GLADSTONE CAPITAL CORPORATION The following analysis of our financial condition and results of operations should be read in conjunction with our accompanying Consolidated Financial Statements and the notes thereto contained elsewhere in this Annual Report. Historical financial condition and results of operations and percentage relationships among any amounts in the financial statements are not necessarily indicative of financial condition, results of operations or percentage relationships for any future periods. Except per share amounts, dollar amounts in the tables included herein are in thousands unless otherwise indicated.
OVERVIEW
General
We were incorporated under the Maryland General Corporation Law onMay 30, 2001 . We operate as an externally managed, closed-end, non-diversified management investment company, and have elected to be treated as a BDC under the 1940 Act. In addition, for federal income tax purposes we have elected to be treated as a RIC under the Code. To continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.
We were established for the purpose of investing in debt and equity securities
of established private businesses operating in the
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investing in equity securities, in connection with our debt investments, that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our investment objectives, our primary investment strategy is to invest in several categories of debt and equity securities, with each investment generally ranging from$8 million to$30 million , although investment size may vary, depending upon our total assets or available capital at the time of investment. We expect that our investment portfolio over time will consist of approximately 90.0% debt investments and 10.0% equity investments, at cost. As ofSeptember 30, 2022 , our investment portfolio was made up of approximately 90.7% debt investments and 9.3% equity investments, at cost. We focus on investing in lower middle market companies (which we generally define as companies with annual earnings before interest, taxes, depreciation and amortization of$3 million to$15 million ) in theU.S. that meet certain criteria, including the following: the sustainability of the business' free cash flow and its ability to grow it over time, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, reasonable capitalization of the borrower, including an ample equity contribution or cushion based on prevailing enterprise valuation multiples and, to a lesser extent, the potential to realize appreciation and gain liquidity in our equity position, if any. We lend to borrowers that need funds for growth capital or to finance acquisitions or recapitalize or refinance their existing debt facilities. We seek to avoid investing in high-risk, early-stage enterprises. Our targeted portfolio companies are generally considered too small for the larger capital marketplace. We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity. InJuly 2012 , theSEC granted us the Co-Investment Order that expanded our ability to co-invest, under certain circumstances, with certain of our affiliates, including Gladstone Investment, a BDC also managed by the Adviser, and any future BDC or registered closed-end management investment company that is advised (or sub-advised if it controls the fund) by the Adviser, or any combination of the foregoing, subject to the conditions in the Co-Investment Order. We believe the Co-Investment Order has enhanced and will continue to enhance our ability to further our investment objectives and strategies. If we are participating in an investment with one or more co-investors, whether or not an affiliate of ours, our investment is likely to be smaller than if we were investing alone.
Business
Portfolio and Investment Activity
In general, our investments in debt securities have a term of no more than seven years, accrue interest at variable rates (generally based on the 30-day LIBOR or one-month Term SOFR) and, to a lesser extent, at fixed rates. We seek debt instruments that pay interest monthly or, at a minimum, quarterly, may have a success fee or deferred interest provision and are primarily interest only, with all principal and any accrued but unpaid interest due at maturity. Generally, success fees accrue at a set rate and are contractually due upon a change of control of a portfolio company, typically from an exit or sale. Some debt securities have deferred interest whereby some portion of the interest payment is added to the principal balance so that the interest is paid, together with the principal, at maturity. This form of deferred interest is often called PIK interest.
Typically, our equity investments consist of common stock, preferred stock, limited liability company interests, or warrants to purchase the foregoing. Often, these equity investments occur in connection with our original investment, recapitalizing a business, or refinancing existing debt.
During the year endedSeptember 30, 2022 , we invested$215.3 million in 14 new portfolio companies and extended$59.6 million in investments to existing portfolio companies. In addition, during the year endedSeptember 30, 2022 , we exited eight portfolio companies through early payoffs or a restructure. We received a total of$175.8 million in combined net proceeds and principal repayments from the aforementioned portfolio company exits as well as principal repayments by existing portfolio companies during the year endedSeptember 30, 2022 . This activity resulted in a net increase in our overall portfolio by six portfolio companies to 52 and a net increase of$109.5 million in our portfolio at cost sinceSeptember 30, 2021 . From our initial public offering inAugust 2001 throughSeptember 30, 2022 , we have made 609 different loans to, or investments in, 268 companies for a total of approximately$2.5 billion , before giving effect to principal repayments on investments and divestitures. 49
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During the year ended
Proprietary Investments
•In
•InNovember 2021 , our investment inLignetics, Inc. was sold, which resulted in the recognition of success fee income of$1.6 million and a realized gain of$13.4 million . In connection with the sale, we received net cash proceeds of approximately$47.2 million , including the repayment of our debt investment of$29.0 million at par. •InNovember 2021 , our investment inProphet Brand Strategy paid off at par for net cash proceeds of$13.1 million . In conjunction with the payoff, we received a prepayment fee of$0.1 million . •InNovember 2021 , our investment inEffective School Solutions LLC paid off at par for net cash proceeds of$19.5 million . In conjunction with the payoff, we received a prepayment fee of$0.5 million .
•In
•In
•In
•In
•In
•InDecember 2021 , we invested$16.8 million inHH-Inspire Acquisition, Inc. ("HH-Inspire") through secured first lien debt and preferred equity. InJune 2022 , we invested an additional$11.5 million in HH-Inspire through secured first lien debt. InAugust 2022 , we invested an additional$0.2 million in HH-Inspire through additional preferred equity. InSeptember 2022 , we invested an additional$8.0 million in HH-Inspire through secured first lien debt.
•In
•In
•InMarch 2022 , our investment inNetFortris Corp. was sold, which resulted in the recognition of success fee income of$3.2 million . In connection with the sale, we received net cash proceeds of$29.0 million , including the repayment of our debt investment of$28.8 million at par. We continue to retain an equity investment inNetFortris Holdings LLC with a cost basis of$0.8 million and fair value of$0.5 million as ofSeptember 30, 2022 .
•In
•In
•In
•InJune 2022 , our investment inLWO Acquisitions Company LLC ("LWO") was restructured upon emergence from Chapter 11 bankruptcy protection. As part of the restructuring, our existing$16.8 million debt investment in LWO was converted to$3.3 million of first lien debt and$6.8 million of common equity inLonestar EMS, LLC . In conjunction with the restructuring, we recorded a net realized loss of approximately$8.5 million , including the write off of approximately$1.8 million in other receivables.
•In
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•In
•In
•In
•InSeptember 2022 , we extendedSalt and Straw, LLC a$2.0 million line of credit commitment and an$11.5 million delayed draw term loan commitment. We funded$0.8 million on the line of credit at close. •InSeptember 2022 ,Unirac, Inc. was sold. In conjunction with the sale, we received net cash proceeds of$11.8 million , including the repayment of our debt investment at par and a$0.1 million prepayment penalty. •InSeptember 2022 , we invested$15.0 million inUnirac Holdings, Inc. through secured first lien debt. We also extendedUnirac Holdings, Inc. a$2.2 million line of credit commitment and a$2.8 million delayed draw term loan commitment, both of which were both unfunded at close.
Syndicated Investments
•In
•In
Refer to Note 15-Subsequent Events in the accompanying Consolidated Financial
Statements included elsewhere in this Annual Report for portfolio activity
occurring subsequent to
Capital Raising
We have been able to meet our capital needs through extensions of and increases to our line of credit under the Credit Facility and by accessing the capital markets in the form of public equity offerings of common stock and public and private debt offerings. We have successfully extended the Credit Facility's revolving period multiple times, most recently toOctober 2023 , and currently have a total commitment amount of$225.0 million . We sold 430,425 and 2,737,521 common shares under our at-the-market program during the years endedSeptember 30, 2022 and 2021, respectively. InNovember 2021 , we completed a private placement of$50.0 million aggregate principal amount of the 2027 Notes. InDecember 2020 , we completed an offering of$100.0 million aggregate principal amount of the 2026 Notes. InMarch 2021 , we completed an offering of an additional$50.0 million aggregate principal amount of the 2026 Notes. Refer to "Liquidity and Capital Resources - Revolving Line of Credit," "Liquidity and Capital Resources - Equity - Common Stock," and "Liquidity and Capital Resources - Notes Payable" for further discussion. Although we were able to access the capital markets historically and in recent years, market conditions may affect the trading price of our capital stock and thus may inhibit our ability to finance new investments through the issuance of equity in the future. When our common stock trades below NAV per common share, our ability to issue equity is constrained by provisions of the 1940 Act, which generally prohibits the issuance and sale of our common stock below NAV per common share without first obtaining approval from our stockholders and our independent directors, other than through sales to our then-existing stockholders pursuant to a rights offering. OnSeptember 30, 2022 , the closing market price of our common stock was$8.49 per share, a 6.5% discount to ourSeptember 30, 2022 NAV per share of$9.08 .
Regulatory Compliance
Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act, which require us to have an asset coverage (as defined in Sections 18 and 61 of the 1940 Act) of at least 150% on our "senior securities representing indebtedness" and our "senior securities that are stock." OnApril 10, 2018 , our Board of Directors, including a "required majority" (as such term is defined in Section 57(o) of the 1940 Act) thereof, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a 51
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result, the Company's asset coverage requirements for senior securities changed
from 200% to 150%, effective
As of
Recent Developments
Credit Facility
In
Distributions
In
Distribution
per Common
Record Date Payment Date Share
October 21, 2022 October 31, 2022 $ 0.07
November 18, 2022 November 30, 2022 0.07
December 20, 2022 December 30, 2022 0.07
Total for the Quarter $ 0.21 Election of Director
Effective
LIBOR Transition
In general, our investments in debt securities have a term of five years, accrue interest at variable rates (based on the one-month LIBOR or SOFR) and, to a lesser extent, at fixed rates. MostU.S. dollar LIBOR are currently anticipated to be phased out inJune 2023 . LIBOR is currently expected to transition to a new standard rate, the SOFR, which will incorporate certain overnight repo market data collected from multiple data sets. The majority of the new variable rate debt investments that we made during the quarter endedSeptember 30, 2022 are based on SOFR and certain of our other existing investments have been transitioned to SOFR. Further, the majority of our outstanding loan agreements for variable rate debt investments that are still based on one-month LIBOR have been amended to include LIBOR replacement language should LIBOR cease to exist. Assuming that SOFR replaces LIBOR, we expect that there should be minimal impact on our operations. In addition, our Credit Facility has been amended to update the reference rate from LIBOR to SOFR plus an 11 basis point credit spread adjustment.
Impact of Inflation
We believe the effects of inflation, if any, on our historical results of operations and financial condition have been immaterial. During the six months endedSeptember 30, 2022 , general inflationary pressures and certain commodity price volatility have impacted our portfolio companies to varying degrees; however, the broad based impact of these pricing changes have largely been mitigated by price adjustments without adverse sales implications, and thus, have not materially impacted our portfolio companies' ability to service their indebtedness, including our loans. Notwithstanding the results to date, the cumulative effect of these inflationary pressures may, in the future, impact the profit margins or sales of certain portfolio companies and their ability to service their debts. We continue to monitor the current inflationary environment to anticipate any impact on our portfolio companies, including their availability to pay interest on our loans. We cannot assure you that our results of operations and financial condition or that of our portfolio companies will not be materially impacted by inflation in the future. See "Risk Factors- We may experience fluctuations in our quarterly and annual results based on the impact of inflation in theU.S. " 52
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RESULTS OF OPERATIONS
Comparison of the Year EndedSeptember 30, 2022 to the Year EndedSeptember 30, 2021 For the Year Ended September 30, 2022 2021 $ Change % Change INVESTMENT INCOME Interest income$ 53,988 $ 49,959 $ 4,029 8.1 % Other income 9,162 3,835 5,327 138.9 Total investment income 63,150 53,794 9,356 17.4 EXPENSES Base management fee 10,247 8,674 1,573 18.1 Loan servicing fee 6,329 5,579 750 13.4 Incentive fee 7,511 5,746 1,765 30.7 Administration fee 1,610 1,438 172 12.0 Interest expense 12,966 11,513 1,453 12.6 Amortization of deferred financing costs 1,175 1,347 (172) (12.8) Other expenses 2,165 1,907 258 13.5 Expenses, before credits from Adviser 42,003 36,204 5,799 16.0 Credit to base management fee - loan servicing fee (6,329) (5,579) (750) 13.4 Credit to fees from Adviser - other (4,803) (2,953) (1,850) 62.6 Total expenses, net of credits 30,871 27,672 3,199 11.6 NET INVESTMENT INCOME 32,279 26,122 6,157 23.6 NET REALIZED AND UNREALIZED GAIN (LOSS) Net realized gain (loss) on investments 5,416 4,179 1,237 29.6 Net realized gain (loss) on other (243) (999) 756 (75.7) Net unrealized appreciation (depreciation) of investments (17,538) 55,347 (72,885) (131.7) Net unrealized appreciation (depreciation) of other - (350) 350 (100.0) Net gain (loss) from investments and other (12,365) 58,177 (70,542) (121.3) NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS$ 19,914 $ 84,299 $ (64,385) (76.4) % PER BASIC AND DILUTED COMMON SHARE Net investment income$ 0.94 $ 0.79 $ 0.15 19.0 % Net increase (decrease) in net assets resulting from operations$ 0.58 $ 2.54 $ (1.96) (77.2) %
Investment Income
Interest income increased by 8.1% for the year endedSeptember 30, 2022 , as compared to the prior year. The increase was due primarily to an increase in the weighted average principal balance of our interest-bearing portfolio, partially offset by a decrease in the weighted average yield on our interest-bearing portfolio. The weighted average principal balance of our interest-bearing investment portfolio for the year endedSeptember 30, 2022 , was$517.0 million , compared to$462.8 million for the year endedSeptember 30, 2021 , an increase of$54.2 million , or 11.7%. The weighted average yield on our interest-bearing investments is based on the current stated interest rate on interest-bearing investments, which decreased slightly to 10.4% for the year endedSeptember 30, 2022 , compared to 10.6% for the year endedSeptember 30, 2021 , inclusive of any allowances on interest receivables made during those periods. The decrease in the weighted average yield was driven mainly by competitive marketplace conditions. 53
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As of
Other income increased by 138.9% during the year endedSeptember 30, 2022 , as compared to the prior year period primarily due to a$4.6 million increase in success fees received and a$1.2 million increase in dividend income year over year.
As of
Expenses
Expenses, net of any non-contractual, unconditional and irrevocable credits to fees from the Adviser, increased$3.2 million , or 11.6%, for the year endedSeptember 30, 2022 as compared to the prior year. This increase was primarily due to a$1.8 million increase in the net incentive fee and a$1.5 million increase in interest expense on borrowings. Total interest expense on borrowings and notes payable increased by$1.5 million , or 12.6%, during the year endedSeptember 30, 2022 compared to the prior year. This increase was driven by an increase in interest rates and a change in the composition of our overall debt financing. Interest expense on our notes payable increased by$1.0 million year over year with the issuance of the 2027 Notes inNovember 2021 and the 2026 Notes inDecember 2020 andMarch 2021 , partially offset by the redemption of the 2023 Notes inJanuary 2021 and the 2024 Notes inNovember 2021 . Interest expense on our Credit Facility increased by$0.4 million period over period, driven primarily by an increase in the effective interest rate on our Credit Facility, partially offset by a decrease in the weighted average balance outstanding on our Credit Facility and a decrease in unused commitment fees, period over period. The effective interest rate on our Credit Facility, including unused commitment fees incurred, but excluding the impact of deferred financing costs, was 6.1% during the year endedSeptember 30, 2022 , compared to 5.0% during the prior year. The increase in the effective interest rate was driven primarily by an increase in interest rates. The weighted average balance outstanding on our Credit Facility was$56.1 million during the year endedSeptember 30, 2022 , as compared to$59.4 million in the prior year, a decrease of 5.6%. The gross base management fee earned by the Adviser increased by$1.6 million , or 18.1%, during the year endedSeptember 30, 2022 , as compared to the prior year, resulting from an increase in average total assets subject to the base management fee year over year. The income-based incentive fee increased by$1.8 million , or 30.7%, for the year endedSeptember 30, 2022 , as compared to the prior year, due to higher pre-incentive fee net investment income over the respective periods. Our Board of Directors accepted non-contractual, unconditional and irrevocable credits from the Adviser of$0.4 million and$0.5 million , to reduce the income-based incentive fee to the extent net investment income did not cover 100.0% of our distributions to common stockholders during the years endedSeptember 30, 2022 and 2021, respectively. 54
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The base management, loan servicing and incentive fees, and associated non-contractual, unconditional and irrevocable credits, are computed quarterly, as described under "Transactions with the Adviser" in Note 4- Related Party Transactions of the Notes to Consolidated Financial Statements and are summarized in the following table:
Year Ended
2022 2021
Average total assets subject to base management fee(A)
$ 495,657 Multiplied by annual base management fee of 1.75% 1.75 % 1.75 % Base management fee (B) 10,247
8,674
Portfolio company fee credit (4,196) (2,195) Syndicated loan fee credit (170) (307) Net Base Management Fee$ 5,881 $ 6,172 Loan servicing fee(B)$ 6,329 $ 5,579 Credit to base management fee - loan servicing fee(B) (6,329) (5,579) Net Loan Servicing Fee $ - $ - Incentive fee(B)$ 7,511 $ 5,746 Incentive fee credit (437) (451) Net Incentive Fee$ 7,074 $ 5,295 Portfolio company fee credit$ (4,196) $ (2,195) Syndicated loan fee credit (170) (307) Incentive fee credit (437) (451) Credit to Fees from Adviser-Other(B)$ (4,803)
(A)Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the two most recently completed quarters within the respective years and adjusted appropriately for any share issuances or repurchases during the period. (B)Reflected, on a gross basis, as a line item on our accompanying Consolidated Statement of Operations located elsewhere in this Annual Report.
Realized Loss and Unrealized Appreciation
Net Realized Gain (Loss) on Investments
For the year ended
For the year endedSeptember 30, 2021 , we recorded a net realized gain on investments of$4.2 million , which resulted primarily from a$5.3 million net realized gain recognized from the exit ofAG Transportation Holdings, LLC , a$0.6 million net realized gain from the exit ofAmerican Trailer Rental Group LLC and gains from previous exits of certain other investments, partially offset by a$2.4 million net realized loss on our investment inEdmentum Ultimate Holdings, LLC . 55
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Net Unrealized Appreciation of Investments
During the year ended
Year Ended
Reversal of
Unrealized Unrealized
Realized Gain Appreciation Depreciation Net Gain
Portfolio Company (Loss) (Depreciation) (Appreciation) (Loss)
LWO Acquisitions Company LLC $ (8,496) $ (328) $ 14,119 $ 5,295
ENET Holdings, LLC - 4,785 447 5,232
NetFortris Holdings LLC - 3,949 (284) 3,665
WB Xcel Holdings, LLC - 2,937 - 2,937
Imperative Holdings Corporation - 2,195 - 2,195
R2i Holdings, LLC - 620 - 620
TNCP Intermediate HoldCo, LLC - 609 - 609
AG Transportation Holdings, LLC 468 - - 468
HH-Inspire Acquisition, Inc. - (277) - (277)
Axios Industrial Group, LLC - (345) - (345)
ALS Education, LLC - (351) - (351)
GFRC Holdings, LLC - (357) - (357)
SpaceCo Holdings, LLC - (359) - (359)
Café Zupas - (386) - (386)
Tailwind Smith Cooper Intermediate
Corporation - (416) - (416)
Viva Railings, L.L.C. - (436) - (436)
PIC 360, LLC - (529) - (529)
Eegee's LLC - (536) - (536)
8th Avenue Food & Provisions, Inc. - (622) - (622)
DKI Ventures, LLC - (645) - (645)
Triple H Food Processors, LLC - (814) - (814)
Ohio Armor Holdings, LLC - (1,136) - (1,136)
Defiance Integrated Technologies, Inc. - (1,468) (28) (1,496)
MCG Energy Solutions, LLC - (1,549) - (1,549)
Lignetics, Inc. 13,408 - (14,958) (1,550)
Engineering Manufacturing Technologies,
LLC - (1,593) - (1,593)
Targus Cayman HoldCo, Ltd. - (2,052) - (2,052)
B+T Group Acquisition Inc. - (3,350) - (3,350)
Encore Dredging Holdings, LLC - (3,353) - (3,353)
Edge Adhesives Holdings, Inc. - (3,590) - (3,590)
Lonestar EMS, LLC - (6,970) - (6,970)
Other, net (<$500 ) 36 (124) (343) (431)
Total: $ 5,416 $ (16,491) $ (1,047) $ (12,122)
The primary driver of net unrealized depreciation of $17.5 million for the year
ended September 30, 2022 was the reversal of unrealized depreciation associated
with the exit of our investment in Lignetics, Inc. , the decrease in comparable
transaction multiples used to estimate the fair value of certain of our other
portfolio companies, a pricing decrease in the broadly syndicated loan market,
and the decline in the financial and operational performance of certain of our
other portfolio companies, partially offset by the reversal of unrealized
depreciation associated with the restructuring of our investment in LWO and
unrealized appreciation recognized on ENET Holdings, LLC and NetFortris Holdings
LLC .
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During the year ended September 30, 2021 , we recorded net unrealized
appreciation of investments in the aggregate amount of $55.3 million . The net
realized gain (loss) and unrealized appreciation (depreciation) across our
investments for the year ended September 30, 2021 were as follows:
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Year Ended September 30, 2021
Reversal of
Unrealized Unrealized
Realized Gain Appreciation Depreciation Net Gain
Portfolio Company (Loss) (Depreciation) (Appreciation) (Loss)
Lignetics, Inc. $ - $ 14,420 $ - $ 14,420
Antenna Research Associates, Inc. - 9,306 - 9,306
B+T Group Acquisition Inc. - 6,453 - 6,453
AG Transportation Holdings, LLC 5,289 6,788 (7,934) 4,143
Targus Cayman HoldCo, Ltd. - 4,125 - 4,125
Defiance Integrated Technologies, Inc. - 2,535 - 2,535
Imperative Holdings Corporation - 2,281 - 2,281
Leeds Novamark Capital I, L.P - 2,219 - 2,219
MCG Energy Solutions, LLC - 1,659 - 1,659
PIC 360, LLC - 1,641 - 1,641
Triple H Food Processors, LLC - 1,523 - 1,523
Encore Dredging Holdings, LLC - 1,443 - 1,443
TNCP Intermediate HoldCo, LLC - 1,252 - 1,252
Iten Defense, LLC - 798 - 798
Tailwind Smith Cooper Intermediate
Corporation - 789 - 789
American Trailer Rental Group LLC 598 1,213 (1,042) 769
EL Academies, Inc. - 760 - 760
Café Zupas - 746 - 746
DKI Ventures, LLC - 732 - 732
Sea Link International IRB, Inc. - 662 - 662
Canopy Safety Brands, LLC - 657 - 657
SpaceCo Holdings, LLC - 500 - 500
Keystone Acquisition Corp. - 481 - 481
Edmentum Ultimate Holdings, LLC (2,351) - 2,770 419
Medical Solutions Holdings, Inc. - 406 - 406
R2i Holdings, LLC - 351 - 351
Belnick, Inc. - 350 - 350
Vertellus Holdings LLC (41) - 313 272
Gray Matter Systems, LLC - 260 - 260
Unirac, Inc. - 238 - 238
ALS Education, LLC - 237 - 237
Magpul Industries Corp. - 210 (210) -
Drive Chassis Holdco, LLC - 260 (261) (1)
Precision International, LLC 354 (184) (332) (162)
GFRC Holdings, LLC - (548) - (548)
LWO Acquisitions Company LLC - (609) - (609)
ENET Holdings, LLC - (674) - (674)
NetFortris Corp. - (1,371) - (1,371)
Other, net (<$500 ) 330 72 62 464
Total: $ 4,179 $ 61,981 $ (6,634) $ 59,526
The primary driver of net unrealized appreciation of $55.3 million for the year
ended September 30, 2021 was the improvement in the financial and operational
performance across a number of our portfolio companies and an increase in
comparable transaction multiples used to estimate the fair value of several of
our portfolio companies, partially offset by the reversal of unrealized
depreciation associated with the exit of our investment in AG Transportation
Holdings, LLC and a decrease in performance of certain of our other portfolio
companies.
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As ofSeptember 30, 2022 , the fair value of our investment portfolio was less than its cost basis by approximately$6.4 million and our entire investment portfolio was valued at 99.0% of cost, as compared to cumulative net unrealized appreciation of$11.1 million and a valuation of our entire portfolio at 102.0% of cost as ofSeptember 30, 2021 .
Net Unrealized (Appreciation) Depreciation of Other
During the year endedSeptember 30, 2021 , we recorded$0.4 million of unrealized depreciation on our Credit Facility at fair value. No such amounts were recorded during the year endedSeptember 30, 2022 . The comparison of the fiscal year endedSeptember 30, 2021 to the fiscal year endedSeptember 30, 2020 can be found in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2021 , as filed with theSEC onNovember 15, 2021 , located within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Our cash flows from operating activities are primarily generated from the interest payments on debt securities that we receive from our portfolio companies, as well as net proceeds received through repayments or sales of our investments. We utilize this cash primarily to fund new investments, make interest payments on our Credit Facility and notes payable, make distributions to our stockholders, pay management and administrative fees to the Adviser and Administrator, and for other operating expenses. Net cash used in operating activities for the year endedSeptember 30, 2022 was$76.4 million as compared to$14.1 million for the year endedSeptember 30, 2021 . The change was primarily due to an increase in purchases of investments. Purchases of investments were$274.9 million during the year endedSeptember 30, 2022 compared to$181.8 million during the year endedSeptember 30, 2021 . Net cash used in operating activities for the year endedSeptember 30, 2021 was$14.1 million as compared to$46.1 million for the year endedSeptember 30, 2020 . The change was primarily due to an increase in principal repayments and net proceeds from sales of investments. Repayments and net proceeds from sales were$142.7 million during the year endedSeptember 30, 2021 compared to$78.8 million during the year endedSeptember 30, 2020 .
As of
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The following table summarizes our total portfolio investment activity during
the years ended
Year Ended
2022 2021
Beginning investment portfolio, at fair value $ 557,612 $ 450,400
New investments 215,254 138,992
Disbursements to existing portfolio companies 59,644 42,849
Scheduled principal repayments (8,838) (4,854)
Unscheduled principal repayments (151,154) (121,962)
Net proceeds from sales of investments (15,758) (12,457)
Net unrealized appreciation (depreciation) of investments (16,491) 61,981
Reversal of prior period net appreciation (depreciation) of investments
(1,047) (6,634)
Net realized gain (loss) on investments 5,416 4,179
Increase in investment balance due to PIK interest (A) 4,532 5,994
Net change in premiums, discounts and amortization 445 (876)
Ending Investment Portfolio, at Fair Value $ 649,615 $ 557,612 (A)PIK interest is a non-cash source of income and is calculated at the contractual rate stated in a loan agreement and added to the principal balance of a loan.
The following table summarizes the contractual principal repayment and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, as ofSeptember 30, 2022 . Year EndingSeptember 30 , Amount 2023(A)$ 17,708 2024 58,399 2025 80,786 2026 155,974 2027 246,348 Thereafter 36,975 Total contractual repayments$ 596,190 Adjustments to cost basis of debt investments (1,142) Investments in equity securities 61,005
Investments held as of
(A)Includes debt investments with contractual principal amounts totaling
Financing Activities
Net cash provided by financing activities for the year endedSeptember 30, 2022 was$77.7 million , which consisted primarily of$91.3 million in net borrowings on our Credit Facility and$50.0 million in gross proceeds from the issuance of notes payable, partially offset by$38.8 million used in the redemption of our 2024 Notes and$27.3 million in distributions to common shareholders. Net cash provided by financing activities for the year endedSeptember 30, 2021 was$12.4 million , which consisted primarily of$150.0 million in gross proceeds from the issuance of notes payable and$26.9 million in gross proceeds from the issuance of common stock, partially offset by$77.5 million in net repayments on our Credit Facility,$57.5 million used in the redemption of our 2023 Notes, and$26.0 million in distributions to common shareholders. Net cash provided by financing activities for the year endedSeptember 30, 2020 was$32.8 million , which consisted primarily of$61.1 million in net borrowings on our Credit Facility and$38.8 million in gross proceeds from the issuance 60
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of notes payable, partially offset by
Distributions to Stockholders
Common Stock Distributions
To qualify to be taxed as a RIC and thus avoid corporate level federal income tax on the income we distribute to our stockholders, we are required to distribute to our stockholders on an annual basis at least 90.0% of our Investment Company Taxable Income. Additionally, our Credit Facility has a covenant that generally restricts the amount of distributions to stockholders that we can pay out to be no greater than our aggregate net investment income, net capital gains and amounts elected to have been paid during the prior year in accordance with Section 855(a) of the Code. In accordance with these requirements, during the year endedSeptember 30, 2022 , we paid monthly cash distributions of$0.065 per common share for the months ofOctober 2021 throughMarch 2022 and paid monthly cash distributions of$0.0675 per common share for the months ofApril 2022 throughSeptember 2022 . These distributions totaled an aggregate of$27.3 million . During the year endedSeptember 30, 2021 , we paid monthly cash distributions of$0.065 per common share for each month, which totaled an aggregate of$26.0 million . During the year endedSeptember 30, 2020 , we paid monthly cash distributions of$0.07 per common share for the months ofOctober 2019 throughMarch 2020 and paid monthly cash distributions of$0.065 per common share for the months ofApril 2020 throughSeptember 2020 . These distributions totaled an aggregate of$25.2 million . InOctober 2022 , our Board of Directors declared a monthly distribution of$0.07 per common share for each of October, November, andDecember 2022 . Our Board of Directors declared these distributions to our stockholders based on our estimates of our Investment Company Taxable Income for the fiscal year endingSeptember 30, 2023 . From inception throughSeptember 30, 2022 , we have paid 236 monthly or quarterly consecutive distributions to common stockholders totaling approximately$423.6 million or$21.83 per share. For the fiscal years endedSeptember 30, 2022 , 2021, and 2020, distributions declared and paid exceeded taxable income available for common distributions resulting in a partial return of capital of approximately$1.4 million ,$1.0 million , and$0.4 million , respectively.
Preferred Stock Dividends
OnOctober 2, 2019 , we voluntarily redeemed all 2,070,000 outstanding shares of our Series 2024 Term Preferred Stock at a redemption price of$25.00 per share which represents the liquidation preference per share, plus accrued and unpaid dividends throughOctober 1, 2019 in the amount of$0.004166 per share, for a payment per share of$25.004166 and an aggregate redemption price of approximately$51.8 million . In accordance with GAAP, we treated these monthly dividends as an operating expense. For federal income tax purposes, the dividends paid by us to preferred stockholders generally constituted ordinary income to the extent of our current and accumulated earnings and profits and is reported after the end of the calendar year based on tax information for the full fiscal year. Such a characterization made on an interim, quarterly basis may not be representative of the actual tax characterization for the full fiscal year.
Dividend Reinvestment Plan
Our common stockholders who hold their shares through our transfer agent,Computershare, Inc. ("Computershare"), have the option to participate in a dividend reinvestment plan offered by Computershare, as the plan agent. This is an "opt in" dividend reinvestment plan, meaning that common stockholders may elect to have their cash distributions automatically reinvested in additional shares of our common stock. Common stockholders who do make such election will receive their distributions in cash. Common stockholders who receive distributions in the form of stock will be subject to the same federal, state and local tax consequences as stockholders who elect to receive their distributions in cash. The common stockholder will have an adjusted basis in the additional common shares purchased through the plan equal to the amount of the reinvested distribution. The additional shares will have a new holding period commencing on the day following the date on which the shares are credited to the common stockholder's account. Computershare purchases shares in the open market in connection with the obligations under the plan. 61
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Table of Contents Equity Registration Statement Our shelf registration statement permits us to issue, through one or more transactions, up to an aggregate of$300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock or preferred stock. As ofSeptember 30, 2022 , we had the ability to issue up to an additional$295.5 million in securities under the registration statement. Common Stock InMay 2021 , we entered into an equity distribution agreement withJefferies LLC , as amended inAugust 2022 (the "Jefferies Sales Agreement") under which we have the ability to issue and sell, from time to time, shares of our common stock with an aggregate offering price of up to$60.0 million . During the year endedSeptember 30, 2022 , we sold 430,425 shares of our common stock under the Jefferies Sales Agreement, at a weighted-average price of$10.53 per share and raised$4.5 million of gross proceeds. Net proceeds, after deducting commissions and offering costs borne by us, were approximately$4.5 million . As ofSeptember 30, 2022 , we had a remaining capacity to sell up to an additional$47.8 million of our common stock under the Jefferies Sales Agreement. We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the timing or terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. To the extent that our common stock trades at a market price below our NAV per share, we will generally be precluded from raising equity capital through public offerings of our common stock, other than pursuant to stockholder and independent director approval or a rights offering to existing common stockholders.
On
Revolving Line of Credit
OnMay 13, 2021 , we, through Business Loan, amended and restated the Credit Facility to, among other things, (i) decrease the commitment amount from$205.0 million to$175.0 million , (ii) extend the revolving period end date toOctober 31, 2023 , (iii) extend the maturity date toOctober 31, 2025 (at which time all principal and interest will be due and payable if the Credit Facility is not extended by the revolving period end date), (iv) reduce the interest rate margin to 2.70% during the revolving period and 3.25% thereafter, with a LIBOR floor of 0.35%, (v) revise the unused fee to include an additional fee tier of 0.35% per annum on the daily undrawn amounts if the average unused amount is equal to or less than 35% during the applicable period, (vi) provide for certain excess concentration limits, including a reduced second lien limit and a new broadly syndicated loan limit and (vii) add customary LIBOR replacement language. We incurred fees of approximately$1.1 million in connection with this amendment and restatement, which are being amortized through our Credit Facility's revolving period end date ofOctober 31, 2023 . OnSeptember 12, 2022 , we, through Business Loan, entered into Amendment No. 1 to the Credit Facility to update the reference rate from LIBOR to Term SOFR plus an 11 basis point credit spread adjustment. OnSeptember 20, 2022 , we, through Business Loan, entered into Amendment No. 2 to the Credit Facility to increase the size of the credit facility by$50.0 million from$175.0 million to$225.0 million , as permitted under the terms of the Credit Facility. Interest is payable monthly during the term of our Credit Facility. Available borrowings are subject to various constraints imposed under our Credit Facility, based on the aggregate loan balance pledged by Business Loan, which varies as loans are added and repaid, regardless of whether such repayments are prepayments or made as contractually required. Our Credit Facility also requires that any interest or principal payments on pledged loans be remitted directly by the borrower into a lockbox account withKeyBank and withThe Bank of New York Mellon Trust Company, N.A. as custodian.KeyBank , which also serves as the trustee of the account, generally remits the collected funds to us once a month. Our Credit Facility contains covenants that require Business Loan to maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions), and restrict material changes to our credit and collection policies without the lenders' consents. Our Credit Facility generally limits distributions to our stockholders on a fiscal year basis to the sum of our net investment income, net capital gains and amounts elected to have been paid during the prior year in accordance with Section 855(a) of the Code. Business Loan is also subject to certain limitations on the type of loan investments it can apply as collateral towards the borrowing base to 62
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receive additional borrowing availability under our Credit Facility, including restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life, portfolio company leverage and lien property. Our Credit Facility further requires Business Loan to comply with other financial and operational covenants, which obligate Business Loan to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of 25 obligors required in the borrowing base. Additionally, we are required to maintain (i) a minimum net worth (defined in our Credit Facility to include any outstanding mandatorily redeemable preferred stock) of$325.0 million plus 50.0% of all equity and subordinated debt raised afterMay 13, 2021 less 50% of any equity and subordinated debt retired or redeemed afterMay 13, 2021 , which equates to$336.7 million as ofSeptember 30, 2022 , (ii) asset coverage with respect to "senior securities representing indebtedness" of at least 150% (or such percentage as may be set forth in Section 18 of the 1940 Act, as modified by Section 61 of the 1940 Act), and (iii) our status as a BDC under the 1940 Act and as a RIC under the Code. As ofSeptember 30, 2022 , and as defined in our Credit Facility, we had a net worth of$512.3 million , asset coverage on our "senior securities representing indebtedness" of 190.4% and an active status as a BDC and RIC. In addition, as ofSeptember 30, 2022 , we had 33 obligors in our Credit Facility's borrowing base and we were in compliance with all of our Credit Facility covenants. Refer to Note 5-Borrowings of the notes to our Consolidated Financial Statements included elsewhere in this Annual Report for additional information regarding our Credit Facility. Notes Payable InNovember 2021 , we completed a private placement of$50.0 million aggregate principal amount of 3.75% Notes due 2027 (the "2027 Notes") for net proceeds of approximately$48.5 million after deducting initial purchasers' costs, commissions and offering expenses borne by us. The 2027 Notes will mature onMay 1, 2027 and may be redeemed in whole or in part at any time or from time to time at the Company's option prior to maturity at par plus a "make-whole" premium, if applicable. The 2027 Notes bear interest at a rate of 3.75% per year. Interest is payable semi-annually onMay 1 andNovember 1 of each year (which equates to approximately$1.9 million per year). InApril 2022 , pursuant to the registration rights agreement we entered into in connection with the 2027 Notes, we conducted an exchange offer through which we offered to exchange all of our then outstanding 2027 Notes (the "Restricted Notes") that were issued onNovember 4, 2021 , for an equal aggregate principal amount of our new 3.75% Notes due 2027 (the "Exchange Notes") that had been registered with theSEC under the Securities Act. The terms of the Exchange Notes are identical to those of the outstanding Restricted Notes, except that the transfer restrictions and registration rights relating to the Restricted Notes do not apply to the Exchange Notes, and the Exchange Notes do not provide for the payment of additional interest in the event of a registration default. InDecember 2020 , we completed an offering of$100.0 million aggregate principal amount of 5.125% Notes due 2026 (the "2026 Notes") for net proceeds of approximately$97.7 million after deducting underwriting discounts, commissions and offering expenses borne by us. InMarch 2021 , we completed an offering of an additional$50.0 million aggregate principal amount of the 2026 Notes for net proceeds of approximately$50.6 million after adding premiums and deducting underwriting costs, commissions and offering expenses borne by us. The 2026 Notes will mature onJanuary 31, 2026 and may be redeemed in whole or in part at any time or from time to time at the Company's option prior to maturity at par plus a "make-whole" premium, if applicable. The 2026 Notes bear interest at a rate of 5.125% per year. Interest is payable semi-annually onJanuary 31 andJuly 31 of each year (which equates to approximately$7.7 million per year). InOctober 2019 , we completed an offering of$38.8 million aggregate principal amount of 5.375% Notes due 2024 (the "2024 Notes"), inclusive of the overallotment option exercised by the underwriters, for net proceeds of approximately$37.5 million after deducting underwriting discounts, commissions and offering expenses borne by us. OnNovember 1, 2021 , we voluntarily redeemed the 2024 Notes with an aggregate principal amount outstanding of$38.8 million . The 2024 Notes would have otherwise matured onNovember 1, 2024 . InNovember 2018 , we completed an offering of$57.5 million aggregate principal amount of 6.125% Notes due 2023 (the "2023 Notes"), inclusive of the overallotment option exercised by the underwriters, for net proceeds of$55.4 million after deducting underwriting discounts, commissions and offering expenses borne by us. OnJanuary 7, 2021 , we voluntarily redeemed the 2023 Notes with an aggregate principal amount outstanding of$57.5 million . The redemption amount was$58.1 million inclusive of accrued interest through the date of redemption. In connection with the voluntary redemption of the 2023 Notes, we incurred a loss on extinguishment of debt of$1.2 million , which is primarily comprised of the unamortized deferred issuance costs at the time of redemption. The 2023 Notes would have otherwise matured onNovember 1, 2024 . 63
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The indenture relating to the 2027 Notes and the 2026 Notes contains certain covenants, including (i) an inability to incur additional debt or issue additional debt or preferred securities unless the Company's asset coverage meets the threshold specified in the 1940 Act after such borrowing, (ii) an inability to declare any dividend or distribution (except a dividend payable in our stock) on a class of our capital stock or to purchase shares of our capital stock unless the Company's asset coverage meets the threshold specified in the 1940 Act at the time of (and giving effect to) such declaration or purchase, and (iii) if, at any time, we are not subject to the reporting requirements of the Exchange Act, we will provide the holders of the 2027 Notes and the 2026 Notes, as applicable, and the trustee with audited annual consolidated financial statements and unaudited interim consolidated financial statements.
Off-Balance Sheet Arrangements
We generally recognize success fee income when the payment has been received. As ofSeptember 30, 2022 and 2021, we had off-balance sheet success fee receivables on our accruing debt investments of$4.7 million and$11.7 million (or approximately$0.13 per common share and$0.34 per common share), respectively, that would be owed to us, generally upon a change of control of the portfolio companies. Consistent with GAAP, we generally have not recognized our success fee receivables and related income in our Consolidated Financial Statements until earned. Due to the contingent nature of our success fees, there are no guarantees that we will be able to collect all of these success fees or know the timing of such collections. Contractual Obligations We have lines of credit, delayed draw term loans, and an uncalled capital commitment with certain of our portfolio companies that have not been fully drawn. Since these commitments have expiration dates and we expect many will never be fully drawn, the total commitment amounts do not necessarily represent future cash requirements. We estimate the fair value of the combined unused lines of credit, the unused delayed draw term loans, and the uncalled capital commitment as ofSeptember 30, 2022 and 2021 to be immaterial. The following table shows our contractual obligations as ofSeptember 30, 2022 , at cost: Payments Due by Period Less than More than Contractual Obligations(A) 1 Year 1-3 Years 3-5 Years 5 Years Total Credit Facility(B) $ - $ -$ 141,800 $ -$ 141,800 Notes Payable - - 200,000 - 200,000 Interest expense on debt obligations(C) 18,755 37,509 6,297 - 62,561 Total$ 18,755 $ 37,509 $ 348,097 $ -$ 404,361 (A)Excludes our unused line of credit commitments, unused delayed draw term loans, and uncalled capital commitments to our portfolio companies in an aggregate amount of$74.8 million , at cost, as ofSeptember 30, 2022 . (B)Principal balance of borrowings outstanding under our Credit Facility, based on the maturity date following the current contractual revolver period end date. (C)Includes estimated interest payments on our Credit Facility, 2027 Notes, and 2026 Notes. The amount of interest expense calculated for purposes of this table was based upon rates and balances as ofSeptember 30, 2022 .
Critical Accounting Estimates
The preparation of financial statements and related disclosures in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported consolidated amounts of assets and liabilities, including disclosure of
contingent assets and liabilities at the date of the financial statements, and
revenues and expenses during the period reported. Actual results could differ
materially from those estimates under different assumptions or conditions. We
have identified our investment valuation policy (which has been approved by our
Board of Directors) as our most critical accounting policy, which is described
in Note 2-Summary of Significant Accounting Policies in the accompanying notes
to our Consolidated Financial Statements included elsewhere in this Annual
Report. Additionally, refer to Note 3-Investments in our accompanying Notes to
Consolidated Financial Statements included elsewhere in this Annual Report for
additional information regarding fair value measurements and our application of
Financial Accounting Standards Board Accounting Standards Codification Topic
820, "Fair Value Measurements and Disclosures." We have also identified our
revenue recognition policy as a critical accounting policy, which is described
in Note 2-Summary of Significant
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Accounting Policies in our accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report.
Investment Valuation
Credit Monitoring and Risk Rating
The Adviser monitors a wide variety of key credit statistics that provide information regarding our portfolio companies to help us assess credit quality and portfolio performance and, in some instances, used as inputs in our valuation techniques. Generally, we, through the Adviser, participate in periodic board meetings of our portfolio companies in which we hold board seats and also require them to provide annual audited and monthly unaudited financial statements. Using these statements or comparable information and board discussions, the Adviser calculates and evaluates certain credit statistics. The Adviser risk rates all of our investments in debt securities. The Adviser does not risk rate our equity securities. For syndicated loans that have been rated by anSEC registeredNationally Recognized Statistical Rating Organization ("NRSRO"), the Adviser generally uses the average of two corporate level NRSRO's risk ratings for such security. For all other debt securities, the Adviser uses a proprietary risk rating system. While the Adviser seeks to mirror the NRSRO systems, we cannot provide any assurance that the Adviser's risk rating system will provide the same risk rating as an NRSRO would for these securities. The Adviser's risk rating system is used to estimate the probability of default on debt securities and the expected loss if there is a default. The Adviser's risk rating system uses a scale of 0 to >10, with >10 being the lowest probability of default. It is the Adviser's understanding that most debt securities of medium-sized companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in the middle market that would meet the definition ofAAA , AA or A. Therefore, the Adviser's scale begins with the designation >10 as the best risk rating which may be equivalent to a BBB from an NRSRO; however, no assurance can be given that a >10 on the Adviser's scale is equal to a BBB or Baa2 on an NRSRO scale. The Adviser's risk rating system covers both qualitative and quantitative aspects of the business and the securities we hold. The following table reflects risk ratings for all proprietary loans in our portfolio as ofSeptember 30, 2022 and 2021, representing approximately 97.9% and 95.5%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period: As of September 30, Rating 2022 2021 Highest 10.0 10.0 Average 7.1 6.6 Weighted Average 7.6 7.0 Lowest 1.0 1.0 The following table reflects the risk ratings for all syndicated loans in our portfolio that were rated by an NRSRO as ofSeptember 30, 2022 and 2021, representing approximately 1.6% and 3.9%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period: As of September 30, Rating 2022 2021 Highest 4.0 5.0 Average 3.4 4.6 Weighted Average 3.6 4.5 Lowest 3.0 4.0 65
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The following table reflects the risk ratings for all syndicated loans in our portfolio that were not rated by an NRSRO as ofSeptember 30, 2022 and 2021, representing approximately 0.5% and 0.6%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period: As of September 30, Rating 2022 2021 Highest 5.0 5.0 Average 5.0 5.0 Weighted Average 5.0 5.0 Lowest 5.0 5.0 Tax Status We intend to continue to maintain our qualification as a RIC under Subchapter M of the Code for federal income tax purposes and also to limit certain federal excise taxes imposed on RICs. Refer to Note 10-Federal and State Income Taxes in our accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report for additional information regarding our tax status.
Recent Accounting Pronouncements
Refer to Note 2-Summary of Significant Accounting Policies in the notes to our accompanying Consolidated Financial Statements included elsewhere in this Annual Report for a description of recent accounting pronouncements.
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