UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

(Mark One)

  x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended March 31, 2018
    OR
  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    COMMISSION FILE NUMBER: 1-35730

 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

( Exact Name of Registrant as Specified in Its Charter)

 

 

 

Maryland   46-0937320
(State or other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)

 

4400 Post Oak Parkway, Suite 2200
Houston, Texas 77027

(Address of Principal Executive Offices) (Zip Code)

(713) 292-5400

(Registrant’s Telephone Number, Including Area Code)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

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

 

Large accelerated filer ¨   Accelerated filer x
Non-accelerated filer ¨   Smaller reporting company ¨
Emerging growth company ¨      
(do not check if a smaller reporting company)  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

The number of shares of the issuer’s Common Stock, $0.001 par value per share, outstanding as of May 4, 2018 was 15,953,810.

 

 

 

 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION  
Item 1. Financial Statements 1
  Consolidated Statements of Assets and Liabilities as of March 31, 2018 (unaudited) and December 31, 2017 1
  Consolidated Statements of Operations for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited) 2
  Consolidated Statements of Changes in Net Assets for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited) 3
  Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited) 4
  Consolidated Schedules of Investments as of March 31, 2018 (unaudited) and December 31 2017 5
  Notes to Unaudited Financial Statements 21
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 49
Item 3. Quantitative and Qualitative Disclosures About Market Risk 63
Item 4. Controls and Procedures 63
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings 64
Item 1A. Risk Factors 64
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 64
Item 3. Defaults Upon Senior Securities 64
Item 4. Mine Safety Disclosures 64
Item 5. Other Information 64
Item 6. Exhibits 65

 

 i  

 

 

PART I — FINANCIAL INFORMATION

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

 

   March 31,     
   2018   December 31, 
   (unaudited)   2017 
ASSETS          
Non-controlled, affiliated investments, at fair value          
(amortized cost of $135,519 and $1,052,185, respectively)  $140,000   $990,000 
Non-controlled, non-affiliated investments, at fair value          
(amortized cost of $426,244,352 and $367,401,021, respectively)   431,159,720    370,849,772 
Cash and cash equivalents   45,494,363    25,110,718 
Receivable for sales and repayments of investments   26,891    26,891 
Interest receivable   3,787,060    2,922,204 
Other receivables   37,647     
Prepaid expenses   298,186    361,270 
Total Assets  $480,943,867   $400,260,855 
           
LIABILITIES          
Notes payable  $47,389,684   $47,306,488 
Credit facility payable   116,948,703    39,332,479 
SBA-guaranteed debentures   87,919,481    87,818,813 
Dividends payable   1,807,570    1,806,671 
Management fees payable   1,575,366    1,621,592 
Incentive fees payable   1,164,735    371,647 
Interest payable   683,980    1,021,173 
Unearned revenue   175,989    139,304 
Administrative services payable   361,727    327,033 
Other accrued expenses and liabilities   653,500    268,413 
Total Liabilities  $258,680,735   $180,013,613 
Commitments and contingencies (Note 7)          
Net Assets  $222,263,132   $220,247,242 
NET ASSETS          
Common Stock, par value $0.001 per share (200,000,000 and 100,000,000 shares authorized; 15,953,810 and 15,945,879 shares issued and outstanding, respectively)  $15,954   $15,946 
Paid-in capital   228,161,215    228,066,762 
Accumulated net realized loss from investments, net of cumulative dividends of $4,246,819 for both periods   (9,450,971)   (10,786,240)
Distributions in excess of net investment income   (1,382,915)   (435,794)
Net Unrealized appreciation on investments and cash equivalents, net of provision for taxes of $0 for both periods   4,919,849    3,386,568 
Net Assets  $222,263,132   $220,247,242 
Total Liabilities and Net Assets  $480,943,867   $400,260,855 
Net Asset Value Per Share  $13.93   $13.81 

 

 1 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

 

   For the   For the 
   three months   three months 
   ended   ended 
   March 31,   March 31, 
   2018   2017 
INVESTMENT INCOME          
Interest income  $10,730,748   $9,476,252 
Other income   181,033    387,728 
Total Investment Income  $10,911,781   $9,863,980 
OPERATING EXPENSES          
Management fees  $1,748,896   $1,564,528 
Valuation fees   134,410    166,089 
Administrative services expenses   351,229    309,098 
Incentive fees   968,826    1,021,227 
Professional fees   469,138    227,677 
Directors’ fees   92,000    92,000 
Insurance expense   85,697    109,252 
Interest expense and other fees   2,464,980    2,068,630 
Other general and administrative expenses   121,226    161,852 
Total Operating Expenses  $6,436,402   $5,720,353 
Net Investment Income  $4,475,379   $4,143,627 
Net Realized Gain (Loss) on Investments and Cash Equivalents  $1,335,269   $(712,051)
Net Change in Unrealized Appreciation on Investments and Cash Equivalents  $1,533,281   $2,584,583 
Benefit for taxes on unrealized gain on investments  $   $8,593 
Net Increase in Net Assets Resulting from Operations  $7,343,929   $6,024,752 
Net Investment Income Per Share  $0.28   $0.33 
Net Increase in Net Assets Resulting from Operations Per Share  $0.46   $0.48 
Weighted Average Shares of Common Stock Outstanding   15,952,841    12,479,957 
Distributions Per Share  $0.34   $0.34 

 

 2 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (unaudited)

 

   For the   For the 
   three months   three months 
   ended   ended 
   March 31,   March 31, 
   2018   2017 
Increase in Net Assets Resulting from Operations          
Net investment income  $4,475,379   $4,143,627 
Net realized gain/(loss) on investments and cash equivalents   1,335,269    (712,051)
Net change in unrealized appreciation on investments and cash equivalents   1,533,281    2,584,583 
Benefit for taxes on unrealized appreciation  on investments       8,593 
Net Increase in Net Assets Resulting from Operations  $7,343,929   $6,024,752 
           
Stockholder distributions from          
Net investment income   (5,422,500)   (4,241,903)
Total Distributions  $(5,422,500)  $(4,241,903)
           
Capital share transactions          
Issuance of common stock   94,788     
Partial Share Redemption   (327)    
Net increase in net assets resulting from capital share transactions  $94,461   $ 
Total increase in net assets  $2,015,890   $1,782,849 
Net assets at beginning of period  $220,247,242   $170,881,785 
Net assets at end of period (includes $1,382,915 and $435,794 of distributions in excess of net investment income, respectively)  $222,263,132   $172,664,634 

 

 

 3 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

 

   For the   For the 
   three months   three months 
   ended   ended 
   March 31, 2018   March 31, 2017 
Cash flows from operating activities          
Net Increase in net assets resulting from operations  $7,343,929   $6,024,752 
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities:          
Purchases of investments   (71,713,787)   (23,151,902)
Proceeds from sales and repayments of investments   15,618,134    39,279,309 
Net change in unrealized appreciation on investments   (1,533,281)   (2,584,583)
Deferred tax benefit       (8,593)
Increase in investments due to PIK   (152,006)   (82,119)
Amortization of premium and accretion of discount, net   (343,739)   (267,611)
Amortization of loan structure fees   66,224    122,908 
Amortization of deferred financing costs   83,196    46,669 
Amortization of loan fees on SBA-guaranteed debentures   100,668    80,211 
Net realized loss (gain) on investments   (1,335,269)   712,051 
Changes in other assets and liabilities          
Decrease (increase) in interest receivable   (864,856)   329,975 
Increase in other receivable   (37,647)   (7,294)
Decrease (increase) in prepaid expenses   63,084    (62)
Decrease in management fees payable   (46,226)   (43,767)
Increase (decrease) in incentive fees payable   793,088    (129,650)
Increase in administrative services payable   34,694    31,358 
Decrease in interest payable   (337,193)   (550,338)
Increase (decrease) in unearned revenue   36,685    (1,786)
Increase in dividend payable   899     
Increase in other accrued expenses and liabilities   385,087    318,964 
Net cash provided by (used in) operating activities  $(51,838,316)  $20,118,492 
Cash flows from financing activities          
Proceeds from the issuance of common stock        
Offering costs paid for common stock issued       (81,813)
Stockholder distributions paid   (5,327,712)   (4,241,903)
Borrowings under credit facility   86,550,000    9,000,000 
Repayments of credit facility   (9,000,000)   (22,500,000)
Partial Share Redemption   (327)    
Net cash provided by (used in) financing activities  $72,221,961   $(17,823,716)
Net increase in cash and cash equivalents  $20,383,645   $2,294,776 
Cash and cash equivalents balance at beginning of period   25,110,718    9,194,129 
Cash and cash equivalents balance at end of period  $45,494,363   $11,488,905 
Supplemental and non-cash financing activities          
Interest expense paid   2,512,086    2,369,181 
Excise tax paid   27,717    37,648 
Shares issued pursuant to Dividend Reinvestment Plan   94,788     
Conversion from debt to equity       864,101 

 

 4 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/
Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair
Value (1)

   % of Net
Assets
 
                                           
Non-controlled, affiliated investments  (2)                                         
Glori Energy Production Inc.                          Houston, TX                  
Glori Energy Production, LLC Class A Common Units  (4)  Equity              2/1/2017     Energy: Oil & Gas  1,000 shares   135,519    140,000    0.06%
Subtotal Non-controlled,  affiliated investments                                 135,518    140,000    0.06%
                                              
Non-controlled, non-affiliated investments  (2)                                          
Abrasive Products & Equipment, LLC, et al                          Deer Park, TX                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+10.50%  1.00%  12.80%     9/5/2014  3/5/2020  Chemicals, Plastics, & Rubber  $5,325,237  $5,277,775   $5,250,000    2.36%
APE Holdings, LLC Class A Common Units  (4)  Equity              9/5/2014        375,000 units   375,000    130,000    0.06%
Total                                 5,652,775    5,380,000    2.42%
Apex Environmental Resources Holdings, LLC                          Amsterdam, OH                  
Common Units  (4)  Equity              10/30/2015     Environmental Industries  766 shares   766    769    0.00%
Preferred Units  (4)  Equity                       766 shares   765,676    769,231    0.35%
Total                    10/30/2015            766,442    770,000    0.35%
Atmosphere Aggregator Holdings II, LP                          Atlanta, GA                  
Common Units  (4)  Equity              6/30/2015     Services: Business  254,250 units   254,250    916,490    0.41%
Atmosphere Aggregator Holdings, LP Common Units  (4)  Equity              6/30/2015        750,000 units   750,000    2,703,510    1.22%
Total                                 1,004,250    3,620,000    1.63%
ASC Communications, LLC  (7)                       Chicago, IL                  
Term Loan (SBIC)  (2)(12)  First Lien  L+6.25%  1.00%  8.13%     6/29/2017  6/29/2022  Healthcare & Pharmaceuticals  $6,462,500   6,405,939    6,462,500    2.91%
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)  (2)(4)  Equity              6/29/2017        73,529 shares   500,000    570,000    0.26%
Total                                 6,905,939    7,032,500    3.17%

 

 5 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair
Value (1)

   % of Net
Assets
 
Beneplace, LLC                          Austin TX                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+10.00%  1.00%  12.30%    3/27/2017  9/27/2022  FIRE: Insurance  $5,000,000   4,913,835    5,000,000    2.25%
Beneplace Holdings, LLC Preferred Units  (4)  Equity              3/27/2017        500,000 units   500,000    510,000    0.23%
Total                                 5,413,835    5,510,000    2.48%
Binder & Binder National Social Security Disability Advocates, LLC  (8)                       Hauppauge, NY                  
Residual claim from Term Loan  (4)  Unsecured              11/7/2012     Services: Consumer  $100,000   100,000    100,000    0.04%
BW DME Acquisition, LLC                          Tempe, AZ                  
Term Loan (SBIC)  (2)(12)(13)  First Lien  L+6.00%  1.00%  10.03%     8/24/2017  8/24/2022  Healthcare & Pharmaceuticals  $16,695,804   16,232,009    16,610,000    7.47%
BW DME Holdings, LLC Class A Preferred Units  (4)  Equity              8/24/2017        1,937,261 shares   1,937,261    2,180,000    0.98%
Total                                 18,169,270    18,790,000    8.45%
C.A.R.S. Protection Plus, Inc.                          Murrysville, PA                  
Term Loan  (12)  First Lien  L+8.50%  0.50%  10.07%     12/23/2015  12/31/2020  Automotive  $98,746   97,546    98,746    0.04%
Term Loan (SBIC)  (2)(12)  First Lien  L+8.50%  0.50%  10.07%     12/23/2015  12/31/2020     $7,702,191   7,608,556    7,702,191    3.47%
CPP Holdings LLC Class A Common Units  (4)  Equity              12/23/2015        149,828 shares   149,828    210,000    0.09%
Total                                 7,855,930    8,010,937    3.60%
Catapult Learning, LLC et al                          Camden, NJ                  
Term Loan  (12)(13)  First Lien  L+6.50%  1.00%  9.69%     8/6/2015  7/16/2020  Education  $12,171,053   12,107,195    12,171,053    5.48%
Colford Capital Holdings, LLC                          New York, NY                  
Preferred Units  (4)(5)  Equity              8/20/2015     Finance  38,893 units   497,388    470,000    0.21%
Total                                            % 
Condor Borrower, LLC                          Clifton, NJ                  
Term Loan  (12)  Second Lien  L+8.75%  1.00%  10.51%     10/27/2017  4/27/2025  Services: Business  $13,750,000   13,485,438    13,480,000    6.06%
Condor Top Holdco Limited Convertible Preferred Shares  (4)  Equity              10/27/2017        500,000 shares   442,197    424,510    0.19%
Condor Holdings Limited Preferred Shares, Class B  (4)  Equity              10/27/2017        500,000 shares   57,804    55,491    0.02%
Total                                 13,985,439    13,960,001    6.27%
Dream II Holdings, LLC                          Boca Raton, FL                  
Class A Common Units  (4)  Equity              10/20/2014     Services: Consumer  250,000 units   242,304    380,000    0.17%

 

 6 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair

Value (1)

   % of Net
Assets
 
Empirix Inc.                          Billerica, MA                  
Term Loan  (12)  Second Lien  L+9.50%  1.00%  11.25%    11/1/2013  5/1/2020  Software  $11,657,850   11,564,571    11,657,850    5.25%
Term Loan (SBIC)  (2)(12)  Second Lien  L+9.50%  1.00%  11.25%     11/1/2013  5/1/2020     $9,750,000   9,670,117    9,750,000    4.39%
Empirix Holdings I, Inc. Common Shares, Class A  (4)  Equity              11/1/2013        1,304 shares   1,304,232    772,200    0.35%
Empirix Holdings I, Inc. Common Shares, Class B  (4)  Equity              11/1/2013        1,317,406 shares   13,174    7,800    0.00%
Total                                 22,552,094    22,187,850    9.99%
Energy Labs Inc.                          Houston, TX                  
Term Loan (SBIC)  (2)(12)(13)  First Lien  L+7.00%  0.50%  12.16%     9/29/2016  9/29/2021  Energy: Oil & Gas  $8,548,387   8,405,123    8,548,387    3.85%
Energy Labs Holding Corp. Common Stock  (4)  Equity              9/29/2016        500 shares   500,000    380,000    0.17%
Total                                 8,905,123    8,928,387    4.02%
EOS Fitness OPCO Holdings, LLC                          Phoenix, AZ                  
Term Loan (SBIC)  (2)(12)  First Lien  L+8.25%  0.75%  9.92%     12/30/2014  12/30/2019  Hotel, Gaming, & Leisure  $3,150,812   3,124,893    3,150,812    1.42%
EOS Fitness Holdings, LLC Class A Preferred Units  (4)  Equity              12/30/2014        118 shares   117,670    243,750    0.11%
EOS Fitness Holdings, LLC Class B Common Units  (4)  Equity              12/30/2014        3,017 shares   3,017    6,250    0.00%
Total                                 3,245,580    3,400,812    1.53 
Fast Growing Trees, LLC  (16)                       Fort Mill, SC                  
Term Loan (SBIC)  (2)(12)  First Lien  L+7.75%  1.00%  9.54%     2/5/2018  02/05/23  Retail  $20,500,000   20,100,842    20,090,000    9.04%
SP FGT Holdings, LLC, Class A Common  (4)  Equity              2/5/2018        1,000,000 shares   1,000,000    1,000,000    0.45%
Total                                 21,100,842    21,090,000    9.49%
Fumigation Holdings, Inc.                          Liberty, MO                  
Class A Common Stock  (4)  Equity              6/30/2015     Chemicals, Plastics, & Rubber  250 shares   0    300,000    0.13%
Furniture Factory Outlet, LLC                          Fort Smith, AR                  
Term Loan  (12)  First Lien  L+9.00%  0.50%  11.30%     6/10/2016  6/10/2021  Consumer Goods: Durable  $15,405,284   15,147,399    15,405,284    6.93%
Furniture Factory Holdings, LLC Term Loan  (11)  Unsecured  11.00%           6/10/2016  2/3/2021     $122,823   122,823    122,823    0.06%
Sun Furniture Factory, LP Common Units  (4)  Equity              6/10/2016        13,445 shares   94,569    150,000    0.07%
Total                                 15,364,791    15,678,107    7.06%
GK Holdings, Inc.                          Cary, NC                  
Term Loan  (12)  Second Lien  L+10.25%  1.00%  12.55%     2/6/2015  1/30/2022  Education  $5,000,000   4,936,044    5,000,000    2.25%

 

 7 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair

Value (1)

   % of Net
Assets
 
Good Source Solutions, Inc.                          Carlsbad, CA                  
Term Loan  (12)(13)  First Lien  L+7.25%  0.50%  12.53%    7/15/2016  7/15/2021  Beverage, Food, & Tobacco  $1,350,000   1,330,576    1,350,000    0.61%
Term Loan (SBIC)  (2)(12)(13)  First Lien  L+7.25%  0.50%  12.53%     7/15/2016  7/15/2021     $1,200,000   1,182,734    1,200,000    0.54%
Good Source Holdings, LLC Class A Preferred Units  (4)  Equity              7/15/2016        159 shares   159,375    170,000    0.08%
Good Source Holdings, LLC Class B Common Units  (4)  Equity              7/15/2016        4,482 shares   0    0    0.00%
Total                                 2,672,685    2,720,000    1.23%
Grupo HIMA San Pablo, Inc., et al                          San Juan, PR                  
Term Loan  (12)  First Lien  L+7.00%  1.50%  8.84%     2/1/2013  1/31/2018  Healthcare & Pharmaceuticals  $4,750,000   4,750,000    4,180,000    1.88%
Term Loan  (15)  Second Lien  13.75%     0.00%     2/1/2013  7/31/2018     $4,109,524   4,092,160    900,000    0.40%
Total                                 8,842,160    5,080,000    2.28%
Hostway Corporation                          Chicago, IL                  
Term Loan  (12)  Second Lien  L+4.25%  1.25%  6.13%     12/27/2013  12/13/2020  High Tech Industries  $6,750,000   6,685,113    6,010,000    2.70%
J.R. Watkins, LLC  (9)                       San Francisco, CA                  
Term Loan (SBIC)  (2)(12)  First Lien  L+6.50%  1.25%  8.80%     12/22/2017  12/22/2022  Consumer Goods: non-durable  $12,468,750   12,229,561    12,220,000    5.50%
J.R. Watkins Holdings, Inc. Class A Preferred  (4)  Equity              12/22/2017        1,000 shares   1,000,000    1,000,000    0.45%
Total                                 13,229,561    13,220,000    5.95%
ICD Intermediate Holdco 2, LLC                          San Francisco, CA                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+9.00%  1.00%  11.30%     1/1/2018  7/1/2024  Finance  $10,000,000   9,805,457    9,800,000    4.41%
ICD Holdings, LLC, Class A Preferred  (4)  Equity              1/1/2018        9,962 shares   500,000    500,000    0.22%
Total                                 10,305,457    10,300,000    4.63%

 

 8 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair

Value (1)

   % of Net
Assets
 
Kelleyamerit Holdings, Inc.                          Walnut Creek, CA                  
Term Loan  (12)(13)  First Lien  L+7.50%  1.00%  10.54%     3/30/2018  3/30/2023  Automotive  $9,750,000   9,555,000    9,560,000    4.30%
Keais Records Service, LLC                          Houston, TX                  
Term Loan  (12)  Second Lien  L+10.50%  0.50%  12.80%     6/30/2016  6/30/2022  Services: Business  $7,750,000   7,642,494    7,750,000    3.49%
Keais Holdings, LLC Class A Units  (4)  Equity              6/30/2016        148,335 units   748,239    700,000    0.31%
Total                                 8,390,733    8,450,000    3.80%
KidKraft, Inc.                          Dallas, TX                  
Term Loan  (6)  Second Lien  12.00%     11.00%  1.00%  9/30/2016  3/30/2022  Consumer Goods: Durable  $9,338,418   9,192,061    9,100,000    4.09%
Livingston International, Inc.                          Toronto, Ontario                  
Term Loan  (5)(12)  Second Lien  L+8.25%  1.25%  10.55%     4/23/2013  4/18/2020  Transportation: Cargo  $6,841,739   6,791,312    6,841,739    3.08%
Madison Logic, Inc.                          New York, NY                  
Term Loan (SBIC)  (2)(12)  First Lien  L+8.00%  0.50%  9.88%     11/30/2016  11/30/2021  Media: Broadcasting & Subscription  $4,843,750   4,806,241    4,843,750    2.18%
Madison Logic Holdings, Inc. Common Stock (SBIC)  (2)(4)  Equity              11/30/2016        5,000 shares   50,000    67,000    0.03%
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)  (2)(4)  Equity              11/30/2016        4,500 shares   450,000    603,000    0.27%
Total                                 5,306,241    5,513,750    2.48%
Magdata Intermediate Holdings, LLC                          Austin TX                  
Term Loan  (12)  Second Lien  L+9.50%  1.00%  11.80%     10/16/2017  4/16/2024  Software  $12,500,000   12,261,274    12,380,000    5.57%
MBS Holdings, Inc.                          Birmingham, AL                  
Series E Preferred Stock  (4)  Equity              3/10/2014     Media: Broadcasting & Subscription  2,774,695 shares   1,000,000    2,734,772    1.23%
Series F Preferred Stock  (4)  Equity              3/10/2014        399,308 shares   206,682    565,228    0.25%
Total                                 1,206,682    3,300,000    1.48%
Mobileum, Inc.                          Santa Clara, CA                  
Term Loan  (12)  Second Lien  L+10.25%  0.75%  12.55%     11/1/2016  5/1/2022  Software  $9,000,000   8,856,059    9,000,000    4.05%
Mobile Acquisition Holdings, LP Class A-2 Common Units  (4)  Equity              11/1/2016        750 units   750,000    1,000,000    0.45%
Total                                 9,606,059    10,000,000    4.50%

 

 9 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair

Value (1)

   % of Net
Assets
 
MTC Parent, L.P.                          Oak Brook, IL                  
Class A-2 Common Units  (4)  Equity              12/1/2015     Finance  750,000 shares   0    1,670,000    0.75%
National Trench Safety, LLC, et al                          Houston, TX                  
Term Loan (SBIC)  (2)  Second Lien  11.50%     11.50%     3/31/2017  3/31/2022  Construction & Building  $10,000,000   9,852,196    9,850,000    4.43%
NTS Investors, LP Class A Common Units  (4)  Equity              3/31/2017        2,335 units   500,000    340,000    0.15%
Total                                 10,352,196    10,190,000    4.58%
OGS Holdings, Inc.                          Chantilly, Virginia                  
Series A Convertible Preferred Stock  (4)  Equity              4/22/2014     Services: Government  11,521 shares   50,001    100,000    0.04%
Price for Profit, LLC  (17)                       Cleveland, OH                  
Term Loan (SBIC)  (2)(12)  First Lien  L+6.50%  1.00%  8.80%     1/31/2018  1/31/2023  Services: Business  $11,000,000   10,786,010    10,780,000    4.85%
I2P Holdings, LLC, Series A Preferred  (4)  Equity              1/31/2018        750,000 shares   750,000    750,000    0.34%
Total                                 11,536,010    11,530,000    5.19%
Protect America, Inc.                          Austin TX                  
Term Loan (SBIC)  (2)(6)(12)  Second Lien  L+9.75%  1.00%  10.06%  2.00%  8/30/2017  10/30/2020  Services: Consumer  $17,705,875   17,339,275    17,530,000    7.89%
Refac Optical Group, et al                          Blackwood, NJ                  
Revolver  (10)(12)  First Lien  L+8.00%     9.88%     11/7/2012  9/30/2018  Retail  $880,000   880,000    880,000    0.40%
Term A Loan  (12)  First Lien  L+8.00%     9.88%     11/7/2012  9/30/2018     $825,767   825,767    825,767    0.37%
Term B Loan  (6)(12)  First Lien  L+10.75%     10.88%  1.75%  11/7/2012  9/30/2018     $6,482,871   6,482,871    6,482,871    2.92%
Total                                 8,188,638    8,188,638    3.69 
Resolute Industrial, LLC  (14)                       Wheeling, IL                  
Term Loan  (12)  First Lien  L+7.62%  1.00%  9.31%     7/26/2017  7/26/2022  Capital Equipment  $3,797,222   3,738,154    3,780,000    1.70%
Term Loan (SBIC)  (2)(12)  First Lien  L+7.62%  1.00%  9.31%     7/26/2017  7/26/2022     $13,290,278   13,083,499    13,220,000    5.95%
Resolute Industrial Holdings, LLC  Class A Preferred Units  (4)  Equity              7/26/2017        601 units   750,000    900,000    0.40%
Total                                 17,571,653    17,900,000    8.05%
Roberts-Gordon, LLC                          Buffalo, NY                  
Term Loan  (12)  Second Lien  L+10.00%  1.00%  12.30%     6/30/2017  1/1/2022  Construction & Building  $7,200,000   7,074,687    7,160,000    3.22%
Specified Air Solutions, LLC Class A Common Unites  (4)  Equity              6/30/2017        3,846 shares   500,045    430,000    0.19%
Total                                 7,574,732    7,590,000    3.41%
Sitel Worldwide Corporation                          Nashville, TN                  
Term Loan  (12)  Second Lien  L+9.50  1.00%  11.25%     9/24/2015  9/18/2022  High Tech Industries  $10,000,000   9,854,786    10,000,000    4.50%
Skopos Financial, LLC                          Irving, TX                  
Term Loan  (5)  Unsecured  12.00%     12.00%     1/31/2014  1/31/2019  Finance  $19,500,000   19,413,984    19,310,000    8.69%
Skopos Financial Group, LLC Series A Common Units  (4)(5)  Equity              1/31/2014        1,120,684 units   1,162,544    730,000    0.33%
Total                                 20,576,528    20,040,000    9.02%

 

 10 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/

Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair

Value (1)

   % of Net
Assets
 
SPM Capital, LLC                          Bloomington, MN                  
Term Loan  (12)  First Lien  L+6.50  1.50%  8.38%     12/10/2012  10/31/2018  Healthcare & Pharmaceuticals  $5,130,946   5,130,946    5,130,946    2.31%
SQAD, LLC                          Tarrytown, NY                  
Term Loan (SBIC)  (2)(12)  First Lien  L+6.50  1.00%  8.81%     12/22/2017  12/22/2022  Media: Broadcasting & Subscription  $14,961,500   14,884,999    14,880,000    6.69%
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)  (2)(4)  Equity              10/31/2013        3,598 shares   156,001    257,043    0.12%
SQAD Holdco, Inc. Common Shares (SBIC)  (2)(4)  Equity              10/31/2013        5,800 shares   62,485    102,957    0.05%
Total                                 15,103,485    15,240,000    6.86%
TechInsights, Inc.                          Ottawa, Ontario                  
Term Loan  (5)(12)(13)  First Lien  L+6.50%  1.00%  9.30%     8/16/2017  8/16/2022  High Tech Industries  $20,000,000   19,549,367    19,800,000    8.91%
Time Manufacturing Acquisition, LLC                          Waco, TX                  
Term Loan  (6)  Unsecured  11.50%     10.75%  0.75%  2/3/2017  8/3/2023  Capital Equipment  $6,385,182   6,274,450    6,320,000    2.84%
Time Manufacturing Investments, LLC Class A Common  Units  (4)  Equity              2/3/2017        5,000 units   500,000    360,000    0.16%
Total                                 6,774,450    6,680,000    3.00%
TFH Reliability, LLC                          Houston, TX                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+10.75%  0.50%  13.05%     10/20/2016  4/21/2022  Chemicals, Plastics, & Rubber  $5,875,000   5,780,283    5,875,000    2.64%
TFH Reliability Group, LLC Class A Common Units  (4)  Equity              10/20/2016        250,000 shares   250,000    510,000    0.23%
Total                                 6,030,283    6,385,000    2.87%
U.S. Auto Sales, Inc. et al                          Lawrenceville, GA                  
Term Loan  (5)(12)  Second Lien  L+10.50%  1.00%  12.17%     6/8/2015  6/8/2020  Finance  $4,500,000   4,477,246    4,500,000    2.02%
USASF Blocker II, LLC Common Units  (4)(5)  Equity              6/8/2015        441 units   441,000    420,000    0.19%
USASF Blocker III, LLC Series C Preferred Units  (4)(5)  Equity              2/13/2018        50 Units   50,000    100,000    0.04 
USASF Blocker LLC Common Units  (4)(5)  Equity              6/8/2015        9,000 units   9,000    10,000    0.00%
Total                                 4,977,246    5,030,000    2.25%

 

 11 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

Investments  Footnotes  Security  Coupon  LIBOR
floor
  Cash  PIK  Initial
Investment

Date
  Maturity 

Headquarters/
Industry

  Principal
Amount/
Shares
  Amortized
Cost
  

Fair
Value (1)

   % of Net
Assets
 
VRI Intermediate Holdings, LLC et al                          Franklin, OH                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+9.25%  1.00%  11.55%    5/31/2017  10/31/2020  Healthcare & Pharmaceuticals  $9,000,000   8,857,928    8,910,000    4.01%
VRI Ultimate Holdings, LLC Class A Preferred Units  (4)  Equity              5/31/2017        326,797 shares   500,000    550,000    0.25%
Total                                 9,357,928    9,460,000    4.26%
Wise Holding Corporation                          Salt Lake City, UT                  
Term Loan  (12)  Unsecured  L+11.00%  1.00%  13.30%     6/30/2016  12/31/2021  Beverage, Food, & Tobacco  $1,250,000   1,235,911    880,000    0.40%
WCI Holdings LLC Class A Preferred Units  (4)  Equity              6/30/2016        56 units   55,550    0    0.00%
WCI Holdings LLC Class B Common  Units  (4)  Equity              6/30/2016        3,044 units   3,044    0    0.00%
Total                                 1,294,505    880,000    0.40%
Zemax, LLC                          Redmond, WA                  
Term Loan (SBIC)  (2)(12)  Second Lien  L+10.00%  1.00%  11.88%     10/23/2014  4/23/2020  Software  $1,900,000   1,882,745    1,900,000    0.85%
Zemax Software Holdings, LLC Preferred Units (SBIC)  (2)(4)  Equity              10/23/2014        24,500 units   5,000    13,200    0.01%
Zemax Software Holdings, LLC Common Units (SBIC)  (2)(4)  Equity              10/23/2014        5,000 shares   245,000    646,800    0.29%
Total                                 2,132,745    2,560,000    1.15%
                                              
Total Non-controlled, non-affiliated investments                                 426,244,352    431,159,720    193.99%
Net Investments                                 426,379,871    431,299,720    194.05%
LIABILITIES IN EXCESS OF OTHER ASSETS                                      (209,036,588)   (94.05)%
NET ASSETS                                      222,263,132    100.00%

 

 12 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments

March 31, 2018

 

(1)See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.

 

(2)Investments held by the SBIC subsidiary, which include $12,433,557 of cash and $196,848,571 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.

 

(3)These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.

 

(4)Security is non-income producing.

 

(5)The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of March 31, 2018.

 

(6)Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.

 

(7)Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(8)In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.

 

(9)Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(10)Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(11)Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.

 

(12)These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.

 

(13)These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.

 

(14)Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(15)Investment has been on non-accrual since November 1, 2017.

 

(16)Excluded from the investment is an undrawn commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 7.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(17)Excluded from the investment is an undrawn commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 6.50% and a maturity of January 31, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.

 

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

 

 13 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2017

  

Investments  Footnotes  Security  Coupon    LIBOR
floor
   Cash  

PIK

    Initial Investment Date     Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
Non-controlled, affiliated investments  (2)                                                            
Glori Energy Production Inc.                                          Houston, TX                    
Glori Energy Production, LLC Class A Common Units  (4)  Equity                           2/1/2017        Energy: Oil & Gas   1,000 shares   $1,052,185   $990,000    0.45%
Subtotal Non-controlled, affiliated investments                                                   1,052,185    990,000    0.45%
Non-controlled, non-affiliated investments  (2)                                                            
Abrasive Products & Equipment, LLC, et al                                        Deer Park, TX                    
Term Loan (SBIC)  (2)(12)  Second Lien    L+10.50%     1.00%   12.20%          9/5/2014     3/5/2020  Chemicals, Plastics, & Rubber  $5,325,237    5,272,397    5,220,000    2.37%
APE Holdings, LLC Class A Common Units  (4)  Equity                           9/5/2014            375,000 units    375,000    180,000    0.08%
Total                                                   5,647,397    5,400,000    2.45%
Apex Environmental Resources Holdings,
LLC
                                          Amsterdam, OH                    
Common Units  (4)  Equity                           10/30/2015        Environmental Industries   766 shares    766    579    0.00%
Preferred Units  (4)  Equity                           10/30/2015            766 shares    765,676    579,421    0.26%
Total                                                   766,442    580,000    0.26%
Atmosphere Aggregator Holdings II, LP                                          Atlanta, GA                    
Common Units  (4)  Equity                           6/30/2015        Services: Business   254,250 units    254,250    820,284    0.37%
Atmosphere Aggregator Holdings, LP Common Units  (4)  Equity                           6/30/2015            750,000 units    750,000    2,419,714    1.10%
Total                                                   1,004,250    3,239,998    1.47%
ASC Communications, LLC  (7)                                       Chicago, IL                    
Term Loan (SBIC)  (2)(12)  First Lien    L+6.25%     1.00%   7.94%          6/29/2017     6/29/2022  Healthcare & Pharmaceuticals  $6,879,167    6,816,044    6,879,167    3.12%
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)  (2)(4)  Equity                           6/29/2017            73,529 shares    500,000    620,000    0.28%
Total                                                   7,316,044    7,499,167    3.40%
Beneplace, LLC                                          Austin TX                    
Term Loan (SBIC)  (2)(12)  Second
Lien
    L+10.00%     1.00%   11.70%          3/27/2017     9/27/2022  Insurance  $5,000,000    4,910,226    5,000,000    2.27%
Beneplace Holdings, LLC Preferred Units  (4)  Equity                           3/27/2017            500,000 units    500,000    500,000    0.23%
Total                                                   5,410,226    5,500,000    2.50%
Binder & Binder National Social Security Disability Advocates, LLC  (8)                                       Hauppauge, NY                    
Residual claim from Term Loan  (4)  Unsecured                           11/7/2012        Services: Consumer  $400,000    400,000    380,000    0.17%
BW DME Acquisition, LLC                                          Tempe, AZ                    
Term Loan (SBIC)  (2)(12)(13)  First Lien    L+6.00%     1.00%   9.43%          8/24/2017     8/24/2022  Healthcare & Pharmaceuticals  $9,550,000    9,281,016    9,310,000    4.23%
BW DME Holdings, LLC Class A Preferred Units  (4)  Equity                           8/24/2017            1,000,000 shares    1,000,000    1,110,000    0.50%
Total                                                   10,281,016    10,420,000    4.73%

 

 14 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017 

 

Investments  Footnotes  Security  Coupon    LIBOR
floor
   Cash    PIK     Initial Investment Date    Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
C.A.R.S. Protection Plus, Inc.                                          Murrysville, PA                    
Term Loan  (12)  First Lien    L+8.50%     0.50%   9.74%           12/23/2015    12/31/2020  Automotive  $98,746   $97,451   $98,746    0.04%
Term Loan (SBIC)  (2)(12)  First Lien    L+8.50%     0.50%   9.74%           12/23/2015    12/31/2020     $7,702,191    7,601,191    7,700,000    3.50%
CPP Holdings LLC Class A Common Units  (4)  Equity                            12/23/2015           149,828 shares    149,828    260,000    0.12%
Total                                                   7,848,470    8,058,746    3.66%
Catapult Learning, LLC et al                                          Camden, NJ                    
Term Loan  (13)  First Lien    L+6.50%     1.00%   9.30%           8/6/2015    7/16/2020  Education  $12,335,526    12,264,670    12,335,526    5.60%
Colford Capital Holdings, LLC                                          New York, NY                    
Preferred Units  (4)(5)  Equity                            8/20/2015       Finance   38,893 units    497,388    470,000    0.21%
Condor Borrower, LLC                                          Clifton, NJ                    
Term Loan  (12)  Second Lien    L+8.75%     1.00%   10.12%           10/27/2017    4/27/2025  Services: Business  $13,750,000    13,479,122    13,480,000    6.12%
Condor Top Holdco Limited Convertible Preferred Shares  (4)  Equity                            10/27/2017           500,000 shares    442,197    442,197    0.20%
Condor Holdings Limited Preferred Shares, Class B  (4)  Equity                            10/27/2017           500,000 shares    57,804    57,804    0.03%
Total                                                   13,979,123    13,980,001    6.35%
Douglas Products & Packaging Company, LLC                                          Liberty, MO                    
Term Loan (SBIC)  (2)(12)  Second Lien    L+10.50%     0.50%   12.20%           6/30/2015    12/31/2020  Chemicals, Plastics, & Rubber  $9,000,000    8,902,087    9,000,000    4.09%
Fumigation Holdings, Inc. Class A Common Stock  (4)  Equity                            6/30/2015           250 shares    250,000    530,000    0.24%
Total                                                   9,152,087    9,530,000    4.33%
Dream II Holdings, LLC                                          Boca Raton, FL                    
Class A Common Units  (4)  Equity                            10/20/2014       Services: Consumer   250,000 units    242,304    420,000    0.19%
Empirix Inc.                                          Billerica, MA                    
Term Loan  (12)  Second Lien    L+9.50%     1.00%   10.88%           11/1/2013    5/1/2020  Software  $11,657,850    11,554,734    11,657,850    5.29%
Term Loan (SBIC)  (2)(12)  Second Lien    L+9.50%     1.00%   10.88%           11/1/2013    5/1/2020     $9,750,000    9,662,051    9,750,000    4.43%
Empirix Holdings I, Inc. Common Shares, Class A  (4)  Equity                            11/1/2013           1,304 shares    1,304,232    831,600    0.38%
Empirix Holdings I, Inc. Common Shares, Class B  (4)  Equity                            11/1/2013           1,317,406 shares    13,174    8,400    0.00%
Total                                                   22,534,191    22,247,850    10.10%
Energy Labs Inc.                                          Houston, TX                    
Term Loan (SBIC)  (2)(13)  First Lien    L+7.00%     0.50%   11.58%           9/29/2016    9/29/2021  Energy: Oil & Gas  $5,300,000    5,214,783    5,300,000    2.41%
Energy Labs Holding Corp. Common Stock  (4)  Equity                            9/29/2016           500 shares    500,000    410,000    0.19%
Total                                                   5,714,783    5,710,000    2.60%
EOS Fitness OPCO Holdings, LLC                                          Phoenix, AZ                    
Term Loan (SBIC)  (2)(12)  First Lien    L+8.25%     0.75%   9.62%           12/30/2014    12/30/2019  Hotel, Gaming, & Leisure  $3,193,890    3,164,255    3,190,000    1.45%
EOS Fitness Holdings, LLC Class A Preferred Units  (4)  Equity                            12/30/2014           118 shares    117,670    224,250    0.10%

 

 15 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

 

Investments  Footnotes  Security  Coupon   LIBOR
floor
   Cash   PIK    Initial
Investment
Date
   Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
EOS Fitness Holdings, LLC Class B Common Units  (4)  Equity                       12/30/2014           3,017 shares   $3,017   $5,750    0.00%
Total                                              3,284,942    3,420,000    1.55 
Furniture Factory Outlet, LLC                                     Fort Smith, AR                    
Term Loan  (12)  First Lien   L+9.00%    0.50%   10.70%        6/10/2016    6/10/2021  Consumer Goods: Durable  $7,288,484    7,180,489    7,288,484    3.31%
Furniture Factory Holdings, LLC Term Loan  (11)  Unsecured   11.00%                   6/10/2016    2/3/2021     $122,823    122,823    120,000    0.05%
Sun Furniture Factory, LP Common Units  (4)  Equity                       6/10/2016           13,445 shares    94,569    210,000    0.10%
Total                                              7,397,881    7,618,484    3.46%
GK Holdings, Inc.                                     Cary, NC                    
Term Loan  (12)  Second
Lien
   L+10.25%    1.00%   11.94%        2/6/2015    1/30/2022  Education  $5,000,000    4,932,726    5,000,000    2.27%
Good Source Solutions, Inc.                                     Carlsbad, CA                    
Term Loan  (13)  First Lien   L+7.25%    0.50%   11.96%        7/15/2016    7/15/2021  Beverage, Food, & Tobacco  $1,350,000    1,329,398    1,350,000    0.61%
Term Loan (SBIC)  (2)(13)  First Lien   L+7.25%    0.50%   11.96%        7/15/2016    7/15/2021     $1,200,000    1,181,687    1,200,000    0.54%
Good Source Holdings, LLC Class A Preferred Units  (4)  Equity                       7/15/2016           159 shares    159,375    150,000    0.07%
Good Source Holdings, LLC Class B Common Units  (4)  Equity                       7/15/2016           4,482 shares    0    0    0.00%
Total                                              2,670,460    2,700,000    1.22%
Grupo HIMA San Pablo, Inc., et al                                     San Juan, PR                    
Term Loan  (3)  First Lien   L+7.00%    1.50%   8.50%        2/1/2013    1/31/2018  Healthcare & Pharmaceuticals  $4,750,000    4,748,168    4,180,000    1.90%
Term Loan  (15)  Second Lien   13.75%         0.00%        2/1/2013    7/31/2018     $4,109,524    4,079,696    900,000    0.41%
Total                                              8,827,864    5,080,000    2.31%
Hostway Corporation                                     Chicago, IL                    
Term Loan  (4)(6)(12)  Second Lien   L+10.00%    1.25%   5.94%        12/27/2013    12/13/2020  High Tech Industries  $6,750,000    6,680,080    5,910,000    2.68%
J.R. Watkins, LLC  (9)                                  San Francisco, CA                    
Term Loan (SBIC)  (2)(12)  First Lien   L+6.50%    1.25%   8.16%        12/22/2017    12/22/2022  Consumer Goods: non-durable  $12,500,000    12,250,000    12,250,000    5.56%
J.R. Watkins Holdings, Inc. Class A Preferred  (4)  Equity                       12/22/2017           1,000 shares    1,000,000    1,000,000    0.45%
Total                                              13,250,000    13,250,000    6.01%
Keais Records Service, LLC                                     Houston, TX                    
Term Loan  (12)  Second Lien   L+10.50%    0.50%   12.20%        6/30/2016    6/30/2022  Services: Business  $7,750,000    7,637,741    7,750,000    3.52%
Keais Holdings, LLC Class A Units  (4)  Equity                       6/30/2016           148,335 units    765,600    780,000    0.35%
Total                                              8,403,341    8,530,000    3.87%
KidKraft, Inc.                                     Dallas, TX                    
Term Loan  (6)  Second Lien   12.00%         11.00%   1.00%   9/30/2016    3/30/2022  Consumer Goods: Durable  $9,315,194    9,162,066    9,180,000    4.17%
Livingston International, Inc.                                     Toronto, Ontario                    
Term Loan  (5)(12)  Second Lien   L+8.25%    1.25%   9.94%        4/23/2013    4/18/2020  Transportation: Cargo  $6,841,739    6,785,894    6,840,000    3.11%

 

 16 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

 

Investments  Footnotes  Security  Coupon   LIBOR
floor
   Cash   PIK    Initial
Investment
Date
   Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
Madison Logic, Inc.                                     New York, NY                    
Term Loan (SBIC)  (2)(12)  First Lien   L+8.00%    0.50%   9.57%        11/30/2016    11/30/2021  Media: Broadcasting & Subscription  $4,875,000   $4,835,088   $4,875,000    2.21%
Madison Logic Holdings, Inc. Common Stock (SBIC)  (2)(4)  Equity                       11/30/2016           5,000 shares    50,000    56,000    0.03%
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)  (2)(4)  Equity                       11/30/2016           4,500 shares    450,000    504,000    0.23%
Total                                              5,335,088    5,435,000    2.47%
Magdata Intermediate Holdings, LLC                                     Austin TX                    
Term Loan  (12)  Second Lien   L+9.50%    1.00%   11.20%        10/16/2017    4/16/2024  Software  $12,500,000    12,254,448    12,250,000    5.56%
Mobileum, Inc.                                     Santa Clara, CA                    
Term Loan  (12)  Second Lien   L+10.25%    0.75%   11.95%        11/1/2016    5/1/2022  Software  $9,000,000    8,849,293    9,000,000    4.09%
Mobile Acquisition Holdings, LP Class A-2 Common Units  (4)  Equity                       11/1/2016           750 units    750,000    980,000    0.44%
Total                                              9,599,293    9,980,000    4.53%
MBS Holdings, Inc.                                     Birmingham, AL                    
Series E Preferred Stock  (4)  Equity                       3/10/2014       Media: Broadcasting & Subscription   2,774,695
shares
    1,000,000    2,386,710    1.08%
Series F Preferred Stock  (4)  Equity                       3/10/2014           399,308 shares    206,682    493,290    0.22%
Total                                              1,206,682    2,880,000    1.30%
MTC Parent, L.P.                                     Oak Brook, IL                    
Class A-2 Common Units  (4)  Equity                       12/1/2015       Finance   750,000 shares    28,842    2,200,000    1.00%
National Trench Safety, LLC, et al                                     Houston, TX                    
Term Loan (SBIC)  (2)  Second Lien   11.50%         11.50%        3/31/2017    3/31/2022  Construction & Building  $10,000,000    9,845,090    9,900,000    4.49%
NTS Investors, LP Class A Common Units  (4)  Equity                       3/31/2017           2,335 units    500,000    350,000    0.16%
Total                                              10,345,090    10,250,000    4.65%
OGS Holdings, Inc.                                     Chantilly, Virginia                    
Series A Convertible Preferred Stock  (4)  Equity                       4/22/2014       Services: Government   11,521 shares    50,001    100,000    0.05%
Protect America, Inc.                                     Austin TX                    
Term Loan (SBIC)  (2)(6)(12)  Second Lien   L+9.75%    1.00%   9.50%   2.00%   8/30/2017    10/30/2020  Services: Consumer  $17,617,786    17,220,312    17,270,000    7.84%
Refac Optical Group, et al                                     Blackwood, NJ                    
Revolver  (10)(12)  First Lien   L+8.00%         9.56%        11/7/2012    9/30/2018  Retail  $880,000    880,000    880,000    0.40%
Term A Loan  (12)  First Lien   L+8.00%         9.56%        11/7/2012    9/30/2018     $943,367    943,367    940,000    0.43%
Term B Loan  (6)(12)  First Lien   L+10.75%         10.56%   1.75%   11/7/2012    9/30/2018     $6,464,716    6,464,716    6,460,000    2.93%
Total                                              8,288,083    8,280,000    3.76 
Resolute Industrial, LLC  (14)                                  Wheeling, IL                    
Term Loan  (12)  First Lien   L+7.62%    1.00%   8.95%        7/26/2017    7/26/2022  Capital Equipment  $3,797,222    3,731,397    3,740,000    1.70%
Term Loan (SBIC)  (2)(12)  First Lien   L+7.62%    1.00%   8.95%        7/26/2017    7/26/2022     $13,290,278    13,059,850    13,090,000    5.94%
Resolute Industrial Holdings, LLC Class A Preferred Units  (4)  Equity                       7/26/2017           601 units    750,000    760,000    0.35%
Total                                              17,541,247    17,590,000    7.99%
Roberts-Gordon, LLC                                     Buffalo, NY                    
Term Loan  (12)  Second Lien   L+10.00%    1.00%   11.70%        6/30/2017    1/1/2022  Construction & Building  $7,200,000    7,068,278    7,130,000    3.24%

 

 17 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

 

Investments  Footnotes  Security  Coupon   LIBOR
floor
   Cash   PIK    Initial
Investment
Date
   Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
Specified Air Solutions, LLC Class A Common Unites  (4)  Equity                       6/30/2017           3,846 shares   $500,045   $600,000    0.27%
Total                                              7,568,323    7,730,000    3.51%
Sitel Worldwide Corporation                                     Nashville, TN                    
Term Loan  (12)  Second Lien   L+9.50    1.00%   10.88%        9/24/2015    9/18/2022  High Tech Industries  $10,000,000    9,848,614    9,950,000    4.52%
Skopos Financial, LLC                                     Irving, TX                    
Term Loan  (5)  Unsecured   12.00%        12.00%        1/31/2014    1/31/2019  Finance  $20,000,000    19,886,350    19,800,000    8.99%
Skopos Financial Group, LLC Class A Units  (4)(5)  Equity                       1/31/2014           1,120,684 units    1,162,544    770,000    0.35%
Total                                              21,048,894    20,570,000    9.34%
SPM Capital, LLC                                     Bloomington, MN                    
Term Loan  (12)  First Lien   L+6.50    1.50%   8.19%        12/10/2012    10/31/2018  Healthcare & Pharmaceuticals  $5,421,770    5,421,770    5,420,000    2.46%
SQAD, LLC                                     Tarrytown, NY                    
Term Loan (SBIC)  (2)  First Lien   L+6.50    1.00%   8.16%        12/22/2017    12/22/2022  Media: Broadcasting & Subscription  $15,000,000    14,919,983    14,920,000    6.77%
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)  (2)(4)  Equity                       10/31/2013           3,598 shares    156,001    307,023    0.14%
SQAD Holdco, Inc. Common Shares
(SBIC)
  (2)(4)  Equity                       10/31/2013           5,800 shares    62,485    122,977    0.06%
Total                                              15,138,469    15,350,000    6.97%
TechInsights, Inc.                                     Ottawa, Ontario                    
Term Loan  (5)(12)(13)  First Lien   L+6.50%    1.00%   8.71%        8/16/2017    8/16/2022  High Tech Industries  $20,000,000    19,529,783    19,600,000    8.90%
Time Manufacturing Acquisition, LLC                                     Waco, TX                    
Term Loan  (6)  Unsecured   11.50%        10.75%   0.75%   2/3/2017    8/3/2023  Capital Equipment  $6,373,100    6,258,780    6,250,000    2.84%
Time Manufacturing Investments, LLC Class A Common
Units
  (4)  Equity                       2/3/2017           5,000 units    500,000    330,000    0.15%
Total                                              6,758,780    6,580,000    2.99%
TFH Reliability, LLC                                     Houston, TX                    
Term Loan (SBIC)  (2)(12)  Second Lien   L+10.75%    0.50%   12.45%        10/26/2016    4/21/2022  Chemicals, Plastics, & Rubber  $5,875,000    5,775,974    5,875,000    2.67%
TFH Reliability Group, LLC Class A Common Units  (4)  Equity                       10/26/2016           250,000 shares    250,000    340,000    0.15%
Total                                              6,025,974    6,215,000    2.82%
U.S. Auto Sales, Inc. et al                                     Lawrenceville, GA                    
Term Loan  (5)(12)  Second Lien   L+11.75%    1.00%   13.12%        6/8/2015    6/8/2020  Finance  $4,500,000    4,474,973    4,500,000    2.04%
USASF Blocker II, LLC Common Units  (4)(5)  Equity                       6/8/2015           441 units    441,000    578,200    0.26%
USASF Blocker LLC Common Units  (4)(5)  Equity                       6/8/2015           9,000 units    9,000    11,800    0.01%
Total                                              4,924,973    5,090,000    2.31%
VRI Intermediate Holdings, LLC                                     Franklin, OH                    
Term Loan (SBIC)  (2)(12)  Second Lien   L+9.25%    1.00%   10.95%        5/31/2017    10/31/2020  Healthcare & Pharmaceuticals  $9,000,000    8,846,185    8,910,000    4.05%
VRI Ultimate Holdings, LLC Class A Preferred Units  (4)  Equity                       5/31/2017           326,797 shares    500,000    500,000    0.23%
Total                                              9,346,185    9,410,000    4.28%

 

 18 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

 

Investments  Footnotes  Security  Coupon    LIBOR
floor
   Cash    PIK     Initial
Investment
Date
   Maturity  Headquarters/
Industry
  Principal
Amount/
Shares
   Amortized
Cost
   Fair
Value(1)
   % of
Net
Assets
 
Wise Holding Corporation                                          Salt Lake City, UT                    
Term Loan  (12)  Unsecured    L+11.00%     1.00%   12.70%           6/30/2016    12/31/2021  Beverage, Food, & Tobacco  $1,250,000   $1,235,188   $880,000    0.40%
WCI Holdings LLC Class A Preferred Units  (4)  Equity                            6/30/2016           56 units    55,550    0    0.00%
WCI Holdings LLC Class B Common Units  (4)  Equity                            6/30/2016           3,044 units    3,044    0    0.00%
Total                                                   1,293,782    880,000    0.40%
Zemax, LLC                                          Redmond, WA                    
Term Loan (SBIC)  (2)(12)  Second Lien    L+10.00%     1.00%   11.60%           10/23/2014    4/23/2020  Software  $3,962,500    3,922,743    3,960,000    1.80%
Zemax Software Holdings, LLC Preferred Units (SBIC)  (2)(4)  Equity                            10/23/2014           24,500 units    5,000    11,200    0.01%
Zemax Software Holdings, LLC Common Units (SBIC)  (2)(4)  Equity                            10/23/2014           5,000 shares    245,000    548,800    0.25%
Total                                                   4,172,743    4,520,000    2.06%
Total Non-controlled, non-affiliated
investments
                                                   367,401,021    370,849,772    168.38%
Net Investments                                                   368,453,206    371,839,772    168.83%
LIABILITIES IN EXCESS OF OTHER ASSETS                                                        (151,592,530)   (68.83)%
NET ASSETS                                                       $220,247,242    100.00%

 

(1)See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.

 

(2)Investments held by the SBIC Subsidiary, which include $5,258,500 of cash and $155,769,170 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.

 

(3)These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.

 

(4)Security is non-income producing.

 

(5)The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of December 31, 2017.

 

(6)Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.

 

(7)Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(8)In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.

 

(9)Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

 19 

 

 

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

 

(10)Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(11)Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.

 

(12)These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.

 

(13)These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.

 

(14)Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

 

(15)Investment has been on non-accrual since November 1, 2017.

 

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

 

 20 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

 

Stellus Capital Investment Corporation (“we”, “us”, “our” and the “Company”) was formed as a Maryland corporation on May 18, 2012 (“Inception”) and is an externally managed, closed-end, non-diversified investment management company. The Company is applying the guidance of Accounting Standards Codification (“ASC”) Topic 946, Financial Services Investment Companies. The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), and treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), for U.S. federal income tax purposes. The Company’s investment activities are managed by our investment adviser, Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

 

As of March 31, 2018, the Company had issued a total of 15,953,810 shares and raised $235,743,704 in gross proceeds since Inception, incurring $7,566,535 in offering expenses and sales load fees for net proceeds from offerings of $228,177,169. The Company’s shares are currently listed on the New York Stock Exchange under the symbol ‘‘SCM’’. See Note 4 for further details.

 

The Company has established wholly owned subsidiaries: SCIC — Consolidated Blocker 1, Inc., SCIC – ICD Blocker 1, Inc., SCIC — CC Blocker 1, Inc., SCIC — ERC Blocker 1, Inc., SCIC — SKP Blocker 1, Inc. and SCIC — APE Blocker 1, Inc. and SCIC — Hollander Blocker 1, Inc., which are structured as Delaware entities, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities) (collectively, the “Taxable Subsidiaries”). The Taxable Subsidiaries are consolidated for U.S. generally accepted accounting principles (“U.S. GAAP”) reporting purposes, and the portfolio investments held by them are included in the consolidated financial statements.

 

On June 14, 2013, we formed Stellus Capital SBIC, LP (the “SBIC subsidiary”), a Delaware limited partnership, and its general partner, Stellus Capital SBIC GP, LLC, a Delaware limited liability company, as wholly owned subsidiaries of the Company. On June 20, 2014, the SBIC subsidiary received a license from the U.S. Small Business Administration (“SBA”) to operate as a Small Business Investment Company (“SBIC”) under Section 301(c) of the Small Business Investment Company Act of 1958, as amended. The SBIC subsidiary and its general partner are consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.

 

The SBIC license allows the SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities. The SBA, as a creditor, will have a superior claim to the SBIC’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary upon an event of default. SBA regulations currently limit the amount that a single licensee may borrow to a maximum of $150,000,000 when it has at least $75,000,000 in regulatory capital, as such term is defined by the SBA, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75,000,000 and $67,500,000 of regulatory capital, respectively, as such term is defined by the SBA, and has received commitments from the SBA of $90,000,000. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90,000,000 of SBA-guaranteed debentures outstanding. See footnote (2) of the Consolidated Schedule of Investments for additional information regarding the treatment of SBIC investments with respect to the Credit Facility.

 

 21 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

The Company’s investment objective is to maximize the total return to its stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The Company seeks to achieve its investment objective by originating and investing primarily in private U.S. middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments. It sources investments primarily through the extensive network of relationships that the principals of Stellus Capital have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries.

 

Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying the annual financial statements prepared in accordance with U.S. GAAP are omitted. The unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.

 

In the opinion of management, the unaudited consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of the financial statements for the interim periods included herein. The results of operations for the three months ended March 31, 2018 and March 31, 2017 are not necessarily indicative of the operating results to be expected for the full year. Also, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2017. In accordance with Regulation S-X under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments. The accounting records of the Company are maintained in U.S. dollars.

 

Portfolio Investment Classification

 

The Company classifies its portfolio investments in accordance with the requirements of the 1940 Act as follows: (a) “Control Investments” are defined as investments in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation, (b) “Affiliate Investments” are defined as investments in which the Company owns between 5% and 25% of the voting securities and does not have rights to maintain greater than 50% of the board representation, and (c) “Non-controlled, non-affiliate investments” are defined as investments that are neither Control Investments or Affiliate Investments.

 

Cash and Cash Equivalents

 

At March 31, 2018, cash balances held at two separate institutions totaling $2,203,127 and $590,148 exceeded FDIC insurance protection levels of $250,000 by $1,953,127 and $340,148, subjecting the Company to risk related to the uninsured balance. In addition, at March 31, 2018, the Company held $42,701,088 in cash equivalents, which are carried at cost, which approximates fair value. All of the Company’s cash deposits are held at large established high credit quality financial institutions and management believes that risk of loss associated with any uninsured balances is remote. 

 

Cash consists of bank demand deposits. We deem certain U.S. Treasury Bills and other high-quality, short-term debt securities as cash equivalents. At the end of each fiscal quarter, we may take proactive steps to ensure we are in compliance with the RIC diversification requirements under Subchapter M of the Code, which are dependent upon the composition of our total assets at quarter end. We may accomplish this in several ways, including purchasing U.S. Treasury Bills and closing out positions after quarter-end or temporarily drawing down on the Credit Facility (see Note 9). On March 31, 2018 and December 31, 2017, we held no U.S. Treasury Bills.

 

 22 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

Fair Value Measurements

 

We account for substantially all of our financial instruments at fair value in accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (‘‘ASC Topic 820’’). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying values of our Credit Facility and SBIC debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input). The carrying value of our Notes is based on the closing price of the security (level 2 input). See Note 6 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy.

 

Consolidation

 

As permitted under Regulation S-X under the Exchange Act and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary. Accordingly, we consolidated the results of the SBIC subsidiary and the Taxable Subsidiaries. All intercompany balances have been eliminated upon consolidation.

 

Use of Estimates

 

The preparation of the consolidated statements of assets and liabilities in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

 

Deferred Financing Costs, Prepaid Loan Fees on SBA-Guaranteed Debentures and Prepaid Loan Structure Fees

 

Deferred financing costs, prepaid loan fees on SBA-guaranteed debentures and prepaid loan structure fees consist of fees and expenses paid in connection with the closing of our Notes, Credit Facility, and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are presented as a direct deduction to the carrying amount of the respective liability and amortized using the straight line method over the term of the respective instrument.

 

Offering Costs

 

Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when incurred and recognized as a reduction of offering proceeds when the offering is consummated and shown on the Consolidated Statement of Changes in Net Assets and Liabilities as a reduction to Paid-in-Capital. No such costs were incurred during the quarter ended March 31, 2018. During the quarter ended March 31, 2017, the Company incurred costs related to the preparation of a shelf registration statement. As a result, the Company capitalized $81,813 related to the offering that was consummated in April 2017. See Note 4 for further discussion.

 

Investments

 

As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity securities of middle-market companies. Under procedures established by the board of directors, the Company intends to value investments for which market quotations are readily available at such market quotations. The Company will obtain these market values from an independent pricing service or at the median between the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available will be valued at fair value as determined in good faith by our board of directors. Such determination of fair values may involve subjective judgments and estimates. The Company also engages independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least twice annually.

 

 

 

 23 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

Investments purchased within approximately 90 days of the valuation date will be valued at cost plus accreted discount, or minus amortized premium, which approximates fair value. With respect to unquoted securities, our board of directors, together with our independent valuation advisors, will value each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the board of directors will use the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because the Company expects that there will not be a readily available market for many of the investments in our portfolio, the Company expects to value most of our portfolio investments at fair value as determined in good faith by the board of directors using a documented valuation policy and a 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 differences could be material.

 

In following these approaches, the types of factors that will be taken into account in fair value pricing investments will include, as relevant, but not be limited to:

 

available current market data, including relevant and applicable market trading and transaction comparables;

 

applicable market yields and multiples;

 

security covenants;

 

call protection provisions;

 

information rights;

 

the nature and realizable value of any collateral;

 

the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;

 

comparisons of financial ratios of peer companies that are public;

 

comparable merger and acquisition transactions; and

 

the principal market and enterprise values.

 

Revenue Recognition

 

We record interest income on an accrual basis to the extent such interest is deemed collectible. For loan and debt securities with contractual payment-in-kind (‘‘PIK’’) interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we do not accrue PIK interest if the portfolio company valuation indicates that such PIK interest is not collectible. We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination fee is recorded as interest income. We record prepayment premiums on loans and debt securities as other income. Dividend income, if any, will be recognized on the ex-dividend date.

 

To maintain our treatment as a RIC, substantially all of this income must be paid to stockholders in the form of distributions, even if we have not collected any cash.

 

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

 

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

 

 24 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

Investment Transaction Costs

 

Costs that are material associated with an investment transaction, including legal expenses, are included in the cost basis of purchases and deducted from the proceeds of sales unless such costs are reimbursed by the borrower.

 

Receivables and Payables for Unsettled Securities Transaction

 

The Company records all investments on a trade date basis.

 

U.S. Federal Income Taxes

 

The Company has elected to be treated as a RIC under Subchapter M of the Code, and to operate in a manner so as to qualify for the tax treatment applicable to RICs. To qualify for tax treatment as a RIC, among other things, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. So long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the consolidated financial statements of the Company.

 

To avoid a 4% U.S federal excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending December 31 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). The Company, at its discretion, may choose not to distribute all of its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned. Deducted from excise tax expense for the three months ended March 31, 2018 is a refund of the estimated excise tax paid relating to the year ended December 31, 2016 of $37,648.

 

The Company evaluates tax positions taken or expected to be taken in the course of preparing its tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the applicable period.

 

As of March 31, 2018 and December 31, 2017, the Company had not recorded a liability for any unrecognized tax positions. Management’s evaluation of uncertain tax positions may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof. The Company’s policy is to include interest and penalties related to income taxes, if applicable, in general and administrative expenses. Any expenses for the three months ended March 31, 2018 and 2017 were de minimis.

 

On December 22, 2017, the “Tax Cuts and Jobs Act” legislation was signed into law. The Tax Cuts and Jobs Act includes significant changes to the U.S. corporate tax system, including a reduction in the U.S. corporate income tax rate from 35% to 21%. ASC 740, Income Taxes, requires the effect of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As such, we have accounted for the tax effects as a result of the Tax Cuts and Jobs Act beginning with the period ending December 31, 2017.

 

The Taxable Subsidiaries are direct wholly owned subsidiaries of the Company that have elected to be taxable entities. The Taxable Subsidiaries permit the Company to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in the Company’s consolidated financial statements.

 

 25 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

The Taxable Subsidiaries use the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.

 

For the three months ended March 31, 2018 and 2017, the Company recorded deferred income tax benefit of $0 and $8,593, respectively, related to the Taxable Subsidiaries. In addition, as of March 31, 2018 and December 31, 2017, the Company had a deferred tax liability of $0 and $0, respectively.

 

Earnings per Share

 

Basic per share calculations are computed utilizing the weighted average number of shares of common stock outstanding for the period. The Company has no common stock equivalents. As a result, there is no difference between diluted earnings per share and basic per share amounts.

 

Paid In Capital

 

The Company records the proceeds from the sale of its common stock on a net basis to (i) capital stock and (ii) paid in capital in excess of par value, excluding all commissions and marketing support fees.

 

Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Note, the guidance exempts interest income from the above guidance, indicating recognition will remain the same. We have completed our analysis on the above guidance and have concluded on the recognition treatment of other income streams such as repayment penalty fees, origination fees, miscellaneous fees etc. Stellus will continue to recognize origination fees over the life of the loan. Repayment penalty fees will be recognized immediately if a repayment is made and miscellaneous fees such as administration fees will be recognized on the contract renewal date or other discrete point in time per the credit agreement. Per the Topic 606 update, Stellus’ timing of its revenue recognition will remain the same for the identified revenue streams as previously reported.

 

In November 2015, the FASB issued ASU 2015-17 — Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. It simplifies the current guidance, which requires entities to separately present deferred tax assets and liabilities as current or noncurrent in a classified balance sheet. The guidance was effective for the Company as of January 1, 2017 and there is no material impact on its consolidated financial statement.

 

In January 2016, the FASB issued ASU No. 2016-01 — Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods therein. The Company adopted this standard effective January 1, 2018, which did not have a material impact on its consolidated financial statements.

 

 26 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

In August 2016, the FASB issued ASU 2016-15 — Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The new guidance addresses the classification of various transactions including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, distributions received from equity method investments, beneficial interests in securitization transactions, and others. The update is effective for annual periods beginning after December 31, 2018, and interim periods within those annual periods. While the Company is currently assessing the impact of the guidance we do not expect the impact of this new standard on our consolidated financial statements to be material.

 

From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. We believe the impact of the recently issued standards and any that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

 

NOTE 2 — RELATED PARTY ARRANGEMENTS

 

Investment Advisory Agreement

 

The Company has entered into an investment advisory agreement with Stellus Capital. Pursuant to this agreement, the Company has agreed to pay to Stellus Capital an annual base management fee of 1.75% of gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents, and an annual incentive fee.

 

For the three months ended March 31, 2018 and 2017, the Company recorded an expense for base management fees of $1,748,896 and $1,564,528, respectively. As of March 31, 2018 and December 31, 2017, $1,575,366 and $1,621,592, respectively, were payable to Stellus Capital.

 

The incentive fee has two components, investment income and capital gains, as follows:

 

Investment Income Incentive Fee

 

The investment income component (“Investment Income Incentive Fee”) is calculated, and payable to the Advisor, quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The pre-incentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as the “Hurdle”). Pre-incentive fee net investment income means interest income, dividend income and any other income accrued during the calendar quarter, minus the Company’s operating expenses for the quarter excluding the incentive fee. Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle. Subject to the cumulative total return requirement described below, the Advisor receives 100% of the Company’s pre-incentive fee net investment income for any calendar quarter with respect to that portion of the pre-incentive net investment income for such quarter, if any, that exceeds the Hurdle but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “Catch-up”) and 20.0% of the Company’s pre-incentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets.

 

 27 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any Investment Income Incentive Fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the Catch-up, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.

 

For the three months ended March 31, 2018 and March 31, 2017, the Company incurred $968,826 and $1,021,136, respectively, of Investment Income Incentive Fees. As of March 31, 2018 and December 31, 2017, $1,164,735 and $371,648, respectively, of such incentive fees were payable to the Advisor, of which $951,729 and $175,739, respectively, are currently payable (as explained below). As of March 31, 2018 and December 31, 2017, $213,006 and $195,909, respectively, of incentive fees incurred but not paid by the Company were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received in cash.

 

Capital Gains Incentive Fee

 

The Company also pays the Advisor an incentive fee based on capital gains (the “Capital Gains Incentive Fee”). The Capital Gains Incentive Fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). The Capital Gains Incentive Fee is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from Inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid Capital Gain Incentive Fees is subtracted from such Capital Gain Incentive Fees calculated.

 

U.S. GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation or depreciation of investments or other financial instruments in the calculation, as an incentive fee would be payable if such realized gains and losses and unrealized capital appreciation or depreciation were realized, even though such realized gains and losses and unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment advisory agreement (the “Capital Gains Incentive Fee”). There can be no assurance that unrealized appreciation or depreciation will be realized in the future. Accordingly, such fees, as calculated and accrued, would not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. For the three months ended March 31, 2018 and 2017, the Company incurred no incentive fees related to the Capital Gains Incentive Fee. As of March 31, 2018 and December 31, 2017, no Capital Gains Incentive Fees were payable to the Advisor.

 

The following tables summarize the components of the incentive fees discussed above:

 

   Three Months Ended 
   March 31 
   2018   2017 
Investment Income Incentive Fees Incurred  $968,826   $1,021,227 
Capital Gains Incentive Fee Incurred        
Incentive Fee Expense  $968,826   $1,021,227 

 

 28 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

   March 31,   December 31, 
   2018   2017 
Investment Income Incentive Fee Currently Payable  $951,729   $175,738 
Investment Income Incentive Fee Deferred   213,006    195,909 
Incentive Fee Payable  $1,164,735   $371,647 

 

Director Fees

 

For both the three months ended March 31, 2018 and 2017, the Company recorded an expense relating to director fees of $92,000. As of both March 31, 2018 and December 31, 2017, the Company owed its independent directors no director fees.

 

Co-Investment Pursuant to SEC Order

 

The Company has received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with its investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with its investment objectives and strategies. The Company intends to co-invest, subject to the conditions included in the exemptive order the Company received from the SEC, with a private credit fund managed by Stellus Capital Management that has an investment strategy that is identical to the Company’s investment strategy. The Company believes that such co-investments may afford it additional investment opportunities and an ability to achieve greater diversification.

 

Administrative Agent

 

The Company serves as the administrative agent on certain investment transactions. As of March 31, 2018 and December 31, 2017, Cash and Cash Equivalents included $109,346 and $0, respectively, of cash due to other investment funds managed by Stellus Capital Management related to interest paid by a borrower to the Company as administrative agent. Any such amount are included in “Other Accrued Expenses and Liabilities” on the Consolidated Statement of Assets and Liabilities.

 

License Agreement

 

The Company has entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant the Company a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, the Company has a right to use the “Stellus Capital” name for so long as Stellus Capital Management or one of its affiliates remains its investment advisor. Other than with respect to this limited license, the Company has no legal right to the “Stellus Capital” name. This license agreement will remain in effect for so long as the investment advisory agreement with Stellus Capital Management is in effect.

 

Administration Agreement

 

The Company has entered into an administration agreement with Stellus Capital pursuant to which Stellus Capital will furnish the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital will perform, or oversee the performance of, the its required administrative services, which includes, among other things, being responsible for the financial records which the Company is required to maintain and preparing reports to its stockholders and reports filed with the SEC.

 

For the three months ended March 31, 2018 and 2017, the Company recorded expenses of $313,833 and $279,922 respectively, relating to the administration agreement. As of March 31, 2018 and December 31, 2017, $313,833 and $279,141, respectively, remained payable to Stellus Capital under the administration agreement.

 

 29 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

Indemnifications

 

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

 

NOTE 3 — DISTRIBUTIONS

 

Distributions are generally declared by the Company’s board of directors each calendar quarter, paid monthly and recognized as distribution liabilities on the ex-dividend date. The Company intends to distribute net realized gains (i.e., net capital gains in excess of net capital losses), if any, at least annually. The stockholder distributions, if any, will be determined by the board of directors. Any distribution to stockholders will be declared out of assets legally available for distribution.

 

 30 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

The following table reflects the Company’s distributions declared and paid or to be paid on its common stock since Inception:

 

Date Declared  Record Date  Payment Date  Per Share 
Fiscal 2012           
December 7, 2012  December 21, 2012  December 27, 2012  $0.1812 
Fiscal 2013 (1)           
various  various  various  $1.3600 
Fiscal 2014 (2)(3)           
various  various  various  $1.4246 
Fiscal 2015(2)           
various  various  various  $1.3596 
Fiscal 2016(2)           
various  various  various  $1.3596 
Fiscal 2017(2)           
January 13, 2017  January 31, 2017  February 15, 2017  $0.1133 
January 13, 2017  February 28, 2017  March 15, 2017  $0.1133 
January 13, 2017  March 31, 2017  April 14, 2017  $0.1133 
April 14, 2017  April 28, 2017  May 15, 2017  $0.1133 
April 14, 2017  May 31, 2017  June 15, 2017  $0.1133 
April 14, 2017  June 30, 2017  July 14, 2017  $0.1133 
July 7, 2017  July 31, 2017  August 15, 2017  $0.1133 
July 7, 2017  August 31, 2017  September 15, 2017  $0.1133 
July 7, 2017  September 29, 2017  October 13, 2017  $0.1133 
October 12, 2017  October 31, 2017  November 15, 2017  $0.1133 
October 12, 2017  November 30, 2017  December 15, 2017  $0.1133 
October 12, 2017  December 29, 2017  January 12, 2018  $0.1133 
Fiscal 2018(2)           
January 11, 2018  January 31, 2018  February 15, 2018  $0.1133 
January 11, 2018  February 28, 2018  March 15, 2018  $0.1133 
January 11, 2018  March 29, 2018  April 13, 2018  $0.1133 
Total        $7.3845 

 

(1)Distributions made quarterly

(2)Distributions made monthly

(3)Includes special distribution of $0.065 per share in addition to monthly distributions

 

Unless the stockholder elects to receive its distributions in cash, the Company intends to make such distributions in additional shares of the Company’s common stock under the Company’s dividend reinvestment plan. Although distributions paid in the form of additional shares of the Company’s common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in the Company’s dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes. Any distributions reinvested through the issuance of shares through the Company’s dividend reinvestment plan will increase the Company’s gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital. The Company issued 7,931 and 0 shares, respectively, in connection with the distributions made during the three months ended March 31, 2018 and 2017.

 

 31 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES

 

The table below illustrates the number of common stock shares the Company issued since Inception through various equity offerings.

 

                       Average 
   Number of   Gross   Underwriting   Offering   Net   Offering 
Issuance of Common Stock  Shares   Proceeds (1)(2)   fees   Expenses   Proceeds   Price 
Year ended December 31, 2012   12,035,023   $180,522,093   $4,959,720   $835,500   $174,726,873   $14.90 
Year ended December 31, 2013   63,998    899,964            899,964    14.06 
Year ended December 31, 2014   380,936    5,485,780    75,510    29,904    5,380,366    14.47 
Year ended December 31, 2017   3,465,922    48,741,407    1,358,880    307,022    47,075,505    14.06 
Quarter ended March 31, 2018   7,931    94,461            94,461    11.95 
Total   15,953,810   $235,743,705   $6,394,110   $1,172,426   $228,177,169      

 

(1)Net of partial share redemptions. Such share redemptions reduced gross proceeds by $327, $142, $29 and $31 in 2018, 2017, 2016 and 2015, respectively.

 

(2)Includes common shares issued under the DRIP of $94,788 during the year ended 2018, $0 for the years ended 2017, 2016 and 2015, and $398,505, $938,385, $113,000 for the years ended 2014, 2013, and 2012, respectively.

  

The Company issued 7,931 and 0 shares, respectively, of common stock during the three months ended March 31, 2018 and the year ended December 31, 2017 in connection with the stockholder distribution reinvestment plan.

 

The Company issued 3,162,500 shares in a secondary offering and 303,422 shares in connection with the ATM program during the year ended December 31, 2017. Gross proceeds resulting from the secondary offering totaled $44,591,250 and underwriting and other expenses totaled $1,530,632. The per share offering price for the secondary offering was $14.10. Gross proceeds resulting from the ATM Program in 2017 totaled $4,150,299 and underwriting and other expenses totaled $135,270. The average per share offering price of shares issued in the ATM Program during 2017 was $13.68.

 

NOTE 5 — NET INCREASE IN NET ASSETS PER COMMON SHARE

 

The following information sets forth the computation of net increase in net assets resulting from operations per common share for the three months ended March 31, 2018 and March 31, 2017.

 

   Three Months Ended 
   March 31,   March 31, 
   2018   2017 
Net increase in net assets resulting from operations  $7,343,929   $6,024,752 
Weighted average common shares   15,952,841    12,479,957 
Basic and diluted earnings per common share  $0.46   $0.48 

 

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE

 

In accordance with the authoritative guidance on fair value measurements and disclosures under U.S. GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

 

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

 

 32 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

Level 2 — Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;

 

Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

 

The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

 

At March 31, 2018, the Company had investments in 52 portfolio companies. The total fair value and cost of the investments were $431,299,720 and $426,379,871, respectively. The composition of our investments as of March 31, 2018 is as follows:

 

   Cost   Fair Value 
Senior Secured – First Lien(1)  $198,445,230   $199,372,307 
Senior Secured – Second Lien   180,292,855    177,644,589 
Unsecured Debt   27,147,168    26,732,823 
Equity   20,494,618    27,550,001 
Total Investments  $426,379,871   $431,299,720 

 

(1) Includes unitranche investments, which account for 16.1% of our portfolio at fair value.

 

At December 31, 2017, the Company had investments in 48 portfolio companies. The composition of our investments as of December 31, 2017 was as follows:

 

   Cost   Fair Value 
Senior Secured – First Lien(1)  $140,915,106   $141,006,923 
Senior Secured – Second Lien   181,164,730    178,432,850 
Unsecured Debt   27,903,141    27,430,000 
Equity   18,470,229    24,969,999 
Total Investments  $368,453,206   $371,839,772 

 

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value.

 

The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of March 31, 2018 and December 31, 2017, the Company had six and four such investments, respectively, with aggregate unfunded commitments of $11,186,667 and $8,686,667, respectively. The Company maintains sufficient liquidity to fund such unfunded commitments should the need arise.

 

 

 33 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of March 31, 2018 are as follows:

 

   Quoted Prices             
   in Active             
   Markets   Significant Other   Significant     
   for Identical   Observable   Unobservable     
   Securities   Inputs   Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Senior Secured – First Lien  $   $   $199,372,307   $199,372,307 
Senior Secured – Second Lien           177,644,589    177,644,589 
Unsecured Debt           26,732,823    26,732,823 
Equity           27,550,001    27,550,001 
Total Investments  $   $   $431,299,720   $431,299,720 

 

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2017 are as follows:

 

 34 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

 

   Quoted Prices             
   in Active             
   Markets   Significant Other   Significant     
   for Identical   Observable   Unobservable     
   Securities   Inputs   Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Senior Secured – First Lien  $   $   $141,006,923   $141,006,923 
Senior Secured – Second Lien           178,432,850    178,432,850 
Unsecured Debt           27,430,000    27,430,000 
Equity           24,969,999    24,969,999 
Total Investments  $   $   $371,839,772   $371,839,772 

 

The aggregate values of Level 3 portfolio investments changed during the three months ended March 31, 2018 are as follows:

 

   Senior Secured   Senior Secured             
   Loans - First   Loans - Second   Unsecured         
   Lien   Lien   Debt   Equity   Total 
Fair value at beginning of year  $141,006,923   $178,432,850   $27,430,000   $24,969,999   $371,839,772 
Purchases of investments   58,676,526    9,800,000        3,237,261    71,713,787 
Payment-in-kind interest   28,610    111,314    12,082        152,006 
Sales and redemptions   (1,319,663)   (10,952,460)   (797,872)   (2,548,139)   (15,618,134)
Realized Loss               1,335,269    1,335,269 
Change in unrealized appreciation included in earnings   835,261    83,614    58,795    555,611    1,533,281 
Amortization of premium and accretion of discount, net   144,650    169,271    29,818        343,739 
Transfer from Level 2                    
Fair value at end of period  $199,372,307   $177,644,589   $26,732,823   $27,550,001   $431,299,720 
Change in unrealized appreciation (depreciation) on Level 3 investments still held as of March 31, 2018  $835,260   $181,527   $58,795   $555,611   $1,631,193 

 

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2017 are as follows:

 

   Senior Secured   Senior Secured            
   Loans - First   Loans - Second   Unsecured         
   Lien   Lien   Debt   Equity   Total 
Fair value at beginning of year  $113,482,205   $144,521,388   $70,725,412   $18,931,886   $347,660,891 
Purchases of investments   85,892,733    73,388,500    6,203,400    6,686,613    172,171,246 
Payment-in-kind interest   113,723    319,629    66,244        499,596 
Sales and redemptions   (57,242,106)   (47,725,650)   (49,578,812)   (9,369,308)   (163,915,876)
Transfer from term loan to equity   (864,101)           864,101     
Net realized gain (loss)   (626,949)           5,367,925    4,740,976 
Change in unrealized depreciation (appreciation) included in earnings   (126,190)   (2,146,961)   (278,564)   2,488,782    (62,933)
Amortization of premium and accretion of discount, net   377,608    525,944    292,320        1,195,872 
Transfer from Level 2       9,550,000            9,550,000 
Fair value at end of year  $141,006,923   $178,432,850   $27,430,000   $24,969,999   $371,839,772 
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2017  $(498,183)  $(1,679,419)  $(278,567)  $3,465,063   $1,008,894 

 

 35 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

There were no Level 3 transfers during the quarter ended March 31, 2018.

 

During the year ended December 31, 2017, there was one transfer from a Level 2 to a Level 3 because the observable inputs were not available. Transfers are reflected at the value of the securities at the beginning of the period.

 

The following is a summary of geographical concentration of our investment portfolio as of March 31, 2018:

 

           % of Total 
   Cost   Fair Value   Investments 
Texas  $111,024,052   $110,713,387    25.67%
California   45,368,765    45,800,000    10.62%
New Jersey   34,281,271    34,319,692    7.96%
New York   28,581,847    28,913,750    6.70%
Canada   26,340,678    26,641,739    6.18%
Illinois   24,256,766    25,580,000    5.93%
Arizona   21,414,850    22,190,812    5.15%
Massachusetts   22,552,094    22,187,850    5.14%
Ohio   21,660,379    21,760,000    5.05%
South Carolina   21,100,842    21,090,000    4.89%
Arkansas   15,364,791    15,678,106    3.64%
North Carolina   11,841,982    12,032,500    2.79%
Tennessee   9,854,786    10,000,000    2.32%
Georgia   5,981,496    8,650,000    2.01%
Pennsylvania   7,855,929    8,010,938    1.86%
Minnesota   5,130,946    5,130,946    1.19%
Puerto Rico   8,842,160    5,080,000    1.18%
Alabama   1,206,682    3,300,000    0.77%
Washington   2,132,745    2,560,000    0.59%
Utah   1,294,505    880,000    0.20%
Florida   242,304    380,000    0.09%
Missouri   -    300,000    0.07%
Virginia   50,001    100,000    0.02%
   $426,379,871   $431,299,720    100.00%

 

 36 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

 

           % of Total 
   Cost   Fair Value   Investments 
Texas  $109,043,496   $108,445,000    29.16%
New Jersey   34,531,876    34,595,527    9.30%
New York   28,939,268    29,365,000    7.90%
Canada   26,315,677    26,440,000    7.11%
California   25,519,753    25,930,000    6.97%
Illinois   24,250,169    25,700,000    6.91%
Massachusetts   22,534,191    22,247,850    5.98%
Arizona   13,565,958    13,840,000    3.72%
North Carolina   12,248,770    12,499,167    3.36%
Ohio   10,112,627    9,990,000    2.69%
Tennessee   9,848,614    9,950,000    2.68%
Missouri   9,152,087    9,530,000    2.56%
Georgia   5,929,223    8,329,998    2.24%
Pennsylvania   7,848,470    8,058,746    2.17%
Arkansas   7,397,881    7,618,484    2.05%
Minnesota   5,421,770    5,420,000    1.46%
Puerto Rico   8,827,864    5,080,000    1.37%
Washington   4,172,743    4,520,000    1.22%
Alabama   1,206,682    2,880,000    0.77%
Utah   1,293,782    880,000    0.24%
Florida   242,304    420,000    0.11%
Virginia   50,001    100,000    0.03%
   $368,453,206   $371,839,772    100.00%

 

 37 

 

  

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The following is a summary of industry concentration of our investment portfolio as of March 31, 2018:

 

           % of Total 
   Cost   Fair Value   Investments 
Software  $46,552,172   $47,127,850    10.93%
Healthcare & Pharmaceuticals   48,406,241    45,493,446    10.55%
Services: Business   34,916,431    37,560,001    8.71%
Finance   36,356,619    37,510,000    8.70%
High Tech Industries   36,089,266    35,810,000    8.30%
Retail   29,289,480    29,278,638    6.79%
Consumer Goods: Durable   24,556,850    24,778,106    5.74%
Capital Equipment   24,346,104    24,580,000    5.70%
Media: Broadcasting & Subscription   21,616,409    24,053,750    5.58%
Services: Consumer   17,681,579    18,010,000    4.18%
Construction & Building   17,926,928    17,780,000    4.12%
Automotive   17,410,929    17,570,938    4.07%
Education   17,043,239    17,171,053    3.98%
Consumer goods: non-durable   13,229,563    13,220,000    3.07%
Chemicals, Plastics, & Rubber   11,683,058    12,065,000    2.80%
Energy: Oil & Gas   9,040,642    9,068,387    2.10%
Transportation: Cargo   6,791,312    6,841,739    1.59%
Insurance   5,413,835    5,510,000    1.28%
Beverage, Food, & Tobacco   3,967,191    3,600,000    0.83%
Hotel, Gaming, & Leisure   3,245,580    3,400,812    0.79%
Environmental Industries   766,442    770,000    0.18%
Services: Government   50,001    100,000    0.02%
   $426,379,871   $431,299,720    100.00%

 

 38 

 

  

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

 

           % of Total 
   Cost   Fair Value   Investments 
Software  $48,560,675   $48,997,850    13.18%
Healthcare & Pharmaceuticals   41,192,879    37,829,167    10.17%
High Tech Industries   36,058,477    35,460,000    9.54%
Finance   26,500,097    28,330,000    7.62%
Services: Business   23,386,714    25,749,999    6.93%
Capital Equipment   24,300,027    24,170,000    6.50%
Media: Broadcasting & Subscription   21,680,239    23,665,000    6.36%
Chemicals, Plastics, & Rubber   20,825,458    21,145,000    5.69%
Services: Consumer   17,862,616    18,070,000    4.86%
Construction & Building   17,913,413    17,980,000    4.84%
Education   17,197,396    17,335,526    4.66%
Consumer Goods: Durable   16,559,947    16,798,484    4.52%
Consumer goods: non-durable   13,250,000    13,250,000    3.56%
Retail   8,288,083    8,280,000    2.23%
Automotive   7,848,470    8,058,746    2.17%
Transportation: Cargo   6,785,894    6,840,000    1.84%
Energy: Oil & Gas   6,766,968    6,700,000    1.80%
Insurance   5,410,226    5,500,000    1.48%
Beverage, Food, & Tobacco   3,964,242    3,580,000    0.96%
Hotel, Gaming, & Leisure   3,284,942    3,420,000    0.92%
Environmental Industries   766,442    580,000    0.16%
Services: Government   50,001    100,000    0.03%
   $368,453,206    371,839,772    100.00%

 

The following provides quantitative information about Level 3 fair value measurements as of March 31, 2018:

 

 

Description:  Fair Value   Valuation Technique  Unobservable Inputs  Range (Average) (1) (3)
           HY credit spreads,  -3.84% to 5.28% (-0.97%)
        Income/Market  Risk free rates  0.69% to 1.64% (1.02%)
First lien debt  $199,372,307   approach (2)  Market multiples  5x to 17x (12x)(4)
               
           HY credit spreads,  -2.29% to 4.52% (-0.67)
        Income/Market  Risk free rates  0.19% to 1.46% (0.81%)
Second lien debt  $177,644,589   approach (2)  Market multiples  7x to 30x (13x)(4)
               
           HY credit spreads,  -0.82% to 3.68% (0.71%)
        Income/Market  Risk free rates  0.57% to 1.64% (0.98%)
Unsecured debt  $26,732,823   approach (2)  Market multiples  1x to 14x (5x)(4)
               
           Underwriting multiple/   
Equity investments  $27,550,001   Market approach (5)  EBITDA Multiple  1x to 12x (9x)
               
Total Long Term Level 3 Investments  $431,299,720          

 

(1)Weighted average based on fair value as of March 31, 2018.

 

(2)Inclusive of not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.

 

 39 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

(3)The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for second lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -2.29% (-229 basis points) to 4.52% (452 basis points). The average of all changes was -0.67% (-67 basis points).

 

(4)Median of LTM (last twelve months) EBITDA multiples of comparable companies.

 

(5)The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

 

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2017:

 

Description:  Fair Value   Valuation Technique   Unobservable Inputs   Range (Average) (1) (3) 
           HY credit spreads,   -3.73% to 5.53% (-0.81%) 
       Income/Market   Risk free rates   -0.24% to 1.12% (0.54%) 
First lien debt  $141,006,923    approach (2)    Market multiples    11x to 13x (10x)(4) 
                     
              HY credit spreads,    -2.52% to 4.78% (-0.58%) 
         Income/Market    Risk free rates    -0.28% to 1.01% (0.39%) 
Second lien debt  $178,432,850    approach (2)    Market multiples    8x to 8x (8x)(4) 
                     
              HY credit spreads,    -0.67% to 3.93% (0.89%) 
         Income/Market    Risk free rates    0.12% to 1.18% (0.52%) 
Unsecured debt  $27,430,000    approach (2)    Market multiples    1x to 14x (13x)(4) 
                     
              Underwriting multiple/      
Equity investments  $24,969,999    Market approach (5)    EBITDA Multiple    1x to 15x (9x) 
                     
Total Long Term Level 3 Investments  $371,839,772                

 

(1)Weighted average based on fair value as of December 31, 2017.

 

(2)Inclusive of not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.

 

(3)The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -3.73% (-373 basis points) to 5.53% (535 basis points). The average of all changes was -.81% (-81 basis points).

 

(4)Median of LTM (last twelve months) EBITDA multiples of comparable companies.

 

 40 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

(5)The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

 

NOTE 7 — COMMITMENTS AND CONTINGENCIES

 

The Company is currently not subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations.

 

As of March 31, 2018 and December 31, 2017, the Company had unfunded commitments of $11,186,667 and $8,686,667, respectively, to provide debt financing for six and four portfolio companies, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments should the need arise.

 

NOTE 8 — FINANCIAL HIGHLIGHTS

 

  

For the

three months

ended

March 31, 2018

(unaudited)

  

For the

three months

ended

March 31, 2017

(unaudited)

 
Per Share Data: (1)          
Net asset value at beginning of period  $13.81   $13.69 
Net investment income   0.28    0.33 
Change in unrealized appreciation   0.10    0.22 
Net realized gain (loss)   0.08    (0.06)
Total from investment operations  $0.46   $0.48 
Stockholder distributions from:          
Net investment income   (0.34)   (0.34)
Net asset value at end of period  $13.93   $13.83 
           
Per share market value at end of period  $11.51   $14.55 
Total return based on market value(2)   (10.6)%   23.7%
Weighted average shares outstanding   15,952,841    12,479,957 

 

 41 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

   For the   For the 
   three months   three months 
   ended   ended 
   March 31, 2018   March 31, 2017 
   (unaudited)   (unaudited) 
Ratio/Supplemental Data:          
Net assets at end of period  $222,263,132   $172,664,634 
Weighted Average net assets  $220,269,641   $170,901,594 
Annualized ratio of gross operating expenses to net assets(3)(6)   11.85%   13.58%
Annualized ratio of interest expense and other fees to net assets(3)   4.54%   4.91%
Annualized ratio of net investment income to net assets(3)(6)   8.24%   9.84%
Portfolio Turnover(4)   3.89%   6.45%
Notes payable  $48,875,000   $25,000,000 
Credit Facility payable  $118,300,000   $102,500,000 
SBA Debentures  $90,000,000   $65,000,000 
Asset coverage ratio(5)   2.33x   2.35x

 

(1)Financial highlights are based on weighted average shares outstanding as of period end.

 

(2)Total return on market value is based on the change in market price per share since the end of the prior year and assumes enrollment in the Company’s dividend reinvestment plan. The total returns are not annualized.

 

(3)Financial highlights for periods of less than one year are annualized, with exception of the provision for taxes on the unrealized gain on investments.

 

(4)Calculated as the lesser of purchases or sales divided by average portfolio balance and is not annualized.

 

(5)Asset coverage ratio is equal to (i) the sum of (a) net assets at the end of the period and (b) total debt outstanding at the end of the period, divided by (ii) total debt outstanding at the end of the period. SBA debentures are excluded from the numerator and denominator.

 

(6)These ratios include the impact of the benefit for income taxes related to unrealized loss on investments of $0 for the three months ended March 31, 2018 and a benefit for income taxes related to unrealized gain on investments of $8,593 for the three months ended March 31, 2017, which are not reflected in net investment income, gross operating expenses or net operating expenses. The provision for income taxes related to unrealized gain or loss on investments to net assets for the three months ended March 31, 2018 and 2017 is 0.00% and < .01%, respectively.

 

NOTE 9 — CREDIT FACILITY

 

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120,000,000 on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017 and amended on March 28, 2018, with ZB, N.A., dba Amegy Bank and various other leaders (the ‘‘Credit Facility’’).

 

 42 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The Credit Facility provides for borrowings up to a maximum of $140,000,000 on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

 

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021.

 

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10,000,000, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 2.0 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of March 31, 2018, the Company was in compliance with these covenants.

 

As of March 31, 2018 and December 31, 2017, $118,300,000 and $40,750,000, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair values of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. The Company has incurred total costs of $3,067,715 in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred costs of $1,198,616 in connection with the Credit Facility, which are being amortized over the life of the facility. Additionally, $341,979 of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of March 31, 2018 and December 31, 2017, $1,351,297 and $1,417,521 of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

 

The following is a summary of the Credit Facility, net of prepaid loan structure fees:

 

   March 31,   December 31, 
   2018   2017 
Credit Facility payable  $118,300,000   $40,750,000 
Prepaid loan structure fees   1,351,297    1,417,521 
Credit facility payable, net of prepaid loan structure fees  $116,948,703   $39,332,479 

 

 43 

 

 

STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three months ended March 31, 2018 and 2017:

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $746,998   $895,668 
Loan fee amortization   91,667    110,613 
Commitment fees on unused portion   89,747    19,066 
Administration fees   14,557    12,295 
Total interest and financing expenses  $942,969   $1,037,642 
           
Weighted average interest rate   4.4%   3.5%
Effective interest rate   5.6%   4.0%
Average debt outstanding  $68,202,778   $104,747,222 
           
Cash paid for interest and unused fees  $648,017   $961,681 

 

NOTE 10 — SBA-GUARANTEED DEBENTURES

 

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, a single licensee can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75,000,000 and $67,500,000 in regulatory capital, as such term is defined by the SBA.

 

As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150% if certain requirements are met) after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

 

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the asset coverage test by permitting us to borrow up to $150,000,000 more than we would otherwise be able to absent the receipt of this exemptive relief.

 

On a stand-alone basis, the SBIC subsidiary held $210,260,118 and $161,992,327 in assets at March 31, 2018 and December 31, 2017, respectively, which accounted for approximately 43.7% and 40.4% of our total consolidated assets, respectively.

 

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90,000,000 of SBA-guaranteed debentures outstanding. SBA-guaranteed debentures incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September each year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.

 

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STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The following table summarizes the SBIC subsidiary’s SBA-guaranteed debentures as of March 31, 2018:

 

Issuance Date  Maturity Date  Debenture Amount   Interest Rate   SBA Annual
Charge
 
                
October 14, 2014  March 1, 2025  $6,500,000    2.52%   0.36%
October 17, 2014  March 1, 2025   6,500,000    2.52%   0.36%
December 24, 2014  March 1, 2025   3,250,000    2.52%   0.36%
June 29, 2015  September 1, 2025   9,750,000    2.83%   0.36%
October 22, 2015  March 1, 2026   6,500,000    2.51%   0.36%
October 22, 2015  March 1, 2026   1,500,000    2.51%   0.74%
November 10, 2015  March 1, 2026   8,800,000    2.51%   0.74%
November 18, 2015  March 1, 2026   1,500,000    2.51%   0.74%
November 25, 2015  March 1, 2026   8,800,000    2.51%   0.74%
December 16, 2015  March 1, 2026   2,200,000    2.51%   0.74%
December 29, 2015  March 1, 2026   9,700,000    2.51%   0.74%
November 28, 2017  March 1, 2028   25,000,000    3.19%   0.22%
Total SBA-guaranteed debentures  $90,000,000           

 

As of March 31, 2018 and December 31, 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At March 31, 2018 and December 31, 2017, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

 

As of March 31, 2018, the Company has incurred $3,082,500 in financing costs related to the SBA-guaranteed debentures since receiving our license, which were recorded as prepaid loan fees. As of March 31, 2018 and December 31, 2017, $2,080,519 and $2,181,187 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

 

The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:

 

   March 31,   December 31, 
   2018   2017 
SBA debentures payable  $90,000,000   $90,000,000 
Prepaid loan fees   2,080,519    2,181,187 
SBA Debentures, net of prepaid loan fees  $87,919,481   $87,818,813 

 

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STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three ended March 31, 2018 and 2017:

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $635,570   $497,859 
Debenture fee amortization   100,668    80,211 
Total interest and financing expenses  $736,238   $578,070 
           
Weighted average interest rate   2.9%   3.1%
Effective interest rate   3.3%   3.6%
Average debt outstanding  $90,000,000   $65,000,000 
           
Cash paid for interest  $1,161,490   $1,001,250 

 

NOTE 11 — NOTES

 

On May 5, 2014, the Company closed a public offering of $25,000,000 in aggregate principal amount of 6.50% notes (the “2019 Notes”), due on April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25,000,000 in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.

 

The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for the three months ended March 31, 2018 and 2017:

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $   $406,250 
Deferred financing costs       44,939 
Administration fees       1,730 
Total interest and financing expenses  $   $452,919 
           
Cash paid for interest  $   $406,250 

 

On August 21, 2017, the Company issued $42,500,000 in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6,375,000 in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

 

The Company used all of the net proceeds from this offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of both March 31, 2018 and December 31, 2017, the aggregate carrying amount of the 2022 Notes was approximately $48,875,000 and the fair value of the Notes was approximately $49,148,700 and $49,520,150, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

 

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STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1,688,961 of fees which are being amortized over the term of the 2022 Notes, of which $1,485,316 and $1,568,512 remains to be amortized as of March 31, 2018 and December 31, 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

 

The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the three months ended March 31, 2018 and 2017:

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $702,578   $ 
Deferred financing costs   81,963     
Administration fees   1,233     
Total interest and financing expenses  $785,774   $ 
           
Cash paid for interest  $702,578   $ 

 

The following is a summary of the 2022 Notes Payable, net of deferred financing costs:

 

   March 31,   December 31, 
   2018   2017 
Notes payable  $48,875,000   $48,875,000 
Deferred financing costs   1,485,316    1,568,512 
Notes payable, net of deferred financing costs  $47,389,684   $47,306,488 

 

The indenture and supplements thereto relating to each of the 2019 Notes and 2022 Notes contain certain covenants, including but not limited to (i) a requirement that the Company comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement to provide financial information to the holders of the notes and the trustee under the indenture if the Company should no longer be subject to the reporting requirements under the Exchange Act.

 

NOTE 12 — SUBSEQUENT EVENTS

 

Investment Portfolio

 

On April 2, 2018, the Company invested $7.9 million in the first lien term loan and $0.9 million in the unfunded revolver of BFC SolmeteX LLC, a leading provider of filtration products in the U.S. and Canada. The Company also invested $1.2 million in a first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex LLC.

 

On April 13, 2018, the Company invested $16.4 million in the first lien term loan and a $0.75 million in the unfunded revolver of DTE Enterprises, Inc., a provider of industrial powertrain repair and maintenance services for the oil & gas and mining sectors. Additionally, the Company invested $1.5 million in the equity of the company.

 

On April 13, 2018, the Company made an additional investment of $12.5 million in the 2nd lien term loan of Mobileum, Inc., an existing portfolio company.

 

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STELLUS CAPITAL INVESTMENT CORPORATION

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

 

On April 24, 2018, the Company received full repayment of the first lien term loan of Catapult Learning, LLC for total proceeds of $12.1 million.

 

On April 30, 2018, the Company received full repayment of the unsecured term loan of Binder & Binder National Social Security Disability Advocates, LLC for total proceeds of $0.1 million.

 

On May 2, 2018, the Company invested $4.5 million in the second lien term loan of General LED OPCO, LLC, a provider of LED lighting systems and modules.

 

Credit Facilities

 

The outstanding balance under the Credit Facility as of May 4, 2018 was $66.1 million.

 

SBA-guaranteed Debentures

 

On April 25, 2018, the Company drew $40.0 million of SBA-guaranteed debentures, bringing the total balance of SBA-guaranteed Debentures outstanding to $130.0 million as of May 4, 2018.

 

Legislative Changes

 

On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

 

On April 4, 2018, the board of directors (the “Board”) of Stellus Capital Investment Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective April 4, 2019 unless approved earlier by a vote of the Company’s stockholders. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act at the Company’s 2018 annual meeting of stockholders.

 

Dividend Declared

 

On April 16, 2018, the Company’s board of directors declared a regular monthly dividend for each of April, May and June 2018 as follows:

 

Declared  Ex-Dividend Date  Record Date  Payment Date  Amount per Share 
4/16/2018  4/27/2018  4/30/2018  5/15/2018  $0.1133 
4/16/2018  5/30/2018  5/31/2018  6/15/2018  $0.1133 
4/16/2018  6/28/2018  6/29/2018  7/13/2018  $0.1133 

 

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Company  Investment(1)  December 31, 2017
Fair Value
   Amount of Realized
Gain / (Loss)
   Amount of Unrealized
Gain / (Loss)
   Amount of Interest, Fees or Dividends Credit to Income(2)   Gross
Additions(3)
   Gross
Reductions(4)
   March 31,
2018
Fair Value
Non-control Investments                                     
Affiliate investments                                     
                                      
Glori Energy Production Inc.  Class A Common Units  $990       $5   $   $62   $(917)  $140
Amounts related to investments transferred to or from other 1940 Act Classification during the period          $   $5   $   $62   $(917)  $140
Total Non-Control/Non-Affiliate investments          $1,335   $4,914   $               
Total Portfolio          $1,335   $4,919   $               

 

This schedule should be read in conjunction with Stellus’s consolidated financial statements, including the consolidated schedule of investments and notes to the consolidated financial statements.

 

(1)The principal amount, the ownership detail for equity investments accrual status is included in the consolidated schedule of investments. 

 

(2)Represents the total amount of interest, fees and dividends credited to income for the portion of the period for which an investment was included in Control or Affiliate categories, respectively. For investments transferred between Control and Affiliate categories during the period, any income or investment balances related to the time period it was in the category other than the one shown at period end is included in "Amounts from investments transferred from other 1940 Act classifications during the period." 

 

(3)Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in net unrealized depreciation as well as the movement of an existing portfolio company into this category and out of a different category. 

 

(4)Gross reductions include decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities. Gross reductions also include net increases in net unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.

 49 

 

 

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

 

Forward-Looking Statements

 

Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties, including statements as to:

 

  our future operating results;
  our business prospects and the prospects of our portfolio companies;
  the effect of investments that we expect to make;
  our contractual arrangements and relationships with third parties;
  actual and potential conflicts of interest with Stellus Capital Management;
  the dependence of our future success on the general economy and its effect on the industries in which we invest;
  the ability of our portfolio companies to achieve their objectives;
  the use of borrowed money to finance a portion of our investments;
  the adequacy of our financing sources and working capital;
  the timing of cash flows, if any, from the operations of our portfolio companies;
  the ability of Stellus Capital Management to locate suitable investments for us and to monitor and administer our investments;
  the ability of Stellus Capital Management to attract and retain highly talented professionals;
  our ability to maintain our qualification as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, or the Code, and as a BDC under the Investment Company Act of 1940, as amended, or the 1940 Act, and
  the effect of future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to BDCs or RICs.

 

Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.

 

We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or rules or regulations of the Securities and Exchange Commission. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

 

Overview

 

We were organized as a Maryland corporation on May 18, 2012, and formally commenced operations on November 7, 2012. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies.

 

We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. Our investment activities are managed by our investment advisor, Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

 

As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we may not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets. Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized and with their principal of business in the United States.

 

 50 

 

 

We have elected to be treated for U.S. federal tax purposes as a RIC under Subchapter M of the Code. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As of March 31, 2018, we were in compliance with the RIC requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income we distribute to our stockholders.

 

Portfolio Composition and Investment Activity

 

Portfolio Composition

 

We originate and invest primarily in privately-held middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, often times with a corresponding equity investment.

 

As of March 31, 2018, we had $431.3 million (at fair value) invested in 52 portfolio companies. As of March 31, 2018, our portfolio included approximately 46% of first lien debt, 41% of second lien debt, 6% of mezzanine debt and 6% of equity investments at fair value. The composition of our investments at cost and fair value as of March 31, 2018 was as follows:

 

   Cost   Fair Value 
Senior Secured – First Lien(1)  $198,445,230   $199,372,307 
Senior Secured – Second Lien   180,292,855    177,644,589 
Unsecured Debt   27,147,168    26,732,823 
Equity   20,494,618    27,550,001 
Total Investments  $426,379,871   $431,299,720 

 

(1) Includes unitranche investments, which account for 16.1% of our portfolio at fair value.

 

As of December 31, 2017, we had $371.8 million (at fair value) invested in 48 portfolio companies. As of December 31, 2017, our portfolio included approximately 38% of first lien debt, 48% of second lien debt, 7% of mezzanine debt and 7% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2017 was as follows:

 

   Cost   Fair Value 
Senior Secured – First Lien(1)  $140,915,106   $141,006,923 
Senior Secured – Second Lien   181,164,730    178,432,850 
Unsecured Debt   27,903,141    27,430,000 
Equity   18,470,229    24,969,999 
Total Investments  $368,453,206   $371,839,772 

 

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value.

 

Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of March 31, 2018 and December 31, 2017, we had six and four such investments, respectively, with aggregate unfunded commitments of $11.2 million and $8.7 million, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments should the need arise.

 

 51 

 

 

The following is a summary of geographical concentration of our investment portfolio as of March 31, 2018:

 

           % of Total 
   Cost   Fair Value   Investments 
Texas  $111,024,052   $110,713,387    25.67%
California   45,368,765    45,800,000    10.62%
New Jersey   34,281,271    34,319,692    7.96%
New York   28,581,847    28,913,750    6.70%
Canada   26,340,678    26,641,739    6.18%
Illinois   24,256,766    25,580,000    5.93%
Arizona   21,414,850    22,190,812    5.15%
Massachusetts   22,552,094    22,187,850    5.14%
Ohio   21,660,379    21,760,000    5.05%
South Carolina   21,100,842    21,090,000    4.89%
Arkansas   15,364,791    15,678,106    3.64%
North Carolina   11,841,982    12,032,500    2.79%
Tennessee   9,854,786    10,000,000    2.32%
Georgia   5,981,496    8,650,000    2.01%
Pennsylvania   7,855,929    8,010,938    1.86%
Minnesota   5,130,946    5,130,946    1.19%
Puerto Rico   8,842,160    5,080,000    1.18%
Alabama   1,206,682    3,300,000    0.77%
Washington   2,132,745    2,560,000    0.59%
Utah   1,294,505    880,000    0.20%
Florida   242,304    380,000    0.09%
Missouri   -    300,000    0.07%
Virginia   50,001    100,000    0.02%
   $426,379,871   $431,299,720    100.00%

 

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

 

           % of Total 
   Cost   Fair Value   Investments 
Texas  $109,043,496   $108,445,000    29.16%
New Jersey   34,531,876    34,595,527    9.30%
New York   28,939,268    29,365,000    7.90%
Canada   26,315,677    26,440,000    7.11%
California   25,519,753    25,930,000    6.97%
Illinois   24,250,169    25,700,000    6.91%
Massachusetts   22,534,191    22,247,850    5.98%
Arizona   13,565,958    13,840,000    3.72%
North Carolina   12,248,770    12,499,167    3.36%
Ohio   10,112,627    9,990,000    2.69%
Tennessee   9,848,614    9,950,000    2.68%
Missouri   9,152,087    9,530,000    2.56%
Georgia   5,929,223    8,329,998    2.24%
Pennsylvania   7,848,470    8,058,746    2.17%
Arkansas   7,397,881    7,618,484    2.05%
Minnesota   5,421,770    5,420,000    1.46%
Puerto Rico   8,827,864    5,080,000    1.37%
Washington   4,172,743    4,520,000    1.22%
Alabama   1,206,682    2,880,000    0.77%
Utah   1,293,782    880,000    0.24%
Florida   242,304    420,000    0.11%
Virginia   50,001    100,000    0.03%
   $368,453,206   $371,839,772    100.00%

 

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The following is a summary of industry concentration of our investment portfolio as of March 31, 2018:

 

           % of Total 
   Cost   Fair Value   Investments 
Software  $46,552,172   $47,127,850    10.93%
Healthcare & Pharmaceuticals   48,406,241    45,493,446    10.55%
Services: Business   34,916,431    37,560,001    8.71%
Finance   36,356,619    37,510,000    8.70%
High Tech Industries   36,089,266    35,810,000    8.30%
Retail   29,289,480    29,278,638    6.79%
Consumer Goods: Durable   24,556,850    24,778,106    5.74%
Capital Equipment   24,346,104    24,580,000    5.70%
Media: Broadcasting & Subscription   21,616,409    24,053,750    5.58%
Services: Consumer   17,681,579    18,010,000    4.18%
Construction & Building   17,926,928    17,780,000    4.12%
Automotive   17,410,929    17,570,938    4.07%
Education   17,043,239    17,171,053    3.98%
Consumer goods: non-durable   13,229,563    13,220,000    3.07%
Chemicals, Plastics, & Rubber   11,683,058    12,065,000    2.80%
Energy: Oil & Gas   9,040,642    9,068,387    2.10%
Transportation: Cargo   6,791,312    6,841,739    1.59%
Insurance   5,413,835    5,510,000    1.28%
Beverage, Food, & Tobacco   3,967,191    3,600,000    0.83%
Hotel, Gaming, & Leisure   3,245,580    3,400,812    0.79%
Environmental Industries   766,442    770,000    0.18%
Services: Government   50,001    100,000    0.02%
   $426,379,871   $431,299,720    100.00%

 

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The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

 

           % of Total 
   Cost   Fair Value   Investments 
Software  $48,560,675   $48,997,850    13.18%
Healthcare & Pharmaceuticals   41,192,879    37,829,167    10.17%
High Tech Industries   36,058,477    35,460,000    9.54%
Finance   26,500,097    28,330,000    7.62%
Services: Business   23,386,714    25,749,999    6.93%
Capital Equipment   24,300,027    24,170,000    6.50%
Media: Broadcasting & Subscription   21,680,239    23,665,000    6.36%
Chemicals, Plastics, & Rubber   20,825,458    21,145,000    5.69%
Services: Consumer   17,862,616    18,070,000    4.86%
Construction & Building   17,913,413    17,980,000    4.84%
Education   17,197,396    17,335,526    4.66%
Consumer Goods: Durable   16,559,947    16,798,484    4.52%
Consumer goods: non-durable   13,250,000    13,250,000    3.56%
Retail   8,288,083    8,280,000    2.23%
Automotive   7,848,470    8,058,746    2.17%
Transportation: Cargo   6,785,894    6,840,000    1.84%
Energy: Oil & Gas   6,766,968    6,700,000    1.80%
Insurance   5,410,226    5,500,000    1.48%
Beverage, Food, & Tobacco   3,964,242    3,580,000    0.96%
Hotel, Gaming, & Leisure   3,284,942    3,420,000    0.92%
Environmental Industries   766,442    580,000    0.16%
Services: Government   50,001    100,000    0.03%
   $368,453,206    371,839,772    100.00%

 

At March 31, 2018, our average portfolio company investment at amortized cost and fair value was approximately $8.2 million and $8.3 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $22.6 million and $22.2 million, respectively. At December 31, 2017, our average portfolio company investment at amortized cost and fair value was approximately $7.7 million and $7.4 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $22.5 million and $22.2 million, respectively.

 

At March 31, 2018, 89% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 11% bore interest at fixed rates. At December 31, 2017, 87% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 13% bore interest at fixed rates.

 

The weighted average yield on all of our debt investments as of March 31, 2018 and December 31, 2017 was 11.1% and 10.8%, respectively. The weighted average yield was computed using the effective interest rates for all of our debt investments, including accretion of original issue discount. The weighted average yield of our debt investments is not the same as a return on investment for our stockholder, but, rather relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses.

 

As of March 31, 2018 and December 31, 2017, we had cash and cash equivalents of $45.5 million and $25.1 million, respectively.

 

Investment Activity

 

During the three months ended March 31, 2018, we made an aggregate of $71.7 million of investments in four new portfolio companies and four existing portfolio companies. During the three months ended March 31, 2018, we received an aggregate of $15.6 million in proceeds from repayments of our investments.

 

Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital required by middle-market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.

 

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Asset Quality

 

In addition to various risk management and monitoring tools, Stellus Capital uses an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our investment portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:

 

  Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
  Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
  Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.
  Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected.
  Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.

 

   As of March 31, 2018   As of December 31, 2017 
   (dollars in millions)   (dollars in millions) 
           Number of           Number of 
       % of Total   Portfolio       % of Total   Portfolio 
Investment Category  Fair Value   Portfolio   Companies(1)   Fair Value   Portfolio   Companies 
1  $21.3    5%   8   $25.9    7%   5 
2   372.5    86%   37    306.7    82%   36 
3   36.5    9%   5    37.0    10%   5 
4   1.0    -%   2    1.9    1%   1 
5       -%   1    0.4    %   1 
Total  $431.3    100%   53   $371.9    100%   48 

 

(1)One portfolio company appears in two categories as of March 31, 2018

 

Loans and Debt Securities on Non-Accrual Status

 

We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. As of March 31, 2018, we had two loans on non-accrual status which represented approximately 1.0% of our loan portfolio at cost and 0.2% at fair value. As of December 31, 2017, we had two loans on non-accrual status, which represented approximately 1.2% of our loan portfolio at cost and 0.3% at fair value.

 

Results of Operations

 

An important measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses including interest on borrowed funds. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

 

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Comparison of the three months ended March 31, 2018 and 2017

 

Revenues

 

We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the total dollar amount of interest and any dividend income that we earn will increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

 

The following shows the breakdown of investment income for the three months ended March 31, 2018 and 2017 (in millions).

 

   Three months   Three months 
   ended   ended 
   March 31,   March 31, 
   2018   2017 
Interest income  $10.5   $9.4 
PIK Interest   0.2    0.1 
Miscellaneous fees   0.2    0.4 
Total  $10.9   $9.9 

 

The increase in interest income from the respective periods was due to the growth in the overall investment portfolio.

 

Expenses

 

Our primary operating expenses include the payment of fees to Stellus Capital under the investment advisory agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:

 

  organization and offering expenses;
  Expenses incurred in valuing our assets and calculating our net asset value (including the cost and expenses of any independent valuation firm);
  fees and expenses incurred by Stellus Capital 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;
  interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
  offerings of our common stock and other securities;
  base management and incentive fees;
  administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our chief compliance officer, chief financial officer and their respective staffs);
  transfer agent and custodial fees and expenses;
  U.S. federal and state registration fees;
  all costs of registration and listing our shares on any securities exchange;
  U.S. federal, state and local taxes;

 

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  independent directors’ fees and expenses;
  costs of preparing and filing reports or other documents required by the SEC or other regulators;
  costs of any reports, proxy statements or other notices to stockholders, including printing costs;
  costs associated with individual or group stockholders;
  costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
  direct costs and expenses of administration and operation, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs; and
  all other expenses incurred by us or Stellus Capital in connection with administering our business.

 

The following shows the breakdown of operating expenses for the three months ended March 31, 2018 and 2017 (in millions).

 

   Three months   Three months 
   ended   ended 
   March 31,   March 31, 
   2018   2017 
Operating Expenses          
Management fees  $1.7   $1.6 
Valuation Fees   0.1    0.2 
Administrative services expenses   0.3    0.3 
Incentive fees   1.0    1.0 
Professional fees   0.5    0.2 
Directors’ fees   0.1    0.1 
Insurance expense   0.1    0.1 
Interest expense and other fees   2.5    2.1 
Other general and administrative   0.1    0.1 
Total Operating Expenses  $6.4   $5.7 

 

The increase in operating expenses for the respective periods was primarily due to 1) an increase in management fees, directly related to the growth of our portfolio, 2) increased interest expense due to our additional 2022 Notes and SBA-guaranteed debentures outstanding during the period, and 3) an increase in professional fees, primarily related to increased costs of Sarbanes-Oxley compliance.

 

Net Investment Income

 

For the three months ended March 31, 2018, net investment income was $4.5 million, or $0.28 per common share (based on 15,952,841 weighted-average common shares outstanding at March 31, 2018).

 

For the three months ended March 31, 2017, net investment income was $4.1 million, or $0.33 per common share (based on 12,479,957 weighted-average common shares outstanding at March 31, 2017).

 

Net Realized Gains and Losses

 

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

 

Repayments of investments and amortization of other investments and a non-cash conversion of debt to equity for the three months ended March 31, 2018 totaled $15.6 million and net realized gain totaled $1.3 million.

 

Repayments of investments and amortization of other investments for the three months ended March 31, 2017 totaled $39.3 million and net realized loss totaled $0.8 million.

 

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Net Change in Unrealized Appreciation/(Depreciation) of Investments

 

Net change in unrealized appreciation (depreciation) primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.

 

Net change in unrealized appreciation on investments and cash equivalents for the three months ended March 31, 2018 and 2017 totaled $1.5 million and $2.6 million, respectively.

 

The net change in unrealized appreciation between the respective periods was due to a general tightening of credit spreads. The quarter ending March 31, 2018 did not have as significant of a reversal of previously recorded depreciation as was experienced in the quarter ending March 31, 2017 when one of our debt investments converted into equity.

 

Provision for Taxes on Unrealized Appreciation on Investments

 

We have direct wholly owned subsidiaries that have elected to be taxable entities (the “Taxable Subsidiaries”). The Taxable Subsidiaries permit us to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in our consolidated financial statements. For the three months ended March 31, 2018 and 2017, we recognized a benefit for income tax on unrealized investments of $0 and $8.0 thousand for the Taxable Subsidiaries, respectively. As of March 31, 2018 and December 31, 2017, there was no deferred tax liability or asset on the Consolidated Statement of Assets and Liabilities.

 

Net Increase in Net Assets Resulting from Operations

 

For the three months ended March 31, 2018, net increase in net assets resulting from operations totaled $7.3 million, or $0.46 per common share (based on 15,952,841 weighted-average common shares outstanding at March 31, 2018).

 

For the three months ended March 31, 2017, net increase in net assets resulting from operations totaled $6.0 million, or $0.48 per common share (based on 12,479,957 weighted-average common shares outstanding at March 31, 2017).

 

The increase in the net increase in net assets between the respective periods was due a higher net investment income during the three months ended March 31, 2018, as well as a realized gain during the period.

 

Financial condition, liquidity and capital resources

 

Cash Flows from Operating and Financing Activities

 

Our operating activities used net cash of $51.8 million for the three months ended March 31, 2018, primarily in connection with the purchase and origination of new portfolio investments, some of which was offset by the sales and repayments on our investments. Our financing activities for the three months ended March 31, 2018 provided cash of $72.2 million due to net borrowings under the Credit Facility during the period.

 

Our operating activities provided cash of $20.1 million for the three months ended March 31, 2017, primarily in connection with cash interest received and repayments of our investments, much of which was offset by the purchase and origination of new portfolio investments. Our financing activities for the three months ended March 31, 2017 used cash of $17.8 million due to distributions to stockholders and net repayments of the Original Credit Facility during the period.

 

Liquidity and Capital Resources

 

Our liquidity and capital resources are derived from the Credit Facility, the 2022 Notes, SBA-guaranteed debentures and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and other operating expenses we incur, as well as the payment of dividends to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from turnover within our portfolio and from public and private offerings of securities to finance our investment activities.

 

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Although we expect to fund the growth of our investment portfolio through the net proceeds from future public and private equity offerings and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, if our common stock trades at a price below our then-current net asset value per share, we may be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our board of directors makes certain determinations in connection therewith. A proposal, approved by our stockholders at our 2017 annual stockholders meeting, authorizes us to sell shares equal to up to 25% of our outstanding common stock of our common stock below the then current net asset value per share of our common stock in one or more offerings. This authorization will expire on the earlier of May 24, 2018, the one year anniversary of our 2017 annual stockholders meeting. We would need similar future approval from our stockholders to issue shares below the then current net asset value per share any time after the expiration of the current approval. In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

 

Also, as a BDC, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200% (or 150% if certain requirements are met). This requirement limits the amount that we may borrow. We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the asset coverage test under the 1940 Act. We were in compliance with the asset coverage ratios at all times. As of March 31, 2018 and December 31, 2017, our asset coverage ratio was 233% and 346%, respectively. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of March 31, 2018 and December 31, 2017, we had cash and cash equivalents of $45.5 million and $25.1 million, respectively.

 

Credit Facility

 

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120.0 million on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017 and as amended on March 28, 2018, with ZB, N.A., dba Amegy Bank and various other leaders (the ‘‘Credit Facility’’).

 

The Credit Facility provides for borrowings up to a maximum of $140.0 million on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

 

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021. This represents an interest rate reduction of 12.5 basis points and a three year extension of maturity over the Original Facility.

 

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10.0 million, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 2.0 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of March 31, 2018, the Company was in compliance with these covenants.

 

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As of March 31, 2018 and December 31, 2017, $118.3 and $40.8 million, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The Company incurred total costs of $3.1 million in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred costs of $1.2 million in connection with the Credit Facility, which are being amortized over the life of the facility. Additionally, $0.3 million of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of both March 31, 2018 and December 31, 2017, $1.4 million of such prepaid loan structure fees and administration fees had yet to be amortized. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

 

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three months ended March 31, 2018 and 2017 (in millions):

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $0.7   $0.9 
Loan fee amortization   0.1    0.1 
Commitment fees on unused portion   0.1    - 
Total interest and financing expenses  $0.9   $1.0 
           
Weighted average interest rate   4.4%   3.5%
Effective interest rate   5.6%   4.0%
Average debt outstanding  $68.2   $104.7 
           
Cash paid for interest and unused fees  $0.6   $1.0 

 

SBA-Guaranteed Debentures

 

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, an SBIC can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. The 2016 omnibus spending bill approved by the U.S. Congress and signed into law by the President increased the amount of SBA-guaranteed debentures that affiliated SBIC funds can have outstanding from $225.0 million to $350.0 million, subject to SBA approval. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75.0 million and $67.5 million in regulatory capital, as such term is defined by the SBA.

 

As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

 

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our 200% asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 200% asset coverage test by permitting us to borrow up to $150.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.

 

On a stand-alone basis, the SBIC subsidiary held $210.3 and $162.0 million in assets at March 31, 2018 and December 31, 2017, respectively, which accounted for approximately 43.7% and 40.4% of our total consolidated assets, respectively.

 

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90.0 million of SBA-guaranteed debentures outstanding. See Note 10 for further detail on the SBA-guaranteed debentures outstanding.

 

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As of March 31, 2018 and December 31, 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At March 31, 2018 and December 31, 2017 the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

 

As of March 31, 2018, the Company has incurred $3.1 million in financing costs related to the SBA-guaranteed debentures since receiving our license, which were recorded as prepaid loan fees. As of March 31, 2018 and December 31, 2017, $2.1 and $2.2 million of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

 

Interest is paid semi-annually, in March and September. The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three ended March 31, 2018 and 2017 (in millions):

 

   For the three months ended 
   March 31,   March 31, 
   2018   2017 
Interest expense  $0.6   $0.5 
Debenture fee amortization   0.1    0.1 
Total interest and financing expenses  $0.7   $0.6 
           
Weighted average interest rate   2.9%   3.1%
Effective interest rate   3.3%   3.6%
Average debt outstanding  $90.0   $65.0 
           
Cash paid for interest  $1.2   $1.0 

 

Notes Offering

 

On May 5, 2014, the Company closed a public offering of $25.0 million in aggregate principal amount of 6.50% notes (the “2019 Notes”), due on April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25.0 million in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.

 

The Company incurred no costs on the 2019 Notes for the three months ended March 31, 2018, and incurred interest and fee expense on the Notes of $0.5 million, of which $0.4 million was interest expense and the remainder was amortization of loan fees paid on the Notes and administration fees, for the three months ended March 31, 2017. The Company paid $0 and $0.4 million in interest expense on the 2019 Notes during the respective periods ended March 31, 2018 and 2017.

 

On August 21, 2017, the Company issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

 

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The Company used all of the net proceeds from this offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of March 31, 2018 and December 31, 2017, the aggregate carrying amount of the 2022 Notes was approximately $48.9 million for both periods and the fair value of the Notes was approximately $49.1 million and $49.5 million, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

 

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1.7 million of fees which are being amortized over the term of the 2022 Notes, of which $1.5 million and $1.6 million remains to be amortized as of March 31, 2018 and December 31, 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

 

For the three months ended March 31, 2018, the Company incurred interest and fee expense on the 2022 Notes of $0.8 million, of which $0.7 million was interest expense and the remainder was amortization of loan fees paid on the 2022 Notes and administration fees. The Company paid $0.7 million in interest expense on the 2022 Notes during the period. The Company neither incurred nor paid any costs associated with the 2022 Notes during the three months ended March 31, 2017.

 

Off-Balance Sheet Arrangements

 

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of March 31, 2018 and December 31, 2017, our off-balance sheet arrangements consisted of unfunded commitments to provide debt financing to six and four of our portfolio companies respectively totaling $11.2 million and $8.7 million, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments (through cash on hand and available borrowings under the Credit Facility) should the need arise.

 

Regulated Investment Company Status and Dividends

 

We have elected to be treated as a RIC under Subchapter M of the Code. So long as we maintain our status as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.

 

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

 

To qualify for RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). If we maintain our qualification as a RIC, we must also satisfy certain distribution requirements each calendar year in order to avoid a federal excise tax on our undistributed earnings of a RIC.

 

We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, the covenants contained in the Credit Facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.

 

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in the Credit Facility. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

 

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In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

 

Recent Accounting Pronouncements

 

See Note 1 to the consolidated financial statements contained herein for a description of recent accounting pronouncements, if any, including the expected dates of adoption and the anticipated impact on the financial statements.

 

Critical Accounting Policies

 

See Note 1 to the consolidated financial statements contained herein for a description of critical accounting policies.

 

Subsequent Events

 

Investment Portfolio

 

On April 2, 2018, the Company invested $7.9 million in the first lien term loan and $0.9 million in the unfunded revolver of BFC SolmeteX LLC, a leading provider of filtration products in the U.S. and Canada. The Company also invested $1.2 million in a first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex LLC.

 

On April 13, 2018, the Company invested $16.4 million in the first lien term loan and a $0.75 million in the unfunded revolver of DTE Enterprises, Inc., a provider of industrial powertrain repair and maintenance services for the oil & gas and mining sectors. Additionally, the Company invested $1.5 million in the equity of the Company.

 

On April 13, 2018, the Company made an additional investment of $12.5 million in the 2nd lien term loan of Mobileum, Inc., an existing portfolio company.

 

On April 24, 2018, the Company received full repayment of the first lien term loan of Catapult Learning, LLC for total proceeds of $12.1 million.

 

On April 30, 2018, the Company received full repayment of the unsecured term loan of Binder & Binder National Social Security Disability Advocates, LLC for total proceeds of $0.1 million.

 

On May 2, 2018, the Company invested $4.5 million in the second lien term loan of General LED OPCO, LLC, a provider of LED lighting systems and modules.

 

Credit Facilities

 

The outstanding balance under the Credit Facility as of May 4, 2018 was $66.1 million.

 

SBA-guaranteed Debentures

 

On April 25, 2018, the Company drew $40.0 million of SBA-guaranteed debentures, bringing the total balance of SBA-guaranteed Debentures outstanding to $130.0 million as of May 4, 2018.

 

Legislative Changes

 

On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

 

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On April 4, 2018, the board of directors (the “Board”) of Stellus Capital Investment Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective April 4, 2019 unless approved earlier by a vote of the Company’s stockholders. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act at the Company’s 2018 annual meeting of stockholders.

 

Dividend Declared

 

On April 16, 2018, the Company’s board of directors declared a regular monthly dividend for each of April, May and June 2018 as follows:

 

Declared  Ex-Dividend Date  Record Date  Payment Date  Amount per Share 
4/16/2018  4/27/2018  4/30/2018  5/15/2018  $0.1133 
4/16/2018  5/30/2018  5/31/2018  6/15/2018  $0.1133 
4/16/2018  6/28/2018  6/29/2018  7/13/2018  $0.1133 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We are subject to financial market risks, including changes in interest rates. For the three months ended March 31, 2018 and 2017, 89% and 77% of the loans in our portfolio bore interest at floating rates, respectively. These floating rate loans typically bear interest in reference to LIBOR, which are indexed to 30-day or 90-day LIBOR rates, subject to an interest rate floor. As of March 31, 2018 and 2017, the weighted average interest rate floor on our floating rate loans was 0.94% and 0.86%, respectively.

 

Assuming that the Statement of Assets and Liabilities as of March 31, 2018 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, hypothetical 1% increase in LIBOR would increase our interest income approximately $3.6 million on an annualized basis. A hypothetical 1% decrease in LIBOR would decrease our interest income by $3.3 million on an annualized basis, considering interest rate floors where applicable.

 

Changes in interest rates will also affect our cost of funding. Our interest expense will be affected by changes in the published LIBOR rate in connection with the Credit Facility. At March 31, 2018, based on our applicable levels of our Credit Facility, a 1% increase in interest rates would decrease our annual net investment income by $1.2 million.

 

Although we believe that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate. We may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contacts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio of investments. For the three months ended March 31, 2018 and 2017, we did not engage in hedging activities.

  

Item 4. Controls and Procedures

 

(a)Evaluation of Disclosure Controls and Procedures

 

The Company’s management, under the supervision and with the participation of various members of management, including its Chief Executive Officer and its Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Company’s CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.

 

(b)Changes in Internal Control Over Financial Reporting

 

The Company’s management did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2018 that has materially affected, or is reasonable likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

 

Item 1A. Risk Factors

 

Other than as listed below and those described under Item 1A - Risk Factors in our quarterly report on Form 10-Q for the quarter ended March 31, 2018, there have been no other material changes in the information provided under the heading “Risk Factors” in our Annual Report on Form 10-K as of December 31, 2017. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may materially affect our business, financial condition and/or operating results.

 

Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.

 

There has been on-going discussion and commentary regarding potential significant changes to United States trade policies, treaties and tariffs. The current administration, along with Congress, has created significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and tariffs. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and have a material adverse effect on their business, financial condition and results of operations, which in turn would negatively impact us.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the quarter ended March 31, 2018, we issued a total of 7,931 shares of common stock under the DRIP. This issuance was not subject to the registration requirements of the Securities Act of 1933. The aggregate value of the shares of our common stock issued under the DRIP was approximately $94,788.

  

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

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Item 6. EXHIBITS.

 

The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:

 

Exhibit    
Number   Description
10.1   Consent and Waiver, dated March 28, 2018, between the Registrant, as a borrower, the lenders party hereto and ZB, N.A. dba Amegy Bank, as administrative agent*
     
31.1   Chief Executive Officer Certification pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
31.2   Chief Financial Officer Certification pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
32.1   Chief Executive Officer Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
     
32.2   Chief Financial Officer Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
     
*   Filed herewith

 

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Dated: May 8, 2018

STELLUS CAPITAL INVESTMENT CORPORATION

   
     
  By: /s/ Robert T. Ladd
  Name: Robert T. Ladd 
  Title:   Chief Executive Officer and President 

 

 

  By: /s/ W. Todd Huskinson
  Name: W. Todd Huskinson 
  Title: Chief Financial Officer

 

 

   

 

 

Exhibit 10.1

 

 

CONSENT AND WAIVER

 

THIS CONSENT AND WAIVER, dated effective as of March 28, 2018 (this “Consent”), is among STELLUS CAPITAL INVESTMENT CORPORATION, a Maryland corporation (the “Borrower”), ZB, N.A. dba Amegy Bank, as Administrative Agent (in such capacity, the “Administrative Agent”), and the Lenders party hereto. Capitalized terms used herein and not otherwise defined shall have the meanings given to such terms in Article I.

 

W I T N E S S E T H:

 

WHEREAS, the Borrower, the Lenders party thereto, and the Administrative Agent are parties to the Senior Secured Revolving Credit Agreement dated as of October 10, 2017 (as amended, supplemented, amended and restated or otherwise modified from time to time through the date hereof, the “Credit Agreement”);

 

WHEREAS, Borrower has requested that Administrative Agent and Lenders consent to the Proposed Over-advance (defined in Section 2.1 of this Consent), and Administrative Agent and Lenders have agreed to provide such consent, subject to the terms and conditions of this Consent;

 

WHEREAS, Borrower anticipates that an Event of Default may occur if the (a) the Proposed Over-advance occurs prior to March 31, 2018, and (b) as a result thereof, Borrower fails to comply with Section 6.07(c) (Liquidity Test) of the Credit Agreement for the fiscal quarter ending March 31, 2018 (the “Anticipated Event of Default”);

 

WHEREAS, Borrower has requested that Administrative Agent and Lenders waive the Anticipated Event of Default, and Administrative Agent and Lenders have agreed to provide such waiver, subject to the terms and conditions of this Consent.

 

NOW, THEREFORE, the parties hereto hereby covenant and agree as follows:

 

ARTICLE I

DEFINITIONS

 

SECTION 1.1 Certain Definitions. The following terms when used in this Consent shall have the following meanings (such meanings to be equally applicable to the singular and plural forms thereof):

 

Consent” is defined in the preamble.

 

Borrower” is defined in the preamble.

 

Credit Agreement” is defined in the first recital.

 

Consent Effective Date” is defined in Article III.

 

1

 

 

 

 

SECTION 1.2 Other Definitions. Capitalized terms for which meanings are provided in the Credit Agreement are, unless otherwise defined herein or the context otherwise requires, used in this Consent with such meanings.

 

ARTICLE II

CONSENT AND WAIVER

 

SECTION 2.1 Proposed Over-advance. The following transactions shall collectively be referred to as the “Proposed Over-advance”:

 

(a)       Borrower has requested that Administrative Agent and Lenders advance up to $25,000,000 (the “Over-advance Amount”) in Dollar Loans under the Credit Agreement, the principal amount of which exceeds the Borrowing Base in effect as of the Consent Effective Date.

 

(b)       Borrower has proposed that the Over-advance Amount be advanced by Lenders in two tranches, with (a) $10,000,000 (the “Initial Over-advance”) of the Over-advance Amount to be advanced simultaneously upon the closing of this Consent, and (b) $15,000,000 (the “Second Over-advance”) of the Over-advance Amount to be advanced upon final approval of the SBA Debentures (as defined in clause (c) below) by the U.S. Small Business Administration (the “SBA”), which shall in no event be later than April 30, 2018.

 

(c)       Borrower will contribute (i) some or all of the proceeds of the Over-Advance Amount to its wholly-owned subsidiary, Stellus Capital SBIC LP, a Delaware limited partnership (“Stellus Capital SBIC”), to temporarily fund new loans for Stellus Capital SBIC until such date that certain debentures in the amount of $60,000,000 (the “SBA Debentures”) are issued and funded to Stellus Capital SBIC by the SBA and (ii) use any remaining proceeds of the Over-advance Amount to fund new loans made by the Borrower.

 

SECTION 2.2 Consent and Waiver – Proposed Over-advance. Subject to the conditions set out in this Consent, as of the Consent Effective Date, each of the Administrative Agent and the Lenders hereby (a) consents to the Proposed Over-advance for the period beginning on the Consent Effective Date and ending May 14, 2018 (the “Consent Period”), (b) during such Consent Period, and subject to clause (ii) below, waives any requirement for mandatory prepayment of the Over-Advance Amount pursuant to Section 2.10(c) (Mandatory Prepayments due to Borrowing Base Deficiency) of the Credit Agreement, (c) waives any Events of Default that may arise under the Agreement and the other Loan Documents solely as a result of the Proposed Over-advance, and (d) agrees not to exercise any of the rights or remedies available to Administrative Agent or Lenders under the Loan Documents solely as a result of the Proposed Over-advance; provided that,

 

(i)       with respect to the Second Over-advance, prior to making such advance, Administrative Agent has received evidence in writing of final approval by the SBA with respect to the SBA Debentures; and

 

2

 

 

 

 

(ii)       Borrower repays to Lenders in full all outstanding principal with respect to the Over-advance Amount, together with all accrued and unpaid interest thereon, upon the earlier to occur of (A) the second Business Day after the date that Stellus Capital SBIC receives the proceeds of the SBA Debentures, and (B) the last day of the Consent Period.

 

Borrower, Administrative Agent and Lender hereby agree that the outstanding principal amount of the Over-advance Amount shall accrue interest at a rate per annum equal to the Adjusted LIBO Rate for an Interest Period of one month plus 3.50%.

 

SECTION 2.3 Consent and Waiver – Anticipated Event of Default. Subject to the conditions set out in this Consent, as of the Consent Effective Date, each of the Administrative Agent and the Lenders hereby (a) waives the Anticipated Event of Default, and (b) agrees not to exercise any of the rights or remedies available to Administrative Agent or Lenders under the Loan Documents solely as a result the Anticipated Event of Default.

 

SECTION 2.4 Limited Consent and Waiver. The Borrower acknowledges and agrees that (a) the consents and waivers set forth in this Article II shall be strictly limited to its terms with respect to the express provisions temporarily waived hereunder and (b) no waiver or approval by the Administrative Agent or Lenders shall (i) be applicable to subsequent transactions or (ii) require any other waiver (whether similar or dissimilar to the waiver granted under this Article II).

 

ARTICLE III

CONDITIONS TO EFFECTIVENESS; FEES.

 

SECTION 3.1 Effective Date. This Consent shall become effective on the date (the “Consent Effective Date”) when the Administrative Agent shall have received counterparts of this Consent duly executed and delivered on behalf of the Borrower.

 

SECTION 3.2 Fees.

 

(a)       On the Consent Effective Date, Borrower shall pay to Administrative Agent, for the account of each of the Lenders, in each case payable to such Lenders based on their ratable share of the Initial Over-Advance, an over-advance fee equal to $40,000.

 

(b)       On the date that the Second Over-advance is made, Borrower shall pay to Administrative Agent, for the account of each of the Lenders, in each case payable to such Lenders based on their ratable share of the Second Over-Advance, an over-advance fee equal to $60,000.

 

ARTICLE IV

MISCELLANEOUS

 

SECTION 4.1 Representations. The Borrower hereby represents and warrants that (i) this Consent constitutes a legal, valid and binding obligation of it, enforceable against it in accordance with its terms, (ii) upon the effectiveness of this Consent, no Event of Default shall exist, and (iii) its representations and warranties as set forth in the Loan Documents, as applicable, are true and correct in all material respects (except those representations and warranties qualified by materiality or by reference to a material adverse effect, which are true and correct in all respects) on and as of the date hereof as though made on and as of the date hereof (unless such representations and warranties specifically refer to a previous day, in which case, they shall be complete and correct in all material respects (or, with respect to such representations or warranties qualified by materiality or by reference to a material adverse effect, complete and correct in all respects) on and as of such previous day).

 

3

 

 

 

 

SECTION 4.2 Cross-References. References in this Consent to any Article or Section are, unless otherwise specified, to such Article or Section of this Consent.

 

SECTION 4.3 Loan Document Pursuant to Credit Agreement. This Consent is a Loan Document executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated therein) be construed, administered and applied in accordance with all of the terms and provisions of the Credit Agreement, as amended hereby, including Article IX thereof.

 

SECTION 4.4 Successors and Assigns. The provisions of this Consent shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns.

 

SECTION 4.5 Counterparts. This Consent may be executed in counterparts (and by different parties hereto on different counterparts), each of which shall constitute an original, but all of which when taken together shall constitute a single contract. Delivery of an executed counterpart of a signature page of this Consent by telecopy electronically (e.g. pdf) shall be effective as delivery of a manually executed counterpart of this Consent.

 

SECTION 4.6 Governing Law. This Consent shall be governed by and construed in accordance with the laws of the State of New York.

 

SECTION 4.7 Full Force and Effect; Limited Consent. Except as expressly amended hereby, all of the representations, warranties, terms, covenants, conditions and other provisions of the Credit Agreement and the other Loan Documents shall remain unchanged and shall continue to be, and shall remain, in full force and effect in accordance with their respective terms. The consent, waiver, and release set forth herein shall be limited precisely as provided for herein to the provisions expressly amended and shall not be deemed to be an amendment to, consent to or modification of any other terms or provisions of the Credit Agreement or any other Loan Document or of any transaction or further or future action on the part of the Borrower which would require the consent of the Lenders under the Credit Agreement or any of the Loan Documents. Upon and after the execution of this Consent by each of the parties hereto, each reference in the Credit Agreement to “this Agreement”, “hereunder”, “hereof” or words of like import referring to the Credit Agreement, and each reference in the other Loan Documents to “the Credit Agreement”, “thereunder”, “thereof” or words of like import referring to the Credit Agreement, shall mean and be a reference to the Credit Agreement as may be modified hereby.

 

[Signatures appear on following pages.]

 

4

 

 

IN WITNESS WHEREOF, the parties hereto have executed and delivered this Consent as of the date first above written.

 

  BORROWER:
   
  STELLUS CAPITAL INVESTMENT CORPORATION
   
   
  By: /s/ W. Todd Huskinson
    W. Todd Huskinson
    Chief Financial Officer, Chief Compliance Officer, Treasurer, and Secretary

Signature Page to Consent and Waiver

 

 

 

  ADMINISTRATIVE AGENT:
   
  ZB, N.A. dba Amegy Bank,
  as Administrative Agent
     
  By: /s/ Natalie Garza
    Natalie Garza
    Senior Vice President

 

Signature Page to Consent and Waiver

 

 

 

  LENDERS:
   
  ZB, N.A. dba Amegy Bank,
  as a Lender
   
   
  By: /s/ Natalie Garza
    Natalie Garza
    Senior Vice President

Signature Page to Consent and Waiver

 

 

  CADENCE BANK, N.A.,
  as a Lender
   
   
  By: /s/ Andrew Arizpe
    Andrew Arizpe
    Vice President

Signature Page to Consent and Waiver

 

 

FROST BANK,
  as a Lender
   
   
  By: /s/ Jake Fitzpatrick
    Jake Fitzpatrick
    Assistant Vice President

Signature Page to Consent and Waiver

 

 

  STIFEL BANK AND TRUST,
  as a Lender
   
   
  By: /s/ Joseph L. Sooter, Jr.
    Joseph L. Sooter, Jr.
    Senior Vice President

 

Signature Page to Consent and Waiver

 

 

 

  TEXAS CAPITAL BANK,
  as a Lender
   
   
  By: /s/ Eva Pawelek
    Eva Pawelek
    Senior Vice President

Signature Page to Consent and Waiver

 

 

  COMMUNITYBANK OF TEXAS, N.A.,
  as a Lender
   
   
  By: /s/ Stephen L. Jukes
    Stephen L. Jukes
    Executive Vice President

Signature Page to Consent and Waiver

 

 

 

  WOODFOREST NATIONAL BANK,
  as a Lender
   
   
  By: /s/ Sushim R. Shah
    Sushim R. Shah
    Senior Vice President

 

Signature Page to Consent and Waiver

 

 

  WHITNEY BANK,
  as a Lender
   
   
  By: /s/ D. Scott Wiginton
    D. Scott Wiginton
    Senior Vice President
     

 

 

 

Signature Page to Consent and Waiver

 

Exhibit 31.1

 

I, Robert T. Ladd, Chief Executive Officer of Stellus Capital Investment Corporation certify that:

 

1.I have reviewed this quarterly report on Form 10-Q of Stellus Capital Investment Corporation;

 

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated this 8th day of May 2018.

 

  By: /s/ Robert T. Ladd
  Robert T. Ladd
Chief Executive Officer

 

 

 

 

Exhibit 31.2

 

I, W. Todd Huskinson, Chief Financial Officer of Stellus Capital Investment Corporation certify that:

 

1.I have reviewed this quarterly report on Form 10-Q of Stellus Capital Investment Corporation;

 

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated this 8th day of May 2018.

 

  By: /s/ W. Todd Huskinson
    W. Todd Huskinson
Chief Financial Officer

 

 

 

 

Exhibit 32.1

 

Certification of Chief Executive Officer
Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

In connection with this Quarterly report on Form 10-Q (the “Report”) of Stellus Capital Investment Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Robert T. Ladd, the Chief Executive Officer of the Registrant, hereby certify, to the best of my knowledge, that:

 

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

 

  /s/ Robert T. Ladd
  Name: Robert T. Ladd
Date: May 8, 2018

 

 

 

 

Exhibit 32.2

 

Certification of Chief Financial Officer
Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

In connection with this Quarterly report on Form 10-Q (the “Report”) of Stellus Capital Investment Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, W. Todd Huskinson, the Chief Financial Officer of the Registrant, hereby certify, to the best of my knowledge, that:

 

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

 

  /s/ W. Todd Huskinson
  Name: W. Todd Huskinson
Date: May 8, 2018