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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
☒
For the fiscal year ended December 31, 2019
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
(State or other jurisdiction of
incorporation or organization)
4400 Post Oak Parkway, Suite 2200
Houston, TX
(Address of principal executive offices)
46-0937320
(I.R.S. Employer
Identification Number)
77027
(Zip Code)
Registrant’s telephone number, including area code: (713) 292-5400
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, par value $0.001 per share
5.75% Notes Due 2022
New York Stock Exchange
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ☒
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in
Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
☐
☐
Accelerated filer
Smaller reporting company
Emerging growth 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 Act). Yes ☐ No ☒
The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2019 was: $247,477,542.
The number of shares of the issuer’s Common Stock, $0.001 par value per share, outstanding as of February 28, 2020 was 19,474,247.
Documents Incorporated by Reference
Portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2020 Annual Meeting of Stockholders, to be filed with the
Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year, are incorporated by reference in Part III of this
Annual Report on Form 10-K as indicated herein.
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STELLUS CAPITAL INVESTMENT CORPORATION
FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2019
TABLE OF CONTENTS
PART I.
ITEM 1.
BUSINESS
ITEM 1A.
RISK FACTORS
ITEM 1B.
UNRESOLVED STAFF COMMENTS
ITEM 2.
ITEM 3.
ITEM 4.
PART II.
ITEM 5.
ITEM 6.
ITEM 7.
PROPERTIES
LEGAL PROCEEDINGS
MINE SAFETY DISCLOSURES
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
SELECTED FINANCIAL DATA
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 7A.
QUANTITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
ITEM 9.
AUDITED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM ON ACCOUNTING AND FINANCIAL
DISCLOSURE
ITEM 9A.
CONTROLS AND PROCEDURES
ITEM 9B.
OTHER INFORMATION
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
ITEM 11.
EXECUTIVE COMPENSATION
ITEM 12.
ITEM 13.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
PART IV
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
SIGNATURES
1
31
59
59
60
60
61
64
65
84
85
144
144
145
145
145
145
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Item 1.
Business
PART I
Except as otherwise indicated, the terms “we,” “us,” “our,” and the “Company” refer to Stellus Capital
Investment Corporation; and “Stellus Capital Management” refers to our investment adviser and administrator,
Stellus Capital Management, LLC.
General
We are an externally managed, closed-end, non-diversified management investment company that has
elected to be regulated as a business development company, or “BDC”, under the Investment Company Act of
1940, or the “1940 Act.” We were organized as a Maryland corporation on May 8, 2012, and formally
commenced operations on November 7, 2012. We originate and invest primarily in private middle-market
companies (typically those with $5 million to $50 million of EBITDA (earnings before interest, taxes,
depreciation and amortization)) through first lien (including unitranche), second lien, and unsecured debt
financing, often with corresponding equity co-investments. Unitranche structures may combine characteristics of
first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us
to the risks associated with second lien and subordinated loans to the extent we invest in the “last-out” tranche.
Unsecured debt includes senior unsecured and subordinated loans.
Our investment activities are managed by our investment adviser, Stellus Capital Management, an
investment advisory firm led by Robert T. Ladd and its other senior investment professionals. We source
investments primarily through the extensive network of relationships that the senior investment professionals of
Stellus Capital Management have developed with financial sponsor firms, financial institutions, middle-market
companies, management teams and other professional intermediaries. The companies in which we invest are
typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national
rating agencies. If such investments were rated, we believe that they would likely receive a rating that is often
referred to as “junk.”
Our investment objective is to maximize the total return to our stockholders in the form of current income
and capital appreciation. We seek to achieve our investment objective by:
•
•
•
•
•
•
accessing the extensive origination channels that have been developed and established by the Stellus
Capital Management senior investment professionals that include long-standing relationships with private
equity firms, commercial banks, investment banks and other financial services firms;
investing in what we believe to be companies with strong business fundamentals, generally within our
core middle-market company focus;
focusing on a variety of industry sectors, including business services, energy, general industrial,
government services, healthcare, software and specialty finance;
focusing primarily on directly originated transactions;
applying the disciplined underwriting standards that the Stellus Capital Management senior investment
professionals have developed over their extensive investing careers; and
capitalizing upon the experience and resources of the Stellus Capital Management investment team to
monitor our investments.
We previously received an exemptive order (the “Prior Order”) from the SEC to co-invest with private funds
managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as
applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18,
2018, we received a new exemptive order (the “Order”) that supersedes the Prior Order and permits us greater
flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows us to co-
invest with additional types of private funds, other BDCs, and registered investment companies managed by
Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus
Capital Management, subject to the conditions included therein. Pursuant to the Order, a “required majority” (as
defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in
connection with a co-investment transaction, including (1) the terms of
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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. We co-invest, subject to the conditions in the Order, with private
credit funds managed by Stellus Capital Management that have an investment strategy that is similar or identical
to our investment strategy, and the we may co-invest with other BDCs and registered investment companies
managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control
with Stellus Capital Management in the future. We believe that such co-investments may afford it additional
investment opportunities and an ability to achieve greater diversification.
As a BDC, we are required to comply with certain regulatory requirements. Prior to June 28, 2018, we were
only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at
least 200% after giving effect to such leverage. 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, our board of directors, or the “Board”, 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. 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, which was approved by stockholders at the
Company’s 2018 annual meeting of stockholders. As a result, the asset coverage ratio test applicable to the
Company was decreased from 200% to 150%, effective June 28, 2018. In other words, prior to the enactment of
the SBCAA, a BDC could borrow $1.00 for investment purposes for every $1.00 of investor equity. Now, for
those BDCs that satisfy the Act’s approval and disclosure requirements, the BDC can borrow $2.00 for
investment purposes for every $1.00 of investor equity. 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.
We have elected and intend to qualify annually to be treated for federal income tax purposes as a regulated
investment company, or “RIC,” under Subchapter M of the Internal Revenue Code, or the Code. So long as we
maintain our qualification 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 as dividends on a timely basis.
Our principal executive office is currently located at 4400 Post Oak Parkway, Suite 2200, Houston, TX
77027, and our telephone number is (713) 292-5400. We maintain a website on the Internet at
www.stelluscapital.com (under the “Public Investors” section). Information contained on our website is not
incorporated by reference into this annual report on Form 10-K and you should not consider information
contained on our website to be part of this annual report on Form 10-K.
SBIC Licenses
Two of our wholly owned subsidiaries (the “SBIC subsidiaries”) hold a license to operate as small business
investment companies, or SBICs. Current SBA regulations allow an SBIC to obtain leverage by issuing
debentures guaranteed by the SBA up to a maximum of $175 million under current SBIC regulations, subject to
required capitalization of the SBIC subsidiary, SBA approval, and other requirements. SBA-guaranteed
debentures 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. We believe that
the SBA-guaranteed debentures are an attractive source of debt capital.
We have obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiaries
guaranteed by the SBA from our asset coverage test under the 1940 Act. The exemptive relief provides us
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with increased flexibility under the asset coverage test by permitting us to borrow up to $325,000,000 more than
we would otherwise be able to absent the receipt of this exemptive relief.
Portfolio Composition
Our investments generally range in size from $5 million to $30 million, and we may also selectively invest
in larger positions. We generally expect that the size of our positions will increase in proportion to the size of our
capital base. Pending such investments, we may reduce our outstanding indebtedness or invest in cash, cash
equivalents, U.S. government securities and other high-quality debt investments with a maturity of one year or
less. In the future, we may adjust opportunistically the percentage of our assets held in various types of loans, our
principal loan sources and the industries to which we have greatest exposure, based on market conditions, the
credit cycle, available financing and our desired risk/return profile.
The following table provides a summary of our portfolio investments as of December 31, 2019:
Number of investments in portfolio companies
Fair value
(a)
Cost
% of portfolio at fair value – first lien debt
(b)
% of portfolio at fair value – second lien debt
% of portfolio at fair value – unsecured debt
% of portfolio at fair value – equity
Weighted-average annual yield
(c)
As of
December 31, 2019
($ in millions)
63
$628.9
$642.7
72.4
17.8
3.5
%
%
%
6.3
%
9.2
%
(a)
(b)
(c)
As of December 31, 2019, $ 548.7 million of our debt investments at fair value were at floating interest
rates, which represented approximately 93% of our total portfolio of debt investments at fair value. As of
December 31, 2019, $ 40.5 million of our debt investments at fair value were at fixed interest rates, which
represented approximately 7% of our total portfolio of debt investments at fair value.
Includes unitranche investments, which account for 14.4% of our portfolio at fair value.
The weighted average yield on all of our debt investments as of December 31, 2019, was approximately
9.2%, of which approximately 8.7% was current cash interest. The weighted average yield of our debt
investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of
our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and
expenses. The weighted average yield was computed using the effective interest rates for all of our debt
investments, which represents the interest rate on our debt investments restated as an interest rate payable
annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion
of original issue discount. There can be no assurance that the weighted average yield will remain at its
current level.
Stellus Capital Management
Stellus Capital Management manages our investment activities and is responsible for analyzing investment
opportunities, conducting research and performing due diligence on potential investments, negotiating and
structuring our investments, originating prospective investments and monitoring our investments and portfolio
companies on an ongoing basis.
The senior investment professionals of Stellus Capital Management have an average of over 30 years of
investing, corporate finance, restructuring, consulting and accounting experience and have worked together at
several companies. The Stellus Capital Management senior investment professionals have a wide range of
experience in middle-market investing, including originating, structuring and managing loans and debt securities
through market cycles. The Stellus Capital Management senior investment professionals continue to provide
investment sub-advisory services to the D. E. Shaw & Co., L.P. and its associated investment funds
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(the “D.E. Shaw group”) with respect to an approximately $10.0 million investment portfolio at fair value (as of
December 31, 2019) in middle-market companies pursuant to sub-advisory arrangements.
In addition to serving as our investment adviser and the sub-advisor to the D. E. Shaw group as noted above,
Stellus Capital Management currently manages private credit funds, some of which have an investment strategy
that is similar or identical to our investment strategy, and energy private equity funds. We received the Order
from the SEC, which permits us to co-invest with investment funds managed by Stellus Capital Management or
an adviser that is controlled, controlling, or under common control with Stellus Capital Management, where
doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions
of the exemptive order issued by the SEC). We believe that such co-investments may afford us additional
investment opportunities and an ability to achieve greater diversification. We will not co-invest with the energy
private equity funds, as the energy private equity funds focus on equity-related investments only in the energy
industry, and we focus on predominantly credit-related investments across many industries. In addition, we will
not co-invest with D.E. Shaw group funds.
Stellus Capital Management is headquartered in Houston, Texas, and also maintains offices in the
Washington, D.C. area and Charlotte, North Carolina.
Market Opportunity
We originate and invest primarily in private middle-market companies through first lien (including
unitranche), second lien and unsecured debt financing, often with corresponding equity co-investments. We
believe the environment for investing in middle-market companies is attractive for several reasons, including:
Robust Demand for Debt Capital.
We believe that private equity firms have significant committed but uncalled capital, a large portion of
which is still available for investment in the United States. We expect the large amount of uninvested capital
commitments will drive buyout activity over the next several years, which should, in turn, create lending
opportunities for us.
Attractive Environment to Lend To Middle-Market Companies.
The current strength of the U.S. economy provides an attractive environment to lend to middle-market
companies. The U.S. services, healthcare, technology and consumer products sectors continue to show strong
growth and profitability, allowing middle market companies to continue to service their debt and prudently
borrow to support growth initiatives and mergers and acquisitions activity. This dynamism, coupled with ample
capital from private equity firms to support middle market companies, is creating a large population of credit
worthy companies looking for debt capital.
Attractive Deal Pricing and Structures.
We believe that the pricing of middle-market debt investments is higher, and the terms of such investments
are more conservative, compared to larger liquid, public debt financings, due to the more limited universe of
lenders as well as the highly negotiated nature of these financings. These transactions tend to offer stronger
covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger
financings. In addition, middle-market loans typically offer other investor protections such as default penalties,
lien protection, change of control provisions and information rights for lenders.
Specialized Lending Requirements.
Lending to middle-market companies requires in-depth diligence, credit expertise, restructuring experience
and active portfolio management. We believe that several factors render many U.S. financial institutions ill-suited
to lend to middle-market companies. For example, based on the experience of Stellus Capital Management’s
senior investment professionals, lending to middle-market companies in the United States (a) is generally more
labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented
nature of the information available with respect to such companies,
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(b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive
ongoing monitoring by the lender. We believe that, through Stellus Capital Management, we have the experience
and expertise to meet these specialized lending requirements.
Competitive Strengths
We believe that the following competitive strengths will allow us to achieve positive returns for our
investors:
Experienced Investment Team.
Through our investment adviser, Stellus Capital Management, we have access to the experience and
expertise of the Stellus Capital Management senior investment professionals, including its senior investment
professionals who have an average of over 30 years of investing, corporate finance, restructuring, consulting and
accounting experience and have worked together at several companies. The Stellus Capital Management
investment professionals have a wide range of experience in middle-market investing, including originating,
structuring and managing debt and equity securities through market cycles. We believe the members of Stellus
Capital Management’s senior investment team are proven and experienced, with extensive capabilities in credit
investing, having participated in these markets for the predominant portion of their careers. We believe that these
characteristics enhance the quantity and quality of investment opportunities available to us.
Established, Rigorous Investment and Monitoring Process.
The Stellus Capital Management investment professionals have developed an extensive review and credit
analysis process. Each investment that is reviewed by Stellus Capital Management is brought through a
structured, multi-stage approval process. In addition, Stellus Capital Management takes an active approach in
monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular
discussions with management. Stellus Capital Management’s investment and monitoring process and the depth
and experience of its investment professionals should allow it to conduct the type of due diligence and
monitoring that enables it to identify and evaluate risks and opportunities.
Demonstrated Ability to Structure Investments Creatively.
Stellus Capital Management has the expertise and ability to structure investments across all levels of a
company’s capital structure. Furthermore, we believe that current market conditions will allow us to structure
attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as
commitment fees, original issue discounts, early redemption premiums, payment-in-kind, or “PIK,” interest and
various forms of equity securities.
Resources of Stellus Capital Management Platform.
We have access to the resources and capabilities of Stellus Capital Management, which has 15 investment
professionals, including Robert T. Ladd, Dean D’Angelo, Joshua T. Davis and Todd A. Overbergen, who are
supported by six managing directors, two vice presidents and three analysts. These individuals have developed
long-term relationships with middle-market companies, management teams, financial sponsors, lending
institutions and deal intermediaries by providing flexible financing throughout the capital structure. We believe
that these relationships provide us with a competitive advantage in identifying investment opportunities in our
target market. We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis,
origination and transaction execution experience and capabilities, including the support provided with respect to
those functions by Mr. Huskinson, who serves as our chief financial officer and chief compliance officer, and his
staff of ten finance and operations professionals.
Investment Strategy
The Stellus Capital Management senior investment professionals employ an opportunistic and flexible
investing approach, combined with strong risk management processes, which we believe yields a highly
diversified portfolio across companies, geographies, industries, and investment types. We seek direct origination
opportunities of first lien (including unitranche), second lien, and unsecured debt financing,
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often with corresponding equity co-investments, in middle-market companies. We believe that businesses in this
size range often have limited access to public financial markets and will benefit from Stellus Capital
Management’s reliable lending approach. Many financing providers have chosen to focus on large corporate
clients and managing capital markets transactions rather than lending to middle-market businesses. Further, many
financial institutions and traditional lenders are faced with constrained balance sheets and are requiring existing
borrowers to reduce leverage.
With an average of over 30 years of investing, corporate finance, restructuring, consulting and accounting
experience, the senior investment professionals of Stellus Capital Management have demonstrated investment
expertise throughout the balance sheet and in a variety of situations, including financial sponsor buyouts, growth
capital, debt refinancings, balance sheet recapitalizations, rescue financings, distressed opportunities, and
acquisition financings. Our investment philosophy emphasizes capital preservation through superior credit
selection and risk mitigation. We expect our portfolio to provide downside protection through conservative cash
flow and asset coverage requirements, priority in the capital structure and information requirements. We also
anticipate benefiting from equity participation through equity co-investments. This flexible approach enables
Stellus Capital Management to respond to market conditions and offer customized lending solutions.
Stellus Capital Management invests across a wide range of industries with deep expertise in select verticals
including, but not limited to, business services, retail, general industrial, government services, healthcare,
software and specialty finance. Our typical transactions include providing financing for leveraged buyouts,
acquisitions, recapitalizations and growth opportunities. We seek to maintain a diversified portfolio of
investments as a method to manage risk and capitalize on specific sector trends. In addition, we co-invest with
private credit funds managed by Stellus Capital Management that have a similar, overlapping or identical
investment strategy as us and where doing so is consistent with conditions of the Order, and we may co-invest
with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser
that is controlled, controlling, or under common control with Stellus Capital Management in the future.
Our objective is to act as the lead or largest investor in transactions, generally investing between $5 million
and $30 million per transaction. We expect the average investment holding period to be between two and
four years, depending upon portfolio company objectives and conditions in the capital markets.
We focus on middle-market companies with between $5 million and $50 million of EBITDA in a variety of
industry sectors with positive long-term dynamics and dependable cash flows. We seek businesses with
management teams with demonstrated track records and economic incentives in strong franchises and sustainable
competitive advantages with dependable and predictable cash flows.
We employ leverage prudently and within the limitations of the applicable laws and regulations for BDCs.
Any decision on our part to use leverage will depend upon our assessment of the attractiveness of available
investment opportunities in relation to the costs and perceived risks of such leverage.
Transaction Sourcing
As access to investment opportunities is highly relationship-driven, the senior investment team and other
investment professionals of Stellus Capital Management spend considerable time developing and maintaining
contacts with key deal sources, including private equity firms, investment banks and senior lenders. The senior
investment team and other investment professionals of Stellus Capital Management have been actively investing
in the middle-market for more than a decade and have focused on extensive calling and marketing efforts via
speaking engagements, sponsorships, industry events and referrals to broaden their relationship network. Existing
relationships are constantly cultivated through transactional work and other personal contacts.
In addition to financial sponsors, Stellus Capital Management has developed a network of other deal
sources, including:
•
•
management teams and entrepreneurs;
portfolio companies of private equity firms;
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•
•
•
•
other investment firms that have similar strategies to Stellus Capital Management and are seeking co-
investors;
placement agents and investment banks representing financial sponsors and issuers;
corporate operating advisers and other financial advisers; and
consultants, attorneys and other service providers to middle-market companies and financial sponsors.
We believe that Stellus Capital Management’s broad network of deal origination contacts will afford us with
a continuous source of investment opportunities.
These origination relationships provide access not only to potential investment opportunities but also to
market intelligence on trends across the credit markets. Since inception, Stellus Capital Management has
completed financing transactions with more than 150 equity sponsors and completed multiple financing
transactions with 33 of those equity sponsors.
We believe that, over the past decade, the senior investment team and other investment professionals of
Stellus Capital Management have built a reputation as a thoughtful and disciplined provider of capital to middle-
market companies and a preferred financing source for private equity sponsors and management teams. We
believe these factors give Stellus Capital Management a competitive advantage in sourcing investment
opportunities, which are used for our benefit.
Investment Structuring
Stellus Capital Management believes that each investment has unique characteristics that must be
considered, understood and analyzed. Stellus Capital Management structures investment terms based on the
business, the credit profile, the outlook for the industry in which a potential portfolio company operates, the
competitive landscape, the products or services which the company sells and the management team and
ownership of the company, among other factors. Stellus Capital Management relies upon the analysis conducted
and information gathered through the investment process to evaluate the appropriate structure for our
investments.
We invest primarily in the debt securities of middle-market companies. Our investments typically carry a
high level of cash pay interest and may incorporate other return-enhancing mechanisms such as commitment fees,
original issue discounts, early redemption premiums, PIK interest and some form of equity participation,
including preferred stock, common stock, warrants and other forms of equity participation. We expect that a
typical debt investment in which we invest will have a term at origination of between five and seven years. We
expect to hold most of our investments to maturity or repayment, but we may sell some of our investments earlier
if a liquidity event occurs, such as a sale, recapitalization or worsening of the credit quality of the portfolio
company.
Stellus Capital Management negotiates covenants in connection with debt investments that provide
protection for us but allow appropriate flexibility for the portfolio company. Such covenants may include
affirmative and negative covenants, default penalties, lien protection and change of control provisions. Stellus
Capital Management requires comprehensive information rights including access to management, financial
statements and budgets and, in some cases, membership on the portfolio company’s board of directors or board
observation rights. Additionally, Stellus Capital Management generally requires financial covenants and terms
that restrict an issuer’s use of leverage and limitations on asset sales and capital expenditures.
Secured Debt
Secured debt, including first lien (including unitranche) and second lien financing, has liens on the assets of
the borrower that serve as collateral in support of the repayment of such loans.
First Lien Debt First lien debt is structured with first-priority liens on the assets of the borrower that serve
as collateral in support of the repayment of such loans. First lien loans may provide for moderate loan
amortization in the early years of the loan, with most of the amortization deferred until loan maturity.
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Unitranche Debt Unitranche debt typically is structured as first lien loans that combine both senior and
junior debt with lenders agreeing separately to an order of priority among them. To the extent that we invest in
the “last out” tranche of a unitranche facility, our unitranche investments will have certain risk characteristics of
second lien debt. Unitranche debt typically provides for moderate loan amortization in the initial years of the
debt, with the majority of the principal payment deferred until loan maturity. Since unitranche debt generally
allows the borrower to make a large lump sum payment of principal at the end of the loan term, there is a risk of
loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. In some cases, we
will be the sole lender, or we together with our affiliates will be the sole lender, of unitranche debt, which can
provide us with more influence interacting with a borrower in terms of monitoring and, if necessary, remediation
in the event of underperformance.
Second Lien Debt Second lien debt is structured as junior, secured loans, with second priority liens on an
issuer’s assets. These loans typically provide for moderate loan amortization in the initial years of the loan, with
the majority of the amortization deferred until loan maturity.
Unsecured Debt
Unsecured debt, including senior unsecured and subordinated loans, is not be secured by any collateral and
is effectively subordinated to the borrower’s secured indebtedness (to the extent of the collateral securing such
indebtedness), including pursuant to one or more intercreditor agreements that we enter into with holders of a
borrower’s senior debt.
Senior Unsecured Loans. Senior unsecured loans are structured as loans that rank senior in right of
payment to any of the borrower’s unsecured indebtedness that is contractually subordinated to such loans. These
loans generally provide for fixed interest rates and amortize evenly over the term of the loan. Senior unsecured
loans are generally less volatile than subordinated loans due to their priority over subordinated loans.
Subordinated Loans. Subordinated loans are structured as unsecured, subordinated loans that provide for
relatively high, fixed interest rates that provide us with significant current interest income. These loans typically
have interest-only payments (often representing a combination of cash pay and PIK interest) in the early years,
with amortization of principal deferred to maturity. Subordinated loans generally allow the borrower to make a
large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is
unable to pay the lump sum or refinance the amount owed at maturity. Subordinated loans are generally more
volatile than secured loans and senior unsecured loans and may involve a greater risk of loss of principal as
compared to other types of loans. Subordinated loans often include a PIK feature, which effectively operates as
negative amortization of loan principal, thereby increasing credit risk exposure over the life of the loan.
Equity Securities
In connection with some of our debt investments, we may also invest in preferred or common stock or
receive nominally priced warrants or options to buy an equity interest in the portfolio company. As a result, as a
portfolio company appreciates in value, we may achieve additional investment return from this equity interest.
We may structure such equity investments and warrants to include provisions protecting our rights as a minority-
interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the occurrence of
specified events. In many cases, we may also seek to obtain registration rights in connection with these equity
interests, which may include demand and “piggyback” registration rights.
Investment Process
Through the resources of Stellus Capital Management, we have access to significant research resources,
experienced investment professionals, internal information systems and a credit analysis framework and
investment process. Stellus Capital Management has designed a highly involved and interactive investment
management process, which is the core of its culture and the basis for what we believe is a strong track record of
investment returns. The investment process seeks to select only those investments that it believes have the most
attractive risk/reward characteristics. The process involves several levels of review and is coordinated in an effort
to identify risks in potential investments. Stellus Capital Management applies its expertise to
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screen our investment opportunities as described below. This rigorous process, combined with our broad
origination capabilities, has allowed the Stellus Capital Management team to be prudent in selecting opportunities
in which to make an investment.
All potential investment opportunities undergo an initial informal review by Stellus Capital Management’s
investment professionals. Each potential investment opportunity that an investment professional determines
merits consideration is presented and evaluated at a weekly meeting in which Stellus Capital Management’s
senior investment professionals discuss the merits and risks of a potential investment opportunity as well as the
due diligence process and the pricing and structure. If Stellus Capital Management’s senior investment
professionals believe an investment opportunity merits further review, the investment opportunity is assigned a
deal team and the deal team prepares and presents to the investment committee for initial review a prescreen
memorandum that generally describes the potential transaction and includes a description of the risks, due
diligence process and proposed structure and pricing for the proposed investment opportunity.
Prior to making an investment, Stellus Capital Management conducts rigorous diligence on each investment
opportunity. In connection with its due diligence on a potential investment opportunity, Stellus Capital
Management utilizes its internal diligence resources, which include its internally developed credit analytical
framework, subscriptions to third party research resources, discussions with industry experts, internal information
sharing systems and the analytical expertise of its investment professionals. Stellus Capital Management typically
reviews the company’s historical financials; industry drivers and outlook, competitive threats, customer
concentration, asset coverage, projected financials and credit metrics; management background checks; and, if
applicable, the track record and funding capabilities of the private equity sponsor.
Upon review of the prescreen memorandum, if the investment committee determines to proceed with the
review of an investment opportunity, the deal team continues its diligence and deal structuring plans and prepares
a credit approval memorandum for review by the investment committee. The credit approval memorandum,
updates the prescreen memorandum with more deal specific detail, including an update to the diligence process
and any changes in the structure and pricing of the proposed investment. Upon unanimous approval by the
investment committee of the proposed investment as presented in the credit approval memorandum, Stellus
Capital Management’s Chief Investment Officer reviews any amendments before finalizing and closing
negotiations with the prospective portfolio company.
Investment Committee
Each new investment opportunity must be unanimously approved by Stellus Capital Management’s
investment committee. Follow-on investments in existing portfolio companies also require the investment
committee’s unanimous approval. The purpose of Stellus Capital Management’s investment committee is to
evaluate and approve all of our investments, subject at all times to the oversight of our Board. The investment
committee process is intended to bring the diverse experience and perspectives of the committee’s members to
the analysis and consideration of each investment. The investment committee consists of Messrs. Ladd,
D’Angelo, Davis, Overbergen and Huskinson. The investment committee serves to provide investment
consistency and adherence to our core investment philosophy and policies. The investment committee also
determines appropriate investment sizing and suggests ongoing monitoring requirements.
In addition to reviewing investments, investment committee meetings serve as a forum to discuss credit
views and outlooks. Potential transactions and deal flow are reviewed on a regular basis. Members of the
investment team are encouraged to share information and views on credits with the investment committee early in
their analysis. We believe this process improves the quality of the analysis and assists the deal team members to
work more efficiently.
Each member of the investment committee performs a similar role for other accounts managed by Stellus
Capital Management. In certain instances, including in connection with co-investments under our exemptive
order, approval by our Board may also be required prior to the making of an investment.
Monitoring Investments
In most cases, we do not have board influence over portfolio companies. In some instances, Stellus Capital
Management’s senior investment professionals may obtain board representation or observation
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rights in conjunction with our investments. Stellus Capital Management takes an active approach in monitoring
all investments, including reviews of financial performance on at least a quarterly basis and regular discussions
with management. The monitoring process begins with structuring terms and conditions, which require the timely
delivery and access to critical financial and business information on portfolio companies.
Specifically, Stellus Capital Management’s monitoring system consists of the following activities:
Regular Investment Committee Updates. Key portfolio company developments are discussed each week as
part of the standard investment committee meeting agenda.
Written Reports. The deal teams provide periodic written updates as appropriate for key events that impact
portfolio company performance or valuation. In addition, deal teams provide written updates following each
portfolio company board meeting.
Quarterly Full Portfolio Review. Stellus Capital Management’s Chief Investment Officer and our Chief
Compliance Officer perform a quarterly comprehensive review of every portfolio company with the deal teams.
This process includes a written performance and valuation update, and credit-specific discussion on each of our
portfolio companies. In addition, pursuant to our valuation policy, the valuation of each portfolio investment for
which a market quotation is not readily available is reviewed by our independent third-party valuation firm at
least twice annually. In addition, portfolio investments that are not publicly traded or whose market price is not
readily available are valued at fair value as determined in good faith by our Board based on the input of our
management and audit committee.
As part of the monitoring process, Stellus Capital Management also tracks developments in the broader
marketplace. Stellus Capital Management’s investment professionals have a wealth of information on the
competitive landscape, industry trends, relative valuation metrics, and analyses that assist in the execution of our
investment strategy. In addition, Stellus Capital Management’s extensive communications with brokers and
dealers allows its investment professionals to monitor market and industry trends that could affect portfolio
investments. Stellus Capital Management may provide ongoing strategic, financial and operational guidance to
some portfolio companies either directly or by recommending its investment professionals or other experienced
representatives to participate on the board of directors. Stellus Capital Management maintains an extensive
network of strategic and operational advisers to call upon for industry expertise or to supplement existing
management teams.
Asset Quality
In addition to various risk management and monitoring tools, Stellus Capital Management uses an
investment ranking system to characterize and monitor the credit profile and expected level of returns on each
investment in our portfolio. This investment ranking 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 contractual 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.
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In the event that Stellus Capital Management determines that an investment is underperforming, or
circumstances suggest that the risk associated with a particular investment has significantly increased, Stellus
Capital Management will increase its monitoring intensity and prepare regular updates for the investment
committee, summarizing current operating results and material impending events and suggesting recommended
actions. While the investment ranking system identifies the relative risk for each investment, the ranking alone
does not dictate the scope and/or frequency of any monitoring that is performed. The frequency of Stellus Capital
Management’s monitoring of an investment is determined by a number of factors, including, but not limited to,
the trends in the financial performance of the portfolio company, the investment structure and the type of
collateral securing the investment.
Determination of Net Asset Value and Portfolio Valuation Process
The net asset value per share of our outstanding shares of common stock is determined quarterly by dividing
the value of total assets minus liabilities by the total number of shares outstanding.
In calculating the value of our total assets, investment transactions will be recorded on the trade date.
Realized gains or losses will be computed using the specific identification method. Investments for which market
quotations are readily available may be valued at such market quotations. Debt and equity securities that are not
publicly traded or whose market price is not readily available are valued at fair value as determined in good faith
by our Board based on the input of our management and audit committee. In addition, our Board retains one or
more independent valuation firms to review at least twice annually, the valuation of each portfolio investment for
which a market quotation is not readily available. We also have adopted Accounting Standards Board Accounting
Standards Codification 820, Fair Value Measurements and Disclosures, or “ASC 820.” This accounting statement
requires us to assume that the portfolio investment is assumed to be sold in the principal market to market
participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical
market. Market participants are defined as buyers and sellers in the principal or most advantageous market that
are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the market in
which we can exit portfolio investments with the greatest volume and level activity is considered our principal
market.
A readily available market value is not expected to exist for most of the investments in our portfolio, and we
value these portfolio investments at fair value as determined in good faith by our Board under our valuation
policy and process. The types of factors that our Board may take into account in determining the fair value of our
investments generally include, as appropriate, comparisons of financial ratios portfolio company to peer
companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to
make payments and its earnings and discounted cash flow, the markets in which the portfolio company does
business, and other relevant factors.
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we
consider the pricing indicated by the external event to corroborate our valuation. 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 the
investments may differ materially from the values that would have been used had a readily available market value
existed for such investments. In addition, changes in the market environment and other events that may occur
over the life of the investments may cause the gains or losses ultimately realized on these investments to be
different from the valuations currently assigned.
With respect to investments for which market quotations are not readily available, our Board undertakes a
multi-step valuation process each quarter, as described below:
•
•
•
our quarterly valuation process begins with each portfolio company or investment being initially valued
by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
preliminary valuation conclusions are then documented and discussed with our senior investment
professionals and Stellus Capital Management;
at least twice annually, the valuation for each portfolio investment is reviewed by an independent
valuation firm;
•
the audit committee of our board of directors then reviews these preliminary valuations;
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•
the Board then discusses the valuations and determines the fair value of each investment in our portfolio
in good faith, based on the input of Stellus Capital Management, the independent valuation firm and the
audit committee.
In following these approaches, the types of factors that are taken into account in fair value pricing our
investments include, as relevant, but are not 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.
Realization of Investments
The potential exit scenarios of a portfolio company play an important role in evaluating investment
decisions. Our debt-orientation provides for increased potential exit opportunities, including (a) the sale of
investments in the private markets, (b) the refinancing of investments held, often due to maturity or
recapitalizations, and (c) other liquidity events including the sale or merger of the portfolio company. Since we
seek to maintain a debt orientation in our investments, we expect to receive interest income over the course of the
investment period, resulting in a return on invested capital well in advance of final exit.
Derivatives
We may utilize hedging techniques such as interest rate swaps to mitigate potential interest rate risk on our
indebtedness. Such interest rate swaps would principally be used to protect us against higher costs on our
indebtedness resulting from increases in both short-term and long-term interest rates. We also may use various
hedging and other risk management strategies to seek to manage various risks, including changes in currency
exchange rates and market interest rates. Such hedging strategies would be utilized to seek to protect the value of
our portfolio investments, for example, against possible adverse changes in the market value of securities held in
our portfolio.
Managerial Assistance
As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This
assistance could involve monitoring the operations of our portfolio companies, participating in board and
management meetings, consulting with and advising officers of portfolio companies and providing other
organizational and financial guidance. Stellus Capital Management or an affiliate of Stellus Capital Management
provides such managerial assistance on our behalf to portfolio companies that request this assistance. We may
receive fees for these services and will reimburse Stellus Capital Management or an affiliate of Stellus Capital
Management for its allocated costs in providing such assistance, subject to the review by our Board, including
our independent directors.
Competition
Our primary competitors in providing financing to middle-market companies include public and private
funds, other BDCs, commercial and investment banks, commercial financing companies and, to the
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extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are
substantially larger and have considerably greater financial, technical and marketing resources than we do. For
example, we believe some competitors may have access to funding sources that are not available to us. In
addition, some of our competitors may have higher risk tolerances or different risk assessments, which could
allow them to consider a wider variety of investments and establish more relationships than us. Furthermore,
many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC
or to the distribution and other requirements we must satisfy to maintain our qualification as a RIC.
We use the expertise of the investment professionals of Stellus Capital Management to which we have
access to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In
addition, we believe that the relationships of the investment professionals of Stellus Capital Management enable
us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in
the industries in which we invest.
Employees
We do not have any direct employees, and our day-to-day investment operations are managed by Stellus
Capital Management. We have a chief executive officer and president and a chief financial officer, chief
compliance officer, treasurer and secretary. To the extent necessary, we may hire additional personnel going
forward. Our officers are employees of Stellus Capital Management and our allocable portion of the cost of our
chief financial officer and chief compliance officer and his staff is paid by us pursuant to the administration
agreement that we have entered into with Stellus Capital Management.
Management Agreements
Stellus Capital Management serves as our investment adviser and is registered as an investment adviser
under the Investment Advisers Act of 1940, as amended, or the “Advisers Act.” In addition, Stellus Capital
Management serves as our administrator.
Investment Advisory Agreement
Subject to the overall supervision of our Board and in accordance with the 1940 Act, Stellus Capital
Management manages our day-to-day operations and provides investment advisory services to us. Under the
terms of the investment advisory agreement, Stellus Capital Management:
•
•
•
•
•
•
determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the
manner of implementing such changes;
identifies, evaluates and negotiates the structure of the investments we make;
executes, closes, services and monitors the investments we make;
determines the securities and other assets that we purchase, retain or sell;
performs due diligence on prospective portfolio companies; and
provides us with such other investment advisory, research and related services as we may, from time to
time, reasonably require for the investment of our funds.
Pursuant to the investment advisory agreement, we have agreed to pay Stellus Capital Management a fee for
investment advisory and management services consisting of two components — a base management fee and an
incentive fee. The cost of both the base management fee and the incentive fee are borne by our stockholders.
Management Fee
The base management fee is calculated at an annual rate of 1.75% of our gross assets, including assets
purchased with borrowed funds or other forms of leverage (including preferred stock, public and private debt
issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and
excluding cash and cash equivalents. For services rendered under the investment advisory agreement,
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the base management fee is payable quarterly in arrears. The base management fee is calculated based on the
average value of our gross assets, excluding cash and cash equivalents, at the end of the two most recently
completed calendar quarters. Base management fees for any partial month or quarter are appropriately pro-rated.
Incentive Fee
We pay Stellus Capital Management an incentive fee. Incentive fees are calculated as below. The incentive
fee, which provides Stellus Capital Management with a share of the income that it generates for us, has two
components, ordinary income and capital gains, calculated as follows:
The ordinary income component is calculated and payable quarterly in arrears based on our pre-incentive fee
net investment income for the immediately preceding calendar quarter, subject to a total return requirement, and
deferral of non-cash amounts, and is 20.0% of the amount, if any, by which our pre-incentive fee net investment
income, expressed as a rate of return on the value of our net assets attributable to our common stock, for the
immediately preceding calendar quarter, exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up”
provision, for the benefit off Stellus Capital Management, measured as of the end of each calendar quarter. Under
this provision, in any calendar quarter, Stellus Capital Management receives no incentive fee until our pre-
incentive fee net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of
our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment
income, if any, that exceeds the hurdle rate but is less than 2.5%.
The effect of the “catch-up” provision is that, subject to the total return provision discussed below, if pre-
incentive fee net investment income exceeds 2.5% in any calendar quarter, Stellus Capital Management receives
20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. For this purpose, pre-
incentive fee net investment income means interest income, dividend income and any other income (including
any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees
or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating
expenses for the quarter (including the base management fee, expenses payable under the administration
agreement (as described below), and any interest expense and any distributions paid on any issued and
outstanding preferred stock, but 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 we have not yet received in cash. 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 will be 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 quarters exceeds the
cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income
incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20.0% of the amount by
which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to
the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations
for the then current and 11 preceding calendar 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 portion of such incentive fee that is attributable to deferred interest (such as PIK interest or OID)
will be paid to Stellus Capital Management, without any interest thereon, only if and to the extent we actually
receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed
in connection with any write-off or similar treatment of the investment giving rise to any deferred interest
accrual. Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal
(after taking into account the reversal of incentive fees payable) and would result in a reduction and possible
elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from
quarter to quarter, and accordingly there is no clawback of amounts previously paid if subsequent quarters are
below the quarterly hurdle, and there is no delay of payment if
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prior quarters are below the quarterly hurdle. Stellus Capital Management has agreed to permanently waive any
interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or
unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that we
may pay an incentive fee in a quarter where we incur a loss, subject to the total return requirement. For example,
if we receive pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, we will
pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized and unrealized
capital losses. Our net investment income used to calculate this component of the incentive fee is also included in
the amount of our gross assets used to calculate the 1.75% base management fee. These calculations are
appropriately prorated for any period of less than three months and adjusted for any share issuances or
repurchases during the current quarter.
The following is a graphical representation of the calculation of the income-related portion of the incentive
fee:
Quarterly Incentive Fee Based on Net Investment Income
Pre-Incentive Fee Net Investment Income
(expressed as a percentage of the value of net assets)
Percentage of Pre-incentive Fee Net Investment Income
Allocated to Income-Related Portion of Incentive Fee
The capital gains component of the incentive fee is determined and payable in arrears as of the end of each
calendar year (or upon termination of the investment advisory agreement, as of the termination date), is equal to
20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year,
computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital
depreciation through the end of such year, less the aggregate amount of any previously paid capital gains
incentive fees. If such amount is negative, then no capital gains incentive fee will be payable for such year.
Additionally, if the investment advisory agreement is terminated as of a date that is not a calendar year end, the
termination date will be treated as though it were a calendar year end for purposes of calculating and paying the
capital gains incentive fee.
Examples of Quarterly Incentive Fee Calculation
Example 1: Income Related Portion of Incentive Fee before Total Return Requirement Calculation:
Alternative 1
Assumptions
(1)
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate = 2.0%
Management fee = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 0.6125%
(2)
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Pre-incentive fee net investment income does not exceed hurdle rate, therefore there is no income-related
incentive fee.
Alternative 2
Assumptions
Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate = 2.0%
Management fee = 0.4375%
(1)
(2)
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 2.2625%
Incentive fee
= 100% × Pre-incentive fee net investment income (subject to “catch-up”)
= 100% × (2.2625% - 2.0%)
= 0.2625%
(3)
Pre-incentive fee net investment income exceeds the hurdle rate but does not fully satisfy the “catch-up”
provision, therefore the income related portion of the incentive fee is 0.2625%.
Alternative 3
Assumptions
(1)
(2)
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate = 2.0%
Management fee = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 2.8625%
Incentive fee = 100% × Pre-incentive fee net investment income (subject to “catch-up”)
Incentive fee = 100% × “catch-up” + (20.0% × (Pre-Incentive Fee Net Investment Income - 2.5%))
(3)
“Catch-up”
= 2.5% - 2.0%
= 0.5%
Incentive fee
= (100% × 0.5%) + (20.0% × (2.8625% - 2.5%))
= 0.5% + (20.0% × 0.3625%)
= 0.5% + 0.0725%
= 0.5725%
Pre-incentive fee net investment income exceeds the hurdle rate, and fully satisfies the “catch-up” provision,
therefore the income related portion of the incentive fee is 0.5725%.
(1)
Represents 8.0% annualized hurdle rate.
(2)
Represents 1.75% annualized base management fee.
(3)
The “catch-up” provision is intended to provide Stellus Capital Management with an incentive fee of 20.0%
on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment
income exceeds 2.5% in any fiscal quarter.
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Example 2: Income Portion of Incentive Fee with Total Return Requirement Calculation:
Alternative 1:
Assumptions
(1)
(2)
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate = 2.0%
Management fee = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding
11 calendar quarters = $8,000,000
Although our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% (as shown in
Alternative 3 of Example 1 above), no incentive fee is payable because 20.0% of the cumulative net increase in
net assets resulting from operations over the then current and 11 preceding calendar quarters did not exceed the
cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters.
Alternative 2:
Assumptions
(2)
(1)
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate = 2.0%
Management fee = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding
11 calendar quarters = $10,000,000
Because our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% and because 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 income and capital gains incentive fees accrued and/or paid for the
preceding 11 calendar quarters, an incentive fee would be payable, as shown in Alternative 3 of Example 1
above.
(1)
Represents 8.0% annualized hurdle rate.
(2)
Represents 1.75% annualized base management fee.
Example 3: Capital Gains Portion of Incentive Fee (*):
Alternative 1:
Assumptions
Year 1: $2.0 million investment made in Company A (“Investment A”), and $3.0 million investment made in
Company B (“Investment B”)
Year 2: Investment A sold for $5.0 million and fair market value (“FMV”) of Investment B determined to be
$3.5 million
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Year 3: FMV of Investment B determined to be $2.0 million
Year 4: Investment B sold for $3.25 million
The capital gains portion of the incentive fee would be:
Year 1: None
Year 2: Capital gains incentive fee of $0.6 million - ($3.0 million realized capital gains on sale of
Investment A multiplied by 20.0%)
Year 3: None - $0.4 million (20.0% multiplied by ($3.0 million cumulative capital gains less $1.0 million
cumulative capital depreciation)) less $0.6 million (previous capital gains fee paid in Year 2)
Year 4: Capital gains incentive fee of $50,000 - $0.65 million ($3.25 million cumulative realized capital
gains multiplied by 20.0%) less $0.6 million (capital gains incentive fee taken in Year 2)
Alternative 2
Assumptions
Year 1: $2.0 million investment made in Company A (“Investment A”), $5.25 million investment made in
Company B (“Investment B”) and $4.5 million investment made in Company C (“Investment C”)
Year 2: Investment A sold for $4.5 million, FMV of Investment B determined to be $4.75 million and FMV
of Investment C determined to be $4.5 million
Year 3: FMV of Investment B determined to be $5.0 million and Investment C sold for $5.5 million
Year 4: FMV of Investment B determined to be $6.0 million
Year 5: Investment B sold for $4.0 million
The capital gains incentive fee, if any, would be:
Year 1: None
Year 2: $0.4 million capital gains incentive fee - 20.0% multiplied by $2.0 million ($2.5 million realized
capital gains on Investment A less $0.5 million unrealized capital depreciation on Investment B)
Year 3: $0.25 million capital gains incentive fee - $0.65 million (20.0% multiplied by $3.25 million
($3.5 million cumulative realized capital gains less $0.25 million unrealized capital depreciation)) less
$0.4 million capital gains incentive fee received in Year 2
(1)
Year 4: $0.05 million capital gains incentive fee - $0.7 million ($3.50 million cumulative realized capital
gains multiplied by 20.0%) less $0.65 million cumulative capital gains incentive fee paid in Year 2 and Year
3
Year 5: None - $0.45 million (20.0% multiplied by $2.25 million (cumulative realized capital gains of
$3.5 million less realized capital losses of $1.25 million)) less $0.7 million cumulative capital gains
incentive fee paid in Year 2, Year 3 and Year 4
(2)
*
(1)
The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no
leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those
shown in this example.
As illustrated in Year 3 of Alternative 1 above, if a portfolio company were to be wound up on a date other
than its fiscal year end of any year, it may have paid aggregate capital gains incentive fees that are more than
the amount of such fees that would be payable if such portfolio company had been wound up on its fiscal
year end of such year.
(2)
As noted above, it is possible that the cumulative aggregate capital gains fee received by Stellus Capital
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Management ($0.70 million) is effectively greater than $0.45 million (20.0% of cumulative aggregate
realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)).
Payment of Our Expenses
All investment professionals of Stellus Capital Management, when and to the extent engaged in providing
investment advisory and management services to us, and the compensation and routine overhead expenses of
personnel allocable to these services to us, are provided and paid for by Stellus Capital Management and not by
us. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without
limitation, those relating to:
•
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organization and offering;
calculating our net asset value (including the cost and expenses of any independent valuation firm);
fees and expenses 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 Management’s overhead in performing its obligations under the
administration agreement, including rent and the allocable portion of the cost of our chief compliance
officer and chief financial officer and his staff);
transfer agent, dividend 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;
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 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, including printing, mailing, long distance telephone, copying,
secretarial and other staff, independent auditors and outside legal costs;
proxy voting expenses; and
all other expenses incurred by us or Stellus Capital Management in connection with administering our
business.
Duration and Termination
Unless terminated earlier as described below, the investment advisory agreement will continue in effect from
year to year if approved annually by our Board or by the affirmative vote of the holders of a majority of our
outstanding voting securities, and, in either case, if also approved by a majority of our directors who are not
“interested persons.” The investment advisory agreement automatically terminates in the event of its assignment,
as defined in the 1940 Act, by Stellus Capital Management and may be terminated by either party without penalty
upon 60 days’ written notice to the other. The holders of a majority of our outstanding voting securities may also
terminate the investment advisory agreement without penalty upon
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60 days’ written notice. See Item 1A. “Risk Factors — Risks Relating to our Business and Structure.” We are
dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital
Management were to lose any of its key personnel, our ability to achieve our investment objective could be
significantly harmed.
Indemnification
The investment advisory agreement provides that Stellus Capital Management 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 us for any damages, liabilities, costs and expenses (including reasonable
attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital
Management’s services under the investment advisory agreement or otherwise as our investment adviser. Our
obligation to provide indemnification under the investment advisory agreement, however, is limited by the 1940
Act and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying
any director, officer or other individual from any liability resulting directly from the willful misconduct, bad
faith, gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of
the directors, officers or other individuals and require us to set forth reasonable and fair means for determining
whether indemnification shall be made.
Board Approval of the Investment Advisory Agreement
Our Board, including a majority of our independent directors, approved the investment advisory agreement
at its first meeting, held on September 24, 2012, and approved the annual continuation of the investment advisory
agreement on January 23, 2020. In its consideration of the investment advisory agreement, the Board focused on
information it had received relating to, among other things: (a) the nature, quality and extent of the advisory and
other services to be provided to us by our investment adviser; (b) comparative data with respect to advisory fees
or similar expenses paid by other BDCs with similar investment objectives; (c) our projected operating expenses
and expense ratio compared to BDCs with similar investment objectives; (d) any existing and potential sources of
indirect income to our investment adviser from its relationships with us and the profitability of those
relationships; (e) information about the services to be performed and the personnel performing such services
under the investment advisory agreement; (f) the organizational capability and financial condition of our
investment adviser; and (g) various other factors.
In voting to approve the investment advisory agreement, our Board, including all of the directors who are
not “interested persons,” of the Company, made the following conclusions:
•
Nature, Extent and Quality of Services. Our Board considered the nature, extent and quality of the
advisory and other services to be provided by Stellus Capital Management, including the investment
performance of Stellus Capital Management’s investment team. Our Board also considered the investment
selection process expected to be employed by Stellus Capital Management, including the flow of
transaction opportunities resulting from its investment team’s significant experience in originating,
structuring and managing loans and debt securities through market cycles; the employment of Stellus
Capital Management’s investment strategy, rigorous due diligence process, investment structuring, and
ongoing relationships with and monitoring of portfolio companies, in light of the investment objective of
the Company. Our Board also considered Stellus Capital Management’s personnel and their prior
experience in connection with the types of investments made by us, including such personnel’s corporate
relationships and relationships with private equity firms, investment banks, restructuring advisors, law
firms, boutique advisory firms and distressed/specialty lenders. In addition, our Board considered the
other terms and conditions of the investment advisory agreement, including the fact that we could
terminate the investment advisory agreement without penalty upon 60 days’ notice to Stellus Capital
Management. As a result, our Board determined that the substantive terms of the investment advisory
agreement (other than the fees payable thereunder, which our Board reviewed separately), including the
services to be provided, are similar to those of comparable BDCs described in the available market data
and in the best interests of our stockholders. Moreover, our Board concluded that although the substantive
terms of the Investment Advisory Agreement, including the services to be provided, are generally the
same as those of comparable BDCs described in the market data then available, it would be difficult to
obtain similar services from other third-party
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•
•
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service providers in light of the nature, quality and extent of the advisory and other services provided to
us by Stellus Capital Management.
Projected Costs of the Services Provided to the Company. Our Board considered (i) comparative data
based on publicly available information with respect to services rendered and the advisory fees (including
the base management fee and incentive fees) of other externally managed BDCs that invest in similar
securities, our total expenses, and expense ratios compared to other BDCs of similar size and with similar
investment objectives and (ii) the administrative services that Stellus Capital Management will provide to
us at cost pursuant to the administration agreement. Based upon its review, our Board concluded that the
fees to be paid under the investment advisory agreement are generally comparable to or more favorable
than those payable under agreements of comparable BDCs and reasonable in relation to the services
expected to be provided by Stellus Capital Management.
Projected Profitability of Stellus Capital Management. Our Board considered information about Stellus
Capital Management, including the anticipated costs of the services to be provided by Stellus Capital
Management and the anticipated profits to be realized by it, including as a result of our investment
performance, which would generally be equal or similar to the profitability of investment advisers
managing comparable BDCs. Our Board reviewed our investment performance, as well as comparative
data with respect to the investment performance of other externally managed BDCs, as it relates to the
management and incentive fees we pay Stellus Capital Management. As a result of this review, our Board
determined that our investment performance supported the renewal of the investment advisory agreement.
Economies of Scale. Our Board considered the extent to which economies of scale would be realized as
the Company grows, and whether the fees payable under the investment advisory agreement reflect these
economies of scale for the benefit of our stockholders. Considering such information, our Board
determined that the advisory fee structure under the investment advisory agreement was reasonable with
respect to any economies of scale that may be realized as the Company grows.
Limited Potential for Additional Benefits Derived by Stellus Capital Management. Our Board considered
existing and potential sources of indirect income Stellus Capital Management would receive as a result of
the relationship with us, and whether there would be potential for additional benefits to be derived by
Stellus Capital Management as a result of our relationship, and was advised any such potential would be
limited.
Conclusions. In view of the wide variety of factors that our Board considered in connection with its
evaluation of the investment advisory agreement, it is not practical to quantify, rank or otherwise assign
relative weights to the specific factors it considered in reaching its decision. The Board did not rank or
otherwise assign relative weights to the specific factors it considered in connection with its evaluation of
the Investment Advisory Agreement, nor did it undertake to make any specific determination as to
whether any particular factor, or any aspect of any particular factor, was favorable or unfavorable to the
ultimate decision made by our Board. Rather, the Board based its approval of the Investment Advisory
Agreement on the totality of information presented to it. In considering the factors discussed above,
individual directors may have given different weights to different factors.
Based on the information reviewed and the discussions, the Board, including a majority of the non-interested
directors, concluded that the investment management fee rates and terms are reasonable in relation to the services
to be provided and approved the investment advisory agreement as being in the best interests of our stockholders.
Administration Agreement
Under the administration agreement, Stellus Capital Management furnishes us with office facilities and
equipment and will provide us with clerical, bookkeeping, recordkeeping and other administrative services at
such facilities. Stellus Capital Management also performs, or oversees the performance of, our required
administrative services, which include being responsible for the financial and other records that we are required
to maintain and preparing reports to our stockholders and reports and other materials filed with the SEC. In
addition, Stellus Capital Management assists us in determining and publishing our net asset value, oversees the
preparation and filing of our tax returns and the printing and dissemination of reports and
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other materials to our stockholders, and generally oversees the payment of our expenses and the performance of
administrative and professional services rendered to us by others. Under the administration agreement, Stellus
Capital Management also provides managerial assistance on our behalf to those portfolio companies that have
accepted our offer to provide such assistance.
Payments under the administration agreement are equal to an amount based upon our allocable portion
(subject to the review of our Board) of Stellus Capital Management’s overhead in performing its obligations
under the administration agreement, including rent, the fees and expenses associated with performing compliance
functions and our allocable portion of the cost of our chief financial officer and chief compliance officer and his
staff. In addition, if requested to provide significant managerial assistance to our portfolio companies, Stellus
Capital Management will be paid an additional amount based on the services provided, which shall not exceed
the amount we receive from such portfolio companies for providing this assistance. The administration agreement
has an initial term of two years and may be renewed with the approval of our Board. The administration
agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To
the extent that Stellus Capital Management outsources any of its functions, we will pay the fees associated with
such functions on a direct basis without any incremental profit to Stellus Capital Management. Stockholder
approval is not required to amend the administration agreement.
Indemnification
The administration agreement provides that Stellus Capital Management, its affiliates and their respective,
officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity
affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses
(including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of
Stellus Capital Management’s services under the administration agreement or otherwise as our administrator. Our
obligation to provide indemnification under the administration agreement, however, is limited by the 1940 Act
and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying any
director, officer or other individual from any liability resulting directly from the willful misconduct, bad faith,
gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of the
directors, officers or other individuals and require us to set forth reasonable and fair means for determining
whether indemnification shall be made.
License Agreement
We have entered into a license agreement with Stellus Capital Management under which Stellus Capital
Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under
this agreement, we have a right to use the “Stellus Capital” name for so long as Stellus Capital Management or
one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have 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.
Exchange Act Reports
We maintain a website at www.stelluscapital.com (under the public investors section). The information on
our website is not incorporated by reference in this annual report on Form 10-K.
We make available on or through our website certain reports and amendments to those reports that we file
with or furnish to the SEC in accordance with the Securities Exchange Act of 1934, or the “Exchange Act.”
These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on
Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable
after we electronically file the information with, or furnish it to, the SEC.
Regulation as a Business Development Company
We are a BDC under the 1940 Act that has elected to be treated as a RIC under the Code. The 1940 Act
contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any
investment advisers), principal underwriters and affiliates of those affiliates or underwriters
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and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in
the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease
to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated
transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an
“underwriter” as that term is defined in the Securities Act. Our intention is to not write (sell) or buy put or call
options to manage risks associated with the publicly traded securities of our portfolio companies, except that we
may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we
may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in
connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may
acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain
circumstances. We also do not intend to acquire securities issued by any investment company that exceed the
limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting
stock of any registered investment company, invest more than 5% of the value of our total assets in the securities
of one investment company or invest more than 10% of the value of our total assets in the securities of more than
one investment company. With regard to that portion of our portfolio invested in securities issued by investment
companies, it should be noted that such investments might subject our stockholders to additional expenses. None
of these policies is fundamental and may be changed without stockholder approval upon 60 days’ prior written
notice to stockholders.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of
the 1940 Act, which are referred to as “qualifying assets,” unless, at the time the acquisition is made, qualifying
assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant
to our business are the following:
(1)
Securities purchased in transactions not involving any public offering from the issuer of such securities,
which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person
who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio
company, or from any other person, subject to such rules as may be prescribed by the SEC. Under the
1940 Act and the rules thereunder, “eligible portfolio companies” include (1) private domestic
operating companies, (2) public domestic operating companies whose securities are not listed on a
national securities exchange (e.g., the New York Stock Exchange), and (3) public domestic operating
companies having a market capitalization of less than $250 million. Public domestic operating
companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets
LLC are not listed on a national securities exchange and therefore are eligible portfolio companies.
(2)
Securities of any eligible portfolio company which we control.
(3)
(4)
(5)
(6)
Securities purchased in a private transaction from a U.S. issuer that is not an investment company or
from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the
issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase
of its securities, was unable to meet its obligations as they came due without material assistance other
than conventional lending or financing arrangements.
Securities of an eligible portfolio company purchased from any person in a private transaction if there
is no ready market for such securities and we already own 60% of the outstanding equity of the eligible
portfolio company.
Securities received in exchange for or distributed on or with respect to securities described above, or
pursuant to the exercise of warrants or rights relating to such securities.
Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one
year or less from the date of investment.
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The regulations defining qualifying assets may change over time. We may adjust our investment focus as
needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in
this area.
Managerial Assistance to Portfolio Companies
To count portfolio securities as qualifying assets for the purpose of the 70% test, a BDC must either control
the issuer of the securities or must offer to make available to the issuer of the securities significant managerial
assistance. However, when the BDC purchases securities in conjunction with one or more other persons acting
together and one of the other persons in the group may make available such managerial assistance. Making
available managerial assistance means any arrangement whereby the BDC, through its directors, officers,
employees or agents, offers to provide, and, if accepted, does so provide, significant guidance and counsel
concerning the management, operations or business objectives and policies of a portfolio company. With respect
to an SBIC, making available managerial assistance means the making of loans to a portfolio company. Stellus
Capital Management will provide such managerial assistance on our behalf to portfolio companies that request
this assistance.
Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of
cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt investments that
mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments,
so that 70% of our assets are qualifying assets or temporary investments. Typically, we will invest in U.S.
Treasury bills or in repurchase agreements, so long as the agreements are fully collateralized by cash or securities
issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such
as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon
future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest
rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase
agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single
counterparty, we would not meet the diversification tests in order to maintain our qualification as a RIC for U.S.
federal income tax purposes. Accordingly, we do not intend to enter into repurchase agreements with a single
counterparty in excess of this limit. Stellus Capital Management will monitor the creditworthiness of the
counterparties with which we enter into repurchase agreement transactions.
Warrants and Options
Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or
rights to purchase shares of capital stock that it may have outstanding at any time. Under the 1940 Act, we may
generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise
or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders
authorize the proposal to issue such warrants, and our Board approves such issuance on the basis that the issuance
is in the best interests of us and our stockholders and (iv) if the warrants are accompanied by other securities, the
warrants are not separately transferable unless no class of such warrants and the securities accompanying them
has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that would
result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not
exceed 25% of our outstanding voting securities. In particular, the amount of capital stock that would result from
the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed
25% of the BDC’s total outstanding shares of capital stock.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock
senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 150%
immediately after each such issuance. We may also borrow amounts up to 5% of the value of our total assets for
temporary or emergency purposes without regard to asset coverage. For a discussion of the risks
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associated with leverage, see Item 1A. “Risk Factors — Risks Relating to our Business and Structure —
Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional
capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks
associated with leverage.”
Common Stock
We are not generally able to issue and sell our common stock at a price below net asset value per share. We
may, however, sell our common stock at a price below the current net asset value of the common stock if our
Board determines that such sale is in our best interests and that of our stockholders, and our stockholders approve
such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price
which, in the determination of our Board, closely approximates the market value of such securities (less any
distributing commission or discount). We would need 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. We may also make
rights offerings to our stockholders at prices per share less than the net asset value per share, subject to applicable
requirements of the 1940 Act.
Codes of Ethics
We and Stellus Capital Management have each adopted a code of ethics pursuant to Rule 17j-1 under the
1940 Act that establishes procedures for personal investments and restricts certain personal securities
transactions. Personnel subject to each such code may invest in securities for their personal investment accounts,
including securities that may be purchased or held by us, so long as such investments are made in accordance
with such code’s requirements. In addition, each code of ethics is available on the EDGAR Database on the
SEC’s website at www.sec.gov. You may also obtain copies of each code of ethics, after paying a duplicating fee,
by electronic request at the following e-mail address: publicinfo@sec.gov.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to Stellus Capital Management. The proxy voting policies
and procedures of Stellus Capital Management are set out below. The guidelines will be reviewed periodically by
Stellus Capital Management and our directors who are not “interested persons,” and, accordingly, are subject to
change.
Introduction. As an investment adviser registered under the Advisers Act, Stellus Capital Management has
a fiduciary duty to act solely in our best interests. As part of this duty, Stellus Capital Management recognizes
that it must vote our securities in a timely manner free of conflicts of interest and in our best interests.
Stellus Capital Management’s policies and procedures for voting proxies for its investment advisory clients
are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies. Stellus Capital Management votes proxies relating to our portfolio securities in what it
perceives to be the best interest of our stockholders. Stellus Capital Management reviews on a case-by-case basis
each proposal submitted to a stockholder vote to determine its effect on the portfolio securities we hold. In most
cases Stellus Capital Management will vote in favor of proposals that Stellus Capital Management believes are
likely to increase the value of the portfolio securities we hold. Although Stellus Capital Management will
generally vote against proposals that may have a negative effect on our portfolio securities, Stellus Capital
Management may vote for such a proposal if there exist compelling long-term reasons to do so.
Stellus Capital Management has established a proxy voting committee and adopted proxy voting guidelines
and related procedures. The proxy voting committee establishes proxy voting guidelines and procedures, oversees
the internal proxy voting process, and reviews proxy voting issues. To ensure that Stellus Capital Management’s
vote is not the product of a conflict of interest, Stellus Capital Management requires that anyone involved in the
decision-making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware
of and any contact that he or she has had with any interested party
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regarding a proxy vote. Where conflicts of interest may be present, Stellus Capital Management will disclose
such conflicts to us, including our independent directors and may request guidance from us on how to vote such
proxies.
Proxy Voting Records. You may obtain information about how Stellus Capital Management voted proxies
by making a written request for proxy voting information to: Stellus Capital Investment Corporation, Attention:
Investor Relations, 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, or by calling us collect at (713)
292-5414. The SEC also maintains a website at www.sec.gov that contains this information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic
personal information. The following information is provided to help you understand what personal information
we collect, how we protect that information and why, in certain cases, we may share information with select other
parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although
certain nonpublic personal information of our stockholders may become available to us. We do not disclose any
nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by
law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party
administrator).
We restrict access to nonpublic personal information about our stockholders to employees of Stellus Capital
Management and its affiliates with a legitimate business need for the information. We intend to maintain physical,
electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.
Other
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect
us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or
officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence
or reckless disregard of the duties involved in the conduct of such person’s office.
We and Stellus Capital Management are each required to adopt and implement written policies and
procedures reasonably designed to prevent violation of relevant federal securities laws, review these policies and
procedures annually for their adequacy and the effectiveness of their implementation, and designate a chief
compliance officer to be responsible for administering the policies and procedures.
In general, BDCs are prohibited under the 1940 Act from knowingly participating in certain transactions
with our affiliates without the prior approval of our Board who are not interested persons and, in some cases,
prior approval by the SEC. The SEC has interpreted the BDC prohibition on transactions with affiliates to
prohibit all “joint transactions” between entities that share a common investment adviser. The staff of the SEC
has granted no-action relief permitting purchases of a single class of privately placed securities provided that the
adviser negotiates no term other than price and certain other conditions are met.
In addition, we previously received the Prior Order from the SEC to co-invest with private funds managed
by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable
law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, we
received the Order, which supersedes the Prior Order and permits us greater flexibility to enter into co-investment
transactions. The Order expands on the Prior Order and allows us to co-invest with additional types of private
funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser
that is controlled, controlling, or under common control with Stellus Capital Management, subject to the
conditions included therein. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940
Act) of our independent directors must make certain conclusions in connection with a co-investment transaction,
including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and
fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any
person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with
our investment objectives and
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strategies. We co-invest, subject to the conditions included in the Order, with private credit funds managed by
Stellus Capital Management that have an investment strategy that is similar to or identical to our investment
strategy, and we may co-invest with other BDCs and registered investment companies managed by Stellus
Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital
Management in the future. We believe that such co-investments may afford us additional investment
opportunities and an ability to achieve greater diversification.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 imposes a wide variety of regulatory requirements on publicly held
companies and their insiders. Many of these requirements affect us. For example:
•
•
•
•
pursuant to Rule 13a-14 under the Exchange Act, our principal executive officer and principal financial
officer must certify the accuracy of the financial statements contained in our periodic reports;
pursuant to Item 307 under Regulation S-K, our periodic reports must disclose our conclusions about the
effectiveness of our disclosure controls and procedures;
pursuant to Rule 13a-15 under the Exchange Act, our management must prepare an annual report
regarding its assessment of our internal control over financial reporting; and
pursuant to Item 308 of Regulation S-K and Rule 13a-15 under the Exchange Act, our periodic reports
must disclose whether there were significant changes in our internal controls over financial reporting or in
other factors that could significantly affect these controls subsequent to the date of their evaluation,
including any corrective actions with regard to significant deficiencies and material weaknesses.
Taxation as a Regulated Investment Company
As a BDC, we have elected and intend to qualify annually to be treated as a RIC under Subchapter M of the
Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any net ordinary
income or capital gains that we distribute to our stockholders as dividends. To continue to maintain our
qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification
requirements (as described below). In addition, to maintain our RIC treatment we must distribute to our
stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally
our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term
capital losses (the “Annual Distribution Requirement”).
For any taxable year in which we:
•
•
qualify as a RIC; and
satisfy the Annual Distribution Requirement;
We will not be subject to U.S. federal income tax on the portion of our income we distribute to stockholders.
We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not
distributed (or deemed distributed) to our stockholders.
We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed income unless we
distribute in a timely manner an amount at least equal to the sum of (a) 98% of our net ordinary income for each
calendar year, (b) 98.2% of our capital gain net income for the one-year period ending December 31 (c) any
income realized, but not distributed, in the preceding year and on which we paid no U.S. 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). In order to qualify as a
RIC for U.S. federal income tax purposes, we must, among other things:
•
•
continue to qualify as a BDC under the 1940 Act at all times during each year;
derive in each taxable year at least 90% of our gross income from dividends, interest, payments with
respect to certain securities loans, gains from the sale of stock or other securities, or other income derived
with respect to our business of investing in such stock or securities, and net income derived
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from interests in “qualified publicly traded partnerships” (which generally are partnerships that are traded
on an established securities market or tradable on a secondary market, other than partnerships that derive
90% of their income from interest, dividends and other permitted RIC income), or the 90% Income Test;
and
•
diversify our holdings so that at the end of each quarter of the taxable year:
•
•
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities,
securities of other RICs, and other securities if such other securities of any one issuer do not
represent more than 5% of the value of our assets or more than 10% of the outstanding voting
securities of the issuer; and
no more than 25% of the value of our assets is invested in the securities, other than U.S. government
securities or securities of other RICs, of one issuer or of two or more issuers that are controlled, as
determined under applicable tax rules, by us and that are engaged in the same or similar or related
trades or businesses or in the securities of one or more qualified publicly traded partnerships, or the
Diversification Tests.
We may invest in partnerships, including qualified publicly traded partnerships, which may result in our
being subject to state, local or foreign income, franchise or withholding tax liabilities.
We may be required to recognize taxable income in circumstances in which we do not receive cash. For
example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount
(such as debt instruments with PIK interest or, in certain cases, with increasing interest rates or issued with
warrants), we must include in income each year a portion of the original issue discount that accrues over the life
of the obligation, regardless of whether cash representing such income is received by us in the same taxable year.
Because any original issue discount accrued will be included in our investment company taxable income for the
year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual
Distribution Requirement, even though we will not have received any corresponding cash amount. If we are not
able to obtain sufficient cash from other sources to satisfy the Annual Distribution Requirement, we may fail to
maintain our tax treatment as a RIC and become subject to corporate-level U.S. federal income taxes on all of our
taxable income without the benefit of the dividends-paid deduction.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order
to satisfy (i) the Annual Distribution Requirement and to otherwise eliminate our liability for U.S. federal income
and excise taxes and/or (ii) the Diversification Tests. However, under the 1940 Act, we are not permitted in
certain circumstances to make distributions to our stockholders while our debt obligations and other senior
securities are outstanding unless certain “asset coverage” tests are met. See Item 1A. “Regulation as a Business
Development Company — Senior Securities.” Moreover, our ability to dispose of assets to meet the Annual
Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests may be limited by
(a) the illiquid nature of our portfolio and/or (b) other requirements relating to our qualifications as a RIC,
including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement,
the Excise Tax Avoidance Requirement or the Diversification Tests, we may make such dispositions at times that,
from an investment standpoint, are not advantageous.
In addition, we have formed and operate two SBIC subsidiaries, and are partially dependent on the SBIC
subsidiaries for cash distributions to enable us to meet the RIC distribution requirement. The SBIC subsidiaries
may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from
making certain distributions to us that may be necessary to maintain our tax treatment as a RIC. We may have to
request a waiver of the SBA’s restrictions for the SBIC subsidiaries to make certain distributions to maintain our
RIC tax treatment. We cannot assure you that the SBA will grant such waiver. If the SBIC subsidiaries are unable
to obtain a waiver, compliance with the SBA regulations may cause us to fail to maintain our tax treatment as a
RIC, which would result in us becoming subject to corporate-level federal income tax.
Certain of our investment practices may be subject to special and complex U.S. federal income tax
provisions that may, among other things, (a) treat dividends that would otherwise constitute qualified dividend
income as non-qualified dividend income, (b) treat dividends that would otherwise be eligible for
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the corporate dividends received deduction as ineligible for such treatment, (c) disallow, suspend or otherwise
limit the allowance of certain losses or deductions, (d) convert lower-taxed long term capital gain into higher-
taxed short-term capital gain or ordinary income, (e) convert an ordinary loss or a deduction into a capital loss
(the deductibility of which is more limited), (f) cause us to recognize income or gain without a corresponding
receipt of cash, (g) adversely affect the time as to when a purchase or sale of stock or securities is deemed to
occur, (h) adversely alter the characterization of certain complex financial transactions and (i) produce income
that will not be qualifying income for purposes of the 90% Income Test. We intend to monitor our transactions
and may make certain tax elections to mitigate the effect of these provisions and prevent our disqualification as a
RIC.
Gain or loss realized by us from warrants acquired by us as well as any loss attributable to the lapse of such
warrants generally will be treated as capital gain or loss. Such capital gain or loss generally will be long term or
short term, depending on how long we held a particular warrant. Some of the income and fees that we may
recognize will not satisfy the 90% Income Test. In order to ensure that such income and fees do not disqualify us
as a RIC for a failure to satisfy the 90% Income Test, we may hold assets that generate such income and provide
services that generate such fees indirectly through one or more entities treated as corporations for U.S. federal
income tax purposes. Such corporations will be required to pay U.S. federal corporate income tax on their
earnings, which ultimately will reduce our return on such income and fees.
If we are unable to qualify for tax treatment as a RIC, and if certain remedial provisions are not available,
we would be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct
distributions to stockholders, nor would they be required to be made. Subject to certain limitations under the
Code, corporate stockholders would be eligible to claim a dividends received deduction with respect to such
distributions, non-corporate stockholders would be able to treat such dividend income as “qualified dividend
income,” which is subject to reduced rates of U.S. federal income tax. Distributions in excess of our current and
accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax
basis, and any remaining distributions would be treated as a capital gain. If we fail to qualify as a RIC for a
period greater than two taxable years, to requalify as a RIC in a subsequent year we may be subject to regular
corporate tax on any net built-in gains with respect to certain of our assets ( i.e. , the excess of the aggregate
gains, including items of income, over aggregate losses that would have been realized with respect to such assets
if we had been liquidated) that we elect to recognize on requalification or when recognized over the next
five years.
Our Status as an Emerging Growth Company
We ceased to qualify as an “emerging growth company” beginning January 1, 2017.
The New York Stock Exchange Corporate Governance Regulations
The New York Stock Exchange has adopted corporate governance regulations that listed companies must
comply with. We are in compliance with such corporate governance listing standards applicable to BDCs.
Regulation as a Small Business Investment Company
Our wholly owned subsidiaries’ SBIC licenses allow them to obtain leverage by issuing SBA-guaranteed
debentures, subject to 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 at the time of issuance at a market-driven spread over
U.S. Treasury Notes with ten-year maturities.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA
regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small
businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net
worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for
the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller”
enterprises as defined by the SBA. A smaller enterprise is one that has a net worth not
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exceeding $6 million and has average annual fully taxed net income not exceeding $2 million for the two most
recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which
depend on the industry in which the business is engaged and are based on such factors as the number of
employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses,
invest in the equity securities of such businesses and provide them with consulting and advisory services.
SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of
$175.0 million, subject to SBA approval, with sufficient regulatory capital (as such term is defined in SBA
regulations). The amount of SBA-guaranteed debentures that affiliated SBIC funds can have outstanding is
$350.0 million. As of December 31, 2019, our SBIC I subsidiary had $75.0 million in regulatory capital and
$150.0 million in SBA-guaranteed debentures outstanding, which approximated their fair value. As of
December 31, 2019, our SBIC II subsidiary had $20.0 million in regulatory capital and $11.0 million in SBA-
guaranteed debentures outstanding, which approximated their fair value.
We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries
guaranteed by the SBA from the definition of senior securities in the 150% asset coverage test under the
1940 Act. This allows us increased flexibility under the 150% asset coverage test by permitting us to borrow up
to $325.0 million more (subject to SBA approval) than we would otherwise be able to absent the receipt of this
exemptive relief.
The SBA restricts the ability of SBICs to repurchase their capital stock. SBA regulations also include
restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in
accordance with SBA regulations. In addition, our SBIC subsidiaries may also be limited in their ability to make
distributions to us if they do not have sufficient capital, in accordance with SBA regulations.
Our SBIC subsidiaries are subject to regulation and oversight by the SBA, including requirements with
respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not
assure that our SBIC subsidiaries will receive SBA guaranteed debenture funding, which is dependent upon our
SBIC subsidiaries continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will
have a superior claim to our SBIC subsidiaries’ assets over our stockholders in the event we liquidate one or both
of our SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by our
SBIC subsidiaries upon an event of default.
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Item 1A.
Risk Factors
RISK FACTORS
Investing in our securities involves a number of significant risks. Before you invest in our securities, you
should be aware of various risks, including those described below. You should carefully consider these risk
factors, together with all of the other information included in this annual report on Form 10-K, before you decide
whether to make an investment in our securities. The risks set out below are the principal risks with respect to an
investment in our securities generally and with respect to a BDC with investment objectives, investment policies,
capital structures or trading markets similar to ours. However, they may not be the only risks we face. Additional
risks and uncertainties not presently known to us or not presently deemed material by us may also impair our
operations and performance. If any of the following events occur, our business, financial condition, results of
operations and cash flows could be materially and adversely affected. In such case, our net asset value and the
trading price of our securities could decline, and you may lose all or part of your investment.
Risks Relating to our Business and Structure
We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital
Management were to lose any of its key personnel, our ability to achieve our investment objective could be
significantly harmed.
We depend on the diligence, skill and network of business contacts of the senior investment professionals of
Stellus Capital Management to achieve our investment objective. Stellus Capital Management’s team of
investment professionals evaluates, negotiates, structures, closes and monitors our investments in accordance
with the terms of our investment advisory agreement. We can offer no assurance, however, that Stellus Capital
Management’s investment professionals will continue to provide investment advice to us.
Stellus Capital Management’s investment committee, which provides oversight over our investment
activities, is provided to us by Stellus Capital Management under the investment advisory agreement. Stellus
Capital Management’s investment committee consists of five members, including Messrs. Ladd, D’Angelo and
Davis, each a member of our Board, Mr. Huskinson, chief financial officer and chief compliance officer for us
and Stellus Capital Management and Mr. Overbergen, a senior investment professional of Stellus Capital
Management. The loss of any of Messrs. Ladd, D’Angelo, Davis or Huskinson may limit our ability to achieve
our investment objective and operate our business. This could have a material adverse effect on our financial
condition, results of operations and cash flows.
Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus
Capital Management to maintain or develop these relationships, or the failure of these relationships to
generate investment opportunities, could adversely affect our business.
We depend upon the investment professionals Stellus Capital Management to maintain their relationships
with private equity sponsors, placement agents, investment banks, management groups and other financial
institutions, and we rely to a significant extent upon these relationships to provide us with potential investment
opportunities. If the investment professionals of Stellus Capital Management fail to maintain such relationships,
or to develop new relationships with other sources of investment opportunities, we will not be able to grow our
investment portfolio. In addition, individuals with whom the investment professionals of Stellus Capital
Management have relationships are not obligated to provide us with investment opportunities, and we can offer
no assurance that these relationships will generate investment opportunities for us in the future.
Our financial condition, results of operations and cash flows will depend on our ability to manage our
business effectively.
Our ability to achieve our investment objective will depend on our ability to manage our business and to
grow our investments and earnings. This will depend, in turn, on Stellus Capital Management’s ability to identify,
invest in and monitor portfolio companies that meet our investment criteria. The achievement of our investment
objective on a cost-effective basis will depend upon Stellus Capital Management’s execution
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of our investment process, its ability to provide competent, attentive and efficient services to us and, to a lesser
extent, our access to financing on acceptable terms. Stellus Capital Management’s senior investment
professionals will have substantial responsibilities in connection with the management of other investment funds,
accounts and investment vehicles. The personnel of Stellus Capital Management may be called upon to provide
managerial assistance to our portfolio companies. These activities may distract them from sourcing new
investment opportunities for us or slow our rate of investment. Any failure to manage our business and our future
growth effectively could have a material adverse effect on our business, financial condition, results of operations
and cash flows.
There are significant potential conflicts of interest that could negatively affect our investment returns.
The members of Stellus Capital Management’s investment committee serve, or may serve, as officers,
directors, members, or principals of entities that operate in the same or a related line of business as we do, or of
investment funds, accounts, or investment vehicles managed by Stellus Capital Management. Similarly, Stellus
Capital Management may have other clients with similar, different or competing investment objectives. In serving
in these multiple capacities, they may have obligations to other clients or investors in those entities, the
fulfillment of which may not be in the best interests of us or our stockholders. For example, Stellus Capital
Management currently manages private credit funds that have an investment strategy that is similar to,
overlapping with or identical to our investment strategy, and with which we co-invest. Stellus Capital
Management also provides sub-advisory services to the D. E. Shaw group with respect to a private investment
fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves as
investment adviser that have an investment strategy similar to our investment strategy.
In addition, there may be times when Stellus Capital Management, members of its investment committee or
its other investment professionals have interests that differ from those of our stockholders, giving rise to a
conflict of interest. In particular, a private investment fund for which Stellus Capital Management provides
investment advisory services hold minority equity interests in certain of the portfolio companies in which we hold
debt investments. As a result, Stellus Capital Management, members of its investment committee or its other
investment professionals may face conflicts of interest in connection with making business decisions for these
portfolio companies to the extent that such decisions affect the debt and equity holders in these portfolio
companies differently. In addition, Stellus Capital Management may face conflicts of interests in connection with
making investment or other decisions, including granting loan waivers or concessions, on our behalf with respect
to these portfolio companies given that they also provide investment advisory services to a private investment
fund that holds the equity interests in these portfolio companies. Although our investment adviser will endeavor
to handle these investment and other decisions in a fair and equitable manner, we and the holders of the shares of
our common stock could be adversely affected by these decisions. Moreover, given the subjective nature of the
investment and other decisions made by our investment adviser on our behalf, we are unable to monitor these
potential conflicts of interest between us and our investment adviser; however, our Board, including the
independent directors, reviews conflicts of interest in connection with its review of the performance of our
investment adviser.
The senior investment professionals and other investment team members of Stellus Capital Management may,
from time to time, possess material non-public information, limiting our investment discretion.
The senior investment professionals and other investment team members of Stellus Capital Management,
including members of Stellus Capital Management’s investment committee, may serve as directors of, or in a
similar capacity with, portfolio companies in which we invest, the securities of which are purchased or sold on
our behalf. In the event that material nonpublic information is obtained with respect to such companies, or we
become subject to trading restrictions under the internal trading policies of those companies or as a result of
applicable law or regulations, we could be prohibited for a period of time from purchasing or selling the
securities of such companies, and this prohibition may have an adverse effect on us.
Our management and incentive fees may induce Stellus Capital Management to incur additional leverage.
Generally, the management and incentive fees payable by us to Stellus Capital Management may create an
incentive for Stellus Capital Management to use the additional available leverage if this proposal is
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approved. For example, the fact that the base management fee that we pay to Stellus Capital Management is
payable based upon our gross assets (which includes any borrowings for investment purposes) may encourage
Stellus Capital Management to use leverage to make additional investments. Such a practice could result in our
investing in more speculative securities than would otherwise be the case, which could result in higher
investment losses, particularly during cyclical economic downturns. Under certain circumstances, the use of
additional leverage may increase the likelihood of our default on our borrowings, which would disfavor holders
of our common stock.
In addition, because the incentive fee on net investment income is calculated as a percentage of our net
assets subject to a hurdle, having additional leverage available may encourage Stellus Capital Management to use
leverage to increase the leveraged return on our investment portfolio. To the extent additional leverage is
available at favorable rates, Stellus Capital Management could use leverage to increase the size of our investment
portfolio to generate additional income, which may make it easier to meet the incentive fee hurdle. Our adoption
of the reduced minimum asset coverage will allow us to incur additional leverage above the previous 1940 Act
limitations. As a result, the incentives for Stellus Capital Management to cause us to use additional leverage may
be greater.
Our Board is charged with protecting our interests by monitoring how Stellus Capital Management
addresses these and other conflicts of interests associated with its management services and compensation. While
our Board is not expected to review or approve each investment decision, borrowing or incurrence of leverage,
our independent directors will periodically review Stellus Capital Management’s services and fees as well as its
portfolio management decisions and portfolio performance. In connection with these reviews, our independent
directors will consider whether our fees and expenses (including those related to leverage) remain appropriate.
Our incentive fee may induce Stellus Capital Management to make speculative investments.
We pay Stellus Capital Management an incentive fee based, in part, upon net capital gains realized on our
investments. Unlike that portion of the incentive fee based on income, there is no hurdle rate applicable to the
portion of the incentive fee based on net capital gains. Additionally, under the incentive fee structure, Stellus
Capital Management may benefit when capital gains are recognized and, because Stellus Capital Management
will determine when to sell a holding, Stellus Capital Management will control the timing of the recognition of
such capital gains. As a result, Stellus Capital Management may have a tendency to invest more capital in
investments that are likely to result in capital gains as compared to income producing securities. Such a practice
could result in our investing in more speculative securities than would otherwise be the case, which could result
in higher investment losses, particularly during economic downturns.
We may be obligated to pay Stellus Capital Management incentive compensation even if we incur a loss and
may pay more than 20.0% of our net capital gains because we cannot recover payments made in
previous years.
Stellus Capital Management is entitled to incentive compensation for each fiscal quarter in an amount equal
to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation)
above a threshold return for that quarter and subject to a total return requirement. The general effect of this total
return requirement is to prevent payment of the foregoing incentive compensation 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 calendar
quarters. Consequently, we may pay an incentive fee if we incurred losses more than three years prior to the
current calendar quarter even if such losses have not yet been recovered in full. Thus, we may be required to pay
Stellus Capital Management incentive compensation for a fiscal quarter even if there is a decline in the value of
our portfolio or we incur a net loss for that quarter. If we pay an incentive fee of 20.0% of our realized capital
gains (net of all realized capital losses and unrealized capital depreciation on a cumulative basis) and thereafter
experience additional realized capital losses or unrealized capital depreciation, we will not be able to recover any
portion of the incentive fee previously paid.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result
in losses.
A number of entities compete with us to make the types of investments that we make. We compete with
public and private funds, commercial and investment banks, commercial financing companies and, to the
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extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are
substantially larger and have considerably greater financial, technical and marketing resources than we do. For
example, we believe some of our competitors may have access to funding sources that are not available to us. In
addition, some of our competitors may have higher risk tolerances or different risk assessments, which could
allow them to consider a wider variety of investments and establish more relationships than us. Furthermore,
many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC
or the source-of-income, asset diversification and distribution requirements we must satisfy to maintain our RIC
qualification. The competitive pressures we face may have a material adverse effect on our business, financial
condition, results of operations and cash flows. As a result of this competition, we may not be able to take
advantage of attractive investment opportunities from time to time, and we may not be able to identify and make
investments that are consistent with our investment objective.
With respect to the investments we make, we do not seek to compete based primarily on the interest rates we
offer, and we believe that some of our competitors may make loans with interest rates that are lower than the rates
we offer. With respect to all investments, we may lose some investment opportunities if we do not match our
competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we
may experience decreased net interest income, lower yields and increased risk of credit loss. We may also
compete for investment opportunities with investment funds, accounts and investment vehicles managed by
Stellus Capital Management. Although Stellus Capital Management will allocate opportunities in accordance
with its policies and procedures, allocations to such investment funds, accounts and investment vehicles will
reduce the amount and frequency of opportunities available to us and may not be in the best interests of us and
our stockholders.
We will be subject to corporate-level income tax and may default under our revolving credit facility if we are
unable to maintain our tax treatment as a RIC under Subchapter M of the Code.
To maintain our tax treatment as a RIC under Subchapter M of the Code, we must meet certain source-of-
income, asset diversification and distribution requirements. The distribution requirement for a RIC is satisfied if
we distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term
capital losses, if any, to our stockholders on an annual basis. Because we incur debt, we are subject to certain
asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements
that could, under certain circumstances, restrict us from making distributions necessary to maintain our tax
treatment as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our tax treatment
as a RIC and, thus, may be subject to corporate-level income tax. To maintain our tax treatment as a RIC, we
must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these
tests may result in our having to dispose of certain investments quickly in order to prevent the loss of our tax
treatment as a RIC. Because most of our investments are in private or thinly traded public companies, any such
dispositions may be made at disadvantageous prices and may result in substantial losses. No certainty can be
provided, that we will satisfy the asset diversification requirements or the other requirements necessary to
maintain our tax treatment as a RIC. If we fail to maintain our tax treatment as a RIC for any reason and become
subject to corporate income tax, the resulting corporate income taxes could substantially reduce our net assets, the
amount of income available for distributions to our stockholders and the amount of funds available for new
investments. Furthermore, if we fail to maintain our tax treatment as a RIC, we may be in default under the terms
of our $220.0 million senior secured revolving credit facility with various lenders (the “Credit Facility”). Such a
failure could have a material adverse effect on us and our stockholders.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving
cash representing such income.
For U.S. federal income tax purposes, we include in income certain amounts that we have not yet received in
cash, such as the accrual of original issue discount. This may arise if we receive warrants in connection with the
making of a loan and in other circumstances, or through contracted PIK interest, which represents contractual
interest added to the loan balance and due at the end of the loan term. Such original issue discount, which could
be significant relative to our overall investment activities and increases
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in loan balances as a result of contracted PIK arrangements are included in income before we receive any
corresponding cash payments. We also may be required to include in income certain other amounts that we will
not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income,
we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and net
short-term capital gains in excess of net long-term capital losses, if any, to maintain our tax treatment as a RIC. In
such a case, we may have to sell some of our investments at times we would not consider advantageous or raise
additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If
we are not able to obtain such cash from other sources, we may fail to maintain our tax treatment as a RIC and
thus be subject to corporate-level income tax.
PIK interest payments we receive will increase our assets under management and, as a result, will increase the
amount of base management fees and incentive fees payable by us to Stellus Capital Management.
Certain of our debt investments may contain provisions providing for the payment of PIK interest. Because
PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt by us of PIK
interest will have the effect of increasing our assets under management. As a result, because the base
management fee that we pay to Stellus Capital Management is based on the value of our gross assets, the receipt
by us of PIK interest will result in an increase in the amount of the base management fee payable by us. In
addition, any such increase in a loan balance due to the receipt of PIK interest will cause such loan to accrue
interest on the higher loan balance, which will result in an increase in our pre-incentive fee net investment
income and, as a result, an increase in incentive fees that are payable by us to Stellus Capital Management.
Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional
capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks
associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial
institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the
1940 Act. Under the provisions of the 1940 Act, we are permitted as a BDC that has satisfied certain
requirements to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act,
equals at least 150% of our gross assets less all liabilities and indebtedness not represented by senior securities,
after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If
that happens, we would not be able to borrow additional funds until we were able to comply with the 150% asset
coverage ratio applicable to us under the 1940 Act. Also, any amounts that we use to service our indebtedness
would not be available for distributions to our common stockholders. If we issue senior securities, we will be
exposed to typical risks associated with leverage, including an increased risk of loss.
We are not generally able to issue and sell our common stock at a price below net asset value per share. We
may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price
below then-current net asset value per share of our common stock if our Board determines that such sale is in our
best interests, and if our stockholders approve such sale. A proposal, approved by our stockholders at our 2019
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 approval will expire on the earlier of our 2020 annual stockholder meeting or July 22, 2020, the one-year
anniversary of our 2019 annual stockholders meeting. The proposal approved by our stockholders did not specify
a maximum discount below net asset value at which we are able to issue our common stock, although the number
of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such
sale. 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
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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. In addition, we cannot issue shares of our common stock below net asset value unless our
Board determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at
prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our
net asset value per share and may reduce our market price per share. In addition, continuous sales of common
stock below net asset value may have a negative impact on total returns and could have a negative impact on the
market price of our shares of common stock. If we raise additional funds by issuing common stock, then
the percentage ownership of our stockholders at that time will decrease, and you may experience dilution.
Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested
in us is magnified and may increase the risk of investing in us.
The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is
generally considered a speculative investment technique and increases the risks associated with investing in our
securities. If we continue to use leverage to partially finance our investments through banks, insurance companies
and other lenders, you will experience increased risks of investing in our common stock. Lenders of these funds
have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would
expect such lenders to seek recovery against our assets in the event of a default. We, through our SBIC
subsidiaries, intend to issue debt securities guaranteed by the SBA and sold in the capital markets. Upon any such
issuance of debt securities and as a result of its guarantee of the debt securities, if any, the SBA would also have
fixed dollar claims on the assets of our SBIC subsidiaries that are superior to the claims of our common
stockholders.
Upon the issuance of any debt securities guaranteed by the SBA, if we are unable to meet the financial
obligations under our 5.75% notes due 2022 or (the “2022 Notes”) or the Credit Facility, the SBA, as a creditor,
would have a superior claim to the assets of our SBIC subsidiaries over our stockholders in the event we liquidate
or the SBA exercises its remedies under such debentures as the result of a default by us. In addition, under the
terms of the Credit Facility and any borrowing facility or other debt instrument we may enter into, we are likely
to be required to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed
under such facility or instrument before applying such net proceeds to any other uses. If the value of our assets
decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we
not leveraged, thereby magnifying losses or eliminating our stake in a leveraged investment. Similarly, any
decrease in our revenue or income will cause our net income to decline more sharply than it would have had we
not borrowed. Such a decline would also negatively affect our ability to make distributions with respect to our
common stock. Our ability to service any debt depends largely on our financial performance and is subject to
prevailing economic conditions and competitive pressures. Moreover, as the base management fee payable to
Stellus Capital Management is payable based on the value of our gross assets, including those assets acquired
through the use of leverage, Stellus Capital Management will have a financial incentive to incur leverage, which
may not be consistent with our stockholders’ interests. In addition, our common stockholders bear the burden of
any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the
base management fee payable to Stellus Capital Management.
As a BDC that has satisfied certain requirements under the 1940 Act, we generally are required to meet a
coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings
and any preferred stock that we may issue in the future, of at least 150%. If this ratio declines below 150%, we
will not be able to incur additional debt until we are able to comply with the 150% asset coverage ratio applicable
to us under the 1940 Act. This could have a material adverse effect on our operations, and we may not be able to
make distributions. The amount of leverage that we employ will depend on Stellus Capital Management’s and our
Boards’ assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that
we will be able to obtain credit at all or on terms acceptable to us.
We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries
guaranteed by the SBA from the definition of senior securities in the 150% asset coverage ratio we are
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required to maintain under the 1940 Act. This relief allows us increased flexibility under the 150% asset coverage
test by allowing us to borrow up to $325 million more through our SBIC subsidiaries than we would otherwise be
able to borrow absent the receipt of this exemptive relief.
In addition, our debt facilities may impose financial and operating covenants that restrict our business
activities, including limitations that hinder our ability to finance additional loans and investments or to make the
distributions required to maintain our qualification as a RIC under the Code.
Substantially all of our assets are subject to security interests under the Credit Facility or claims of the SBA
with respect to SBA-guaranteed debentures we may issue and, if we default on our obligations thereunder, we
may suffer adverse consequences, including foreclosure on our assets.
As of December 31, 2019, substantially all of our assets were pledged as collateral under the Credit Facility
or are subject to a superior claim over the holders of our common stock by the SBA pursuant to the SBA-
guaranteed debentures. If we default on our obligations under the Credit Facility or the SBA-guaranteed
debentures the lenders and/or the SBA may have the right to foreclose upon and sell, or otherwise transfer, the
collateral subject to their security interests or their superior claim. In such event, we may be forced to sell our
investments to raise funds to repay our outstanding borrowings in order to avoid foreclosure and these forced
sales may be at times and at prices we would not consider advantageous. Moreover, such deleveraging of our
company could significantly impair our ability to effectively operate our business in the manner in which we have
historically operated. As a result, we could be forced to curtail or cease new investment activities and lower or
eliminate the dividends that we have historically paid to our stockholders.
In addition, if the lenders exercise their right to sell the assets pledged under the Credit Facility, such sales
may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash
available to us after repayment of the amounts outstanding under the Credit Facility.
Because we use debt to finance our investments and may in the future issue senior securities including
preferred stock and debt securities, if market interest rates were to increase, our cost of capital could increase,
which could reduce our net investment income.
Because we borrow money to make investments and may in the future issue additional senior securities
including preferred stock and debt securities, our net investment income will depend, in part, upon the difference
between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer
no assurance that a significant change in market interest rates would not have a material adverse effect on our net
investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost
of funds would increase, which could reduce our net investment income. We may use interest rate risk
management techniques to limit our exposure to interest rate fluctuations. We may utilize instruments such as
forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against
fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market
interest rates to the extent permitted by the 1940 Act. For example, to the extent any such instruments were to
constitute senior securities under the 1940 Act, we would have to and will comply with the asset coverage
requirements thereunder or, as permitted in lieu thereof, place certain assets in a segregated account to cover such
instruments in accordance with SEC guidance, including, for example, Investment Company Act Release No. IC-
10666, as applicable. There is otherwise no limit as to our ability to enter into such derivative transactions. In
addition, a rise in the general level of interest rates typically leads to higher interest rates applicable to our debt
investments. Accordingly, an increase in interest rates may result in an increase of the amount of our pre-
incentive fee net investment income and, as a result, an increase in incentive fees payable to Stellus Capital
Management. Adverse developments resulting from changes in interest rates or hedging transactions could have a
material adverse effect on our business, financial condition and results of operations.
Provisions in the Credit Facility or any other future borrowing facility may limit our discretion in operating
our business.
The Credit Facility is, and any future borrowing facility may be, backed by all or a portion of our loans and
securities on which the lenders will or, in the case of a future facility, may have a security interest. We
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may pledge up to 100% of our assets and may grant a security interest in all of our assets under the terms of any
debt instrument we enter into with lenders. We expect that any security interests we grant will be set forth in a
guarantee and security agreement and evidenced by the filing of financing statements by the agent for the lenders.
In addition, we expect that the custodian for our securities serving as collateral for such loan would include in its
electronic systems notices indicating the existence of such security interests and, following notice of occurrence
of an event of default, if any, and during its continuance, will only accept transfer instructions with respect to any
such securities from the lender or its designee. If we were to default under the terms of any debt instrument, the
agent for the applicable lenders would be able to assume control of the timing of disposition of any or all of our
assets securing such debt, which would have a material adverse effect on our business, financial condition, results
of operations and cash flows.
In addition, any security interests as well as negative covenants under the Credit Facility or any other
borrowing facility may limit our ability to incur additional liens or debt and may make it difficult for us to
restructure or refinance indebtedness at or prior to maturity or obtain additional debt or equity financing. For
example, under the terms of the Credit Facility, we have generally agreed to not incur any additional secured
indebtedness, other than certain indebtedness that we may incur, in accordance with the Credit Facility, to allow
us to purchase investments in U.S. Treasury Bills. In addition, we have agreed not to incur any additional
indebtedness that has a maturity date prior to the maturity date of the Credit Facility. Further, if our borrowing
base under the Credit Facility or any other borrowing facility were to decrease, we would be required to secure
additional assets in an amount equal to any borrowing base deficiency. In the event that all of our assets are
secured at the time of such a borrowing base deficiency, we could be required to repay advances under the Credit
Facility or any other borrowing facility or make deposits to a collection account, either of which could have a
material adverse impact on our ability to fund future investments and to make stockholder distributions.
In addition, under the Credit Facility or any other borrowing facility, we may be subject to limitations as to
how borrowed funds may be used, which may include restrictions on geographic and industry concentrations,
loan size, payment frequency and status, average life, collateral interests and investment ratings, as well as
regulatory restrictions on leverage which may affect the amount of funding that may be obtained. There may also
be certain requirements relating to portfolio performance, including required minimum portfolio yield and
limitations on delinquencies and charge-offs, a violation of which could limit further advances and, in some
cases, result in an event of default. Furthermore, we expect that the terms of the Credit Facility will contain a
covenant requiring us to maintain compliance with RIC provisions at all times, subject to certain remedial
provisions. Thus, a failure to maintain compliance with RIC provisions could result in an event of default under
the Credit Facility. An event of default under the Credit Facility or any other borrowing facility could result in an
accelerated maturity date for all amounts outstanding thereunder, which could have a material adverse effect on
our business and financial condition. This could reduce our revenues and, by delaying any cash payment allowed
to us under the Credit Facility or any other borrowing facility until the lenders have been paid in full, reduce our
liquidity and cash flow and impair our ability to grow our business and maintain our qualification as a RIC.
We may in the future determine to fund a portion of our investments with preferred stock, which would
magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.
Preferred stock, which is another form of leverage, has the same risks to our common stockholders as
borrowings because the dividends on any preferred stock we issue must be cumulative. Payment of such
dividends and repayment of the liquidation preference of such preferred stock must take preference over any
dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of
our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated
preference.
Adverse developments in the credit markets may impair our ability to enter into any other future borrowing
facility.
During the economic downturn in the United States that began in mid-2007, many commercial banks and
other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort
to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some
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financial institutions limited refinancing and loan modification transactions and reviewed the terms of existing
facilities to identify bases for accelerating the maturity of existing lending facilities. If these conditions recur (for
example, as a result of a broadening of the current Euro zone credit crisis), it may be difficult for us to enter into a
new borrowing facility, obtain other financing to finance the growth of our investments, or refinance any
outstanding indebtedness on acceptable economic terms, or at all.
Most of our portfolio investments are recorded at fair value as determined in good faith by our Board and, as a
result, there may be uncertainty as to the value of our portfolio investments.
Most of our portfolio investments will take the form of securities that are not publicly traded. The fair value
of loans, securities and other investments that are not publicly traded may not be readily determinable, and we
value these investments at fair value as determined in good faith by our Board, including to reflect significant
events affecting the value of our investments. Most, if not all, of our investments (other than cash and cash
equivalents) are classified as Level 3 under ASC Topic 820. This means that our portfolio valuations are based on
unobservable inputs and our own assumptions about how market participants would price the asset or liability in
question. Inputs into the determination of fair value of our portfolio investments require significant management
judgment or estimation. Even if observable market data is available, such information may be the result of
consensus pricing information or broker quotes, which include a disclaimer that the broker would not be held to
such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by
disclaimers materially reduces the reliability of such information. We have retained the services of independent
service providers to review the valuation of these loans and securities. The types of factors that Board may take
into account in determining the fair value of our investments generally include, as appropriate, comparison to
publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise
value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to
make payments and its earnings and discounted cash flow, the markets in which the portfolio company does
business and other relevant factors. Because such valuations, and particularly valuations of private securities and
private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on
estimates, our determinations of fair value may differ materially from the values that would have been used if a
ready market for these loans and securities existed. Our net asset value could be adversely affected if our
determinations regarding the fair value of our investments were materially higher than the values that we
ultimately realize upon the disposal of such loans and securities.
We adjust quarterly the valuation of our portfolio to reflect our Boards’ determination of the fair value of
each investment in our portfolio. Any changes in fair value are recorded in our statement of operations as net
change in unrealized appreciation or depreciation.
We may expose ourselves to risks if we engage in hedging transactions.
We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars
and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in
currency exchange rates and market interest rates. Use of these hedging instruments may expose us to counter-
party credit risk. Hedging against a decline in the values of our portfolio positions does not eliminate the
possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline.
However, such hedging can establish other positions designed to gain from those same developments, thereby
offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the
opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to
hedge against an exchange rate or interest rate fluctuation that is generally anticipated at an acceptable price.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to
accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our
financial and other public reporting, which would harm our business and the trading price of our common
stock.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports
and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to
implement required new or improved controls, or difficulties encountered in their implementation
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could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection
with Section 404 of the Sarbanes-Oxley Act, or the subsequent testing by our independent registered public
accounting firm (when undertaken, as noted below), may reveal deficiencies in our internal controls over
financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive
changes to our consolidated financial statements or identify other areas for further attention or improvement.
Inferior internal controls could also cause investors to lose confidence in our reported financial information,
which could have a negative effect on the trading price of our common stock.
We incur significant costs as a result of being a publicly traded company.
As a publicly traded company, we incur legal, accounting, investor relations and other expenses, including
costs associated with corporate governance requirements, such as those under the Sarbanes-Oxley Act of 2002, or
the Sarbanes-Oxley Act, other rules implemented by the SEC and the listing standards of the NYSE. Our
independent registered public accounting firm is required to attest to the effectiveness of our internal controls
over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, which increases the costs associated
with our periodic reporting requirements.
We are obligated to maintain proper and effective internal control over financial reporting. We may not
complete our analysis of our internal control over financial reporting in a timely manner, or our internal
controls may not be determined to be effective, which may adversely affect investor confidence in our company
and, as a result, the value of our securities.
We are required to comply with the independent auditor attestation requirements of Section 404 of the
Sarbanes-Oxley Act. Complying with Section 404 requires a rigorous compliance program as well as adequate
time and resources. We may not be able to complete our internal control evaluation, testing and any required
remediation in a timely fashion. Additionally, if we identify one or more material weaknesses in our internal
control over financial reporting, we will be unable to assert that our internal controls are effective. If we are
unable to assert that our internal control over financial reporting is effective, or if our auditors are unable to attest
to management’s report on the effectiveness of our internal controls, we could lose investor confidence in the
accuracy and completeness of our financial reports, which would have a material adverse effect on the price of
our securities.
We are required to disclose changes made in our internal control and procedures on a quarterly basis and our
management is required to assess the effectiveness of these controls annually. An independent assessment of the
effectiveness of our internal controls could detect problems that our management’s assessment might not.
Undetected material weaknesses in our internal controls could lead to financial statement restatements and
require us to incur the expense of remediation.
New or modified laws or regulations governing our operations may adversely affect our business.
We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels.
These laws and regulations, as well as their interpretation, may change from time to time, and new laws,
regulations and interpretations may also come into effect. Any such new or changed laws or regulations could
have a material adverse effect on our business.
Additionally, changes to the laws and regulations governing our operations related to permitted investments
may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such
changes could result in material differences to the strategies and plans set forth in this annual report on Form 10-
K and may shift our investment focus from the areas of expertise of Stellus Capital Management to other types of
investments in which Stellus Capital Management may have little or no expertise or experience. Any such
changes, if they occur, could have a material adverse effect on our results of operations and the value of your
investment.
Legislative or other actions relating to taxes could have a negative effect on us.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the
legislative process and by the IRS and the U.S. Treasury Department. In 2017, the U.S. House of Representatives
and U.S. Senate passed tax reform legislation, which the President signed into law. Such
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legislation makes many changes to the Internal Revenue Code, including, among other things, significant changes
to the taxation of business entities, the deductibility of interest expense, and the tax treatment of capital
investment. We cannot predict with certainty how any changes in the tax laws might affect us, investors or our
portfolio investments. New legislation and any U.S. Treasury regulations, administrative interpretations or court
decisions interpreting such legislation could significantly and negatively affect our ability to qualify for tax
treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification or
could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax
legislative, regulatory or administrative developments and proposals and their potential effect on an investment in
our securities.
Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiaries’
operations.
On June 20, 2014 and August 14, 2019, our wholly owned subsidiaries, Stellus Capital SBIC LP, and Stellus
Capital SBIC II LP, respectively, received licenses from the SBA to operate as SBICs. The SBA places certain
limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from
providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBIC
requirements may cause our SBIC subsidiaries to forgo attractive investment opportunities that are not permitted
under SBA regulations.
Further, SBA regulations require that an SBIC be examined by the SBA to determine its compliance with the
relevant SBA regulations at least every two years. The SBA prohibits, without prior SBA approval, a “change of
control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning
10% or more of a class of capital stock of an SBIC. If either of our SBIC subsidiaries fails to comply with
applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit its use of
debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new
investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful
or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or
regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our
SBIC subsidiaries are our wholly owned subsidiaries.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio
companies and, in turn, may have a negative impact on our business.
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 our business.
Risks Related to Our Operations
Because we intend to distribute substantially all of our income to our stockholders to obtain and maintain our
status as a RIC, we will continue to need additional capital to finance our growth. If additional funds are
unavailable or not available on favorable terms, our ability to grow may be impaired.
We will need additional capital to fund new investments and grow our portfolio of investments. We intend to
access the capital markets periodically to issue debt or equity securities or borrow from financial institutions in
order to obtain such additional capital. Unfavorable economic conditions could increase our funding costs, limit
our access to the capital markets or result in a decision by lenders not to extend credit to us. A reduction in the
availability of new capital could limit our ability to grow. In addition, we are required to distribute at least 90% of
our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our
stockholders to maintain our qualification as a RIC. As a result, these earnings will not be available to fund new
investments. An inability on our part to access the capital markets
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successfully could limit our ability to grow our business and execute our business strategy fully and could
decrease our earnings, if any, which would have an adverse effect on the value of our shares of common stock.
As a BDC that has satisfied certain conditions under the 1940 Act, we are required to meet a coverage ratio
of total assets, less liabilities and indebtedness not represented by senior securities and excluding SBA-
guaranteed debentures as permitted by exemptive relief obtained from the SEC, to total senior securities, which
includes all of our borrowings with the exception of SBA-guaranteed debentures, of at least 150%. This
requirement limits the amount that we may borrow. Since we continue to need capital to grow our investment
portfolio, these limitations may prevent us from incurring debt and require us to raise additional equity at a time
when it may be disadvantageous to do so. While we expect that we will be able to borrow and to issue additional
debt securities and expect that we will be able to issue additional equity securities, which would in turn increase
the equity capital available to us, we cannot assure you that debt and equity financing will be available to us on
favorable terms, or at all. In addition, as a BDC, we generally are not permitted to issue equity securities priced
below net asset value without stockholder approval. If additional funds are not available us, we may be forced to
curtail or cease new investment activities, and our net asset value could decline.
Our wholly owned SBIC subsidiaries may be unable to make distributions to us that will enable us to maintain
RIC tax treatment, which could result in the imposition of an entity-level tax.
In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we are
required to distribute substantially all of our net ordinary income and net capital gain income, including income
from certain of our subsidiaries, which includes the income from our SBIC subsidiaries. We are partially
dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements.
Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations
governing SBICs, from making certain distributions to us that may be necessary to maintain our tax treatment as
a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain
distributions to maintain our RIC tax treatment. We cannot assure you that the SBA will grant such waiver and if
our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may result in loss of
RIC tax treatment and a consequent imposition of an entity-level tax on us.
Our ability to enter into certain transactions with our affiliates is restricted, which may limit the scope of
investments available to us.
We are prohibited under the 1940 Act from participating in certain transactions with our affiliates without
the prior approval of our independent directors and, in some cases, the SEC. Any person that owns, directly or
indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act, and
we are generally prohibited from buying or selling any security from or to such affiliate without the prior
approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our
affiliates, which could include concurrent investments in the same portfolio company, without prior approval of
our independent directors and, in some cases, of the SEC. We are prohibited from buying or selling any security
from or to any person that controls us or who owns more than 25% of our voting securities or certain of that
person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of
the SEC. As a result of these restrictions, we may be prohibited from buying or selling any security (other than
any security of which we are the issuer) from or to any portfolio company of a private fund managed by Stellus
Capital Management or its affiliates without the prior approval of the SEC, which may limit the scope of
investment opportunities that would otherwise be available to us.
We have received exemptive relief from the SEC to co-invest with investment funds managed by Stellus
Capital Management (other than the D. E. Shaw group funds, as defined below) where doing so is consistent with
our 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 our independent
directors must make certain conclusions in connection with a co-investment transaction, including that (1) the
terms of the proposed transaction, including the consideration to be paid, are
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reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the
part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is
consistent with our investment objectives and strategies.
The involvement of our interested directors in the valuation process may create conflicts of interest.
We make many of our portfolio investments in the form of loans and securities that are not publicly traded
and for which no market-based price quotation is available. As a result, our Board determines the fair value of
these loans and securities in good faith as described elsewhere in this annual report on Form 10-K. In connection
with that determination, investment professionals from Stellus Capital Management provide our Board with
valuations based upon the most recent portfolio company financial statements available and projected financial
results of each portfolio company. While the valuation for each portfolio investment is reviewed by an
independent valuation firm at least twice annually, the ultimate determination of fair value is made by our Board,
including our interested directors, and not by such third-party valuation firm. In addition, Messrs. Ladd,
D’Angelo and Davis, each an interested member of our Board, has a direct pecuniary interest in Stellus Capital
Management. The participation of Stellus Capital Management’s investment professionals in our valuation
process, and the pecuniary interest in Stellus Capital Management by certain members of our Board, could result
in a conflict of interest as Stellus Capital Management’s management fee is based, in part, on the value of our
gross assets, and incentive fees are based, in part, on realized gains and realized and unrealized losses.
There are conflicts related to other arrangements with Stellus Capital Management.
We have entered into a license agreement with Stellus Capital Management under which Stellus Capital
Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” In
addition, we have entered into an administration agreement with Stellus Capital Management pursuant to which
we are required to pay to Stellus Capital Management our allocable portion of overhead and other expenses
incurred by Stellus Capital Management in performing its obligations under such administration agreement, such
as rent and our allocable portion of the cost of our chief financial officer and chief compliance officer and his
staff. This will create conflicts of interest that our Board will monitor. For example, under the terms of the license
agreement, we will be unable to preclude Stellus Capital Management from licensing or transferring the
ownership of the “Stellus Capital” name to third parties, some of whom may compete against us. Consequently,
we will be unable to prevent any damage to goodwill that may occur as a result of the activities of Stellus Capital
Management or others. Furthermore, in the event the license agreement is terminated, we will be required to
change our name and cease using “Stellus Capital” as part of our name. Any of these events could disrupt our
recognition in the marketplace, damage any goodwill we may have generated and otherwise harm our business.
The investment advisory agreement and the administration agreement with Stellus Capital Management were
not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with
an unaffiliated third party.
The investment advisory agreement and the administration agreement were negotiated between related
parties. Consequently, their terms, including fees payable to Stellus Capital Management, may not be as favorable
to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or
to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our
ongoing relationship with Stellus Capital Management and its affiliates. Any such decision, however, would
breach our fiduciary obligations to our stockholders.
The time and resources that Stellus Capital Management devote to us may be diverted, and we may face
additional competition due to the fact that Stellus Capital Management and its affiliates are not prohibited
from raising money for, or managing, another entity that makes the same types of investments that we target.
Stellus Capital Management and some of its affiliates, including our officers and our non-independent
directors, are not prohibited from raising money for, or managing, another investment entity that makes the same
types of investments as those we target. For example, Stellus Capital Management currently manages private
credit funds that have investment strategies that are similar, overlapping or identical to our investment
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strategy and with which we co-invest. In addition, pursuant to sub-advisory arrangements, Stellus Capital
Management provides non-discretionary advisory services to the D. E. Shaw group related to a private
investment fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves
as investment adviser. As a result, the time and resources they could devote to us may be diverted. In addition, we
may compete with any such investment entity for the same investors and investment opportunities.
Our incentive fee arrangements with Stellus Capital Management may vary from those of other investment
funds, account or investment vehicles managed by Stellus Capital Management, which may create an
incentive for Stellus Capital Management to devote time and resources to a higher fee-paying fund.
If Stellus Capital Management is paid a higher performance-based fee from any of its other funds, it may
have an incentive to devote more research and development or other activities, and/or recommend the allocation
of investment opportunities, to such higher fee-paying fund. For example, to the extent Stellus Capital
Management’s incentive compensation is not subject to a hurdle or total return requirement with respect to
another fund, it may have an incentive to devote time and resources to such other fund.
Stellus Capital Management’s liability is limited under the investment advisory agreement and we have agreed
to indemnify Stellus Capital Management against certain liabilities, which may lead Stellus Capital
Management to act in a riskier manner on our behalf than it would when acting for its own account.
Under the investment advisory agreement, Stellus Capital Management has not assumed any responsibility
to us other than to render the services called for under that agreement. It will not be responsible for any action of
our Board in following or declining to follow Stellus Capital Management’s advice or recommendations. Under
the investment advisory agreement, Stellus Capital Management, its officers, members and personnel, and any
person controlling or controlled by Stellus Capital Management will not be liable to us, any subsidiary of ours,
our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in
accordance with and pursuant to the investment advisory agreement, except those resulting from acts constituting
gross negligence, willful misfeasance, bad faith or reckless disregard of the duties that Stellus Capital
Management owes to us under the investment advisory agreement. In addition, as part of the investment advisory
agreement, we have agreed to indemnify Stellus Capital Management and each of its officers, directors, members,
managers and employees from and against any claims or liabilities, including reasonable legal fees and other
expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken
or omitted on our behalf pursuant to authority granted by the investment advisory agreement, except where
attributable to gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under
the investment advisory agreement. These protections may lead Stellus Capital Management to act in a riskier
manner when acting on our behalf than it would when acting for its own account.
Stellus Capital Management can resign as our investment adviser or administrator upon 60 days’ notice and
we may not be able to find a suitable replacement within that time, or at all, resulting in a disruption in our
operations that could adversely affect our financial condition, business and results of operations.
Stellus Capital Management has the right under the investment advisory agreement to resign as our
investment adviser at any time upon 60 days’ written notice, whether we have found a replacement or not.
Similarly, Stellus Capital Management has the right under the administration agreement to resign at any time
upon 60 days’ written notice, whether we have found a replacement or not. If Stellus Capital Management was to
resign, we may not be able to find a new investment adviser or administrator or hire internal management with
similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at
all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition,
business and results of operations as well as our ability to pay distributions to our stockholders are likely to be
adversely affected and the market price of our shares may decline. In addition, the coordination of our internal
management and investment or administrative activities, as applicable, is likely to suffer if we are unable to
identify and reach an agreement with a single institution or group of executives having the expertise possessed by
Stellus Capital Management. Even if we are able to retain comparable management, whether internal or external,
the integration of such management and
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their lack of familiarity with our investment objective may result in additional costs and time delays that may
adversely affect our business, financial condition, results of operations and cash flows.
If we fail to maintain our status as a BDC, our business and operating flexibility could be significantly
reduced.
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act imposes numerous constraints
on the operations of BDCs. For example, BDCs are required to invest at least 70.0% of their total assets in
specified types of securities, primarily in private companies or thinly traded U.S. public companies, cash, cash
equivalents, U.S. government securities and other high quality debt investments that mature in one year or less.
Failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an
enforcement action against us and/or expose us to claims of private litigants. In addition, upon approval of a
majority of our stockholders, we may elect to withdraw their respective election as a BDC. If we decide to
withdraw our election, we may be required to register as an investment company under the 1940 Act and be
subject to the substantially greater regulation under the 1940 Act as a closed-end investment company.
Compliance with these regulations would significantly decrease our operating flexibility and could significantly
increase our cost of doing business.
If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act
provisions applicable to BDCs or be precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after
giving effect to such acquisition, at least 70% of our total assets are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets.
However, we may be precluded from investing in what we believe to be attractive investments if such
investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our
assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such
violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in
existing portfolio companies (which could result in the dilution of our position).
If we do not maintain our election to be regulated as a BDC, we would be subject to regulation as a
registered closed-end investment company under the 1940 Act. As a registered closed-end investment company,
we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly
decrease our operating flexibility.
We may experience fluctuations in our annual and quarterly operating results.
We could experience fluctuations in our annual and quarterly operating results due to a number of factors,
including the interest rate payable on the loans and debt securities we acquire, the default rate on such loans and
securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized
gains or losses, the degree to which we encounter competition in our markets and general economic conditions.
In light of these factors, results for any period should not be relied upon as being indicative of performance in
future periods.
Our Board may change our investment objective, operating policies and strategies without prior notice or
stockholder approval.
Our Board has the authority, except as otherwise provided in the 1940 Act, to modify or waive certain of our
operating policies and strategies without prior notice and without stockholder approval. However, absent
stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election
as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have
on our business, operating results and the market price of our common stock. Nevertheless, any such changes
could adversely affect our business and impair our ability to make distributions to our stockholders.
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Our Board is authorized to reclassify any unissued shares of common stock into one or more classes of
preferred stock, which could convey special rights and privileges to its owners.
Under Maryland General Corporation Law and our charter, our Board is authorized to classify and reclassify
any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to
issuance of shares of each class or series, the Board will be required by Maryland law and our charter to set the
terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to stockholder
distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the Board could
authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of
delaying, deferring or preventing a transaction or a change in control that might involve a premium price for
holders of our common stock or that otherwise might be in their best interest. The cost of any such
reclassification would be borne by our common stockholders. Certain matters under the 1940 Act require the
separate vote of the holders of any issued and outstanding preferred stock. For example, the 1940 Act provides
that holders of preferred stock are entitled to vote separately from holders of common stock to elect two preferred
stock directors. We currently have no plans to issue preferred stock. The issuance of preferred shares convertible
into shares of common stock may also reduce the net income and net asset value per share of our common stock
upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent
we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder
approval. These effects, among others, could have an adverse effect on your investment in our common stock.
Provisions of the Maryland General Corporation Law and of our charter and bylaws could deter takeover
attempts and have an adverse impact on the price of our common stock.
The Maryland General Corporation Law and our charter and bylaws contain provisions that may discourage,
delay or make more difficult a change in control of Stellus Capital Investment Corporation or the removal of our
directors. We are subject to the Maryland Business Combination Act, subject to any applicable requirements of
the 1940 Act. Our Board has adopted a resolution exempting from the Business Combination Act any business
combination between us and any other person, subject to prior approval of such business combination by our
Board, including approval by a majority of our independent directors. If the resolution exempting business
combinations is repealed or our Board does not approve a business combination, the Business Combination Act
may discourage third parties from trying to acquire control of us and increase the difficulty of consummating
such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions of our stock by
any person. If we amend our bylaws to repeal the exemption from the Control Share Acquisition Act, the Control
Share Acquisition Act also may make it more difficult for a third party to obtain control of us and increase the
difficulty of consummating such a transaction.
We have also adopted measures that may make it difficult for a third party to obtain control of us, including
provisions of our charter classifying our Board in three classes serving staggered three-year terms, and
authorizing our Board to classify or reclassify shares of our stock in one or more classes or series, to cause the
issuance of additional shares of our stock, to amend our charter without stockholder approval and to increase or
decrease the number of shares of stock that we have authority to issue. These provisions, as well as other
provisions of our charter and bylaws, may delay, defer or prevent a transaction or a change in control that might
otherwise be in the best interests of our stockholders.
We are highly dependent on information systems and systems failures could significantly disrupt our business,
which may, in turn, negatively affect the market price of our common stock and our ability to make
distributions to our stockholders.
Our business is highly dependent on the communications and information systems of Stellus Capital
Management. In addition, certain of these systems are provided to Stellus Capital Management by third party
service providers. Any failure or interruption of such systems, including as a result of the termination of an
agreement with any such third-party service provider, could cause delays or other problems in our activities. This,
in turn, could have a material adverse effect on our operating results and negatively affect the market price of our
common stock and our ability to make distributions to our stockholders.
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The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery
systems and management continuity planning could impair our ability to conduct business effectively.
The occurrence of a disaster such as a cyber-attack, a natural catastrophe, an industrial accident, a terrorist
attack or war, public health crises (including the recent coronavirus outbreak), events unanticipated in our disaster
recovery systems, or a support failure from external providers, could have an adverse effect on our ability to
conduct business and on our results of operations and financial condition, particularly if those events affect our
computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant
number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our
business could be severely compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our
implementation of a variety of security measures, our computer systems could be subject to cyber-attacks and
unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies,
we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized
access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the
confidential, proprietary and other information processed and stored in, and transmitted through, our computer
systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in
damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer
dissatisfaction or loss.
Risks Related to Economic Conditions
Global economic, political and market conditions may adversely affect our business, results of operations and
financial condition, including our revenue growth and profitability.
The current worldwide financial market situation, as well as various social and political tensions in the
United States and around the world, may contribute to increased market volatility, may have long-term effects on
the United States and worldwide financial markets and may cause economic uncertainties or deterioration in the
U.S. and worldwide. The impact of downgrades by rating agencies to the U.S. government’s sovereign credit
rating or its perceived creditworthiness as well as potential government shutdowns could adversely affect the U.S.
and global financial markets and economic conditions. Since 2010, several European Union, or EU, countries
have faced budget issues, some of which may have negative long-term effects for the economies of those
countries and other EU countries. There is continued concern about national-level support for the Euro and the
accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member
countries. In addition, the fiscal policy of foreign nations, such as Russia and China, may have a severe impact on
the worldwide and U.S. financial markets. The decision made in the United Kingdom referendum to leave the EU
(“Brexit”) has led to volatility in global financial markets and may lead to weakening in consumer, corporate and
financial confidence in the United Kingdom and Europe. While the United Kingdom exited the EU on
January 31, 2020, uncertainty remains as to the effects of the transition period and the United Kingdom’s ability
to negotiate a free trade deal, which may lead to continued volatility. Additionally, volatility in the Chinese stock
markets and global markets for commodities may affect other financial markets worldwide. We cannot predict the
effects of these or similar events in the future on the U.S. and global economies and securities markets or on our
investments. We monitor developments in economic, political and market conditions and seek to manage our
investments in a manner consistent with achieving our investment objective, but there can be no assurance that
we will be successful in doing so.
The Chinese capital markets have experienced periods of instability over the past several years. The current
political climate has also intensified concerns about a potential trade war between the U.S. and China in
connection with each country’s recent or proposed tariffs on the other country’s products. These market and
economic disruptions, the potential trade war with China and the impact of public health epidemics like the
coronavirus currently affecting China and the wider global community may have a material adverse impact on the
ability of our portfolio companies to fulfill their end customers’ orders due to supply chain delays, limited access
to key commodities or technologies or other events that impact their manufacturers or their suppliers. Such events
have affected, and may in the future affect, the global and U.S. capital markets, and our business, financial
condition or results of operations.
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Risks Related to our Investments
Economic recessions or downturns could impair our portfolio companies, which would harm our operating
results.
Many of the portfolio companies in which we make, and expect to make, investments, including those
currently included in our portfolio, are likely to be susceptible to economic slowdowns or recessions and may be
unable to repay our loans during such periods. Therefore, the number of our non-performing assets is likely to
increase, and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions
may decrease the value of collateral securing some of our loans and debt securities and the value of our equity
investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in
revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit
our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could
prevent us from increasing our investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders
could lead to defaults and, potentially, termination of its loans and foreclosure on its assets, which could trigger
cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations
under the loans and debt securities that we hold. We may incur expenses to the extent necessary to seek recovery
upon default or to negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases
can be subject to lender liability claims for actions taken by them when they become too involved in the
borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender’s
liability claim, including as a result of actions taken if we render significant managerial assistance to the
borrower. Furthermore, if one of our portfolio companies were to file for bankruptcy protection, a bankruptcy
court might re-characterize our debt holding and subordinate all or a portion of our claim to claims of other
creditors, even though we may have structured our investment as senior secured debt. The likelihood of such a re-
characterization would depend on the facts and circumstances, including the extent to which we provided
managerial assistance to that portfolio company.
Our investments in leveraged portfolio companies may be risky, and we could lose all or part of our
investment.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which
we invest may have limited financial resources and may be unable to meet their obligations under their loans and
debt securities that we hold. Such developments may be accompanied by a deterioration in the value of any
collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in
connection with our investment. Smaller leveraged companies also may have less predictable operating results
and may require substantial additional capital to support their operations, finance their expansion or maintain
their competitive position.
We may hold the loans and debt securities of leveraged companies that may, due to the significant operating
volatility typical of such companies, enter into bankruptcy proceedings.
Leveraged companies may experience bankruptcy or similar financial distress. The bankruptcy process has a
number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested
matters and adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by a portfolio
company may adversely and permanently affect that company. If the proceeding is converted to a liquidation, the
value of the portfolio company may not equal the liquidation value that was believed to exist at the time of the
investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on
investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes
effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be
paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims
under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own
may be lost by increases in the number and amount of claims in the same class or by different classification and
treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to
identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for
example, claims for taxes) may be substantial.
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Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of
our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little
public information exists about these companies, and we rely on the ability of Stellus Capital Management’s
investment professionals to obtain adequate information to evaluate the potential returns from investing in these
companies. If we are unable to uncover all material information about these companies, we may not make a fully
informed investment decision, and we may lose money on our investments. Middle-market companies may have
limited financial resources and may be unable to meet their obligations under their loans and debt securities that
we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the
likelihood of our realizing any guarantees we may have obtained in connection with our investment. In addition,
such companies typically have shorter operating histories, narrower product lines and smaller market shares than
larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as
well as general economic downturns. Additionally, middle-market companies are more likely to depend on the
management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or
termination of one or more of these persons could have a material adverse impact on one or more of the portfolio
companies we invest in and, in turn, on us. Middle-market companies also may be parties to litigation and may be
engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition,
our executive officers, directors and investment adviser may, in the ordinary course of business, be named as
defendants in litigation arising from our investments in portfolio companies.
The lack of liquidity in our investments may adversely affect our business.
Most of our assets are invested in illiquid loans and securities, and a substantial portion of our investments
in leveraged companies are subject to legal and other restrictions on resale or are otherwise less liquid than more
broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such
investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly,
we may realize significantly less than the value at which we have previously recorded our investments. Also, as
noted above, we may be limited or prohibited in our ability to sell or otherwise exit certain positions in our
portfolio as such a transaction could be considered a joint transaction prohibited by the 1940 Act.
Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio
investments, reducing our net asset value through increased net unrealized depreciation.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable,
at fair value as determined in good faith by our Board. As part of the valuation process, we may take into account
the following types of factors, if relevant, in determining the fair value of our investments:
•
•
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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.
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When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we
use the pricing indicated by the external event to corroborate our valuation. We record decreases in the market
values or fair values of our investments as unrealized depreciation. Declines in prices and liquidity in the
corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of
these factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our
portfolio. Depending on market conditions, we could incur substantial realized losses and may suffer additional
unrealized losses in future periods, which could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we are not
limited with respect to the proportion of our assets that may be invested in securities of a single issuer.
We are classified as a non-diversified investment company within the meaning of the 1940 Act, which
means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in
securities of a single issuer. Beyond the asset diversification requirements associated with our qualification as a
RIC under the Code, we do not have fixed guidelines for diversification. To the extent that we assume large
positions in the securities of a small number of issuers or our investments are concentrated in relatively few
industries, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a
result of changes in the financial condition or the market’s assessment of the issuer. We may also be more
susceptible to any single economic or regulatory occurrence than a diversified investment company.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that
portfolio company as “follow-on” investments, in seeking to:
•
•
increase or maintain in whole or in part our position as a creditor or equity ownership percentage in a
portfolio company;
exercise warrants, options or convertible securities that were acquired in the original or subsequent
financing; or
•
preserve or enhance the value of our investment.
We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on
our part to make follow-on investments may, in some circumstances, jeopardize the continued viability of a
portfolio company and our initial investment, or may result in a missed opportunity for us to increase our
participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment,
we may elect not to make a follow-on investment because we may not want to increase our level of risk, because
we prefer other opportunities or because we are inhibited by compliance with BDC requirements of the 1940 Act
or the desire to maintain our qualification as a RIC. Our ability to make follow-on investments may also be
limited by our compliance with the conditions under the exemptive relief order we received from the SEC related
to co-investments with investment funds managed by Stellus Capital Management or Stellus Capital
Management’s allocation policy.
Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able
to exercise control over our portfolio companies or to prevent decisions by management of our portfolio
companies that could decrease the value of our investments.
We do not hold controlling equity positions in any of the portfolio companies included in our portfolio and,
although we may do so in the future, we do not currently intend to hold controlling equity positions in our
portfolio companies (including those included in our portfolio). As a result, we are subject to the risk that a
portfolio company may make business decisions with which we disagree, and that the management and/or
stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due
to the lack of liquidity of the debt and equity investments that we hold in our portfolio companies, we may not be
able to dispose of our investments in the event we disagree with the actions of a portfolio company and may
therefore suffer a decrease in the value of our investments.
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Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders
could lead to defaults and, potentially, termination of its loans and foreclosure on its assets. This could trigger
cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations
under the loans or debt or equity securities that we hold. We may incur expenses to the extent necessary to seek
recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants,
with a defaulting portfolio company.
Prepayments of our debt investments by our portfolio companies could adversely impact our results of
operations and ability to make stockholder distributions and result in a decline in the market price of our
shares.
We are subject to the risk that the debt investments we make in our portfolio companies may be repaid prior
to maturity. We expect that our investments will generally allow for repayment at any time subject to certain
penalties. When this occurs, we intend to generally reinvest these proceeds in temporary investments, pending
their future investment in accordance with our investment strategy. These temporary investments will typically
have substantially lower yields than the debt being prepaid, and we could experience significant delays in
reinvesting these amounts. Any future investment may also be at lower yields than the debt that was repaid. As a
result, our results of operations could be materially adversely affected if one or more of our portfolio companies
elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our ability to make, or
the amount of, stockholder distributions with respect to our common stock, which could result in a decline in the
market price of our shares.
The interest rates of our floating-rate loans to our portfolio companies that extend beyond 2021 might be
subject to change based on recent regulatory changes.
LIBOR, the London Interbank Offered Rate, is the basic rate of interest used in lending transactions between
banks on the London interbank market and is widely used as a reference for setting the interest rate on loans
globally. We typically use LIBOR as a reference rate in floating-rate loans we extend to portfolio companies such
that the interest due to us pursuant to a term loan extended to a portfolio company is calculated using LIBOR.
The terms of our debt investments generally include minimum interest rate floors which are calculated based on
LIBOR.
On July 27, 2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading or
compelling banks to submit the London Interbank Offered Rate (“LIBOR”) after 2021. It is unclear if at that time
whether LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it
continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates
Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S.
dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities
called the Secured Overnight Financing Rate (“SOFR”). The first publication of SOFR was released in
April 2018. Whether or not SOFR attains market traction as a LIBOR replacement remains a question and the
future of LIBOR at this time is uncertain.
Additionally, on June 12, 2019 the Staff of the SEC’s Division of Corporate Finance, Division of Investment
Management, Division of Trading and Markets, and Office of the Chief Accountant issued a statement about the
potentially significant effects on financial markets and market participants when LIBOR is discontinued in 2021
and no longer available as a reference benchmark rate. The Staff encouraged all market participants to identify
contracts that reference LIBOR and begin transitions to alternative rates. On December 30, 2019, the SEC’s
Chairman, Division of Corporate Finance and Office of the Chief Accountant issued a statement to encourage
audit committees in particular to understand management’s plans to identify and address the risks associated with
the elimination of LIBOR, and, specifically, the impact on accounting and financial reporting and any related
issues associated with financial products and contracts that reference LIBOR, as the risks associated with the
discontinuation of LIBOR and transition to an alternative reference rate will be exacerbated if the work is not
completed in a timely manner.
The elimination of LIBOR or any other changes or reforms to the determination or supervision of LIBOR
could have an adverse impact on the market for or value of any LIBOR-linked securities, loans, and
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other financial obligations or extensions or credit held by or due to us or on our overall financial condition or
results of operations. If LIBOR ceases to exist, we may need to renegotiate the credit agreements extending
beyond 2021 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate to
replace LIBOR with the new standard that is established. In addition, the cessation of LIBOR could:
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Adversely impact the pricing, liquidity, value of, return on and trading for a broad array of financial
products, including any LIBOR-linked securities, loans and derivatives that are included in our assets and
liabilities;
Require extensive changes to documentation that governs or references LIBOR or LIBOR-based
products, including, for example, pursuant to time-consuming renegotiations of existing documentation to
modify the terms of outstanding investments;
Result in inquiries or other actions from regulators in respect of our preparation and readiness for the
replacement of LIBOR with one or more alternative reference rates;
Result in disputes, litigation or other actions with portfolio companies, or other counterparties, regarding
the interpretation and enforceability of provisions in our LIBOR-based investments, such as fallback
language or other related provisions, including, in the case of fallbacks to the alternative reference rates,
any economic, legal, operational or other impact resulting from the fundamental differences between
LIBOR and the various alternative reference rates;
Require the transition and/or development of appropriate systems and analytics to effectively transition
our risk management processes from LIBOR-based products to those based on one or more alternative
reference rates, which may prove challenging given the limited history of the proposed alternative
reference rates; and
•
Cause us to incur additional costs in relation to any of the above factors.
There is no guarantee that a transition from LIBOR to an alternative will not result in financial market
disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have a
material adverse effect on our business, result of operations, financial condition, and unit price.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and
some of our portfolio companies may be adversely affected by climate change. For example, the needs of
customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent
weather conditions are affected by climate change, energy use could increase or decrease depending on the
duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of
operations of our portfolio companies if the use of energy products or services is material to their business. A
decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition,
through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs,
and can contribute to increased system stresses, including service interruptions. In December 2015 the United
Nations, of which the U.S. is a member, adopted a climate accord (the “Paris Agreement”) with the long-term
goal of limiting global warming and the short-term goal of significantly reducing greenhouse gas emissions.
Although the U.S. ratified the Paris Agreement on November 4, 2016, the current administration announced the
U.S. would cease participation. As a result, some of our portfolio companies may become subject to new or
strengthened regulations or legislation, at least through November 4, 2020 (the earliest date the U.S. may
withdraw from the Paris Agreement), which could increase their operating costs and/or decrease their revenues.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such
companies.
We invest a portion of our capital in second lien and subordinated loans issued by our portfolio companies.
The portfolio companies usually have, or may be permitted to incur, other debt that ranks equally with, or senior
to, the loans in which we invest. By their terms, such debt instruments may provide that the holders are entitled to
receive payment of interest or principal on or before the dates on which we are entitled to receive payments in
respect of the loans in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization
or bankruptcy of a portfolio company, holders of debt instruments
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ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full
before we receive any distribution in respect of our investment. After repaying senior creditors, a portfolio
company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking
equally with loans in which we invest, we would have to share any distributions on an equal and ratable basis
with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or
bankruptcy of the relevant portfolio company.
Additionally, certain loans that we make to portfolio companies may be secured on a second priority basis
by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral
will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other
future debt that may be permitted to be incurred by the portfolio company under the agreements governing the
loans. The holders of obligations secured by first priority liens on the collateral will generally control the
liquidation of, and be entitled to receive proceeds from, any realization of the collateral to repay their obligations
in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and
economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if
any, from sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second
priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such
proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second
priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an
unsecured claim against the portfolio company’s remaining assets, if any.
We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from
any interest in collateral of such companies. Liens on such portfolio companies’ collateral, if any, will secure the
portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is
permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations
secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any
realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in
the event of liquidation will depend on market and economic conditions, the availability of buyers and other
factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to
satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were
not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally
with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies
with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements
that we enter into with the holders of such senior debt. Under a typical intercreditor agreement, at any time that
obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may
be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first
priority liens:
•
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•
•
•
the ability to cause the commencement of enforcement proceedings against the collateral;
the ability to control the conduct of such proceedings;
the approval of amendments to collateral documents;
releases of liens on the collateral; and
waivers of past defaults under collateral documents.
We may not have the ability to control or direct such actions, even if our rights are adversely affected.
We may be exposed to special risks associated with bankruptcy cases.
One or more of our portfolio companies may be involved in bankruptcy or other reorganization or
liquidation proceedings. Many of the events within a bankruptcy case are adversarial and often beyond the
control of the creditors. While creditors generally are afforded an opportunity to object to significant actions, we
cannot assure you that a bankruptcy court would not approve actions that may be contrary to our
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interests. There also are instances where creditors can lose their ranking and priority if they are considered to
have taken over management of a borrower.
To the extent that portfolio companies in which we have invested through a unitranche facility are involved
in bankruptcy proceedings, the outcome of such proceedings may be uncertain. For example, it is unclear whether
a bankruptcy court would enforce an agreement among lenders which sets the priority of payments among
unitranche lenders. In such a case, the “first out” lenders in the unitranche facility may not receive the same
degree of protection as they would if the agreement among lenders was enforced.
The reorganization of a company can involve substantial legal, professional and administrative costs to a
lender and the borrower. It is subject to unpredictable and lengthy delays and during the process a company’s
competitive position may erode, key management may depart and a company may not be able to invest
adequately. In some cases, the debtor company may not be able to reorganize and may be required to liquidate
assets. The debt of companies in financial reorganization will, in most cases, not pay current interest, may not
accrue interest during reorganization and may be adversely affected by an erosion of the issuer’s fundamental
value.
In addition, lenders can be subject to lender liability claims for actions taken by them where they become
too involved in the borrower’s business or exercise control over the borrower. For example, we could become
subject to a lender liability claim (alleging that we misused our influence on the borrower for the benefit of its
lenders), if, among other things, the borrower requests significant managerial assistance from us and we provide
that assistance. To the extent we and an affiliate both hold investments in the same portfolio company that are of
a different character, we may also face restrictions on our ability to become actively involved in the event that
portfolio company becomes distressed as a result of the restrictions imposed on transactions involving affiliates
under the 1940 Act. In such cases, we may be unable to exercise rights we may otherwise have to protect our
interests as security holders in such portfolio company.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash
flow to service their debt obligations to us.
We may make subordinated investments that rank below other obligations of the obligor in right of payment.
Subordinated investments are subject to greater risk of default than senior obligations as a result of adverse
changes in the financial condition of the obligor or economic conditions in general. If we make a subordinated
investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-
to-equity ratio may create increased risks that its operations might not generate sufficient cash flow to service all
of its debt obligations.
The disposition of our investments may result in contingent liabilities.
Substantially all of our investments involve loans and private securities. In connection with the disposition
of an investment in loans and private securities, we may be required to make representations about the business
and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We
may also be required to indemnify the purchasers of such investment to the extent that any such representations
turn out to be inaccurate or with respect to potential liabilities. These arrangements may result in contingent
liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions
previously made to us.
We may not realize gains from our equity investments.
When we invest in loans and debt securities, we may acquire warrants or other equity securities of portfolio
companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, we
will attempt to dispose of them and realize gains upon our disposition of them. However, the equity interests we
receive may not appreciate in value and, may decline in value. As a result, we may not be able to realize gains
from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be
sufficient to offset any other losses we experience.
Changes in healthcare laws and other regulations applicable to some of our portfolio companies’ businesses
may constrain their ability to offer their products and services.
As of December 31, 2019, our investments in Healthcare & Pharmaceuticals companies represented 14.9%
of our total portfolio, at fair value. Changes in healthcare or other laws and regulations applicable to
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the businesses of some of our portfolio companies may occur that could increase their compliance and other costs
of doing business, require significant systems enhancements, or render their products or services less profitable or
obsolete, any of which could have a material adverse effect on their results of operations. There has also been an
increased political and regulatory focus on healthcare laws in recent years, and new legislation could have a
material effect on the business and operations of some of our portfolio companies.
Our ability to enter into transactions involving derivatives and financial commitment transactions may be
limited.
In November 2019, the SEC proposed a rule regarding the ability of a BDC (or a registered investment
company) to use derivatives and other transactions that create future payment or delivery obligations (except
reverse repurchase agreements and similar financing transactions). If adopted as proposed, BDCs that use
derivatives would be subject to a value-at-risk (“VaR”) leverage limit, certain other derivatives risk management
program and testing requirements and requirements related to board reporting. These new requirements would
apply unless the BDC qualified as a “limited derivatives user,” as defined in the SEC’s proposal. A BDC that
enters into reverse repurchase agreements or similar financing transactions would need to aggregate the amount
of indebtedness associated with the reverse repurchase agreements or similar financing transactions with the
aggregate amount of any other senior securities representing indebtedness when calculating the BDC’s asset
coverage ratio. Under the proposed rule, a BDC may enter into an unfunded commitment agreement that is not a
derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has a
reasonable belief, at the time it enters into such an agreement, that it will have sufficient cash and cash
equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as it
becomes due. If the BDC cannot meet this test, it is required to treat unfunded commitments as a derivatives
transaction subject to the requirements of the rule. Collectively, these proposed requirements, if adopted, may
limit our ability to use derivatives and/or enter into certain other financial contracts.
Risks Relating to Our Common Stock
There is a risk that you may not receive distributions or that our distributions may not grow over time and a
portion of our distributions may be a return of capital.
We intend to make distributions on a monthly basis to our stockholders out of assets legally available for
distribution (i.e., not subject to any legal restrictions under Maryland law on the distribution thereof). We cannot
assure you that we will achieve investment results that will allow us to make a specified level of cash
distributions or year-to-year increases in cash distributions. All distributions will be made at the discretion of our
Board and will depend on our earnings, financial condition, maintenance of RIC status, compliance with
applicable BDC, SBA regulations and such other factors as our Board may deem relative from time to time. We
cannot assure you that we will make distributions to our stockholders in the future.
Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors
described in this annual report on Form 10-K. Due to the asset coverage test applicable to us under the 1940 Act
as a BDC, we may be limited in our ability to make distributions. In addition, restrictions and provisions in our
Credit Facility, the 2022 Notes and any future credit facilities, as well as in the terms of any debt securities we
issue, may limit our ability to make distributions in certain circumstances.
When we make distributions, we will be required to determine the extent to which such distributions are
paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated
earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our
stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain.
Stockholders may experience dilution in their ownership percentage if they do not participate in our dividend
reinvestment plan.
All distributions declared in cash payable to stockholders that are participants in our dividend reinvestment
plan are generally automatically reinvested in shares of our common stock. As a result, stockholders that do not
participate in the dividend reinvestment plan may experience dilution over time. Stockholders who receive
distributions in shares of common stock may experience accretion to the net asset
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value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount. The
level of accretion or discount would depend on various factors, including the proportion of our stockholders who
participate in the plan, the level of premium or discount at which our shares are trading and the amount of the
distribution payable to a stockholder.
Our shares might trade at premiums that are unsustainable or at discounts from net asset value.
Shares of BDCs like us may, during some periods, trade at prices higher than their net asset value per share
and, during other periods, as frequently occurs with closed-end investment companies, trade at prices lower than
their net asset value per share. The perceived value of our investment portfolio may be affected by a number of
factors including perceived prospects for individual companies we invest in, market conditions for common stock
generally, for initial public offerings and other exit events for venture capital backed companies, and the mix of
companies in our investment portfolio over time. Negative or unforeseen developments affecting the perceived
value of companies in our investment portfolio could result in a decline in the trading price of our common stock
relative to our net asset value per share.
The possibility that our shares will trade at a discount from net asset value or at premiums that are
unsustainable are risks separate and distinct from the risk that our net asset value per share will decrease. The risk
of purchasing shares of a BDC that might trade at a discount or unsustainable premium is more pronounced for
investors who wish to sell their shares in a relatively short period of time because, for those investors, realization
of a gain or loss on their investments is likely to be more dependent upon changes in premium or discount levels
than upon increases or decreases in net asset value per share.
Investing in our securities may involve an above average degree of risk.
The investments we make in accordance with our investment objective may result in a higher amount of
risk, and higher volatility or loss of principal, than alternative investment options. Our investments in portfolio
companies may be speculative and, therefore, an investment in our securities may not be suitable for someone
with lower risk tolerance.
The market price of our securities may fluctuate significantly.
The market price and liquidity of the market for our securities may be significantly affected by numerous
factors, some of which are beyond our control and may not be directly related to our operating performance.
These factors include:
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significant volatility in the market price and trading volume of securities of BDCs or other companies in
our sector, which is not necessarily related to the operating performance of these companies;
changes in regulatory policies or tax guidelines, particularly with respect to RICs, BDCs and SBICs;
loss of our qualification as a RIC or BDC or the status of either of our SBIC subsidiaries as a SBIC;
changes in earnings or variations in operating results;
changes in the value of our portfolio of investments;
changes in accounting guidelines governing valuation of our investments;
any shortfall in revenue or net income or any increase in losses from levels expected by investors or
securities analysts;
departure of Stellus Capital Management’s key personnel;
operating performance of companies comparable to us; and
general economic trends and other external factors.
Risks Relating to Our Debt Securities
The 2022 Notes are unsecured and therefore are effectively subordinated to any secured indebtedness we have
incurred or may incur in the future.
The 2022 Notes are not and will not be secured by any of our assets or any of the assets of any future
subsidiaries and rank equally in right of payment of our future unsubordinated, unsecured senior
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indebtedness. As a result, the 2022 Notes are effectively subordinated to any secured indebtedness we or our
subsidiaries have incurred and may incur in the future (or any indebtedness that is initially unsecured to which we
subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation,
dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured
indebtedness and the secured indebtedness of any future subsidiaries may assert rights against the assets pledged
to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to
pay other creditors, including the holders of the 2022 Notes. As of December 31, 2019, we had $161.6 million
outstanding under the Credit Facility. The indebtedness under the Credit Facility is effectively senior to the 2022
Notes to the extent of the value of the assets securing such indebtedness.
The 2022 Notes are structurally subordinated to the indebtedness and other liabilities of any future
subsidiaries.
The 2022 Notes are obligations exclusively of Stellus Capital Investment Corporation and not of our
subsidiaries. None of our subsidiaries are or will be a guarantor of the 2022 Notes and the 2022 Notes are not
required to be guaranteed by any subsidiaries we may acquire or create in the future. Except to the extent we are a
creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have
priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders
of the 2022 Notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one
or more of our subsidiaries, our claims would still be effectively subordinated to any security interests in the
assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our
claims. Consequently, the 2022 Notes are structurally subordinated to all indebtedness, including any future SBA-
guaranteed debentures, and other liabilities of any of our subsidiaries and any subsidiaries that we may in the
future acquire or establish. In addition, our subsidiaries may incur substantial additional indebtedness in the
future, all of which would be structurally senior to the 2022 Notes.
The indenture under which the 2022 Notes is issued contains limited protection for holders of the 2022 Notes.
The indenture under which the 2022 Notes is issued offers limited protection to holders of the 2022 Notes.
The terms of the indenture and the 2022 Notes do not restrict our or any of our subsidiaries’ ability to engage in,
or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have an adverse
impact on an investment in the 2022 Notes. In particular, the terms of the indenture and the 2022 Notes do not
place any restrictions on our or our subsidiaries’ ability to:
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•
issue securities or otherwise incur additional indebtedness or other obligations, including (1) any
indebtedness or other obligations that would be equal in right of payment to the 2022 Notes, (2) any
indebtedness or other obligations that would be secured and therefore rank effectively senior in right of
payment to the 2022 Notes to the extent of the values of the assets securing such debt, (3) indebtedness of
ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the
2022 Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries or that
would be senior to our equity interests in those entities and therefore rank structurally senior to the 2022
Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness
or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(1) of
the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of
the 1940 Act, but giving effect, in each case, to any exemptive relief granted to us by the SEC. Currently,
these provisions generally prohibit us from making additional borrowings, including through the issuance
of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the
1940 Act, equals at least 150% after such borrowings;
pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other
securities ranking junior in right of payment to the 2022 Notes, including subordinated indebtedness, in
each case other than dividends, purchases, redemptions or payments that would cause a violation of
Section 18(a)(1)(B) as modified by (i) Section 61(a)(1) of the 1940 Act or any successor provisions and
(ii) the exception set forth below, despite the fact that we are not currently subject to such provisions of
the 1940 Act in connection with the offer and sale of the 2022 Notes, except that we will be permitted to
declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as
modified by Section 61(a)(1) of the 1940 Act, but only up to such amount
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as is necessary in order for us to maintain our status as a regulated investment company under Subchapter
M of the Internal Revenue Code of 1986 and, provided that, any such prohibition will not apply until such
time as our asset coverage has been below the minimum asset coverage required pursuant to clause
(i) above for more than six consecutive months. If Section 18(a)(1)(B) as modified by Section 61(a)(1) of
the 1940 Act were currently applicable to us in connection with the offering of the 2022 Notes, these
provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of
our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act,
were below 150% at the time of the declaration of the dividend or distribution or the purchase and after
deducting the amount of such dividend, distribution or purchase;
sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or
substantially all of our assets);
enter into transactions with affiliates;
create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;
make investments; or
create restrictions on the payment of dividends or other amounts to us from our subsidiaries.
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In addition, the indenture does not require us to offer to purchase the 2022 Notes in connection with a
change of control or any other event.
Furthermore, the terms of the indenture and the 2022 Notes do not protect holders of the 2022 Notes in the
event that we experience changes (including significant adverse changes) in our financial condition, results of
operations or credit ratings, as they do not require that we or our subsidiaries adhere to any financial tests or
ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.
Our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by
the terms of the 2022 Notes may have important consequences for holders of the 2022 Notes, including making it
more difficult for us to satisfy our obligations with respect to the 2022 Notes or negatively affecting the trading
value of the 2022 Notes.
Other debt we issue or incur in the future could contain more protections for its holders than the indenture
and the 2022 Notes, including additional covenants and events of default. For example, the indenture under
which the 2022 Notes is issued does not contain cross-default provisions that are contained in the Credit Facility.
The issuance or incurrence of any such debt with incremental protections could affect the market for and trading
levels and prices of the 2022 Notes.
An active trading market for the 2022 Notes may not develop, which could limit the market price of the 2022
Notes. Moreover, the 2022 Notes are not expected to be rated, which may subject them to greater volatility than
rated 2022 Notes and particularly, greater than similar securities with an investment grade rating.
Although we have listed the 2022 Notes on the NYSE under the symbol “SCA,” we cannot provide any
assurances that an active trading market will develop or be maintained for the 2022 Notes. The 2022 Notes are
not rated which would impact their trading and subject them to greater price volatility. To the extent they are
rated and received a non-investment grade rating, their price and trading activity could be negatively impacted.
Moreover, if a rating agency assigns the 2022 Notes a non-investment grade rating, the 2022 Notes may be
subject to greater price volatility than securities of similar maturity without such a non-investment grade rating.
Certain of the underwriters have advised us that they intend to make a market in the 2022 Notes, but they are not
obligated to do so. The underwriters may discontinue any market-making in the 2022 Notes at any time at their
sole discretion. Accordingly, we cannot assure you that a liquid trading market will develop for the 2022 Notes,
that you will be able to sell your 2022 Notes at a particular time or that the price you receive when you sell will
be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the 2022
Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the 2022
Notes for an indefinite period of time.
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We may choose to redeem the 2022 Notes when prevailing interest rates are relatively low.
Since September 15, 2019, we have had the option to choose to redeem the 2022 Notes from time to time,
especially when prevailing interest rates are lower than the rate borne by the 2022 Notes. If prevailing rates are
lower at the time of redemption, holders of the 2022 Notes may not be able to reinvest the redemption proceeds
in a comparable security at an effective interest rate as high as the interest rate on the 2022 Notes being
redeemed. Our redemption right also may adversely impact a Noteholder’s ability to sell the 2022 Notes as the
optional redemption date or period approaches.
If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the
2022 Notes.
As of December 31, 2019, we had approximately $161.6 million of indebtedness outstanding under the
Credit Facility. Any default under the agreements governing our indebtedness, including a default under the
Credit Facility or other indebtedness to which we may be a party that is not waived by the required lenders, and
the remedies sought by the holders of such indebtedness could make us unable to pay principal, premium, if any,
and interest on the 2022 Notes and substantially decrease the market value of the 2022 Notes. If we are unable to
generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of
principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various
covenants, including financial and operating covenants, in the instruments governing our indebtedness (including
the Credit Facility), we could be in default under the terms of the agreements governing such indebtedness. In the
event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to
be due and payable, together with accrued and unpaid interest, the lenders under the Credit Facility or other debt
we may incur in the future could elect to terminate their commitments, cease making further loans and institute
foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. Our ability to
generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive,
legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that
our business will generate cash flow from operations, or that future borrowings will be available to us under the
Credit Facility or otherwise, in an amount sufficient to enable us to meet our payment obligations under the 2022
Notes and our other debt and to fund other liquidity needs.
If our operating performance declines and we are not able to generate sufficient cash flow to service our debt
obligations, we may in the future need to refinance or restructure our debt, including any 2022 Notes sold, sell
assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the
required lenders under the Credit Facility or other debt that we may incur in the future to avoid being in default.
If we are unable to implement one or more of these alternatives, we may not be able to meet our payment
obligations under the 2022 Notes and our other debt. If we breach our covenants under the Credit Facility or other
debt and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would
be in default under the Credit Facility or other debt, the lenders could exercise their rights as described above,
and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured
obligations could proceed against the collateral securing the debt. Because the Credit Facility has, and any future
credit facilities will likely have, customary cross-default provisions, if the indebtedness under the 2022 Notes, the
Credit Facility or under any future credit facility is accelerated, we may be unable to repay or finance the
amounts due.
Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Properties
We do not own any real estate or other physical properties materially important to our operation. Our
headquarters are located at 4400 Post Oak Parkway, Suite 2200, Houston, Texas. We also maintain offices in
Charlotte, North Carolina and in the Washington, D.C. area. All locations are provided to us by Stellus Capital
Management pursuant to the administration agreement. We believe that our office facilities are suitable and
adequate for our business as we contemplate conducting it.
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Item 3.
Legal Proceedings
We and Stellus Capital Management 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 4.
Mine Safety Disclosures
Not applicable.
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PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Our common stock is traded on the New York Stock Exchange, or “NYSE”, under the symbol “SCM.” As of
January 31, 2020, we had 10 stockholders of record, which did not include stockholders for whom shares are held
in nominee or street name.
We generally intend to pay monthly distributions to our stockholders out of assets legally available for
distribution. Our monthly distributions, if any, will be determined by our board of directors. From Inception to
December 2013, we paid dividends equivalent to $.1133 per share on a quarterly basis. Beginning in
January 2014, we have paid aggregate monthly dividends of $0.1133 per share on our common shares. Payment
of dividends on our common shares is within the discretion of the Board, and depends on, among other factors,
net earnings, capital requirements and the financial condition of the Company. However, the Company intends to
continue to pay comparable dividends to shareholders in the future. See Note 3 for detail of distributions paid life
to date.
Recent Sales of Unregistered Securities
During the year ended December 31, 2019, no shares of common stock were issued under the distribution
reinvestment program (“DRIP”). During the year ended December 31, 2018, we issued a total of 7,931 shares of
common stock under the distribution reinvestment program (“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 for the year ended December 31, 2018 was approximately $94,788. No shares were issued
under the DRIP program during the year ended December 31, 2017.
Use of Proceeds from Recent Sales of Registered Securities
In March and April 2019, the Company sold 2,952,149 shares of its common stock for net proceeds of
$41,302,707, which was used to repay borrowings under the Credit Facility.
For the year ended December 31, 2019, the Company sold 225,787 additional shares of common stock
through an at-the-market sales program (the “ATM Program”) for net proceeds of $3,022,689, (including
underwriter and other expenses of $240,040) which was used to repay borrowings under the Credit Facility.
During April 2017, the Company sold 3,162,500 shares of its common stock for net proceeds of
$43,060,618, which was used to repay borrowings under the Credit Facility. Subsequently, the Credit Facility was
redrawn to fund additional equity in the SBIC I Subsidiary and fund new transactions.
During August and September 2017, the Company issued unsecured notes totaling $48,875,000, the
proceeds of which were used to redeem the existing unsecured notes and repay borrowings under the Credit
Facility.
For the year ended December 31, 2017, the Company sold 303,422 additional shares of common stock
through the ATM Program for net proceeds of $4,014,887, which was used to repay borrowings under the Credit
Facility.
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Purchases of Equity Securities
Dividend Reinvestment Plan
During the year ended December 31, 2019, as a part of our dividend reinvestment plan for our common
stockholders, we purchased 117,713 shares of our common stock for an average price per share of $14.03 in the
open market in order to satisfy the reinvestment portion of our dividends. The following chart outlines such
purchases of our common stock during the year ended December 31, 2019:
Period
January 1, 2019 through January 31, 2019
February 1, 2019 through February 29, 2019
March 1, 2019 through March 31, 2019
April 1, 2019 through April 30, 2019
May 1, 2019 through May 31, 2019
June 1, 2019 through June 30, 2019
July 1, 2019 through July 31, 2019
August 1, 2019 through August 31, 2019
September 1, 2019 through September 30, 2019
October 1, 2019 through October 31, 2019
November 1, 2019 through November 30, 2019
December 1, 2019 through December 31, 2019
Total
Total Number
of Shares
Purchased
Average Price
Paid Per
Share
Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
Maximum (or
Approximate Dollar
Value) of Shares
that May Yet Be
Purchased Under
the Plans or
Programs
9,681
9,024
11,019
10,154
10,896
10,983
10,348
9,868
9,223
9,279
8,739
8,499
117,713
$ 13.90
$ 14.79
$ 14.06
$ 14.38
$ 14.14
$ 14.14
$ 14.20
$ 12.97
$ 13.66
$ 13.44
$ 14.21
$ 14.54
$ 14.03
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$—
$—
$—
$—
$—
$—
$—
$—
$—
$—
$—
$—
$—
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Stock Performance Graph
This graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index,
the Russell 2000 Financial Services Index, and the Raymond James BDC Index, for the period from inception
through March 2, 2020. The graph assumes that, at inception, a person invested $100 in each of our common
stock, the S&P 500 Index, the Russell 2000 Financial Services Index, and the Raymond James BDC Index. The
graph measures total stockholder return, which takes into account both changes in stock price and dividends. It
assumes that dividends paid are invested in like securities.
The graph and other information furnished under this Part II Item 5 of this Form 10-K shall not be deemed
to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities
of Section 18 of the 1934 Act. The stock price performance included in the above graph is not necessarily
indicative of future stock price performance.
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Item 6.
Selected Financial Data
The selected financial data for the years ended December 31, 2019, 2018, 2017, 2016 and 2015 set forth
below was derived from our financial statements which have been audited by Grant Thornton LLP, our
independent registered public accounting firm. The data should be read in conjunction with our financial
statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” included elsewhere in this report.
Statement of Operations Data:
Total investment income
Total expenses, net of fee waiver
Net investment income
Net increase in net assets resulting
from operations
Per Share Data:
Net asset value
Net investment income
Net increase in net assets resulting
from operations
Distributions declared
Balance Sheet Data:
Investments at fair value
Cash and cash equivalents
Total assets
Total liabilities
Total net assets
Other Data:
Number of portfolio companies
at period end
Weighted average yield on debt
investments at period
end
(1) (3)
For the year
ended
December 31,
2019
For the year
ended
December 31,
2018
For the year
ended
December 31,
2017
For the year
ended
December 31,
2016
For the year
ended
December 31,
2015
$58,911,889 $53,266,338
$30,629,801
$36,473,080
$22,636,537
$22,438,809
$39,648,193
$21,677,433
$17,970,760
$39,490,197
$22,177,996
$17,312,201
$35,158,559
$18,611,431
$16,547,128
$26,438,186
$26,194,578
$22,613,257
$23,199,062
$ 7,670,536
$
$
$
$
14.14
1.23
1.45
1.36
$
$
$
$
14.09
1.42
1.64
1.36
$
$
$
$
13.81
1.21
1.52
1.36
$
$
$
$
13.69
1.39
1.86
1.36
$
$
$
$
13.19
1.33
0.61
1.36
As of
December 31,
2019
As of
December 31,
2018
As of
December 31,
2017
As of
December 31,
2016
As of
December 31,
2015
(2)
$628,948,077 $504,483,668
$ 16,133,315 $ 17,467,146
$648,513,227 $526,287,251
$377,942,054 $301,442,244
$270,571,173 $224,845,007
$371,839,772
$ 25,110,718 $
$400,260,855
$180,013,613
$220,247,242
$365,625,891
9,194,129
$379,878,729
$208,996,944
$170,881,785
$349,017,697
$ 10,875,790
$365,368,412
$200,717,308
$164,651,104
63
57
48
45
39
9.2
%
10.9
%
10.8
%
11.0
%
10.6
%
(1)
(2)
(3)
Computed using the effective interest rates for all of our debt investments, including accretion of original
issue discount.
ASU No. 2015-03 — Simplifying the Presentation of Debt Issuance Costs was effective from the quarter
ended March 31, 2016. Total assets and total liabilities as of December 31, 2015 have been modified by debt
issuance costs of $3,905,673 to conform to this presentation.
The weighted average yield of our debt investments is not the same as a return on investment for our
stockholders, rather, relates to a portion of our investment portfolio and is calculated before the payment of
all of our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective
interest rates for all of our debt investment restated as an interest rate payable annually in arrears and is
computed including cash and payment in kind, or PIK interest, as well as accretion of original issue
discount.
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Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Some of the statements in this annual report on Form 10-K constitute forward-looking statements, which
relate to future events or our future performance or financial condition. The forward-looking statements
contained in this annual report on Form 10-K 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 RIC and as a BDC; 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
business development companies 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 annual report on Form 10-K on information
available to us on the date of this annual report on Form 10-K. 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 SEC rule or regulation. 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 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 adviser, Stellus
Capital Management.
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.
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As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we must
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 all 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.
We have elected to be treated for 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 December 31, 2019, 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.
Prior to June 28, 2018, we were only allowed to employ leverage to the extent that our asset coverage, as
defined in the 1940 Act, was equal to at least 200% after giving effect to such leverage. 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, 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. The Board also approved the
submission of a proposal to stockholders to approve the application of the modified asset coverage requirements
set forth in Section 61(a)(2) of the 1940 Act, which was approved by stockholders at our 2018 annual meeting of
stockholders. As a result, the asset coverage ratio applicable to us was decreased from 200% to 150%, effective
June 28, 2018, which effectively increased the amount of leverage we may incur. As of December 31, 2019, our
asset coverage ratio was 229%. 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.
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) through first lien (including unitranche), second lien, and unsecured
debt financing, often times with a corresponding equity investment.
As of December 31, 2019, we had $ 628.9 million (at fair value) invested in 63 companies. As of
December 31, 2019, our portfolio included approximately 72% of first lien debt, 18% of second lien debt, 4% of
unsecured debt and 6% of equity investments at fair value. The composition of our investments at cost and fair
value as of December 31, 2019 was as follows:
(1)
Senior Secured – First Lien
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Cost
$461,107,595
130,600,172
22,279,519
28,720,538
$642,707,824
Fair Value
$455,169,878
111,961,013
22,137,186
39,680,000
$628,948,077
(1)
Includes unitranche investments, which account for 14.4% of our portfolio at fair value. Unitranche
structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated
loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated
loans to the extent we invest in the “last-out” tranche.
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As of December 31, 2018, we had $504.5 million (at fair value) invested in 57 companies. As of
December 31, 2018, our portfolio included approximately 58% of first lien debt, 30% of second lien debt, 5% of
unsecured debt and 7% of equity investments at fair value. The composition of our investments at cost and fair
value as of December 31, 2018 was as follows:
(1)
Senior Secured – First Lien
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Cost
$297,965,589
155,382,612
25,436,237
23,959,211
$502,743,649
Fair Value
$292,004,982
149,661,220
23,697,466
39,120,000
$504,483,668
(1)
Includes unitranche investments, which account for 20.6% of our portfolio at December 31, 2018 fair value.
Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or
subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and
subordinated loans to the extent we invest in the “last-out” tranche.
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 December 31, 2019 and December 31, 2018, we
had unfunded commitments of $37.5 million and $21.2 million, respectively, to provide debt financing for
seventeen and eleven portfolio companies, respectively. As of December 31, 2019, the Company had sufficient
liquidity to fund such unfunded commitments should the need arise.
The following is a summary of geographical concentration of our investment portfolio as of December 31,
2019:
Texas
California
Arizona
New Jersey
Ohio
Illinois
Canada
New York
United Kingdom
Wisconsin
South Carolina
Tennessee
Pennsylvania
Maryland
Indiana
Florida
Colorado
Arkansas
Missouri
Georgia
North Carolina
Puerto Rico
Utah
Massachusetts
Cost
$134,451,527
79,090,474
52,390,949
52,548,769
48,502,609
41,869,947
21,201,137
19,922,689
20,116,695
19,207,770
19,935,337
19,854,956
17,408,508
17,103,044
14,064,012
13,663,116
10,867,843
14,920,694
10,078,235
575,000
4,961,969
8,613,244
41,894
1,317,406
$642,707,824
Fair Value
$120,672,985
78,136,331
53,274,526
51,637,750
50,092,839
44,406,252
21,217,811
20,584,020
20,116,695
19,466,054
19,366,716
19,260,076
17,566,213
17,325,000
13,997,251
13,820,256
12,444,250
11,989,446
10,428,223
5,250,000
4,375,000
3,490,383
30,000
—
$628,948,077
% of Total
Investments
at fair value
%
19.19
%
12.42
%
8.47
%
8.21
%
7.96
%
7.06
%
3.37
%
3.27
%
3.20
%
3.10
%
3.08
%
3.06
%
2.79
%
2.75
%
2.23
%
2.20
%
1.98
%
1.91
%
1.66
%
0.83
%
0.70
%
0.55
%
0.00
%
—
%
100.00
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The following is a summary of geographical concentration of our investment portfolio as of December 31,
2018:
Texas
California
New Jersey
Ohio
Illinois
Canada
Arizona
South Carolina
New York
Tennessee
Arkansas
Pennsylvania
Maryland
Wisconsin
Colorado
Georgia
Indiana
Puerto Rico
North Carolina
Massachusetts
Missouri
Virginia
Florida
Utah
Cost
Fair Value
% of Total
Investments
$100,229,354
86,550,134
43,513,698
36,209,514
19,941,053
27,902,537
21,682,522
20,871,587
20,446,690
20,117,218
17,696,537
17,732,831
17,237,500
11,437,711
10,777,822
5,988,728
7,363,628
8,797,954
4,946,554
1,317,406
139,656
50,001
242,304
1,550,710
$ 97,474,226
85,880,918
41,473,072
36,273,224
29,880,018
27,935,931
21,603,741
20,385,325
20,287,086
19,381,134
18,013,941
17,824,372
17,237,500
10,869,000
10,777,822
9,820,000
7,087,500
5,029,913
4,425,000
1,670,000
670,000
280,000
110,000
93,945
19.32
17.03
8.22
7.19
5.92
5.54
4.28
4.04
4.02
3.84
3.57
%
%
%
%
%
%
%
%
%
%
%
3.53
%
3.42
%
2.15
%
2.14
%
1.95
%
1.40
%
1.00
%
0.88
%
0.33
%
0.13
%
0.06
%
0.02
%
0.02
%
$502,743,649
$504,483,668
100.00
%
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The following is a summary of industry concentration of our investment portfolio as of December 31, 2019:
Healthcare & Pharmaceuticals
Services: Business
Aerospace & Defense
Consumer Goods: Durable
Beverage, Food, & Tobacco
Media: Broadcasting & Subscription
Finance
Education
Media: Advertising, Printing & Publishing
High Tech Industries
Capital Equipment
Retail
Metals & Mining
Transportation & Logistics
Automotive
Software
Containers, Packaging, & Glass
Environmental Industries
Energy: Oil & Gas
Services: Consumer
Chemicals, Plastics, & Rubber
Consumer goods: non-durable
Construction & Building
Utilities: Oil & Gas
Hotel, Gaming, & Leisure
Cost
Fair Value
$ 98,307,360
56,354,433
44,970,957
47,933,468
42,131,354
32,353,301
27,776,880
26,594,771
22,425,972
$ 94,000,860
62,410,845
46,547,324
44,158,660
42,592,966
33,218,991
29,562,500
25,661,125
21,965,124
21,201,137
20,093,379
19,935,337
17,103,044
17,173,599
17,151,902
15,807,191
14,306,286
15,256,675
12,624,269
26,075,606
11,880,825
14,973,711
21,217,811
20,237,066
19,366,716
17,325,000
17,226,294
17,221,213
15,516,250
14,564,570
14,410,327
13,582,102
13,345,105
11,857,228
11,770,000
10,408,323
10,750,000
9,868,044
—
9,900,000
540,000
% of Total
Investments
at fair value
14.95
9.92
7.40
7.02
6.77
5.28
4.70
4.08
3.49
%
%
%
%
%
%
%
%
%
3.37
%
3.22
%
3.08
%
2.75
%
2.74
%
2.74
%
2.47
%
2.32
%
2.29
%
2.16
%
2.12
%
1.89
%
1.87
%
1.71
%
1.57
%
0.09
%
$642,707,824
$628,948,077
100.00
%
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The following is a summary of industry concentration of our investment portfolio as of December 31, 2018:
Cost
Fair Value
% of Total
Investments
Healthcare & Pharmaceuticals
Software
Finance
Media: Broadcasting & Subscription
Retail
Services: Business
Consumer Goods: Durable
Education
High Tech Industries
Beverage, Food, & Tobacco
Services: Consumer
Automotive
Metals & Mining
Energy: Oil & Gas
Consumer goods: non-durable
Environmental Industries
Chemicals, Plastics, & Rubber
Containers, Packaging, & Glass
Aerospace & Defense
Construction & Building
Utilities: Oil & Gas
Capital Equipment
Media: Advertising, Printing & Publishing
Transportation: Cargo
Insurance
Hotel, Gaming, & Leisure
Services: Government
$ 58,682,811
51,432,916
34,208,412
31,079,169
28,764,221
22,942,733
26,981,015
26,562,249
21,094,192
$ 54,785,327
51,458,750
41,910,000
30,857,379
27,525,897
27,094,812
26,811,552
25,325,000
21,094,192
20,709,134
17,952,663
17,457,259
17,237,500
14,312,328
14,994,980
14,004,667
11,835,100
11,437,711
10,777,822
10,374,827
9,853,435
7,535,876
7,058,675
6,808,345
5,425,301
3,170,307
50,001
18,213,945
17,640,255
17,282,187
17,237,500
15,542,102
14,579,375
12,835,509
11,707,835
10,869,000
10,777,822
10,280,000
9,853,435
7,929,775
6,875,625
6,841,739
5,460,000
3,414,655
280,000
10.86
10.20
8.31
6.12
5.46
5.37
5.30
5.02
4.18
%
%
%
%
%
%
%
%
%
3.61
%
3.50
%
3.43
%
3.42
%
3.08
%
2.89
%
2.54
%
2.32
%
2.15
%
2.14
%
2.04
%
1.95
%
1.57
%
1.36
%
1.36
%
1.08
%
0.68
%
0.06
%
$502,743,649
504,483,668
100.00
%
Certain portfolio company classifications were updated to more adequately align to the risks of the portfolio
investments with other companies in such industries. Industry classification for the prior year financial statements
included above were reclassified to the current presentation. The following changes and their December 31, 2018
cost and fair value, respectively, were made: 1) Consumer Goods: Durable to Metals & Mining; $17,237,500 for
both cost and fair value, 2) Media: Broadcasting & Subscription to Media: Advertising, Printing & Publishing;
$7,058,675 and $6,875,625, 3) Services: Business to Aerospace & Defense; $10,777,822 for both cost and value,
4) Services: Business to Environmental Industries; $13,058,543 and $12,505,509, 5) Services: Business to
Software; $14,005,369 and $13,432,500.
At December 31, 2019, our average portfolio company investment at amortized cost and fair value was
approximately $10.2 million and $10.0 million, respectively, and our largest portfolio company investment at
amortized cost and fair value was approximately $ 21.6 million and $ 21.3 million, respectively. At December 31,
2018, our average portfolio company investment at both amortized cost and fair value was approximately
$8.9 million, and our largest portfolio company investment at amortized cost and fair value was approximately
$21.6 million and $22.3 million, respectively.
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At December 31, 2019, 93% of our debt investments bore interest based on floating rates (subject to interest
rate floors), such as LIBOR, and 7% bore interest at fixed rates. At December 31, 2018, 91% of our debt
investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 9% bore
interest at fixed rates.
The weighted average yield on all of our debt investments as of December 31, 2019 and December 31, 2018
was approximately 9.2% and 10.9%, 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 stockholders, 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 December 31, 2019 and December 31, 2018, we had cash and cash equivalents of $16.1 million and
$17.5 million, respectively.
Investment Activity
During the year ended December 31, 2019, we made $246.5 million of investments in seventeen new
portfolio companies and twelve existing portfolio companies. During the year ended December 31, 2019, we
received $128.2 million in proceeds principally from prepayments of our investments, including $19.2 million
from amortization of certain other investments.
During the year ended December 31, 2018, we made $272.9 million of investments in seventeen new
portfolio companies and twelve existing portfolio companies. During the year ended December 31, 2018, we
received $147.6 million in proceeds principally from prepayments of our investments, including $22.9 million
from amortization of certain other 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 to 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.
Asset Quality
In addition to various risk management and monitoring tools, Stellus Capital Management uses an
investment rating system to characterize and monitor the credit profile and expected level of returns on each
investment in our 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.
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Investment Category
1
2
3
4
5
Total
As of December 31, 2019
As of December 31, 2018
Fair Value
% of Total
Portfolio
Number of
Portfolio
Companies
(1)
Fair Value
% of Total
Portfolio
Number of
Portfolio
Companies
(dollars in millions)
$ 70.4
492.2
49.3
12.0
5.0
$628.9
11
78
8
2
1
%
%
%
%
%
100
%
11
41
7
1
4
64
$ 92.5
372.3
26.8
12.8
0.1
$504.5
18
74
5
3
—
%
%
%
%
%
100
%
13
37
3
4
1
58
(1)
One portfolio company appears in two categories as of December 31, 2019 and December 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 December 31, 2019, we had loans to 2 portfolio companies that were on non-accrual status, which
represented approximately 3.6% of our loan portfolio at cost and 0.9% at fair value. As of December 31, 2018,
we had loans to four portfolio companies that were on non-accrual status, which represented approximately 3.9%
of our loan portfolio at cost and 2.8% 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.
Comparison of the Years ended December 31, 2019, 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 primarily floating rates. 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 interest. 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.
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The following shows the breakdown of investment income for the years ended December 31, 2019, 2018,
and 2017 (in millions).
Interest Income
(1)
PIK Income
Miscellaneous fees
(1)
Total
Year ended
December 31,
2019
Year ended
December 31,
2018
Year ended
December 31,
2017
$56.5
0.4
2.0
$58.9
$49.6
1.9
1.8
$53.3
$37.6
0.5
1.6
$39.7
(1)
For the years ended December 31, 2019, 2018, and 2017, we recognized $2.8 million, $3.4 million and
$2.5 million of non-recurring income, respectively. Non-recurring income was related to early repayments,
the recognition of previously reserved income from a prior period, and amendments to specific loan
positions.
The increase in interest income from the respective periods were due primarily to growth in the overall
investment portfolio.
Expenses
Our primary operating expenses include the payment of fees to Stellus Capital Management 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;
calculating our net asset value (including the cost and expenses of any independent valuation firm);
fees and expenses 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;
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 and chief
financial officer and their respective staff);
transfer agent, dividend agent and custodial fees and expenses;
U.S. federal and state registration fees;
all costs of registration and listing our securities on any securities exchange;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;
costs of preparing and filing reports or other documents required by the SEC or other regulators;
costs of distributing any reports, proxy statements or other notices to stockholders, including printing
costs;
costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability
insurance, and any other insurance premiums;
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•
•
•
direct costs and expenses of administration, including printing, mailing, long distance telephone, copying,
secretarial and other staff, independent auditors and outside legal costs;
proxy voting expenses; 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 years ended December 31, 2019, 2018
and 2017 (in millions).
Operating Expenses
Management Fees
Valuation Fees
Administrative services expenses
Income incentive fees
Capital gain incentive fees
Professional fees
Directors’ fees
Insurance expense
Interest expense and other fees
Income tax expense
Other general and administrative
Total Operating Expenses
Loss on extinguishment of debt
Total Expenses
Year ended
December 31,
2019
Year ended
December 31,
2018
Year ended
December 31,
2017
$ 9.7
0.3
1.7
5.8
0.8
1.0
0.4
0.3
15.0
0.9
0.6
$36.5
—
$36.5
$ 8.2
0.3
1.4
5.5
0.1
1.2
0.3
0.3
12.3
0.3
0.7
$30.6
—
$30.6
$ 6.3
0.3
1.3
2.9
—
1.3
0.3
0.4
7.9
—
0.6
$21.3
0.4
$21.7
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 the higher
balances on the Credit Facility and SBA-guaranteed debentures outstanding during the period, 3) excise taxes as
a result of capital gains on certain equity positions, and 4) higher income incentive fees and capital gains
incentive fees due to performance of the portfolio.
Net Investment Income
Net investment income was $22.4 million, or $1.23 per common share based on 18,275,696 weighted-
average common shares outstanding at December 31, 2019. Net investment income was $22.6 million, or $1.42
per common share based on 15,953,571 weighted-average common shares outstanding at December 31, 2018.
Net investment income was $18.0 million, or $1.21 per common share based on 14,870,981 weighted-average
common shares outstanding at December 31, 2017.
Net investment income for the year ended December 31, 2019 decreased compared to the year ended
December 31, 2018 as a result of an increase in accrued capital gains incentive fees and excise taxes generated by
realized gains on certain equity positions and higher interest expense from larger amounts outstanding under the
Credit Facility and SBA-guaranteed debentures; offset by higher investment income due to a larger portfolio.
Net Realized Gains and Losses
We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or
other disposition and the amortized cost basis of the investment, using the specific identification method, without
regard to unrealized appreciation or depreciation previously recognized.
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Proceeds from repayments of investments and amortization of certain other investments for the year ended
December 31, 2019 totaled $128.2 million and net realized gains totaled $19.6 million. Proceeds from
repayments of investments and amortization of certain other investments for the year ended December 31, 2018
totaled $147.5 million and net realized gain totaled $5.5 million. Proceeds from the sales and repayments of
investments and amortization of certain other investments for the year ended December 31, 2017 totaled
$172.3 million and net realized gains totaled $4.7 million. Net realized gains in all periods presented resulted
from the realization of our equity investments in certain portfolio companies.
Net Change in Unrealized Appreciation (Depreciation) of Investments
Net change in unrealized appreciation 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 (depreciation) on investments and cash equivalents for the year ended
December 31, 2019, 2018 and 2017 totaled ($15.5) million, ($1.6) million, and ($0.0) million, respectively.
The change in unrealized depreciation in 2019 was primarily due to write downs on specific investments.
The change in unrealized depreciation in 2018 was due to a significant widening of spreads during the fourth
quarter, offset by the write up of a specific equity investment. There was relatively no change in unrealized
appreciation in 2017.
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-of-income” requirements
contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for income
tax filing 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 year ended December 31, 2019, 2018 and 2017, we recognized a deferred tax benefit (provision)
related to unrealized appreciation on certain equity investments for income tax at our Taxable Subsidiaries of
$(66.8) thousand, $(68.0) thousand and $9.0 thousand, respectively. As of December 31, 2019 and 2018, a
deferred tax liabilities of $134.7 thousand and $68.0 thousand, respectively, were included on the Consolidated
Statement of Assets and Liabilities.
For the year ended December 31, 2018, we recognized tax expense related to the realized gains on certain
equity investments at our taxable subsidiaries of $267.0 thousand. There was no such tax expense for the years
ended December 31, 2019 and 2017. As of December 31, 2019 and 2018, no tax liability related to the taxes on
realized gains were included on the Consolidated Statement of Assets and Liabilities.
Net Increase in Net Assets Resulting from Operations
Net increase in net assets resulting from operations totaled $26.4 million, or $1.45 per common share based
on weighted-average shares of 18,275,696 for the year ended December 31, 2019, as compared to $26.2 million,
or $1.64 per common share based on weighted-average shares of 15,953,571 common shares outstanding for the
year ended December 31, 2018, as compared to $22.6 million, or $1.52 per common share based on weighted-
average shares of 14,870,981 common shares outstanding for the year ended December 31, 2017.
The increase in net assets resulting from operations for the year ended December 31, 2019 as compared to
the year ended December 31, 2018 was higher due primarily to a larger amount of realized gains, offset by
unrealized depreciation. The increase in net assets resulting from operations for the year ended December 31,
2018 as compared to the year ended December 31, 2017 was higher due primarily to a higher net investment
income as a result of portfolio growth, as well as a larger amount of realized gains.
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Financial condition, liquidity and capital resources
Cash Flows from Operating and Financing Activities
Our operating activities used net cash of ($93.3) million for the year ended December 31, 2019, primarily in
connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments.
Our financing activities for the year ended December 31, 2019 provided cash of $92.0 million primarily from
proceeds from the issuance of common stock, proceeds from SBA-guaranteed debentures and net borrowings on
our credit facility.
Our operating activities used net cash of ($102.4) million for the year ended December 31, 2018, primarily
in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments.
Our financing activities for the year ended December 31, 2018 provided cash of $94.8 million primarily from
proceeds from SBA-guaranteed debentures and net borrowings on our credit facility
Our operating activities provided net cash of $18.9 million for the year ended December 31, 2017, primarily
in connection with income earned on our portfolio investments, offset by the purchase and origination of portfolio
investments. Our financing activities for the year ended December 31, 2017 used cash of ($2.9) million,
primarily from net repayments on our credit facility.
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.
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 2019 annual stockholders meeting, authorizes us to sell up to 25% of our
outstanding common shares at a price equal to or below the then current net asset value per share in one or more
offerings. This approval will expire on the earlier of our 2020 annual stockholder meeting or July 22, 2020, the
one-year anniversary of our 2019 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 150% effective June 28, 2018 (at least 200% prior to June 28,
2018). 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 subsidiaries 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 December 31, 2019 and December 31, 2018, our asset coverage ratio was 229% and 251%,
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,
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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 December 31, 2019 and December 31, 2018, we had cash and cash
equivalents of $16.1 million and $17.5 million, respectively.
Credit Facility
On November 7, 2012, we 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. We
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, as amended on March 28, 2018, August 2,
2018, September 13, 2019, and December 27, 2019, with ZB, N.A., dba Amegy Bank and various other lenders
(the “Credit Facility”).
The Credit Facility, as amended, provides for borrowings up to a maximum of $220.0 million on a
committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to
$250.0 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 our election, on a per annum basis equal to
(i) LIBOR plus 2.50% (or 2.75% during certain periods in which the our asset coverage ratio is equal to or below
1.90 to 1.00) with no LIBOR floor, or (ii) 1.50% (or 1.75% during certain periods in which our asset coverage
ratio is equal to or below 1.90 to 1.00) 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%. We pay unused commitment fees of 0.50% per annum on
the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. The
commitment to fund the revolver expires on October 10, 2020, after which we may no longer borrow under the
Credit Facility. We must begin repaying principal equal to 1/12 of the aggregate amount outstanding under the
Credit Facility beginning October 15, 2020. 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.
Our obligations to the lenders are secured by a first priority security interest in its portfolio of securities and
cash not held at the SBIC subsidiaries, 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
1.75 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of December 31, 2019, we were in
compliance with these covenants.
As of December 31, 2019 and December 31, 2018, the outstanding balance under the Credit Facility was
$161.6 million and $99.6 million, respectively. 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. We have incurred costs of $1.8 million in connection with
the current 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
December 31, 2019 and 2018, $1.0 million and $1.3 million of such prepaid loan structure fees and
administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our
consolidated statement of assets and liabilities as a deduction from the debt liability attributable to the Credit
Facility.
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Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan
fees on the Credit Facility for the years ended December 31, 2019, 2018, and 2017 (dollars in millions):
Interest expense
Loan fee amortization
Commitment fees on unused portion
Administration fees
Total interest expense and other fees
Loss on extinguishment of debt
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest and unused fees
SBA-guaranteed debentures
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
$
5.1
0.5
0.4
—
6.0
$ —
4.8
%
5.7
%
$106.2
$
5.2
$ 3.7
0.4
0.4
0.1
$ 4.6
$ —
4.7
%
5.7
%
$79.8
$ 4.2
$ 2.2
0.4
0.3
0.1
$ 3.0
$ 0.1
3.7
%
5.0
%
$60.1
$ 2.5
Due to the SBIC subsidiaries’ status as licensed SBICs, we can 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 both December 31, 2019 and 2018, the SBIC subsidiary had $75.0 million in regulatory
capital, as such term is defined by the SBA.
As of December 31, 2019, the year ending the first year of operations, the SBIC II subsidiary had
$20.0 million in regulatory capital, as such term is defined by the SBA.
On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the
SBIC subsidiaries 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
$325.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.
On a stand-alone basis, the SBIC subsidiaries held $240.1 million and $225.5 million in assets at
December 31, 2019 and 2018, respectively, which accounted for approximately 37.0% and 42.9% of our total
consolidated assets at December 31, 2019 and 2018, 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 December 31, 2019 and 2018, the SBIC subsidiaries had $161.0 million and $150.0
million of the SBA-guaranteed debentures outstanding, respectively. SBA-guaranteed debentures drawn before
October 1, 2019 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. SBA-guaranteed debentures
drawn after October 1, 2019 incur upfront fees of 3.435%, which consists of a 1.00% commitment fee and a
2.435% 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.
As of December 31, 2019 and 2018, 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
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rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At
December 31, 2019 and 2018, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in
Note 6.
As of December 31, 2019, we have incurred $5.6 million in financing costs related to the SBA-guaranteed
debentures since the SBIC subsidiaries have received their licenses, which were recorded as prepaid loan fees. As
of December 31, 2019 and 2018, $3.5 million and $3.6 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.
The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures
for the years ended December 31, 2019, 2018 and 2017 (dollars in millions; averages for periods outstanding):
Interest expense
Debenture fee amortization
Total interest expense and other fees
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
Notes
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
$
5.2
0.6
5.8
3.4
3.8
%
%
$151.9
$
5.0
$
$
4.0
0.6
4.6
3.2
3.7
%
%
$125.4
$
3.1
$ 2.1
0.3
$ 2.4
3.1
3.6
%
%
$67.3
$ 2.0
On May 5, 2014, we closed a public offering of $25.0 million aggregate principal amount of 6.50% notes
(the “2019 Notes”) due April 30, 2019. We redeemed all $25.0 million in aggregate principal amount of the 2019
Notes on September 20, 2017. As a result of the redemption, we recognized a loss on the extinguishment of debt
of $0.3 million for the year ended December 31, 2017, due to the write off of the remaining deferred financing
costs on the 2019 Notes.
The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for
the years ended December 31, 2019, 2018, and 2017 (dollars in millions; averages for period outstanding):
Interest expense
Deferred financing costs
Total interest expense and other fees
Loss on extinguishment of debt
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
For the year ended
December 31,
2019
December 31,
2018
December 31,
2017
$ —
—
$ —
—
—
%
—
%
$ —
—
$ —
—
—
%
—
%
$ —
$ —
$ —
$ —
$ 1.2
0.1
$ 1.3
0.3
6.5
%
7.3
%
$25.0
$ 1.4
On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due
2022 (the “2022 Notes”). On September 8, 2017, we 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
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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.
We 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 December 31, 2019 and 2018, the aggregate carrying
amount of all Notes was $48.9 million and the fair value of the Notes was approximately $49.7 million and
$47.6 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 $0.9 million and $1.2 million remained to
be amortized as of December 31, 2019 and 2018, respectively. These financing costs are presented on the
consolidated statement of assets and liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for
the years ended December 31, 2019, 2018, 2017 (in millions):
For the year ended
December 31,
2019
For the year ended
December 31,
2018
For the year ended
December 31,
2017
(1)
$ 2.8
0.3
$ 3.1
5.8
6.4
$ 48.9
$ 2.8
%
%
$ 2.8
0.3
$ 3.1
5.8
6.4
$ 48.9
$ 2.8
%
%
$ 1.0
0.1
$ 1.1
5.8
6.5
$ 48.0
$ 0.9
%
%
Interest expense
Deferred financing costs
Total interest expense and other fees
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
(1)
for the period outstanding
Contractual Obligations
As of December 31, 2019, our future fixed commitments for cash payments on contractual obligations for
each of the next five years and thereafter are as follows:
Total
2020
2021
2022
2023
2024
2025 and
thereafter
(dollars in thousands)
Credit facility payable
(1)
Notes payable
SBA-guaranteed debentures
$161,550
$ 48,875
$161,000
$ —
—
— 161,550
$ —
— 48,875
—
—
—
—
— $ —
—
—
—
— $161,000
Total
$371,425
$ — $161,550
$48,875
$ — $ — $161,000
(1)
We must begin repaying principal equal to 1/12 of the aggregate amount outstanding under the Credit
Facility beginning October 15, 2020. See Note 9 for further discussion.
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 December 31, 2019, our only off-balance sheet
arrangements consisted of $37.5 million of unfunded commitments to provide debt financing to seventeen of our
portfolio companies. As of December 31, 2018, our only off-balance sheet arrangements consisted of a
$21.2 million unfunded commitments to provide debt financing to eleven of our portfolio companies.
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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 as dividends
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. Distributions 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 Credit Facility. We cannot assure stockholders that they
will receive any distributions or distributions at a particular level.
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 financial statements 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
The preparation of our financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic
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environment, financial markets and any other parameters used in determining such estimates could cause actual
results to differ. In addition to the discussion below, our significant accounting policies are further described in
the notes to the financial statements.
Valuation of portfolio investments
As a business development company, we generally invest in illiquid loans and securities including debt and
equity securities of middle-market companies. Under procedures established by our Board, we may value
investments for which market quotations are readily available at such market quotations. We obtain these market
values from an independent pricing service or at the mean 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 are valued at fair
value as determined in good faith by our Board. Such determination of fair values may involve subjective
judgments and estimates, although we engage independent valuation providers to review the valuation of each
portfolio investment that does not have a readily available market quotation at least twice each year. Investments
purchased within 90 days of maturity are valued at cost plus accreted discount, or minus amortized premium,
which approximates value. With respect to unquoted securities, our Board, together with our independent
valuation advisors, values 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, our
Board uses the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because
there is not a readily available market for substantially all of the investments in our portfolio, we value most of
our portfolio investments at fair value as determined in good faith by our Board 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.
With respect to investments for which market quotations are not readily available, our Board undertakes a
multi-step valuation process each quarter, as described below:
•
•
•
•
•
Our quarterly valuation process begins with each portfolio company or investment being initially valued
by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
Preliminary valuation conclusions are then documented and discussed with our senior management and
Stellus Capital Management;
At least twice annually, the valuation for each portfolio investment is reviewed by an independent
valuation firm;
The audit committee of our Board then reviews these preliminary valuations; and
The Board then discusses valuations and determines the fair value of each investment in our portfolio in
good faith, based on the input of Stellus Capital Management, the independent valuation firm and the
audit committee.
Revenue recognition
We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans
and debt securities with contractual 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
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debt security, any unamortized loan origination is recorded as interest income. We record prepayment premiums
on loans and debt securities as interest income. Dividend income, if any, will be recognized on the ex-dividend
date.
We have investments in our portfolio that contain a PIK interest provision. Any PIK interest is added to the
principal balance of such investments and is recorded as income, if the portfolio company valuation indicates that
such PIK interest is collectible. In order to maintain our status as a RIC, substantially all of this income must be
paid out to stockholders in the form of dividends, 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
other 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.
Capital Gains Incentive Fee
Under GAAP, the Company calculates the capital gains incentive fee payable to the Advisor as if the
Company had realized all investments at their fair values as of the reporting date. Accordingly, the Company
accrues a provisional capital gains incentive fee taking into account any unrealized gains or losses. As the
provisional incentive fee is subject to the performance of investments until there is a realization event, the amount
of provisional capital gains incentive fee accrued at a reporting date may vary from the incentive fee that is
ultimately realized and the differences could be material.
Recent Developments
Investment Portfolio
On January 3, we received full repayment on the first lien term loan of APG Intermediate Sub 2 Corp. for
total proceeds of $10 million, including a $0.1 million prepayment fee. We also received $2.4 million in full
realization on the equity of the company, resulting in a $1.3 million gain.
On January 7, 2020, we invested $14.4 million in the first lien term loan of Sales Benchmark Index, LLC,
$1.3 million in the unfunded revolver, and $3.3 million in the unfunded delayed draw term loan of Sales
Benchmark, LLC, a provider of revenue growth management consulting services for private equity-owned and
large enterprise clients. Additionally, we invested $0.7 million in the preferred equity of the company.
On January 15, 2020, Apex Environmental Resources Holdings, LLC was merged with a provider of non-
hazardous waste management, collection, and recycling services, creating Interstate Waste Services, Inc. Our
common and preferred ownership positions in Apex Environmental Resources Holdings, LLC was rolled into the
combined entity.
On January 31, 2020, we invested $18.9 million in the first lien term loan and $2.7 million in the unfunded
revolver of Elliott Aviation, LLC, a provider of maintenance, repair, and overhaul and fixed-base operator
services to the business aviation sector. Additionally, we invested $0.9 million in the preferred equity of the
company.
Credit Facility
The outstanding balance under the Credit Facility as of February 28, 2020 was $175.3 million.
ATM Program
Since December 31, 2019, we issued 332,591 shares under the At-the-Market (“ATM”) Program, for gross
proceeds of $4.8 million. The average per share offering price of shares issued in the ATM Program was $14.42.
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SBA-guaranteed Debentures
The outstanding balance under SBA-guaranteed Debentures as of February 28, 2020 was $161.0 million.
Dividend Declared
On January 10, 2020, the Company’s Board declared a regular monthly dividend for each of January,
February and March 2020.
Declared
1/10/2020
1/10/2020
1/10/2020
Ex-Dividend Date
Record Date
Payment Date
Amount per Share
1/30/2020
2/27/2020
3/30/2020
1/31/2020
2/28/2020
3/31/2020
2/14/2020
3/13/2020
4/15/2020
$0.1133
$0.1133
$0.1133
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
We are subject to financial market risks, including changes in interest rates. For the year ended
December 31, 2019 and 2018, 93% and 91% of the loans in our portfolio bore interest at floating rates,
respectively. These floating rate loans typically bear interest in reference to LIBOR, which are indexed to 30-day
or 90-day LIBOR rates, subject to an interest rate floor. As of December 31, 2019 and 2018, the weighted
average interest rate floor on our floating rate loans was 1.13% and 0.94%, respectively.
Assuming that the Statement of Assets and Liabilities as of December 31, 2019 were to remain constant and
no actions were taken to alter the existing interest rate sensitivity, the following table shows the annual impact on
net income of changes in interest rates:
Change in Basis Points
Up 200 basis points
Up 150 basis points
Up 100 basis points
Up 50 basis points
Down 50 basis points
Down 100 basis points
Down 150 basis points
Down 200 basis points
Interest Income
Interest Expense
Net Interest Income
(1)
($ in millions)
$10.8
8.1
5.4
2.7
(2.5
)
(4.1
)
(4.8
)
(5.3
)
$(3.2
(2.4
(1.6
)
)
)
(0.8
)
0.8
1.6
2.4
3.2
$ 7.6
5.7
3.8
1.9
(1.7
)
(2.5
)
(2.4
)
(2.1
)
(1)
Excludes the impact of incentive fees based on pre-incentive fee net investment income. See Note 2 for
more information on the incentive fee.
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. 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 years ended December 31, 2019 and
2018, we did not engage in hedging activities.
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Item 8.
Financial Statements and Supplementary Data
Index to Financial Statements
Report of Independent Registered Public Accounting Firm
Statements of Assets and Liabilities as of December 31, 2019 and December 31, 2018
Statements of Operations for the years ended December 31, 2019, 2018, and 2017
Statements of Changes in Net Assets for the years ended December 31, 2019, 2018, and 2017
Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017
Schedule of Investments as of December 31, 2019 and December 31, 2018
Notes to Financial Statements
Page
86
89
90
91
92
93
108
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Stellus Capital Investment Corporation
Opinion on the financial statements
We have audited the accompanying consolidated statements of assets and liabilities of Stellus Capital
Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”), including the consolidated
schedules of investments as of December 31, 2019 and 2018, the related consolidated statements of operations,
changes in net assets, and cash flows for each of the three years in the period ended December 31, 2019, and the
related notes, schedules, and financial highlights (collectively referred to as the “financial statements”). In our
opinion, the financial statements present fairly, in all material respects, the financial position of the Company as
of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in
the period ended December 31, 2019 and the financial highlights for each of the five years in the period ended
December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019,
based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 2, 2020
expressed an unqualified opinion.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm
registered with the PCAOB and are required to be independent with respect to the Company in accordance with
the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the
risks of material misstatement of the financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of
the financial statements. Our procedures included verification by confirmation of securities as of December 31,
2019 and 2018, by correspondence with the portfolio companies and custodians, or by other appropriate auditing
procedures where replies were not received. We believe that our audits provide a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2012
Dallas, Texas
March 2, 2020
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Stellus Capital Investment Corporation
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of Stellus Capital Investment Corporation (a
Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established
in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013
Internal Control — Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended
December 31, 2019, and our report dated March 2, 2020 expressed an unqualified opinion on those financial
statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public
accounting firm registered with the PCAOB and are required to be independent with respect to the Company in
accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
87
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/ GRANT THORNTON LLP
Dallas, Texas
March 2, 2020
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PART I — FINANCIAL INFORMATION
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
Non-controlled, affiliated investments, at fair value (amortized cost of $0
and $52,185, respectively)
$
— $
50,000
December 31,
2019
December 31,
2018
Non-controlled, non-affiliated investments, at fair value (amortized cost of
$642,707,824 and $502,691,464, respectively)
Cash and cash equivalents
Receivable for sales and repayments of investments
Interest receivable
Other receivables
Deferred offering costs
Prepaid expenses
Total Assets
LIABILITIES
Notes payable
Credit facility payable
SBA-guaranteed debentures
Dividends payable
Management fees payable
Income incentive fees payable
Capital gains incentive fees payable
Interest payable
Unearned revenue
Administrative services payable
Deferred tax liability (Note 13)
Income tax payable
Other accrued expenses and liabilities
Total Liabilities
Commitments and contingencies (Note 7)
Net Assets
NET ASSETS
628,948,077
504,433,668
16,133,315
17,467,146
123,409
2,914,710
25,495
—
368,221
99,213
3,788,684
85,246
18,673
344,621
$648,513,227
$526,287,251
$ 47,974,202
$ 47,641,797
160,510,633
98,237,227
157,543,853
146,387,802
2,167,630
2,695,780
1,618,509
880,913
2,322,314
559,768
413,278
134,713
917,000
203,461
1,807,570
2,183,975
1,936,538
81,038
1,863,566
410,593
392,191
67,953
316,092
115,902
$377,942,054
$301,442,244
$270,571,173
$224,845,007
Common stock, par value $0.001 per share (100,000,000 shares authorized;
19,131,746 and 15,953,810 issued and outstanding, respectively)
$
19,132
$
15,954
Paid-in capital
Accumulated undistributed deficit
Net Assets
Total Liabilities and Net Assets
Net Asset Value Per Share
272,117,091
228,160,491
(1,565,050
)
(3,331,438
)
$270,571,173
$224,845,007
$648,513,227
$526,287,251
$
14.14
$
14.09
See accompanying notes to these consolidated financial statements.
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STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
INVESTMENT INCOME
Interest income
Other income
Total Investment Income
OPERATING EXPENSES
Management fees
Valuation fees
Administrative services expenses
Income incentive fees
Capital gains incentive fees
Professional fees
Directors’ fees
Insurance expense
Interest expense and other fees
Income tax expense
Other general and administrative expenses
Total Operating Expenses
Loss on extinguishment of debt
Net Investment Income
Net realized gain on non-controlled, non-affiliated
investments
Tax provision on realized gain on investments
Net change in unrealized appreciation (depreciation) on
For the year
ended
December 31,
2019
For the year
ended
December 31,
2018
For the year
ended
December 31,
2017
$ 56,895,990
2,015,899
$51,463,033
1,803,305
38,071,449
1,576,744
$ 58,911,889
$53,266,338
$39,648,193
$ 9,703,706
265,103
1,691,764
5,809,672
799,876
1,040,011
383,000
352,382
$ 8,154,842
307,838
1,390,375
5,529,376
81,038
1,189,071
317,000
348,500
14,976,024
12,338,755
903,905
547,637
275,106
697,900
6,255,911
336,300
1,245,727
2,911,392
—
1,274,066
331,000
429,897
7,855,211
—
621,204
$ 36,473,080
$30,629,801
$21,260,708
—
—
416,725
$ 22,438,809
$22,636,537
$17,970,760
$ 19,565,903
$ 5,540,518
4,655,976
—
(267,975
)
—
non-controlled, non-affiliated investments
$(15,501,951
)
$ (1,706,549
)
40,113
Net change in unrealized appreciation (depreciation) on
non-controlled, affiliated investments
Benefit (provision) for taxes on net unrealized gain on
investments in taxable subsidiaries
2,185
60,000
(62,185
)
(66,760
)
(67,953
)
8,593
Net Increase in Net Assets Resulting from Operations
$ 26,438,186
$26,194,578
$22,613,257
Net Investment Income Per Share
Net Increase in Net Assets Resulting from Operations
Per Share
Weighted Average Shares of Common Stock
Outstanding
Distributions Per Share
$
$
$
1.23
1.45
$
$
1.42
1.64
$
$
1.21
1.52
18,275,696
15,953,571
14,870,981
1.36
$
1.36
$
1.36
See accompanying notes to these consolidated financial statements.
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TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
Increase in Net Assets Resulting from Operations
Net investment income
Net realized gain on non-controlled, non-affiliated
investments
Tax provision on realized gain on investments
Net change in unrealized appreciation (depreciation) on non-
For the year
ended
December 31,
2019
For the year
ended
December 31,
2018
For the year
ended
December 31,
2017
$ 22,438,809
$ 22,636,537
17,970,760
19,565,903
5,540,518
4,655,976
—
(267,975
)
—
controlled, non-affiliated investments
(15,501,951
)
(1,706,549
)
40,113
Net change in unrealized appreciation (depreciation) on non-
controlled, affiliated investments
2,185
60,000
(62,185
)
Benefit (provision) for taxes on unrealized appreciation on
investments
(66,760
)
(67,953
)
8,593
Net Increase in Net Assets Resulting from Operations
$ 26,438,186
$ 26,194,578
$ 22,613,257
Stockholder Distributions From:
Net investment income
Net realized capital gains
Total Distributions
Capital Share Transactions
Issuance of common stock
Sales load
Offering costs
Partial share transactions
Net Increase in Net Assets Resulting From Capital Share
Transactions
Total Increase in Net Assets
$ (10,000,000
(15,038,173
)
)
$ (16,418,007
(5,272,543
)
)
$ (17,970,760
(2,352,545
)
)
$ (25,038,173
)
$ (21,690,550
)
$ (20,323,305
)
$ 45,862,239
(1,015,127
(521,715
755
)
)
$ 44,326,153
$ 45,726,166
$
$
$
94,788
—
—
(1,051
)
$ 48,741,549
(1,358,880
(307,022
(142
)
)
)
93,737
$ 47,075,505
4,597,765
$ 49,365,457
Net Assets at Beginning of Period
$224,845,007
$220,247,242
$170,881,785
Net Assets at End of Period
$270,571,173
$224,845,007
$220,247,242
See accompanying notes to these consolidated financial statements.
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TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities
Net Increase in net assets resulting from operations
Adjustments to reconcile net increase in net assets resulting from
operations to net cash used in operating activities:
Purchases of investments
Proceeds from sales and repayments of investments
Net change in unrealized depreciation (appreciation) on investments
Increase in investments due to PIK
Amortization of premium and accretion of discount, net
Deferred tax provision
Amortization of loan structure fees
Amortization of deferred financing costs
Amortization of loan fees on SBA-guaranteed debentures
Net realized gain on investments
Loss on extinguishment of debt
Changes in other assets and liabilities
Decrease (increase) in interest receivable
Decrease (increase) in other receivable
Decrease (increase) in prepaid expenses
Increase in management fees payable
Increase (decrease) in incentive fees payable
Increase in capital gains incentive fees payable
Increase in administrative services payable
Increase in interest payable
Increase in unearned revenue
Increase in income tax payable
Increase (decrease) in other accrued expenses and liabilities
Net Cash Provided by (Used in) Operating Activities
Cash flows from Financing Activities
Proceeds from the issuance of common stock
Sales load for common stock issued
Offering costs paid for common stock
Proceeds from notes issued
Financing costs paid for Notes issued
Repayments on Notes issued
Stockholder distributions paid
Proceeds from SBA Debentures
Financing costs paid on SBA Debentures
Borrowings under Credit Facility
Repayments of Credit Facility
Financing costs paid on Credit Facility
Partial share transactions
Net Cash Provided by (Used in) Financing Activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and cash equivalents balance at beginning of period
Cash and Cash Equivalents Balance at End of Period
Supplemental and Non-Cash Activities
Cash paid for interest expense
Excise tax paid
Shares issued pursuant to Dividend Reinvestment Plan
Increase in distribution payable
Increase (decrease) in deferred offering costs
For the year
ended
December 31,
2019
For the year
ended
December 31,
2018
For the year
ended
December 31,
2017
$ 26,438,186
$ 26,194,578
$ 22,613,257
)
)
)
)
)
)
)
)
)
)
)
)
)
)
(246,438,384
128,206,318
15,499,766
(415,933
(1,774,469
66,760
519,995
332,407
623,900
(19,565,903
—
873,974
59,751
(23,600
511,805
(318,029
799,875
21,087
458,748
149,175
600,908
87,559
$ (93,286,104
$ 45,862,239
(1,015,127
(503,042
—
—
—
(24,678,113
11,000,000
(467,850
245,750,000
(183,750,000
(246,589
755
$ 91,952,273
(1,333,831
$
17,467,146
$ 16,133,315
(272,927,459
147,528,448
1,646,549
(1,869,905
(1,553,333
67,953
456,151
335,309
623,989
(5,540,518
—
(866,480
(85,246
16,649
562,383
1,564,891
81,038
65,158
842,393
271,289
316,092
(152,511
$(102,422,582
)
)
)
)
)
)
)
)
(172,171,246
172,260,541
22,072
(499,595
(1,196,566
(8,593
455,893
251,826
333,027
(4,655,976
416,725
)
)
)
)
)
1,679,538
748
94,949
13,297
(981,624
—
54,522
47,361
119,349
—
1,022
$ 18,850,527
)
)
$
— $ 48,741,549
(1,358,880
—
(307,022
(18,673
48,875,000
—
(1,688,961
—
(25,000,000
—
(19,930,616
(21,594,863
25,000,000
60,000,000
(856,250
(2,055,000
194,250,000
246,300,000
(269,500,000
(187,500,000
(1,158,616
(351,403
(142
(1,051
$
$ 94,779,010
(2,933,938
$ 15,916,589
(7,643,572
$
9,194,129
25,110,718
$ 25,110,718
$ 17,467,146
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
$ 13,035,976
280,000
—
360,060
(18,673
)
$ 10,075,913
27,717
94,788
899
18,673
$
6,762,104
37,648
—
392,689
—
See accompanying notes to these consolidated financial statements.
92
TABLE OF CONTENTS
Investments
Non-controlled, non-affiliated
investments
Abrasive Products & Equipment,
LLC, et al
Term Loan (SBIC)
APE Holdings, LLC Class A
Common Units
Total
Adams Publishing Group, LLC
Term Loan
Delayed Draw Term Loan
Total
Advanced Barrier Extrusions,
LLC
Term Loan (SBIC)
GP ABX Holdings Partnership,
L.P. Common Stock
Total
Apex Environmental Resources
Holdings, LLC
Common Units
Preferred Units
Total
APG Intermediate Sub 2 Corp.
Term Loan
APG Holdings, LLC Class A
Preferred Units
Total
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
(2)(9)
(2)(12)
Second Lien
L+10.50% 1.00
%
12.45
%
9/5/2014
3/5/2021
Rubber
$5,325,237
$ 5,320,277 $ 5,112,228
1.89
%
3M
Deer Park, TX
Chemicals, Plastics, &
Equity
9/5/2014
375,000 units
375,000
160,000
$ 5,695,277 $ 5,272,228
0.06
1.95
%
%
(4)
(3)
(12)
(12)
(8)
3M
First Lien
L+7.50% 1.00
%
9.44
%
8/3/2018
6/30/2023
3M
First Lien
L+7.50% 1.00
%
9.45
%
8/3/2018
6/30/2023
(2)(12)
First Lien
L+5.75% 1.00
%
7.70
%
8/8/2018
8/8/2023
3M
(4)
Equity
8/8/2018
(4)
(4)
Equity
Equity
10/30/2015
10/30/2015
Greenville, TN
Media: Advertising,
Printing &
Publishing
Rhinelander, WI
Containers,
Packaging & Glass
Amsterdam, OH
Environmental
Industries
Castle Rock, CO
$5,411,955
5,371,128
5,222,536
1.93
%
$173,277
173,277
167,213
$ 5,544,405 $ 5,389,749
0.06
1.99
%
%
$14,286,000
14,056,286
14,214,570
5.25
%
250,000 units
250,000
350,000
$14,306,286 $14,564,570
0.13
5.38
%
%
945 shares
945 shares
945
945,179
946,124 $
0
540,000
540,000
0.00
0.20
0.20
%
%
%
$
1,127,652 units
1,127,652
2,420,000
$10,867,843 $12,444,250
0.89
4.59
%
%
Atlanta, GA
Services: Business
Chicago, IL
Healthcare &
Pharmaceuticals
254,250 units
0
1,100,000
0.41
%
750,000 units
$
0
3,250,000
0 $ 4,350,000
1.20
1.61
%
%
$4,537,037
4,511,837
4,514,352
1.67
%
(22)
First Lien
P+5.00%
1.00
%
9.75
%
11/30/2018 11/30/2023 Aerospace & Defense
$9,925,000
9,740,191
10,024,250
3.70
%
(4)
Equity
11/30/2018
Atmosphere Aggregator Holdings II,
LP
Common Units
Stratose Aggregator Holdings, LP
Common Units
Total
ASC Communications, LLC
(4)
(4)
(7)
Equity
Equity
1/26/2016
6/30/2015
Term Loan (SBIC)
(2)(12)
First Lien
L+6.25% 1.00
%
8.05
%
6/29/2017
6/29/2023
1M
1M
(12)
First Lien
L+6.25% 1.00
%
8.05
%
2/4/2019
6/29/2023
$7,712,963
7,634,025
7,674,398
2.84
%
Term Loan
ASC Communications Holdings,
LLC Class A Preferred Units
(SBIC)
Total
(2)(4)
Equity
6/29/2017
BFC Solmetex, LLC
(23)
3M
Revolver
(12)(19)
First Lien
L+6.50% 1.00
%
8.45
%
4/2/2018
9/26/2023
3M
Nashville, TN
Environmental
Industries
73,529 shares
90,895
580,000
$12,236,757 $12,768,750
0.21
4.72
%
%
$1,650,367
1,650,367
1,584,352
0.59
%
Term Loan (SBIC)
Bonded Filter Co. LLC, Term Loan
(SBIC)
Total
BW DME Acquisition, LLC
Term Loan (SBIC)
BW DME Holdings, LLC, Term
Loan
BW DME Holdings, LLC Class A-1
Preferred Units
BW DME Holdings, LLC Class A-2
Preferred Units
Total
Café Valley, Inc.
Term Loan
CF Topco LLC, Common
Units
Total
(2)(12)
First Lien
L+6.50% 1.00
%
8.45
%
4/2/2018
9/26/2023
$11,592,818
11,468,077
11,129,105
4.11
%
(2)(12)
First Lien
L+6.50% 1.00
%
8.45
%
4/2/2018
9/26/2023
3M
(2)(13)(22) First Lien
L+6.00% 1.00
%
9.59
%
8/24/2017
8/24/2022
3M
Tempe, AZ
Healthcare &
Pharmaceuticals
$1,205,073
1,192,107
1,156,870
$14,310,551 $13,870,327
0.43
5.13
%
%
$16,695,804
16,392,213
16,445,367
6.08
%
(6)
(4)
(4)
Unsecured
17.50%
17.50
%
6/1/2018
6/30/2020
$329,504
329,504
329,504
0.12
%
Equity
Equity
3M
8/24/2017
1/26/2018
1,000,000 shares
1,000,000
1,110,000
0.41
%
937,261 shares
937,261
1,040,000
$18,658,978 $18,924,871
0.38
6.99
%
%
Phoenix, AZ
Beverage, Food, &
(12)
First Lien
L+6.00% 1.25
%
7.95
%
8/28/2019
8/28/2024
Tobacco
$17,575,000
17,242,956
17,399,250
6.43
%
(4)
Equity
8/28/2019
8,810 shares
880,952
860,000
$18,123,908 $18,259,250
0.32
6.75
%
%
See accompanying notes to these consolidated financial statements.
93
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Investments
C.A.R.S. Protection Plus, Inc.
Footnotes
Security
Coupon
LIBOR
floor
Cash PIK
Investment
Date
Maturity
1M
Headquarters/
Industry
Murrysville, PA
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
Term Loan
(12)
First Lien
L+8.50% 0.50
%
10.30
%
12/31/2015 12/31/2020
Automotive
$94,003
$
93,553 $
94,003
0.03
%
Term Loan (SBIC)
CPP Holdings LLC Class A
Common Units
Total
Colford Capital Holdings, LLC
Preferred Units
Condor Borrower, LLC
Term Loan
Condor Top Holdco Limited
Convertible Preferred Shares
Condor Holdings Limited
Preferred Shares, Class B
Total
Convergence Technologies, Inc.
(2)(12)
First Lien
L+8.50% 0.50
%
10.30
%
12/31/2015 12/31/2020
$7,332,210
7,297,083
7,332,210
2.71
%
1M
(4)
Equity
(4)(5)
Equity
3M
12/31/2015
8/20/2015
149,828 shares
149,828
240,000
$ 7,540,464 $ 7,666,213
0.09
2.83
%
%
38,893 units
195,036
20,000
0.01
%
New York, NY
Finance
Clifton, NJ
(12)
Second Lien
L+8.75% 1.00
%
10.68
%
10/27/2017
4/27/2025
Software
$13,750,000
13,534,399
13,406,250
4.95
%
(4)
(4)
Equity
Equity
10/27/2017
10/27/2017
500,000 shares
442,197
330,000
0.12
%
500,000 shares
57,804
40,000
$14,034,400 $13,776,250
0.01
5.08
%
%
3M
Indianpolis, IN
Term Loan (SBIC)
(2)(12)
First Lien
L+6.75% 1.50
%
8.70
%
8/31/2018
8/30/2024
Services: Business
$7,053,571
6,937,850
6,983,036
2.58
%
Term Loan
Delayed Draw Term Loan
Tailwind Core Investor, LLC
Class A Preferred Units
Total
Data Centrum Communications,
Inc.
(12)
(12)
(4)
3M
First Lien
L+6.75% 1.50
%
8.70
%
2/28/2019
8/30/2024
$1,417,857
1,392,977
1,403,679
0.52
%
3M
First Lien
L+6.75% 1.50
%
8.70
%
8/31/2018
8/30/2024
$5,303,571
5,303,571
5,250,536
1.94
%
Equity
8/31/2018
4,275 units
429,614
360,000
$14,064,012 $13,997,251
0.13
5.17
%
%
(12)
First Lien
L+5.50% 1.00
%
7.44
%
5/15/2019
5/15/2024
3M
Term Loan
Health Monitor Holdings, LLC
Seires A Preferred Units
Total
Douglas Products Group, LP
(4)
Equity
Class A Common Units
DRS Holdings III, Inc.
(4)
Equity
1M
5/15/2019
12/27/2018
(12)
First Lien
L+5.75% 1.00
%
7.55
%
11/1/2019
11/1/2025
1M
(10)(12)
First Lien
L+5.75% 1.00
%
7.55
%
11/1/2019
11/1/2025
Montvale, NJ
Media: Advertising,
Printing &
Publishing
Liberty, MO
Chemicals, Plastics, &
Rubber
St. Louis, MO
Consumer Goods:
Durable
Roselle, IL
$16,168,750
15,881,567
15,845,375
5.86
%
1,000,000 shares
1,000,000
730,000
$16,881,567 $16,575,375
0.27
6.13
%
%
322 shares
139,656
490,000
0.18
%
$10,000,000
9,902,215
9,902,215
3.66
%
$36,364
36,364
36,008
$ 9,938,579 $ 9,938,223
0.01
3.67
%
%
Term Loan
Revolver
Total
DTE Enterprises, LLC
Term Loan
DTE Holding Company, LLC
Common Shares, Class A-2
DTE Holding Company, LLC
Preferred Shares, Class AA
Total
Empirix Holdings I, Inc.
Common Shares, Class A
Common Shares, Class B
Total
Energy Labs Holding Corp.
Common Stock
Exacta Land Surveyors, LLC
Term Loan (SBIC)
SP ELS Holdings LLC, Class A
Common Units
Total
EOS Fitness Holdings,
LLC
Preferred Units
Class B Common Units
Total
(18)
(12)
(4)
(4)
(4)
(4)
(4)
(14)(25)
1M
First Lien
L+7.50% 1.50
%
9.24
%
4/13/2018
4/13/2023
Energy: Oil & Gas
$10,991,941
10,836,199
10,772,102
3.98
%
Equity
Equity
Equity
Equity
Equity
3M
4/13/2018
4/13/2018
11/1/2013
11/1/2013
9/29/2016
776,316 shares
466,204
1,000,000
0.37
%
723,684 shares
723,684
940,000
$12,026,087 $12,712,102
0.35
4.70
%
%
1,304 shares
1,317,406 shares
1,304,232
13,174
$ 1,317,406 $
0
0
0
0.00
0.00
0.00
%
%
%
598 shares
598,182
870,000
0.32
%
Billerica, MA
Software
Houston, TX
Energy: Oil & Gas
Cleveland, OH
(2)(12)
First Lien
L+5.75% 1.50
%
7.70
%
2/8/2019
2/8/2024
Services: Business
$16,884,375
16,594,835
16,715,532
6.18
%
(4)
Equity
2/8/2019
1,069,143 shares
1,069,143
880,000
$17,663,978 $17,595,532
0.33
6.51
%
%
(4)
(4)
Equity
Equity
12/30/2014
12/30/2014
Phoenix, AZ
Hotel, Gaming, &
Leisure
118 shares
3,017 shares
$
0
0
0 $
530,000
10,000
540,000
0.20
0.00
0.20
%
%
%
See accompanying notes to these consolidated financial statements.
94
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Investments
Fast Growing Trees, LLC
Footnotes
(16)
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Fort Mill, SC
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
Term Loan (SBIC)
SP FGT Holdings, LLC, Class A
Common
Total
FB Topco, Inc.
Term Loan
(2)(12)
First Lien
(4)
Equity
(13)(22)
First Lien
Delayed Draw Term Loan
(13)(22)
First Lien
3M
L+7.75%
3M
L+6.35%
3M
L+6.35%
1.00
%
9.70
%
2/5/2018
02/05/23
Retail
$19,192,490
$18,935,337 $18,616,716
6.88
%
2/5/2018
1,000,000 shares
1,000,000
750,000
$19,935,337 $19,366,716
0.28
7.16
%
%
Camden, NJ
1.00
%
10.45
%
6/27/2018
4/24/2023
Education
$20,803,881
20,492,224
20,179,764
7.46
%
1.00
%
10.48
%
6/27/2018
4/24/2023
$1,140,578
1,140,578
1,106,361
$21,632,802 $21,286,125
0.41
7.87
%
%
First Lien
7.00%
7.00
%
6/10/2016
6/10/2021
Fort Smith, AR
Consumer Goods:
Durable
$14,801,785
14,678,894
11,989,446
4.43
%
(6)
Unsecured
11.00%
11.00
%
6/10/2016
2/3/2021
$147,231
147,231
0
0.00
%
(4)
Equity
6/10/2016
(12)
Second Lien
L+10.25% 1.00
%
12.19
%
1/30/2015
1/20/2022
3M
1.50
%
10.95
%
5/1/2018
11/1/2023
13,445 shares
94,569
0
$14,920,694 $11,989,446
0.00
4.43
%
%
$5,000,000
4,961,969
4,375,000
1.62
%
$4,500,000
4,432,260
4,230,000
1.56
%
Cary, NC
Education
San Antonio, TX
Services: Business
Carlsbad, CA
Beverage, Food, &
Total
Furniture Factory Outlet, LLC
Term Loan
Furniture Factory Holdings, LLC
Term Loan
Furniture Factory Ultimate
Holding, LP Common
Units
Total
GK Holdings, Inc.
Term Loan
General LED OPCO, LLC
Term Loan
GS HVAM Intermediate, LLC
(12)
(21)(34)
Second Lien
Term Loan
HV GS Acquisition, LP Class A
Interests
Total
Grupo HIMA San Pablo, Inc.,
(12)
First Lien
(4)
Equity
et al
Term Loan
Term Loan
Total
(12)(27)
(15)(27) Second Lien
First Lien
ICD Intermediate Holdco 2, LLC
Term Loan (SBIC)
ICD Holdings, LLC, Class A
Preferred
Total
(2)(5)(12) Second Lien
(4)(5)
Equity
Integrated Oncology Network,
LLC
(29)(30)
Term Loan
Intuitive Health, LLC
(12)
First Lien
Term Loan (SBIC II)
(9)(12)
First Lien
Term Loan
Total
Invincible Boat Company, LLC
(12)
First Lien
Term Loan (SBIC II)
(9)(12)
First Lien
Term Loan
(12)
First Lien
Revolver
Invincible Parent Holdco, LLC
Class A Common Units
(12)(28)
First Lien
(4)
Equity
Total
J.R. Watkins, LLC
Revolver
(12)
First Lien
Term Loan (SBIC)
J.R. Watkins Holdings, Inc.
Class A Preferred
Total
(2)(12)
First Lien
(4)
Equity
3M
L+9.00%
1M
L+5.75%
3M
L+7.00%
13.75%
3M
L+9.00%
3M
L+5.50%
3M
L+6.00%
3M
L+6.00%
3M
L+6.50%
3M
L+6.50%
3M
L+6.50%
1M
L+6.50%
1M
L+6.50%
1.00
%
7.56
%
10/18/2019
10/2/2024
Tobacco
$13,257,576
13,128,716
13,128,716
4.85
%
6/29/2018
1,796 shares
1,618,844
1,620,000
$14,747,560 $14,748,716
0.60
5.45
%
%
1.50
%
8.94
0.00
%
%
2/1/2013
2/1/2013
1/31/2018
7/31/2018
San Juan, PR
Healthcare &
Pharmaceuticals
San Francisco, CA
$4,503,720
$4,109,524
4,503,720
4,109,524
3,490,383
0
$ 8,613,244 $ 3,490,383
1.29
0.00
1.29
%
%
%
1.00
%
10.95
%
1/1/2018
7/1/2024
Finance
$10,000,000
9,847,895
10,000,000
3.70
%
1/1/2018
9,962 shares
496,405
1,030,000
$10,344,300 $11,030,000
0.38
4.08
%
%
1.50
%
7.43
%
7/17/2019
6/24/2024
1.50
%
7.95
%
10/18/2019 10/18/2024
1.50
%
7.95
%
10/18/2019 10/18/2024
1.50
%
8.45
%
8/28/2019
8/28/2025
Newport Beach, CA
Healthcare &
Pharmaceuticals
Plano, TX
Healthcare &
Pharmaceuticals
Opa Locka, FL
Consumer Goods:
Durable
$16,637,202
16,332,432
16,387,644
6.06
%
$6,000,000
5,883,278
5,883,278
2.17
%
$11,500,000
11,276,284
11,276,284
$17,159,562 $17,159,562
4.17
6.34
%
%
$5,962,500
5,848,418
5,843,250
2.16
%
1.50
%
8.45
%
8/28/2019
8/28/2025
$6,459,375
6,264,417
6,330,188
2.34
%
1.50
%
8.45
%
8/28/2019
8/28/2025
$568,182
568,182
556,818
0.21
%
8/28/2019
1,000,000 shares
982,099
1,090,000
$13,663,116 $13,820,256
0.40
5.11
%
%
1.25
%
8.30
%
12/22/2017 12/22/2022
San Francisco, CA
Consumer Goods:
non-durable
$1,750,000
1,750,000
1,470,000
0.54
%
1.25
%
8.30
%
12/22/2017 12/22/2022
$12,250,000
12,091,135
10,290,000
3.80
%
12/22/2017
1,133 shares
1,132,576
10,000
$14,973,711 $11,770,000
0.00
4.34
%
%
See accompanying notes to these consolidated financial statements.
95
TABLE OF CONTENTS
Investments
Jurassic Acquisiton Corp.
Term Loan
Kelleyamerit Holdings, Inc.
Term Loan (SBIC)
KidKraft, Inc.
Term Loan
Lynx FBO Operating, LLC
Term Loan
Lynx FBO Investments, LLC
Class A-1 Common Units
Total
Madison Logic, Inc.
Term Loan (SBIC)
Madison Logic Holdings, Inc.
Common Stock (SBIC)
Madison Logic Holdings, Inc.
Series A Preferred Stock (SBIC)
Total
Mobile Acquisition Holdings, LP
Class A Common Units
Munch’s Supply, LLC
Term Loan
Cool Supply Holdings, LLC Class A
Common Units
Total
National Trench Safety, LLC,
et al
Term Loan (SBIC)
NTS Investors, LP Class A Common
Units
Total
Naumann/Hobbs Material Handling
Corporation II, Inc.
(6)
(31)
(12)
(4)
(4)
(20)
(12)
(4)
(2)
(4)
(32)
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Footnotes
Security
Coupon
floor Cash
PIK
LIBOR
(12)
First Lien
L+5.50% 0.00
%
7.30
%
1M
Investment
Date
Maturity
Headquarters/
Industry
Sparks, MD
12/28/2018 11/15/2024 Metals & Mining
Walnut Creek, CA
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$17,325,000
$17,103,044 $17,325,000
6.40
%
(2)(13)(22) First Lien
L+7.50% 1.00
%
10.03
%
3/30/2018
3/30/2023
3M
Second Lien
12.00%
11.00
%
1.00
%
9/30/2016
3/30/2022
3M
First Lien
L+5.75% 1.50
%
7.86
%
9/30/2019
9/30/2024 Aerospace & Defense
$13,750,000
13,486,379
13,486,379
4.98
%
Equity
9/30/2019
3,704 shares
500,040
500,000
$13,986,419 $13,986,379
0.18
5.16
%
%
Automotive
Dallas, TX
Consumer Goods:
Durable
Houston, TX
$9,750,000
9,611,438
9,555,000
3.53
%
$9,503,655
9,411,079
8,410,735
3.11
%
(2)(12)
First Lien
L+8.00% 0.50
%
9.80
%
11/30/2016 11/30/2021
1M
New York, NY
Media: Broadcasting
&
Subscription
Santa Clara, CA
Software
New Lenox, IL
$4,581,402
4,561,449
4,581,402
1.69
%
5,000 shares
50,000
60,000
0.02
%
4,500 shares
450,000
520,000
$ 5,061,449 $ 5,161,402
0.19
1.90
%
%
750 units
455,385
1,740,000
0.64
%
11/30/2016
11/30/2016
11/1/2016
(2)(4)
Equity
(2)(4)
Equity
Equity
3M
First Lien
L+6.25% 1.00
%
8.35
%
4/11/2019
4/11/2024 Capital Equipment
$7,960,000
7,890,332
7,880,400
2.91
%
Equity
4/11/2019
500,000 units
498,779
410,000
$ 8,389,111 $ 8,290,400
0.15
3.06
%
%
Second Lien
11.50%
11.50
%
3/31/2017
3/31/2022
Equity
3/31/2017
Houston, TX
Construction &
Building
Phoenix, AZ
$10,000,000
9,908,323
10,000,000
3.70
%
2,335 units
500,000
500,000
$10,408,323 $10,500,000
0.18
3.88
%
%
Term Loan (SBIC II)
(9)(12)
First Lien
L+6.25% 1.50
%
8.20
%
8/30/2019
8/30/2024
Services: Business
$5,978,693
5,865,655
5,859,119
2.17
%
3M
Term Loan
CGC NH, Inc. Common Units
Total
NGS US Finco, LLC
Term Loan (SBIC)
NS412, LLC
Term Loan
NS Group Holding Company, LLC
Class A Common
Units
Total
NuMet Machining Techniques,
LLC
Term Loan
Bromford Industries Limited Term
(12)
(4)
First Lien
Equity
3M
L+6.25% 1.50
%
8.20
%
8/30/2019
8/30/2019
8/30/2024
$9,480,904
123 shares
9,301,650
440,758
9,291,286
400,000
$15,608,063 $15,550,405
3.43
0.15
5.75
%
%
%
1M
Bradford, PA
(2)(12)
Second Lien
L+8.50% 1.00
%
10.30
%
10/1/2018
4/1/2026 Utilities: Oil & Gas
$10,000,000
9,868,044
9,900,000
3.66
%
(12)
Second Lien
L+8.50% 1.00
%
10.45
%
5/6/2019
11/6/2025 Services: Consumer
$7,615,000
7,474,214
7,500,775
2.77
%
3M
Dallas, TX
(4)
Equity
5/6/2019
750 shares
750,000
810,000
$ 8,224,214 $ 8,310,775
0.30
3.07
%
%
6M
Birmingham, UK
(5)(35)
Second Lien
L+9.00% 2.00
%
11.00
%
11/5/2019
5/5/2026 Aerospace & Defense
$11,700,000
11,470,017
11,470,017
4.24
%
6M
Loan
(5)(35)
Second Lien
L+9.00% 2.00
%
11.00
%
11/5/2019
5/5/2026
$7,800,000
7,646,678
7,646,678
2.83
%
Bromford Holdings, L.P. Class A
Membership Units
Total
Nutritional Medicinals, LLC
Term Loan
Functional Aggregator, LLC
Common Units
Total
PCP MT Aggregator Holdings,
L.P.
Common LP Units
(4)(5)
Equity
11/5/2019
(24)
(12)
(4)
3M
First Lien
L+6.00% 1.00
%
7.95
%
11/15/2018 11/15/2023
Centerville, OH
Healthcare &
Pharmaceuticals
Equity
11/15/2018
1,000,000 shares
1,000,000
1,000,000
$20,116,695 $20,116,695
0.37
7.44
%
%
$14,845,000
14,606,657
14,399,650
5.32
%
12,500 shares
1,250,000
1,260,000
$15,856,657 $15,659,650
0.47
5.79
%
%
(4)
Equity
3/29/2019
Oak Brook, IL
Finance
750,000 shares
0
1,080,000
0.40
%
See accompanying notes to these consolidated financial statements.
96
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Investments
PCS Software, Inc.
Footnotes
(11)(33)
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Term Loan (SBIC)
(2)(12)
First Lien
L+5.75% 1.50
%
7.70
%
7/1/2019
7/1/2024
3M
3M
Headquarters/
Industry
Shenandoah, Tx
Transportation &
Logistics
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$1,990,000
$ 1,953,461 $ 1,960,150
0.72
%
First Lien
L+5.75% 1.50
%
7.70
%
7/1/2019
7/1/2024
$15,173,750
14,895,138
14,946,144
5.52
%
(12)
(4)
Term Loan
PCS Software Holdings, LLC
Class A Preferred Units
Total
Pioneer Transformers, L.P.
Term Loan (SBIC II)
Premiere Digital Services, Inc.
Equity
7/1/2019
(9)(12)
First Lien
L+6.00% 1.50
%
7.79
%
11/22/2019
1M
Franklin, WI
8/16/2024 Capital Equipment
Los Angeles, CA
Media: Broadcasting
325,000 shares
325,000
320,000
$17,173,599 $17,226,294
0.12
6.36
%
%
$4,987,500
4,901,484
4,901,484
1.81
%
Term Loan (SBIC)
(2)(13)(22)
First Lien
L+5.50% 1.50
%
8.73
%
10/18/2018 10/18/2023
3M
3M
&
Subscription
$9,992,518
9,753,256
9,842,630
3.64
%
Class A Common Units
(4)
Equity
SQAD, LLC
Term Loan
Premiere Digital Holdings, Inc.,
Common Stock
Premiere Digital Holdings, Inc.,
Preferred Stock
Total
Price for Profit, LLC
Term Loan (SBIC)
I2P Holdings, LLC, Series A
Preferred
Total
Protect America, Inc.
Term Loan (SBIC)
Skopos Financial, LLC
Term Loan
Skopos Financial Group, LLC
Series A Preferred Units
Total
Specified Air Solutions, LLC
Term Loan (SBIC)
SQAD Holdco, Inc. Preferred
Shares, Series A (SBIC)
SQAD Holdco, Inc. Common
Shares (SBIC)
Total
TechInsights, Inc.
Term Loan
Time Manufacturing Acquisition,
LLC
Term Loan
Time Manufacturing
Investments, LLC Class A
Common Units
Total
TFH Reliability, LLC
Term Loan (SBIC)
TFH Reliability Group, LLC
Class A Common Units
Total
U.S. Auto Sales, Inc. et al
USASF Blocker II, LLC
Common Units
USASF Blocker III, LLC
Series C Preferred Units
USASF Blocker LLC Common
Units
Total
(13)(22)
First Lien
L+5.50% 1.50
%
8.73
%
10/18/2018 10/18/2023
$2,428,772
2,372,392
2,392,341
0.88
%
Equity
Equity
(4)
(4)
(17)
3M
10/18/2018
10/18/2018
5,000 shares
50,000
70,000
0.03
%
4,500 shares
450,000
600,000
$12,625,648 $12,904,971
0.22
4.77
%
%
Cleveland, OH
(2)(12)
First Lien
L+6.50% 1.00
%
8.45
%
1/31/2018
1/31/2023
Services: Business
$3,887,657
3,836,120
3,887,657
1.44
%
(4)
Equity
1/31/2018
750,000 shares
750,000
2,800,000
$ 4,586,120 $ 6,687,657
1.03
2.47
%
%
Austin TX
(2)(6)(12)(26) Second Lien
L+7.75% 1.00
%
0.00
%
8/30/2017 10/30/2020 Services: Consumer
$17,979,749
17,851,392
5,034,330
1.86
%
3M
(5)
Unsecured
12.00%
12.00
%
1/31/2014
1/31/2021
(4)(5)
Equity
1/31/2014
6/30/2017
(2)(12)
First Lien
L+6.50% 1.00
%
8.44
%
12/22/2017 12/22/2022
3M
(2)(4)
(2)(4)
Equity
Equity
10/31/2013
10/31/2013
Irving, TX
Finance
Buffalo, NY
Construction &
Building
Tarrytown, NY
Media: Broadcasting
&
Subscription
Ottawa, Ontario
$15,500,000
15,500,000
15,422,500
5.70
%
1,120,684 units
1,162,544
1,110,000
$16,662,544 $16,532,500
0.41
6.11
%
%
3,846 shares
0
250,000
0.09
%
$14,497,594
14,447,718
14,352,618
5.30
%
5,624 shares
156,001
720,000
0.27
%
5,800 shares
62,485
80,000
$14,666,204 $15,152,618
0.03
5.60
%
%
(5)(13)(22)
First Lien
L+6.00% 1.00
%
9.33
%
8/16/2017
10/2/2023 High Tech Industries
$21,540,925
21,201,137
21,217,811
7.84
%
3M
(6)
(4)
Unsecured
11.50%
10.75
%
0.75
%
2/3/2017
8/3/2023 Capital Equipment
$6,385,182
6,302,784
6,385,182
2.36
%
Waco, TX
Equity
2/3/2017
5,000 units
500,000
660,000
$ 6,802,784 $ 7,045,182
0.24
2.60
%
%
3M
Houston, TX
Chemicals, Plastics, &
(2)(12)
Second Lien
L+10.75% 0.50
%
12.70
%
10/21/2016
4/21/2022
Rubber
$5,875,000
5,814,371
5,875,000
2.17
%
(4)
Equity
10/21/2016
(4)(5)
(4)(5)
(4)(5)
Equity
Equity
Equity
6/8/2015
2/13/2018
6/8/2015
250,000 shares
231,521
220,000
$ 6,045,892 $ 6,095,000
0.08
2.25
%
%
Lawrenceville, GA
Finance
441 units
441,000
690,000
0.26
%
125 Units
125,000
200,000
0.07
%
9,000 units
9,000
575,000 $
10,000
900,000
0.00
0.33
%
%
$
See accompanying notes to these consolidated financial statements.
97
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Investments
VRI Intermediate Holdings, LLC
Term Loan (SBIC)
VRI Ultimate Holdings, LLC Class A
Preferred Units
Total
Whisps Acquisiton Corp.
Term Loan
Whisps Holding LP Class A Common
Units
Total
Wise Parent Company, LLC
Footnotes Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
(2)(12) Second Lien
L+9.25% 1.00
%
11.20
%
5/31/2017 10/31/2020
3M
Headquarters/
Industry
Franklin, OH
Healthcare &
Pharmaceuticals
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$9,000,000
$
8,949,730 $
9,000,000
3.33
%
(4)
Equity
5/31/2017
326,797 shares
(12)
First Lien
L+6.00% 0.00
%
7.95
%
4/26/2019
4/18/2025
Tobacco
$8,875,000
3M
Elgin, IL
Beverage, Food, &
(4)
Equity
4/18/2019
500,000 shares
500,000
9,449,730 $
610,000
9,610,000
0.23
3.56
%
%
8,717,992
8,875,000
3.28
%
500,000
9,217,992 $
680,000
9,555,000
0.25
3.53
%
%
$
$
Salt Lake City, UT
Beverage, Food, &
Membership Units
(4)
Equity
8/27/2018
Tobacco
6 units
41,894
30,000
0.01
%
Total Non-controlled, non-affiliated
investments
Net Investments
LIABILITIES IN EXCESS OF OTHER
ASSETS
NET ASSETS
642,707,824
642,707,824
628,948,077 232.45
628,948,077 232.45
%
%
(358,376,904 (132.45
$ 270,571,173 100.00
)
)%
%
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used
to value securities in the portfolio.
Investments held by the SBIC subsidiaries (as defined in Note 1), which include $8,445,923 of cash and
$222,009,613 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility
as defined in Note 9. The Company’s obligations to the lenders of the Credit Facility are secured by a first
priority security interest in all investments and cash and cash equivalents, except for investments held by the
SBIC subsidiaries.
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $669,231, with an interest rate of LIBOR plus 7.50% and a maturity of June 30, 2023. This
investment is accruing an unused commitment fee of 0.375% per annum.
Security is non-income producing.
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 89% of the
Company’s total assets as of December 31, 2019.
Represents a PIK interest security. At the option of the issuer, interest can be paid in cash or cash and PIK
interest. The percentage of PIK interest shown is the maximum PIK interest that can be elected by the issuer.
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.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000,
with an interest rate of LIBOR plus 5.75% and a maturity of August 8, 2023. This investment is accruing an
unused commitment fee of 0.50% per annum.
Investments held by the SBIC II subsidiary (as defined in Note 1), which include $477,392 of cash and
$22,498,836 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility
as defined in Note 9. The Company’s obligations to the lenders of the Credit Facility are secured by a first
priority security interest in all investments and cash and cash equivalents, except for investments held by the
SBIC II subsidiary.
See accompanying notes to these consolidated financial statements.
98
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
(10)
(11)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $872,727,
with an interest rate of LIBOR plus 5.75% and a maturity of November 1, 2025. This investment is accruing
an unused commitment fee of 0.50% per annum.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000,
with an interest rate of LIBOR plus 5.75% and a maturity of July 1, 2024. This investment is accruing an
unused commitment fee of 0.50% per annum.
(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 revolver commitment in an amount not to exceed $1,500,000,
with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. This investment is accruing
an unused commitment fee of 0.50% per annum.
(15)
Investment has been on non-accrual since October 31, 2017.
(16)
Excluded from the investment is an undrawn revolver 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 revolver 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.
(18)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $750,000,
with an interest rate of LIBOR plus 7.50% and a maturity of April 13, 2023. This investment is accruing an
unused commitment fee of 0.50% per annum.
(19)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $488,998,
with an interest rate of LIBOR plus 6.50% and a maturity of September 26, 2023. This investment is
accruing an unused commitment fee of 0.50% per annum.
(20)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $2,222,222, with an interest rate of LIBOR plus 6.25% and a maturity of April 11, 2024. This
investment is accruing an unused commitment fee of 1.00% per annum
(21)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,651,515,
with an interest rate of LIBOR plus 5.75% and a maturity of October 2, 2024. This investment is accruing an
unused commitment fee of 0.50% per annum.
(22)
This loan is a unitranche investment.
(23)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $1,662,592, with an interest rate of LIBOR plus 6.50% and a maturity of September 26, 2023. This
investment is not accruing an unused commitment fee.
(24)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000
with an interest rate of LIBOR plus 6.00% and a maturity of November 15, 2023. This investment is
accruing an unused commitment fee of 0.50% per annum.
(25)
Excluded from the investment is an undrawn delayed draw term commitment in an amount not to exceed
$4,000,000, with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. This investment
is accruing an unused commitment fee of 0.50% per annum.
See accompanying notes to these consolidated financial statements.
99
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
(26)
Investment has been on non-accrual since June 28, 2019.
(27)
Maturity date is under on-going negotiations with portfolio company and other lenders, if applicable.
(28)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $852,273,
with an interest rate of LIBOR plus 6.50% and a maturity of August 28, 2025. This investment is accruing
an unused commitment fee of 0.50% per annum.
(29)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $553,517,
with an interest rate of LIBOR plus 5.50% and a maturity of June 24, 2024. This investment is accruing an
unused commitment fee of 0.50% per annum.
(30)
Excluded from the investment is an undrawn delated draw term loan commitment in an amount not to
exceed $2,767,584, with an interest rate of LIBOR plus 5.50% and a maturity of June 24, 2024. This
investment is accruing an unused commitment fee of 1.00% per annum.
(31)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,875,000,
with an interest rate of LIBOR plus 5.75% and a maturity of September 30, 2024. This investment is
accruing an unused commitment fee of 0.50% per annum.
(32)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,644,550,
with an interest rate of LIBOR plus 6.25% and a maturity of August 30, 2024. This investment is accruing
an unused commitment fee of 0.50% per annum.
(33)
Excluded from the investment is an undrawn delated draw term loan commitment in an amount not to
exceed $3,750,000, with an interest rate of LIBOR plus 5.75% and a maturity of March 31, 2020. This
investment is not accruing an unused commitment fee.
(34)
Excluded from the investment is an undrawn delated draw term loan commitment in an amount not to
exceed $1,590,909, with an interest rate of LIBOR plus 5.75% and a maturity of October 2, 2024. This
investment is accruing an unused commitment fee of 1.00% per annum.
(35)
These loans have LIBOR Floors which are higher than the current applicable LIBOR rates; therefore, the
floors are in effect.
Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar
See accompanying notes to these consolidated financial statements.
100
TABLE OF CONTENTS
Investments
Non-controlled, affiliated
investments
Glori Energy Production Inc.
Glori Energy Production, LLC
Class A Common Units
Subtotal Non-controlled,
affiliated investments
Non-controlled, non-affiliated
investments
Abrasive Products & Equipment,
LLC, et al
Term Loan (SBIC)
APE Holdings, LLC Class A
Common Units
Total
Adams Publishing Group,
LLC
Term Loan
Advanced Barrier Extrusions,
LLC
Term Loan (SBIC)
GP ABX Holdings
Partnership, L.P. Common
Stock
Total
Apex Environmental Resources
Holdings, LLC
Common Units
Preferred Units
Total
APG Intermediate Sub 2 Corp.
Term Loan
APG Holdings, LLC Class A
Preferred Units
Total
Atmosphere Aggregator Holdings
II, LP
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2018
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
(2)
(4)
(2)
Equity
2/1/2017
Energy: Oil & Gas
1,000 shares $
52,185 $
50,000
0.02
%
Houston, TX
52,185
50,000
0.02
%
(2)(12)(20)
Second Lien
L+10.50% 1.00
%
0.00
%
9/5/2014
3/5/2020
Plastics, & Rubber
$5,325,237
5,294,907
4,712,835
2.10
%
3M
Deer Park, TX
Chemicals,
Equity
9/5/2014
375,000 units
375,000
5,669,907
0
4,712,835
0.00
2.10
%
%
(4)
(3)
(12)
(8)
First Lien
3M
L+7.50%
1.00
%
9.93
%
8/3/2018
6/30/2023
(2)(12)
First Lien
3M
L+5.75%
1.00
%
8.56
%
8/8/2018
8/8/2023
(4)
Equity
8/8/2018
Greenville, TN
Media:
Advertising,
Printing &
Publishing
Rhinelander, WI
Containers,
Packaging &
Glass
Amsterdam, OH
Environmental
Industries
Castle Rock, CO
Aerospace &
Atlanta, GA
Services:
Business
Chicago, IL
Healthcare &
Pharmaceuticals
Austin TX
FIRE:
Insurance
Nashville, TN
Environmental
Industries
$7,125,000
7,058,675
6,875,625
3.06
%
$11,400,000
11,187,711
10,659,000
4.74
%
250,000 units
250,000
11,437,711
210,000
10,869,000
0.09
4.83
%
%
945 shares
945 shares
945
945,179
946,124
0
330,000
330,000
0.00
0.15
0.15
%
%
%
10,000,000
1,000,000
units
9,777,822
9,777,822
4.35
%
1,000,000
10,777,822
1,000,000
10,777,822
0.44
4.79
%
%
254,250
units
750,000
units
254,250
1,190,000
0.53
%
750,000
1,004,250
3,510,000
4,700,000
1.56
2.09
%
%
$5,083,335
$ 5,045,552 $ 5,057,916
2.25
%
73,529 shares
483,540
5,529,092
800,000
5,857,916
0.36
2.61
%
%
$5,000,000
4,925,301
4,950,000
2.20
%
500,000
units
500,000
5,425,301
510,000
5,460,000
0.23
2.43
%
%
$305,623
305,623
288,814
0.13
%
(4)
(4)
Equity
Equity
(13)(22)
First Lien
(4)
Equity
3M
L+6.00%
1.00
%
10.05
%
11/30/2018 11/30/2023
Defense
10/30/2015
10/30/2015
11/30/2018
6/30/2015
6/30/2015
Common Units
Atmosphere Aggregator
Holdings, LP Common Units
Total
ASC Communications, LLC
(4)
(4)
(7)
Equity
Equity
Term Loan (SBIC)
ASC Communications Holdings,
LLC Class A Preferred Units
(SBIC)
Total
Beneplace, LLC
Term Loan (SBIC)
Beneplace Holdings, LLC
Preferred
Units
Total
BFC Solmetex, LLC
(2)(12)
First Lien
1M
L+5.75%
1.00
%
8.27
%
6/29/2017
6/29/2022
(2)(4)
Equity
6/29/2017
(2)(12)
SecondLien
L+10.00% 1.00
%
12.81
%
3/27/2017
9/27/2022
3M
Equity
3/27/2017
(4)
(23)
Revolver
(12)(19)
First Lien
Term Loan (SBIC)
Bonded Filter Co. LLC, Term
Loan (SBIC)
Total
(2)(12)
First Lien
(2)(12)
First Lien
3M
L+6.25%
3M
L+6.25%
3M
L+6.25%
1.00
%
9.06
%
4/2/2018
9/26/2023
1.00
%
9.06
%
4/2/2018
9/26/2023
$11,711,033
11,552,684
11,066,926
4.92
%
1.00
%
9.06
%
4/2/2018
9/26/2023
$1,216,687
1,200,236
13,058,543
1,149,769
12,505,509
0.51
5.56
%
%
See accompanying notes to these consolidated financial statements.
101
Term Loan
(13)(22)
First Lien
Delayed Draw Term Loan
(13)(22)
First Lien
TABLE OF CONTENTS
Investments
BW DME Acquisition, LLC
Term Loan (SBIC)
BW DME Holdings, LLC,
Term Loan (SBIC)
BW DME Holdings, LLC
Class A-1 Preferred
Units
BW DME Holdings, LLC
Class A-2 Preferred
Units
Total
C.A.R.S. Protection Plus,
Inc.
Term Loan
Term Loan (SBIC)
CPP Holdings LLC Class A
Common Units
Total
Catapult Learning, Inc.
Total
Colford Capital Holdings,
LLC
Preferred Units
Condor Borrower, LLC
Term Loan
Condor Top Holdco Limited
Convertible Preferred
Shares
Condor Holdings Limited
Preferred Shares,
Class B
Total
Convergence Technologies,
Inc.
Term Loan (SBIC)
Tailwind Core Investor, LLC
Class A Preferred Units
Total
Douglas Products Group, LP
Class A Common
Units
Dream II Holdings, LLC
Class A Common
Units
DTE Enterprises, LLC
Term Loan
DTE Holding Company, LLC
Common Shares, Class A-2
DTE Holding Company, LLC
Preferred Shares, Class AA
Total
Empirix Inc.
Empirix Holdings I, Inc.
Common Shares,
Class A
Empirix Holdings I, Inc.
Common Shares,
Class B
Total
Energy Labs Inc.
Energy Labs Holding Corp.
Common Stock
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
(2)(13)(22)
First Lien
3M
L+6.00%
1.00
%
10.50
%
8/24/2017
8/24/2022
Headquarters/
Industry
Tempe, AZ
Healthcare &
Pharmaceuticals
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$16,695,804
16,297,319
16,111,451
7.17
%
(6)
(4)
(4)
Unsecured
17.50%
17.50
%
6/1/2018 12/31/2019
$277,635
277,635
277,635
0.12
%
Equity
Equity
8/24/2017
1/26/2018
1,000,000
shares
937,261
shares
1,000,000
930,000
0.41
%
937,261
18,512,215
870,000
18,189,086
0.39
8.09
%
%
(12)
First Lien
(2)(12)
First Lien
(4)
Equity
Murrysville, PA
3M
L+8.50%
3M
L+8.50%
3M
L+6.35%
3M
L+6.35%
0.50
%
11.21
%
12/31/2015 12/31/2020
Automotive
$98,746
97,843
98,746
0.04
%
0.50
%
11.21
%
12/31/2015 12/31/2020
12/31/2015
$7,702,191
149,828
shares
7,631,725
7,702,191
3.43
%
149,828
7,879,396
170,000
7,970,937
0.08
3.55
%
%
Camden, NJ
1.00
%
11.08
%
6/27/2018
4/24/2023
Education
$20,856,549
20,472,244
19,813,722
8.81
%
1.00
%
11.22
%
6/27/2018
4/24/2023
$1,143,451
1,143,451
21,615,695
1,086,278
20,900,000
0.48
9.29
%
(4)(5)
Equity
8/20/2015
New York, NY
Finance
Clifton, NJ
38,893 units
247,815
60,000
0.03
%
(12)
Second Lien
3M
L+8.75%
1.00
%
11.28
%
10/27/2017
4/27/2025
Software
$13,750,000
13,505,368
13,062,500
5.81
%
Equity
Equity
(4)
(4)
(14)
(2)(12)
First Lien
(4)
Equity
(4)
Equity
(4)
(18)
(12)
(4)
(4)
(4)
(4)
Equity
First Lien
3M
L+7.50%
Equity
Equity
Equity
Equity
(4)
Equity
10/27/2017
10/27/2017
3M
L+6.75%
1.50
%
9.56
%
8/31/2018
8/30/2024
Indianpolis, IN
Services:
Business
8/31/2018
12/27/2018
10/20/2014
1.50
%
10.12
%
4/13/2018
4/13/2023
4/13/2018
4/13/2018
Liberty, MO
Chemicals, Plastics, &
Rubber
Boca Raton, FL
Services:
Consumer
Roselle, IL
Energy: Oil &
Gas
Billerica, MA
500,000
shares
500,000
shares
$
442,197 $
330,000
0.15
%
57,804
14,005,369
40,000
13,432,500
0.02
5.98
%
%
$7,125,000
6,988,628
6,697,500
2.98
%
3,750 units
375,000
7,363,628
390,000
7,087,500
0.17
3.15
%
%
322 shares
139,656
670,000
0.30
%
250,000
units
$12,491,941
776,316
shares
723,684
shares
242,304
110,000
0.05
%
12,271,851
12,242,102
5.44
%
776,316
1,410,000
0.63
%
613,794
13,661,961
1,320,000
14,972,102
0.59
6.66
%
%
11/1/2013
Software
1,304 shares
1,304,232
1,650,000
0.73
%
11/1/2013
9/29/2016
1,317,406
shares
13,174
1,317,406
20,000
1,670,000
0.01
0.74
%
%
598 shares
598,182
520,000
0.23
%
Houston, TX
Energy: Oil &
Gas
See accompanying notes to these consolidated financial statements.
102
TABLE OF CONTENTS
Investments
EOS Fitness OPCO Holdings,
LLC
Term Loan (SBIC)
EOS Fitness Holdings, LLC
Class A Preferred Units
EOS Fitness Holdings, LLC
Class B Common Units
Total
Fast Growing Tree, LLC
Term Loan (SBIC)
SP FGT Holdings, LLC,
Class A Common
Total
Furniture Factory Outlet,
LLC
Term Loan
Revolver
Furniture Factory Holdings,
LLC Term Loan
Furniture Factory Ultimate
Holdings, LP Common
Units
Total
GK Holdings, Inc.
General LED OPCO, LLC
Term Loan
Good Source Solutions, Inc.
Term Loan
HV GS Acquisition, LLC
Class A Preferred Units
HV GS Acquisition, LLC
Class B Common Units
Total
Grupo HIMA San Pablo, Inc.,
et al
Term Loan
Term Loan
Total
ICD Intermediate Holdco 2,
LLC
Term Loan (SBIC)
ICD Holdings, LLC, Class A
Preferred
Total
J.R. Watkins, LLC
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
(2)(12)
First Lien
1M
L+8.25%
0.75
%
10.60
%
12/30/2014 12/30/2019
Phoenix, AZ
Hotel, Gaming, &
Leisure
Equity
Equity
(4)
(4)
(16)
(2)(12)
First Lien
(4)
Equity
12/30/2014
12/30/2014
3M
L+7.75%
1.00
%
10.56
%
2/5/2018
02/05/23
Retail
Fort Mill, SC
2/5/2018
$3,064,655
3,049,620
3,064,655
1.36
%
118 shares
117,670
340,000
0.15
%
3,017 shares
3,017
3,170,307
10,000
3,414,655
%
0.00
1.51
$20,215,000
1,000,000
shares
19,871,587
19,305,325
8.59
%
$ 1,000,000 $ 1,080,000
20,385,325
20,871,587
0.48
9.07
%
%
First Lien
First Lien
3M
L+8.00%
3M
L+8.00%
0.50
%
10.81
%
6/10/2016
6/10/2021
Fort Smith, AR
Consumer
Goods: Durable
$15,163,885
14,961,912
15,163,885
6.74
%
0.50
%
10.81
%
12/17/2018
6/10/2021
$2,500,000
2,500,000
2,500,000
1.11
%
Unsecured
11.00%
11.00
%
6/10/2016
2/3/2021
$140,056
140,056
140,056
0.06
%
(12)
(12)
(6)
(4)
Equity
6/10/2016
Term Loan
(12)
Second Lien
L+10.25% 1.00
%
13.05
%
1/30/2015
1/20/2022
3M
(12)
Second
Lien
3M
L+9.00%
1.50
%
11.81
%
5/1/2018
11/1/2023
(13)(22)
First Lien
3M
L+6.00%
1.00
%
11.13
%
6/29/2018
6/29/2023
(4)
(4)
Equity
Equity
6/29/2018
6/29/2018
(12) (25)
(15) (25)
First Lien
Second Lien
3M
L+7.00%
13.75%
1.50
%
9.54
0.00
%
%
2/1/2013
2/1/2013
1/31/2018
7/31/2018
13,445
shares
94,569
17,696,537
210,000
18,013,941
0.09
8.00
%
%
$5,000,000
4,946,554
4,425,000
1.97
%
$4,500,000
4,418,420
4,252,500
1.89
%
$18,500,000
18,158,424
17,390,000
7.73
%
1,000 shares
1,000,000
730,000
0.32
%
28,125 shares
0
19,158,424
0
18,120,000
0.00
8.05
%
%
$4,688,430
$4,109,524
4,688,430
4,109,524
8,797,954
4,125,818
904,095
5,029,913
1.83
0.40
2.23
%
%
%
Cary, NC
Education
San Antonio,
TX
Services:
Business
Carlsbad, CA
Beverage,
Food, &
Tobacco
San Juan, PR
Healthcare &
Pharmaceuticals
San Francisco,
CA
(2)(5)(12)
Second
Lien
3M
L+9.00%
1.00
%
11.81
%
1/2/2018
7/1/2024
Finance
$10,000,000
9,822,706
9,900,000
4.40
%
(4)(5)
Equity
1/2/2018
9,962 shares
496,409
10,319,115
820,000
10,720,000
0.36
4.76
%
%
Revolver
(12)
First Lien
Term Loan (SBIC)
J.R. Watkins Holdings, Inc.
Class A Preferred
Total
Jurassic Intermediate Holdings
Corp.
Term Loan
Kelleyamerit Holdings, Inc.
(2)(12)
First Lien
(4)
Equity
(12)
First Lien
Term Loan (SBIC)
(2)(13)(22)
First Lien
3M
L+6.50%
3M
L+6.50%
3M
L+5.50%
3M
L+7.50%
1.25
%
9.31
%
12/22/2017 12/22/2022
San Francisco,
CA
Consumer
Goods:
non-durable
$1,750,000
1,750,000
1,671,250
0.74
%
1.25
%
9.31
%
12/22/2017 12/22/2022
$12,375,000
12,169,222
11,818,125
5.26
%
12/22/2017
1,076 shares
1,075,758
14,994,980
1,090,000
14,579,375
0.48
6.48
%
%
0.00
%
8.14
%
12/28/2018 11/15/2024
Sparks, MD
Metals &
Mining
Walnut Creek,
CA
$17,500,000 $ 17,237,500 $ 17,237,500
7.67
%
1.50
%
10.98
%
3/30/2018
3/30/2023
Automotive
$9,750,000
9,577,863
9,311,250
4.14
%
See accompanying notes to these consolidated financial statements.
103
TABLE OF CONTENTS
Investments
Keais Records Service, LLC
Keais Holdings, LLC Class A
Units
KidKraft, Inc.
Term Loan
Livingston International, Inc.
Term Loan
Madison Logic, Inc.
Term Loan (SBIC)
Madison Logic Holdings, Inc.
Common Stock (SBIC)
Madison Logic Holdings, Inc.
Series A Preferred Stock
(SBIC)
Total
Magdata Intermediate
Holdings, LLC
Term Loan
Mobileum, Inc.
Term Loan
Mobile Acquisition Holdings,
LP Class A-2 Common
Units
Total
MTC Parent, L.P.
Class A-2 Common Units
National Trench Safety, LLC,
et al
Term Loan (SBIC)
NTS Investors, LP Class A
Common Units
Total
NGS US Finco, LLC
Term Loan (SBIC)
Nutritional Medicinals, LLC
Term Loan
Functional Aggregator, LLC
Common Units
Total
OGS Holdings, Inc.
Series A Convertible Preferred
Stock
Premiere Digital Services,
Inc.
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
(4)
(6)
Equity
6/30/2016
Second Lien
12.00%
11.00 1.00
% %
9/30/2016
3/30/2022
(5)(12)
Second
Lien
3M
L+8.25%
1.25
%
11.05
%
4/23/2013
4/18/2020
(2)(12)
First Lien
(2)(4)
Equity
(2)(4)
Equity
(12)
Second Lien
(12)
Second
Lien
1M
L+8.00%
0.50
%
10.51
%
11/30/2016 11/30/2021
11/30/2016
11/30/2016
1.00
%
12.31
%
10/16/2017
4/16/2024
3M
L+9.50%
3M
(4)
Equity
11/1/2016
(4)
Equity
12/1/2015
Finance
Oak Brook, IL
Second
Lien
Equity
Second
Lien
First Lien
Equity
11.50%
11.50
%
3/31/2017
3/31/2022
3/31/2017
1M
L+8.50%
3M
L+6.00%
1.00
%
10.88
%
10/4/2018
4/1/2026
1.00
%
8.81
%
11/15/2018 11/15/2023
11/15/2018
Equity
4/22/2014
(2)
(4)
(2)(12)
(24)
(12)
(4)
(4)
(10)
Principal
Amount/
Shares
148,335
units
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
736,595
820,000
0.36
%
$9,409,210
9,284,478
8,797,611
3.91
%
$6,841,739
6,808,345
6,841,739
3.04
%
$4,730,117
4,700,059
4,706,466
2.09
%
5,000 shares
50,000
50,000
0.02
%
4,500 shares
450,000
5,200,059
470,000
5,226,466
0.21
2.32
%
%
$14,750,000
14,490,683
14,086,250
6.26
%
Headquarters/
Industry
Houston, TX
Dallas, TX
Consumer
Goods: Durable
Toronto,
Ontario
Transportation:
Cargo
New York, NY
Media:
Broadcasting &
Subscription
Austin TX
Software
Santa Clara,
CA
750 units
750,000
shares
455,385
21,619,458
770,000
22,270,000
0.34
9.90
%
%
0
7,750,000
3.45
%
$10,000,000
9,874,827
9,650,000
4.29
%
2,335 units
500,000
10,374,827
380,000
10,030,000
0.17
4.46
%
%
$10,000,000
9,853,435
9,853,435
4.38
%
$15,500,000
12,500
shares
15,198,412
15,198,412
6.76
%
$ 1,250,000 $ 1,250,000
16,448,412
16,448,412
0.56
7.32
%
%
11,521 shares
50,001
280,000
0.12
%
$8,250,000
8,019,407
8,019,407
3.57
%
Houston, TX
Construction &
Building
Bradford, PA
Utilities: Oil &
Gas
Centerville, OH
Healthcare &
Pharmaceuticals
Chantilly,
Virginia
Services:
Government
Los Angeles,
CA
Media:
Broadcasting &
Subscription
L+10.25% 0.75
%
13.06
%
11/1/2016
5/1/2022
Software
$21,500,000
21,164,073
21,500,000
9.56
%
Term Loan (SBIC)
(2)(13)(22)
First Lien
Term Loan
Premiere Digital Holdings,
Inc., Common Stock
Premiere Digital Holdings,
Inc., Preferred Stock
Total
Price for Profit, LLC
(13)(22)
First Lien
Equity
Equity
(4)
(4)
(17)
Term Loan (SBIC)
I2P Holdings, LLC, Series A
Preferred
Total
(2)(12)
First Lien
(4)
Equity
3M
L+5.50%
3M
L+5.50%
1.50
%
9.60
%
10/18/2018 10/18/2023
1.50
%
9.60
%
10/18/2018 10/18/2023
$2,428,772
2,360,887
2,360,887
1.05
%
10/18/2018
10/18/2018
3M
L+6.50%
1.00
%
9.31
%
1/31/2018
1/31/2023
Cleveland, OH
Services:
Business
1/31/2018
5,000 shares
50,000
50,000
0.02
%
4,500 shares
450,000
10,880,294
450,000
10,880,294
0.20
4.84
%
%
$8,818,907
750,000
shares
8,669,840
8,774,812
3.90
%
750,000
9,419,840
1,460,000
10,234,812
0.65
4.55
%
%
See accompanying notes to these consolidated financial statements.
104
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
Investments
Protect America, Inc.
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Term Loan (SBIC)
Refac Optical Group, et al
(2)(6)(12)
(11)
Second
Lien
1.00
%
10.56 2.00
% %
8/30/2017 10/30/2020
Headquarters/
Industry
Austin TX
Services:
Consumer
Blackwood, NJ
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$17,979,749
17,710,359
17,530,255
7.80
%
Revolver
Term A Loan
Term B Loan
Total
(9)(10)(12)(26)
First Lien
(9)(12)(26)
First Lien
0.00
%
11/7/2012
9/30/2018
Retail
$880,000
880,000
880,000
0.39
%
0.00
%
11/7/2012
9/30/2018
$472,968
472,968
472,968
0.21
%
(6)(9)(12)(26)
First Lien
L+10.75%
0.00 0.00
% %
11/7/2012
9/30/2018
$6,539,666
6,539,666
7,892,634
5,787,604
7,140,572
%
2.57
3.17
3M
L+9.75%
1M
L+8.00%
1M
L+8.00%
1M
Resolute Industrial, LLC
Resolute Industrial Holdings,
LLC Class A Preferred
Units
Total
Roberts-Gordon, LLC
Specified Air Solutions, LLC
Class A Common Units
Skopos Financial, LLC
Term Loan
Skopos Financial Group, LLC
(4)
(4)
(5)
Equity
Equity
7/26/2017
6/30/2017
Unsecured
12.00%
12.00
%
1/31/2014
1/31/2020
(4)(5)
Equity
1/31/2014
(2)
First Lien
3M
L+6.50
1.00
%
9.30
%
12/22/2017 12/22/2022
(2)(4)
Equity
(2)(4)
Equity
10/31/2013
10/31/2013
(5)(13)(22)
First Lien
3M
L+6.00%
1.00
%
10.32
%
8/16/2017
10/2/2023
(6)
Unsecured
11.50%
10.75 0.75
% %
2/3/2017
8/3/2023
(4)
Equity
2/3/2017
3M
L+10.75% 0.50
%
13.56
%
10/21/2016
4/21/2022
10/21/2016
(2)(12)
Second
Lien
(4)
Equity
(5)(12)
Second
Lien
(4)(5)
Equity
(4)(5)
(4)(5)
Equity
Equity
6/8/2015
2/13/2018
6/8/2015
Class A Units
Total
SQAD, LLC
Term Loan
(SBIC)
SQAD Holdco,
Inc. Preferred Shares,
Series A (SBIC)
SQAD Holdco,
Inc. Common Shares
(SBIC)
Total
TechInsights, Inc.
Term Loan
Time Manufacturing
Acquisition, LLC
Term Loan
Time Manufacturing
Investments, LLC Class A
Common
Units
Total
TFH Reliability,
LLC
Term Loan
(SBIC)
TFH Reliability Group, LLC
Class A Common Units
Total
U.S. Auto Sales, Inc. et al
Term Loan
USASF Blocker II, LLC
Common
Units
USASF Blocker III, LLC
Series C Preferred
Units
USASF Blocker LLC
Common Units
Total
VRI Intermediate Holdings,
LLC
Term Loan (SBIC)
VRI Ultimate Holdings, LLC
Class A Preferred Units
Total
(2)(12)
Second
Lien
3M
L+9.25%
1.00
%
12.06
%
5/31/2017 10/31/2020
Franklin, OH
Healthcare &
Pharmaceuticals
(4)
Equity
5/31/2017
See accompanying notes to these consolidated financial statements.
105
Wheeling, IL
Capital
Equipment
Buffalo, NY
Construction &
Building
Irving, TX
Finance
Tarrytown, NY
Media:
Broadcasting &
Subscription
Ottawa, Ontario
High Tech
Industries
Waco, TX
Capital
Equipment
Houston, TX
Chemicals,
Plastics, &
Rubber
Lawrenceville,
GA
601 units
750,000
1,300,000
0.58
%
%
3,846 shares
$17,500,000
1,120,684
units
0
250,000
0.11
%
17,494,460
17,150,000
7.63
%
1,162,544
18,657,004
1,110,000
18,260,000
0.49
8.12
%
%
$14,846,000 $ 14,780,330 $ 14,400,620
6.40
%
5,624 shares
156,001
310,000
0.14
%
5,800 shares
62,485
14,998,816
40,000
14,750,620
0.02
6.56
%
%
$21,540,923
21,094,192
21,094,192
9.38
%
$6,385,182
6,285,876
6,129,775
2.73
%
5,000 units
500,000
6,785,876
500,000
6,629,775
0.22
2.95
%
%
$5,875,000
250,000
shares
5,794,016
5,875,000
2.61
%
231,521
6,025,537
450,000
6,325,000
0.20
2.81
%
%
441 units
441,000
550,000
0.24
%
50 units
50,000
60,000
0.03
9,000 units
9,000
4,984,478
10,000
5,120,000
0.00
2.27
%
%
$9,000,000
326,797
shares
8,895,138
8,820,000
3.92
%
500,000
9,395,138
440,000
9,260,000
0.20
4.12
%
%
1M
L+10.50% 1.00
%
12.85
%
6/8/2015
6/8/2020
Finance
$4,500,000
4,484,478
4,500,000
2.00
%
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
Investments
Footnotes
Security
Coupon
floor Cash PIK
LIBOR
Investment
Date
Maturity
Wise Holding Corporation
Term Loan
(12)(20)
Unsecured
L+11.00% 1.00
%
0.00
%
6/30/2016 12/31/2021
3M
Headquarters/
Industry
Salt Lake City,
UT
Beverage,
Food, &
Tobacco
Principal
Amount/
Shares
Amortized
Cost
Fair
Value
(1)
% of
Net
Assets
$1,250,000
1,238,210
0
0.00
%
Delayed Draw Term Loan
Wise Parent Company, LLC
Membership Units
Total
Total Non-controlled, non-
affiliated investments
Net Investments
LIABILITIES IN EXCESS OF
OTHER ASSETS
NET ASSETS
(12)(21)
First Lien
(4)
Equity
1M
L+6.5%
1.00
%
0.00
%
8/27/2018
6/30/2021
$253,906
253,906
93,945
0.04
%
6/30/2016
1 units
58,594
1,550,710
0
93,945
0.00
0.04
%
%
$502,691,464 $ 504,433,668 224.35
504,483,668 224.37
502,743,649
%
%
(279,638,661 (124.37
$ 224,845,007 100.00
)
)%
%
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used
to value securities in the portfolio.
Investments held by the SBIC subsidiary, which include $13,410,706 of cash and $214,114,498 of
investments (at cost) 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.
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $865,385, with an interest rate of LIBOR plus 7.50% and a maturity of June 30, 2023. This
investment is accruing an unused commitment fee of 0.375% per annum.
Security is non-income producing.
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 87% of the
Company’s total assets as of December 31, 2018.
Represents a PIK interest security. At the option of the issuer, interest can be paid in cash or cash and PIK
interest. The percentage of PIK interest shown is the maximum PIK interest that can be elected by the issuer.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666,
with an interest rate of LIBOR plus 5.75% and a maturity of June 29, 2022. This investment is accruing an
unused commitment fee of 0.50% per annum.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000,
with an interest rate of LIBOR plus 5.75% and a maturity of August 8, 2023. This investment is accruing an
unused commitment fee of 0.50% per annum.
(9)
Investment has been on non-accrual since November 30, 2018.
(10)
(11)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $3,669,681 with an interest rate of LIBOR plus 5.50% and a maturity of October 18, 2023. This
investment is accruing an unused commitment fee of 0.50% per annum.
Excluded from the investment is an undrawn revolver 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 not
accruing an unused commitment fee.
(12)
These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not
in effect.
See accompanying notes to these consolidated financial statements.
106
TABLE OF CONTENTS
Stellus Capital Investment Corporation
Consolidated Schedule of Investments (continued)
December 31, 2018
(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 delayed draw term loan commitment in an amount not to
exceed $5,357,143, with an interest rate of LIBOR plus 6.75% and a maturity of August 30, 2024. 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)
(17)
(18)
(19)
Excluded from the investment is an undrawn revolver 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.
Excluded from the investment is an undrawn revolver 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.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $750,000,
with an interest rate of LIBOR plus 7.50% and a maturity of April 13, 2023. This investment is accruing an
unused commitment fee of 0.50% per annum.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,222,494,
with an interest rate of LIBOR plus 6.25% and a maturity of September 26, 2023. This investment is
accruing an unused commitment fee of 0.50% per annum.
(20)
Investment has been on non-accrual since March 29, 2018.
(21)
Investment has been on non-accrual since October 31, 2018.
(22)
This loan is a unitranche investment.
(23)
(24)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to
exceed $1,662,592, with an interest rate of LIBOR plus 6.25% and a maturity of September 26, 2023. This
investment is accruing an unused commitment fee of 0.50% per annum.
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000
with an interest rate of LIBOR plus 6.00% and a maturity of November 15, 2023. This investment is
accruing an unused commitment fee of 0.50% per annum.
(25)
Maturity date is under on-going negotiations with the portfolio company and other lenders, if applicable.
(26)
Payments on the Company’s investment in Refac Optical Group are currently past due.
Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar
See accompanying notes to these consolidated financial statements.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 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 December 31, 2019 the Company has issued a total of 19,131,746 shares and raised $281,605,976 in
gross proceeds since inception, incurring $9,103,378 in offering expenses and sales load fees for net proceeds
from offerings of $272,502,598. 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 — Invincible Blocker 1, Inc., SCIC — FBO Blocker 1, Inc., SCIC — SKP Blocker 1,
Inc., SCIC — APE Blocker 1, Inc., SCIC — CC Blocker 1, Inc., SCIC — ERC 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.
On November 29, 2018, we formed Stellus Capital SBIC II, LP (The “SBIC II subsidiary”), a Delaware
limited partnership, and its general partner, Stellus Capital SBIC II GP, LLC, a Delaware limited liability
company, as wholly owned subsidiaries of the Company. On August 14, 2019, the SBIC II subsidiary received a
license from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Company
Act of 1958, as amended. The SBIC II 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 licenses allow the SBIC subsidiary and SBIC II subsidiary (together, “the SBIC subsidiaries”) 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
subsidiaries’ assets over the Company’s stockholders in the event the Company liquidates one or both of the
SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
debentures issued by the SBIC subsidiaries upon an event of default. For the SBIC subsidiary, 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. For the SBIC II subsidiary, SBA
regulations limit these amounts to $175,000,000 of borrowings when it has at least $87,500,000 of regulatory
capital.
As of both December 31, 2019 and 2018, the SBIC subsidiary had $75,000,000 of regulatory capital, as such
term is defined by the SBA. As of both December 31, 2019 and 2018, the SBIC subsidiary had $150,000,000 of
SBA-guaranteed debentures outstanding.
As of December 31, 2019, which was the end of its the first year of operations, the SBIC II subsidiary had
$20,000,000 in regulatory capital and $11,000,000 of SBA-guaranteed debentures outstanding.
See footnote (2) of the Consolidated Schedule of Investments for additional information regarding the
treatment of investments in the SBIC subsidiaries with respect to the Credit Facility.
As a BDC, we are required to comply with certain regulatory requirements. Prior to June 28, 2018, we were
only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at
least 200% after giving effect to such leverage. 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 Company’s board of directors (the “Board”), 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. 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, which was approved by shareholders at the
Company’s 2018 annual meeting of stockholders. As a result, the asset coverage ratio test applicable to the
Company was decreased from 200% to 150%, effective June 28, 2018. 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. As of
December 31, 2019, the Company’s asset coverage ratio was 229%.
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 unsecured 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 consolidated financial statements have been prepared on the accrual basis of accounting
in conformity with generally accepted accounting principles in the United States of America (“GAAP”) and
pursuant to the requirements for reporting on Form 10-K and Article 10 of regulation S-X.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
In the opinion of management, the consolidated financial results included herein contain all adjustments,
consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial
statements for the periods included herein. Certain reclassifications have been made to certain prior period
balances to conform with current presentation.
In accordance with Regulation S-X under the Securities Act of 1933, as amended, and Securities Exchange
Act of 1934, as amended, 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 with the requirements of the 1940 Act, (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 December 31, 2019, cash balances totaling $151,909 did not exceed FDIC insurance protection levels of
$250,000. In addition, at December 31, 2019, the Company held $15,981,406 in cash equivalents which are
carried at cost, which approximates the fair value of the cash equivalents. 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.
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 SBA-guaranteed
debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input).
The carrying value of our 2022 Notes (as defined in Note 11 below) 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 subsidiaries and the Taxable Subsidiaries. All intercompany balances have
been eliminated upon consolidation.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Use of Estimates
The preparation of the statement of assets and liabilities in conformity with 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
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 the Company’s Credit Facility, 2022 Notes
and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are 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. During the
year ended December 31, 2018, the Company incurred $18,673 of costs related to the preparation of a registration
statement, which were capitalized until the related offering consummated during 2019. There were no such costs
on the Consolidated Statement of Assets and Liabilities as of December 31, 2019.
Investments
As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity
securities of private middle-market companies. Under procedures established by our 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.
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, 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 its
portfolio, the Company expects to value most of its 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.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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. Payment-in-
kind (“PIK”) interest, represents contractual interest accrued and added to the loan balance that generally
becomes due at maturity. We will not accrue any form of 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.
A presentation of the interest income we have received from portfolio companies for the years ended
December 31, 2019, 2018 and 2017 is as follows:
Loan interest
PIK income
Fee amortization income
(1)
Fee income acceleration
(2)
Total Interest Income
For the year ended
December 31,
2019
December 31,
2018
December 31,
2017
$53,358,856
415,933
$46,501,235
1,869,905
$34,890,298
499,595
1,982,868
1,138,333
1,636,168
1,455,725
1,235,568
1,445,988
$56,895,990
$51,463,033
$38,071,449
(1)
(2)
Includes amortization of fees on unfunded commitments.
Unamortized loan origination fees recognized upon realization.
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.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such
interest. Management considers portfolio specific circumstances as well as other economic factors in determining
collectability. As of December 31, 2019, we had two loans on non-accrual status, which represented
approximately 3.6% of our loan portfolio at cost and 0.9% at fair value. As of December 31, 2018, we had four
loans on non-accrual status, which represented approximately 3.9% of our loan portfolio at cost and 2.8% at fair
value. As of December 31, 2019 and 2018, $3,779,593 and $1,856,272 of earned income from investments has
not been accrued. If a loan or debt security’s status significantly improves regarding the debtor’s ability to service
the debt or other obligations, or if a loan or debt security is sold or written off, we will remove it from non-
accrual status.
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.
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. As of
December 31, 2019, the Company had approximately $24,602,435 of undistributed taxable income that was
carried forward toward distributions to be paid in 2020.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Income tax expense of $903,905 and $275,106 for the years ended December 31, 2019 and 2018 is related
to state and excise taxes. Excise taxes for the year ended December 31, 2017 of $42,552 is included in Other
general and administrative expense.
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 December 31, 2019 and 2018, 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 years ended December 31, 2019, 2018
and 2017, were de minimis.
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
that 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.
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 years ended December 31, 2019, 2018 and 2017, the Company recorded deferred income tax benefit
(provision) of $ (66,760), $ (67,953) and $ 8,593, respectively, related to the Taxable Subsidiaries. As of
December 31, 2019 and 2018, the Company had a net deferred tax liability of $134,713 and $67,953,
respectively. See Note 13 for a schedule of the deferred tax asset and valuation allowance reducing the deferred
tax asset.
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.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Recently Issued Accounting Standards
In August 2018, the FASB issued ASU No. 2018-13 -- Changes to the Disclosure Requirements for Fair
Value Measurement. ASU 2018-13 is part of the disclosure framework project, which primarily focuses on
improving the effectiveness of disclosures in the notes to financial statements. The amendments in this update
remove, modify, and add certain disclosure requirements on fair value measurements in Topic 820, Fair Value
Measurement. The update is effective for annual periods beginning after December 31, 2019. Early adoption is
allowed and the Company adopted this guidance on January 1, 2019. No material changes were required to the
disclosures in the notes to financial statements.
Securities Exchange Commission (“SEC”) Disclosure Update and Simplification
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532 (the “Rule”), Disclosure
Update and Simplification, amending certain disclosure requirements that were redundant, outdated or
superseded. The Rule is intended to facilitate the disclosure of information to investors and simplify compliance.
The Company has adopted the Rule. The Rule included amendments to Regulation S-X (the “Amendments”),
including revisions to Rule 6-04.17 under Regulation S-X to remove the requirement to separately state the book
basis components of net assets on the Consolidated Statement of Assets and Liabilities: undistributed (over
distribution of) net investment income, accumulated undistributed net realized gains (losses), and net unrealized
appreciation (depreciation). Instead, consistent with GAAP, funds are required to disclose total distributable
earnings.
The components that make up distributable earnings (accumulated undistributed deficit) on the Statement of
Assets and Liabilities as of December 31, 2019 and 2018 are as follows:
Accumulated net realized loss from investments, net of
cumulative dividends of $24,557,535 and $9,519,362,
respectively
Net unrealized appreciation (depreciation) on non-controlled
non-affiliated investments and cash equivalents, net of
provision for taxes of $134,713 and $67,953, respectively
Accumulated undistributed net investment income
Accumulated undistributed deficit
As of
December 31, 2019
As of
December 31, 2018
)
$ (6,258,510
)
$(10,786,240
)
(13,894,460
18,587,920
1,672,066
5,782,736
)
$ (1,565,050
$ (3,331,438
)
Additionally, the Amendments remove the requirement to separately state the source of distributions paid
and the requirement to parenthetically state the book basis amount of undistributed (over distribution of) net
investment income on the Consolidated Statement of Changes in Net Assets. The Company’s Consolidated
Statement of Assets and Liabilities and Consolidated Statement of Changes in Net Assets for the current and
comparative reporting period have been modified to conform to the rule.
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 which
Stellus Capital serves as its investment adviser. Pursuant to this agreement, the Company has agreed
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 incentive fee.
For the years ended December 31, 2019, 2018 and 2017, the Company recorded an expense for base
management fees of $9,703,706, $8,154,842, and $6,255,911 respectively. As of December 31, 2019 and
December 31, 2018, $2,695,780 and $2,183,975 was payable to Stellus Capital, respectively.
The incentive fee has two components, investment income and capital gains, as follows:
Investment Income Incentive Fee
The income component (“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, has a 2.0% 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% 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% of net assets.
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 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 years ended December 31, 2019, 2018 and 2017, the Company incurred $5,809,672, $5,529,376 and
$2,911,392, respectively, of Investment Income Incentive Fees. As of December 31, 2019 and 2018, $1,618,509
and $1,936,538, respectively, of such incentive fees were payable to the Advisor, of which $1,466,033 and
$1,675,804, respectively, were currently payable (as explained below). As of December 31, 2019 and
December 31, 2018, $152,476 and $260,734, 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.
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 Gains Incentive Fees is subtracted from such Capital Gains Incentive Fee calculated.
GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses
and unrealized capital appreciation and depreciation of investments or other financial instruments in the
calculation, as an incentive fee would be payable if such unrealized capital appreciation or depreciation were
realized, even though such unrealized capital appreciation is not permitted to be considered in calculating the fee
actually payable under the investment advisory agreement. There can be no assurance that unrealized
appreciation or depreciation will be realized in the future. Accordingly, such fees, as calculated and accrued, may
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 years ended December 31, 2019, 2018 and 2017, the
Company incurred $799,876, $81,038, and $0, respectively. As of December 31, 2019 and December 31, 2018,
$880,913 and $81,038, respectively of Capital Gains Incentive Fees were payable to the Advisor.
The following tables summarize the components of the incentive fees discussed above:
Investment Income Incentive Fee Incurred
Capital Gains Incentive Fee Accrued
Incentive Fee Expense
Investment Income Incentive Fee Currently Payable
Investment Income Incentive Fee Deferred
Capital Gains Incentive Fee Deferred
Incentive Fee Payable
Director Fees
For the year
ended
December 31,
2019
$5,809,672
799,876
For the year
ended
December 31,
2018
$5,529,376
81,038
For the year
ended
December 31,
2017
$2,911,392
—
$
$6,609,548
$5,610,414
$2,911,392
December 31,
2019
December 31,
2018
$1,466,033
152,476
880,913
$1,675,804
260,734
81,038
$2,499,422
$2,017,576
For the years ended December 31, 2019, 2018 and 2017, the Company recorded an expense relating to
director fees $383,000, $317,000 and $331,000, respectively. As of December 31, 2019 and 2018, the Company
owed its independent directors no unpaid director fees.
Co-Investments
On October 23, 2013, the Company received an exemptive order (the “Prior Order”) from the SEC to co-
invest with private funds managed by Stellus Capital Management where doing so is consistent with the
Company’s investment strategy as well as applicable law (including the terms and conditions of the exemptive
order issued by the SEC). On December 18, 2018, the Company received a new exemptive order (the
117
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
“Order”) that supersedes the Prior Order and permits the Company greater flexibility to enter into co-investment
transactions. The Order expands on the Prior Order and allows the Company to co-invest with additional types of
private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an
adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the
conditions included therein. Pursuant to the Order, 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 co-invests,
subject to the conditions in the Order, with private credit funds managed by Stellus Capital Management that
have an investment strategy that is similar or identical to the Company’s investment strategy, and the Company
may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or
an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the
future. 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, including co-
investments with its affiliates under the exemptive relief order. As of December 31, 2019 and December 31,
2018, there was no cash due to other investment funds related to interest paid by a borrower to the Company as
administrative agent. Any such amount would be 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 under which Stellus Capital 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 or one of its
affiliates remains its investment adviser. 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 is in effect.
Administration Agreement
The Company 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, its
required administrative services, which includes, among other things, being responsible for the financial records
which it is required to maintain and preparing reports to its stockholders and reports filed with the SEC.
For the years ended December 31, 2019, 2018 and 2017, the Company recorded expenses of $1,469,706,
$1,195,174, and $1,117,011, respectively, related to the administration agreement. As of December 31, 2019 and
December 31, 2018, $372,524 and $323,188, respectively, remained payable to Stellus Capital relating to the
administration agreement.
Indemnification
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
118
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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.
The following table reflects the Company’s distributions declared and paid or to be paid on its common
stock since Inception:
Date Declared
Fiscal 2012
December 7, 2012
Fiscal 2013
March 7, 2013
June 7, 2013
August 21, 2013
November 22, 2013
Fiscal 2014
December 27, 2013
January 20, 2014
January 20, 2014
January 20, 2014
April 17, 2014
April 17, 2014
April 17, 2014
July 7, 2014
July 7, 2014
July 7, 2014
October 15, 2014
October 15, 2014
October 15, 2014
Fiscal 2015
January 22, 2015
January 22, 2015
January 22, 2015
April 15, 2015
April 15, 2015
April 15, 2015
Record Date
Payment Date
Per Share
December 21, 2012
December 27, 2012
$0.1812
March 21, 2013
June 21, 2013
September 5, 2013
December 9, 2013
March 28, 2013
June 28, 2013
September 27, 2013
December 23, 2013
January 15, 2014
January 31, 2014
February 28, 2014
March 31, 2014
April 30, 2014
May 30, 2014
June 30, 2014
July 31, 2014
August 29, 2014
September 30, 2014
October 31, 2014
November 28, 2014
December 31, 2014
January 24, 2014
February 14, 2014
March 14, 2014
April 15, 2014
May 15, 2014
June 16, 2014
July 15, 2014
August 15, 2014
September 15, 2014
October 15, 2014
November 14, 2014
December 15, 2014
January 15, 2015
February 2, 2015
February 27, 2015
March 31, 2015
April 30, 2015
May 29, 2015
June 30, 2015
February 13, 2015
March 13, 2015
April 15, 2015
May 15, 2015
June 15, 2015
July 15, 2015
$0.3400
$0.3400
$0.3400
$0.3400
$0.0650
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
119
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Date Declared
July 8, 2015
July 8, 2015
July 8, 2015
October 14, 2015
October 14, 2015
October 14, 2015
Fiscal 2016
January 13, 2016
January 13, 2016
January 13, 2016
April 15, 2016
April 15, 2016
April 15, 2016
July 7, 2016
July 7, 2016
July 7, 2016
October 7, 2016
October 7, 2016
October 7, 2016
Fiscal 2017
January 13, 2017
January 13, 2017
January 13, 2017
April 14, 2017
April 14, 2017
April 14, 2017
July 7, 2017
July 7, 2017
July 7, 2017
October 12, 2017
October 12, 2017
October 12, 2017
Fiscal 2018
January 11, 2018
January 11, 2018
January 11, 2018
April 16, 2018
April 16, 2018
April 16, 2018
July 12, 2018
July 12, 2018
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Record Date
Payment Date
Per Share
July 31, 2015
August 31, 2015
September 20, 2015
October 30, 2015
November 30, 2015
December 31, 2015
August 14, 2015
September 15, 2015
October 15, 2015
November 13, 2015
December 15, 2015
January 15, 2016
January 29, 2016
February 29, 2016
March 31, 2016
April 29, 2016
May 31, 2016
June 30, 2016
July 29, 2016
August 31, 2016
September 30, 2016
October 31, 2016
November 30, 2016
December 30, 2016
January 31, 2017
February 28, 2017
March 31, 2017
April 28, 2017
May 31, 2017
June 30, 2017
July 31, 2017
August 31, 2017
September 29, 2017
October 31, 2017
November 30, 2017
December 29, 2017
January 31, 2018
February 28, 2018
March 29, 2018
April 30, 2018
May 31, 2018
June 29, 2018
July 31, 2018
August 31, 2018
February 15, 2016
March 15, 2016
April 15, 2016
May 13, 2016
June 15, 2016
July 15, 2016
August 15, 2016
September 15, 2016
October 14, 2016
November 15, 2016
December 15, 2016
January 13, 2017
February 15, 2017
March 15, 2017
April 14, 2017
May 15, 2017
June 15, 2017
July 14, 2017
August 15, 2017
September 15, 2017
October 13, 2017
November 15, 2017
December 15, 2017
January 12, 2018
February 15, 2018
March 15, 2018
April 13, 2018
May 15, 2018
June 15, 2018
July 13, 2018
August 15, 2018
September 14, 2018
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Date Declared
July 12, 2018
October 16, 2018
October 16, 2018
October 16, 2018
Fiscal 2019
January 11, 2019
January 11, 2019
January 11, 2019
April 11, 2019
April 11, 2019
April 11, 2019
July 3, 2019
July 3, 2019
July 3, 2019
October 15, 2019
October 15, 2019
October 15, 2019
Total
Record Date
September 28, 2018
October 31, 2018
November 29, 2018
December 31, 2018
Payment Date
October 15, 2018
November 15, 2018
December 14, 2018
January 15, 2019
January 31, 2019
February 28, 2019
March 29, 2019
April 30, 2019
May 31, 2019
June 28, 2019
July 31, 2019
August 30, 2019
September 30, 2019
October 31, 2019
November 29, 2019
December, 2019
February 15, 2019
March 15, 2019
April 15, 2019
May 15, 2019
June 14, 2019
July 15, 2019
August 15, 2019
September 13, 2019
October 15, 2019
November 15, 2019
December 13, 2019
January 15, 2020
Per Share
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$0.1133
$9.7638
The Company has adopted an “opt out” dividend reinvestment plan (“DRIP”) pursuant to which a
stockholder whose shares are held in his own name will receive distributions in shares of the Company’s common
stock under the Company’s DRIP unless it elects to receive distributions in cash. Stockholders whose shares are
held in the name of a broker or the nominee of a broker may have distributions reinvested only if such service is
provided by the broker or the nominee, or if the broker of the nominee permits participation in our DRIP.
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 DRIP 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 DRIP 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 shares through the DRIP during the year ended December 31, 2018.
No new shares were issued in connection with the DRIP during the year ended December 31, 2019.
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NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 and pursuant to the Company’s DRIP.
Issuance of Common Stock
Year ended December 31, 2012
Year ended December 31, 2013
Year ended December 31, 2014
Year ended December 31, 2015
Year ended December 31, 2016
Year ended December 31, 2017
Year ended December 31, 2018
Year ended December 31, 2019
Total
Number of
Shares
Gross
Proceeds
(1)(2)
Underwriting
fees
Offering
Expenses
Net
Proceeds
(3)
Offering
Price
12,035,023 $180,522,093 $ 4,959,720 $ 835,500 $174,726,873 $14.90
899,964 $14.06
—
63,998
5,380,366 $14.47
75,510
380,936
—
—
—
—
—
—
—
—
47,075,505 $14.06
1,358,880
3,465,922
93,737 $11.85
—
7,931
3,177,936
44,326,153 $14.43
1,015,127
19,131,746 $281,605,975 $ 7,409,237 $1,694,140 $272,502,598
899,964
5,485,780
—
—
48,741,406
93,737
45,862,995
—
29,904
—
—
307,021
—
521,715
(1)
(2)
(3)
Net of partial share redemptions. Such share redemptions impacted gross proceeds by $755, $(1,051),
$(142), $(31) and $(29) in 2019, 2018, 2017, 2016 and 2015, respectively.
Includes common shares issued under the DRIP of $94,788 during the year ended December 31, 2018, $0
for the years ended 2019, 2017, 2016 and 2015, and $390,505, $930,385, $113,000 for the years ended
2014, 2013, and 2012, respectively.
Net Proceeds per this equity table will differ from the Statement of Assets and Liabilities as of December 31,
2019 in the amount of $366,375, which represents a tax reclassification of stockholders’ equity in
accordance with generally accepted accounting principles. This reclassification reduces paid-in capital and
increases distributable earnings (reducing the accumulated undistributed deficit).
The Company issued 2,952,149 shares during the year ended December 31, 2019 in a secondary offering on
March 15, 2019 and the underwriters’ exercise of their overallotment option on April 11, 2019. Gross proceeds
resulting from the secondary offering totaled $42,599,510 and underwriting and other expenses totaled
$1,296,803. The per share offering price for the secondary offering was $14.43. The Company issued
225,787 shares under the At-the-Market (“ATM”) Program in 2019, for gross proceeds of $3,262,729 and
underwriting and other expenses of $240,040. The average per share offering price of shares issued in the ATM
Program during 2019 was $14.45.
The Company issued 7,931 shares through the DRIP during the year ended December 31, 2018. No new
shares were issued in connection with the DRIP during the year ended December 31, 2019.
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 years ended December 31, 2019, 2018 and 2017.
Net increase in net assets resulting from operations
Weighted average common shares
$ 26,438,186
18,275,696
$ 26,194,578
15,953,571
$ 22,613,257
14,870,981
Basic and diluted earnings per common share
$
1.45
$
1.64
$
1.52
For the year ended
December 31,
2019
For the year ended
December 31,
2018
For the year ended
December 31,
2017
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE
In accordance with the authoritative guidance on fair value measurements and disclosures under 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;
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 December 31, 2019, the Company had investments in 63 portfolio companies. The total cost and fair
value of the investments were $642,707,824 and $628,948,077, respectively. The composition of our investments
as of December 31, 2019 is as follows:
Senior Secured – First Lien
(1)
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Cost
Fair Value
$461,107,595
130,600,172
22,279,519
28,720,538
$455,169,878
111,961,013
22,137,186
39,680,000
$642,707,824
$628,948,077
(1)
Includes unitranche investments, which account for 14.4% of our portfolio at fair value. Unitranche
structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated
loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated
loans to the extent we invest in the “last-out” tranche.
123
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
At December 31, 2018, the Company had investments in 57 portfolio companies. The total cost and fair
value of the investments were $502,743,649 and $504,483,668, respectively. The composition of our investments
as of December 31, 2018 was as follows:
(1)
Senior Secured – First Lien
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Cost
Fair Value
$297,965,589
155,382,612
25,436,237
23,959,211
$502,743,649
$292,004,982
149,661,220
23,697,466
39,120,000
$504,483,668
(1)
Includes unitranche investments, which account for 20.6% of our portfolio at fair value. Unitranche
structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated
loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated
loans to the extent we invest in the “last-out” tranche.
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 of the underlying loan agreements. As of December 31, 2019 and December 31, 2018,
the Company had seventeen and eleven such investments with aggregate unfunded commitments of $37,517,784
and $21,213,962, respectively. The Company maintains sufficient liquidity to fund such unfunded loan
commitments should the need arise.
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, 2019 are as follows:
Senior Secured – First Lien
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Quoted Prices
in Active
Markets
for Identical
Securities
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
$ —
—
—
—
$ —
$ —
—
—
—
$ —
Significant
Unobservable
Inputs
(Level 3)
$455,169,878
111,961,013
22,137,186
39,680,000
$628,948,077
Total
$455,169,878
111,961,013
22,137,186
39,680,000
$628,948,077
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, 2018 are as follows:
Senior Secured – First Lien
Senior Secured – Second Lien
Unsecured Debt
Equity
Total Investments
Significant Other
Observable
Inputs
(Level 2)
$ —
—
—
—
$ —
Significant
Unobservable
Inputs
(Level 3)
$292,004,982
149,661,220
23,697,466
39,120,000
$504,483,668
Total
$292,004,982
149,661,220
23,697,466
39,120,000
$504,483,668
Quoted Prices
in Active
Markets
for Identical
Securities
(Level 1)
$ —
—
—
—
$ —
124
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2019
are as follows:
Senior Secured
Loans-First
Lien
Senior Secured
Loans-Second
Lien
Unsecured
Debt
Equity
Total
Fair value at beginning of period
Purchases of investments
Payment-in-kind interest
Sales and Redemptions
Realized Gains
Change in unrealized
appreciation (depreciation) included
in earnings
Amortization of premium and
accretion of discount, net
$292,004,982 $149,661,220 $23,697,466 $ 39,120,000 $ 504,483,668
246,480,276
415,933
(128,274,623
19,568,120
— 9,940,714
—
(22,594,613
17,415,227
209,966,863
262,444
(48,114,716
(212,012
59,044
(5,605,908
— 2,364,905
26,572,699
94,445
(51,959,386
)
)
)
)
)
)
22,891
(12,917,767
)
1,596,438
(4,201,328
)
(15,499,766
)
1,239,426
509,802
25,241
—
1,774,469
Fair value at end of period
$455,169,878 $ 111,961,013 $22,137,186 $ 39,680,000 $ 628,948,077
There were no Level 3 transfers during the twelve months ended December 31, 2019.
The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2018
are as follows:
Senior Secured
Loans-First
Lien
Senior Secured
Loans-Second
Lien
Unsecured
Debt
Equity
Total
Fair value at beginning of year
Purchases of investments
Payment-in-kind interest
Sales and redemptions
Realized gains
Change in unrealized appreciation
$141,006,923 $178,432,850 $27,430,000 $24,969,999 $ 371,839,772
272,927,459
1,869,905
(147,600,770
5,540,518
9,605,730
—
(9,657,263
— 5,540,518
224,555,549
106,314
(68,382,321
—
38,515,000
1,696,547
(66,658,090
—
251,180
67,044
(2,903,096
)
)
)
)
)
(depreciation)
(6,052,424
)
(2,989,511
)
(1,265,630
)
8,661,016
(1,646,549
)
Amortization of premium and
accretion of discount, net
770,941
664,424
117,968
—
1,553,333
Fair value at end of year
$292,004,982 $149,661,220 $23,697,466 $39,120,000 $ 504,483,668
There were no Level 3 transfers during the twelve months ended December 31, 2018.
125
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following is a summary of geographical concentration of our investment portfolio as of December 31,
2019:
Texas
California
Arizona
New Jersey
Ohio
Illinois
Canada
New York
United Kingdom
Wisconsin
South Carolina
Tennessee
Pennsylvania
Maryland
Indiana
Florida
Colorado
Arkansas
Missouri
Georgia
North Carolina
Puerto Rico
Utah
Massachusetts
Cost
Fair Value
$134,451,527
79,090,474
52,390,949
52,548,769
48,502,609
41,869,947
21,201,137
19,922,689
20,116,695
19,207,770
19,935,337
$120,672,985
78,136,331
53,274,526
51,637,750
50,092,839
44,406,252
21,217,811
20,584,020
20,116,695
19,466,054
19,366,716
19,854,956
17,408,508
17,103,044
14,064,012
13,663,116
10,867,843
14,920,694
10,078,235
575,000
4,961,969
8,613,244
41,894
1,317,406
19,260,076
17,566,213
17,325,000
13,997,251
13,820,256
12,444,250
11,989,446
10,428,223
5,250,000
4,375,000
3,490,383
30,000
—
% of Total
Investments
at fair value
19.19
12.42
8.47
8.21
7.96
7.06
3.37
3.27
3.20
3.10
3.08
%
%
%
%
%
%
%
%
%
%
%
3.06
%
2.79
%
2.75
%
2.23
%
2.20
%
1.98
%
1.91
%
1.66
%
0.83
%
0.70
%
0.55
%
0.00
%
—
%
$642,707,824
$628,948,077
100.00
%
126
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following is a summary of geographical concentration of our investment portfolio as of December 31,
2018:
Texas
California
New Jersey
Ohio
Illinois
Canada
Arizona
South Carolina
New York
Tennessee
Arkansas
Pennsylvania
Maryland
Wisconsin
Colorado
Georgia
Indiana
Puerto Rico
North Carolina
Massachusetts
Missouri
Virginia
Florida
Utah
Cost
Fair Value
% of Total
Investments
$100,229,354
86,550,134
43,513,698
36,209,514
19,941,053
27,902,537
21,682,522
20,871,587
20,446,690
20,117,218
17,696,537
17,732,831
17,237,500
11,437,711
10,777,822
5,988,728
7,363,628
8,797,954
4,946,554
1,317,406
139,656
50,001
242,304
1,550,710
$ 97,474,226
85,880,918
41,473,072
36,273,224
29,880,018
27,935,931
21,603,741
20,385,325
20,287,086
19,381,134
18,013,941
17,824,372
17,237,500
10,869,000
10,777,822
9,820,000
7,087,500
5,029,913
4,425,000
1,670,000
670,000
280,000
110,000
93,945
19.32
17.03
8.22
7.19
5.92
5.54
4.28
4.04
4.02
3.84
3.57
%
%
%
%
%
%
%
%
%
%
%
3.53
%
3.42
%
2.15
%
2.14
%
1.95
%
1.40
%
1.00
%
0.88
%
0.33
%
0.13
%
0.06
%
0.02
%
0.02
%
$502,743,649
$504,483,668
100.00
%
127
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following is a summary of industry concentration of our investment portfolio as of December 31, 2019:
Healthcare & Pharmaceuticals
Services: Business
Aerospace & Defense
Consumer Goods: Durable
Beverage, Food, & Tobacco
Media: Broadcasting & Subscription
Finance
Education
Media: Advertising, Printing & Publishing
High Tech Industries
Capital Equipment
Retail
Metals & Mining
Transportation & Logistics
Automotive
Software
Containers, Packaging, & Glass
Environmental Industries
Energy: Oil & Gas
Services: Consumer
Chemicals, Plastics, & Rubber
Consumer goods: non-durable
Construction & Building
Utilities: Oil & Gas
Hotel, Gaming, & Leisure
Cost
Fair Value
% of Total
Investments
at fair value
$ 98,307,360
56,354,433
44,970,957
47,933,468
42,131,354
32,353,301
27,776,880
26,594,771
22,425,972
21,201,137
20,093,379
19,935,337
17,103,044
17,173,599
17,151,902
15,807,191
14,306,286
15,256,675
12,624,269
26,075,606
11,880,825
14,973,711
$ 94,000,860
62,410,845
46,547,324
44,158,660
42,592,966
33,218,991
29,562,500
25,661,125
21,965,124
21,217,811
20,237,066
19,366,716
17,325,000
17,226,294
17,221,213
15,516,250
14,564,570
14,410,327
13,582,102
13,345,105
11,857,228
11,770,000
10,408,323
10,750,000
9,868,044
—
9,900,000
540,000
14.95
9.92
7.40
7.02
6.77
5.28
4.70
4.08
3.49
3.37
3.22
%
%
%
%
%
%
%
%
%
%
%
3.08
%
2.75
%
2.74
%
2.74
%
2.47
%
2.32
%
2.29
%
2.16
%
2.12
%
1.89
%
1.87
%
1.71
%
1.57
%
0.09
%
$642,707,824
$628,948,077
100.00
%
128
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following is a summary of industry concentration of our investment portfolio as of December 31, 2018:
Cost
Fair Value
% of Total
Investments
Healthcare & Pharmaceuticals
Software
Finance
Media: Broadcasting & Subscription
Retail
Services: Business
Consumer Goods: Durable
Education
High Tech Industries
Beverage, Food, & Tobacco
Services: Consumer
Automotive
Metals & Mining
Energy: Oil & Gas
Consumer goods: non-durable
Environmental Industries
Chemicals, Plastics, & Rubber
Containers, Packaging, & Glass
Aerospace & Defense
Construction & Building
Utilities: Oil & Gas
Capital Equipment
Media: Advertising, Printing & Publishing
Transportation: Cargo
Insurance
Hotel, Gaming, & Leisure
Services: Government
$ 58,682,811
51,432,916
34,208,412
31,079,169
28,764,221
22,942,733
26,981,015
26,562,249
21,094,192
$ 54,785,327
51,458,750
41,910,000
30,857,379
27,525,897
27,094,812
26,811,552
25,325,000
21,094,192
20,709,134
17,952,663
17,457,259
17,237,500
14,312,328
14,994,980
14,004,667
11,835,100
11,437,711
10,777,822
10,374,827
9,853,435
7,535,876
7,058,675
6,808,345
5,425,301
3,170,307
50,001
18,213,945
17,640,255
17,282,187
17,237,500
15,542,102
14,579,375
12,835,509
11,707,835
10,869,000
10,777,822
10,280,000
9,853,435
7,929,775
6,875,625
6,841,739
5,460,000
3,414,655
280,000
10.86
10.20
8.31
6.12
5.46
5.37
5.30
5.02
4.18
%
%
%
%
%
%
%
%
%
3.61
%
3.50
%
3.43
%
3.42
%
3.08
%
2.89
%
2.54
%
2.32
%
2.15
%
2.14
%
2.04
%
1.95
%
1.57
%
1.36
%
1.36
%
1.08
%
0.68
%
0.06
%
$502,743,649
504,483,668
100.00
%
Certain portfolio company classifications were updated to more adequately align to the risks of the portfolio
investments with other companies in such industries. Industry classification for the prior year financial statements
included above were reclassified to the current presentation. The following changes and their December 31, 2018
cost and fair value, respectively, were made: 1) Consumer Goods: Durable to Metals & Mining; $17,237,500 for
both cost and fair value, 2) Media: Broadcasting & Subscription to Media: Advertising, Printing & Publishing;
$7,058,675 and $6,875,625, 3) Services: Business to Aerospace & Defense; $10,777,822 for both cost and value,
4) Services: Business to Environmental Industries; $13,058,543 and $12,505,509, 5) Services: Business to
Software; $14,005,369 and $13,432,500.
129
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following provides quantitative information about Level 3 fair value measurements as of December 31,
2019:
Description:
First lien debt
Fair Value
Valuation Technique Unobservable Inputs
Range (Average)
(1)(3)
$455,169,878
Income/Market
approach
(2)
HY credit spreads,
Risk free rates
Market multiples
-2.19% to 6.98% (0.57%)
-1.48% to 0.52% (-0.68%)
6x to 29x (12x)
(4)
Second lien debt
$111,961,013
Unsecured debt
$ 22,137,186
Income/Market
approach
(2)
HY credit spreads,
Risk free rates
Market multiples
-0.69% to 5.94% (1.19%)
-1.34% to 0.48% (-0.42%)
7x to 34x (14x)
(4)
Income/Market
(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-0.39% to 0.00% (-0.35%)
-0.45% to -0.42% (-0.43%)
1x to 20x (4x)
(4)
Equity investments
$ 39,680,000
Market
approach
(5)
Underwriting
EBITDA Multiple
2x to 17x (10x)
Total Long Term Level 3
Investments
$628,948,077
(1)
Weighted average based on fair value as of December 31, 2019.
(2)
(3)
Inclusive of but 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.
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 a 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 -2.19% (-219 basis points) to 6.98% (698 basis points). The average of all changes was 0.57%.
(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.
130
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following provides quantitative information about Level 3 fair value measurements as of December 31,
2018:
Description:
First lien debt
Fair Value
Valuation Technique
Unobservable Inputs
Range (Average)
(1)(3)
$292,004,982
Income/Market
(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-1.03% to 2.59% (0.85%)
-5.62% to 6.64% (1.64%)
4x to 22x (10x)
(4)
Second lien debt
$149,661,220
Unsecured debt
$ 23,697,466
Income/Market
(2)
approach
Income/Market
(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-0.00% to 2.66% (0.93%)
-0.14% to 10.66% (1.70%)
2x to 17x (11x)
(4)
HY credit spreads,
Risk free rates
Market multiples
-1.03% to 0.57% (-0.01%)
-5.62% to 0.32% (-1.27%)
2x to 9x (3x)
(4)
Equity investments
$ 39,120,000 Market approach
(5)
Underwriting multiple/
EBITDA Multiple
2x to 15x (10x)
Total Long Term Level 3
Investments
$504,483,668
(1)
(2)
(3)
(4)
(5)
Weighted average based on fair value as of December 31, 2018.
Inclusive of but 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.
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 a 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 -1.03% (-103 basis points) to 2.59% (259 basis points). The average of all changes was 0.85%.
Median of LTM (last twelve months) EBITDA multiples of comparable companies.
The primary significant unobservable input used in the fair value measurement of the Company’s equity
investments is 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.
131
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
As of December 31, 2019, the Company had $37,517,784 of unfunded commitments to provide debt
financing to seventeen existing portfolio companies. As of December 31, 2018 the Company had $21,213,961 of
unfunded commitments to provide debt financing to eleven existing portfolio companies. As of December 31,
2019, the Company had sufficient liquidity to fund such unfunded loan commitments should the need arise.
NOTE 8 — FINANCIAL HIGHLIGHTS
For the year
ended
December 31,
2019
For the year
ended
December 31,
2018
For the year
ended
December 31,
2017
For the year
ended
December 31,
2016
For the year
ended
December 31,
2015
Per Share Data:
(1)
Net asset value at beginning of year/period
Net investment income
Net change in unrealized appreciation
(depreciation) on investments
Net realized gain (loss) on investments
Tax provision on realized gain on investments
Benefit (provision) for taxes on net unrealized gain
on investments in taxable subsidiaries
Total from investment operations
Sales Load
Offering Costs
Stockholder distributions from:
Net investment income
Net realized capital gains
Other
(3)
Net asset value at the end of year/period
Per share market value at end of year/period
Total return based on market value
Weighted average shares outstanding at the end of
(4)
$
$
period
Ratio/Supplemental Data:
$
$
14.09
1.23
$
13.81
1.42
$
13.69
1.21
$
13.19
1.39
)
(0.85
1.07
—
—
1.45
(0.06
(0.03
)
)
(0.54
(0.82
)
)
0.05
14.14
14.23
$
$
(0.11
0.35
(0.02
)
)
—
1.64
—
—
(1.03
(0.33
)
)
—
14.09
12.95
$
$
—
0.31
—
—
1.52
(0.09
(0.02
)
)
(1.20
(0.16
)
)
0.07
13.81
13.14
$
$
1.49
(1.05
—
)
0.03
1.86
—
—
)
(1.36
—
—
13.69
12.06
$
$
13.94
1.33
)
(0.74
0.03
—
(0.01
)
0.61
—
—
(1.33
(0.03
)
)
—
13.19
9.64
21.97
%
8.68
%
20.29
%
42.83
%
(7.76
)%
18,275,696
15,953,571
14,870,981
12,479,959
12,479,961
Net assets at the end of year/period
$270,571,173
$224,845,007
$220,247,242
$170,881,785
$164,651,104
Weighted average net assets
Annualized ratio of gross operating expenses to net
assets
(7)(8)
Annualized ratio of net operating expenses to net
assets
(7)(8)
Annualized ratio of interest expense and other fees
to net assets
(2 )
Annualized ratio of net investment income before
fee waiver to net assets
(7)(8)
Annualized ratio of net investment income to net
assets
(7)(8)
Portfolio Turnover
(5)
Notes Payable
Credit Facility Payable
SBA-guaranteed debentures
Asset Coverage Ratio
(6)
$259,020,507
$223,750,302
$ 195,211,550
$165,189,142
$173,453,813
14.11
%
13.72
%
11.10
%
14.11
%
13.72
%
11.10
%
5.78
%
5.51
%
8.64
%
10.09
%
8.64
%
23
%
10.09
%
32
%
4.02
%
9.21
%
9.21
%
48
%
13.2
%
13.2
%
4.84
%
10.71
%
10.71
%
16
%
11.16
%
10.78
%
3.56
%
9.11
%
9.49
%
29
%
$ 48,875,000
$ 48,875,000
$ 48,875,000
$ 25,000,000
$ 25,000,000
$161,550,000
$ 99,550,000
$ 40,750,000
$ 116,000,000
$109,500,000
$161,000,000
$150,000,000
$ 90,000,000
$ 65,000,000
$ 65,000,000
2.29x
2.51x
3.46x
2.21x
2.22x
(1)
Financial highlights are based on weighted average shares outstanding as of year/period ended.
132
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
(2)
(3)
(4)
(5)
(6)
(7)
Excludes debt extinguishment costs of $416,725 for the year ended December 31, 2017. Including these
costs, this ratio would be 4.24%.
Includes the impact of different share amounts as a result of calculating certain per share data based on
weighted average shares outstanding during the period and certain per share data based on shares
outstanding as of the period end.
Total return on market value is based on the change in market price per share since the end of the prior
quarter and includes dividends paid, which are assumed to be reinvested. The total returns are not
annualized.
Calculated as the lesser of purchases or paydowns divided by average portfolio balance and is not
annualized.
Asset coverage ratio is equal to total assets less all liabilities and indebtedness not represented by senior
securities over the aggregate amount of the senior securities. SBA-guaranteed debentures are excluded from
the numerator and denominator.
These ratios include the impact of the benefit (provision) for income taxes related to net unrealized loss
(gain) on certain investments of $(66,760), $(67,953), and $8,593 for the years ended December 31, 2019,
2018 and 2017 respectively, which are not reflected in net investment income, gross operating expenses or
net operating expenses. The benefit (provision) for income taxes related to net realized loss or unrealized
loss (gain) on investments at taxable subsidiaries to net assets for the years ended December 31, 2019, 2018
and 2017 is less than (0.03)%, (0.03)% and (0.01)%, respectively.
(8)
Deferred offering costs of $261,761 for the year ended December 31, 2016 are not annualized.
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 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, as amended on March 28,
2018, August 2, 2018, September 13, 2019, and December 27, 2019 with ZB, N.A., dba Amegy Bank and various
other lenders (the “Credit Facility”).
The Credit Facility, as amended, provides for borrowings up to a maximum of $220,000,000 on a
committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to
$250,000,000, 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% (or 2.75% during certain periods in which the Company’s asset coverage ratio is
equal to or below 1.90 to 1.00) with no LIBOR floor, or (ii) 1.50% (or 1.75% during certain periods in which the
Company’s asset coverage ratio is equal to or below 1.90 to 1.00) 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. The commitment to fund the revolver expires on October 10, 2020, after which the
Company may no longer borrow under the Credit Facility. The Company must begin repaying principal equal to
1/12 of the aggregate amount outstanding under the Credit Facility beginning October 15, 2020. 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.
133
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 subsidiaries, 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 1.75 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of December 31, 2019, the
Company was in compliance with these covenants.
As of December 31, 2019 and December 31, 2018, the outstanding balance under the Credit Facility was
$161,550,000 and $99,550,000, respectively. 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 costs of $1,756,607 in
connection with the current 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 December 31, 2019 and 2018, $1,039,367 and $1,312,773 of such prepaid loan structure fees and
administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our
consolidated statement of assets and liabilities as a deduction from the debt liability.
The following is a summary of the Credit Facility, net of prepaid loan structure fees:
Credit Facility payable
Prepaid loan structure fees
Credit facility payable, net of prepaid loan structure fees
December 31,
2019
December 31,
2018
$161,550,000
1,039,367
$99,550,000
1,312,773
$160,510,633
$98,237,227
Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan
fees on the Credit Facility for the years ended December 31, 2019, 2018, and 2017:
Interest expense
Loan fee amortization
Commitment fees on unused portion
Administration fees
Total interest expense and other fees
Loss on extinguishment of debt
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest and unused fees
134
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
$
$
5,112,499
485,017
405,438
34,978
$ 3,737,735
415,179
387,601
40,972
$ 2,247,048
416,612
311,174
39,282
6,037,932
$ 4,581,487
$ 3,014,116
— $
— $
113,993
4.8
%
5.7
%
4.7
%
5.7
%
3.7
%
5.0
%
$106,244,521
$79,818,493
$60,053,425
$
5,217,832
$ 4,158,382
$ 2,476,340
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
NOTE 10 — SBA-GUARANTEED DEBENTURES
Due to the SBIC subsidiaries’ status as licensed SBICs, the Company has 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 both December 31, 2019 and 2018, the SBIC subsidiary had
$75,000,000 in regulatory capital, as such term is defined by the SBA, and $150,000,000 of SBA-guaranteed
debentures outstanding.
As of December 31, 2019, which was the end of the first year of operations of the SBIC II subsidiary, it had
$20,000,000 in regulatory capital and $11,000,000 of SBA-guaranteed debentures outstanding.
On August 12, 2014, the Company obtained exemptive relief from the SEC to permit it to exclude the debt
of the SBIC subsidiaries guaranteed by the SBA from its asset coverage test under the 1940 Act. The exemptive
relief provides the Company with increased flexibility under the asset coverage test by permitting it to borrow up
to $325,000,000 more than it would otherwise be able to absent the receipt of this exemptive relief.
On a stand-alone basis, the SBIC subsidiaries held $240,109,144 and $225,525,663 in assets at
December 31, 2019 and 2018, respectively, which accounted for approximately 37.0% and 42.9% of our total
consolidated assets at December 31, 2019 and 2018, 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 December 31, 2019 and 2018, the SBIC subsidiaries had $161,000,000 and
$150,000,000 of the SBA-guaranteed Debentures outstanding, respectively. SBA-guaranteed debentures drawn
before October 1, 2019 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. SBA-guaranteed
debentures drawn after October 1, 2019 incur upfront fees of 3.435%, which consists of a 1.00% commitment fee
and a 2.435% 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.
135
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following table summarizes the SBIC subsidiary’s SBA-guaranteed debentures as of December 31,
2019:
Issuance Date
October 14, 2014
October 17, 2014
December 24, 2014
June 29, 2015
October 22, 2015
October 22, 2015
November 10, 2015
November 18, 2015
November 25, 2015
December 16, 2015
December 29, 2015
November 28, 2017
April 27, 2018
July 30, 2018
September 25, 2018
October 17, 2019
November 15, 2019
Maturity Date
Debenture Amount
Interest Rate
SBA Annual Charge
March 1, 2025
March 1, 2025
March 1, 2025
September 1, 2025
March 1, 2026
March 1, 2026
March 1, 2026
March 1, 2026
March 1, 2026
March 1, 2026
March 1, 2026
March 1, 2028
September 1, 2028
September 1, 2028
March 1, 2029
March 1, 2030
March 1, 2030
$
6,500,000
6,500,000
3,250,000
9,750,000
6,500,000
1,500,000
8,800,000
1,500,000
8,800,000
2,200,000
9,700,000
25,000,000
40,000,000
17,500,000
2,500,000
6,000,000
5,000,000
2.52
2.52
2.52
2.83
2.51
2.51
2.51
2.51
%
%
%
%
%
%
%
%
2.51
%
2.51
%
2.51
%
3.19
%
3.55
%
3.55
%
2.88
2.27
2.21
%
%(1)
%(1)
0.36
0.36
0.36
0.36
0.36
0.74
0.74
0.74
%
%
%
%
%
%
%
%
0.74
%
0.74
%
0.74
%
0.22
%
0.22
%
0.22
%
0.22
%
0.09
%
0.09
%
Total SBA-guaranteed debentures
$ 161,000,000
(1)
Debenture interest rate will be set as determined by the SBA when pooled on March 25, 2020
As of December 31, 2019 and 2018, 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 December 31, 2019 and 2018, the SBA-
guaranteed debentures would be deemed to be Level 3, as defined in Note 6.
As of December 31, 2019, the Company has incurred $5,605,350 in financing costs related to the SBA-
guaranteed debentures since receiving our licenses, which were recorded as prepaid loan fees. As of
December 31, 2019 and 2018, $3,456,147 and $3,612,198 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.
The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:
SBA-guaranteed debentures payable
Prepaid loan fees
SBA-guaranteed debentures, net of prepaid loan fees
136
December 31,
2019
December 31,
2018
$161,000,000
3,456,147
$150,000,000
3,612,198
$157,543,853
$146,387,802
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures
for the years ended December 31, 2019, 2018 and 2017:
Interest expense
Debenture fee amortization
Total interest expense and other fees
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
NOTE 11 — NOTES
For the years ended
December 31,
2019
December 31,
2018
$
$
5,166,475
623,900
5,790,375
$
$
3,982,658
623,989
December 31,
2017
$ 2,067,308
333,027
4,606,647
$ 2,400,335
3.4
3.8
%
%
3.2
3.7
%
%
3.1
3.6
%
%
$151,893,151
$125,390,411
$67,328,767
$
5,007,832
$
3,107,218
$ 2,019,095
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. The Company redeemed all $25,000,000 in aggregate
principal amount of the 2019 Notes on September 20, 2017 at 100% of their principal amount, plus the accrued
and unpaid interest thereon through the redemption date. As a result of the redemption, the Company recognized
a loss on the extinguishment of debt of $302,732 for the year ended December 31, 2017, due to the write off of
the remaining deferred financing costs on the 2019 Notes.
The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for
the years ended December 31, 2019, 2018, and 2017:
For the year ended
December 31,
2019
December 31,
2018
December 31,
2017
Interest expense
Deferred financing costs
Administration fees
Total interest expense and other fees
Loss on extinguishment of debt
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
$
$
$
$
— $
—
—
— —
— $ 1,169,097
131,377
5,000
— $
— $ 1,305,474
—
—
%
—
%
— $
— $
—
—
%
—
%
302,732
6.5
%
7.3
%
— $25,000,000
— $ 1,376,736
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.
137
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
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 December 31, 2019 and 2018, the aggregate
carrying amount of all Notes was $48,875,000 and the fair value of the Notes was approximately $49,715,650
and $47,604,250, 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 $1,688,961 of fees
which are being amortized over the term of the 2022 Notes, of which $900,798 and $1,233,203 remained to be
amortized as of December 31, 2019 and 2018, respectively. These financing costs are presented on the
consolidated statement of assets and liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for
the years ended December 31, 2019, 2018, 2017.
Interest expense
Deferred financing costs
Administration fees
For the year ended
December 31,
2019
For the year ended
December 31,
2018
For the year ended
December 31,
2017
(1)
$ 2,810,312
332,403
5,000
$ 2,810,312
332,404
7,905
$ 1,014,835
118,066
2,383
Total interest expense and other fees
$ 3,147,715
$ 3,150,621
$ 1,135,284
Weighted average interest rate
Effective interest rate (including fee amortization)
Average debt outstanding
Cash paid for interest
5.8
6.4
$ 48,875,000
%
%
5.8
6.4
$ 48,875,000
%
%
5.8
6.5
$ 48,012,218
%
%
$ 2,810,312
$ 2,810,312
$
889,932
(1)
averages for period outstanding in 2017
The following is a summary of the Notes Payable, net of deferred financing costs:
Notes payable
Deferred financing costs
Notes payable, net of deferred financing costs
December 31,
2019
December 31,
2018
$48,875,000
900,798
$48,875,000
1,233,203
$47,974,202
$47,641,797
The indenture and supplements thereto relating to the 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.
138
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
NOTE 12 — SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the results of operations for the years ended December 31, 2019, 2018, and
2017. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.
Total Investment Income
Net Investment Income
Net Increase in Net Assets from Operations
Total Investment Income per share
(1)
(1)
Net Investment Income per share
Net Increase in Net Assets from Operations per
(1)
share
Total Investment Income
Net Investment Income
Net Increase in Net Assets from Operations
Total Investment Income per share
(1)
Net Investment Income per share
Net Increase in Net Assets from Operations per
(1)
(1)
share
Total Investment Income
Net Investment Income
Net Increase in Net Assets from operations
Total Investment Income per share
(1)
Net Investment Income per share
Net Increase in Net Assets from Operations per
(1)
share
(1)
2019
Qtr. 1
Qtr. 2
Qtr. 3
Qtr. 4
$13,834,929
$ 4,333,659
$10,142,443
$14,170,255
$ 5,415,400
$ 5,994,683
$15,515,227
$ 5,798,659
$ 8,468,254
$15,391,478
$ 6,891,091
$ 1,832,807
$
$
$
0.85
0.27
0.62
$
$
$
0.75
0.29
0.32
$
$
$
2018
0.82
0.31
0.45
$
$
$
0.81
0.36
0.10
Qtr. 1
$10,911,781
$ 4,475,379
$ 7,343,929
0.68
$
0.28
$
Qtr. 2
$12,619,657
$ 4,727,236
$ 7,603,246
0.79
$
0.30
$
Qtr. 3
$14,487,623
$ 5,609,974
$ 8,884,517
0.91
$
0.35
$
Qtr. 4
$15,247,277
$ 7,823,948
$ 2,362,886
0.96
$
0.49
$
$
0.46
$
0.48
$
0.56
$
0.14
Qtr. 1
$9,863,980
$4,143,627
$6,024,752
0.79
$
0.33
$
2017
Qtr. 2
$10,394,365
$ 4,938,459
$ 6,044,766
0.68
$
0.32
$
Qtr. 3
$9,978,345
$4,475,952
$5,636,598
0.64
$
0.29
$
Qtr. 4
$9,411,503
$4,412,722
$4,907,141
0.59
$
0.28
$
$
0.48
$
0.39
$
0.36
$
0.31
(1)
Per share amounts are calculated using weighted average shares outstanding during the period.
NOTE 13 — INCOME TAXES
As of December 31, 2019 and December 31, 2018, the Company had $22,548,941 and $8,572,366,
respectively, of undistributed ordinary income.
the periods ended December 31, 2019 and December 31, 2018, respectively. Undistributed qualified
Undistributed capital gains were $2,053,494 and $700,000 for
(1)
(1)
The Company’s taxable income for each period is an estimate and will not be finally determined until the
Company files its tax return for each year. Therefore, final taxable income earned in each period, and the
undistributed ordinary income and capital gains for each period carried forward for distribution in the
following period, may be different than this estimate.
139
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
dividends were $0 and $31,504 for the years ended December 31, 2019 and 2018, respectively. All of the
undistributed ordinary income as of December 31, 2019 will have been distributed within the required period of
time such that the Company will not have to pay corporate-level U.S. federal income tax for the year ended
December 31, 2019. We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed
income to the extent we did not distribute an amount equal to at least 98% of our net ordinary income plus 98.2%
of our capital gain net income attributable to the period. The Company has accrued $900,000 and $316,092 of
U.S. federal excise tax for the tax years ended December 31, 2019 and December 31, 2018, respectively,
independent of prior year adjustments. See note 1 for further discussion of tax expense in each year.
Ordinary dividend distributions from a RIC do not qualify for the reduced maximum tax rate on qualified
dividend income from domestic corporations, except to the extent that the RIC received the income in the form of
qualifying dividends from domestic corporations and qualified foreign corporations. The tax character
distributions paid in the years ended December 31, 2019 and 2018 was as follows:
of
(2)
Ordinary income
Qualified dividends
Distributions of long-term capital gains
(2)
Total distributions accrued or paid to common stockholders
December 31, 2019
$10,000,000
103,080
14,935,093
$25,038,173
December 31, 2018
$15,492,724
250,000
5,947,826
$21,690,550
Listed below is a reconciliation of “Net increase in net assets resulting from operations” to taxable income
and total distributions declared to common stockholders for the years ended December 31, 2019, 2018 and 2017:
Net increase in net assets resulting from operations (includes NII,
realized gain/loss, unrealized gain/loss and taxes)
$ 26,438,186
$26,194,578
$22,613,257
Net change in unrealized depreciation (appreciation)
Income tax provision (benefit)
Pre-tax (income) expense, (gain) loss reported at Taxable
Subsidiaries, not consolidated for tax purposes
15,499,766
66,760
1,646,549
67,953
22,072
(8,593
)
(5,819,114
)
416,203
(4,721,039
)
2019
2018
2017
Book income and tax income differences, including debt
origination, interest accrual, income from pass-through
investments, dividends, realized gains (losses) and changes in
estimates
Estimated taxable income
Taxable income earned in prior year and carried forward for
3,791,081
1,524,556
1,835,779
$ 39,976,679
$29,849,839
$19,741,476
distribution in current year
7,496,299
(662,990
)
(106,530
)
Taxable income earned prior to period end and carried forward
for distribution next period
(24,602,435
)
(9,303,869
)
(1,118,312
)
(2)
Distributions of long-term capital gains of $14,935,093 as of December 31, 2019 differs from distributions
of net capital gains on the Consolidated Statement of Changes in Net Assets because certain long-term
capital gains were recognized in Taxable Subsidiaries. The qualified dividend amount in 2019 and 2018 are
derived from qualified dividends received by the Company from a portfolio company. Additional differences
arise because certain prepayment gains are characterized differently for tax reporting purposes.
140
TABLE OF CONTENTS
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
Distribution payable as of period end and paid in following
period
2,167,630
1,807,570
1,806,671
Total distributions accrued or paid to common
stockholders
$25,038,173
$21,690,550
$ 20,323,305
2019
2018
2017
The aggregate gross unrealized appreciation and depreciation, the net unrealized appreciation, and the
aggregate cost of the Company’s portfolio company securities for federal income tax purposes as of
December 31, 2019 and December 31, 2018 were as follows:
Aggregate cost of portfolio securities for federal income tax purposes
$643,573,873
$503,079,738
Gross unrealized appreciation of portfolio company securities
17,587,984
18,423,224
Gross unrealized depreciation of portfolio company securities
(31,347,731
)
(16,683,205
)
Net unrealized appreciation (depreciation) of portfolio company
securities
$ (13,759,747
)
$
1,740,019
2019
2018
As of December 31, 2019, the Taxable Subsidiaries had unrealized losses in investments, net operating loss
(“NOL”) carryovers, and capital loss carryovers creating a net deferred tax asset equal to $146,797, as reflected
below. As of December 31, 2019, for U.S. federal income tax purposes, the Taxable Subsidiaries had capital loss
capital forward of $1,103,401, which, if unused, will expire in the taxable year 2021. As of December 31, 2019,
for U.S. federal income tax purposes, the Taxable Subsidiaries had net operating loss carryforwards totaling
$2,761,004 of which $1,615,912 will expire during the tax years 2023 through 2037 if unused. Due to the nature
of the Taxable Subsidiaries’ holdings, a valuation allowance was established when management determined it is
more likely than not that some of the deferred tax assets will not be realized prior to expiration. Although our
future projections indicate that we may be able to realize a portion of these deferred tax assets, due to the degree
of uncertainty of these projections, management has recorded a deferred tax asset valuation allowance of
$281,510.
Deferred Tax Asset
Deferred Tax Liability
Total Deferred Tax Asset before valuation allowance
Deferred tax valuation allowance
Net Deferred Tax Liability
2019
2018
$ 2,189,818
(2,043,021
)
$ 2,930,694
(1,648,207
)
146,797
$
$ (281,510
)
$ 1,282,487
$(1,350,440
)
$ (134,713
)
$
(67,953
)
Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The 2016,
2017 and 2018 federal tax years for the Company remain subject to examination by the Internal Revenue Service.
NOTE 14 — SUBSEQUENT EVENTS
Investment Portfolio
On January 3, 2020, the Company received full repayment on the first lien term loan of APG Intermediate
Sub 2 Corp. for total proceeds of $10,066,786, including a $141,785 prepayment fee. The Company also
received $2,424,445 in full realization on the equity of APG Holdings, resulting in a $1,296,793 gain.
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
On January 7, 2020, the Company invested $14,424,157 in the first lien term loan of Sales Benchmark
Index, LLC, $1,331,461 in the unfunded revolver, and $3,328,652 in the unfunded delayed draw term loan of
Sales Benchmark, LLC, a provider of revenue growth management consulting services for private equity-owned
and large enterprise clients. Additionally, the Company invested $665,730 in the preferred equity of the company.
On January 15, 2020, Apex Environmental Resources Holdings, LLC was merged with a provider of non-
hazardous waste management, collection, and recycling services, creating Interstate Waste Services, Inc. The
Company's common and preferred ownership positions in Apex Environmental Resources Holdings, LLC was
rolled into the combined entity.
On January 31, 2020, the Company invested $18,900,000 in the first lien term loan and $2,700,000 in the
unfunded revolver of Elliott Aviation, LLC, a provider of maintenance, repair, and overhaul and fixed-base
operator services to the business aviation sector. Additionally, the Company invested $900,000 in the preferred
equity of the company.
Credit Facility
The outstanding balance under the Credit Facility as of February 28, 2020 was $175,250,000.
ATM Program
Since December 31, 2019, the Company issued 332,591 shares under the At-the-Market (“ATM”) Program,
for gross proceeds of $4,794,995 and underwriting expenses of $5,684. The average per share offering price of
shares issued in the ATM Program was $14.42.
SBA-guaranteed Debentures
The outstanding balance of SBA-guaranteed Debentures as of February 28, 2020 was $161,000,000.
Dividend Declared
On January 10, 2020, the Company’s board of directors declared a regular monthly dividend for each of
January, February and March 2020 as follows:
Declared
1/10/2020
1/10/2020
1/10/2020
Ex-Dividend Date
Record Date
Payment Date
Amount per Share
1/30/2020
2/27/2020
3/30/2020
1/31/2020
2/28/2020
3/31/2020
2/14/2020
3/13/2020
4/15/2020
$ 0.1133
$ 0.1133
$ 0.1133
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STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2019
STELLUS CAPITAL INVESTMENT CORPORATION
Consolidated Schedule of Investments in and Advances to Affiliates
December 31, 2019
(dollars in thousands)
Investment
(1)
December 31,
2018
Fair Value
Amount of
Realized
Gain/(Loss)
Amount of
Unrealized
Gain/(Loss)
Amount of
Interest,
Fees or
Dividends
Credit to
(2)
Income
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2019
Fair Value
Company
Non-control Investments
Affiliate investments
Glori Energy Production Inc.
Total Non-Control/Affiliate investments
Class A
Common Units
$50
$50
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$ —
$(50
)
$(50
)
$ —
$ —
(1)
(2)
(3)
(4)
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.
The principal amount and ownership detail for equity investments is included in the consolidated schedule
of investments.
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.”
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 the movement of an existing portfolio company into
this category and out of a different category.
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 the movement of an existing portfolio company out of this category and into a different
category.
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Item 9.
Changes in and Disagreements with Independent Registered Public Accounting Firm on
Accounting and Financial Disclosure
None.
Item 9A.
Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2019 (the end of the period covered by this report), we, including our Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) of the 1934 Act). Based on that evaluation, our
management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure
controls and procedures were effective and provided reasonable assurance that information required to be
disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
(b) Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial
reporting as such term is defined in Exchange Act Rule 13a-15(f), and for performing an assessment of the
effectiveness of internal control over financial reporting as of December 31, 2019. Internal control over financial
reporting is a process designed by, or under the supervision of, our principal executive and principal financial
officers, or persons performing similar functions, and effected by our Board of Directors, management and other
personnel, 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. Our
internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance
of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the
company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures are being made only in accordance with authorizations; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation.
Management performed an assessment of the effectiveness of our internal control over financial reporting as
of December 31, 2019 based upon the criteria set forth in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment,
management determined that our internal control over financial reporting was effective as of December 31, 2019.
(c) Report of the Independent Registered Public Accounting Firm
Our independent registered public accounting firm Grant Thornton, LLP, has issued an attestation report on
the effectiveness of our internal control over financial reporting, which is set forth above under the heading
“Reports of Independent Registered Public Accounting Firm” in Item 8.
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(d) Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal control over financing reporting that occurred during the fourth
fiscal quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Item 9B.
Other Information.
None.
PART III
We will file with the SEC a definitive Proxy Statement for our 2020 Annual Meeting of Stockholders,
pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain
information required by Part III has been omitted under General Instruction G(3) to the annual report on Form
10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are
incorporated by reference.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by Item 10 is hereby incorporated by reference from the Company’s definitive
Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities
and Exchange Commission within 120 days following the end of the Company’s fiscal year.
We have adopted a code of business conduct and ethics that applies to our directors, officers and employees.
This code of ethics is published on our website at www.stelluscapital.com . We intend to disclose any future
amendments to, or waivers from, this code of conduct within four business days of the waiver or amendment
through a website posting.
Item 11.
Executive Compensation
The information required by Item 11 is hereby incorporated by reference from the Company’s definitive
Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities
and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The information required by Item 12 is hereby incorporated by reference from the Company’s definitive
Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities
and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is hereby incorporated by reference from the Company’s definitive
Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities
and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 14.
Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from the Company’s definitive
Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities
and Exchange Commission within 120 days following the end of the Company’s fiscal year.
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PART IV
Item 15.
Exhibits, Financial Statement Schedules
a. Documents Filed as Part of this Report
The following financial statements are set forth in Item 8:
Report of Independent Registered Public Accounting Firm
Statements of Assets and Liabilities as of December 31, 2019 and December 31, 2018
Statements of Operations for the years ended December 31, 2019, 2018, and 2017
Statements of Changes in Net Assets for the years ended December 31, 2019, 2018, and 2017
Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017
Schedule of Investments as of December 31, 2019 and December 31, 2018
Notes to Financial Statements
b. Exhibits
Page
86
89
90
91
92
93
108
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits
previously filed with the SEC:
3.1
3.3
4.1
4.2
4.4
4.6
Articles of Amendment and Restatement (Incorporated by reference to Exhibit (a)(1) to the Registrant’s
Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
Bylaws (Incorporated by reference to Exhibit (b)(1) to the Registrant’s Registration Statement on Form
N-2 (File No. 333-184195), filed on October 23, 2012).
Form of Stock Certificate (Incorporated by reference to Exhibit (d) to the Registrant’s Registration
Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
Form of Indenture (Incorporated by reference to Exhibit (d)(2) to the Registrant’s Registration Statement
on Form N-2 (File No. 333-189938, filed January 29, 2014).
Second Supplemental Indenture between the Registrant and U.S. Bank National Association, date
August 21, 2017, (Incorporated by reference on exhibit (d)(6) to the Registrant’s Registration Statement
on Form N-2 (File No. 333-216138), filed on August 23, 2017).
Form of Global Note with respect to the 5.75% Note due 2022 (Incorporated by reference to
Exhibit 4.4).
4.7* Description of Securities
10.1
10.2
10.3
10.4
Form of Investment Advisory Agreement between Registrant and Stellus Capital Management, LLC
(Incorporated by reference to Exhibit (g)(1) to the Registrant’s Registration Statement on Form N-2 (File
No. 333-184195), filed on October 23, 2012).
Custody Agreement between Registrant and ZB, National Association (Incorporated by reference to
Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File No. 814-00971), filed on
November 7, 2017).
Administration Agreement between Registrant and Stellus Capital Management, LLC (Incorporated by
reference to Exhibit (k)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-
184195), filed on October 23, 2012).
Dividend Reinvestment Plan (Incorporated by reference to Exhibit (e) to the Registrant’s Registration
Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
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10.5
10.6
10.7
10.8
10.9
10.10
10.11
Form of License Agreement between the Registrant and Stellus Capital Management (Incorporated by
reference to Exhibit (k)(2) to the Registrant’s Registration Statement on Form N-2 (File No. 333-
184195), filed on October 23, 2012).
Form of Indemnification Agreement between the Registrant and the directors (Incorporated by
reference to Exhibit (k)(3) to the Registrant’s Registration Statement on Form N-2 (File No. 333-
184195), filed on October 23, 2012).
Form of Senior Secured Revolving Credit Agreement, between the Registrant, as a borrower, the
lenders party hereto and ZB, N.A. dba Amegy Bank, as administrative agent (Incorporated by reference
to the Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File No 814-00971), filed on
October 13, 2017).
Form of Guarantee and Security Agreement, the Registrant, ZB, N.A., dba Amegy Bank, as
administrative agent, and ZB, N.A. dba Amegy Bank, as collateral agent (Incorporated by reference to
Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (File No. 814-00971), filed on October 13,
2017).
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 (Incorporated by reference to
Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q (File No.814-00971), filed on May 8,
2018).
First Amendment to Senior Secured Revolving Credit Agreement and Commitment Increase, dated
August 2, 2018, between the Registrant, as a borrower, the lenders party thereto and ZB, N.A. dba
Amegy Bank, as administrative agent (Incorporated by reference to Exhibit 10.1 to the Registrant’s
Quarterly Report on Form 10-Q (File No.814-00971), filed on August 8, 2018).
Second Amendment to Senior Secured Revolving Credit Agreement and Commitment Increase, dated
September 13, 2019, between the Registrant, as a borrower, the lenders party thereto and ZB, N.A. dba
Amegy Bank, as administrative agent (Incorporated by reference to Exhibit 10.1 to the Registrant’s
Current Report on Form 8-K(File No. 814-00971), filed on September 18, 2019).
10.12*
Increase Agreement, dated December 27, 2019, between the Registrant, as a borrower, the lenders party
thereto and ZB, N.A. dba Amegy Bank, as administrative agent
14.1
21.1
Code of Ethics (Incorporated by reference to Exhibit (r)(1) to the Registrant’s Registration Statement on
Form N-2 (File No. 333-184195), filed on October 23, 2012).
Subsidiaries of the Registrant and jurisdiction of incorporation/organizations:
Stellus Capital SBIC, LP — Delaware
Stellus Capital SBIC GP, LLC — Delaware
Stellus Capital SBIC II, LP — Delaware
Stellus Capital SBIC II GP, LLC — Delaware
SCIC-SKP Blocker 1, Inc. — Delaware
SCIC-ERC Blocker 1, Inc. — Delaware
SCIC-Consolidated Blocker 1, Inc. — Delaware
SCIC-CC Blocker 1, Inc. — Delaware
SCIC-APE Blocker 1, Inc. — Delaware
SCIC-Hollandar Blocker 1, Inc. — Delaware
SCIC-Invincible Blocker 1, Inc. — Delaware
SCIC-FBO Blocker 1, Inc. — Delaware
SCIC-ICD Blocker 1, Inc. — Delaware
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of
1934, as amended.
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31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934,
as amended.
32.1*
Certification of Chief Executive Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2*
Certification of Chief Financial Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
*
Filed herewith.
c. Financial statement schedules
No financial statement schedules are filed herewith because (1) such schedules are not required or (2) the
information has been presented in the aforementioned financial statements.
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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.
SIGNATURES
Date: March 2, 2020
STELLUS CAPITAL INVESTMENT CORPORATION
/s/ Robert T. Ladd
Robert T. Ladd
Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacity and on the dates indicated.
Date: March 2, 2020
/s/ Robert T. Ladd
Robert T. Ladd
Chief Executive Officer, President and
Chairman of the Board of Directors
Date: March 2, 2020
/s/ W. Todd Huskinson
W. Todd Huskinson
Chief Financial Officer, Chief Compliance Officer and
Secretary(Principal Accounting and
Financial Officer)
Date: March 2, 2020
Date: March 2, 2020
Date: March 2, 2020
Date: March 2, 2020
Date: March 2, 2020
Date: March 2, 2020
/s/ Dean D’Angelo
Dean D’Angelo
Director
/s/ Joshua T. Davis
Joshua T. Davis
Director
/s/ J. Tim Arnoult
J. Tim Arnoult
Director
/s/ Bruce R. Bilger
Bruce R. Bilger
Director
/s/ Paul Keglevic
Paul Keglevic
Director
/s/ William C. Repko
William C. Repko
Director
149
DESCRIPTION OF SECURITIES
Exhibit 4.7
The following is a brief description of the securities of Stellus Capital Investment Corporation (the “Company,” “we,” “our” or “us”), registered pursuant to
Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This description of our securities does not purport to be complete and
is subject to and qualified in its entirety by reference to the applicable provisions of Maryland General Corporation Law (the “MGCL”), and the full text of
our charter, bylaws and the relevant indenture and supplemental indenture governing the debt securities described herein. As of December 31, 2019 and the
date hereof, our common stock and the debt securities described herein are the only securities that we have registered under Section 12 of the Exchange Act.
A. Common Stock
As of December 31, 2019, our authorized stock consists of 100,000,000 shares of stock, par value $0.001 per share, all of which are initially designated as
common stock. Our common stock is listed on the New York Stock Exchange under the ticker symbol “SCM.” There are no outstanding options or warrants
to purchase our stock. No stock has been authorized for issuance under any equity compensation plans. Our fiscal year-end is December 31st. Under
Maryland law, our stockholders generally are not personally liable for our debts or obligations.
Under our charter, our board of directors is authorized to classify and reclassify any unissued shares of stock into other classes or series of stock without
obtaining stockholder approval. As permitted by the MGCL, our charter provides that the board of directors, without any action by our stockholders, may
amend the charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series
that we have authority to issue.
All shares of our common stock have equal rights as to earnings, assets, voting, and distributions and, when they are issued, will be duly authorized, validly
issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our board of directors and
declared by us out of assets legally available therefor. Shares of our common stock have no preemptive, conversion or redemption rights and are freely
transferable, except where their transfer is restricted by federal and state securities laws or by contract. In the event of our liquidation, dissolution or winding
up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for distribution after we pay all debts and
other liabilities and subject to any preferential rights of holders of our preferred stock, if any preferred stock is outstanding at such time. Each share of our
common stock is entitled to one vote on all matters submitted to a vote of stockholders, including the election of directors. Except as provided with respect to
any other class or series of stock, the holders of our common stock possess exclusive voting power. There is no cumulative voting in the election of directors,
which means that holders of a majority of the outstanding shares of common stock can elect all of our directors, and holders of less than a majority of such
shares will be unable to elect any director.
Certain Provisions of the MGCL and Our Charter and Bylaws
The MGCL and our charter and bylaws contain provisions that could make it more difficult for a potential acquirer to acquire us by means of a tender offer,
proxy contest or otherwise. These provisions are expected to discourage certain coercive takeover practices and inadequate takeover bids and to encourage
persons seeking to acquire control of us to negotiate first with our board of directors. We believe that the benefits of these provisions outweigh the potential
disadvantages of discouraging any such acquisition proposals because, among other things, the negotiation of such proposals may improve their terms.
Classified Board of Directors
Our board of directors is divided into three classes of directors serving staggered three-year terms. Upon expiration of their terms, directors of each class will
be elected to serve for three-year terms and until their successors are duly elected and qualify and each year one class of directors will be elected by the
stockholders. A classified board may render a change in control of us or removal of our incumbent management more difficult. We believe, however, that the
longer time required to elect a majority of a classified board of directors will help to ensure the continuity and stability of our management and policies.
Election of Directors
Our charter and bylaws provide that the affirmative vote of the holders of a plurality of the outstanding shares of stock entitled to vote in the election of
directors cast at a meeting of stockholders duly called and at which a quorum is present will be required to elect a director. Pursuant to our charter our board
of directors may amend the bylaws to alter the vote required to elect directors.
Number of Directors; Vacancies; Removal
Our charter provides that the number of directors will be set only by the board of directors in accordance with our bylaws. Our bylaws provide that a majority
of our entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of
directors may never be less than one or more than nine. Our charter provides that, at such time as we have at least three independent directors and our
common stock is registered under the Exchange Act, we elect to be subject to the provision of Subtitle 8 of Title 3 of the MGCL regarding the filling of
vacancies on the board of directors. Accordingly, at such time, except as may be provided by the board of directors in setting the terms of any class or series
of preferred stock, any and all vacancies on the board of directors may be filled only by the affirmative vote of a majority of the remaining directors in office,
even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy will serve for the remainder of the full term of the
directorship in which the vacancy occurred and until a successor is elected and qualifies, subject to any applicable requirements of the Investment Company
Act of 1940, as amended (the “1940 Act”).
Our charter provides that a director may be removed only for cause, as defined in our charter, and then only by the affirmative vote of at least two-thirds of
the votes entitled to be cast in the election of directors.
Action by Stockholders
Under the MGCL, stockholder action can be taken only at an annual or special meeting of stockholders or (unless the charter provides for stockholder action
by less than unanimous written consent, which our charter does not) by unanimous written consent in lieu of a meeting. These provisions, combined with the
requirements of our bylaws regarding the calling of a stockholder-requested special meeting of stockholders discussed below, may have the effect of delaying
consideration of a stockholder proposal until the next annual meeting.
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals
Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the board of directors and the proposal of
business to be considered by stockholders may be made only (a) pursuant to our notice of the meeting, (b) by the board of directors or (c) by a stockholder
who is entitled to vote at the meeting and who has complied with the advance notice procedures of our bylaws. With respect to special meetings of
stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of persons for election to the board of
directors at a special meeting may be made only (1) pursuant to our notice of the meeting, (2) by the board of directors or (3) provided that the board of
directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and who has complied with the
advance notice provisions of the bylaws. The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our
board of directors a meaningful opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and,
to the extent deemed necessary or desirable by our board of directors, to inform stockholders and make recommendations about such qualifications or
business, as well as to provide a more orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our board of directors any
power to disapprove stockholder nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a
contest for the election of directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third
party from conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of
such nominees or proposals might be harmful or beneficial to us and our stockholders.
Calling of Special Meetings of Stockholders
Our bylaws provide that special meetings of stockholders may be called by our board of directors and certain of our officers. Additionally, our bylaws provide
that, subject to the satisfaction of certain procedural and informational requirements by the stockholders requesting the meeting, a special meeting of
stockholders will be called by the secretary of the corporation upon the written request of stockholders entitled to cast not less than a majority of all the votes
entitled to be cast at such meeting.
Approval of Extraordinary Corporate Action; Amendment of Charter and Bylaws
Under Maryland law, a Maryland corporation generally cannot dissolve, amend its charter, merge, sell all or substantially all of its assets, engage in a share
exchange or engage in similar transactions outside the ordinary course of business, unless approved by the affirmative vote of stockholders entitled to cast at
least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a
lesser percentage, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter generally provides for approval of charter
amendments and extraordinary transactions by the stockholders entitled to cast at least a majority of the votes entitled to be cast on the matter. Our charter
also provides that certain charter amendments, any proposal for our conversion, whether by charter amendment, merger or otherwise, from a closed-end
company to an open-end company and any proposal for our liquidation or dissolution requires the approval of the stockholders entitled to cast at least 80% of
the votes entitled to be cast on such matter. However, if such amendment or proposal is approved by a majority of our continuing directors (in addition to
approval by our board of directors), such amendment or proposal may be approved by a majority of the votes entitled to be cast on such a matter. In either
event, in accordance with the requirements of the 1940 Act, any such amendment or proposal that would have the effect of changing the nature of our
business so as to cause us to cease to be, or to withdraw our election as, a BDC would be required to be approved by a majority of our outstanding voting
securities, as defined under the 1940 Act. The “continuing directors” are defined in our charter as (a) our current directors, (b) those directors whose
nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of our current directors then on the
board of directors or (c) any successor directors whose nomination for election by the stockholders or whose election by the directors to fill vacancies is
approved by a majority of continuing directors or the successor continuing directors then in office.
Our charter and bylaws provide that the board of directors have the exclusive power to make, alter, amend or repeal any provision of our bylaws.
No Appraisal Rights
Except with respect to appraisal rights arising in connection with the Control Share Act discussed below, as permitted by the MGCL, our charter provides that
stockholders will not be entitled to exercise appraisal rights unless a majority of the board of directors shall determine such rights apply.
Control Share Acquisitions
The MGCL provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved
by a vote of two-thirds of the votes entitled to be cast on the matter, or the Control Share Act. Shares owned by the acquirer, by officers or by directors who
are employees of the corporation are excluded from shares entitled to vote on the matter. Control shares are voting shares of stock which, if aggregated with
all other shares of stock owned by the acquirer or in respect of which the acquirer is able to exercise or direct the exercise of voting power (except solely by
virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting power:
•
•
•
one-tenth or more but less than one-third;
one-third or more but less than a majority; or
a majority or more of all voting power.
The requisite stockholder approval must be obtained each time an acquirer crosses one of the thresholds of voting power set forth above. Control shares do
not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A control share acquisition
means the acquisition of control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition may compel the board of directors of the corporation to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights of the shares. The right to compel the calling of a special meeting is subject to
the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the corporation may
itself present the question at any stockholders meeting.
If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then the
corporation may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved. The right of the
corporation to redeem control shares is subject to certain conditions and limitations, including, as provided in our bylaws, compliance with the 1940 Act. Fair
value is determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquirer or
of any meeting of stockholders at which the voting rights of the shares are considered and not approved. If voting rights for control shares are approved at a
stockholders meeting and the acquirer becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights.
The fair value of the shares as determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquirer in the control
share acquisition.
The Control Share Act does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b)
to acquisitions approved or exempted by the charter or bylaws of the corporation. Our bylaws contain a provision exempting from the Control Share Act any
and all acquisitions by any person of our shares of stock. There can be no assurance that such provision will not be amended or eliminated at any time in the
future. However, we will amend our bylaws to be subject to the Control Share Act only if the board of directors determines that it would be in our best
interests and if the Securities and Exchange Commission (the “SEC”) staff does not object to our determination that our being subject to the Control Share
Act does not conflict with the 1940 Act.
Business Combinations
Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are
prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder, or the Business Combination Act.
These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or
reclassification of equity securities. An interested stockholder is defined as:
•
•
any person who beneficially owns 10% or more of the voting power of the corporation’s outstanding voting stock; or
an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10%
or more of the voting power of then outstanding voting stock of the corporation.
A person is not an interested stockholder under this statute if the board of directors approved in advance the transaction by which the stockholder otherwise
would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to
compliance, at or after the time of approval, with any terms and conditions determined by the board. After the five-year prohibition, any business combination
between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved
by the affirmative vote of at least:
•
•
80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom
or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.
These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for
their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares.
The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors before the time that
the interested stockholder becomes an interested stockholder. Our board of directors has adopted a resolution that any business combination between us and
any other person is exempted from the provisions of the Business Combination Act, provided that the business combination is first approved by the board of
directors, including a majority of the directors who are not interested persons as defined in the 1940 Act. This resolution may be altered or repealed in whole
or in part at any time; however, our board of directors will adopt resolutions so as to make us subject to the provisions of the Business Combination Act only
if the board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the
Business Combination Act does not conflict with the 1940 Act. If this resolution is repealed, or the board of directors does not otherwise approve a business
combination, the statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Conflict with 1940 Act
Our bylaws provide that, if and to the extent that any provision of the MGCL, including the Control Share Act (if we amend our bylaws to be subject to such
Act) and the Business Combination Act, or any provision of our charter or bylaws conflicts with any provision of the 1940 Act, the applicable provision of
the 1940 Act will control.
B. Debt Securities – 5.75% Notes due 2022
On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”) under an indenture dated
as of May 5, 2014 and the second supplemental indenture thereto, dated August 21, 2017, entered into between us and U.S. Bank National Association, as
trustee (together, the “Indenture”). 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. The principal payable at maturity will be 100% of the aggregate principal amount. The interest rate of
the 2022 Notes is 5.75% per year and will be paid every March 15, June 15, September 15 and December 15, which began December 15, 2017, and the
regular record dates for interest payments will be every March 1, June 1, September 1 and December 1 of each year, beginning December 1, 2017. If an
interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue
as a result of such delayed payment. The initial interest period was the period from and including August 21, 2017, to, but excluding, the initial interest
payment date, and the subsequent interest periods are the periods from and including an interest payment date to, but excluding, the next interest payment date
or the stated maturity date, as the case may be.
The 2022 Notes are issued in denominations of $25 and integral multiples of $25 in excess thereof. The 2022 Notes are not subject to any sinking fund and
holders of the 2022 Notes (the “Noteholders”) do not have the option to have the 2022 Notes repaid prior to the stated maturity date.
The Indenture does not contain any provisions that give the Noteholders protection in the event we issue a large amount of debt or are acquired by another
entity.
We have the ability to issue indenture securities with terms different from the 2022 Notes and, without the consent of the holders thereof, to reopen the 2022
Notes and issue additional 2022 Notes.
Optional Redemption
The 2022 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after September 15, 2019 upon not less than 30 days
nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount
of the 2022 Notes to be redeemed plus accrued and unpaid interest payments otherwise payable thereon for the then-current quarterly interest period accrued
to the date fixed for redemption.
The Noteholders may be prevented from exchanging or transferring the 2022 Notes when they are subject to redemption. In case any 2022 Notes are to be
redeemed in part only, the redemption notice will provide that, upon surrender of such Note, the Noteholders will receive, without a charge, a new 2022 Note
or 2022 Notes of authorized denominations representing the principal amount of the Noteholders remaining unredeemed 2022 Notes. Any exercise of our
option to redeem the 2022 Notes will be done in compliance with the 1940 Act.
If we redeem only some of the 2022 Notes, the trustee will determine the method for selection of the particular 2022 Notes to be redeemed, in accordance
with the Indenture and in accordance with the rules of any national securities exchange or quotation system on which the 2022 Notes are listed. Unless we
default in payment of the redemption price, interest will cease to accrue on the 2022 Notes called for redemption on and after the date of redemption.
Events of Default
The Noteholders have rights if an Event of Default occurs in respect of the 2022 Notes, as described later in this subsection. The term “Event of Default” in
respect of the 2022 Notes means any of the following:
• We do not pay the principal of (or premium, if any, on) any 2022 Note within five days of its due date.
• We do not pay interest on any 2022 Note when due, and such default is not cured within 30 days.
• We remain in breach of any other covenant with respect to the 2022 Notes for 60 days after we receive a written notice of default stating we are in
breach. The notice must be sent by either the Trustee or holders of at least 25% of the principal amount of the 2022 Notes.
• We file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and in the case of certain orders or decrees entered
against us under any bankruptcy law, such order or decree remains undischarged or unstayed for a period of 60 days.
•
On the last business day of each of twenty-four consecutive calendar months, the 2022 Notes have an asset coverage of less than 100%, after giving
effect to any exemptive relief granted to us by the SEC.
No periodic evidence is required to be furnished as to the absence of default or as to compliance with the terms of the Indenture. An Event of Default for the
2022 Notes does not necessarily constitute an Event of Default for any other series of debt securities issued under the same or any other indenture. The trustee
may withhold notice to the holders of the 2022 Notes of any default, except in the payment of principal or interest, if it in good faith considers the
withholding of notice to be in the best interests of the holders.
Remedies if an Event of Default Occurs
If an Event of Default has occurred and is continuing, the trustee or the holders of not less than 25% in principal amount of the 2022 Notes may declare the
entire principal amount of all the 2022 Notes to be due and immediately payable. This is called a declaration of acceleration of maturity. In certain
circumstances, a declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the 2022 Notes if (1) we have
deposited with the trustee all amounts due and owing with respect to the 2022 Notes (other than principal that has become due solely by reason of such
acceleration) and certain other amounts, and (2) any other Events of Default have been cured or waived.
The trustee is not required to take any action under the Indenture at the request of any holders unless the holders offer the trustee protection from expenses
and liability reasonably satisfactory to it (called an “indemnity”). If indemnity reasonably satisfactory to the trustee is provided, the holders of a majority in
principal amount of the 2022 Notes may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy
available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or remedy
will be treated as a waiver of that right, remedy or Event of Default.
Before the Noteholders are allowed to bypass the trustee and bring their own lawsuit or other formal legal action or take other steps to enforce their rights or
protect their interests relating to the 2022 Notes, the following must occur:
•
•
The Noteholders must give the trustee written notice that an Event of Default has occurred and remains uncured;
the holders of at least 25% in principal amount of all the 2022 Notes must make a written request that the trustee take action because of the default
and must offer reasonable indemnity to the trustee against the costs, expenses and other liabilities of taking that action;
•
•
the trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity; and
the holders of a majority in principal amount of the 2022 Notes must not have given the trustee a direction inconsistent with the above notice during
that 60-day period.
However, the Noteholders are entitled at any time to bring a lawsuit for the payment of money due on their 2022 Notes on or after the due date.
Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request
of the trustee and how to declare or cancel an acceleration of maturity.
Each year, we will furnish to the trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the
Indenture and the 2022 Notes, or else specifying any default.
Waiver of Default
The holders of a majority in principal amount of the 2022 Notes may waive any past defaults other than a default:
•
•
the payment of principal of (or premium, if any) or interest; or
in respect of a covenant that cannot be modified or amended without the consent of each holder.
Modification or Waiver
There are three types of changes we can make to the Indenture and the 2022 Notes issued thereunder.
Changes Requiring the Noteholders’ Approval
First, there are changes that we cannot make to the Noteholders’ 2022 Notes without their specific approval. The following is a list of those types of changes:
•
•
change the stated maturity of the principal of or interest on the 2022 Notes;
reduce any amounts due on the 2022 Notes;
•
•
•
•
•
•
reduce the amount of principal payable upon acceleration of the maturity of a 2022 Note following a default;
change the place or currency of payment on a 2022 Note;
impair the Noteholders’ right to sue for payment;
adversely affect any rights to convert or exchange any note in accordance with its terms;
reduce the percentage of the Noteholders whose consent is needed to modify or amend the Indenture;
reduce the percentage of the Noteholders whose consent is needed to waive compliance with certain provisions of the Indenture or to waive certain
defaults; and
• modify any other material aspect of the Indenture dealing with supplemental indentures, modification and waiver of past defaults, reduction of the
quorum or voting requirements or the waiver of certain covenants.
Changes Not Requiring Approval
The second type of change does not require any vote by the Noteholders. This type is limited to clarifications and certain other changes that would not
adversely affect the Noteholders in any material respect.
Changes Requiring Majority Approval
Any other change to the Indenture and the 2022 Notes would require the following approval:
•
•
if the change affects only the 2022 Notes, it must be approved by the holders of a majority in principal amount of the 2022 Notes; and
if the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a majority in
principal amount of all of the series affected by the change, with all affected series voting together as one class for this purpose.
In each case, the required approval must be given by written consent.
The holders of a majority in principal amount of all of the series of debt securities issued under an indenture, voting together as one class for this purpose,
may waive our compliance with some of our covenants in that indenture. However, we cannot obtain a waiver of a payment default or of any of the matters
covered by the bullet points included above under “— Changes Requiring the Noteholders’ Approval.”
Further Details Concerning Voting
When taking a vote, we use the principal amount that would be due and payable on the voting date if the maturity of the 2022 Notes were accelerated to that
date because of a default, to decide how much principal to attribute to the 2022 Notes:
The 2022 Notes will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or
redemption. The 2022 Notes will also not be eligible to vote if they have been fully defeased as described later under “— Defeasance — Full Defeasance.”
We are generally entitled to set any day as a record date for the purpose of determining the Noteholders that are entitled to vote or take other action under the
Indenture. However, the record date may not be more than 30 days before the date of the first solicitation of holders to vote on or take such action. If we set a
record date for a vote or other action to be taken by the Noteholders, that vote or action may be taken only by persons who are the Noteholders on the record
date and must be taken within eleven months following the record date.
Defeasance
The following defeasance provisions are applicable to the 2022 Notes. “Defeasance” means that, by depositing with a trustee an amount of cash and/or
government securities sufficient to pay all principal and interest, if any, on the 2022 Notes when due and satisfying any additional conditions noted below, we
will be deemed to have been discharged from our obligations under the 2022 Notes. In the event of a “covenant defeasance,” upon depositing such funds and
satisfying similar conditions discussed below we would be released from certain covenants under the Indenture relating to the 2022 Notes. The consequences
to the Noteholders would be that, while they would no longer benefit from certain covenants under the Indenture, and while the 2022 Notes could not be
accelerated for any reason, the Noteholders nonetheless would be guaranteed to receive the principal and interest owed to them.
Covenant Defeasance
Under current U.S. federal tax law and the Indenture, we can make the deposit described below and be released from some of the restrictive covenants in the
Indenture under which the 2022 Notes were issued. This is called “covenant defeasance.” In that event, the Noteholders would lose the protection of those
restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay their 2022 Notes. If we achieve
covenant defeasance and the Noteholders’ 2022 Notes were subordinated as described under “Indenture Provisions — Ranking” below, such subordination
would not prevent the trustee under the Indenture from applying the funds available to it from the deposit described in the first bullet below to the payment of
amounts due in respect of such debt securities for the benefit of the subordinated debtholders. In order to achieve covenant defeasance, we must do the
following:
•
Since the 2022 Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all the Noteholders a combination of cash and U.S.
government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the 2022
Notes on their various due dates;
•
•
•
•
we must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the above
deposit without causing the Noteholders to be taxed on the 2022 Notes any differently than if we did not make the deposit;
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and
a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with;
defeasance must not result in a breach or violation of, or result in a default under, the Indenture or any of our other material agreements or
instruments; and
no default or event of default with respect to the 2022 Notes shall have occurred and be continuing and no defaults or events of default related to
bankruptcy, insolvency or reorganization shall occur during the next 90 days.
If we accomplish covenant defeasance, the Noteholders can still look to us for repayment of the 2022 Notes if there were a shortfall in the trust deposit or the
trustee is prevented from making payment. In fact, if one of the remaining Events of Default occurred (such as our bankruptcy) and the 2022 Notes became
immediately due and payable, there might be a shortfall. Depending on the event causing the default, the Noteholders may not be able to obtain payment of
the shortfall.
Full Defeasance
If there is a change in U.S. federal tax law, as described below, we can legally release ourselves from all payment and other obligations on the 2022 Notes
(called “full defeasance”) if we put in place the following other arrangements for the Noteholders to be repaid:
•
•
Since the 2022 Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all the Noteholders a combination of money and
U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the
2022 Notes on their various due dates;
we must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or an IRS ruling that allows us to
make the above deposit without causing the Noteholders to be taxed on the 2022 Notes any differently than if we did not make the deposit;
•
•
•
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and
a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with;
defeasance must not result in a breach or violation of, or constitute a default under, of the Indenture or any of our other material agreements or
instruments; and
no default or event of default with respect to the 2022 Notes shall have occurred and be continuing and no defaults or events of default related to
bankruptcy, insolvency or reorganization shall occur during the next 90 days.
If we ever did accomplish full defeasance, as described above, the Noteholders would have to rely solely on the trust deposit for repayment of the 2022 Notes.
The Noteholders could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from
claims of our lenders and other creditors if we ever became bankrupt or insolvent. If the Noteholders’ 2022 Notes were subordinated as described later under
“— Indenture Provisions — Ranking,” such subordination would not prevent the trustee under the Indenture from applying the funds available to it from the
deposit referred to in the first bullet of the preceding paragraph to the payment of amounts due in respect of such 2022 Notes for the benefit of the
subordinated debtholders.
Other Covenants
In addition to any other covenants described in this description, as well as standard covenants relating to payment of principal and interest, maintaining an
office where payments may be made or securities can be surrendered for payment, payment of taxes by the Company and related matters, the following
covenants apply to the 2022 Notes:
• We agree that for the period of time during which the 2022 Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section
61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect,
in either case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making additional borrowings,
including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals
at least 150% after such borrowings.
• We agree that for the period of time during which the 2022 Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section
61(a)(1) of the 1940 Act or any successor provisions and (ii) the exception set forth below, despite the fact that we are not currently subject to such
provisions of the 1940 Act, except that we are permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in
Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, but only up to such amount as is necessary in order for us to maintain our status
as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986 and, provided that, any such prohibition will not apply
until such time as our asset coverage has been below the minimum asset coverage required pursuant to clause (i) above for more than six consecutive
months. If Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act were currently applicable to us in connection with this offering, these
provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such
capital stock if our asset coverage, as defined in the 1940 Act, were below 150% at the time of the declaration of the dividend or distribution or the
purchase and after deducting the amount of such dividend, distribution or purchase.
•
If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Exchange Act, to file any periodic reports with the
SEC, we agree to furnish to the Noteholders and the Trustee, for the period of time during which the 2022 Notes are outstanding, our audited annual
consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of
our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements are prepared, in all material respects, in accordance with
applicable United States generally accepted accounting principles.
Indenture Provisions — Ranking
The 2022 Notes are designated as Senior Securities and, therefore, Senior Indebtedness under the Indenture. Senior Indebtedness is defined in the Indenture as
the principal of (and premium, if any) and unpaid interest on:
•
our indebtedness (including indebtedness of others guaranteed by us), whenever created, incurred, assumed or guaranteed, for money borrowed, that
we have designated as “Senior Indebtedness” for purposes of the Indenture and in accordance with the terms of the Indenture (including any
indenture securities designated as Senior Indebtedness), and
•
renewals, extensions, modifications and refinancings of any of this indebtedness.
The 2022 Notes are not secured by any assets of the Company. As unsecured obligations of the Company designated as Senior Indebtedness under the
Indenture, the 2022 Notes rank
•
•
•
pari passu, or equal, with our future senior unsecured indebtedness;
senior to any of our future indebtedness that expressly provides it is subordinated to the 2022 Notes;
effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we
subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our
$220.0 million senior secured revolving credit facility, or the Credit Facility, of which $161.6 million was outstanding as of December 31, 2019; and
•
structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries.
In particular, as designated Senior Indebtedness under the Indenture, the 2022 Notes will rank senior to any future securities we issue under the Indenture that
are designated as subordinated debt securities. Any such Indenture securities designated as subordinated debt securities will be subordinated in right of
payment of the principal of (and premium if any) and interest, if any, on such subordinated debt securities to the prior payment in full of the 2022 Notes, and
all other Senior Indebtedness under the Indenture, upon any distribution of our assets upon our dissolution, winding up, liquidation or reorganization. In
addition, no payment on account of principal (or premium, if any), sinking fund or interest, if any, may be made on such subordinated debt securities at any
time unless full payment of all amounts due in respect of the principal (and premium, if any), sinking fund and interest on the 2022 Notes, and all other Senior
Indebtedness, has been made or duly provided for in money or money’s worth.
In the event that, notwithstanding the foregoing, any payment by us is received by the trustee in respect of subordinated debt securities or by the holders of
any of such subordinated debt securities, upon our dissolution, winding up, liquidation or reorganization before the 2022 Notes, and all other Senior
Indebtedness, are paid in full, the payment or distribution must be paid over to the holders of our Senior Indebtedness, including the 2022 Notes, or on their
behalf for application to the payment of all Senior Indebtedness, including the 2022 Notes, remaining unpaid until all Senior Indebtedness, including the 2022
Notes, have been paid in full, after giving effect to any concurrent payment or distribution to the holders of our Senior Indebtedness, including the 2022
Notes. Subject to the payment in full of the all Senior Indebtedness, including the 2022 Notes, upon this distribution by us, the holders of such subordinated
debt securities will be subrogated to the rights of the holders of our Senior Indebtedness, including the 2022 Notes, to the extent of payments made to the
holders of our Senior Indebtedness, including the 2022 Notes, out of the distributive share of such subordinated debt securities.
By reason of this subordination, in the event of a distribution of our assets upon our insolvency, our Senior Indebtedness, including the 2022 Notes, and
certain of our senior creditors, may recover more, ratably, than holders of any subordinated debt securities or the holders of any indenture securities that are
not Senior Indebtedness. The Indenture provides that these subordination provisions will not apply to money and securities held in trust under the defeasance
provisions of the Indenture.
The Trustee under the Indenture
U.S. Bank National Association serves as the trustee under the Indenture.
INCREASE AGREEMENT
Exhibit 10.12
THIS INCREASE AGREEMENT dated as of December 27, 2019 (this “Agreement”), is among STELLUS CAPITAL INVESTMENT
CORPORATION, a Maryland corporation (the “Borrower”), the LENDERS party hereto, and ZIONS BANCORPORATION, N.A. dba AMEGY BANK,
as Administrative Agent. Capitalized terms used herein and not otherwise defined shall have the meanings given to such terms in Article I of this
Agreement.
W I T N E S S E T H:
WHEREAS, the Borrower, the Lenders and the Administrative Agent are parties to that certain Senior Secured Revolving Credit Agreement,
dated as of October 10, 2017 (as amended by that certain First Amendment to Senior Secured Revolving Credit Agreement and Commitment Increase
dated as of August 2, 2018, that certain Second Amendment to Senior Secured Revolving Credit Agreement and Commitment Increase dated as of
September 13, 2019, and as the same may be further amended, supplemented, amended and restated or otherwise modified from time to time, the “Credit
Agreement”);
WHEREAS, the Borrower requests that the total Commitments be increased from $200,000,000 to $220,000,000; and
WHEREAS, each Increasing Lender named in Article III hereof is willing on the terms and subject to the conditions hereinafter set forth, to
increase their respective Commitment, subject to the terms and conditions of this Agreement.
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 Agreement shall have the following meanings (such meanings to be
equally applicable to the singular and plural forms thereof):
“Agreement” is defined in the preamble.
“Borrower” is defined in the preamble.
“Credit Agreement” is defined in the first recital.
“Effective Date” is defined in Article V.
Section 1.2 Other Definitions. Capitalized terms used in this Agreement but not defined herein, shall have the meanings given such terms in the
Credit Agreement.
ARTICLE II
COMMITMENT INCREASE REQUEST
On or before December 19, 2019, the Borrower irrevocably requested that the Commitments be increased from $200,000,000 to $220,000,000 in
the aggregate (the “Commitment Increase”) pursuant to Section 2.08(e) of the Credit Agreement.
ARTICLE III
AGREEMENT TO INCREASE COMMITMENTS
Subject to the occurrence of the Effective Date (as hereinafter defined), the Commitments are increased on the Effective Date as follows:
Section 3.1 Increasing Lenders. Zions Bancorporation, N.A. dba Amegy Bank hereby agrees to increase its Dollar Commitment from
$30,000,000 to $35,000,000. Hancock Whitney Bank hereby agrees to increase its Dollar Commitment from $20,000,000 to $30,000,000. Frost Bank
hereby agrees to increase its Dollar Commitment from $30,000,000 to $35,000,000. The foregoing Lenders in this Section 4.1 are referred to herein
collectively, as “Increasing Lenders.”
Section 3.2 Commitment Increase. On the Effective Date, adjustments of Borrowings will be made in accordance with Section 2.08(e)(iv) of
the Credit Agreement that will result in, after giving effect to all such deemed prepayments and borrowings, such Loans and participations in Letters of
Credit, Swingline Loans and Multicurrency Loans being held by the Lenders ratably in accordance with their Commitments, after giving effect to the
Commitment Increase herein, as described on Schedule 1.01(b) attached hereto.
ARTICLE IV
BORROWER COMMITMENT INCREASE CERTIFICATIONS
Pursuant to Section 2.08(e)(i) of the Credit Agreement, the Borrower hereby certifies as of the date hereof that:
Section 4.1 No Default. No Default or Event of Default has occurred and is continuing.
Section 4.2 Representations and Warranties. The representations and warranties contained in the Credit Agreement are be true and correct in
all material respects (or, in the case of any portion of the representations and warranties already subject to a materiality qualifier, true and correct in all
respects) on and as of the date hereof as if made on and as of the date hereof (or, if any such representation or warranty is expressly stated to have been
made as of a specific date, as of such specific date).
Section 5.1 Effective Date. This Agreement shall become effective on the date (the “Effective Date”) when the Administrative Agent shall have
received:
ARTICLE V
CONDITIONS TO EFFECTIVENESS
(a)
(b)
(c)
(d)
(e)
(f)
counterparts of this Agreement duly executed and delivered on behalf of the Borrower and each of the Increasing Lenders,
together with the Subsidiary Guarantors’ Consent and Agreement executed by each Subsidiary Guarantor;
a replacement Revolving Credit Note in the maximum principal amount of $35,000,000 executed by Borrower and made payable
to Zions Bancorporation, N.A. dba Amegy Bank;
a replacement Revolving Credit Note in the maximum principal amount of $35,000,000 executed by Borrower and made payable
to Frost Bank;
a replacement Revolving Credit Note in the maximum principal amount of $30,000,000 executed by Borrower and made payable
to Hancock Whitney Bank;
a certificate of a duly authorized officer of the Borrower stating that each of the applicable conditions set forth in Section 2.8(e)(i)
of the Credit Agreement have been satisfied; and
payment by the Borrower of all fees payable pursuant to the Increase Agreement Fee Letter dated as of the date hereof between
the Borrower and Amegy Bank.
2
ARTICLE VI
MISCELLANEOUS
Section 6.1 Representations. The Borrower hereby represents and warrants that (i) this Agreement constitutes a legal, valid and binding obligation
of it, enforceable against it in accordance with its terms, (ii) upon the effectiveness of this Agreement, 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 specific date, 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 specific date).
Section 6.2 Cross-References. References in this Agreement to any Article or Section are, unless otherwise specified, to such Article or
Section of this Agreement.
Section 6.3 Loan Document Pursuant to Credit Agreement. This Agreement 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 6.4 Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and
their respective successors and assigns.
Section 6.5 Counterparts. This Agreement 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 Agreement by telecopy electronically (e.g. pdf) shall be effective as delivery of a manually executed counterpart of this Agreement.
Section 6.6 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York.
Section 6.7 Full Force and Effect. 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. Upon and after the execution of this Agreement 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 modified hereby.
[Signatures on Following Pages.]
3
IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement 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 INCREASE AGREEMENT – STELLUS
LENDERS:
ZIONS BANCORPORATION, N.A. DBA AMEGY BANK
as Administrative Agent, Swingline Lender,
Issuing Bank and as a Lender
By:
/s/ Lauren Page
Lauren Page
Vice President
SIGNATURE PAGE TO INCREASE AGREEMENT – STELLUS
FROST BANK, as a Lender
/s/ Jake Fitzpatrick
By:
Name: Jake Fitzpatrick
Title: Vice President
SIGNATURE PAGE TO INCREASE AGREEMENT – STELLUS
HANCOCK WHITNEY BANK, as a Lender
/s/ Eric Luttrell
By:
Name: Eric Luttrell
Title:
Senior Vice President
SIGNATURE PAGE TO INCREASE AGREEMENT – STELLUS
SUBSIDIARY GUARANTORS’ CONSENT AND AGREEMENT TO INCREASE AGREEMENT
As an inducement to Administrative Agent and Lenders party thereto to execute, and in consideration of Administrative Agent’s and such Lenders’
execution of, the Increase Agreement dated as of December 27, 2019 (the “Agreement”) (capitalized terms used herein and not otherwise defined shall have
the meanings given to such terms in Article I of the Agreement), among Stellus Capital Investment Corporation, a Maryland corporation, the Lenders party
thereto, and Zions Bancorporation, N.A. dba Amegy Bank, as Administrative Agent, each of the undersigned Subsidiary Guarantors hereby consents to the
Agreement, and agrees that the Agreement shall in no way release, diminish, impair, reduce or otherwise adversely affect the obligations and liabilities of the
undersigned under any Guarantee and Security Agreement executed by the undersigned in connection with the Credit Agreement, or under any Loan
Documents, agreements, documents or instruments executed by the undersigned to create liens, security interests or charges to secure any of the Guaranteed
Obligations (as defined in the Guarantee and Security Agreement), all of which are in full force and effect. Each of the undersigned further represents and
warrants to Administrative Agent and the Lenders that, after giving effect to the Agreement, (a) the representations and warranties in each Loan Document to
which the undersigned is a party are true and correct in all material respects (or, in the case of any portion of the representations and warranties already
subject to a materiality qualifier, true and correct in all respects) on and as of the date of the Agreement as if made on and as of the date of the Agreement (or,
if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date), and (b) no Default or Event of
Default has occurred and is continuing. Each undersigned Subsidiary Guarantor agrees to be bound by the terms, conditions, covenants and agreements in the
Agreement. This Consent and Agreement is executed as of the date of the Agreement and shall be binding upon each of the undersigned, and their respective
successors and assigns, and shall inure to the benefit of Administrative Agent, Lenders, and their successors and assigns.
[Signatures on Following Pages.]
SUBSIDIARY GUARANTORS:
SCIC – ERC BLOCKER 1, INC.,
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – SKP BLOCKER 1, INC.,
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – APE BLOCKER 1, INC.,
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – CONSOLIDATED BLOCKER, INC.
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – INVINCIBLE BLOCKER 1, INC.
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – CC BLOCKER 1, INC.,
a Delaware corporationt
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – HOLLANDER BLOCKER 1, INC.,
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – ICD BLOCKER 1, INC.
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCIC – FBO BLOCKER 1, INC.
a Delaware corporation
By:/s/ W. Todd Huskinson
Name: W. Todd Huskinson
Title: Authorized Signatory
SCHEDULE 1.01(b)
Commitments
Lender
Total Commitment
Applicable Percentage
Zions Bancorporation, N.A. dba Amegy Bank (Administrative Agent)
Frost Bank (Documentation Agent)
Cadence Bank, N.A. (Co-Syndication Agent)
Hancock Whitney Bank (Co-Syndication Agent)
City National Bank
CommunityBank of Texas, N.A.
Woodforest National Bank
Stifel Bank and Trust
Texas Capital Bank, National Association
$35,000,000
$35,000,000
$30,000,000
$30,000,000
$25,000,000
$20,000,000
$20,000,000
$15,000,000
$10,000,000
USD $220,000,000.00
15.9090909091%
15.9090909091%
13.6363636364%
13.6363636364%
11.3636363636%
9.0909090909%
9.0909090909%
6.8181818182%
4.5454545454%
100.0000000000%
SCHEDULE 1.01(B) TO INCREASE A GREEMENT – STELLUS
Exhibit 31.1
I, Robert T. Ladd, Chief Executive Officer of Stellus Capital Investment Corporation certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Stellus Capital Investment Corporation;
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;
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;
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 internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a)
(b)
(c)
(d)
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;
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;
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;
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 2 day of March 2020.
nd
By:
/s/ Robert T. Ladd
Robert T. Ladd
Chief Executive Officer
150
Exhibit 31.2
I, W. Todd Huskinson, Chief Financial Officer of Stellus Capital Investment Corporation certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Stellus Capital Investment Corporation;
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;
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;
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)
(b)
(c)
(d)
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;
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;
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
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 2 day of March 2020.
nd
By:
/s/ W. Todd Huskinson
W. Todd Huskinson
Chief Financial Officer
151
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 Annual Report on Form 10-K (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)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as amended; and
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:
Date:
Robert T. Ladd
March 2, 2020
152
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 Annual Report on Form 10-K (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)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as amended; and
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:
Date:
W. Todd Huskinson
March 2, 2020
153