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THL CREDIT, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The information contained in this section should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This report, and other statements that we may make, may contain forward-looking statements with respect to future financial or business performance, strategies or expectations. Forward-looking statements are typically identified by words or phrases such as "trend," "opportunity," "pipeline," "believe," "comfortable," "expect," "anticipate," "current," "intention," "estimate," "position," "assume," "potential," "outlook," "continue," "remain," "maintain," "sustain," "seek," "achieve" and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may" or similar expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made, and we assume no duty to and do not undertake to update forward-looking statements. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance. In addition to factors previously identified elsewhere in this filing, the following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance: • the introduction, withdrawal, success and timing of business initiatives and strategies; • changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of our assets; • the relative and absolute investment performance and operations of our investment adviser; • the impact of increased competition; • the impact of future acquisitions and divestitures; • the unfavorable resolution of legal proceedings; • our business prospects and the prospects of our portfolio companies; • the impact, extent and timing of technological changes and the adequacy of intellectual property protection; • the impact of legislative and regulatory actions and reforms and regulatory, supervisory or enforcement actions of government agencies relating to us or THL Credit Advisors LLC, the Advisor; • the ability of the Advisor to identify suitable investments for us and to monitor and administer our investments; • our contractual arrangements and relationships with third parties; • any future financings by us; • the ability of the Advisor to attract and retain highly talented professionals; • fluctuations in foreign currency exchange rates; and • the impact of changes to tax legislation and, generally, our tax position. Overview THL Credit, Inc., or the Company, was organized as a Delaware corporation on May 26, 2009 and initially funded on July 23, 2009. We commenced principal operations on April 21, 2010. Our investment objective is to generate both current income and capital appreciation, primarily through investments in privately negotiated investments in debt and equity securities of middle market companies. We are externally managed by THL Credit Advisors LLC, or the Advisor. As of September 30, 2014, we, together with our credit-focused affiliates, collectively had $4,734.8 million of assets under management. This amount included $743.1 million of our assets, $194.0 million of assets of the managed funds and separate account managed by us, and $3,797.7 million of assets of the collateralized loan obligations (CLOs), separate accounts and various fund formats managed by the investment professionals of THL Credit Senior Loan Strategies LLC, the consolidated subsidiary of the Advisor. We are a direct lender to middle market companies and invest in first lien and second lien secured loans, including through unitranche investments, as well as subordinated debt, which may include an associated equity component such as warrants, preferred stock or other similar securities. In certain instances, we will also make direct equity investments and may also selectively invest in the residual interests, or equity, of collateralized loan obligations. We may also provide advisory services to managed funds. We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940 Act, as amended, or the 1940 Act. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," including securities of private or thinly traded public U.S . companies, cash, cash equivalents, U.S. Government securities and high-quality debt investments that mature in one year or less. 42-------------------------------------------------------------------------------- Table of Contents As a BDC, we must not acquire any assets other than "qualifying assets" specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in "eligible portfolio companies." Under the relevant U.S. Securities and Exchange Commission, or SEC, rules the term "eligible portfolio company" includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized in the United States. We are also registered as an investment adviser under the Investment Advisers Act of 1940, as amended, or the Advisers Act. Since April 2010, after we completed our initial public offering and commenced principal operations, we have been responsible for making, on behalf of ourselves, managed funds and separately managed account, over approximately an aggregate of $1,400.0 million in commitments into 74 separate portfolio companies through a combination of both initial and follow-on investments. Since April 2010, we, along with our managed funds and separately managed account, have received $608.0 million from paydowns related to these investments. The Company alone has received $492.4 million from paydowns and sales of investments. We have elected to be treated for tax purposes as a regulated investment company, or RIC, under Subchapter M of the Code. To qualify as a RIC, we must, among other things, meet certain source of income and asset diversification requirements. Pursuant to these elections, we generally will not have to pay corporate-level income taxes on any income we distribute to our stockholders. Portfolio Composition and Investment Activity Portfolio Composition As of September 30, 2014, we had $718.0 million of portfolio investments (at fair value), which represents a $69.1 million, or 10.6% increase from the $648.9 million (at fair value) as of December 31, 2013. We also increased our portfolio to 57 investments, including THL Credit Greenway Fund LLC, or Greenway, and THL Credit Greenway Fund II LLC, or Greenway II, as of September 30, 2014, from fifty-four portfolio investments, including Greenway and Greenway II, as of December 31, 2013. At September 30, 2014, our average portfolio company investment, exclusive of Greenway, Greenway II and portfolio investments where we only have an equity investment, at amortized cost and fair value was approximately $13.7 million and $13.6 million, respectively and our largest portfolio company investment by both amortized cost and fair value was approximately $31.5 million and $31.6 million, respectively. At December 31, 2013, our average portfolio company investment at both amortized cost and fair value was approximately $14.0 million and $13.9 million, respectively, and our largest portfolio company investment by both amortized cost and fair value was approximately $26.6 million. At September 30, 2014, based upon fair value, 70.8% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 29.2% bore interest at fixed rates. At December 31, 2013, 59.1% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 40.9% bore interest at fixed rates. The following table shows the weighted average yield by investment category at their current cost. As of September 30, December 31, Description: 2014 2013 First lien secured debt 11.0 % 11.0 % Second lien debt 11.7 % 11.3 % Subordinated debt (3) 10.7 % 12.1 % Investments in funds (1) - 12.6 % Investments in payment rights (2) 17.0 % 17.0 % CLO Residual interests (2) 13.5 % 14.0 % Income producing equity securities 9.7 % - Debt and income-producing investments 11.3 % 11.7 % Debt investments 11.1 % 11.4 % (1) As of December 31, 2013, investment in funds includes only our investment in LCP Capital Fund LLC, which is the only investment in funds where we receive regular payments. (2) Yields from investments in payment rights and CLO residual interests represents the implied internal rate of return "IRR" calculation expected from cash flow streams. (3) Includes the impact of all loans on non-accrual status. As of September 30, 2014 and December 31, 2013, portfolio investments, in which we have debt investments, had an average EBITDA of approximately $28 million and $30 million, respectively, based on the latest available financial information provided by the portfolio companies for each of these periods. As of September 30, 2014 and December 31, 2013, our weighted average debt to 43-------------------------------------------------------------------------------- Table of Contents EBITDA ratio in the capital structure of our portfolio companies is approximately 4.1 times and 4.2 times EBITDA, respectively, for each of these based on our latest available financial information for each of these periods. As of September 30, 2014, excluding investments in Greenway and Greenway II, 81.8% of our portfolio investments are in sponsored investments and 18.2% of our portfolio investments are in unsponsored investments. Our portfolio investments as of September 30, 2014 have used our capital for change of control transactions (27.3%), acquisitions/growth capital (23.6%), refinancings (12.7%), recapitalizations (20.0%) and other (16.4%). Since inception we have closed portfolio investments with 44 different sponsors. As of December 31, 2013, excluding investments in Greenway and Greenway II, 78.8% of our portfolio investments are in sponsored investments and 21.2% of our portfolio investments are in unsponsored investments. Our portfolio investments as of December 31, 2013 have used our capital for change of control transactions (34.6%), acquisitions/growth capital (13.5%), refinancings (13.5%), recapitalizations (21.2%) and other (17.3%). Since inception we have closed portfolio investments with thirty-four different sponsors. Consistent with our sourcing strategy, approximately 100% and 94% of the Company's new investments for the three and nine months ended September 30, 2014 were directly originated from our relationships with private equity firms, financial advisors, banks and other lending partners, respectively. The following table summarizes the amortized cost and fair value of investments as of September 30, 2014 (in millions). Amortized Percentage of Percentage of Description Cost Total Fair Value (1) Total First lien secured debt $ 317.1 44.2 % $ 319.3 44.5 % Second lien debt 196.0 27.3 % 195.7 27.3 % Subordinated debt 123.2 17.2 % 109.1 15.2 % CLO residual interests 34.1 4.7 % 36.0 5.0 % Equity investments 33.2 4.6 % 41.7 5.8 % Investment in payment rights 12.2 1.7 % 13.8 1.9 % Investments in funds 2.2 0.3 % 2.4 0.3 % Total investments $ 718.0 100.0 % $ 718.0 100.0 % The following table summarizes the amortized cost and fair value of investments as of December 31, 2013 (in millions). Amortized Percentage of Percentage of Description Cost Total Fair Value (1) Total First lien secured debt $ 261.7 40.5 % $ 263.1 40.6 % Subordinated debt 162.6 25.2 % 156.0 24.0 % Second lien debt 157.2 24.3 % 157.9 24.3 % CLO residual interests 37.3 5.8 % 37.6 5.8 % Investment in payment rights 12.2 1.9 % 13.8 2.1 % Investments in funds 9.4 1.4 % 9.5 1.5 % Equity investments 5.5 0.9 % 11.0 1.7 % Total investments $ 645.9 100.0 % $ 648.9 100.0 % (1) All investments are categorized as Level 3 in the fair value hierarchy. 44 -------------------------------------------------------------------------------- Table of Contents The following is a summary of the industry classification in which the Company invests as of September 30, 2014 (in millions). Amortized % of Industry Cost Fair Value Net Assets Consumer products $ 106.7 $ 106.6 23.68 % IT services 95.2 93.7 20.81 % Healthcare 84.6 90.4 20.06 % Financial services 90.5 82.6 18.33 % Industrials 55.0 55.1 12.23 % Retail & grocery 53.0 53.7 11.92 % Energy / utilities 50.3 51.7 11.47 % Business services 46.1 45.7 10.16 % Food & beverage 38.6 39.1 8.68 % Manufacturing 33.8 32.0 7.10 % Media, entertainment and leisure 25.3 28.4 6.30 % Restaurants 20.8 20.9 4.64 % Transportation 11.3 11.3 2.51 % Aerospace & defense 6.8 6.8 1.52 % Total Investments $ 718.0 $ 718.0 159.41 % The following is a summary of the industry classification in which the Company invests as of December 31, 2013 (in millions). Amortized % of Industry Cost Fair Value Net Assets IT services $ 100.5 $ 101.0 22.31 % Financial services 91.2 90.7 20.02 % Industrials 79.4 79.7 17.61 % Food & beverage 52.8 52.3 11.55 % Healthcare 48.8 50.5 11.14 % Retail & grocery 53.4 50.2 11.07 % Business services 50.9 50.0 11.05 % Manufacturing 48.8 49.0 10.81 % Consumer products 38.1 38.4 8.47 % Energy / utilities 32.4 32.8 7.25 % Media, entertainment and leisure 24.6 29.1 6.42 % Restaurants 20.8 20.8 4.60 % Aerospace & defense 4.2 4.4 0.96 % Total Investments $ 645.9 $ 648.9 143.26 % 45 -------------------------------------------------------------------------------- Table of Contents Investment Activity The following is a summary of our investment activity, presented on a cost basis, for the three and nine months ended September 30, 2014 and 2013 (in millions). Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 New portfolio investments $ 27.2 $ 91.7 $ 161.4 $ 280.5 Existing portfolio investments Follow-on investments 3.5 4.6 55.2 15.2 Delayed draw and revolver investments 8.4 0.8 15.6 1.5 Total existing portfolio investments 11.9 5.4 70.8 16.7 Total portfolio investment activity $ 39.1 $ 97.1 $ 232.2 $ 297.2 Number of new portfolio investments 2 5 12 11 Number of existing portfolio investments 8 4 12 9 First lien secured debt $ 28.4 $ 39.4 $ 113.1 $ 121.2 Second lien debt - 44.0 89.9 100.7 Subordinated debt 3.4 4.2 11.7 49.6 Investments in funds 0.5 0.2 1.3 0.4 Equity investments 6.8 0.2 16.2 0.2 CLO residual interests - 9.1 - 25.1 Total portfolio investments $ 39.1 $ 97.1 $ 232.2 $ 297.2 Weighted average yield of new debt investments 11.2 % 11.6 % 11.0 % 11.7 % Weighted average yield, including all new income-producing investments 11.8 % 11.9 % 10.9 % 11.9 % 46 -------------------------------------------------------------------------------- Table of Contents The following is a summary of the proceeds received from prepayments and sales of our investments (in millions). Three months ended September 30, Nine months ended September 30, Investment 2014 2013 2014 2013 20-20 Technologies Inc. $ 0.2 $ 0.1 $ 3.4 $ 0.3 Adirondack Park CLO Ltd. 0.1 - 0.9 - Allied Wireline Services, LLC 0.1 - 0.3 - AIM Media Texas Operating, LLC - 0.5 - 4.2 Charming Charlie, Inc. 0.1 - 0.1 - Blue Coat Systems, Inc. 5.1 - 15.3 - Copperweld Bimetallics LLC 0.3 - 0.8 - Connecture, Inc. (a) - - - 1.0 CRS Reprocessing, LLC - - 2.2 0.5 Cydcor LLC (b) - 0.3 13.4 15.2 Dryden CLO, Ltd. 0.2 - 0.9 - Embarcadero Technologies, Inc. (a) 0.1 0.1 0.4 5.0 Firebirds International, LLC - - - 8.3 Flagship VII, Ltd. 0.2 - 0.2 - Gold, Inc. (a) - - - 19.8 Gryphon Partners 3.5, L.P. 0.2 0.4 0.1 1.3 Harrison Gypsum, LLC 0.3 0.3 0.9 0.9 Hart InterCivic, Inc. 0.2 - 0.2 0.8 HEALTHCAREfirst, Inc. 0.1 0.3 0.5 0.6 Holland Intermediate Acquisition Corp. (a) 1.6 4.9 1.6 7.1 Hostway Corporation - - 9.9 - IMDS Corporation (c) - 13.5 - 13.5 Ingenio Acquisition, LLC (a) 0.1 - 0.5 1.5 Jefferson Management Holdings, LLC - - 0.9 - LCP Capital Fund LLC - - 8.4 - Loadmaster Derrick & Equipment, Inc. - - - 1.0 NCM Group Holdings, LLC - - 28.1 - Key Brand Entertainment, Inc. Sr. Secured Revolving Loan - - 1.5 - Oasis Legal Finance Holding Company LLC 0.7 - 0.7 - Octagon Income Note XIV, Ltd. 0.3 0.7 0.9 0.7 Pinnacle Operating Corporation - 10.3 - 10.3 SeaStar Solutions (f.k.a. Marine Acquisition Corp) - - 16.8 - Sheridan Square CLO, Ltd 0.1 0.4 0.5 0.5 Surgery Center Holdings, Inc. (d) - - 4.9 19.3 Tectum Holdings Inc 12.0 - 12.0 - Trinity Services Group, Inc. 23.5 - 23.5 - Tri Starr Management Services, Inc. (a) - - - 2.4 TriMark USA, LLC 20.2 - 20.2 - Virtus Pharmaceuticals, LLC 0.1 - 0.1 - Wheels Up Partners, LLC 0.1 - 0.2 - Wingspan Portfolio Holdings, Inc. (a) - - - 7.1 YP Intermediate Holdings Corp. - - - 3.4 Total (e) $ 65.9 $ 31.8 $ 170.3 $ 124.7 (a) Proceeds received for the three and nine months ended September 30, 2013 in connection with the sale of investments to Greenway II and co-investors. (b) Proceeds for the nine months ended September 30, 2013 included $14.3 million received in connection with the prepayment of our initial first lien debt investment as part of a refinancing and subsequently closed on another $14.3 million first lien debt investment. (c) Proceeds included $1.5 million recorded as an escrow receivable. 47 -------------------------------------------------------------------------------- Table of Contents (d) Proceeds for the nine months ended September 30, 2013 included $19.3 million, including a prepayment premium, received in connection with the prepayment of our subordinated debt investment as part of a refinancing. We subsequently closed on a $15.0 million second lien debt investment. (e) For the three months ended September 30, 2014 and 2013, proceeds included $0.7 million and $0.3 million, respectively, of prepayment premiums and realized gains. For the nine months ended September 30, 2014 and 2013, proceeds included $2.4 million and $1.1 million, respectively, of prepayment premiums. Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make. The decrease in weighted average yield of new investments is related primarily to an increase in first and second lien investments. The first and second lien debt securities, based on fair value, has increased 22% since December 31, 2013. Investment Risk The value of our investments will generally fluctuate with, among other things, changes in prevailing interest rates, federal tax rates, counterparty risk, general economic conditions, the condition of certain financial markets, developments or trends in any particular industry and the financial condition of the issuer. During periods of limited liquidity and higher price volatility, our ability to dispose of investments at a price and time that we deem advantageous may be impaired. Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. The value of lower-quality debt securities often fluctuates in response to company, political, or economic developments and can decline significantly over short periods of time or during periods of general or regional economic difficulty. Lower-quality debt securities can be thinly traded or have restrictions on resale, making them difficult to sell at an acceptable price. The default rate for lower-quality debt securities is likely to be higher during economic recessions or periods of high interest rates. Managed Funds The Advisor and its affiliates may also manage other funds in the future that may have investment mandates that are similar, in whole and in part, with ours. For example, the Advisor may serve as investment adviser to one or more private funds or registered closed-end funds, and presently serves as an investment adviser to a collateralized loan obligation (CLO), THL Credit Wind River 2013-2 CLO, Ltd., and a subadviser to a closed-end fund, THL Credit Senior Loan Fund (NYSE: TSLF). In addition, our officers may serve in similar capacities for one or more private funds or registered closed-end funds. The Advisor and its affiliates may determine that an investment is appropriate for us and for one or more of those other funds. In such event, depending on the availability of such investment and other appropriate factors, the Advisor or its affiliates may determine that we should invest side-by-side with one or more other funds. Any such investments will be made only to the extent permitted by applicable law and interpretive positions of the SEC and its staff, and consistent with the Advisor's allocation procedures. Greenway On January 14, 2011, THL Credit Greenway Fund LLC, or Greenway, was formed as a Delaware limited liability company. Greenway is a portfolio company of the Company. Greenway is a closed-end investment fund which provides for no liquidity or redemption options and is not readily marketable. Greenway operates under a limited liability agreement dated January 19, 2011, or the Agreement. Greenway will continue in existence until January 14, 2021, subject to earlier termination pursuant to certain terms of the Agreement. The term may also be extended for up to three additional one-year periods pursuant to certain terms of the Agreement. Greenway had a two year investment period. Greenway has $150 million of capital committed by affiliates of a single institutional investor, and is managed by the Company. The Company's capital commitment to Greenway is $0.02 million. As of September 30, 2014 and December 31, 2013, all of the capital had been called by Greenway. Our nominal investment in Greenway is reflected in the September 30, 2014 and December 31, 2013 Consolidated Schedules of Investments. As of September 30, 2014, distributions representing 94.3% of the committed capital of the investor have been made from Greenway. Distributions from Greenway, including return of capital and earnings, to its members from inception through September 30, 2014 totaled $141.4 million. The Company acts as the investment adviser to Greenway and is entitled to receive certain fees relating to its investment management services provided, including a base management fee, a performance fee and a portion of the closing fees on each investment transaction. As a result, Greenway is classified as an affiliate of the Company. For the three months ended September 30, 2014 and 2013, the Company earned $0.3 million and $0.4 million in fees related to Greenway, respectively, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. For the nine months ended September 30, 2014 and 2013, the Company earned $0.7 million and $1.4 million in fees related to Greenway, respectively, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. As of September 30, 2014 and December 31, 2013, $0.2 million of fees related to Greenway were included in due from affiliate on the Consolidated Statements of Assets and Liabilities. 48-------------------------------------------------------------------------------- Table of Contents Greenway invests in securities similar to those of the Company pursuant to investment and allocation guidelines which address, among other things, the size of the borrowers, the types of transactions and the concentration and investment ratio amongst Greenway and the Company. However, the Company has the discretion to invest in other securities. Greenway II On January 31, 2013, THL Credit Greenway Fund II, LLC, or Greenway II LLC, was formed as a Delaware limited liability company and is a portfolio company of the Company. Greenway II LLC is a closed-end investment fund which provides for no liquidity or redemption options and is not readily marketable. Greenway II LLC operates under a limited liability agreement dated February 11, 2013, as amended, or the Greenway II LLC Agreement. Greenway II LLC will continue in existence for eight years from the final closing date, subject to earlier termination pursuant to certain terms of the Greenway II LLC Agreement. The term may also be extended for up to three additional one-year periods pursuant to certain terms of the Greenway II LLC Agreement. Greenway II LLC has a two year investment period. As contemplated in the Greenway II LLC Agreement, we have established a related investment vehicle and entered into an investment management agreement with an account set up by an unaffiliated third party investor to invest alongside Greenway II LLC pursuant to similar economic terms. The account is also managed by the Company. References to "Greenway II" herein include Greenway II LLC and the account of the related investment vehicle. Greenway II has $186.5 million of commitments primarily from institutional investors. The Company's capital commitment to Greenway II is $0.005 million. Our nominal investment in Greenway II LLC is reflected in the September 30, 2014 and December 31, 2013 Consolidated Schedules of Investments. Greenway II LLC is managed by the Company. As of September 30, 2014, distributions representing 10.2% of the committed capital of the investor have been made from Greenway II. Distributions from Greenway II to its members, including return of capital and earnings, from inception through September 30, 2014 totaled $19.1 million. The Company acts as the investment adviser to Greenway II and is entitled to receive certain fees relating to its investment management services provided, including a base management fee, a performance fee and a portion of the closing fees on each investment transaction. As a result, Greenway II is classified as an affiliate of the Company. For the three months ended September 30, 2014 and 2013, we earned $0.4 million and $0.5 million, respectively, in fees related to Greenway II, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. For the nine months ended September 30, 2014 and 2013, we earned $1.5 million and $0.7 million, respectively, in fees related to Greenway II, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. As of September 30, 2014 and December 31, 2013, $0.6 million and $0.7 million, respectively, of fees related to Greenway II were included in due from affiliate on the Consolidated Statements of Assets and Liabilities. During the nine months ended September 30, 2013, the Company sold a portion of its investments in seven portfolio companies at fair value, for total proceeds of $19.5 million, to Greenway II. Fair value was determined in accordance with the Company's valuation policies. Other deferred costs consist of placement agent expenses incurred in connection with the offer and sale of partnership interests in Greenway II. These costs are capitalized when commitments close and are recognized as an expense over the period when the Company expects to collect management fees from Greenway II. For the three and nine months ended September 30, 2014, we recognized $0.1 million and $0.2 million, respectively, in expenses related to placement agent expenses, which are included in other general and administrative expenses in the Consolidated Statements of Operations. For the three and nine months ended September 30, 2013, we did not recognize any expenses related to placement agent expenses. As of September 30, 2014 and December 31, 2013, $0.7 million and $0.8 million, respectively, were included in other deferred costs on the Consolidated Statements of Assets and Liabilities. Greenway II invests in securities similar to those of the Company pursuant to investment and allocation guidelines which address, among other things, the size of the borrowers, the types of transactions and the concentration and investment ratio amongst Greenway II and the Company. However, the Company has the discretion to invest in other securities. Investment in Funds LCP Capital Fund LLC We expected that Series 2005-01 would terminate on February 15, 2015; however, on February 3, 2014, LCP was liquidated and we received proceeds of $8.4 million, which was the remaining value of the Company's interest. We had invested in a membership interest of LCP Capital Fund LLC, or LCP, a private investment company that was organized to participate in investment opportunities that arose when a special purpose entity, or SPE, or sponsor thereof, needed to raise capital to achieve ratings, regulatory, accounting, tax, or other objectives. LCP was a closed vehicle which provided for no liquidity or redemption options and is not readily marketable. LCP was managed by an unaffiliated third party. We had originally contributed $12.0 million of capital in the form of membership interests in LCP, which was invested in an underlying SPE referred to as Series 2005-01. 49-------------------------------------------------------------------------------- Table of Contents Our contributed capital in LCP was maintained in a collateral account held by a third-party custodian, who was neither affiliated with us nor with LCP, and acted as collateral on certain credit default swaps for the Series 2005-01 for which LCP received fixed premium payments throughout the year, adjusted for expenses incurred by LCP. The SPE purchased assets on a non-recourse basis and LCP agreed to reimburse the SPE up to a specified amount for potential losses . LCP held the contributed cash invested for an SPE transaction in a segregated account that secured the payment obligation of LCP. CLO Residual Interests As of September 30, 2014, we had investments in the CLO residual interests, or subordinated notes, which can also be structured as income notes, of five CLOs. These subordinated notes are subordinated to the secured notes issued in connection with each CLO. The secured notes in each structure are collateralized by portfolios consisting primarily of broadly syndicated senior secured bank loans. The following table shows a summary of our investments in CLO residual interests (in millions): As of September 30, 2014 As of December 31, 2013 THL Credit THL Credit THL Credit THL Credit Total CLO Residual Residual Residual Residual Ownership Amount at Amount at Amount at Amount at Amount at Fair Issuer Security Description Interest initial par Amortized Cost Fair Value Amortized Cost Value Adirondack Park CLO Ltd. Subordinated Notes, 18.7 % $ 517.0 $ 8.3 $ 8.5 $ 9.2 $ 9.1 Residual Interest Dryden CLO, Ltd. Subordinated Notes, 23.1 % 516.4 8.3 8.8 9.1 9.3 Residual Interest Flagship VII, Ltd. Subordinated Notes, 12.6 % 441.8 4.3 4.6 4.4 4.4 Residual Interest Octagon Income Note XIV, Ltd. Income Notes, 17.7 % 625.9 7.6 8.2 8.5 8.6 Residual Interest Sheridan Square CLO, Ltd Income Notes, 10.4 % 724.5 5.6 5.9 6.1 6.2 Residual Interest Total CLO Residual Interests $ 34.1 $ 36.0 $ 37.3 $ 37.6 The subordinated notes and income notes do not have a stated rate of interest, but are entitled to receive distributions on quarterly payment dates subject to the priority of payments to secured note holders in the structures if and to the extent funds are available for such purpose. The payments on the subordinated notes and income notes are subordinated not only to the interest and principal claims of all secured notes issued, but to certain administrative expenses, taxes, and the base and subordinated fees paid to the collateral manager. Payments to the subordinated notes and income notes may vary significantly quarter to quarter for a variety of reasons and may be subject to 100% loss. Investments in subordinated notes and income notes, due to the structure of the CLO, can be significantly impacted by change in the market value of the assets, the distributions on the assets, defaults and recoveries on the assets, capital gains and losses on the assets along with prices, interest rates and other risks associated with the assets. Investment in Tax Receivable Agreement Payment Rights In June 2012, we invested in a TRA that entitles us to certain payment rights, or TRA Payment Rights, from Duff & Phelps Corporation, or Duff & Phelps. The TRA transfers the economic value of certain tax deductions, or tax benefits, taken by Duff & Phelps to us and entitles us to a stream of payments to be received. The TRA payment right is, in effect, a subordinated claim on the issuing company which can be valued based on the credit risk of the issuer, which includes projected future earnings, the liquidity of the underlying payment right, risk of tax law changes, the effective tax rate and any other factors which might impact the value of the payment right. Through the TRA, we are entitled to receive an annual tax benefit payment based upon 85% of the savings from certain deductions along with interest. The payments that we are entitled to receive result from cash savings, if any, in U.S. federal, state or local income tax that Duff & Phelps realizes (i) from the tax savings derived from the goodwill and other intangibles created in connection with the Duff & Phelps initial public offering and (ii) from other income tax deductions. These tax benefit payments will continue until the relevant deductions are fully utilized, which is projected to be 16 years. Pursuant to the TRA, we maintain the right to enforce Duff & Phelps payment obligations as a transferee of the TRA contract. If Duff & Phelps chooses to pre-pay and terminate the TRA, we will be entitled to the present value of the expected future TRA payments. If Duff & Phelps breaches any material obligation then all obligations are accelerated and calculated as if an early termination occurred. Failure to make a payment is a breach of a material obligation if the failure occurs for more than three months. The projected annual tax benefit payment is accrued on a quarterly basis and paid annually. The payment is allocated between a reduction in the cost basis of the investment and interest income based upon an amortization schedule. Based upon the characteristics of the investment, we have chosen to categorize the investment in the TRA payment rights as an investment in payment rights. Asset Quality We view active portfolio monitoring as a vital part of our investment process. We consider board observation rights, regular dialogue with company management and sponsors, and detailed internally generated monitoring reports to be critical to our 50 -------------------------------------------------------------------------------- Table of Contents performance. We have developed a monitoring template that promotes compliance with these standards and that is used as a tool by the Advisor's investment committee to assess investment performance relative to plan. In addition, our portfolio companies may rely on us to provide financial and capital market expertise and may view us as a value-added resource. As part of the monitoring process, the Advisor assesses the risk profile of each of our investments and assigns each investment a score of a 1, 2, 3, 4 or 5 The investment performance scores, or IPS, are as follows: 1 - The portfolio company is performing above our underwriting expectations. 2 - The portfolio company is performing as expected at the time of underwriting. All new investments are initially scored a 2. 3 - The portfolio company is operating below our underwriting expectations, and requires closer monitoring. The company may be out of compliance with financial covenants, however, principal or interest payments are generally not past due. 4 - The portfolio company is performing materially below our underwriting expectations and returns on our investment are likely to be impaired. Principal or interest payments may be past due, however, full recovery of principal and interest payments are expected. 5 - The portfolio company is performing substantially below expectations and the risk of the investment has increased substantially. The company is in payment default and the principal and interest payments are not expected to be repaid in full. For any investment receiving a score of a 3 or lower, our manager increases its level of focus and prepares regular updates for the investment committee summarizing current operating results, material impending events and recommended actions. As of September 30, 2014 and December 31, 2013, we had assigned an investment score of 4 or 5 to two and three portfolio companies, respectively. The Advisor monitors and, when appropriate, changes the investment scores assigned to each investment in our portfolio. In connection with our investment valuation process, the Advisor and board of directors review these investment scores on a quarterly basis. Our average investment score was 2.18 and 2.13 at September 30, 2014 and December 31, 2013, respectively. The following is a distribution of the investment scores of our portfolio companies at September 30, 2014 and December 31, 2013 (in millions): September 30, 2014 December 31, 2013 % of Total % of Total Investment Score Fair Value Portfolio Fair Value Portfolio 1(a) $ 36.1 5.0 % $ 58.9 9.1 % 2(b) 538.3 75.0 % 484.5 74.7 % 3(c) 129.3 18.0 % 72.9 11.2 % 4(d) 7.7 1.1 % 32.6 5.0 % 5(e) 6.6 0.9 % - - Total $ 718.0 100.0 % $ 648.9 100.0 % (a) As of September 30, 2014 and December 31, 2013, Investment Score "1" included no loans to companies in which we also hold equity securities. (b) As of September 30, 2014 and December 31, 2013, Investment Score "2" included $118.1 million and $62.4 million, respectively, of loans to companies in which we also hold equity securities. (c) As of September 30, 2014 and December 31, 2013, Investment Score "3" included $14.4 million and $14.5 million, respectively, of loans to companies in which we also hold equity securities. (d) As of September 30, 2014 and December 31, 2013, Investment Score "4" included $0 million and $10.2 million, respectively, of loans to companies in which we also hold equity securities. (e) As of September 30, 2014 and December 31, 2013, Investment Score "5" included no loans to companies in which we also hold equity securities. Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more and/or when it is no longer probable that principal or interest will be collected. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. As of September 30, 2014, we had two loans on non-accrual with an amortized cost basis of $26.1 million and fair value of $14.3 million. As of December 31, 2013, we had two loans on non-accrual with an amortized cost basis of $21.0 million and fair value of $16.8 million. We record the reversal of any previously accrued income against the same income category reflected in the Consolidated Statement of Operations. 51 -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of the Three and Nine Months Ended September 30, 2014 and 2013 Investment Income We generate revenues primarily in the form of interest on the debt and other income-producing securities we hold. Other income-producing securities include investments in funds, investment in payment rights and notional interest, or equity, of collateralized loan obligation, or CLO, residual interests. Our investments in fixed income instruments generally have an expected maturity of five to seven years, and typically bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal of our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt instruments and preferred stock investments may defer payments of dividends or pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. In addition to interest income, we may receive dividends and other distributions related to our equity investments. We may also generate revenue in the form of fees from the management of Greenway and Greenway II, prepayment premiums, commitment, loan origination, structuring or due diligence fees, portfolio company administration fees, fees for providing significant managerial assistance and consulting fees. The following shows the breakdown of investment income for the three and nine months ended September 30, 2014 and 2013 (in millions): Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 Interest income on debt securities Cash interest $ 17.7 $ 13.8 $ 48.4 $ 36.9 PIK interest 0.5 0.6 1.7 2.6 Prepayment premiums 0.7 0.3 2.4 1.0 Accretion of discounts and other fees 1.2 1.2 3.6 3.3 Total interest on debt securities 20.1 15.9 56.1 43.8 Dividend income 0.2 0.4 3.0 4.9 Interest income on other income-producing securities 1.8 1.8 5.2 4.7 Fees related to Greenway and Greenway II 0.7 0.9 2.2 2.1 Other income 0.3 0.1 1.3 0.7 Total $ 23.1 $ 19.1 $ 67.8 $ 56.2 The increases in investment income from the respective periods were primarily due to the growth in the overall investment portfolio and related interest income offset by lower dividend income. The following shows a rollforward of PIK income activity for the three and nine months ended September 30, 2014 and 2013 (in millions): Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 Accumulated PIK balance, beginning of period $ 7.2 $ 6.0 $ 6.1 $ 5.8 PIK income capitalized/receivable 0.5 0.6 1.6 2.6 PIK received in cash from repayments (0.7 ) (0.5 ) (0.7 ) (2.3 ) Accumulated PIK balance, end of period $ 7.0 $ 6.1 $ 7.0 $ 6.1 In certain investment transactions, we may provide advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned. We had no income from advisory services related to portfolio companies for the three and nine months ended September 30, 2014 and 2013. Expenses Our primary operating expenses include the payment of base management fees, an incentive fee, and expenses reimbursable under the investment management agreement and the allocable portion of overhead under the administration and investment management agreements ("administrator expenses"). The base management fee compensates the Advisor for work in identifying, evaluating, negotiating, closing and monitoring our investments. Our investment management agreement and administration 52 -------------------------------------------------------------------------------- Table of Contents agreement provides that we will reimburse the Advisor for costs and expenses incurred by the Advisor for facilities, office equipment and utilities allocable to the performance by the Advisor of its duties under the agreements, as well as any costs and expenses incurred by the Advisor relating to any administrative or operating services provided by the Advisor to us. We bear all other costs and expenses of our operations and transactions. The following shows the breakdown of expenses for the three and nine months ended September 30, 2014 and 2013 (in millions): Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 Expenses Incentive fees(a) $ 2.9 $ 2.1 $ 8.0 $ 8.1 Base management fees 2.9 2.1 8.3 5.3 Administrator expenses 1.0 0.8 2.9 2.5 Credit facility interest and fees(b) 2.7 1.7 7.9 4.9 Other expenses 1.3 0.9 3.9 2.7 Total expenses before taxes 10.8 7.6 31.0 23.5 Income tax provision and excise tax(c) 0.1 (0.1 ) 1.0 0.4 Total expenses after taxes $ 10.9 $ 7.5 $ 32.0 $ 23.9 (a) For the three months ended September 30, 2014 and 2013, incentive fees include the effect of the GAAP Incentive Fee reversal of $0.1 million and reversal of $0.8 million, respectively. For the nine months ended September 30, 2014 and 2013, incentive fees include the effect of the GAAP Incentive Fee reversal of $0.7 million and reversal of $0.1 million, respectively. The GAAP Incentive Fee accrual considers the cumulative aggregate realized gains and losses and unrealized appreciation or depreciation of investments or other financial instruments. There can be no assurance that such amounts of unrealized appreciation or depreciation will be realized in the future. Accordingly, such GAAP Incentive Fee, as calculated and accrued, would not necessarily be payable under the Investment Management Agreement, and may never be paid based upon the computation of incentive fees in subsequent quarters. (b) Interest, fees and amortization of deferred financing costs related to our Revolving Facility and Term Loan Facility. (c) Amounts include the income taxes related to earnings by our consolidated wholly-owned tax blocker corporations established to hold equity or equity-like portfolio company investments organized as pass-through entities and excise taxes related to our undistributed earnings. The increase in operating expenses for the respective periods was due primarily to the increase in base management fees related to the growth of the portfolio and credit facility expenses, which was a result of an increase in the credit facility commitments and borrowings outstanding. The increase to other expenses was due to an increase in professional fees and other operating costs related to the growth and maturity of the portfolio. We expect certain of our operating expenses, including administrator expenses, professional fees and other general and administrative expenses to decline as a percentage of our total assets during periods of growth and increase as a percentage of our total assets during periods of asset declines. Net Investment Income Net investment income was $12.2 million, or $0.36 per common share based on a weighted average of 33,905,202 common shares outstanding for the three months ended September 30, 2014 as compared to $11.6 million, or $0.34 per common share based on a weighted average of 33,905,202 common shares outstanding for the three months ended September 30, 2013. Net investment income was $35.8 million, or $1.06 per common share based on a weighted average of 33,905,202 common shares outstanding for the nine months ended September 30, 2014 as compared to $32.3 million, or $1.11 per common share based on a weighted average of 29,067,620 common shares outstanding for the nine months ended September 30, 2013. The increase in net investment income for the respective periods is primarily attributable to the growth in the overall investment portfolio and related interest income. Net Realized Gains and Losses on Investments We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized. 53-------------------------------------------------------------------------------- Table of Contents The following shows the breakdown of realized gains and losses for the three and nine months ended September 30, 2014 and 2013 (in millions): For the three months ended September 30, For the nine months ended September 30, 2014 2013 2014 2013 Escrow receivable settlement(a) $ - $ - $ (1.0 ) $ - Blue Coat Systems, Inc. 0.1 - 0.6 - C&K Market, Inc.(b) (1.0 ) - (1.1 ) - Jefferson Management Holdings, LLC - - (0.5 ) - Surgery Center Holdings, Inc. - - 0.7 - YP Equity Investors, LLC(c) - (0.4 ) - 2.4 Other 0.1 - 0.2 - Net realized (losses)/gains $ (0.8 ) $ (0.4 ) $ (1.1 ) $ 2.4 (a) Escrow receivable settlement in connection with arbitration proceedings. Escrow related to the sale of IMDS Corporation in a prior period. In addition to the realized loss, we reversed $0.3 million of previously accelerated amortization income against interest income recognized for the nine months ended September 30, 2014. (b) On August 12, 2014, the date C&K emerged from bankruptcy, the cost basis of the senior subordinated note, certain interest due and warrants totaling $14.3 million were converted to common and preferred equity. In connection with the extinguishment and conversion to equity, the Company recognized a loss in the amount of $1.0 million. (c) For the three months ended September 30, 2014 and 2013, an offsetting provision for taxes on realized gains on investments of $0.3 million and $0, respectively, was recorded in the Consolidated Statement of Operations. For the nine months ended September 30, 2014 and 2013, an offsetting benefit of $0 and $1.1 million was recorded in the Consolidated Statements of Operations. These amounts reflect a revision to previously recognized estimated realized gains and dividend income as a result of adjusted tax estimates from the portfolio company. Net Change in Unrealized Appreciation (Depreciation) of Investments Net change in unrealized appreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized. The following shows the breakdown in the changes in unrealized appreciation of investments for the three and nine months ended September 30, 2014 and 2013 (in millions): Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 Gross unrealized appreciation on investments $ 8.6 $ 2.1 $ 18.2 $ 7.3 Gross unrealized depreciation on investments (10.0 ) (5.2 ) (20.3 ) (8.6 ) Reversal of prior period net unrealized depreciation (appreciation) upon a realization 1.9 - (0.9 ) (0.8 ) Total $ 0.5 $ (3.1 ) $ (3.0 ) $ (2.1 ) The net change in unrealized appreciation on our investments was driven primarily by changes in the capital market conditions, financial performance of certain portfolio companies, and the reversal of unrealized (appreciation) depreciation of investments repaid or converted into equity in connection with a debt extinguishment. Provision for Taxes on Unrealized Gain on Investments Certain consolidated subsidiaries of ours are subject to U.S. federal and state income taxes. These taxable entities are not consolidated with the Company for income tax purposes and may generate income tax liabilities or assets from temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries. For the three months ended September 30, 2014 and 2013, the Company recognized a provision for tax on unrealized gain of $0.3 million and $1.1 million for consolidated subsidiaries, respectively. For the nine months ended September 30, 2014 and 2013, the Company recognized a benefit (provision) for tax on unrealized gain of $0.7 million and ($1.0) million for consolidated subsidiaries, respectively. As of September 30, 2014 and December 31, 2013, $1.7 million and $2.4 million, respectively, were included in deferred tax liability on the Consolidated Statements of Assets and Liabilities relating primarily to deferred tax on unrealized gain on investments. The change in provision for tax on unrealized gain relates primarily to changes to the unrealized appreciation of the investments held in these taxable consolidated subsidiaries as well as the change in the 2013 estimates received from certain portfolio companies. 54-------------------------------------------------------------------------------- Table of Contents Realized and Unrealized Appreciation (Depreciation) of Interest Rate Derivative The interest rate derivative was entered into on May 10, 2012. Unrealized depreciation reflects the value of the interest rate derivative agreement at the end of the reporting period. For the three months ended September 30, 2014 and 2013, the net change of unrealized appreciation (depreciation) on interest rate derivative totaled $0.3 million and ($0.2) million, respectively, which is listed under net change in unrealized appreciation (depreciation) on interest rate derivatives in the Consolidated Statement of Operations. For the nine months ended September 30, 2014 and 2013, the net change of unrealized appreciation (depreciation) on interest rate derivative totaled $0.2 million and $0.7 million, respectively, which is listed under net change in unrealized appreciation (depreciation) on interest rate derivatives in the Consolidated Statement of Operations. The changes were due to capital market changes impacting swap rates. We measure realized gains or losses on the interest rate derivative based upon the difference between the proceeds received or the amount paid on the interest rate derivative. For the three months ended September 30, 2014 and 2013, we realized a loss of $0.1 million and $0.1 million, respectively, as interest rate derivative periodic interest payments, net on the Consolidated Statement of Operations. For the nine months ended September 30, 2014 and 2013, we realized a loss of $0.3 million and $0.3 million, respectively, as interest rate derivative periodic interest payments, net on the Consolidated Statement of Operations. Net Increase in Net Assets Resulting from Operations Net increase in net assets resulting from operations totaled $11.8 million, or $0.35 per common share based on a weighted average of 33,905,202 common shares for the three months ended September 30, 2014 as compared to $7.8 million, or $0.23 per common share based on a weighted average of 33,905,202 common shares outstanding for the three months ended September 30, 2013. Net increase in net assets resulting from operations totaled $32.1 million, or $0.95 per common share based on a weighted average of 33,905,202 common shares for the nine months ended September 30, 2014 as compared to $32.0 million, or $1.10 per common share based on a weighted average of 29,067,620 common shares outstanding for the nine months ended September 30, 2013. The increase in net assets resulting from operations is due primarily to the growth in the portfolio and the change in unrealized appreciation of investments. Financial condition, liquidity and capital resources Cash Flows from Operating and Financing Activities Our liquidity and capital resources are derived from our credit facilities, equity raises and cash flows from operations, including investment sales and repayments, and investment income earned. Our primary use of funds from operations includes investments in portfolio companies, payment of dividends to the holders of our common stock and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the turnover in our portfolio and from public and private offerings of securities to finance our investment objectives, to the extent permitted by the 1940 Act. We may raise additional equity or debt capital through both registered offerings off our shelf registration statement and private offerings of securities, by securitizing a portion of our investments or borrowings. To the extent we determine to raise additional equity through an offering of our common stock at a price below net asset value, existing investors will experience dilution. During our 2014 Annual Stockholder Meeting held on June 3, 2014, our stockholders authorized us, with the approval of our Board of Directors, to sell up to 25% of our outstanding common stock at a price below our then current net asset value per share and to offer and issue debt with warrants or debt convertible into shares of our common stock at an exercise or conversion price that will not be less than the fair market value per share but may be below the then current net asset value per share. There can be no assurance that these capital resources will be available. On April 30, 2014, we closed an additional $85.0 million of commitments to our Facilities, which brings the aggregate size to $410.0 million of commitments. We borrowed $234.6 million under our Revolving Facility and $13.5 million under our Term Loan Facility for the nine months ended September 30, 2014 and repaid $170.7 million on our Revolving Facility from proceeds received from the Term Loan Facility, investment, prepayments and sales and investment income. We borrowed $291.6 million under our Revolving Facility and $20.0 million under our Term Loan Facility for the nine months ended September 30, 2013 and repaid $235.7 million on our Revolving Facility from proceeds received from an equity offering, Term Loan Facility and investment income. Our operating activities used cash of $41.5 million and $143.5 million for the nine months ended September 30, 2014 and 2013, respectively, primarily in connection with the purchase and sales of portfolio investments. For the nine months ended September 30, 2014, our financing activities provided cash of $77.3 million from our net borrowings and used $34.6 million for distributions to 55-------------------------------------------------------------------------------- Table of Contents stockholders and $1.9 million for the payment of financing and offering costs. For the nine months ended September 30, 2013, our financing activities provided cash of $186.9 million from our common stock offering, and net borrowings and used cash of $31.9 million for distributions to stockholders and $6.3 million for the payment of financing and offering costs. As of September 30, 2014 and December 31, 2013, we had cash of $7.1 million and $7.8 million, respectively. We had no cash equivalents as of September 30, 2014 and December 31, 2013. We believe cash balances, our Revolving Facility capacity and any proceeds generated from the sale or pay down of investments provides us with ample liquidity to acquit our pipeline in the near future. Credit Facility On April 30, 2014, we entered into an amendment, or the Revolving Amendment, to our existing revolving credit agreement, or Revolving Facility, and entered into an amendment, or the Term Loan Amendment, to our Term Loan Facility. The Revolving Facility and Term Loan Facility are collectively referred to as the Facilities. The Revolving Loan Amendment revised the Facility dated May 10, 2012 to, among other things, increase the amount available for borrowing under the Revolving Facility from $232.0 million to $303.5 million and extend the maturity date from May 2017 to April 2018 (with a one year term out period beginning in April 2017). The one year term out period is the one year anniversary between the revolver termination date, or the end of the availability period, and the maturity date. During this time, we are required to make mandatory prepayments on its loans from the proceeds we receive from the sale of assets, extraordinary receipts, returns of capital or the issuances of equity or debt. The Revolving Amendment also changes the interest rate of the Revolving Facility to LIBOR plus 2.5% (with no LIBOR floor). The non-use fee is 1.0% annually if we use 35% or less of the Revolving Facility and 0.50% annually if we use more than 35% (with LIBOR floor) of the Revolving Facility. We elect the LIBOR rate on the loans outstanding on our Revolving Facility, which can have a maturity date that is one, two, three or nine months. The LIBOR rate on the borrowings outstanding on our Revolving Facility currently has a one month maturity. The Term Loan Amendment revised the Term Loan Facility dated May 10, 2012 to, among other things, increase the amount borrowed from $93.0 million to $106.5 million and extend the maturity date from May 2018 to April 2019. The Term Loan Amendment also changes the interest rate of the Term Loan Facility to LIBOR plus 3.25% (with no LIBOR Floor) and has substantially similar terms to our existing Revolving Facility (as amended by the Revolving Amendment). The Company elects the LIBOR rate on our Term Loan, which can have a maturity date that is one, two, three or nine months. The LIBOR rate on its Term Loan currently has a one month maturity. Each of the Facilities includes an accordion feature permitting us to expand the Facilities, if certain conditions are satisfied; provided, however, that the aggregate amount of the Facilities, collectively, is capped at $600.0 million. The Facilities generally require payment of interest on a quarterly basis for ABR loans (commonly based on the Prime Rate or the Federal Funds Rate), and at the end of the applicable interest period for Eurocurrency loans bearing interest at LIBOR, the interest rate benchmark used to determine the variable rates paid on the Facilities. LIBOR maturities can range between one and nine months at the election of the Company. All outstanding principal is due upon each maturity date. The Facilities also require a mandatory prepayment of interest and principal upon certain customary triggering events (including, without limitation, the disposition of assets or the issuance of certain securities). Borrowings under the Facilities are subject to, among other things, a minimum borrowing/collateral base. The Facilities have certain collateral requirements and/or financial covenants, including covenants related to: (a) limitations on the incurrence of additional indebtedness and liens, (b) limitations on certain investments, (c) limitations on certain restricted payments, (d) limitations on the creation or existence of agreements that prohibit liens on certain properties of ours and our subsidiaries, and (e) compliance with certain financial maintenance standards including (i) minimum stockholders' equity, (ii) a ratio of total assets (less total liabilities not represented by senior securities) to the aggregate amount of senior securities representing indebtedness, of us and our subsidiaries, of not less than 2.10:1.0, (iii) minimum liquidity, (iv) minimum net worth, and (v) a consolidated interest coverage ratio. In addition to the financial maintenance standards, described in the preceding sentence, borrowings under the Facilities (and the incurrence of certain other permitted debt) are subject to compliance with a borrowing base that applies different advance rates to different types of assets in our portfolio. The Facilities' documents also include default provisions such as the failure to make timely payments under the Facilities, the occurrence of a change in control, and the failure by us to materially perform under the operative agreements governing the Facilities, which, if not complied with, could, at the option of the lenders under the Facilities, accelerate repayment under the Facilities, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Each loan originated under the Revolving Facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the Revolving Facility at any particular time or at all. We are currently in compliance with all financial covenants under the Facilities. 56-------------------------------------------------------------------------------- Table of Contents For the nine months ended September 30, 2014, we borrowed $248.1 million and repaid $170.7 million under the Facilities. For the nine months ended September 30, 2013, we borrowed $311.6 million and repaid $235.7 million under the Facilities. 57 -------------------------------------------------------------------------------- Table of Contents The following shows a summary of our Revolving Facility and Term Loan Facility as of September 30, 2014 and December 31, 2013: As of September 30, 2014 Weighted Borrowings Average Facility Commitments Outstanding Interest Rate Revolving Facility $ 303.5 $ 175.1 2.69 % Term Loan Facility 106.5 106.5 3.44 % Total $ 410.0 $ 281.6 2.97 % As of December 31, 2013 Weighted Borrowings Average Facility Commitments Outstanding Interest Rate Revolving Facility $ 232.0 $ 111.3 3.19 % Term Loan Facility 93.0 93.0 4.17 % Total $ 325.0 $ 204.3 3.63 % The fair values of our Facilities are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of our Facilities are estimated based upon market interest rates and entities with similar credit risk. As of September 30, 2014 and December 31, 2013, the Facilities would be deemed to be level 3 of the fair value hierarchy. Interest expense and related fees, excluding amortization of deferred financing costs, of $2.4 million and $1.4 million were incurred in connection with the Facilities during the three months ended September 30, 2014 and 2013, respectively. Interest expense and related fees, excluding amortization of deferred financing costs, of $7.0 million and $3.9 million were incurred in connection with the Facilities during the nine months ended September 30, 2014 and 2013, respectively. In accordance with the 1940 Act, with certain exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The asset coverage as of September 30, 2014 is in excess of 200%. Interest Rate Derivative On May 10, 2012, we entered into a five-year interest rate swap agreement, or swap agreement, with ING Capital Markets, LLC in connection with its Term Loan Facility. Under the swap agreement, with a notional value of $50 million, we pay a fixed rate of 1.1425% and receive a floating rate based upon the current three-month LIBOR rate. We entered into the swap agreement to manage interest rate risk and not for speculative purposes. We record the change in valuation of the swap agreement in unrealized appreciation (depreciation) as of each measurement period. When the quarterly swap amounts are paid or received under the swap agreement, the amounts are recorded as a realized gain (loss) as interest rate derivative periodic interest payments, net on the Consolidated Statement of Operations. For the three months ended September 30, 2014 and 2013, we recognized $0.1 million and $0.1 million, respectively, of realized loss from the swap agreement, which is reflected as interest rate derivative periodic interest payments, net in the Consolidated Statements of Operations. For the nine months ended September 30, 2014 and 2013, we recognized $0.3 million and $0.3 million, respectively, of realized loss from the swap agreement, which is reflected as interest rate derivative periodic interest payments, net in the Consolidated Statements of Operations. For the three months ended September 30, 2014 and 2013, we recognized $0.3 million and ($0.2) million of net change in unrealized appreciation (depreciation) from the swap agreement, respectively, which is listed under net change in unrealized appreciation (depreciation) on interest rate derivative in the Consolidated Statements of Operations. For the nine months ended September 30, 2014 and 2013, we recognized $0.2 million and $0.7 million of net change in unrealized appreciation (depreciation) from the swap agreement, respectively, which is listed under net change in unrealized appreciation (depreciation) on interest rate derivative in the Consolidated Statements of Operations. As of September 30, 2014 and December 31, 2013, our fair value of the swap agreement is $(0.1) million and $(0.3) million, respectively, which is listed as an interest rate derivative liability on the Consolidated Statements of Assets and Liabilities. 58 -------------------------------------------------------------------------------- Table of Contents Commitments and Contingencies From time to time, we, or the Advisor, may become party to legal proceedings in the ordinary course of business, including proceedings related to the enforcement of our rights under contracts with our portfolio companies. Neither we, nor the Advisor, are currently subject to any material legal proceedings. Unfunded commitments to provide funds to portfolio companies are not reflected in our Consolidated Statements of Assets and Liabilities. Our unfunded commitments may be significant from time to time. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We intend to use cash flow from normal and early principal repayments and proceeds from borrowings and offerings to fund these commitments. As of September 30, 2014 and December 31, 2013, we have the following unfunded commitments to portfolio companies (in millions): As of September 30, 2014 December 31, 2013 Unfunded delayed draw facilities (a) $ 58.9 $ 9.5 Unfunded revolving commitments 5.4 9.2 Unfunded commitments to investments in funds 3.2 4.0 Total unfunded commitments $ 67.5 $ 22.7 (a) Certain unfunded delayed draw commitments totaling $20.0 million were sold subsequent to September 30, 2014 Dividends We have elected to be taxed as a regulated investment company under Subchapter M of the Code. In order to maintain our status as a regulated investment company, we are required to distribute at least 90% of our investment company taxable income. To avoid a 4% excise tax on undistributed earnings, we are required to distribute each calendar year the sum of (i) 98% of our ordinary income for such calendar year (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. We intend to make distributions to stockholders on a quarterly basis of substantially all of our net investment income. Although we intend to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, we may in the future decide to retain such capital gains for investment. In addition, the extent and timing of special dividends, if any, will be determined by our board of directors and will largely be driven by portfolio specific events and tax considerations at the time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a BDC under the 1940 Act . The following table summarizes our dividends declared and paid or to be paid on all shares, including dividends reinvested, if any: Date Declared Record Date Payment Date Amount Per Share August 5, 2010 September 2, 2010 September 30, 2010 $ 0.05 November 4, 2010 November 30, 2010 December 28, 2010 $ 0.10 December 14, 2010 December 31, 2010 January 28, 2011 $ 0.15 March 10, 2011 March 25, 2011 March 31, 2011 $ 0.23 May 5, 2011 June 15, 2011 June 30, 2011 $ 0.25 July 28, 2011 September 15, 2011 September 30, 2011 $ 0.26 October 27, 2011 December 15, 2011 December 30, 2011 $ 0.28 March 6, 2012 March 20, 2012 March 30, 2012 $ 0.29 March 6, 2012 March 20, 2012 March 30, 2012 $ 0.05 May 2, 2012 June 15, 2012 June 29, 2012 $ 0.30 July 26, 2012 September 14, 2012 September 28, 2012 $ 0.32 November 2, 2012 December 14, 2012 December 28, 2012 $ 0.33 December 20, 2012 December 31, 2012 January 28, 2013 $ 0.05 February 27, 2013 March 15, 2013 March 29, 2013 $ 0.33 May 2, 2013 June 14, 2013 June 28, 2013 $ 0.34 59 -------------------------------------------------------------------------------- Table of Contents Date Declared Record Date Payment Date Amount Per Share August 2, 2013 September 16, 2013 September 30, 2013 $ 0.34 August 2, 2013 September 16, 2013 September 30, 2013 $ 0.08 October 30, 2013 December 16, 2013 March 31, 2014 $ 0.34 March 4, 2014 March 17, 2014 March 31, 2014 $ 0.34 May 7, 2014 June 16, 2014 June 30, 2014 $ 0.34 August 7, 2014 September 15, 2014 September 30, 2014 $ 0.34 November 4, 2014 December 15, 2014 December 31, 2014 $ 0.34 We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure stockholders that they will receive any distributions at a particular level. We maintain an "opt in" dividend reinvestment plan for our common stockholders. As a result, unless stockholders specifically elect to have their dividends automatically reinvested in additional shares of common stock, stockholders will receive all such dividends in cash. Under the terms of our dividend reinvestment plan, dividends will primarily be paid in newly issued shares of common stock. However, we reserve the right to purchase shares in the open market in connection with the implementation of the plan. This feature of the plan means that, under certain circumstances, we may issue shares of our common stock at a price below net asset value per share, which could cause our stockholders to experience dilution. Distributions in excess of our current and accumulated profits and earnings would be treated first as a return of capital to the extent of the stockholder's tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions will be made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. If we had determined the tax attributes of our 2014 distributions as of September 30, 2014, 93.4% would be from ordinary income, 6.6% would be from capital gains and 0% would be a return of capital. There can be no certainty to stockholders that this determination is representative of what the tax attributes of our 2014 distributions to stockholders will actually be. Each year, a statement on Form 1099-DIV identifying the source of the distribution will be mailed to our stockholders. Contractual obligations We have entered into a contract with the Advisor to provide investment advisory services. Payments for investment advisory services under the investment management agreement in future periods will be equal to (a) an annual base management fee of 1.5% of our gross assets and (b) an incentive fee based on our performance. In addition, under our administration agreement, the Advisor will be reimbursed for administrative services incurred on our behalf. See description below under Related Party Transactions. The following table shows our contractual obligations as of September 30, 2014 (in millions): Payments due by period Less than After 5Contractual Obligations(1) Total 1 year 1 - 3 years 3 - 5 years years Term Loan Facility $ 106.5 - - $ 106.5 - (1) Excludes commitments to extend credit to our portfolio companies. We entered into an interest rate derivative to manage interest rate risk. We record the change in valuation of the swap agreement in unrealized appreciation (depreciation) as of each measurement period. When the quarterly interest rate swap amounts are paid or received under the swap agreement, the amounts are recorded as a realized gain (loss). Further discussion of the interest rate derivative is included in Note 1 "Significant Accounting Policies" and Note 7 "Interest Rate Derivative" in the "Notes to Consolidated Financial Statements". Off-Balance sheet arrangements We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices. Related Party Transactions Investment Management Agreement On March 4, 2014, our investment management agreement with the Advisor was re-approved by our Board of Directors. Under the investment management agreement, the Advisor, subject to the overall supervision of our board of directors, manages the day-today operations of, and provides investment advisory services to us. 60 -------------------------------------------------------------------------------- Table of Contents The Advisor receives a fee for investment advisory and management services consisting of a base management fee and a two-part incentive fee. The base management fee is calculated at an annual rate of 1.5% of our gross assets payable quarterly in arrears on a calendar quarter basis. For purposes of calculating the base management fee, "gross assets" is determined as the value of our assets without deduction for any liabilities. The base management fee is calculated based on the value of our gross assets at the end of the most recently completed calendar quarter, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter. For the three months ended September 30, 2014 and 2013, we incurred base management fees payable to the Advisor of $2.9 million and $2.1 million, respectively. For the nine months ended September 30, 2014 and 2013, we incurred base management fees payable to the Advisor of $8.3 million and $5.3 million, respectively. As of September 30, 2014 and December 31, 2013, $2.9 million and $2.2 million, respectively, was payable to the Advisor. The incentive fee has two components, ordinary income and capital gains, as follows: The ordinary income component is calculated, and payable, quarterly in arrears based on our preincentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The preincentive fee net investment income, which is expressed as a rate of return on the value of our net assets attributable to our common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as "minimum income level"). Preincentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under our administration agreement (discussed below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee and any offering expenses and other expenses not charged to operations but excluding certain reversals to the extent such reversals have the effect of reducing previously accrued incentive fees based on the deferral of non-cash interest. Preincentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which our preincentive fee net investment income does not exceed the minimum income level. Subject to the cumulative total return requirement described below, the Advisor receives 100% of our preincentive fee net investment income for any calendar quarter with respect to that portion of the preincentive net investment income for such quarter, if any, that exceeds the minimum income level but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the "catch-up" provision) and 20.0% of our preincentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of our preincentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which our preincentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the "catch-up" provision, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the "cumulative net increase in net assets resulting from operations" is the amount, if positive, of the sum of our preincentive fee net investment income, base management fees, realized gains and losses and unrealized appreciation and depreciation for the then current and 11 preceding calendar quarters. In addition, the portion of such incentive fee that is attributable to deferred interest (sometimes referred to as payment-in-kind interest, or PIK, or original issue discount, or OID) will be paid to THL Credit Advisors, together with interest thereon from the date of deferral to the date of payment, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. There is no accumulation of amounts on the hurdle rate from quarter to quarter and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle rate and there is no delay of payment if prior quarters are below the quarterly hurdle rate. For the three months ended September 30, 2014 and 2013, we incurred $3.0 million and $2.7 million, respectively, of incentive fees related to ordinary income. For the nine months ended September 30, 2014 and 2013, we incurred $8.8 million and $7.9 million, respectively, of incentive fees related to ordinary income. As of September 30, 2014 and December 31, 2013, $3.0 million and $2.1 million, respectively, of such incentive fees are currently payable to the Advisor. As of September 30, 2014 and December 31, 2013, $1.1 million and $1.3 million, respectively of incentive fees incurred by us were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received in cash. The second component of the incentive fee (capital gains incentive fee) is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). This component is equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid capital gains incentive fees is subtracted from such capital gains incentive fee calculated. 61-------------------------------------------------------------------------------- Table of Contents GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation or depreciation of investments or other financial instruments, such as an interest rate derivative, in the calculation, as an incentive fee would be payable if such realized gains and losses or unrealized capital appreciation or depreciation were realized, even though such realized gains and losses and unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment management agreement ("GAAP Incentive Fee"). There can be no assurance that such unrealized appreciation or depreciation will be realized in the future. Accordingly, such fee, as calculated and accrued, would not necessarily be payable under the investment management agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. For the three months ended September 30, 2014 and 2013, we reversed $0.1 million and $0.8 million, respectively, of incentive fee expenses related to the GAAP Incentive Fee. For the nine months ended September 30, 2014 and 2013, we reversed $0.7 million and $0.1 million, respectively, of incentive fee expenses related to the GAAP Incentive Fee. As of September 30, 2014 and December 31, 2013, $0 and $0.1 million of GAAP Incentive Fees incurred by the Company are not currently payable until the end of each calendar year and the hurdle is met. Administration Agreement We have also entered into an administration agreement with the Advisor under which the Advisor will provide administrative services to us. Under the administration agreement, the Advisor performs, or oversees the performance of administrative services necessary for our operation, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, the Advisor assists in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. We will reimburse the Advisor for our allocable portion of the costs and expenses incurred by the Advisor for overhead in performance by the Advisor of its duties under the administration agreement and the investment management agreement, including facilities, office equipment and our allocable portion of cost of compensation and related expenses of our chief financial officer and chief compliance officer and their respective staffs, as well as any costs and expenses incurred by the Advisor relating to any administrative or operating services provided to us by the Advisor. Our board of directors reviews the allocation methodologies with respect to such expenses. Such costs are reflected as Administrator expenses in the accompanying Consolidated Statements of Operations. Under the administration agreement, the Advisor provides, on our behalf, managerial assistance to those portfolio companies to which the Company is required to provide such assistance. To the extent that our Advisor outsources any of its functions, the Company pays the fees associated with such functions on a direct basis without profit to the Advisor. For the three months ended September 30, 2014 and 2013, we incurred administrator expenses of $1.0 million and $0.8 million, respectively. For the nine months ended September 30, 2014 and 2013, we incurred administrator expenses of $2.9 million and $2.5 million, respectively. As of September 30, 2014 and December 31, 2013, $0.2 million was payable to the Advisor. License Agreement We and the Advisor have entered into a license agreement with THL Partners under which THL Partners has granted to us and the Advisor a non-exclusive, personal, revocable worldwide non-transferable license to use the trade name and service mark THL, which is a proprietary mark of THL Partners, for specified purposes in connection with our respective businesses. This license agreement is royalty-free, which means we are not charged a fee for our use of the trade name and service mark THL. The license agreement is terminable either in its entirety or with respect to us or the Advisor by THL Partners at any time in its sole discretion upon 60 days prior written notice, and is also terminable with respect to either us or the Advisor by THL Partners in the case of certain events of non-compliance. After the expiration of its first one year term, the entire license agreement is terminable by either us or the Advisor at our or its sole discretion upon 60 days prior written notice. Upon termination of the license agreement, we and the Advisor must cease to use the name and mark THL, including any use in our respective legal names, filings, listings and other uses that may require us to withdraw or replace our names and marks. Other than with respect to the limited rights contained in the license agreement, we and the Advisor have no right to use, or other rights in respect of, the THL name and mark. We are an entity operated independently from THL Partners, and third parties who deal with us have no recourse against THL Partners. Due to and from Affiliates The Advisor paid certain other general and administrative expenses on our behalf. As of September 30, 2014 and December 31, 2013, $0.01 million of expenses were included in due to affiliate on the Consolidated Statements of Assets and Liabilities. We act as the investment adviser to Greenway and Greenway II and are entitled to receive certain fees. As a result, Greenway and Greenway II are classified as an affiliate. As of September 30, 2014 and December 31, 2013, $0.8 million and $1.0 million of fees related to Greenway and Greenway II, respectively, were included in due from affiliate on the Consolidated Statements of Assets and 62-------------------------------------------------------------------------------- Table of Contents Liabilities. As of September 30, 2014 and December 31 2013, $0 and $0.5 million was included in due to affiliate on the Consolidated Statements of Assets and Liabilities related to the portion of the escrow receivable, due to THL Corporate Finance, Inc., as the administrative agent, to Greenway. Critical accounting policies Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, the Company's significant accounting policies are further described in the notes to the consolidated financial statements. Valuation of Portfolio Investments As a BDC, we generally invest in illiquid securities including debt and equity investments of middle market companies. Investments for which market quotations are readily available are valued using market quotations, which are generally obtained from an independent pricing service or one or more broker-dealers or market makers. Debt and equity securities for which market quotations are not readily available or are not considered to be the best estimate of fair value are valued at fair value as determined in good faith by our board of directors. Because we expect that there will not be a readily available market value for many of the investments in our portfolio, it is expected that many of our portfolio investments' values will be determined in good faith by our board of directors in accordance with a documented valuation policy that has been reviewed and approved by our board of directors in accordance with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material. With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below: • our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment; • preliminary valuation conclusions are then documented and discussed with senior management of the Advisor; • to the extent determined by the audit committee of our board of directors, independent valuation firms used by us to conduct independent appraisals and review the Advisor's preliminary valuations in light of their own independent assessment; • the audit committee of our board of directors reviews the preliminary valuations of the Advisor and independent valuation firms and, if necessary, responds and supplements the valuation recommendation of the independent valuation firms to reflect any comments; and • our board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of the Advisor, the respective independent valuation firms and the audit committee. The types of factors that we may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company's ability to make payments and its earnings and discounted cash flows, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors. We utilize an income approach to value our debt investments and a combination of income and market approaches to value our equity investments. With respect to unquoted securities, the Advisor and our board of directors, in consultation with our independent third party valuation firms, values each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors, which valuation is then approved by our board of directors. For debt investments, we determine the fair value primarily using an income, or yield, approach that analyzes the discounted cash flows of interest and principal for the debt security, as set forth in the associated loan agreements, as well as the financial position and credit risk of each portfolio investments. Our estimate of the expected repayment date is generally the legal maturity date of the instrument. The yield analysis considers changes in leverage levels, credit quality, portfolio company performance and other factors. We value our interest rate derivative agreement using an income approach that analyzes the discounted cash flows associated with the interest rate derivative agreement. Significant inputs to the discounted cash flows methodology include the forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of the counterparty's credit risk. We value our residual interest investments in collateralized loan obligations using an income approach that analyzes the discounted cash flows of our residual interest. The discounted cash flows model utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar collateralized loan obligation fund subordinated notes or equity, when available. Specifically, 63-------------------------------------------------------------------------------- Table of Contents we use Intex cash flow models, or an appropriate substitute to form the basis for the valuation of our residual interest. The models use a set of assumptions including projected default rates, recovery rates, reinvestment rate and prepayment rates in order to arrive at estimated cash flows. The assumptions are based on available market data and projections provided by third parties as well as management estimates. We value our investment in payment rights using an income approach that analyzes the discounted projected future cash flow streams assuming an appropriate discount rate, which will among other things consider other transactions in the market, the current credit environment, performance of the underlying portfolio company and the length of the remaining payment stream. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future cash flows or earnings to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, the current investment performance rating, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company's ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, transaction comparables, our principal market as the reporting entity and enterprise values, among other factors. In accordance with the authoritative guidance on fair value measurements and disclosures under GAAP, we disclose the fair value of our investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows: Level 1-Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; Level 2-Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly; Level 3-Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes "observable" requires significant judgment by management. We consider whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if we determine that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances. We have adopted the authoritative guidance under GAAP for estimating the fair value of investments in investment companies that have calculated net asset value per share in accordance with the specialized accounting guidance for Investment Companies. Accordingly, in circumstances in which net asset value per share of an investment is determinative of fair value, we estimate the fair value of an investment in an investment company using the net asset value per share of the investment (or its equivalent) without further adjustment if the net asset value per share of the investment is determined in accordance with the specialized accounting guidance for investment companies as of the reporting entity's measurement date. Revenue Recognition We record interest income, adjusted for amortization of premium and accretion of discount, on an accrual basis to the extent that we expect to collect such amounts. Dividend income is recognized on the ex-dividend date. Original issue discount, principally representing the estimated fair value of detachable equity or warrants obtained in conjunction with the acquisition of debt securities, and market discount or premium are capitalized and accreted or amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion/amortization of discounts and premiums and upfront loan origination fees. Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more and/or when it is no longer probable that principal or interest will be collected. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. We record the reversal of any previously accrued income against the same income 64 -------------------------------------------------------------------------------- Table of Contents category reflected in the Consolidated Statement of Operations. For the three and nine months ended September 30, 2014, we reversed previously accrued and unpaid interest income against interest income recognized totaling $1.7 million. For the three and nine months ended September 30, 2013, we did not reverse previously accrued and unpaid interest income recognized. As of September 30, 2014, we had two loans on non-accrual with an amortized cost basis of $26.1 million and fair value of $14.3 million. As of December 31, 2013, we had two loans on non-accrual with an amortized cost basis of $21.0 million and fair value of $16.8 million. We have investments in our portfolio which contain a contractual paid-in-kind, or PIK, interest provision. PIK interest is computed at the contractual rate specified in each investment agreement, is added to the principal balance of the investment, and is recorded as income. We will cease accruing PIK interest if there is insufficient value to support the accrual or if we do not expect amounts to be collectible and will generally only begin to recognize PIK income again when all principal and interest have been paid or upon a restructuring of the investment where the interest is deemed collectable. To maintain our status as a RIC, PIK interest income, which is considered investment company taxable income, must be paid out to stockholders in the form of dividends even though we have not yet collected the cash. Amounts necessary to pay these dividends may come from available cash. We capitalize and amortize upfront loan origination fees received in connection with the closing of investments. The unearned income from such fees is accreted into interest income over the contractual life of the loan based on the effective interest method. Upon prepayment of a loan or debt security, any prepayment premiums, unamortized upfront loan origination fees, and unamortized discounts are recorded as interest income. Interest income from our investment in TRA and CLO residual interest investments are recorded based upon an estimation of an effective yield to expected maturity using anticipated cash flows with any remaining amount recorded to the cost basis of the investment. We monitor the anticipated cash flows from our TRA and CLO residual interest investments and will adjust our effective yield periodically as needed. Other income includes commitment fees, fees related to the management of Greenway and Greenway II, structuring fees, amendment fees and unused commitment fees associated with investments in portfolio companies. These fees are recognized as income when earned by us in accordance with the terms of the applicable management or credit agreement. Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized. We measure realized gains or losses on the interest rate derivative based upon the difference between the proceeds received or the amounts paid on the interest rate derivative. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values or value of the interest rate derivative during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized. Federal Income Taxes, including excise tax We operate so as to maintain our status as a RIC under Subchapter M of the Code and intend to continue to do so. Accordingly, we are not subject to federal income tax on the portion of our taxable income and gains distributed to stockholders. In order to qualify for favorable tax treatment as a RIC, we are required to distribute annually to our stockholders at least 90% of our investment company taxable income, as defined by the Code. To avoid a 4% federal excise tax, we must distribute each calendar year the sum of (i) 98% of our ordinary income for each such calendar year (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. We may choose not to distribute all of our taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If we choose to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. We will accrue excise tax on undistributed taxable income as required. Please refer to "Dividends" above for a summary of the distributions. For the three and nine months ended September 30, 2014, we incurred excise tax expense of $0.1 million and $0.2 million, respectively. For the three and nine months ended September 30, 2013, we did not incur any excise tax expense. Certain consolidated subsidiaries are subject to U.S. federal and state income taxes. These taxable entities are not consolidated for income tax purposes and may generate income tax liabilities or assets from permanent and temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries. 65-------------------------------------------------------------------------------- Table of Contents The following shows the breakdown of current and deferred income tax provisions (benefits) for the three and nine months ended September 30, 2014 and 2013 (in millions): For the three months ended For the nine months ended September 30, September 30, 2014 2013 2014 2013Income tax (provision) benefit $ (0.1 ) $ 0.1 $ (0.8 ) $ (0.4 ) Benefit (provision) for taxes on realized gain on investments - 1.1 (0.2 ) - Benefit (provision) for taxes on unrealized gain on investments (0.3 ) (1.1 ) 0.7 (1.0 ) These current and deferred income taxes are determined from taxable income estimates provided by portfolio companies where we hold equity or equity-like investments organized as pass-through entities in its tax blocker corporations. These tax estimates may be subject to further change once tax information is finalized for the year. As of September 30, 2014 and December 31, 2013, $0.1 million and $0.4 million, respectively, of income tax receivable was included in prepaid expenses and other assets and $0 and $0.1 million, respectively, was included as income taxes payable on the Consolidated Statements of Assets and Liabilities. As of September 30, 2014 and December 31, 2013, $1.7 million and $2.4 million, respectively, were included in deferred tax liability on the Consolidated Statements of Assets and Liabilities primarily relating to deferred taxes on unrealized gains on investments held in tax blocker corporations. As of September 30, 2014 and December 31, 2013, $0.2 million and $0, respectively of deferred tax assets were included in prepaid expenses and other assets on the Consolidated Statements of Assets and Liabilities relating to net operating loss carryforwards that are expected to be used in future periods. Because federal income tax regulations differ from GAAP, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the consolidated financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes. We follow the provisions under the authoritative guidance on accounting for and disclosure of uncertainty in tax positions. The provisions require us to determine whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For tax positions not meeting the more likely than not threshold, the tax amount recognized in the consolidated financial statements is reduced by the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement with the relevant taxing authority. There are no unrecognized tax benefits or obligations in the accompanying consolidated financial statements. Although we file federal and state tax returns, our major tax jurisdiction is federal. Our inception-to-date federal tax years remain subject to examination by taxing authorities. Recent Developments From October 1, 2014 through November 6, 2014, we closed new and follow-on investments totaling $75.6 million in the financial services, healthcare and manufacturing industries. Of the new and follow-on investments, 57.0% were first lien senior secured debt, 23.2% were second lien debt, 5.9% were subordinated debt, 13.2% were CLO residual interests and 0.7% were investments in funds. Of the new and follow-on debt investments, 76.2% were floating and 23.8% were fixed rate debt based upon principal balance. The new and follow-on debt and income-producing investments had a weighted average yield based upon cost at the time of the investment of 10.5%. On October 20, 2014, we restructured our investment in Wingspan Portfolio Holdings, Inc., or Wingspan. As part of the restructuring, we exchanged our subordinated term loan for a controlled equity position of an affiliated entity, Dimont Acquisition Inc., or Dimont. The fair value of the shares for the equity received in the exchange approximated the fair value of the subordinated debt reflected as of September 30, 2014. Concurrently, we made a $4.5 million investment (included in the $75.6 million noted above) in the subordinated term loan of Dimont & Associates, Inc., a wholly-owned subsidiary of Dimont. Dimont was previously a wholly-owned subsidiary of Wingspan. On October 24, 2014, we sold our CLO residual interest in Octagon Income Note XIV, Ltd generating proceeds of $7.7 million and a realized gain of $0.2 million. On November 3, 2014, we received proceeds of $10.2 million from the prepayment of a second lien term loan in Surgery Center Holdings, Inc. The proceeds included a $0.2 million prepayment premium. On November 4, 2014, we sold $5.3 million of our second lien term loan in Expert Global Solutions, Inc. and recognized a realized loss of $0.3 million. On November 4, 2014, our board of directors declared a dividend of $0.34 per share payable on December 31, 2014 to stockholders of record at the close of business on December 15, 2014. |