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EX-31.1 - EX-31.1 - NexPoint Capital, Inc.d625878dex311.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

COMMISSION FILE NUMBER: 814-01074

 

 

NexPoint Capital, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware     38-3926499

(State or other jurisdiction of

incorporation or organization)

   

(I.R.S. Employer

Identification No.)

300 Crescent Court, Suite 700

Dallas, Texas

   

75201

(Address of principal executive offices)    

(Zip Code)

Registrant’s telephone number, including area code (972) 628-4100

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.001 per share

 

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☐    No  ☐

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  

Emerging growth company

   Yes  ☒    No  

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of September 30, 2018, the Registrant had 10,416,708 shares of common stock, $0.001 par value, outstanding.

 

 

 


NexPoint Capital, Inc.

Statements of Assets and Liabilities

 

     September 30,
2018
(Unaudited)
     December 31,
2017
 

Assets

 

Unaffiliated investments, at fair value (cost of $98,243,034 and $92,014,872, respectively)

   $ 103,411,648      $ 93,985,519  

Affiliated investments, at fair value (cost of $4,922,705 and $14,154, respectively)(1)

     2,674,216        16,793  

Cash and cash equivalents

     7,104,691        11,044,982  

Due from counterparty(2)

     18,800,000        13,820,000  

Receivable for investments sold

     1,575,000        2,768,395  

Receivable for common stock sold

     —          5,635  

Receivable due on total return swaps(2)

     417,969        183,515  

Dividends and interest receivable

     1,528,628        1,262,162  

Prepaid expenses

     33,175        90,548  

Capitalized offering costs

     31,461        128,830  
  

 

 

    

 

 

 

Total assets

     135,576,788        123,306,379  
  

 

 

    

 

 

 

Liabilities

 

Credit facility and notes payable(3)

     24,048,974        24,400,000  

Payable for investments purchased

     7,548,036        1,953,152  

Unrealized depreciation on total return swap(2)

     399,188        563,823  

Common stock repurchased

     709,962        103,004  

Payable to Adviser(4)

     607,220        296,092  

Incentive fee payable

     1,287,098        594,306  

Interest expense and commitment fees payable

     7,421        52,856  

Accrued expenses and other liabilities

     443,184        483,189  
  

 

 

    

 

 

 

Total liabilities

     35,051,083        28,446,422  
  

 

 

    

 

 

 

Commitments and contingencies(5)

 

Net assets

 

Preferred stock, $0.001 par value (25,000,000 shares authorized, 0 shares issued and outstanding)

     —          —    

Common stock, $0.001 par value (200,000,000 shares authorized, 10,416,708 and 9,804,321 shares issued and outstanding, respectively)

     10,417        9,804  

Paid-in capital in excess of par

     93,694,541        87,656,780  

Total distributable earnings (loss)

     6,820,747        7,193,373  
  

 

 

    

 

 

 

Total net assets

   $ 100,525,705      $ 94,859,957  
  

 

 

    

 

 

 

Net asset value per share of common stock

   $ 9.65      $ 9.68  
  

 

 

    

 

 

 

 

(1) 

See Note 10 for a discussion of affiliated investments.

(2) 

See Note 7 for a discussion of total return swaps.

(3) 

See Note 7 for a discussion of credit facility.

(4) 

See Note 4 for a discussion of related party transactions and arrangements.

(5) 

See Note 4 and Note 8 for a discussion of the commitments and contingencies of the Company (as defined in Note 1).

See Notes to Financial Statements

 

1


NexPoint Capital, Inc.

Statements of Operations

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2018     2017     2018     2017  

Investment income:

 

Interest

   $ 1,524,419     $ 1,339,035     $ 4,901,607     $ 5,648,677  

Interest paid in kind

     136,910       90,900       375,158       182,695  

Dividend income from unaffiliated investments

     141,782       140,991       465,649       322,131  

Dividend income from affiliated investments(1)

     39,047       398       56,895       551  

Other fee income

     656       173       10,586       8,337  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     1,842,814       1,571,497       5,809,895       6,162,391  
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

 

Investment advisory fees(2)

     527,229       305,288       1,554,540       1,106,346  

Capital gains incentive fees(2)

     95,788       (315,928     692,793       (111,488

Interest expense and commitment fees(3)

     161,124       —         517,747       50,379  

Administration fees(2)

     103,982       69,308       309,444       229,520  

Stock transfer fee

     121,303       136,158       270,437       305,530  

Custodian and accounting service fees

     80,037       79,982       236,201       234,276  

Audit and tax fees

     53,666       58,382       163,919       161,527  

Amortized offering costs

     38,986       91,937       158,831       308,713  

Legal fees

     45,263       46,772       133,447       127,296  

Reports to stockholders

     17,114       —         40,576       95,887  

Directors’ fees(2)

     5,498       4,526       14,844       11,129  

Other expenses

     44,909       28,885       123,958       90,315  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     1,294,899       505,310       4,216,737       2,609,430  

Expenses waived or reimbursed by the Adviser(2)

     (23,992     (311,621     (148,341     (1,675,809
  

 

 

   

 

 

   

 

 

   

 

 

 

Net expenses

     1,270,907       193,689       4,068,396       933,621  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     571,907       1,377,808       1,741,499       5,228,770  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gains (losses) on investments:

 

Net realized gain/(loss) on:

 

Unaffiliated investments and securities sold short

     203,932       141,187       1,602,192       (272,623

Affiliated investments(1)

     —         —         —         —    

Total return swaps(4)

     481,877       (524,777     750,299       (524,777

Net change in unrealized appreciation (depreciation) on:

 

Unaffiliated investments and securities sold short

     80,016       (775,493     3,197,967       872,237  

Affiliated investments(1)

     63,713       843       (2,251,128     1,151  

Total return swaps(4)

     (350,600     (421,401     164,635       (633,427
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gains (losses)

     478,938       (1,579,641     3,463,965       (557,439
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

     1,050,845       (201,833     5,205,464       4,671,331  

Per share information - basic and diluted per common share

 

Net investment income:

   $ 0.05     $ 0.15     $ 0.17     $ 0.63  

Earnings per share:

   $ 0.10     $ (0.02   $ 0.50     $ 0.56  

Weighted average shares outstanding:

     10,408,226       8,966,250       10,332,534       8,287,409  

Distributions declared per share:

   $ 0.18     $ 0.18     $ 0.54     $ 0.54  

 

(1) 

See Note 10 for a discussion of affiliated investments.

(2) 

See Note 4 for a discussion of related party transactions and arrangements.

(3) 

See Note 7 for a discussion of credit facility.

(4) 

See Note 7 for a discussion of total return swaps.

See Notes to Financial Statements

 

2


NexPoint Capital, Inc.

Statements of Changes in Net Assets

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2018     2017  

Increase (decrease) in net assets resulting from operations:

 

Net investment income

   $ 1,741,499     $ 5,228,770  

Net realized gain (loss) on investments and securities sold short

     1,602,192       (272,623

Net realized gain (loss) on total return swaps(1)

     750,299       (524,777

Net change in unrealized appreciation (depreciation) on investments and securities sold short

     946,839       873,388  

Net change in unrealized appreciation (depreciation) on total return swaps(1)

     164,635       (633,427
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

     5,205,464       4,671,331  
  

 

 

   

 

 

 

Distributions to stockholders:

 

Total distributions to stockholders(2)

     (5,578,090     (4,470,423
  

 

 

   

 

 

 

Capital share transactions:

 

Issuance of common stock

     5,315,483       18,195,548  

Issuance of common shares pursuant to distribution reinvestment plan

     3,580,636       2,959,396  

Repurchase of common stock

     (2,857,745     (1,138,801
  

 

 

   

 

 

 

Net increase in net assets resulting from capital transactions

     6,038,374       20,016,143  
  

 

 

   

 

 

 

Total increase in net assets

     5,665,748       20,217,051  

Net assets at beginning of period

     94,859,957       67,292,954  
  

 

 

   

 

 

 

Net assets at end of period

   $ 100,525,705     $ 87,510,005  
  

 

 

   

 

 

 

Changes in common shares

 

Issuance of common stock

     538,995       1,870,378  

Reinvestment of common stock

     367,362       303,769  

Repurchase of common stock

     (293,970     (119,618
  

 

 

   

 

 

 

Net increase in common shares

     612,387       2,054,529  
  

 

 

   

 

 

 

 

(1) 

See Note 7 for a discussion of total return swaps.

(2) 

Per the Securities Exchange Commission release #33-10532 “Disclosure Update and Simplification”; it is no longer required to differentiate distributions from earnings as either from net investment income or net realized capital gains. The presentation for the nine months ended 9/30/2017 has been adjusted for this change.

See Notes to Financial Statements

 

3


NexPoint Capital, Inc.

Statements of Cash Flows

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2018     2017  

Cash flows used in operating activities

 

Net increase in net assets resulting from operations

   $ 5,205,464     $ 4,671,331  

Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities:

    

Purchases of investment securities

     (59,898,327     (62,241,424

Payment-in-kind investments

     (375,158     (182,695

Proceeds from sales and principal repayments of investment securities

     51,413,124       72,746,045  

Net realized (gain) loss on investments

     (1,602,192     272,623  

Net change in unrealized (appreciation) depreciation on investments

     (946,839     (873,388

Net change in unrealized depreciation on total return swaps

     (164,635     633,427  

Amortization of premium/discount, net

     (674,160     (1,406,731

Amortization of capitalized offering costs

     158,831       308,713  

Increase (decrease) in operating assets and liabilities:

    

(Increase) decrease in receivable for investments sold

     1,193,395       —    

(Increase) decrease in dividends and interest receivable

     (266,466     (665,512

(Increase) decrease in receivable from Adviser

     —         4,096,447  

(Increase) decrease in prepaid expenses

     57,373       (104,053

(Increase) decrease in due from counterparty

     (4,980,000     (13,120,000

(Increase) decrease in receivable due on total return swap

     (234,454     —    

Increase (decrease) in payable for investments purchased

     5,594,884       (6,546,043

Increase (decrease) in payable to Adviser

     311,128       20,092  

Increase (decrease) in incentive fees payable

     692,792       —    

Increase (decrease) in interest expense and commitment fees payable

     (45,435     (21,583

Increase (decrease) in accrued expenses and other liabilities

     (40,005     42,175  

Increase (decrease) in payable due on total return swap

     —         719,171  
  

 

 

   

 

 

 

Net cash flow (used in) operating activities

     (4,600,680     (1,651,405
  

 

 

   

 

 

 

Cash flows provided by financing activities

 

Proceeds from issuance of common stock, net of receivable for common stock sold

     5,321,118       18,248,053  

Repurchase of common stock, net of payable

     (2,250,787     (828,352

Distributions paid in cash

     (1,997,454     (1,511,027

Offering costs paid, net of due to Adviser

     (61,462     (213,880

Net increase (decrease) in credit facilities and notes payable

     (351,026     (11,200,000
  

 

 

   

 

 

 

Net cash flow provided by financing activities

     660,389       4,494,794  
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (3,940,291     2,843,389  

Cash and cash equivalents

 

Beginning of the period

     11,044,982       3,948,113  
  

 

 

   

 

 

 

End of the period

   $ 7,104,691     $ 6,791,502  
  

 

 

   

 

 

 

Supplemental disclosure and non-cash financing activities

 

Paid-in-kind interest income

   $ 375,158     $ 182,695  

Cash paid during the period for interest

   $ 563,182     $ 54,473  

Reinvestment of distributions paid

   $ 3,580,636     $ 2,959,396  

Local and excise taxes paid

   $ 168,836     $ 124,672  

See Notes to Financial Statements

 

4


NexPoint Capital, Inc.

Schedule of Investments

As of September 30, 2018

(Unaudited)

 

Portfolio Company(1)(2)

   Interest
Rate
    Base Rate
Floor
     Maturity
Date
     Principal
Amount
     Amortized
Cost(3)
     Fair Value  

Senior Secured Loans – 17.8%(4)

                

Energy – 2.4%

                

Fieldwood Energy, LLC (Second Lien Term Loan)(5)

     L + 725       1.00%        4/11/2023      $ 567,797      $ 548,782      $ 552,892  

Fieldwood Energy LLC (First Lien Term Loan)(5)

     L + 525       1.00%        4/11/2022        1,800,549        1,795,312        1,815,404  
                

 

 

 
                   2,368,296  
                

 

 

 

Healthcare – 9.9%

                

Auris Luxembourg III S.a.r.l. (First Lien Term Loan)(6) (7) (8)

     L + 375       0.00%        7/24/2025        2,586,207        2,573,276        2,621,780  

Envision Healthcare Corp. (First Lien Term Loan)(6) (7) (8)

     L + 375       0.00%        9/28/2025        3,000,000        2,992,500        2,992,500  

U.S. Renal Care, Inc. (Second Lien Term Loan)(7)

     L + 800       1.00%        12/29/2023        4,500,000        4,433,624        4,331,250  
                

 

 

 
                   9,945,530  
                

 

 

 

Media/Telecommunications – 3.7%

                

iHeartCommunications, Inc. (First Lien Term Loan)(9)

             5,000,000        4,051,750        3,769,150  
                

 

 

 

Retail – 1.3%

                

Toys ‘R’ Us-Delaware, Inc. (First Lien Term Loan)(9)

             2,446,815        1,590,430        1,293,754  
                

 

 

 

Telecommunication Services – 0.5%

                

TerreStar Corp. (First Lien Term Loan)(10) (11)

     11% PIK          2/27/2020        504,000        504,000        503,496  
                

 

 

 

Utility – 0.0%

                

Texas Competitive Electric Holdings Company LLC (TXU) (Escrow Loan)(12)

             3,500,000        87,816        7,000  
                

 

 

 

Total Senior Secured Loans

                   17,887,226  
                

 

 

 

Unsecured Loans – 3.7%

                

Materials – 3.7%

                

OmniMax International, Inc.(10) (11)

    
14% PIK, 2%
Cash
 
 
       2/6/2021        3,708,668        3,282,820        3,671,582  

Total Unsecured Loans

                   3,671,582  
                

 

 

 

Asset-Backed Securities – 1.3%

                

Financials – 1.3%

                

Grayson Investor Corp.(8) (13) (14) (15)

          11/1/2021        800        456,000        329,800  

Highland Park CDO I Ltd. 2006 1A A2(7) (8) (13) (15)

     L + 40          11/25/2051        877,343        727,765        833,476  

PAMCO CLO 1997-1A B(9) (8) (10) (11) (13) (15)

             374,239        215,187        143,146  
                

 

 

 
                   1,306,422  
                

 

 

 

Total Asset-Backed Securities

                   1,306,422  
                

 

 

 
                         Shares                

Closed-End Mutual Funds – 1.4%

                

Financials – 1.4%

                

NexPoint Strategic Opportunities Fund(8) (16) (17)

             65,078        1,444,020        1,457,747  
                

 

 

 

Total Closed-End Mutual Funds

                   1,457,747  
                

 

 

 

Portfolio Company(1)(2)

   Interest
Rate
    Base Rate
Floor
     Maturity
Date
     Principal
Amount
     Amortized
Cost(3)
     Fair Value  

Corporate Bonds – 54.3%(17)

                

Financials – 7.0%

                

ASP AMC Merger Sub, Inc.(13) (17)

     8.000        5/15/2025        7,325,000        6,886,134        5,603,625  

Freedom Mortgage Corp.(13) (17)

     8.250        4/15/2025        1,500,000        1,500,000        1,462,500  
                

 

 

 
                   7,066,125  
                

 

 

 

Healthcare – 47.3%

                

DJO Finance LLC / DJO Finance Corp.(13) (17)

     8.125        6/15/2021        6,500,000        6,249,519        6,670,625  

Endo Finance LLC / Endo Finco Inc.(13) (17)

     6.000        7/15/2023        7,500,000        6,452,982        6,693,750  

Ortho-Clinical Diagnostics(13) (17)

     6.625        5/15/2022        9,217,000        8,775,508        9,051,094  

 

 

See Notes to Financial Statements.

 

5


NexPoint Capital, Inc.

Schedule of Investments (continued)

As of September 30, 2018

(Unaudited)

 

Quorum Health Corp.(13) (17)

     11.625        4/15/2023      $ 3,459,000      $ 3,166,463      $ 3,476,295  

Surgery Center Holdings(8) (13) (17)

     6.750        7/1/2025        10,858,000        10,198,352        10,450,825  

Tenet Healthcare Corp.(8) (17)

     8.125        4/1/2022        1,000,000        976,651        1,057,550  

Valeant Pharmaceuticals International, Inc.(8) (13) (17)

     5.875        5/15/2023        4,000,000        3,459,027        3,915,000  

Valeant Pharmaceuticals International, Inc.(8) (13) (17)

     6.125        4/15/2025        6,500,000        5,699,832        6,191,250  
                

 

 

 
                   47,506,389  
                

 

 

 

Total Corporate Bonds

                   54,572,514  
                

 

 

 
                         Shares                

Common Stocks – 26.0%

                

Chemicals – 0.3%

                

MPM Holdings, Inc.(8) (17) (18)

             8,500        250,750        261,460  
                

 

 

 

Energy – 6.2%

                

Enterprise Products Partners L.P.(8) (17)

             170,000        4,144,041        4,884,100  

Energy Transfer Equity L.P.(8) (17)

             75,000        1,438,740        1,307,250  
                

 

 

 
                   6,191,350  
                

 

 

 

Healthcare – 6.6%

                

Acadia Healthcare Co., Inc.(8) (17) (18)

             24,900        981,583        876,480  

Amarin Corp. Plc(6) (8) (17) (18)

             140,000        1,982,260        2,277,800  

Heron Therapeutics, Inc.(8) (17) (18)

             19,232        500,032        608,693  

Nevro Corp.(8) (17) (18)

             8,000        500,402        456,000  

Quorum Health Corp.(17) (18)

             408,514        2,184,094        2,393,892  

SteadyMed Ltd.(8) (10) (11) (18)

             54,749        14,508        14,509  
                

 

 

 
                   6,627,374  
                

 

 

 

Materials – 1.7%

                

OmniMax International, Inc.(10) (11) (18)

             6,698        663,115        1,681,568  
                

 

 

 

Media/Telecommunications – 1.2%

                

Gambier Bay, LLC(10) (11) (16) (18)

             9,180,900        3,478,685        1,216,469  
                

 

 

 

Real Estate Investment Trust (REIT) – 2.6%

                

Independence Realty Trust, Inc.(8) (17)

             246,727        2,216,203        2,598,035  
                

 

 

 

Telecommunication Services – 4.6%

                

TerreStar Corp.(10) (11) (18)

             14,035        1,599,990        4,682,357  
                

 

 

 

Utility – 2.8%

                

Vistra Energy Corp.(17) (18)

             115,000        1,776,757        2,861,200  
                

 

 

 

Total Common Stocks

                   26,119,813  
                

 

 

 
     Preferred
Dividend
Rate
                                   

Preferred Stocks – 0.8%

                

Real Estate Investment Trust (REIT) – 0.8%

                

RAIT Financial Trust(17) (19)

     8.875           148,057        3,215,965        821,716  
                

 

 

 

Total Preferred Stocks

                   821,716  
                

 

 

 

Rights – 0.0%

                

Utility – 0.0%

                

Texas Competitive Electric Holdings Company, LLC (TXU)(18)

             58,356        150,864        45,430  
                

 

 

 

Total Rights

                   45,430  
                

 

 

 

Warrants – 0.2%

                

Healthcare – 0.1%

                

Galena Biopharma, Inc.(11) (18)

          1/12/2021        1,500,054        —          —    

Gemphire Therapeutics, Inc.(11) (18)

          3/15/2022        118,796        —          88,594  

SCYNEXIS, Inc.(11) (18)

          6/21/2021        195,000        —          62,770  
                

 

 

 
                   151,364  
                

 

 

 

Materials – 0.1%

                

OmniMax International, Inc.(10) (11) (18)

          8/6/2025        207        —          52,050  
                

 

 

 

Total Warrants

                   203,414  
                

 

 

 

Total Investments- 105.5%

              $ 103,165,739      $ 106,085,864  
             

 

 

    

 

 

 

Cash Equivalents –6.9%(20)

                 $ 6,959,715  

Other Assets & Liabilities, net- (12.4%)

 

   $ (12,519,874
                

 

 

 

Net Assets- 100.0%

 

   $ 100,525,705  
                

 

 

 

 

 

See Notes to Financial Statements.

 

6


NexPoint Capital, Inc.

Schedule of Investments (continued)

As of September 30, 2018

(Unaudited)

 

                                 Notional
Amount(21)
     Unrealized
Depreciation
 

Total Return Swap – (0.4%)

 

BNP Paribas TRS Facility (Note 7)

               $ 55,081,345      $ (399,188
              

 

 

    

 

 

 

 

(1) 

Unless otherwise noted, the Company did not “control” and was not an “affiliated person” of any of its portfolio companies, each as defined in the Investment Company Act of 1940, as amended (the “1940 Act”). In general, under the 1940 Act, the Company would be presumed to “control” a portfolio company if it owned 25% or more of its voting securities or had the power to exercise control over the management or policies of such portfolio company, and would be an “affiliated person” of a portfolio company if it owned 5% or more of its voting securities. Additionally, companies under common control (e.g., companies with a common owner of greater than 25% of their respective voting securities) are affiliates under the 1940 Act.

(2) 

All investments are denominated in United States Dollars.

(3) 

Amortized cost represents the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on investments.

(4) 

Senior secured loans in which the Company invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a spread (unless otherwise identified, all senior secured loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the coupon rate. Rate shown represents the actual rate at September 30, 2018. Senior secured loans, while exempt from registration under the Securities Act of 1933 (the “1933 Act”), contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity may be substantially less than the stated maturity shown.

(5) 

The interest rate on these investments is subject to a base rate of 1-Month LIBOR, which at September 30, 2018 was 2.26%. The LIBOR rate used to calculate interest is the higher of the prevailing 1 month LIBOR rate in effect on the date of the monthly reset, or the LIBOR base rate floor shown.

(6) 

All or a portion of this position has not settled. Full contract rates do not take effect until settlement date.

(7) 

The interest rate on these investments is subject to a base rate of 3-Month LIBOR, which at September 30, 2018 was 2.40%. The LIBOR rate used to calculate interest is the higher of the prevailing 3 month LIBOR rate in effect on the date of the quarterly reset, or the LIBOR base rate floor shown.

(8) 

The investment is not a qualifying asset under Section 55 of the 1940 Act. A business development company, such as the Company, may not acquire any asset other than a qualifying asset, unless at the time the acquisition is made, qualifying assets represent at least 70% of the business development company’s total assets. Non-qualifying assets represented 29.4% of the Company’s total assets as of September 30, 2018.

(9) 

The issuer is in default of its payment obligation, or is in danger of default.

(10) 

Classified as Level 3 within the three-tier fair value hierarchy. Please see Note 2 for an explanation of this hierarchy, as well as a list of unobservable inputs used in the valuation of these instruments.

(11) 

Represents fair value as determined by the Company’s Board of Directors (the “Board”), or its designee in good faith, pursuant to the policies and procedures approved by the Board. The Board considers fair valued securities to be securities for which market quotations are not readily available and these securities may be valued using a combination of observable and unobservable inputs. Securities with a total aggregate value of $12,116,541 or 12.1% of net assets were fair valued under the Company’s valuation procedures as of September 30, 2018.

(12) 

The investment represents value held in escrow pending future events. No interest is being accrued.

(13) 

Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold in transactions exempt from registration to qualified institutional buyers. As of September 30, 2018, these securities amounted to $54,821,386, or 54.5% of net assets.

(14) 

The investment is considered to be the equity tranche of the issuer.

(15) 

Securities of collateralized loan obligations where an affiliate of the Adviser serves as collateral manager.

(16) 

Represents an affiliated issuer. Assets with a total aggregate market value of $2,674,216, or 2.7% of net assets, were affiliated with the Company as of September 30, 2018 (see Note 10).

(17) 

All or part of this security is pledged as collateral for margin/facility borrowings. The market value of the securities pledged as collateral was $68,793,250.

(18) 

Non-income producing security.

(19) 

The issuer has suspended the quarterly dividend for this security.

(20) 

State Street U.S. Government Money Market Fund.

(21) 

Notional value of the underlying securities in the Total Return Swap is calculated by multiplying par by the initial price.

Glossary

 

ADR 

American Depositary Receipt

PIK 

Payment-in-Kind

 

 

See Notes to Financial Statements.

 

7


NexPoint Capital, Inc.

Schedule of Investments

As of December 31, 2017

 

Portfolio Company(1)(2)

  Interest
Rate
    Base Rate
Floor
    Maturity
Date
    Principal
Amount
    Amortized
Cost(3)
    Fair Value  

Senior Secured Loans – 20.4%(4)

           

Healthcare – 14.8%

           

BioClinica, Inc. (First Lien Term Loan)(5)

    L + 425       1.00     10/20/2023     $ 992,481     $ 978,415     $ 972,632  

Quorum Health Corporation (First Lien Term Loan)(6) (7)

    L + 675       1.00     4/29/2022       1,953,152       1,950,971       1,977,566  

U.S. Renal Care, Inc. (First Lien Term Loan)(5)

    L + 425       1.00     12/31/2022       3,969,620       3,862,685       3,920,000  

U.S. Renal Care, Inc. (Second Lien Term Loan)(5)

    L + 800       1.00     12/31/2023       4,500,000       4,426,629       4,432,500  

Valeant Pharmaceuticals International, Inc. (First Lien Term Loan)(7) (8)

    L + 350       0.75     4/1/2022       2,663,050       2,704,626       2,704,047  
           

 

 

 
              14,006,745  
           

 

 

 

Retail – 3.8%

           

Toys ‘R’ Us-Delaware, Inc. (First Lien Term Loan)(9)

          2,446,815       1,590,430       1,211,173  

Toys ‘R’ Us-Delaware, Inc. DIP Loan (First Lien Term Loan)(7)

    L + 875       1.00     1/18/2019       2,379,212       2,317,512       2,443,451  
           

 

 

 
              3,654,624  
           

 

 

 

Service – 1.8%

           

Weight Watchers International, Inc. (First Lien Term Loan)(7) (10)

    L + 475       0.75     11/29/2024       1,700,000       1,665,653       1,713,464  
           

 

 

 

Utility – 0.0%

           

Texas Competitive Electric Holdings Company LLC (TXU) (Escrow Loan)(11)

          3,500,000       87,816       9,100  
           

 

 

 

Total Senior Secured Loans

              19,383,933  
           

 

 

 

Unsecured Loans – 3.5%

           

Materials – 3.5%

           

OmniMax International, Inc.(12) (13)

   
14% PIK, 2%
Cash
 
 
      2/6/2021       3,346,263       2,799,878       3,326,186  

Total Unsecured Loans

              3,326,186  
           

 

 

 

Asset-Backed Securities – 2.1%

           

Financials – 2.1%

           

Grayson Investor Corp.(8) (14) (15) (16)

        11/1/2021       800       456,000       326,000  

Highland Park CDO I Ltd. 2006 1A A2(5) (8) (14) (16)

    L + 40         11/25/2051       1,394,442       1,152,909       1,345,636  

PAMCO CLO 1997-1A B(8) (9) (12) (13) (14) (16)

          559,644       321,795       294,541  
           

 

 

 
              1,966,177  
           

 

 

 

Total Asset-Backed Securities

              1,966,177  
           

 

 

 

Closed-End Mutual Funds – 0.0%

           
                      Shares              

Financials – 0.0%

           

NexPoint Credit Strategies Fund(8) (17)

          664       14,154       16,793  
           

 

 

 

Total Closed-End Mutual Funds

              16,793  
           

 

 

 

Portfolio Company(1)(2)

  Interest
Rate
    Base Rate
Floor
    Maturity
Date
    Principal
Amount
    Amortized
Cost(3)
    Fair Value  

Corporate Bonds – 55.4%

 

Financials – 3.5%

           

ASP AMC Merger Sub, Inc.(14)

    8.000       5/15/2025     $ 3,400,000       3,279,556       3,281,000  
           

 

 

 

Healthcare – 48.8%

           

CHS/Community Health Systems, Inc.(8)

    8.000       11/15/2019       6,000,000       5,600,220       5,085,000  

DJO Finance LLC / DJO Finance Corp.(14)

    8.125       6/15/2021       6,500,000       6,190,694       6,110,000  

Endo Finance LLC / Endo Finco Inc.(14)

    6.000       7/15/2023       4,000,000       3,470,061       3,160,000  

Ortho-Clinical Diagnostics(14)

    6.625       5/15/2022       7,717,000       6,932,359       7,794,170  

Quorum Health Corp.

    11.625       4/15/2023       7,459,000       6,406,992       7,319,143  

Surgery Center Holdings(8) (14)

    6.750       7/1/2025       8,358,000       7,771,045       7,940,100  

Tenet Healthcare Corp.(8)

    8.125       4/1/2022       1,000,000       972,538       1,021,250  

Valeant Pharmaceuticals International, Inc.(8) (14)

    5.875       5/15/2023       4,000,000       3,391,404       3,720,000  

See Notes to Financial Statements.

 

8


NexPoint Capital, Inc.

Schedule of Investments (continued)

As of December 31, 2017

 

Portfolio Company(1)(2)

   Interest
Rate
    Base Rate
Floor
     Maturity
Date
     Principal
Amount
     Amortized
Cost(3)
     Fair Value  

Valeant Pharmaceuticals International, Inc.(8) (14)

     6.125        4/15/2025      $ 4,500,000      $ 3,788,231      $ 4,134,375  
                

 

 

 
                   46,284,038  
                

 

 

 

Media/Telecommunications – 0.8%

                

iHeartCommunications, Inc.(9)

             9,180,900        3,478,685        803,329  
                

 

 

 

Telecommunication Services – 2.3%

                

Intelsat Jackson Holdings S.A.(8) (14)

     9.750        7/15/2025        2,254,000        2,263,975        2,175,110  
                

 

 

 

Total Corporate Bonds

                   52,543,477  
                

 

 

 
                         Shares                

Common Stocks – 14.6%

                

Chemicals – 0.2%

                

MPM Holdings, Inc.(8) (18)

             8,500        250,750        170,000  
                

 

 

 

Energy – 4.3%

                

Enterprise Products Partners L.P.

             155,000        3,714,862        4,109,050  
                

 

 

 

Healthcare – 2.6%

                

Quorum Health Corp.(18)

             350,000        1,792,620        2,184,000  

SteadyMed Ltd.(8) (18)

             62,500        372,656        231,250  
                

 

 

 
                                       2,415,250  
                

 

 

 

Materials – 2.7%

                

OmniMax International, Inc.(12) (13) (18)

             6,698        663,116        2,566,191  
                

 

 

 

Real Estate Investment Trust (REIT) – 2.6%

                

Independence Realty Trust, Inc.(8)

             246,727        2,216,203        2,489,476  
                

 

 

 

Utility – 2.2%

                

Vistra Energy Corp.(18)

             115,000        1,776,757        2,106,808  
                

 

 

 

Total Common Stocks

                   13,856,775  
                

 

 

 
     Preferred
Dividend
Rate
                                   

Preferred Stocks – 2.1%

                

Real Estate Investment Trust (REIT) – 2.1%

                

RAIT Financial Trust

     8.875        —          148,057        3,215,965        1,960,275  
                

 

 

 

Total Preferred Stocks

                   1,960,275  
                

 

 

 

Rights – 0.1%

                

Utility – 0.1%

                

Texas Competitive Electric Holdings Company, LLC (TXU)(18)

             58,356        150,864        56,897  
                

 

 

 

Total Rights

                   56,897  
                

 

 

 

Warrants – 0.9%

                

Healthcare – 0.8%

                

Galena Biopharma, Inc.(13) (18)

          1/12/2021        1,500,054        —          18  

Gemphire Therapeutics, Inc.(13) (18)

          3/15/2022        118,796        —          493,218  

Kadmon Holdings, Inc.(13) (18)

          4/13/2018        119,047        —          22,727  

SCYNEXIS, Inc.(13) (18)

          6/21/2021        195,000        —          200,511  

SteadyMed Ltd.(8) (13) (18)

          4/25/2022        62,895        —          95,893  
                

 

 

 
                   812,367  
                

 

 

 

Materials – 0.1%

                

OmniMax International, Inc.(12) (13) (18)

          8/6/2025        207        —          79,432  
                

 

 

 

Total Warrants

                   891,799  
                

 

 

 

Total Investments – 99.1%

              $ 92,029,026      $ 94,002,312  
             

 

 

    

 

 

 

Cash Equivalents – 11.4%(19)

                 $ 10,852,235  
                

 

 

 

Other Assets & Liabilities, net – (10.5%)

                 $ (9,994,590
                

 

 

 

Net Assets – 100.0%

                 $ 94,859,957  
                

 

 

 

See Notes to Financial Statements.

 

9


NexPoint Capital, Inc.

Schedule of Investments (continued)

As of December 31, 2017

 

     Notional
Amount(20)
     Unrealized
Depreciation
 

Total Return Swap – (0.6%)

     

BNP Paribas TRS Facility(16) (Note 7)

   $ 35,960,921      $ (563,823
  

 

 

    

 

 

 

 

(1) 

Unless otherwise noted, the Company did not “control” and was not an “affiliated person” of any of its portfolio companies, each as defined in the Investment Company Act of 1940, as amended (the “1940 Act”). In general, under the 1940 Act, the Company would be presumed to “control” a portfolio company if it owned 25% or more of its voting securities or had the power to exercise control over the management or policies of such portfolio company, and would be an “affiliated person” of a portfolio company if it owned 5% or more of its voting securities. Additionally, companies under common control (e.g., companies with a common owner of greater than 25% of their respective voting securities) are affiliates under the 1940 Act.

(2) 

All investments are denominated in United States Dollars.

(3) 

Amortized cost represents the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on investments.

(4)

Senior secured loans in which the Company invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a spread (unless otherwise identified, all senior secured loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the coupon rate. Rate shown represents the actual rate at December 31, 2017. Senior secured loans, while exempt from registration under the Securities Act of 1933 (the “1933 Act”), contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity may be substantially less than the stated maturity shown.

(5) 

The interest rate on these investments is subject to a base rate of 3-Month LIBOR, which at December 31, 2017 was 1.69%. The LIBOR rate used to calculate interest is the higher of the prevailing 3 month LIBOR rate in effect on the date of the quarterly reset, or the LIBOR base rate floor shown.

(6) 

All or a portion of this position has not settled. Full contract rates do not take effect until settlement date.

(7) 

The interest rate on these investments is subject to a base rate of 1-Month LIBOR, which at December 31, 2017 was 1.56%. The LIBOR rate used to calculate interest is the higher of the prevailing 1 month LIBOR rate in effect on the date of the monthly reset, or the LIBOR base rate floor shown.

(8) 

The investment is not a qualifying asset under Section 55 of the 1940 Act. A business development company, such as the Company, may not acquire any asset other than a qualifying asset, unless at the time the acquisition is made, qualifying assets represent at least 70% of the business development company’s total assets. Non-qualifying assets represented 25.7% of the Company’s total assets as of December 31, 2017.

(9) 

The issuer is in default of its payment obligation, or is in danger of default. In some cases, partial payments are still being paid to the lenders.

(10) 

The Company views Weight Watchers to be included in the Healthcare Industry as defined in the Company’s organizational documents. If this classification were reflected, value and percentage of the healthcare sector under Senior Secured Loans would increase to $15,720,209.

(11) 

The investment represents value held in escrow pending future events. No interest is being accrued.

(12) 

Classified as Level 3 within the three-tier fair value hierarchy. Please see Note 2 for an explanation of this hierarchy, as well as a list of unobservable inputs used in the valuation of these instruments.

(13) 

Represents fair value as determined by the Company’s Board of Directors (the “Board”), or its designee in good faith, pursuant to the policies and procedures approved by the Board. The Board considers fair valued securities to be securities for which market quotations are not readily available and these securities may be valued using a combination of observable and unobservable inputs. Securities with a total aggregate value of $7,078,717, or 7.5% of net assets were fair valued under the Company’s valuation procedures as of December 31, 2017.

(14) 

Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold in transactions exempt from registration to qualified institutional buyers. As of December 31, 2017, these securities amounted to $40,280,932, or 42.5% of net assets.

(15) 

The investment is considered to be the equity tranche of the issuer.

(16) 

Securities of collateralized loan obligations where an affiliate of the Adviser serves as collateral manager.

(17) 

Represents an affiliated issuer. Assets with a total aggregate market value of $16,793, or 0.0% of net assets, were affiliated with the Company as of December 31, 2017 (see Note 10).

(18) 

Non-income producing security.

(19) 

State Street U.S. Government Money Market Fund.

(20) 

Notional value of the underlying securities in the Total Return Swap is calculated by multiplying par by the initial price.

Glossary

 

ADR 

American Depositary Receipt

PIK 

Payment-in-Kind

See Notes to Financial Statements.

 

10


NexPoint Capital, Inc.

Notes to Financial Statements (Unaudited)

Note 1 — Organization

NexPoint Capital, Inc. (the “Company”) is an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). The Company follows the investment company accounting and reporting guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standard Codification Topic 946 Financial Services—Investment Companies. The Company’s investment objective is to generate current income and capital appreciation primarily through investments in middle-market healthcare companies, middle-market companies in non-healthcare sectors, syndicated floating rate debt of large public and nonpublic companies and collateralized loan obligations. The Company has elected to be treated for federal income tax purposes, and intends to qualify annually thereafter, as a regulated investment company (“RIC”), under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

The Company was formed in Delaware on September 30, 2013 and formally commenced operations on September 2, 2014 upon satisfying the minimum offering requirement by raising gross proceeds of $10.0 million in connection with a private placement with NexPoint Advisors, L.P. (the “Adviser”), our external advisor. In aggregate as of September 30, 2018, the Adviser controls 2,280,213 total shares, including reinvestment of dividends, for a net amount of approximately $22.0 million.

The Company has retained the Adviser to manage certain aspects of its affairs on a day-to-day basis. Highland Capital Funds Distributor, Inc. (the “Dealer Manager”), an entity under common ownership with the Adviser, served as the dealer manager of the Company’s continuous public offering prior to the termination of the offering. The Adviser and Dealer Manager are related parties and receive fees and other compensation for services related to the investment and management of the Company’s assets and the continuous public offering. The Company’s continuous public offering ended on February 14, 2018.

Note 2 — Summary of Significant Accounting Policies

Basis of Accounting

The accompanying financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Additionally, the accompanying financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Certain financial information that is normally included in annual financial statements is not required for interim financial statements and has been condensed or omitted. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending December 31, 2018. The interim financial data as of September 30, 2018, and for the three and nine months ended September 30, 2018 and September 30, 2017 is unaudited. In the opinion of management, the interim financial data includes all adjustments, consisting only of normal recurring adjustments, necessary to a fair statement of the results for the interim periods.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

11


Statements of Cash Flows

Information on financial transactions which have been settled through the receipt or disbursement of cash is presented in the Statements of Cash Flows. The cash amount shown in the Statements of Cash Flows is the amount included within the Company’s Statements of Assets and Liabilities and includes cash on hand at its custodian bank.

Cash and Cash Equivalents

The Company considers liquid assets deposited with a bank and certain short-term debt instruments with original maturities of three months or less to be cash equivalents. These investments represent amounts held with financial institutions that are readily accessible to pay Company expenses or purchase investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the Statements of Assets and Liabilities. As of September 30, 2018 and December 31, 2017, the Company had cash and cash equivalents of $7,104,691 and $11,044,982, respectively. As of September 30, 2018 and December 31, 2017, $6,959,715 and $10,852,235 was held in the State Street U.S. Government Money Market Fund, and $144,976 and $192,747 was held in a custodial account with State Street Bank and Trust Company, respectively.

Securities Sold Short and Restricted Cash

The Company may sell securities short. A security sold short is a transaction in which the Company sells a security it does not own in anticipation that the market price of that security will decline. When the Company sells a security short, it must borrow the security sold short from a broker-dealer and deliver it to the buyer upon conclusion of the transaction. The Company may have to pay a fee to borrow particular securities and is often obligated to pay over any dividends or other payments received on such borrowed securities. Cash held as collateral for securities sold short is classified as restricted cash on the Statements of Assets and Liabilities. Securities held as collateral for securities sold short are shown on the Schedule of Investments for the Company, as applicable. As of September 30, 2018 and December 31, 2017, the Company did not have any securities sold short.

When securities are sold short, the Company intends to limit exposure to a possible market decline in the value of its portfolio companies through short sales of securities that the Adviser believes possess volatility characteristics similar to those being hedged. In addition, the Company may use short sales for non-hedging purposes to pursue its investment objective. Subject to the requirements of the 1940 Act and the Code, the Company will not make a short sale if, after giving effect to such sale, the market value of all securities sold short by the Company exceeds 25% of the value of its total assets.

Other Fee Income

Fee income may consist of origination/closing fees, amendment fees, administrative agent fees, transaction break-up fees and other miscellaneous fees. Origination fees, amendment fees, and other similar fees are non-recurring fee sources. Such fees are received on a transaction by transaction basis and do not constitute a regular stream of income. For the three and nine months ended September 30, 2018, the Company recognized $656 and $10,586 of fee income, respectively. For the three and nine months ended September 30, 2017, the Company recognized $173 and $8,337 of fee income, respectively.

Fair Value of Financial Instruments

Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure (“ASC Topic 820”) defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The Company determines the net asset value of its investment portfolio each quarter, or more frequently as needed. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Securities that are not publicly-traded are valued at fair value as determined in good faith by the board of directors of the Company (the “Board”) or by the Adviser, pursuant to

 

12


board-approved procedures. In connection with that determination, the Company will provide the Board with portfolio company valuations which are based on relevant inputs, including indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services.

With respect to investments for which market quotations are not readily available, the Board and the Adviser undertake a multi-step valuation process, as described below:

 

   

The valuation process begins with each portfolio company or investment being initially valued by investment professionals of the Adviser responsible for credit monitoring.

 

   

Preliminary valuation conclusions are then documented and discussed with senior management of the Adviser (the “Valuation Committee”).

 

   

The audit committee of the Board reviews these preliminary valuations.

 

   

At least once each quarter, the valuations for approximately one quarter of the portfolio investments that have been fair valued are reviewed by an independent valuation firm such that, over the course of a year, each material portfolio investment that has been fair valued shall have been reviewed by an independent valuation firm at least once.

 

   

Based on this information, the Board discusses valuations and determines the fair value of each investment in the portfolio in good faith.                

As of September 30, 2018, the Company held the following investments for which a sufficient level of current, reliable market quotations were not available:

 

Instrument

  

Type

   Market value  

PAMCO CLO 1997-1A B

   Asset-Backed    $  143,146  

Gambier Bay, LLC.

   Common Stock      1,216,469  

OmniMax International, Inc.

   Common Stock      1,681,568  

SteadyMed Ltd.

   Common Stocks      14,509  

TerreStar Corp.

   Common Stocks      4,682,357  

TerreStar Corp.

   Senior Secured Loans      503,496  

OmniMax International, Inc.

   Unsecured Loans      3,671,582  

Galena Biopharma, Inc.

   Warrant      —    

Gemphire Therapeutics, Inc.

   Warrant      88,594  

OmniMax International, Inc.

   Warrant      52,050  

SCYNEXIS, Inc.

   Warrant      62,770  

As of December 31, 2017, the Company held the following investments for which a sufficient level of current, reliable market quotations were not available:

 

Instrument

  

Type

   Market
value
 

PAMCO CLO 1997-1A B

   Asset-Backed    $  294,541  

OmniMax International, Inc.

   Common Stock      2,566,191  

OmniMax International, Inc.

   Unsecured Loans      3,326,186  

Galena Biopharma, Inc.

   Warrant      18  

Gemphire Therapeutics, Inc.

   Warrant      493,218  

 

13


Kadmon Holdings, Inc.

   Warrant      22,727  

OmniMax International, Inc.

   Warrant      79,432  

SCYNEXIS, Inc.

   Warrant      200,511  

SteadyMed Ltd.

   Warrant      95,893  

Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to the Company’s financial statements will refer to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, in the Company’s financial statements. Below is a description of factors that the Valuation Committee and the Board may consider when valuing the Company’s debt and equity investments.

Valuation of fixed income investments, such as loans and debt securities, depends upon a number of factors, including prevailing interest rates for like securities, expected volatility in future interest rates, call features, put features and other relevant terms of the debt. For investments without readily available market prices, the Company may incorporate these factors into discounted cash flow models to arrive at fair value. Other factors that the Board may consider include the borrower’s ability to adequately service its debt, the fair market value of the portfolio company in relation to the face amount of its outstanding debt and the quality of collateral securing the Company’s debt investments.

The Company’s equity investments in portfolio companies for which there is no liquid public market will be valued at fair value. The Valuation Committee and the Board, in its analysis of fair value, may consider various factors, such as multiples of earnings before interest, taxes, depreciation and amortization (“EBITDA”), cash flows, net income, revenues or, in limited instances, book value or liquidation value. All of these factors may be subject to adjustments based upon the particular circumstances of a portfolio company or the Company’s actual investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, restructuring or other related items.

The Valuation Committee and the Board may also look to private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio companies or industry practices in determining fair value. The Valuation Committee and the Board may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, as well as any other factors it deems relevant in assessing the value. Generally, the value of the Company’s equity interests in public companies for which market quotations are readily available will be based upon the most recent closing public market price.

If the Company receives warrants or other equity-linked securities at nominal or no additional cost in connection with an investment in a debt security, the Company will allocate the cost basis in the investment between the debt securities and any such warrants or other equity-linked securities received at the time of origination. The Valuation Committee and the Board will subsequently value these warrants or other equity-linked securities received at fair value.

As applicable, the Company values its Level 2 assets by using the midpoint of the prevailing bid and ask prices from dealers on the date of the relevant period end, which is provided by an independent third-party pricing service and screened for validity by such service. For investments for which the third-party pricing service is unable to obtain quoted prices, the Company obtains bid and ask prices directly from dealers who make a market in such investments.

To the extent that the Company holds investments for which no active secondary market exists and, therefore, no bid and ask prices can be readily obtained, the Valuation Committee utilizes an independent third-party valuation service to value such investments.

The Company periodically benchmarks the bid and ask prices received from the third-party pricing service and/or dealers, as applicable, and valuations received from the third-party valuation service against the actual prices at which it purchases and sells its investments. The Company believes that these prices are reliable indicators of fair value. The Company’s Valuation Committee and the Board review and approve the valuation determinations made with respect to these investments in a manner consistent with the Company’s valuation process.

 

14


As of September 30, 2018, the Company’s investments consisted of senior secured loans, unsecured loans, bonds, asset-backed securities, common stocks, preferred stock, a closed-end mutual fund, a total return swap (“TRS”) and rights and warrants, which may be purchased for a fraction of the price of the underlying securities. The fair value of the Company’s loans, bonds and asset-backed securities are generally based on quotes received from brokers or independent pricing services. Loans, bonds and asset-backed securities with quotes that are based on actual trades with a sufficient level of activity on or near the measurement date are classified as Level 2 assets. Loans, bonds and asset-backed securities that are priced using quotes derived from implied values, indicative bids or a limited number of actual trades are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable.

The fair value of the Company’s common stocks and options that are not actively traded on national exchanges are generally priced using quotes derived from implied values, indicative bids, or a limited amount of actual trades and are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable. Exchange traded options are valued based on the last trade price on the primary exchange on which they trade. If an option does not trade, the mid-price is utilized to value the option.

The Company values the TRS in accordance with the agreement (the “TRS Agreement”) with BNP Paribas (“BNP Paribas”) that establishes the TRS. Pursuant to the TRS Agreement, the value of the TRS is based on the increase or decrease in the value of the loans underlying the TRS, together with accrued interest income, interest expense and certain other expenses incurred under the TRS. The loans underlying the TRS are valued based on indicative bid prices provided by an independent third-party pricing service. Bid prices reflect the highest price that market participants may be willing to pay. These valuations are sent to the Company for review and testing. The Valuation Committee and the Board review and approve the value of the TRS, as well as the value of the loans underlying the TRS, on a quarterly basis. To the extent the Valuation Committee or the Board have any questions or concerns regarding the valuation of the loans underlying the TRS, such valuation is discussed or challenged pursuant to the terms of the TRS Agreement. For additional information on the TRS, see Note 7.

At the end of each calendar quarter, the Company evaluates the Level 2 and 3 investments for changes in liquidity, including: whether a broker is willing to execute at the quoted price, the depth and consistency of prices from third party services, and the existence of contemporaneous, observable trades in the market. Additionally, management evaluates the Level 1 and 2 assets and liabilities on a quarterly basis for changes in listings or delistings on national exchanges.

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market price, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values the Company may ultimately realize. Further, such investments may be subject to legal and other restrictions on resale or otherwise less liquid than publicly traded securities.

The inputs or methodology used for valuing investments are not necessarily an indication of the risk associated with investing in those investments. Transfers in and out of the levels are recognized at the fair value at the end of the period. The following are summaries of the Company’s investments categorized within the fair value hierarchy as of September 30, 2018 and December 31, 2017:

 

Investments

   Level 1      Level 2      Level 3      Total  

Assets

           

Senior Secured Loans

           

Energy

   $ —          $ 2,368,296      $ —        $ 2,368,296  

Healthcare

     —          9,945,530        —          9,945,530  

Media/Telecommunications

     —          3,769,150        —          3,769,150  

Retail

     —          1,293,754        —          1,293,754  

Telecommunication Services

     —          —          503,496        503,496  

Utility

     —          7,000        —          7,000  

Unsecured Loans

     —          —          3,671,582        3,671,582  

Asset-Backed Securities

     —          1,163,276        143,146        1,306,422  

Closed-End Mutual Funds

     1,457,747        —          —          1,457,747  

Corporate Bonds

     —          54,572,514        —          54,572,514  

Common Stocks

           

Chemicals

     261,460        —          —          261,460  

Energy

     6,191,350        —          —          6,191,350  

Healthcare

     6,612,865        —          14,509        6,627,374  

Materials

     —          —          1,681,568        1,681,568  

Media/Telecommunications

     —          —          1,216,469        1,216,469  

 

15


Real Estate Investment Trusts (REITs)

     2,598,035        —          —          2,598,035  

Telecommunication Services

     —          —          4,682,357        4,682,357  

Utility

     2,861,200        —          —          2,861,200  

Preferred Stocks

     821,716        —          —          821,716  

Rights

     —          45,430        —          45,430  

Warrants

 

Healthcare

     —          151,364        —          151,364  

Materials

     —          —          52,050        52,050  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 20,804,373      $ 73,316,314      $ 11,965,177      $ 106,085,864  
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

 

Derivatives

 

Total Return Swap Contracts

   $ —        $ —        $ (399,188    $ (399,188
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ —        $ —        $ (399,188    $ (399,188
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Investments net of Swap Contracts

   $ 20,804,373      $ 73,316,314      $ 11,565,989      $ 105,686,676  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

16


     December 31, 2017  

Investments

   Level 1      Level 2      Level 3      Total  

Assets

           

Senior Secured Loans

           

Healthcare

   $ —        $ 14,006,745      $ —        $ 14,006,745  

Retail

     —          3,654,624        —          3,654,624  

Service

     —          1,713,464        —          1,713,464  

Utility

     —          9,100        —          9,100  

Unsecured Loans

     —          —          3,326,186        3,326,186  

Asset-Backed Securities

     —          1,671,636        294,541        1,966,177  

Closed-End Mutual Funds

     16,793        —          —          16,793  

Corporate Bonds

     —          52,543,477        —          52,543,477  

Common Stocks

           

Chemicals

     170,000        —          —          170,000  

Energy

     4,109,050        —          —          4,109,050  

Healthcare

     2,415,250        —          —          2,415,250  

Materials

     —          —          2,566,191        2,566,191  

Real Estate Investment Trusts (REITs)

     2,489,476        —          —          2,489,476  

Utility

     2,106,808        —          —          2,106,808  

Preferred Stocks

     1,960,275        —          —          1,960,275  

Rights

     —          56,897        —          56,897  

Warrants

           

Healthcare

     —          812,367        —          812,367  

Materials

     —          —          79,432        79,432  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 13,267,652      $ 74,468,310      $ 6,266,350      $ 94,002,312  
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Derivatives

           

Total Return Swap Contracts

   $ —        $ —        $ (563,823    $ (563,823
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ —        $ —        $ (563,823    $ (563,823
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Investments Net of Swap Contracts

   $ 13,267,652      $ 74,468,310      $ 5,702,527      $ 93,438,489  
  

 

 

    

 

 

    

 

 

    

 

 

 

The table below sets forth a summary of changes in the Company’s Level 3 investments (measured at fair value using significant unobservable inputs) for the nine months ended September 30, 2018.

 

17


Investments:

  Balance as of
December 31,
2017
    Transfers
into
Level 3
    Transfer
out of
Level 3
    Net
amortization
(accretion) of
premium/
(discount)
    Net
realized
gains/
(losses)
    Net change in
unrealized
gains/
(losses)
    Purchases/
PIK
    (Sales
and
redemptions)
    Balance as of
September 30,
2018
    Change in
unrealized
gain/(loss)
on Level 3
securities still
held at period
end
 

Assets

                   

Senior Secured Loans

                   

Telecommunication Services

  $ —       $ —       $ —       $ —       $ —       $ (504   $ 504,000     $ —       $ 503,496   $ (504

Unsecured Loans

                   

Materials

    3,326,186       —         —         120,324     213     (137,546     363,662       (1,257     3,671,582     (137,546

Asset-Backed Securities

                   

Financials

    294,541       —         —         —         78,797       (44,786     —         (185,406     143,146       (44,786

Common Stocks

                   

Healthcare

    —         —         —         —         —         —         14,509       —         14,509       —    

Materials

    2,566,191       —         —         —         —         (884,623     —         —         1,681,568       (884,623

Media/Telecommunications

    —         1,216,469       —         —         —         —         —         —         1,216,469       —    

Telecommunication Services

    —         —         —         —         —         3,082,367       1,599,990       —         4,682,357       3,082,367  

Warrants

                   

Materials

    79,432       —         —         —         —         (27,382     —         —         52,050       (27,382
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 6,266,350     $ 1,216,469     $ —     $ 120,324     $ 79,010     $ 1,987,526     $ 2,482,161     $ (186,663   $ 11,965,177     $ 1,987,526  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

                   

Total Return Swaps(1)

  $ (563,823   $ —       $ —       $ —       $ —       $ 164,635   $ —     $ —     $ (399,188   $ 164,635  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

During the nine months ended September 30, 2018, the Company recognized a net realized gain on the TRS amounting to $750,299. The Company received $653,318 in cash payments from the TRS during the period and paid $137,472, with an increase of $234,453 in receivable from BNP Paribas for the nine months ended September 30, 2018.

The table below sets forth a summary of changes in the Company’s Level 3 investments (measured at fair value using significant unobservable inputs) for the nine months ended September 30, 2017.

 

Investments:

  Balance as of
December 31,
2016
    Transfers
into
Level 3
    Transfer
out of
Level 3
    Net
amortization
(accretion) of
premium/
(discount)
    Net
realized
gains/
(losses)
    Net change
in

unrealized
gains/
(losses)
    Purchases     (Sales
and
redemptions)
    Balance as of
September 30,
2017
    Change in
unrealized
gain/(loss)
on Level 3
securities still
held at period
end
 

Assets

                   

Senior Secured Loans

                   

Healthcare

  $ 4,005,000     $ —       $ —       $ 6,549     $ —     $ 381,576     $ —     $ —     $ 4,393,125     $ 381,576  

Asset-Backed Securities

                   

Financials

    275,625       —         —         —         —         13,151       —         —         288,776       13,151  

Common Stocks Chemicals

    73,665       —         (136,000     —         —         62,335       —         —         —         —    

Warrants Healthcare

    23,851       —         (335     —         —         (23,516     —         —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 4,378,141     $ —       $ (136,335   $ 6,549     $ —     $ 433,546     $ —     $ —     $ 4,681,901     $ 394,727  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

                   

Total Return Swaps(1)

  $ —       $ —       $ —       $ —       $ —       $ (633,427   $ —     $ —       $ (633,427   $ (633,427
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

During the nine months ended September 30, 2017, the Company recognized a net realized loss on the TRS amounting to $524,777. The Company received $194,394 in cash payments from the TRS during the period, with $719,171 being payable to BNP Paribas as of September 30, 2017.

 

18


Investments designated as Level 3 may include investments valued using quotes or indications furnished by brokers which are based on models or estimates and may not be executable prices. In light of the developing market conditions, the Adviser continues to search for observable data points and evaluate broker quotes and indications received for investments. Determination of fair values is uncertain because it involves subjective judgments and estimates that are unobservable. Transfers from Level 2 to Level 3 are due to a decrease in market activity (e.g. frequency of trades), which resulted in a decrease of available market inputs to determine price. For the nine months ended September 30, 2018, $1,216,469 was transferred from Level 2 to Level 3. Transfers from Level 3 to Level 2 and from Level 2 to Level 1 are due to an increase in market activity (e.g. frequency of trades), which resulted in an increase of available market inputs to determine price. For the nine months ended September 30, 2017, $335 was transferred from Level 3 to Level 2, $2,149,358 was transferred from Level 2 to Level 1, and $136,000 was transferred from Level 3 to Level 1.

The following are summaries of significant unobservable inputs used in the fair valuations of investments categorized within Level 3 of the fair value hierarchy as of September 30, 2018 and December 31, 2017:

 

Investment

   Fair value at
September 30,
2018
   

Valuation

technique

  

Unobservable

inputs

   Range of input
value(s)

(weighted average)
 

Common Equity

   $ 7,594,903    

Discounted Cash Flow

 

Multiples Analysis

 

Transaction Analysis

Bid Indication of Value

Enterprise Value Indications

Pricing Feed

Implied Value

  

Discount Rate

Terminal Multiple

Multiple of EBITDA

Price/MHz-PoP

Risk Discount

Multiple of EBITDA

Per Share Value

Approach Weightings

N/A

Cash Payment Value

    

11.00% - 17.00%

6.75x

6.75x - 8.00x

$0.08 - $0.63

33.0% - 35.8%

7.75x - 8.25x

$77.53 - $347.49

20% - 80%

N/A

$4.46

 

 

 

 

 

 

 

 

 

 

Senior Secured Loans

     4,175,078     Discounted Cash Flow   

Discount Rate

Spread Adjustment

    

11.1% - 16.5%

0.1% - 0.5%

 

 

Warrants

     52,050    

Discounted Cash Flow

Multiples Analysis

Transaction Analysis

  

Discount Rate

Terminal Multiple

Multiple of EBITDA

Multiple of EBITDA

    

12.00%

6.75x

6.75x - 8.00x

7.75x - 8.25x

 

 

 

 

Asset-Backed Securities

     143,146     Discounted Cash Flow    Discount Rate      20.88%  
  

 

 

         

Total

   $ 11,965,177          
  

 

 

         

Total Return Swaps

   $ (399,188   Third Party Pricing Vendor    N/A      N/A  

Investment

   Fair value at
December 31,
2017
   

Valuation

technique

  

Unobservable

inputs

   Range of input
value(s)

(weighted average)
 

Senior Secured Loans

   $ 3,326,186     Discounted Cash Flow   

Discount Rate

Spread Adjustment

    

16.20%

0.20%

 

 

Common Equity

     2,566,191    

Discounted Cash Flow

Multiples Analysis

Discount for Lack of Marketability

  

Discount Rate

Minority Discount

Terminal Multiple

Multiple of EBITDA

    

12.00%

20.00%

7.0x

7.75x - 8.25x

15.00%

 

 

 

 

 

Warrants

     79,432    

Discounted Cash Flow

Multiples Analysis

Discount for Lack of Marketability

  

Discount Rate

Minority Discount

Terminal Multiple

Multiple of EBITDA

    

12.00%

20.00%

7.0x

7.75x - 8.25x

15.00%

 

 

 

 

 

Asset-Backed Securities

     294,541     Discounted Cash Flow    Discount Rate      20.85%  
  

 

 

         

Total

   $ 6,266,350          
  

 

 

         

Total Return Swaps

   $ (563,823   Third Party Pricing Vendor    N/A      N/A  

 

19


Derivative Transactions

The Company is subject to equity price risk, interest rate risk and foreign currency exchange rate risk in the normal course of pursuing its investment objective. The Company may invest without limitation in warrants and may also use derivatives, primarily swaps (including equity, variance and volatility swaps), options and futures contracts on securities, interest rates, commodities and/or currencies, as substitutes for direct investments the Company can make. The Company may also use derivatives such as swaps, options (including options on futures), futures, and foreign currency transactions (e.g., foreign currency swaps, futures and forwards) to any extent deemed by the Adviser to be in the best interest of the Company, and to the extent permitted by the 1940 Act, to hedge various investments for risk management and speculative purposes. For additional information on the TRS, please see Note 7.

Options

The Company purchases options, subject to certain limitations. The Company may invest in options contracts to manage its exposure to the stock and bond markets and fluctuations in foreign currency values. Writing puts and buying calls tend to increase the Company’s exposure to the underlying instrument while buying puts and writing calls tend to decrease the Company’s exposure to the underlying instrument, or economically hedge other Company investments. The Company’s risks in using these contracts include changes in the value of the underlying instruments, nonperformance of the counterparties under the contracts’ terms and changes in the liquidity of the secondary market for the contracts. Options are valued at the last sale price, or if no sales occurred on that day, at the last quoted bid price. As of and during the nine months ended September 30, 2018 and September 30, 2017, the Company did not hold options.

Investment Transactions

Investment transactions are accounted for on trade date. Realized gains/(losses) on investments sold are recorded on the basis of specific identification method for both financial statement and U.S. federal income tax purposes. Payable for investments purchased and receivable for investments sold on the Statements of Assets and Liabilities, if any, represents the cost of purchases and proceeds from sales of investment securities, respectively, for trades that have been executed but not yet settled.

Income Recognition

Corporate actions (including cash dividends from common stock and equity tranches of asset-backed securities) are recorded on the ex-dividend date, net of applicable withholding taxes, except for certain foreign corporate actions, which are recorded as soon after the ex-dividend date as such information becomes available. Interest income is recorded on the accrual basis. The Company does not accrue as a receivable interest or dividends on loans, asset-backed securities and other securities if there is a reason to doubt the Company’s ability to collect such income. For loans with contractual PIK (payment-in-kind) interest income, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we will not accrue PIK interest if we believe that the PIK interest is no longer collectible. Loan origination fees, original issue discount and market discount are capitalized and such amounts are amortized as interest income over the respective term of the loan or security. Upon the prepayment of a loan or security, any unamortized loan origination fees and original issue discount are recorded as interest income.

Accretion of discounts and amortization of premiums on taxable bonds, loans and asset-backed securities are computed to the call or maturity date, whichever is shorter, using the effective yield method. Withholding taxes on foreign dividends have been provided for in accordance with the Company’s understanding of the applicable country’s tax rules and rates.

 

20


Organization and Offering Costs

Organization costs are paid by the Adviser and include the cost of incorporating, such as the cost of legal services and other fees pertaining to our organization. Offering costs include legal fees, promotional costs and other costs pertaining to the public offering of our shares of common stock and are also paid by the Adviser. Prior to the termination of the offering, as we raised proceeds, these organization and offering costs were expensed and became payable to the Adviser. Organization and offering costs are limited to 1% of total gross proceeds raised and are not due and payable to the Adviser to the extent they exceed that amount. Please refer to Note 4 for additional information on Organization and Offering Costs.

Paid-in Capital

The proceeds from the issuance of common stock as presented on the Company’s Statements of Changes in Net Assets is presented net of selling commissions and fees for the nine months ended September 30, 2018 and September 30, 2017. Selling commissions and fees of $413,024 and $1,453,224 were paid for the nine months ended September 30, 2018 and September 30, 2017, respectively.

Earnings Per Share

In accordance with the provisions of ASC Topic 260 — Earnings per Share (“ASC 260”), basic earnings per share is computed by dividing earnings available to common stockholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.

The following table sets forth the computation of the weighted average basic and diluted net increase in net assets per share from operations:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 

Basic and diluted

   2018      2017      2018      2017  

Net increase (decrease) in net assets from operations

   $ 1,050,845      $ (201,833    $ 5,205,464      $ 4,671,331  

Weighted average common shares outstanding

     10,408,226        8,966,250        10,332,534        8,287,409  

Earnings per common share-basic and diluted

   $ 0.10      $ (0.02    $ 0.50      $ 0.56  

 

21


Distributions

Distributions to the Company’s stockholders will be recorded as of the record date. Subject to the discretion of the Board and applicable legal restrictions, the Company intends to authorize and declare ordinary cash distributions on a weekly basis and pay such distributions on a monthly basis. Net realized capital gains, if any, will generally be distributed or deemed distributed at least every 12-month period.

Recent Accounting Pronouncements

The Company generally intends to take advantage of the extended transition period available to emerging growth companies to comply with the new or revised accounting standards below until those standards are applicable to private companies.

In November 2016, the FASB issued Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The amendments in this update require the statement of cash flows explain the change during the period in the total of cash, restricted cash and cash equivalents. Amounts generally described as restricted cash or restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. For public entities this update will be effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. For all other entities, this update is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. In addition, Accounting Standards Update 2016-18 must be adopted at the same time as Accounting Standards Update 2016-15. The Company is currently evaluating the impact of this new guidance on its financial statement presentation and disclosures.

In December 2016, the FASB issued Accounting Standards Update 2016-19, Technical Corrections and Improvements. The amendments in this update include an amendment to FASB ASC Topic 820, Fair Value Measurement and Disclosures to clarify the difference between a valuation approach and a valuation technique. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. For public entities, this update will be effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. For all other entities, this update is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company is currently evaluating the impact of this new guidance on its financial statement presentation and disclosures.

In March 2017, the FASB issued Accounting Standards Update 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this update shorten the amortization period for certain callable debt securities held at premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public entities this update will be effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. For all other entities, this update is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating the impact of this new guidance on its financial statement presentation and disclosures.

In February 2018, the FASB issued Accounting Standards Update 2018-03, Technical Corrections and Improvements to Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update provide a variety of technical corrections and improvements to how entities should account for financial instruments, shorten the amortization period for certain callable debt securities held at premium. For public entities this update will be effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years beginning after June 15, 2018. The Company is currently evaluating the impact of this new guidance on its financial statement presentation and disclosures.

Note 3 — Investment Portfolio    

The following table shows the composition of the Company’s invested assets by industry classification at fair value at September 30, 2018:

 

     Fair value      Percentage  

Assets

     

Healthcare

   $ 64,230,657        60.6

Financials

     9,830,294        9.3

Energy

     8,559,646        8.1

Materials

     5,405,200        5.1

 

22


Telecommunication Services

     5,185,853        4.9

Media/Telecommunications

     4,985,619        4.7

Real Estate Investment Trusts (REITs)

     3,419,751        3.2

Utility

     2,913,630        2.7

Retail

     1,293,754        1.2

Chemicals

     261,460        0.2
  

 

 

    

 

 

 

Total Assets

   $ 106,085,864        100.0
  

 

 

    

 

 

 

The following table shows the composition of the Company’s invested assets by industry classification at fair value at December 31, 2017:

 

     Fair value      Percentage  

Assets

     

Healthcare

   $ 63,518,400        67.5

Materials

     5,971,809        6.4

Financials

     5,263,970        5.6

Real Estate Investment Trusts (REITs)

     4,449,751        4.7

Energy

     4,109,050        4.4

Retail

     3,654,624        3.9

Telecommunication Services

     2,175,110        2.3

Utility

     2,172,805        2.3

Service

     1,713,464        1.8

Media/Telecommunications

     803,329        0.9

Chemicals

     170,000        0.2
  

 

 

    

 

 

 

Total Assets

   $ 94,002,312        100.0
  

 

 

    

 

 

 

The following table summarizes the amortized cost and the fair value of the Company’s invested assets by class of financial asset as of September 30, 2018:

     Amortized Cost      Fair value      Percentage of
Portfolio
(at Fair Value)
 

Assets

 

  

Senior Secured Loans – First Lien

   $ 13,507,268      $ 12,996,084        12.3

Senior Secured Loans – Second Lien

     4,982,406        4,884,142        4.6

Senior Secured Loans – Escrow Loan

     87,816        7,000        0.0

Unsecured Loans

     3,282,820        3,671,582        3.5

Asset-Backed Securities

     1,398,952        1,306,422        1.2

Closed-End Mutual Funds

     1,444,020        1,457,747        1.4

Corporate Bonds

     53,364,468        54,572,514        51.4

Common Stocks

     21,731,160        26,119,813        24.6

Preferred Stocks

     3,215,965        821,716        0.8

Rights

     150,864        45,430        0.0

Warrants

     —          203,414        0.2
  

 

 

    

 

 

    

 

 

 

Total Assets

   $ 103,165,739      $ 106,085,864        100.0
  

 

 

    

 

 

    

 

 

 

The following table summarizes the amortized cost and the fair value of the Company’s invested assets by class of financial asset as of December 31, 2017:

 

     Amortized cost      Fair value      Percentage of
portfolio
(at fair value)
 

Assets

 

Senior Secured Loans – First Lien

   $ 15,070,292      $ 14,942,333        15.9

Senior Secured Loans – Second Lien

     4,426,629        4,432,500        4.7

Senior Secured Loans – Escrow Loan

     87,816        9,100        0.0

Unsecured Loans

     2,799,878        3,326,186        3.5

Asset-Backed Securities

     1,930,704        1,966,177        2.1

Closed-End Mutual Funds

     14,154        16,793        0.0

Corporate Bonds

     53,545,760        52,543,477        56.0

Common Stocks

     10,786,964        13,856,775        14.7

Preferred Stocks

     3,215,965        1,960,275        2.1

Rights

     150,864        56,897        0.1

Warrants

     —          891,799        0.9
  

 

 

    

 

 

    

 

 

 

Total Assets

   $ 92,029,026      $ 94,002,312        100.0
  

 

 

    

 

 

    

 

 

 

 

23


The following table summarizes the amortized cost and the fair value of the Company’s invested assets as of September 30, 2018 to include, on a look-through basis, the investments underlying the TRS, as disclosed in Note 7. The investments underlying the TRS had a notional amount and market value of $55,081,345 and $54,472,494, respectively, as of September 30, 2018.

 

     Amortized cost      Fair value      Percentage of
portfolio
(at fair value)
 

Assets

        

Senior Secured Loans—First Lien

   $ 58,392,033      $ 57,757,155        36.0

Senior Secured Loans—Second Lien

     15,178,986        14,595,565        9.1

Senior Secured Loans—Escrow Loan

     87,816        7,000        0.0

Unsecured Loans

     3,282,820        3,671,582        2.3

Asset-Backed Securities

     1,398,952        1,306,422        0.8

Closed-End Mutual Funds

     1,444,020        1,457,747        0.9

Corporate Bonds

     53,364,468        54,572,514        34.0

Common Stocks

     21,731,160        26,119,813        16.3

Preferred Stocks

     3,215,965        821,716        0.5

Rights

     150,864        45,430        0.0

Warrants

     —          203,414        0.1
  

 

 

    

 

 

    

 

 

 

Total Assets

   $ 158,247,084      $ 160,558,358        100.0
  

 

 

    

 

 

    

 

 

 

The following table summarizes the amortized cost and the fair value of the Company’s invested assets as of December 31, 2017 to include, on a look-through basis, the investments underlying the TRS, as disclosed in Note 7. The investments underlying the TRS had a notional amount and market value of $35,960,921 and $35,231,901, respectively, as of December 31, 2017.

 

     Amortized cost      Fair value      Percentage of
portfolio
(at fair value)
 

Assets

        

Senior Secured Loans—First Lien

   $ 41,514,176      $ 40,683,792        31.5

Senior Secured Loans—Second Lien

     13,943,666        13,922,942        10.8

Senior Secured Loans—Escrow Loan

     87,816        9,100        0.0

Unsecured Loans

     2,799,878        3,326,186        2.6

Asset-Backed Securities

     1,930,704        1,966,177        1.5

Closed-End Mutual Funds

     14,154        16,793        0.0

Corporate Bonds

     53,545,760        52,543,477        40.7

Common Stocks

     10,786,964        13,856,775        10.7

Preferred Stocks

     3,215,965        1,960,275        1.5

Warrants

     —          891,799        0.7

Rights

     150,864        56,897        0.0
  

 

 

    

 

 

    

 

 

 

Total Assets

   $ 127,989,947      $ 129,234,213        100.0
  

 

 

    

 

 

    

 

 

 

 

24


The following table shows the composition of the Company’s invested assets by geographic classification at September 30, 2018:

 

Geography    Fair value      Percentage  

Assets

 

Cayman Islands(1)

   $ 1,306,422        1.2

Luxembourg(1)

     2,621,780        2.5

United States

     102,157,662        96.3
  

 

 

    

 

 

 

Total Assets

   $ 106,085,864        100.0
  

 

 

    

 

 

 

 

(1) 

Investment denominated in USD.

The following table shows the composition of the Company’s invested assets by geographic classification at December 31, 2017:

 

Geography    Fair value      Percentage  

Assets

 

Cayman Islands(1)

   $ 1,966,177        2.1

Luxembourg(1)

     2,175,110        2.3

United States

     89,861,025        95.6
  

 

 

    

 

 

 

Total Assets

   $ 94,002,312        100.0
  

 

 

    

 

 

 

 

(1) 

Investment denominated in USD

Note 4 — Related Party Transactions and Arrangements

Investment Advisory Fee

Payments for investment advisory services under the Company’s investment advisory agreement (the “Investment Advisory Agreement”) and administrative services agreement (the “Administration Agreement”) are equal to (a) a base management fee calculated at an annual rate of 2.0% of the average value of the Company’s gross assets at the end of the two most recently completed calendar quarters and (b) an incentive fee based on the Company’s performance. Effective June 5, 2017, the Investment Advisory Agreement and the Administration Agreement were amended to exclude cash and cash equivalents from the calculation of gross assets for the purpose of calculating advisory and administration fees.

For the three and nine months ended September 30, 2018, the Company incurred investment advisory fees payable to the Adviser of $527,229 and $1,554,540. For the three and nine months ended September 30, 2017, the Company incurred investment advisory fees payable to the Adviser of $305,288 and $1,106,346, respectively, which were voluntarily waived. Amounts waived for management fees or administrative services expenses pertaining to periods prior to June 10, 2016 are not recoupable, but amounts waived for management fees or administrative services expenses pertaining to periods from and after June 10, 2016 are subject to recoupment by the Adviser within three years from the date that such fees were otherwise payable, provided that the recoupment will be limited to the amount of such voluntarily waived fees from and after June 10, 2016 and will not cause the sum of the Company’s advisory fees, administration fees, Other Expenses (as defined under “Expense Limits and Reimbursements” below), and any recoupment to exceed the annual rate of 3.40% of average gross assets. Effective December 20, 2017, the Adviser ended its voluntary waiver of advisory fees.

Incentive Fee

The incentive fee consists of two parts. The first part, which is referred to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears, and equals 20.0% of “pre-incentive fee net investment income” for the immediately preceding quarter and is subject to a hurdle rate, expressed as a rate of return on the Company’s net assets, as defined in the Investment Advisory Agreement, equal to 1.875% per quarter. As a result, the Adviser will not earn this incentive fee for any quarter until the Company’s pre-incentive fee net investment income for such quarter exceeds the hurdle rate of 1.875%. Once the Company’s pre-incentive fee net investment income in any quarter exceeds the hurdle rate, the Adviser will be entitled to a “catch-up” fee equal to the amount of the pre-incentive fee net investment income in excess of the hurdle rate, until the Company’s pre-incentive fee net investment income for such quarter equals 2.34375% of the Company’s net assets at the end of such quarter. This “catch-up” feature allows the Adviser to recoup the fees foregone as a result of the existence of the hurdle rate in that quarter. Thereafter, the Adviser will receive 20.0% of the Company’s pre-incentive fee net investment income from the quarter.

 

25


The second part of the incentive fee, which is referred to as the incentive fee on capital gains, is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement). This fee equals 20.0% of the Company’s incentive fee capital gains, which will equal the Company’s realized capital gains on a cumulative basis from formation, calculated as of the end of the applicable period, computed net of all realized capital losses (proceeds less amortized cost) and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. The Company will accrue for the capital gains incentive fee, which, if earned, will be paid annually. The Company will accrue for the capital gains incentive fee based on net realized and unrealized gains; however, under the terms of the Investment Advisory Agreement, the fee payable to the Adviser will be based on realized gains and no such fee will be payable with respect to unrealized gains unless and until such gains are actually realized.

For the three and nine months ended September 30, 2018, the Company incurred $95,788 and $692,793 of incentive fees on capital gains, respectively. For the three and nine months ended September 30, 2017, the Company recognized a reduction of $(315,928) and $(111,488) to its incentive fees on capital gains, respectively, all of which was voluntarily waived. Since inception, the Company has accrued $1,287,098 of incentive fees on capital gains in aggregate. Effective December 20, 2017, the Adviser ended its voluntary waiver of incentive fees. No such fees have been paid with respect to realized gains to the Adviser as of September 30, 2018.

Administration Fee

Pursuant to the Administration Agreement with the Adviser, the Company also reimburses the Adviser for expenses necessary for its performance of services related to the Company’s administration and operations. The amount of the reimbursement will be the lesser of (1) the Company’s allocable portion of overhead and other expenses incurred by the Adviser in performing its obligations under the Administration Agreement and (2) 0.40% of the Company’s average gross assets, (excluding cash and cash equivalents). The Adviser is required to allocate the cost of such services to the Company based on objective factors such as assets, revenues, time allocations and/or other reasonable metrics. The Board assesses the reasonableness of such reimbursements based on the breadth, depth and quality of such services as compared to the estimated cost to the Company of obtaining similar services from third-party service providers known to be available. In addition, the Board will consider whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, the Board will compare the total amount paid to the Adviser for such services as a percentage of the Company’s net assets to the same ratio as reported by other comparable BDCs.

For the three and nine months ended September 30, 2018, the Company incurred administration fees payable to the Adviser of $103,982 and $309,444, respectively. For the three and nine months ended September 30, 2017, the Company incurred administration fees payable to the Adviser of $69,308 and $229,520, respectively, which were voluntarily waived. Amounts waived for management fees or administrative services expenses pertaining to periods prior to June 10, 2016 are not recoupable, but amounts waived for management fees or administrative services, expenses pertaining to periods from and after June 10, 2016 are subject to recoupment by the Adviser within three years from the date that such fees were otherwise payable, provided that the recoupment will be limited to the amount of such voluntarily waived fees from and after June 10, 2016 and will not cause the sum of the Company’s advisory fees, administration fees, Other Expenses, and any recoupment to exceed the annual rate of 3.40% of average gross assets. Effective December 20, 2017, the Adviser ended its voluntary waiver of administration fees.

Investment Advisory and Administration Fees Table

Amounts waived and subject to recoupment pertaining to advisory and administrator fees are shown below.

 

26


Period ended

   Advisory fees waived and
subject to recoupment(1)
     Administration fees
waived
and subject to recoupment(1)
     Recoupment eligibility
expiration

December 31, 2017

   $ 413,916      $ 75,906      December 31, 2020

September 30, 2017

     305,288        69,308      September 30, 2020

June 30, 2017

     389,733        77,947      June 30, 2020

March 31, 2017

     390,969        78,194      March 31, 2020

December 31, 2016

     366,861        73,372      December 31, 2019

September 30, 2016

     343,320        68,664      September 30, 2019

June 30, 2016

     74,421        14,884      June 30, 2019
  

 

 

    

 

 

    

Total

   $ 2,284,508      $ 458,275     

 

(1) 

The Advisor has permanently waived the recoupment of any advisory fees or administration fees calculated on the portion of gross assets attributable to the receivable from Adviser balance on the Statements of Assets and Liabilities. The amounts shown have been reduced by this waiver.

In addition, cumulatively since inception through to June 10, 2016, the Company has voluntarily waived $930,143 and $186,042 of advisory fees and administration fees, respectively, all of which are not recoupable.

Organization and Offering Costs

Organization costs include the cost of incorporating, such as the cost of legal services and other fees pertaining to our organization, and are paid by the Adviser. For the three and nine months ended September 30, 2018 and the three and nine months ended September 30, 2017, the Adviser did not incur or pay organization costs on our behalf.

Offering costs include legal fees, promotional costs and other costs pertaining to the public offering of our shares of common stock, and are capitalized and amortized to expense over one year. For the three and nine months ended September 30, 2018, the Adviser incurred and paid offering costs of $0 and $238,568, respectively, on our behalf. For the three and nine months ended September 30, 2017, the Adviser incurred and paid offering costs of $167,797 and $898,423, respectively, on our behalf. For the three and nine months ended September 30, 2018, the Company capitalized $0 and $61,462 of offering costs, respectively. For the three and nine months ended September 30, 2017, the Company capitalized $41,632 and $213,880 of offering costs, respectively. Of the capitalized offering costs, $38,986 and $158,831 were amortized to expense during the three and nine months ended September 30, 2018, respectively. Of the capitalized offering costs, $91,937 and $308,713 were amortized to expense during the three and nine months ended September 30, 2017, respectively. As of September 30, 2018 and September 30, 2017, $31,461 and $133,722 remained on the Statements of Assets and Liabilities, respectively.

Organization costs and offering costs are limited to 1% of total gross proceeds raised in the offering and are not due and payable to the Adviser to the extent they exceed that amount. As of September 30, 2018, the cumulative aggregate amount of $5,327,574 of organization and offering costs exceeds 1% of total proceeds raised. Subsequent to the termination of the offering, the Adviser forfeited the right to reimbursement of the remaining $4,305,091 of these costs.

Fees Paid to Officers and Directors

Each director who is not an “interested person” of the Company as defined in the 1940 Act (the “Independent Directors”) receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex based on relative net assets. The “Highland Fund Complex” consists of all of the registered investment companies advised by the Adviser and any affiliates as of the period covered by this report. The Company pays no compensation to any of its officers, all of whom are employees of an affiliate of the Adviser. Prior to December 8, 2017, Mr. Powell was treated as an “interested person” of the Company for all purposes other than compensation and the Company’s code of ethics.

For the three and nine months ended September 30, 2018, the Company recorded an expense relating to director fees of $5,498 and $14,844, respectively. For the three and nine months ended September 30, 2017, the Company recorded an expense relating to director fees of $4,526 and $11,129, respectively, which represents the allocation of the director fees to the Company. As of September 30, 2018, there was $0 of expenses payable relating to director fees.

 

27


Expense Limits and Reimbursements

Pursuant to an expense limitation agreement, the Adviser is contractually obligated to waive fees and, if necessary, pay or reimburse certain other expenses to limit the ordinary “Other Expenses” to 1.0% of the quarter-end value of the Company’s gross assets through the one year anniversary of the effective date of the registration statement (the “Expense Limitation Agreement”). Under the Expense Limitation Agreement, “Other Expenses” are all expenses with the exception of advisor and administration fees, organization and offering costs and the following: (i) interest, taxes, dividends tied to short sales, brokerage commissions, and other expenditures which are capitalized in accordance with U.S. GAAP; (ii) expenses incurred indirectly as a result of investments in other investment companies and pooled investment vehicles; (iii) other expenses attributable to, and incurred as a result of, our investments; (iv) expenses payable to the Adviser, as administrator, for providing significant managerial assistance to our portfolio companies; and (v) other extraordinary expenses (including litigation expenses) not incurred in the ordinary course of our business. The obligation will automatically renew for one-year terms unless it is terminated by the Company or the Adviser upon written notice within 120 days of the end of the current term or upon termination of the Investment Advisory Agreement. The Expense Limitation Agreement will continue through at least April 30, 2019.

Any expenses waived or reimbursed by the Adviser pursuant to the Expense Limitation Agreement are subject to possible recoupment by the Adviser within three years from the date of the waiver or reimbursement. The recoupment by the Adviser will be limited to the amount of previously waived or reimbursed expenses and cannot cause the Company’s expenses to exceed any expense limitation in place at the time of recoupment or waiver.

Reimbursable Expenses Table

The cumulative total of fees waived by the Adviser under the Expense Limitation Agreement, which are recoupable as of September 30, 2018 is $928,952. This balance, and the balances in the tables below, only include amounts pertaining to the Expense Limitation Agreement, and do not include waived advisory and administration fees subject to recoupment discussed earlier in Note 4. The following table reflects the fee waivers and expense reimbursements due from the Adviser as of September 30, 2018, June 30, 2018 and March 31, 2018, which may become subject to recoupment by the Adviser.

 

Period ended

   Yearly cumulative
other expense
     Yearly expense
limitation
     Yearly cumulative
expense
reimbursement
     Quarterly
recoupable
amount
     Recoupment
eligibility
expiration
 

September 30, 2018

   $ 950,045      $ 801,704      $ 148,341      $ 23,992        September 30, 2021  

June 30, 2018

     613,809        489,460        124,349        44,203        June 30, 2021  

March 31, 2018

     341,882        261,736        80,146        80,146        March 31, 2021  

The following table reflects the fee waivers and expense reimbursements due from the Adviser as of December 31, 2017, September 30, 2017, June 30, 2017 and March 31, 2017, which may become subject to recoupment by the Adviser.

 

Period ended

   Yearly cumulative
other expense
     Yearly expense
limitation
     Yearly cumulative
expense
reimbursement
     Quarterly
recoupable/(recouped)
amount
    Recoupment
eligibility
expiration
 

December 31, 2017

   $ 1,304,585      $ 975,289      $ 329,296      $ (122,135     December 31, 2020  

September 30, 2017

     983,110        531,679        451,431        252,953       September 30, 2020  

June 30, 2017

     631,906        433,428        198,478        50,913       June 30, 2020  

March 31, 2017

     329,791        182,226        147,565        147,565       March 31, 2020  

The following table reflects the fee waivers and expense reimbursements due from the Adviser as of December 31, 2016, September 30, 2016, June 30, 2016 and March 31, 2016, which may become subject to recoupment by the Adviser.

 

28


Period ended

   Yearly cumulative
other expense
     Yearly expense
limitation
     Yearly cumulative
expense
reimbursement
     Quarterly
recoupable
amount
     Recoupment
eligibility
expiration
 

December 31, 2016

   $ 1,263,735      $ 835,904      $ 427,831      $ 147,943        December 31, 2019  

September 30, 2016

     803,909        524,021        279,888        32,663        September 30, 2019  

June 30, 2016

     567,248        320,023        247,225        90,124        June 30, 2019  

March 31, 2016

     259,420        102,319        157,101        157,101        March 31, 2019  

The following table reflects the fee waivers and expense reimbursements due from the Adviser as of December 31, 2015, September 30, 2015, June 30, 2015 and March 31, 2015, which may become subject to recoupment by the Adviser.

 

Period ended

   Yearly cumulative
other expense
     Yearly expense
limitation
     Yearly cumulative
expense
reimbursement
     Quarterly
recoupable
amount
     Recoupment
eligibility
expiration
 

December 31, 2015

   $ 1,440,686      $ 309,265      $ 1,131,421      $ 23,484        December 31, 2018  

September 30, 2015

     1,272,439        164,502        1,107,937        —          Expired  

June 30, 2015

     771,350        98,330        673,020        —          Expired  

March 31, 2015

     353,760        95,291        258,469        —          Expired  

During the three and nine months ended September 30, 2018, $434,917 and $1,107,937, respectively, of expense reimbursements that were eligible for recoupment by the Adviser expired.

There can be no assurance that the Expense Limitation Agreement will remain in effect or that the Adviser will reimburse any portion of the Company’s expenses in future quarters not covered by the Expense Limitation Agreement. Amounts shown do not include the amounts committed by the Adviser to voluntarily reimburse the Company for unrealized losses, all of which are not recoupable.

Net Increase from Amounts Committed by Affiliates

For the nine months ended September 30, 2018 and September 30, 2017, the Adviser did not voluntarily reimburse the Company for unrealized losses sustained. Cumulatively since inception, the Adviser has paid $2,275,000 to voluntarily reimburse the Company for such losses. Had these payments not been made, the net asset value (“NAV”) as of September 30, 2018 would have been lower by approximately this amount.

Amounts committed and paid by the Adviser to reimburse for unrealized losses are non-recurring and not recoupable, and investors should not expect the Adviser to make similar commitments or payments in the future.

Receivable from Adviser / Payable to Adviser

As of September 30, 2018 and December 31, 2017, there were no amounts owed from the Adviser to the Company.

As of September 30, 2018 and December 31, 2017, the Company owed $607,220 and $296,092, respectively, to the Adviser, largely related to advisory fees, administration fees, and the expense limitation agreement.

Indemnification

Under the Company’s organizational documents, the officers and Directors have been granted certain indemnification rights against certain liabilities that may arise out of performance of their duties to the Company. Additionally, in the normal course of business, the Company may enter into contracts with service providers that contain a variety of indemnification clauses. The Company’s maximum exposure under these arrangements is dependent on future claims that may be made against the Company and, therefore, cannot be estimated.

 

29


Note 5 — U.S. Federal Income Tax Information

The Company has elected to be treated for federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code. To maintain its qualification as a RIC, the Company must, among other things, meet certain source-of-income and asset diversification requirements and distribute to its stockholders, for each taxable year, at least 90% of its “investment company taxable income,” which is generally the Company’s net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses. As a RIC, the Company will not be subject to corporate-level federal income taxes on any income that it timely distributes to its stockholders. The Company intends to make distributions in an amount sufficient to maintain its RIC status each year and to avoid any federal income taxes on income so distributed. The Company will also be subject to nondeductible federal excise taxes if it does not distribute at least 98% of net ordinary income, 98.2% of any capital gain net income, if any, and any recognized and undistributed income from prior years on which it paid no federal income taxes.

The character of income and capital gains to be distributed is determined in accordance with the Code, U.S. Treasury regulations, and other applicable authority, which may differ from U.S. GAAP. These differences include (but are not limited to) investments organized as partnerships for tax purposes, defaulted bonds, losses deferred to off-setting positions, and losses deferred due to wash sale transactions. Reclassifications are made to the Company’s capital accounts to reflect income and gains available for distribution (or available capital loss carryovers) under the Code, U.S. Treasury regulations, and other applicable authority. These reclassifications have no impact on net investment income, realized gains or losses, or net asset value of the Company. The calculation of net investment income per share in the Financial Highlights table excludes these adjustments.

Uncertainty in Income Taxes

The Company will evaluate its tax positions to determine if the tax positions taken meet the minimum recognition threshold in connection with accounting for uncertainties in income tax positions taken or expected to be taken for the purposes of measuring and recognizing tax benefits or liabilities in the financial statements. Recognition of a tax benefit or liability with respect to an uncertain tax position is required only when the position is “more likely than not” to be sustained assuming examination by taxing authorities. The Company’s tax returns are subject to examination by the Internal Revenue Service for a period of three fiscal years after they are filed. The Company recognizes interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in the Statements of Operations. During the nine months ended September 30, 2018 and September 30, 2017, the Company did not incur any interest or penalties. Furthermore, management of the Company is also not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly change in the next 12 months.

Note 6 — Share Repurchase Program

On a quarterly basis, the Company intends to offer to repurchase shares of common stock on such terms as may be determined by the Board in its complete and absolute discretion unless, in the judgment of the Independent Directors of the Board, such repurchases would not be in the best interests of the Company’s stockholders or would violate applicable law. The Company will conduct such repurchase offers in accordance with the requirements of Rule 13e-4 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the 1940 Act. In months in which the Company repurchases shares of common stock, it will conduct repurchases on the same date that it holds its first weekly closing for the sale of shares of common stock in its public offering. Any offer to repurchase shares of common stock will be conducted solely through tender offer materials mailed to each stockholder.

The Company currently intends to limit the number of shares of common stock to be repurchased during any calendar year to the number of shares of common stock it can repurchase with the proceeds it receives from the sale of shares of common stock under its distribution reinvestment plan. At the discretion of the Board, the Company may also use cash on hand, cash available from borrowings and cash from liquidation of securities investments as of the end of the applicable period to repurchase shares of common stock. In addition, the Company will limit the number of shares of common stock to be repurchased in any calendar year to 10.0% of the weighted average number of shares of common stock outstanding in the prior calendar year, or 2.5% in each quarter, though the actual number of shares of common stock that the Company offers to repurchase may be less in light of the limitations noted above. The Company intends to offer to repurchase such shares of common stock at a price equal to 90% of the offering price in effect on each date of repurchase. The Board may amend, suspend or terminate the share repurchase program at any time, upon 30 days’ notice.

The Company conducted its quarterly tender offer from March 2, 2018, until expiration of March 30, 2018 at 5:00p.m. New York City time, during which the Company offered to purchase for cash up to 2.5% of its outstanding shares of common stock. During the first quarter tender offer, 73,736 shares of the Company were tendered for repurchase, constituting approximately 0.71% of the Company’s outstanding shares.

 

30


The Company conducted its quarterly tender offer from June 1, 2018, until expiration of June 28, 2018 at 5:00p.m. New York City time, during which the Company offered to purchase for cash up to 2.5% of its outstanding shares of common stock. During the second quarter tender offer, 142,605 shares of the Company were tendered for repurchase, constituting approximately 1.38% of the Company’s outstanding shares.

The Company conducted its quarterly tender offer from August 28, 2018, until expiration of September 27, 2018 at 5:00p.m. New York City time, during which the Company offered to purchase for cash up to 2.5% of its outstanding shares of common stock. During the third quarter tender offer, 73,877 shares of the Company were tendered for repurchase, constituting approximately 0.71% of the Company’s outstanding shares.

For the nine months ended September 30, 2018, the Company repurchased 3,752 shares as part of its death and disability repurchase program.

Note 7 —   Credit Facility and Leverage Facilities

On January 6, 2015, the Company entered into a senior, secured revolving credit facility (the “Credit Facility”) with State Street Bank and Trust Company (“State Street”), as lender and agent. Under the Credit Facility, State Street had agreed to extend credit to the Company in an aggregate principal amount of up to $25 million, at a rate of L +1.15%, subject to borrowing base availability and restrictions on the Company’s total outstanding debt.

On January 5, 2016, the Company entered into an amendment to the Credit Facility to, among other things, increase the unused commitment fee from 0.15% to 0.25% and extend the final maturity date to January 3, 2017.

On January 3, 2017, the Company entered into an amendment to the Credit Facility to extend the final maturity date to March 20, 2017. The Credit Facility was fully paid down on February 24, 2017, and expired on March 20, 2017.

On October 19, 2017, the Company entered into a financing arrangement (the “Financing Arrangement”) with BNP Paribas Prime Brokerage International, Ltd., BNP Prime Brokerage, Inc., and BNP Paribas (together, the “BNPP Entities”). Under the Financing Agreement, the BNPP Entities may make margin loans to the Company at a rate of one-month LIBOR + 1.30%. The BNPP Entities have the right to cap the amount of margin loans with prior notice to the Company. The Financing Arrangement may be terminated by either the Company or the BNPP Entities with 179 days’ notice. At September 30, 2018, current outstanding and fair value amounts were $24,048,974 and $24,149,185, respectively.

For the three and nine months ended September 30, 2018 and September 30, 2017, the components of total interest expense were as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2018     2017      2018     2017  

Direct interest expense

   $ 161,124     $ —        $ 517,747     $ 42,325  

Commitment fees

     —         —          —         8,054  

Amortization of financing costs

     —         —          —         —    
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest expense

   $ 161,124     $ —        $ 517,747     $ 50,379  
  

 

 

   

 

 

    

 

 

   

 

 

 

Average daily amount outstanding

     19,692,021       —          21,357,133       2,909,158  

Weighted average interest rate

     3.20     —          3.10     1.95

The Company is required to maintain 200% asset coverage with respect to its borrowings outstanding. Asset coverage is calculated by subtracting the Company’s total liabilities, not including any amount representing bank loans and senior securities, from the Company’s total assets and dividing the result by the principal amount of the borrowings outstanding. As of the dates indicated below, the Company’s borrowings outstanding and asset coverage was as follows:

 

31


Nine months ended

   Total amount
outstanding
     % of asset
coverage
 

09/30/2018

   $ 60,330,319        267

06/30/2018

     52,950,925        290

12/31/2017

     46,540,921        304

BNP Paribas Total Return Swap

On June 13, 2017, the Company entered into the TRS with BNP Paribas over one or more loans, with a maximum aggregate notional amount of the portfolio debt securities subject to the TRS of $40 million. The agreements between the Company and BNP Paribas, which collectively establish the TRS, are referred to herein as the “TRS Agreement.”

On April 2, 2018, the Company amended and restated the TRS agreement with BNP Paribas. The amended and restated TRS Agreement, effective April 10, 2018 increases the maximum aggregate notional amount of the portfolio debt securities subject to the TRS to $60 million.

A TRS is a contract in which one party agrees to make payments to another party based on the increase, if any, in the market value of the asset(s) underlying the TRS, which may include a specified security, basket of securities or securities indices during a specified period, and the other party agrees to make payments to the first party based on the decrease, if any, in the market value of such underlying assets plus periodic payments based on a fixed or variable interest rate. A TRS effectively adds leverage to a portfolio by providing investment exposure to an underlying asset without owning or taking physical custody of the underlying asset. A TRS often offers lower financing costs than are offered through more traditional borrowing arrangements.

Each individual security subject to the TRS, and the portfolio of securities taken as a whole, must meet certain criteria described in the TRS Agreement, including a requirement that the securities underlying the TRS be rated by either Moody’s or S&P, and, if rated by Moody’s, have a rating of at least Caa3 and, if rated by S&P, have a rating of at least CCC-. Under the terms of the TRS, BNP Paribas determines whether there has been a failure to satisfy the portfolio criteria in the TRS but may, in its sole discretion, permit assets that do not meet the minimum portfolio criteria set forth in the TRS. If BNP Paribas determines that an asset has failed to meet the minimum portfolio criteria, BNP Paribas may exercise certain rights, including increasing the amount of collateral the Company is required to provide to it or terminating all or part of the TRS, subject to certain conditions. The Company receives from BNP Paribas interest and fees payable to holders of the securities included in the portfolio. The Company pays interest to BNP Paribas generally based on a percentage of the notional amount of the securities subject to the TRS. In addition, upon the termination or repayment of any security subject to the TRS, the Company will either receive from BNP Paribas the appreciation in the value of such security or pay to BNP Paribas any depreciation in the value of such security.

Under the terms of the TRS, the Company or BNP Paribas may be required to post additional collateral, on a dollar-for-dollar basis, in certain circumstances, including in the event of depreciation or appreciation in the value of the underlying loans. The limit on the additional collateral that the Company may be required to post pursuant to the TRS is equal to the difference between the full notional amount of the loans underlying the TRS and the amount of cash collateral already posted by the Company. The amount of collateral required to be posted is determined primarily on the basis of the aggregate value of the underlying securities.

The Company may terminate the TRS at any time more than one month prior to the TRS’s scheduled termination date upon providing no less than 30 days’ prior notice to BNP Paribas.

Included among the customary events of default and termination events in the TRS Agreement are: bankruptcy or insolvency of a party, failure to satisfy any obligations under the TRS (including payment of collateral), and misrepresentation. BNP Paribas also has the right to terminate the TRS in certain circumstances, including if the relevant loans fail to meet the agreed-upon criteria specified in the TRS Agreement or if certain credit events with respect to the “reference entity” specified with respect to a security occur, and the Company declines to provide additional collateral to BNP Paribas upon request.

Upon any termination of the TRS, the Company will be required to pay BNP Paribas the amount of any decline in the aggregate value of the securities subject to the TRS or, alternatively, will be entitled to receive the amount of any appreciation in the aggregate value of such securities. In the event that BNP Paribas chooses to exercise its termination rights, it is possible that the Company will owe more to BNP Paribas or, alternatively, will be entitled to receive less from BNP Paribas than the Company would have if it controlled the timing of such termination, due to the existence of adverse market conditions at the time of such termination.

 

32


For purposes of the asset coverage ratio test applicable to the Company as a BDC, the Company treats the outstanding notional amount of the TRS, less the initial amount of any cash collateral required to be posted by the Company under the TRS, as a senior security for the life of that instrument. The Company may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.

Further, for purposes of Section 55(a) under the 1940 Act, the Company treats each security underlying the TRS as a qualifying asset if such security is a loan and the obligor on such loan is an eligible portfolio company, and as a non-qualifying asset if the obligor is not an eligible portfolio company. The Company may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.

The following is a summary of the underlying loans subject to the TRS as of September 30, 2018:

 

Underlying Loan

   Industry    Interest      Base
Rate
Floor
    Maturity
Date
     Notional
Amount(1)
     Market
Value
     Unrealized
Appreciation
(Depreciation)
 

Advantage Sales & Marketing, Inc. (Second Lien Term Loan)

   Service      L + 650        1.00     7/25/2022      $ 2,853,750      $ 2,490,000      $ (363,750

Air Medical Group Holdings (First Lien Term Loan)

   Aerospace      L + 425        1.00     9/26/2024        3,967,506        3,974,987        7,481  

ASP AMC Merger Sub, Inc. (First Lien Term Loan)

   Financial      L + 350        1.00     4/21/2024        1,838,000        1,822,500        (15,500

Avantor, Inc. (First Lien Term Loan)

   Chemicals      L + 400        1.00     11/21/2024        4,024,862        4,019,874        (4,988

BioClinica, Inc. (First Lien Term Loan)

   Healthcare      L + 425        1.00     10/20/2023        1,898,291        1,876,046        (22,245

Employbridge, LLC (First Lien Term Loan)

   Service      L + 500        1.00     4/10/2025        960,549        954,635        (5,914

Endo Luxembourg Finance Company I S.a r.l. (First Lien Term Loan)

   Healthcare      L + 425        0.75     4/29/2024        4,009,848        4,014,836        4,988  

Granite Acquisition, Inc. (Second Lien Term Loan)

   Utility      L + 725        1.00     12/19/2022        3,736,725        3,713,506        (23,219

BW NHHC Holdco, Inc. (First Lien Term Loan)

   Healthcare      L + 500        0.00     5/15/2025        4,594,965        4,548,784        (46,181

Lanai Holdings II, Inc. (First Lien Term Loan)

   Healthcare      L + 475        1.00     8/28/2022        2,481,858        2,379,609        (102,249

Quorum Health Corp. (First Lien Term Loan)

   Healthcare      L + 675        1.00     4/29/2022        7,177,942        7,198,520        20,578  

SkillSoft Corp. (First Lien Term Loan)

   Technology      L + 475        1.00     4/28/2021        1,862,628        1,860,190        (2,438

Sound Inpatient Physicians (First Lien Term Loan)

   Healthcare      L + 675        0.00     6/26/2026        1,575,000        1,557,500        (17,500

Truck Hero, Inc. (Second Lien Term Loan)

   Manufacturing      L + 825        1.00     5/10/2025        1,666,667        1,679,167        12,500  

U.S Renal Care, Inc. (Second Lien Term Loan)

   Healthcare      L + 800        1.00     12/31/2023        1,939,438        1,828,750        (110,688

Vyaire Medical, Inc. (First Lien Term Loan)

   Healthcare      L + 475        1.00     4/11/2025        4,867,606        4,956,338        88,732  

Weight Watchers International, Inc. (First Lien Term Loan)

   Service      L + 475        0.75     11/29/2024        5,625,710        5,597,252        (28,458
                   

 

 

 
                Total      $ (608,851
                

 

 

 
               
Accrued income and
liabilities
 
 
     209,663  
                

 

 

 
                Total TRS Fair Value      $ (399,188
                

 

 

 

 

(1) 

Notional value of the underlying securities in the TRS is calculated by multiplying par by the initial price.

 

33


The following is a summary of the underlying loans subject to the TRS as of December 31, 2017:

 

Underlying Loan

   Industry      Interest      Base
Rate
Floor
    Maturity
Date
     Notional
Amount(1)
     Market
Value
     Unrealized
Appreciation
(Depreciation)
 

Advantage Sales & Marketing, Inc. (Second Lien Term Loan)

     Service        L + 650        1.00     7/25/2022      $  2,853,750      $  2,775,000      $  (78,750

DJO Finance, LLC (First Lien Term Loan)

     Healthcare        L + 325        1.00     6/16/2020        3,989,796        3,934,936        (54,860

Fieldwood Energy, LLC (First Lien Term Loan)

     Energy        L + 700        1.00     8/31/2020        1,728,527        1,620,494        (108,033

Fieldwood Energy, LLC (First Lien Term Loan)

     Energy        L + 712.5        1.25     9/30/2020        478,369        389,889        (88,480

Granite Acquisition, Inc. (Second Lien Term Loan)

     Utility        L + 725        1.00     12/19/2022        3,736,725        3,717,219        (19,506

iHeartCommunications, Inc. (First Lien Loan)

    

Media/

Telecommunications

 

 

     L + 675        —         1/30/2019        4,112,500        3,737,500        (375,000

Kindred Healthcare, Inc. (First Lien Term Loan)

     Healthcare        L + 350        1.00     4/09/2021        6,503,210        6,499,470        (3,740

Lanai Holdings II, Inc. (First Lien Term Loan)

     Healthcare        L + 475        1.00     8/28/2022        2,503,122        2,375,000        (128,122

Quorum Health Corp. (First Lien Term Loan)

     Healthcare        L + 675        1.00     4/29/2022        5,260,919        5,306,952        46,033  

SkillSoft Corp. (First Lien Term Loan)

     Technology        L + 475        1.00     4/28/2021        1,867,441        1,877,218        9,777  

SkillSoft Corp. (Second Lien Term Loan)

     Technology        L + 825        1.00     4/28/2022        1,259,895        1,327,389        67,494  

Truck Hero, Inc. (Second Lien Term Loan)

     Manufacturing        L + 825        1.00     5/10/2025        1,666,667        1,670,834        4,167  
                   

 

 

 
                Total      $  (729,020
                

 

 

 
               
Accrued income and
liabilities
 
 
     165,197  
                

 

 

 
                Total TRS Fair Value      $ (563,823
                

 

 

 

 

(1) 

Notional value of the underlying securities in the TRS is calculated by multiplying par by the initial price.

As of September 30, 2018 and December 31, 2017, the Company had posted $18,800,000 and $13,820,000, respectively, of cash collateral against the TRS held in an account at the Company’s custodian bank, which is shown as due from counterparty on the Statements of Assets and Liabilities.

During the nine months ended September 30, 2018, the Company recognized a net realized gain on the TRS amounting to $750,299. The Company received $653,318 in cash payments from the TRS during the period and paid $137,472, with an increase of $234,453 in receivable from BNP Paribas for the nine months ended September 30, 2018.

Note 8 — Economic Dependency and Commitments and Contingencies

Under various agreements, the Company has engaged the Adviser and its affiliates to provide certain services that are essential to the Company, including asset management services, asset acquisition and disposition decisions, the sale of shares of the Company’s common stock available for issue, as well as other administrative responsibilities for the Company including accounting services and investor relations. Additionally, prior to the termination of the offering, the Adviser paid all of the Company’s organization and offering costs subject to reimbursement to the extent organization and offering costs paid by the Adviser did not exceed 1% of gross proceeds raised. Please see Note 4 for additional details on organization and offering costs.

 

34


As a result of these relationships, the Company is dependent upon the Adviser and its affiliates. In the event that these companies are unable to provide the Company with the respective services, the Company will be required to find alternative providers of these services.

From time to time, the Company may be involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be predicted with any clarity, management is of the opinion, based on the advice of legal counsel, that final dispositions of any litigation should not have a material adverse effect on the financial position of the Company as of September 30, 2018.

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide general indemnification. The Company’s maximum exposure under these agreements is unknown, as this would involve future claims that may be made against the Company that have not occurred. The Company believes the risk of material obligations under these indemnities to be low. See also Note 12 regarding the end of the offering period.

Note 9 — Market and Other Risk Factors

The primary risks of investing in the Company are described below in alphabetical order:

Concentration Risk

The Company is classified as a non-diversified investment company within the meaning of the 1940 Act, which means that it is not limited by the 1940 Act with respect to the proportion of the Company’s assets that it may invest in securities of a single issuer. To the extent that the Company assumes large positions in the securities of a small number of issuers, the Company’s 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. The Company may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company. Beyond the asset diversification requirements associated with the Company’s qualification as a RIC under the Code and certain contractual diversification requirements under a credit facility or other agreements, the Company does not have fixed guidelines for diversification, and its investments could be concentrated in relatively few portfolio companies. As a result, the aggregate returns the Company realizes may be significantly adversely affected if a small number of investments perform poorly or if the Company needs to write down the value of any one investment. Additionally, the Company’s investments may be concentrated in relatively few industries. As a result, a downturn in any particular industry in which the Company is invested could also significantly impact the aggregate returns realized.

Counterparty Credit Risk

Counterparty credit risk is the potential loss the Company may incur as a result of the failure of a counterparty or an issuer to make payments according to the terms of a contract. Counterparty credit risk is measured as the loss the Company would record if its counterparties failed to perform pursuant to the terms of their obligations to the Company. Because the Company may enter into over-the-counter forwards, options, swaps and other derivative financial instruments, the Company may be exposed to the credit risk of its counterparties. To limit the counterparty credit risk associated with such transactions, the Company conducts business only with financial institutions judged by the Adviser to present acceptable credit risk.

Credit Risk

Investments rated below investment grade are commonly referred to as high-yield, high risk or “junk debt.” They are regarded as predominantly speculative with respect to the issuing company’s continuing ability to meet principal and/or interest payments. Investments in high yield debt and high yield senior loans may result in greater net asset value fluctuation than if the Company did not make such investments. Corporate debt obligations, including senior loans, are subject to the risk of non-payment of scheduled interest and/or principal.

 

35


Non-payment would result in a reduction of income to the Company, a reduction in the value of the corporate debt obligation experiencing non-payment and a potential decrease in the net asset value of the Company. Some of the loans the Company makes or acquires may provide for the payment by borrowers of Payment-In-Kind (“PIK”) interest or accreted original issue discount at maturity. Such loans have the effect of deferring a borrower’s payment obligation until the end of the term of the loan, which may make it difficult for the Company to identify and address developing problems with borrowers in terms of their ability to repay debt. Particularly in a rising interest rate environment, loans containing PIK and original issue discount provisions can give rise to negative amortization on a loan, resulting in a borrower owing more at the end of the term of a loan than what it owed when the loan was originated. Any such developments may increase the risk of default on the Company’s loans by borrowers.

Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered “securities” for purposes of the anti-fraud protections of the federal securities laws and, as a result, as a purchaser of these instruments, the Company may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, the Company may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, the Company may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for us to do so. Alternatively, the Company may choose not to receive material nonpublic information about an issuer of such loans, with the result that the Company may have less information about such issuers than other investors who transact in such assets.

Foreign Securities Risk

Investments in foreign securities involve certain factors not typically associated with investing in U.S. securities, such as risks relating to (i) currency exchange matters, including fluctuations in the rate of exchange between the U.S. dollar (the currency in which the books of the Company are maintained) and the various foreign currencies in which the Company’s portfolio securities will be denominated and costs associated with conversion of investment principal and income from one currency into another; (ii) differences between the U.S. and foreign securities markets, including the absence of uniform accounting, auditing and financial reporting standards and practices and disclosure requirements, and less government supervision and regulation; (iii) political, social or economic instability; and (iv) the extension of credit, especially in the case of sovereign debt.

Illiquid Securities Risk

The Company will generally make investments in private companies. Substantially all of these investments will be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities. The illiquidity of the Company’s investments may make it difficult for the Company to sell such investments if the need arises. In addition, if it is required to liquidate all or a portion of its portfolio quickly, the Company may realize significantly less than the value at which it has previously recorded its investments. In addition, it may face other restrictions on its ability to liquidate an investment in a portfolio company to the extent that it has material non-public information regarding such portfolio company or if an investment is held by one of its subsidiaries and is subject to contractual limitations on sale, such as the limitations on transfer of assets under certain circumstances under a credit facility.

Because loan transactions often take longer to settle than transactions in other securities, the Company may not receive the proceeds from the sale of a loan for a significant period of time. As a result, the Company may maintain higher levels of cash and short-term investments than funds that invest in securities with shorter settlement cycles and/or may use the Credit Facility to permit the Company to meet its obligations pending settlement of the sale of portfolio securities, each of which may adversely affect the Company’s performance.

The company seeks to address its short-term liquidity needs by carefully managing the settlements of its portfolio transactions, including transactions in loans, by maintaining short-term liquid assets sufficient to meet reasonably anticipated obligations, and by maintaining the Credit Facility.

Investments in Foreign Markets Risk

Investments in foreign markets involve special risks and considerations not typically associated with investing in the United States. These risks include revaluation of currencies, high rates of inflation, restrictions on repatriation of income and capital, and adverse political and economic developments. Moreover, securities issued in these markets may be less liquid, subject to government ownership controls, tariffs and taxes, subject to delays in settlements, and their prices may be more volatile. The Company may be

 

36


subject to capital gains and repatriation taxes imposed by certain countries in which they invest. Such taxes are generally based on income and/or capital gains earned or repatriated. Taxes are accrued based upon net investment income, net realized gains and net unrealized appreciation as income and/or capital gains are earned.

Leverage Risk

The Company may use leverage in its investment program, including the use of borrowed funds and investments in certain types of options, such as puts, calls and warrants, which may be purchased for a fraction of the price of the underlying securities. While such strategies and techniques increase the opportunity to achieve higher returns on the amounts invested, they also increase the risk of loss. To the extent the Company purchases securities with borrowed funds, its net assets will tend to increase or decrease at a greater rate than if borrowed funds are not used. If the interest expense on borrowings were to exceed the net return on the portfolio securities purchased with borrowed funds, the Company’s use of leverage would result in a lower rate of return than if the Company were not leveraged.

Options Risk

There are several risks associated with transactions in options on securities. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A transaction in options or securities may be unsuccessful to some degree because of market behavior or unexpected events.

When the Company writes a covered call option, the Company forgoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but retains the risk of loss should the price of the underlying security decline. The writer of an option has no control over the time when it may be required to fulfill its obligation and once an option writer has received an exercise notice, it must deliver the underlying security in exchange for the strike price.

When the Company writes a covered put option, the Company bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Company could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Company received when it wrote the option. While the Company’s potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Company risks a loss equal to the entire exercise price of the option minus the put premium.

Short-Selling Risk

Short sales by the Company that are not made where there is an offsetting long position in the asset that it is being sold short theoretically involve unlimited loss potential since the market price of securities sold short may continuously increase. Short selling allows the Company to profit from declines in market prices to the extent such decline exceeds the transaction costs and costs of borrowing the securities. However, since the borrowed securities must be replaced by purchases at market prices in order to close out the short position, any appreciation in the price of the borrowed securities would result in a loss. Purchasing securities to close out the short position can itself cause the price of securities to rise further, thereby exacerbating the loss. The Company may mitigate such losses by replacing the securities sold short before the market price has increased significantly. Under adverse market conditions, the Company might have difficulty purchasing securities to meet margin calls on its short sale delivery obligations, and might have to sell portfolio securities to raise the capital necessary to meet its short sale obligations at a time when fundamental investment considerations would not favor such sales.

Total Return Swap Risk

The TRS with BNP Paribas enables us to obtain the economic benefit of owning the securities subject to the TRS without actually owning such securities, in return for making periodic interest-type payments to BNP Paribas plus an amount equal to the depreciation in value of the securities. The TRS is subject to market risk, liquidity risk and risk of imperfect correlation between the value of the TRS and the securities underlying the TRS. In addition, we may incur certain costs in connection with the TRS, including

 

37


an underutilization fee in the event that we utilize less than 80% of the amount of the TRS. Costs associated with the TRS could, in the aggregate, be significant. Because this arrangement is not an acquisition of the underlying securities, we have no right to enforce contractual provisions that stem from ownership in the securities and have no voting or other rights of ownership. In the event of insolvency of BNP Paribas, we expect that we would be treated as a general creditor of BNP Paribas and would have no claim of title with respect to the underlying securities.

A TRS is also subject to the risk that a counterparty will default on its payment obligations thereunder or that we will not be able to meet our obligations to the counterparty. In the case of the TRS with BNP Paribas, we are required to post collateral to secure our obligations to BNP Paribas under the TRS. BNP Paribas, however, is not required to collateralize any of its obligations to us under the TRS. We bear the risk of depreciation with respect to the value of the securities underlying the TRS and are required under the terms of the TRS to post additional collateral on a dollar-for-dollar basis in the event of depreciation in the value of the underlying securities after such value decreases below a specified amount. The amount of collateral required to be posted by us is determined primarily on the basis of the aggregate value of the underlying securities.

In addition, because a TRS is a form of leverage, such arrangements are subject to risks similar to those associated with the use of leverage.

Note 10 — Affiliated Investments

Under Section 2(a)(3) of the 1940 Act, a portfolio company is defined as “affiliated” if a fund owns five percent or more of its outstanding voting securities or if the portfolio company is under common control. The table below shows affiliated issuers of the Company as of September 30, 2018:

 

Affiliated investments    Fair value
as of
December 31,
2017
     Purchases      Sales      Realized
gains
(losses)
     Change in
unrealized
gains
(losses)
     Fair value
as of
September 30,
2018
     Dividend
income
 

Gambier Bay, LLC(1)

   $ 803,329      $ —        $ —        $ —        $ 413,140      $ 1,216,469      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NexPoint Strategies Opportunities Fund

     16,793        1,429,865        —                 11,089        1,457,747        56,895  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total affiliated investments

   $ 820,122      $ 1,429,865      $ —        $ —        $ 424,229      $ 2,674,216      $ 56,895  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Includes the value of iHeart Communications, Inc. bonds as of December 31, 2017 and subsequent activity.

 

38


Note 11 — Financial Highlights

Selected data for a share outstanding throughout the nine months ended September 30, 2018 and September 30, 2017 is as follows:

 

     For the Nine
Months Ended
    For the Nine
Months Ended
 
    

September 30, 2018

(Unaudited)

   

September 30, 2017

(Unaudited)

 

Common shares per share operating performance:

 

Net asset value, beginning of period

   $ 9.68     $ 9.47  

Income from investment operations:

 

Net investment income(1)

     0.17       0.63  

Net realized and unrealized gain (loss)

     0.33       (0.02
  

 

 

   

 

 

 

Total from investment operations

     0.50       0.61  
  

 

 

   

 

 

 

Less distribution declared to common shareholders:

 

From net investment income

     (0.54     (0.54

From net realized gains

     —         —    
  

 

 

   

 

 

 

Total distributions declared to common shareholders

     (0.54     (0.54
  

 

 

   

 

 

 

Capital share transactions

 

Issuance of common stock(2)

     0.01       0.02  

Shares tendered(1)

     0.00 (3)       0.00 (3)  

Net asset value, end of period

   $ 9.65     $ 9.56  

Net asset value total return(4)(5)

     5.35     6.68

Ratio and supplemental data:

 

Net assets, end of period (in 000’s)

   $ 100,526     $ 87,510  

Shares outstanding, end of period

     10,416,708       9,156,755  

Common share information at end of period:

    

Ratios based on weighted average net assets of common shares:

    

Gross operating expenses(6)

     5.60     4.35

Fees and expenses waived or reimbursed(6)

     (0.20 )%      (2.79 )% 

Net operating expenses(6)

     5.40     1.56

Net investment income (loss) before fees waived or reimbursed(6)

     2.11     5.93

Net investment income (loss) after fees waived or reimbursed(6)

     2.31     8.72

Ratio of interest and credit facility expenses to average net assets(6)

     0.69     0.08

Ratio of incentive fees to average net assets(6)

     0.92     (0.19 )%(7) 

Portfolio turnover rate(5)

     52     91

Asset coverage ratio

     267     449

Weighted average commission rate paid(8)

   $ 0.0380     $ 0.0229  

 

 

(1) 

Per share data was calculated using weighted average shares outstanding during the period.

(2) 

The continuous issuance of common stock may cause an incremental increase in net asset value per share due to the sale of shares at the then prevailing public offering price and the receipt of net proceeds per share by the Company in excess of net asset value per share on each subscription closing date. The per share data was derived by computing (i) the sum of (A) the number of shares issued in connection with subscriptions and/or distribution reinvestment on each share transaction date times (B) the differences between the net proceeds per share and the net asset value per share on each share transaction date, divided by (ii) the total shares outstanding at the end of the period.

(3) 

Amount rounds to less than $0.005 per share.

(4) 

Total returns are historical and assume changes in share price and reinvestment of dividends and capital gains distributions, and assume no sales charge. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Company’s Dividend Reinvestment Plan. Had the Adviser not absorbed a portion of expenses, total returns would have been lower.

(5) 

Not annualized.

(6) 

Annualized.

(7) 

All incentive fees were waived for the nine months ended September 30, 2017.

(8) 

Represents the total dollar amount of commissions paid on portfolio transactions divided by total number of portfolio shares purchased and sold for which commissions were charged.

 

39


Note 12 — Subsequent Events

The Company has evaluated subsequent events through the date on which these financial statements were issued.

On September 17, 2018, the Board declared a cash distribution of $0.013846 per share of the Company’s common stock, par value $0.001 per share, to be paid on October 31, 2018, to the stockholders of record on October 1, 2018, October 8, 2018, October 15, 2018, October 22, 2018, and October 29, 2018. The Board also declared a cash distribution of $0.013846 per share of the Company’s common stock, par value $0.001 per share, to be paid on November 28, 2018, to the stockholders of record on November 5, 2018, November 12, 2018, November 19, 2018, and November 26, 2018.

On November 7, 2018, the board of directors (the “Board”) of NexPoint Capital, Inc. (the “Company”) declared a cash distribution of $0.013846 per share of the Company’s common stock, par value $0.001 per share, payable on January 3, 2019, to the stockholders of record on December 3, 2018, December 10, 2018, December 17, 2018, December 24, 2018 and December 31, 2018.

 

40