, Inc. equity investment 24.3 24.3 Pool & Electrical Products, LLC Escrow distribution 0.1 0.1Spectra A&D Acquisition, Inc. (fka FDS Avionics Corp.) Escrow distribution $ (0.1 ) $ (0.1 ) Net realized gain (loss) on investments 40.0 65.2 Income tax (provision) benefit from realized gains on investments - (0.1 ) Net realized gain (loss), net of income tax provision, on investments $ 40.0 $ 65.1 (1) As it relates to realization events, we define an 'exit' of a portfolio company as situations where we have completely exited our position in all of the portfolio company's securities and no longer carry the portfolio company on our consolidated schedule of investments. We define a 'sale' of a portfolio company, distinguished from an exit, as situations where the underlying operations of a portfolio company have been sold, but where we retain a residual ownership interest in the legacy entity (we generally distinguish these residual portfolio company investments from 'active' portfolio company investments). For the three and nine months endedSeptember 30, 2021 , the total net realized gain/(loss) on investments, before income tax (provision)/benefit, was$8.3 million and$13.7 million , respectively. Income tax (provision) benefit from realized gains/(losses) on investments was$0.1 million and$0.1 million for the three and nine months endedSeptember 30, 2021 , respectively. We realize a gain/(loss) on our equity investments primarily when we either sell our equity investment or the underlying portfolio company is sold. Significant realized gains (losses) for the three and nine months endedSeptember 30, 2021 are summarized below (dollars in millions): Period Ended September 30, 2021 Three Nine Realization Event Portfolio Company (1) Months Months Spectra A&D Acquisition, Inc. (fka Sale of portfolio FDS Avionics Corp.) company $ - $ 1.0 Exit of portfolio Software Technology, LLC company - 1.4 Exit of portfolio Rohrer Corporation company - 0.9 Exit of portfolio Wheel Pros, Inc. company (0.1 ) 2.0
company (1.0 ) (1.0 )
Sale of portfolio
Worldwide Express Operations, LLC company 3.0 3.0
Exit of portfolio
Pugh Lubricants, LLC company 0.1 0.1
Sale of portfolio
LNG Indy, LLC (dba Kinetrex Energy) company 4.5 4.5
Exit of portfolio
Allied 100 Group, Inc. company 1.8 1.8
Net realized gain (loss) on
investments 8.3 13.7
Income tax (provision) benefit from
realized gains on investments 0.1 0.1
Net realized gain (loss), net of
income tax provision, on investments $ 8.4 $ 13.8
(1) As it relates to realization events, we define an 'exit' of a portfolio
company as situations where we have completely exited our position in all of the
portfolio company's securities and no longer carry the portfolio company on our
schedule of investments. We define a 'sale' of a portfolio company,
distinguished from an exit, as situations where the underlying operations of a
portfolio company have been sold, but where we retain a residual ownership
interest in the legacy entity (we generally distinguish these residual portfolio
company investments from 'active' portfolio company investments).
48
--------------------------------------------------------------------------------
During the nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
Unrealized Appreciation
(Depreciation) 2022 2021 2022 2021
Exit, sale or restructuring of
investments $ (37.3 ) $ (2.6 ) $ (61.2 ) $ (5.9 )
Fair value adjustments to debt
investments (9.5 ) 3.8 (12.9 ) (0.6 )
Fair value adjustments to
equity investments 5.5 14.1 6.3 38.5
Net change in unrealized
appreciation (depreciation) $ (41.3 ) $ 15.3 $ (67.8 ) $ 32.0
Net Increase in Net Assets Resulting From Operations
Net increase (decrease) in net assets resulting from operations during the three months endedSeptember 30, 2022 and 2021 was$11.4 million and$28.4 million , respectively, as a result of the events described above. Net increase (decrease) in net assets resulting from operations during the nine months endedSeptember 30, 2022 and 2021 was$31.1 million and$65.8 million , respectively, as a result of the events described above.
Liquidity and Capital Resources
As ofSeptember 30, 2022 , we had$40.4 million in cash and cash equivalents and our net assets totaled$474.4 million . We believe that our current cash and cash equivalents on hand, our Credit Facility, our continued access to SBA-guaranteed debentures, and our anticipated cash flows from investments will provide adequate capital resources with which to operate and finance our investment business and make distributions to our stockholders for at least the next 12 months. We intend to generate additional cash primarily from the future offerings of securities (including the "at-the-market" program) and future borrowings, as well as cash flows from operations, including income earned from investments in our portfolio companies. On both a short-term and long-term basis, our primary use of funds will be investments in portfolio companies and cash distributions to our stockholders. During the nine months endedSeptember 30, 2022 , we repaid$30.0 million of SBA debentures which would have matured during the periodMarch 1, 2025 throughMarch 1, 2028 . Our remaining outstanding SBA debentures continue to mature in 2025 and subsequent years through 2033, which will require repayment on or before the respective maturity dates. This "Liquidity and Capital Resources" section should be read in conjunction with the "COVID-19 Updates" section above.
Cash Flows
For the nine months endedSeptember 30, 2022 , we experienced a net decrease in cash and cash equivalents in the amount of$129.0 million . During that period, we made payments of$117.4 million of cash for operating activities, which included the funding of$268.0 million of investments which was partially offset by proceeds received from sales and repayments of investments of$128.3 million . During the same period, we received repayments of$0.6 million on our secured borrowings, made repayments of SBA debentures of$30.0 million , which were offset by proceeds from the issuances of SBA debentures of$56.0 million , paid cash dividends to stockholders of$34.0 million , and made payment of deferred financing costs related to our debt financings of$3.0 million .
Capital Resources
We anticipate that we will continue to fund our investment activities on a long-term basis through a combination of additional debt and equity capital.
SBA debentures
The Funds are licensed SBICs, and have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the Small Business Investment Act and the SBA regulations applicable to SBICs, an SBIC can have outstanding at any time debentures guaranteed by the SBA in an amount up to twice its regulatory capital. The SBA regulations currently limit the amount that is available to be borrowed by any SBIC and guaranteed by the SBA to 300.0% of an SBIC's regulatory capital or$175.0 million , whichever is less. For two or more SBICs under common control, the maximum amount of outstanding SBA debentures cannot exceed$350.0 million . SBA debentures have fixed interest rates that approximate prevailing 10-year Treasury Notes rates plus a spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the SBA debentures is not required to be paid before maturity but may be pre-paid at any time. As ofSeptember 30, 2022 , Fund II and Fund III had$40.0 million and$93.0 million of outstanding SBA debentures, respectively. Subject to SBA regulatory requirements and approval, Fund III may access up to$82.0 million of additional SBA debentures under the SBIC debenture program. For more information on the SBA debentures, please refer to Note 6 to our consolidated financial statements.
Credit Facility
49
--------------------------------------------------------------------------------
On June 16, 2014 , we entered into a senior secured revolving credit agreement
(the "Credit Agreement" and the senior secured revolving credit facility, the
"Credit Facility") with ING Capital LLC ("ING"), as the administrative agent,
collateral agent, and lender. The Credit Facility is secured by certain
portfolio investments held by us, but portfolio investments held by the Funds
are not collateral for the Credit Facility. On April 24, 2019 , we entered into
an Amended & Restated Senior Secured Revolving Credit Agreement (the "Amended
Credit Agreement") among us, as borrower, the lenders party thereto, and ING , as
administrative agent. On June 26, 2020 , we entered into an amendment on the
Amended Credit Agreement that, among other changes, modified certain financial
covenants. On August 17, 2022 , the Company entered into a second amendment to
the Amended Credit Agreement ("Second Amendment"). The Second Amendment, among
other things: (i) changed the underlying benchmark used to compute interest
under the Amended Credit Agreement to the Secured Overnight Financing Rate
(SOFR) from the London Interbank Offered Rate (LIBOR); (ii) reduced the
applicable margin from 3.00% to 2.675% on SOFR loans prior to satisfying certain
step-down conditions, and from 2.675% to 2.50% after satisfying certain
step-down conditions, with commensurate reductions in the applicable margins for
base rate loans; (iii) provided for a loan commitment availability period ending
on August 17, 2026 ; (iv) extended the maturity date to August 17, 2027 from
April 24, 2023 ; and (v) amended certain financial covenants, including (a)
amending the asset coverage ratio to no less than 1.50 to 1.00 from no less than
2.00 to 1.00 (on a regulatory basis); and (b) requiring the Company to maintain
a senior asset coverage ratio of no less than 2.00 to 1.00.
We pay a commitment fee that varies depending on the size of the unused portion
of the Credit Facility: 2.500% to 2.675% per annum on the unused portion of the
Credit Facility at or below 35% of the commitments and 0.50% per annum on any
remaining unused portion of the Credit Facility between the total commitments
and the 35% minimum utilization. The Credit Facility is secured by a first
priority security interest in all of our assets, excluding the assets of our
SBIC subsidiaries.
Amounts available to borrow under the Credit Facility are subject to a minimum
borrowing/collateral base that applies an advance rate to certain investments
held by us, excluding investments held by the Funds. We are subject to
limitations with respect to the investments securing the Credit Facility,
including, but not limited to, restrictions on sector concentrations, loan size,
payment frequency and status and collateral interests, as well as restrictions
on portfolio company leverage, which may also affect the borrowing base and
therefore amounts available to borrow.
We have made customary representations and warranties and we are required to
comply with various covenants, reporting requirements and other customary
requirements for similar credit facilities. These covenants are subject to
important limitations and exceptions that are described in the documents
governing the Credit Facility. As of September 30, 2022 , we were in compliance
with all covenants of the Credit Facility and there were no borrowings
outstanding under the Credit Facility.
Notes
OnFebruary 2, 2018 , we closed the public offering of approximately$43.5 million in aggregate principal amount of our 5.875% notes due 2023, or the "2023 Notes." OnFebruary 22, 2018 , the underwriters exercised their option to purchase an additional$6.5 million in aggregate principal of the 2023 Notes. The total net proceeds to us from the 2023 Notes, including the exercise of the underwriters' option, after deducting underwriting discounts of approximately$1.5 million and offering expenses of$0.4 million , were approximately$48.1 million . OnJanuary 19, 2021 , we redeemed$50.0 million in the aggregate principal amount on the issued and outstanding 2023 Notes, resulting in a realized loss on extinguishment of debt of approximately$0.8 million . OnFebruary 8, 2019 , we closed the public offering of approximately$60.0 million in aggregate principal amount of our 6.000% notes due 2024, or the "February 2024 Notes". OnFebruary 19, 2019 , the underwriters exercised their option to purchase an additional$9.0 million in aggregate principal of theFebruary 2024 Notes. The total net proceeds to us from theFebruary 2024 Notes, including the exercise of the underwriters' option, after deducting underwriting discounts of approximately$2.1 million and estimated offering expenses of$0.4 million , were approximately$66.5 million . OnFebruary 16, 2021 , we redeemed$50.0 million of the$69.0 million in aggregate principal amount on theFebruary 2024 Notes, resulting in a realized loss on extinguishment of debt of approximately$1.1 million . OnNovember 2, 2021 , we fully redeemed the remaining$19.0 million in aggregate principal amount on the issued and outstandingFebruary 2024 Notes, resulting in a realized loss on extinguishment of debt of approximately$0.3 million . OnOctober 16, 2019 , we closed the public offering of approximately$55.0 million in aggregate principal amount of our 5.375% notes due 2024, or the "November 2024 Notes" (and collectively with the 2023 Notes and theFebruary 2024 Notes, the "Public Notes"). OnOctober 23, 2019 , the underwriters exercised their option to purchase an additional$8.3 million in aggregate principal of theNovember 2024 Notes. The total net proceeds to us from theNovember 2024 Notes, including the exercise of the underwriters' option, after deducting underwriting discounts of approximately$1.9 million and estimated offering expenses of$0.3 million , were approximately$61.1 million . OnNovember 2, 2021 , we fully redeemed the$63.3 million in aggregate principal amount on the issued and outstandingNovember 2024 Notes, resulting in a realized loss on extinguishment of debt of approximately$1.3 million . 50 -------------------------------------------------------------------------------- OnDecember 23, 2020 , we closed the offering of$125.0 million in aggregate principal amount of our 4.75% notes due 2026, or the "January 2026 Notes". The total net proceeds to us from theJanuary 2026 Notes after deducting underwriting discounts of$2.5 million and estimated offering expenses of approximately$0.4 million , were approximately$122.1 million . TheJanuary 2026 Notes will mature onJanuary 31, 2026 and bear interest at a rate of 4.75%. TheJanuary 2026 Notes may be redeemed in whole or in part at any time or from time to time at our option subject to a make whole provision if redeemed more than three months prior to maturity and at par thereafter. Interest on theJanuary 2026 Notes is payable onJanuary 31 andJuly 31 of each year. We do not intend to list theJanuary 2026 Notes on any securities exchange or automated dealer quotation system. As ofSeptember 30, 2022 , the outstanding principal balance of theJanuary 2026 Notes was approximately$125.0 million . OnOctober 8, 2021 , we closed the offering of$125.0 million in aggregate principal amount of our 3.50% notes due 2026, or the "November 2026 Notes" (collectively with the Public Notes and theJanuary 2026 Notes, the "Notes"). The total net proceeds to us from theNovember 2026 Notes, based on a public offering price of 99.996% of par, after deducting underwriting discounts of$2.5 million and estimated offering expenses of approximately$0.3 million , were approximately$122.2 million . TheNovember 2026 Notes will mature onNovember 15, 2026 and bear interest at a rate of 3.50%. TheNovember 2026 Notes may be redeemed in whole or in part at any time or from time to time at our option subject to a make whole provision if redeemed more than three months prior to maturity and at par thereafter. Interest on theNovember 2026 Notes is payable onMay 15 andNovember 15 of each year. We do not intend to list theNovember 2026 Notes on any securities exchange or automated dealer quotation system. As ofSeptember 30, 2022 , the outstanding principal balance of theNovember 2026 Notes was approximately$125.0 million . Each of the Notes are unsecured obligations and rank pari passu with our existing and future unsecured indebtedness; effectively subordinated to all of our existing and future secured indebtedness; and structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, financing vehicles, or similar facilities we may form in the future, with respect to claims on the assets of any such subsidiaries, financing vehicles, or similar facilities.
Secured Borrowing
As ofSeptember 30, 2022 , the carrying value of secured borrowings totaled$17.0 million and the fair value of the associated loans included in investments was$16.9 million . As ofDecember 31, 2021 , carrying value of secured borrowings totaled$17.6 million and the fair value of the associated loans included in investments was$17.5 million . These secured borrowings were created as a result of our completion of partial loan sales of certain unitranche loan assets that did not meet the definition of a "participating interest." As a result, sale treatment was not permitted and these partial loan sales were treated as secured borrowings. The weighted average interest rate on our secured borrowings was approximately 6.446% and 4.392% as ofSeptember 30, 2022 andDecember 31, 2021 , respectively. As ofSeptember 30, 2022 , the weighted average stated interest rates for our SBA debentures and Notes were 3.214% and 4.125%, respectively. As ofSeptember 30, 2022 , we had$100.0 million of unutilized commitment under our Credit Facility, and we were subject to a 1.200% fee on such amount. As ofSeptember 30, 2022 , the weighted average stated interest rate on total debt outstanding was 3.921%. As a BDC, we are generally required to meet an asset coverage ratio of at least 150.0% (defined as the ratio which the value of our consolidated total assets, less all consolidated liabilities and indebtedness not represented by senior securities, bears to the aggregate amount of senior securities representing indebtedness), which includes borrowings and any preferred stock we may issue in the future. This requirement limits the amount that we may borrow. OnApril 29, 2019 , our Board, including a majority of the non-interested directors, approved a minimum asset coverage ratio of 150% under Sections 18(a)(1) and 18(a)(2) of the 1940 Act. As a result, we are subject to the 150% asset coverage ratio effective as ofApril 29, 2020 . We have received exemptive relief from theU.S. Securities and Exchange Commission ("SEC") to allow us to exclude the senior securities issued by the Funds from the definition of senior securities in the 150% asset coverage requirement applicable to the Company under the 1940 Act, which, in turn, will enable us to fund more investments with debt capital. As a BDC, we are generally not permitted to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of our common stock if the Board, including the Independent Directors, determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve such sale. OnJune 29, 2022 , our stockholders voted to allow us to sell or otherwise issue common stock at a price below net asset value per share for a period of one year ending on the earlier ofJune 29, 2023 or the date of our 2023 Annual Meeting of Stockholders. Our stockholders specified that the cumulative number of shares sold in each offering during the one-year period ending on the earlier ofJune 29, 2023 or the date of our 2023 Annual Meeting of Stockholders may not exceed 25.0% of our outstanding common stock immediately prior to each such sale. 51 --------------------------------------------------------------------------------
Stock Repurchase Program
We have an open market stock repurchase program (the "Stock Repurchase Program") under which we may acquire up to$5.0 million of our outstanding common stock. Under the Stock Repurchase Program, we may, but are not obligated to, repurchase outstanding common stock in the open market from time to time provided that we comply with the prohibitions under our insider trading policies and the requirements of Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market value and timing constraints. The timing, manner, price and amount of any share repurchases will be determined by our management, in its discretion, based upon the evaluation of economic and market conditions, stock price, capital availability, applicable legal and regulatory requirements and other corporate considerations. OnOctober 31, 2022 , the Board extended the Stock Repurchase Program throughDecember 31, 2023 , or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not require us to repurchase any specific number of shares and we cannot assure that any shares will be repurchased under the Stock Repurchase Program. The Stock Repurchase Program may be suspended, extended, modified or discontinued at any time. We did not make any repurchases of common stock during the three and nine months endedSeptember 30, 2022 and 2021. Refer to Note 8 to our consolidated financial statements for additional information concerning stock repurchases.
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the financial statements. We have identified investment valuation, revenue recognition and transfers of financial assets as our most critical accounting policies and estimates. We continuously evaluate our policies and estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.
Valuation of Portfolio Investments
As a BDC, we report our assets and liabilities at fair value at all times consistent with GAAP and the 1940 Act. Accordingly, we are required to periodically determine the fair value of all of our portfolio investments.
Our investments generally consist of illiquid securities including debt and equity investments in lower middle-market companies. Investments for which market quotations are readily available are valued at such market quotations. Because we expect that there will not be a readily available market for substantially all of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our board of directors using a documented valuation policy and consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the difference could be material.
With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:
•
our quarterly valuation process begins with each portfolio company or investment being initially evaluated and rated by the investment professionals of the Investment Advisor responsible for the portfolio investment; • preliminary valuation conclusions are then documented and discussed with the investment committee of the Investment Advisor; • our board of directors engages one or more independent valuation firm(s) to conduct independent appraisals of a selection of our portfolio investments for which market quotations are not readily available. Each portfolio company investment is generally appraised by the valuation firm(s) at least once every calendar year and each new portfolio company investment is appraised at least once in the twelve-month period following the initial investment. In certain instances, we may determine that it is not cost-effective, and as a result it is not in our stockholders' best interest, to request the independent appraisal of certain portfolio company investments. Such instances include, but are not limited to, situations where we determine that the fair value of the portfolio company investment is relatively insignificant to the fair value of the total portfolio. Our board of directors consulted with the independent valuation firm(s) in arriving at our determination of fair value for 14 and 17 of our portfolio company investments representing 29.5% and 40.6% of the total portfolio investments at fair value (exclusive of new portfolio company investments made during the three months endedSeptember 30, 2022 andDecember 31, 2021 , respectively) as ofSeptember 30, 2022 andDecember 31, 2021 , respectively; • the audit committee of our board of directors reviews the preliminary valuations of the Investment Advisor and of the independent valuation firm(s) and responds and supplements the valuation recommendations to reflect any comments; and • our board of directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of the Investment Advisor, the independent valuation firm(s) and the audit committee. 52 -------------------------------------------------------------------------------- In making the good faith determination of the value of portfolio investments, we start with the cost basis of the security. 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 exit values. Consistent with the policies and methodologies adopted by the Board, we perform detailed valuations of our debt and equity investments, including an analysis on the Company's unfunded debt investment commitments, using both the market and income approaches as appropriate. Under the market approach, we typically use the enterprise value methodology to determine the fair value of an investment. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is generally best expressed as a range of values, from which we derive a single estimate of enterprise value. Under the income approach, we typically prepare and analyze discounted cash flow models to estimate the present value of future cash flows of either an individual debt investment or of the underlying portfolio company itself. We evaluate investments in portfolio companies using the most recent portfolio company financial statements and forecasts. We also consult with the portfolio company's senior management to obtain further updates on the portfolio company's performance, including information such as industry trends, new product development and other operational issues. For our debt investments the primary valuation technique used to estimate the fair value is the discounted cash flow method. However, if there is deterioration in credit quality or a debt investment is in workout status, we may consider other methods in determining the fair value, including the value attributable to the debt investment from the enterprise value of the portfolio company or the proceeds that would be received in a liquidation analysis. Our discounted cash flow models estimate a range of fair values by applying an appropriate discount rate to the future cash flow streams of our debt investments, based on future interest and principal payments as set forth in the associated debt investment agreements. We prepare a weighted average cost of capital for use in the discounted cash flow model for each investment, based on factors including, but not limited to: current pricing and credit metrics for similar proposed or executed investment transactions of private companies; the portfolio company's historical financial results and outlook; and the portfolio company's current leverage and credit quality as compared to leverage and credit quality as of the date the investment was made. We may also consider the following factors when determining the fair value of debt investments: the portfolio company's ability to make future scheduled payments; prepayment penalties and other fees; estimated remaining life; the nature and realizable value of any collateral securing such debt investment; and changes in the interest rate environment and the credit markets that generally may affect the price at which similar investments may be made. We estimate the remaining life of our debt investments to generally be the legal maturity date of the instrument, as we generally intend to hold debt investments to maturity. However, if we have information available to us that the debt investment is expected to be repaid in the near term, we would use an estimated remaining life based on the expected repayment date. For our equity investments, including equity securities and warrants, we generally use a market approach, including valuation methodologies consistent with industry practice, to estimate the enterprise value of portfolio companies. Typically, the enterprise value of a private company is based on multiples of EBITDA, net income, revenues, or in limited cases, book value. In estimating the enterprise value of a portfolio company, we analyze various factors consistent with industry practice, including but not limited to original transaction multiples, the portfolio company's historical and projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the nature and realizable value of any collateral, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public. We may also utilize an income approach when estimating the fair value of our equity securities, either as a primary methodology if consistent with industry practice or if the market approach is otherwise not applicable, or as a supporting methodology to corroborate the fair value ranges determined by the market approach. We typically prepare and analyze discounted cash flow models based on projections of the future free cash flows (or earnings) of the portfolio company. We consider various factors, including but not limited to the portfolio company's projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements express the uncertainties with respect to the possible effect of such valuations, and any changes in such valuations, on the consolidated financial statements.
Revenue Recognition
Investments and related investment income. Realized gains or losses on
investments are recorded upon the sale or disposition of a portfolio investment
and are calculated as the difference between the net proceeds from the sale or
disposition and the cost basis of the investment, without regard to unrealized
appreciation or depreciation previously recognized. Net change in unrealized
appreciation or depreciation on the consolidated statements of operations
includes changes in the fair value of investments from the prior period, as
determined by the Board through the application of our valuation policy, as well
as reclassifications of any prior period unrealized appreciation or depreciation
on exited investments to realized gains or losses on investments.
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Interest and dividend income. Interest and dividend income are recorded on the
accrual basis to the extent that we expect to collect such amounts. Interest is
accrued daily based on the outstanding principal amount and the contractual
terms of the debt. Dividend income is recorded as dividends are declared or at
the point an obligation exists for the portfolio company to make a distribution,
and is generally recognized when received. Distributions from portfolio
companies are evaluated to determine if the distribution is a distribution of
earnings or a return of capital. Distributions of earnings are included in
dividend income while a return of capital is recorded as a reduction in the cost
basis of the investment. Estimates are adjusted as necessary after the relevant
tax forms are received from the portfolio company.
PIK income. Certain of our investments contain a PIK income provision. The PIK
income, computed at the contractual rate specified in the applicable investment
agreement, is added to the principal balance of the investment, rather than
being paid in cash, and recorded as interest or dividend income, as applicable,
on the consolidated statements of operations. Generally, PIK can be paid-in-kind
or all in cash. We stop accruing PIK income when there is reasonable doubt that
PIK income will be collected. PIK income that has been contractually capitalized
to the principal balance of the investment prior to the non-accrual designation
date is not reserved against interest or dividend income, but rather is assessed
through the valuation of the investment (with corresponding adjustments to
unrealized depreciation, as applicable). PIK income is included in our taxable
income and, therefore, affects the amount we are required to pay to our
stockholders in the form of dividends in order to maintain our tax treatment as
a RIC and to avoid paying corporate-level U.S. federal income tax, even though
we have not yet collected the cash.
Non-accrual. Debt investments or preferred equity investments (for which we are
accruing PIK dividends) are placed on non-accrual status when principal,
interest or dividend payments become materially past due, or when there is
reasonable doubt that principal, interest or dividends will be collected. Any
original issue discount and market discount are no longer accreted to interest
income as of the date the loan is placed on full non-accrual status. Interest
and dividend payments received on non-accrual investments may be recognized as
interest or dividend income or applied to the investment principal balance based
on management's judgment. Non-accrual investments are restored to accrual status
when past due principal, interest or dividends are paid and, in management's
judgment, are likely to remain current.
Warrants. In connection with our debt investments, we will sometimes receive
warrants or other equity-related securities (Warrants). We determine the cost
basis of Warrants based upon their respective fair values on the date of receipt
in proportion to the total fair value of the debt and Warrants received. Any
resulting difference between the face amount of the debt and its recorded fair
value resulting from the assignment of value to the Warrants is treated as OID
and accreted into interest income using the effective interest method over the
term of the debt investment. Upon the prepayment of a debt investment, any
unaccreted OID is accelerated into interest income.
Fee income. All transaction fees earned in connection with our investments are
recognized as fee income and are generally non-recurring. Such fees typically
include fees for services, including structuring and advisory services, provided
to portfolio companies. We recognize income from fees for providing such
structuring and advisory services when the services are rendered or the
transactions are completed. Upon the prepayment of a debt investment, any
prepayment penalties are recorded as fee income when earned.
We also typically receive debt investment origination or closing fees in
connection with investments. Such debt investment origination and closing fees
are capitalized as unearned income and offset against investment cost basis on
our consolidated statements of assets and liabilities and accreted into interest
income over the term of the investment. Upon the prepayment of a debt
investment, any unaccreted debt investment origination and closing fees are
accelerated into interest income.
Transfers of Financial Assets
Partial loan and equity sales. We follow the guidance in ASC 860, Transfers and
Servicing, when accounting for loan (debt investment) participations, equity
assignments and other partial loan sales. Such guidance requires a
participation, assignment or other partial loan or equity sale to meet the
definition of a "participating interest," as defined in the guidance, in order
for sale treatment to be allowed. Participations, assignments or other partial
loan or equity sales which do not meet the definition of a participating
interest should remain on our consolidated statements of assets and liabilities
and the proceeds recorded as a secured borrowing until the definition is met.
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--------------------------------------------------------------------------------Recently Issued Accounting Standard
InJune 2022 , theFinancial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2022-03, "Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions (Topic 820)," which clarifies that a contractual sale restriction prohibiting the sale of an equity security is a characteristic of the reporting entity holding the equity security and is not included in the equity security's unit of account. Accordingly, an entity should not consider the contractual sale restriction when measuring the equity security's fair value. In addition, ASU No. 2022-03 prohibits an entity from recognizing a contractual sale restriction as a separate unit of account. ASU No. 2022-03's amendments are effective for fiscal years beginning afterDecember 15, 2023 , with early adoption permitted. We are currently evaluating the impact of the adoption of ASU No. 2022-03 on our consolidated financial statements.
SEC Regulation S-K Update
InNovember 2020 , theSEC issued a final rule that modernized and simplifies Management's Discussion and Analysis of Financial Condition and Results of Operations and certain financial disclosure requirements in Regulation S-K (the "Amendments"). Specifically, the Amendments: (i) eliminate Item 301 of Regulation S-K (Selected Financial Data); (ii) simplify Item 302 of Regulation S-K (Supplementary Financial Information); and (iii) amend certain aspects of Item 303 of Regulation S-K (Management's Discussion and Analysis of Financial Condition and Results of Operations). The Amendments became effective onFebruary 10, 2021 and compliance was required for the registrant's fiscal year ending on or afterAugust 9, 2021 . We adopted the Amendments on the effective date which did not have a material impact on our Consolidated Financial Statements.
Related Party Transactions
We have entered into a number of business relationships with affiliated or related parties, including the following:
•
We have entered into the Investment Advisory Agreement withFidus Investment Advisors as our investment advisor. Pursuant to the agreement, the Investment Advisor manages our day-to-day operating and investing activities. We pay the Investment Advisor a fee for its services under the Investment Advisory Agreement consisting of two components - a base management fee and an incentive fee. See Note 5 to our consolidated financial statements. •Fidus Group Holdings, LLC ("Holdings"), a limited liability company organized under the laws ofDelaware , is the parent company ofFidus Investment Advisors .Edward H. Ross , our Chairman and Chief Executive Officer, andThomas C. Lauer , our President, are managers of Holdings. • We entered into the Administration Agreement withFidus Investment Advisors to provide us with the office facilities and administrative services necessary to conduct day-to-day operations. See Note 5 to our consolidated financial statements. • We entered into a license agreement withFidus Partners, LLC , pursuant to whichFidus Partners, LLC has granted us a non-exclusive, royalty-free license to use the name "Fidus ." • OnFebruary 25, 2020 , the Company entered into a Limited Partnership Agreement (the "Agreement") withFidus Equity Fund I, L.P. ("FEF I"). Pursuant to the Agreement, we will serve as the General Partner of FEF I. Owned by third-party investors, FEF I was formed to purchase 50% of select equity investments from us. We will not receive any fees from FEF I for any services provided in our capacity as the General Partner of FEF I. • The Investment Advisor, in consultation with the Board, agreed to voluntarily waive$0.1 million and$0.2 million of the base management fees on any assets accounted for as secured borrowings as defined under GAAP for the three and nine months endedSeptember 30, 2022 , respectively, and$0.1 million and$0.1 million for the three and nine months endedSeptember 30, 2021 , respectively. In connection with the IPO and our election to be regulated as a BDC, we applied for and received exemptive relief from theSEC onMarch 27, 2012 to allow us to take certain actions that would otherwise be prohibited by the 1940 Act, as applicable to BDCs. EffectiveJune 30, 2014 , pursuant to exemptive relief from theSEC , we are permitted to exclude the senior securities issued by Fund II and Fund III from the definition of senior securities in the asset coverage requirement applicable to the Company under the 1940 Act. While we may co-invest with investment entities managed by the Investment Advisor or its affiliates, to the extent permitted by the 1940 Act and the rules and regulations thereunder, the 1940 Act imposes significant limits on co-investment. OnJanuary 4, 2017 , theSEC staff has granted us relief sought in an exemptive order that expands our ability to co-invest in portfolio companies with other funds managed by the Investment Advisor or its affiliates ("Affiliated Funds") in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with certain conditions (the "Order"). Pursuant to the Order, we are permitted to co-invest with our affiliates if a "required majority" (as defined in Section 57(o) of the 1940 Act) or the Independent Directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching by us or our stockholders on the part of any person concerned, and 55 -------------------------------------------------------------------------------- (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. However, neither we nor our affiliates are obligated to invest or co-invest when investment opportunities are referred to us or them. In addition, we and our Investment Advisor have each adopted a joint code of ethics pursuant to Rule 17j-1 under the 1940 Act that governs the conduct of our and the Investment Advisor's officers, directors and employees. Additionally, the Investment Advisor has adopted a code of ethics pursuant to Rule 204A-1 under the Advisers Act of 1940, as amended, and in accordance with Rule 17j-1(c) under the 1940 Act. We have also adopted a code of business conduct that is applicable to all officers, directors and employees ofFidus and our Investment Advisor. Our officers and directors also remain subject to the duties imposed by both the 1940 Act and the Maryland General Corporation Law.
Recent Developments
OnOctober 3, 2022 , we invested$1.0 million in common equity ofEBL, LLC , which was acquired under a new holding company,FOM Eblens Holdings, LLC (dba Eblens), and became a controlled affiliate investment. In conjunction with the transaction, we amended the terms of our second lien debt investment and committed up to$0.4 million in incremental common equity.
On
OnOctober 17, 2022 , we exited our debt and equity investment inOMC Investors, LLC (dbaOhio Medical Corporation ). We received payment in full of$5.2 million on our second lien debt, which included a prepayment fee. We received a distribution on our equity investment for a realized gain of approximately$0.7 million . OnOctober 31, 2022 , our Board declared an incremental supplemental dividend of$0.08 per share and a special dividend of$0.10 per share for the fourth quarter, which are payable onDecember 16, 2022 , to stockholders of record as ofDecember 2, 2022 . OnOctober 31, 2022 , we invested$6.0 million in second lien debt ofEducation Incites, LLC (dba Acceleration Academies), a leading provider of alternative education academies focused on high school dropout recovery throughoutthe United States .
On
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