| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis or our financial condition and results of operations should be read together with the financial statements and the related notes that are included in Item 1 of Part I of this quarterly report on Form 10-Q. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section entitled “Item 1A. Risk Factors” in our transition report on Form 10-K for the transition period from April 1, 2022 to December 31, 2022 and elsewhere in this quarterly report on Form 10-Q. Please also see the section entitled “Special Note Regarding Forward-Looking Statements.”
Overview
We were formed in January 2021 as a Maryland corporation and structured as an externally managed, closed-end, non-diversified management investment company. We have elected to be treated as a BDC under the 1940 Act. In addition, for U.S. federal income tax purposes we have elected to be treated, and intend to qualify annually to be treated, as a RIC under Subchapter M of the Code, commencing with our taxable year ended March 31, 2022. On November 8, 2022, our Board of Directors approved a change in our fiscal year end from March 31 to December 31.
We are a specialty finance company that may invest across the cannabis ecosystem through investments in the form of direct loans to, and equity ownership of, privately held cannabis companies. All of our investments are designed to be compliant with all applicable laws and regulations within the jurisdictions in which they are made or to which we are otherwise subject, including U.S. federal laws. We will make equity investments only in companies that are compliant with all applicable laws and regulations within the jurisdictions in which they are located or operate, including U.S. federal laws. We may make loans to companies that we determine based on our due diligence are licensed in, and complying with, state-regulated cannabis programs, regardless of their status under U.S. federal law, so long as the investment itself is designed to be compliant with all applicable laws and regulations in the jurisdiction in which the investment is made or to which we are otherwise subject, including U.S. federal law. We are externally managed by SSC and seek to expand the compliant cannabis investment activities of SSC’s leading investment platform in the cannabis industry. We primarily seek to partner with private equity firms, entrepreneurs, business owners and management teams to provide credit and equity financing alternatives to support buyouts, recapitalizations, growth initiatives, refinancings and acquisitions across cannabis companies, including cannabis-enabling technology companies, cannabis-related health and wellness companies, and hemp and CBD distribution companies. Under normal circumstances, each such cannabis company derives at least 50% of its revenues or profits from, or commits at least 50% of its assets to, activities related to cannabis at the time of our investment in the cannabis company. We are not required to invest a specific percentage of our assets in such cannabis companies, and we may make debt and equity investments in other companies in the health and wellness sector.
Our investment objective is to maximize risk-adjusted returns on equity for our shareholders. We seek to capitalize on what we believe to be nascent cannabis industry growth and drive return on equity by generating current income from our debt investments and capital appreciation from our equity and equity-related investments. We intend to achieve our investment objective by investing primarily in secured debt, unsecured debt, equity warrants and direct equity investments in privately held businesses. We intend that our debt investments will often be secured by either a first or second priority lien on the assets of the portfolio company, can include either fixed or floating rate terms and will generally have a term of between three and six years from the original investment date. To date, we have invested in first lien secured, fixed and floating rate debt with terms of two to four years. We expect our secured loans to be secured by various types of assets of our borrowers. While the types of collateral securing any given secured loan will depend on the nature of the borrower’s business, common types of collateral we expect to secure our loans include real property and certain personal property, including equipment, inventory, receivables, cash, intellectual property rights and other assets to the extent permitted by applicable laws and the regulations governing our borrowers. Certain attractive assets of our borrowers, such as cannabis licenses and cannabis inventory, may not be able to be used as collateral or transferred to us. See “Item 1A. Risk Factors—Risks Relating to Our Investments—Certain assets of our borrowers may not be used as collateral or transferred to us due to applicable state laws and regulations governing the cannabis industry, and such restrictions could negatively impact our profitability.” In some of our portfolio investments, we expect to receive nominally priced equity warrants and/or make direct equity investments in connection with a debt investment. In addition, a portion of our portfolio may be comprised of derivatives, including total return swaps.
Generally, the loans we invest in have a complete set of financial maintenance covenants, which are used to proactively address materially adverse changes in a portfolio company’s financial performance. However, we may invest in “covenant-lite” loans. We use the term “covenant-lite” to refer generally to loans that do not have a complete set of financial maintenance covenants. Generally, “covenant-lite” loans provide borrower companies more freedom to negatively impact lenders because their covenants are incurrence-based, which means they are only tested and can only be breached following an affirmative action of the borrower, rather than by a deterioration in the borrower’s financial condition. Accordingly, to the extent we invest in “covenant-lite” loans, we may have fewer rights against a borrower and may have a greater risk of loss on such investments as compared to investments in or exposure to loans with a complete set of financial maintenance covenants.
The loans in which we tend to invest typically pay interest at rates which are determined periodically on the basis of PRIME plus a premium. The loans in which we have invested and expect to invest are typically made to U.S. and, to a limited extent, non-U.S. (including emerging market) corporations, partnerships and other business entities which operate in various industries and geographical regions. These loans typically are not rated or are rated below investment grade. Securities rated below investment grade are often referred to as “high-yield” or “junk” securities, and may be considered a higher risk than debt instruments that are rated above investment grade.
We have typically invested in and expect to continue to invest in loans made primarily to private leveraged middle-market companies with up to $100 million of earnings before interest, taxes, depreciation and amortization, or “EBITDA.” Our business model is focused primarily on the direct origination of investments through portfolio companies or their financial sponsors. We expect that our investments will generally range between $4 million and $40 million each, although we expect that this investment size will vary proportionately with the size of our capital base. We have an active pipeline of investments and are currently reviewing over $589 million of potential investments in varying stages of underwriting.
We are externally managed by SSC. SSC also provides the administrative services necessary for us to operate. We believe that our ability to leverage the existing investment management platform of SSC enables us to operate more efficiently and with lower overhead costs than other newly formed funds of comparable size.
Revenues
We generate revenues primarily in the form of interest income from the investments we hold. In addition, we may generate income from dividends on either direct equity investments or equity interests obtained in connection with originating loans, such as options, warrants or conversion rights. Our debt investments typically have a term of three to six years. Our loan portfolio will bear interest at a fixed or floating rate, subject to interest rate floors in certain cases. Interest on our debt investments will generally be payable either monthly or quarterly, but may be semi-annually.
Our investment portfolio consists of fixed and floating rate loans, and our credit facilities, if any, will bear interest at floating rates. Macro trends in base interest rates like PRIME may affect our net investment income over the long term.
Loan origination fees, OID, closing fees and market discount or premium are capitalized, and we accrete or amortize such amounts as interest income and using the effective yield method for term instruments. Repayments of our debt investments will reduce interest income in future periods. The frequency or volume of these repayments may fluctuate significantly. We will record prepayment premiums on loans as interest income. We may also generate revenue in the form of commitment, structuring, or due diligence fees, fees for providing managerial assistance to our portfolio companies, and consulting fees.
Dividend income on equity investments, if applicable, will be recorded on the record date for private portfolio companies or on the ex-dividend date for publicly traded companies.
Our portfolio activity may also reflect the proceeds from sales of investments. We will recognize realized gains or losses on sales of investments based on the difference between the net proceeds from the disposition and the amortized cost basis of the investment, without regard to unrealized gains or losses previously recognized. We will record current-period changes in fair value of investments that are measured at fair value as a component of the net change in unrealized gains (losses) on investments on the Statements of Operations.
Expenses
Our primary operating expenses are a base management fee and any incentive fees under the Investment Advisory Agreement. Our investment management fee compensates our Adviser for its work in identifying, evaluating, negotiating, executing, monitoring, servicing and realizing our investments. See “Item 1. Business—Investment Advisory Agreement.”
Except as specifically provided below, all investment professionals and staff of the Adviser, when and to the extent engaged in providing investment advisory and management services to us, the base compensation, bonus and benefits, and the routine overhead expenses of such personnel allocable to such services, are provided and paid for by the Adviser. We may bear our allocable portion of the compensation paid by the Adviser (or its affiliates) to our CFO and CCO and their respective staffs (based on a percentage of time such individuals devote, on an estimated basis, to our business affairs). We may bear any other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:
| • | the cost of our organization and offerings; |
| • | the cost of calculating our NAV, including the cost of any third-party valuation services; |
| • | the cost of effecting sales and repurchases of shares of our common stock and other securities; |
| • | fees and expenses payable under any underwriting agreements, if any; |
| • | debt service and other costs of borrowings or other financing arrangements; |
| • | expenses, including travel expenses, incurred by the Adviser, or members of the investment team, or payable to third-parties, performing due diligence on prospective portfolio companies and, if necessary, enforcing our rights; |
| • | management and incentive fees payable pursuant to the Investment Advisory Agreement; |
| • | fees payable to third-parties relating to, or associated with, making investments and valuing investments (including third-party valuation firms); |
| • | costs, including legal fees, associated with compliance under cannabis laws; |
| • | transfer agent and custodial fees; |
| • | fees and expenses associated with marketing efforts (including attendance at industry and investor conferences and similar events); |
| • | federal and state registration fees; |
| • | any exchange listing fees and fees payable to rating agencies; |
| • | federal, state and local taxes; |
| • | independent directors’ fees and expenses, including travel expenses; |
| • | cost of preparing financial statements and maintaining books and records and filing reports or other documents with the SEC (or other regulatory bodies) and other reporting and compliance costs, and the compensation of professionals responsible for the preparation of the foregoing; |
| • | the cost of any reports, proxy statements or other notices to our stockholders (including printing and mailing costs), the costs of any stockholder or director meetings and the compensation of investor relations personnel responsible for the preparation of the foregoing and related matters; |
| • | brokerage commissions and other compensation payable to brokers or dealers; |
| • | research and market data; |
| • | fidelity bond, directors’ and officers’ errors and omissions liability insurance and other insurance premiums; |
| • | direct costs and expenses of administration, including printing, mailing and staff; |
| • | fees and expenses associated with independent audits, and outside legal and consulting costs; |
| • | costs incurred in connection with the formation or maintenance of entities or vehicles to hold our assets for tax or other purposes; |
| • | extraordinary expenses (such as litigation or indemnification); and |
| • | costs associated with reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws. |
We expect, but cannot assure, that our general and administrative expenses will increase in dollar terms during periods of asset growth, but will decline as a percentage of total assets during such periods.
Hedging
To the extent that any of our investments are denominated in a currency other than U.S. dollars, we may enter into currency hedging contracts to reduce our exposure to fluctuations in currency exchange rates. We may also enter into interest rate hedging agreements. Such hedging activities, which will be subject to compliance with applicable legal requirements, may include the use of futures, options, swaps and forward contracts. Costs incurred in entering into such contracts or in connection with settling them will be borne by us.
Portfolio Composition and Investment Activity
Portfolio Composition
As of June 30, 2023, our investment portfolio had an aggregate fair value of approximately $57.7 million and was comprised of approximately $49.7 million in first lien, senior secured loans, and approximately $7.9 million in senior secured notes across six portfolio companies. As of December 31, 2022, our investment portfolio had an aggregate fair value of approximately $50.3 million and was comprised of approximately $40.7 million in first lien, senior secured loans, and approximately $9.6 million in senior secured notes across five portfolio companies.
A summary of the composition of our investment portfolio at cost and fair value as a percentage of total investments are shown in the following tables as of June 30, 2023 and December 31, 2022.
| | | June 30, 2023 | |
| Type | | Amortized Cost | | | Fair Value | |
| Senior Secured First Lien Term Loan | | | 86.1 | % | | | | % |
| Senior Secured Notes | | | 13.9 | | | | | |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2022 | |
| Type | | Amortized Cost | | | Fair Value | |
| Senior Secured First Lien Term Loan | | | 80.9 | % | | | 80.9 | % |
| Senior Secured Notes | | | 19.1 | | | | 19.1 | |
| Total | | | 100.0 | % | | | 100.0 | % |
The following tables show the composition of our investment portfolio by geographic region of the United States at cost and fair value as a percentage of total investments as of June 30, 2023 and December 31, 2022. The geographic composition is determined by the location of the headquarters of the portfolio company.
| | | June 30, 2023 | |
| Geographic Region | | Amortized Cost | | | Fair Value | |
| West | | | 43.2 | % | | | | % |
| Midwest | | | 42.7 | | | | | |
| Northeast | | | 14.1 | | | | | |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2022 | |
| Geographic Region | | Amortized Cost | | | Fair Value | |
| Midwest | | | 48.4 | % | | | 48.5 | % |
| West | | | 40.5 | | | | 40.3 | |
| Northeast | | | 7.6 | | | | 7.7 | |
| Southeast | | | 3.5 | | | | 3.5 | |
| Total | | | 100.0 | % | | | 100.0 | % |
Set forth below are tables showing the industry composition of our investment portfolio at cost and fair value as a percentage of total investments as of June 30, 2023 and December 31, 2022.
| | | June 30, 2023 | |
| Industry | | Amortized Cost | | | Fair Value | |
| Wholesale Trade | | | 100.0 | % | | | 100.0 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | | |
| Industry | | Amortized Cost | | | Fair Value | |
| Wholesale Trade | | | 100.0 | % | | | 100.0 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
Concentrations of Credit Risk
Credit risk is the risk of default or non-performance by portfolio companies, equivalent to the investment’s carrying amount. Industry and sector concentrations will vary from period to period based on portfolio activity.
As of June 30, 2023 and December 31, 2022, we had two and two portfolio companies that represented 71.6% and 80.9%, respectively, of the fair value of our portfolio. As of June 30, 2023 and December 31, 2022, our largest portfolio company represents 35.9% and 40.6%, respectively, of the total fair value of our investments in portfolio companies.
Investment Activity
During the three and six months ended June 30, 2023, we made an aggregate of approximately $4.3 million and $8.8 million of investments in one and two portfolio companies, respectively, excluding fees and discounts. During the three and six months ended June 30, 2022, we made an aggregate of approximately $25.25 million of investments in two new portfolio companies, excluding fees. During the three and six months ended June 30, 2023, there were $1.7 million and $1.7 million of repayments received or sales of investments. During the three and six months ended June 30, 2022, there were no repayments received or sales of investments.
The following table provides a summary of the changes in the investment portfolio for the six months ended June 30, 2023 and 2022:
| | | Six Months Ended June 30, 2023 | | | Six Months Ended June 30, 2022 | |
| Beginning Portfolio, at fair value | | $ | 50,254,550 | | | $ | - | |
| Purchases | | | 8,442,000 | | | | 24,417,500 | |
| Accretion of discount and fees (amortization of premium), net | | | 301,558 | | | | 9,508 | |
| PIK interest | | | 62,587 | | | | - | |
| Proceeds from sales of investments and principal repayments | | | (1,690,000 | ) | | | - | |
| Net realized gain/(loss) on investments | | | (210,767 | ) | | | - | |
| Net change in unrealized appreciation/(depreciation) on investments | | | | | | | (9,508 | ) |
| Ending Portfolio, at fair value | | $ | | | | $ | 24,417,500 | |
Portfolio Asset Quality
Our portfolio management team uses an ongoing investment risk rating system to characterize and monitor our outstanding loans. Our portfolio management team monitors and, when appropriate, recommends changes to the investment risk ratings. Our Adviser’s Valuation Committee reviews the recommendations and/or changes to the investment risk ratings, which are submitted on a quarterly basis to the Board of Directors and its Audit Committee.
| Investment | | |
| Performance Risk | | |
| Rating | | Summary Description |
| Grade 1 | | Investments rated 1 involve the least amount of risk to our initial cost basis. The borrower is performing above expectations, and the trends and risk factors for this investment since origination or acquisition are generally favorable. Full return of principal, interest and dividend income is expected. |
| Grade 2 | | Investment is performing in-line with expectations. Investments rated 2 involve an acceptable level of risk that is similar to the risk at the time of origination or acquisition. Risk factors remain neutral or favorable compared with initial underwriting. All investments or acquired investments in new portfolio companies are initially assessed a rating of 2. |
| Grade 3 | | Investments rated 3 involve a borrower performing below expectations and indicates that the loan’s risk has increased somewhat since origination or acquisition. Capital impairment or payment delinquency is not anticipated. The investment may also be out of compliance with certain financial covenants. |
| Grade 4 | | Investments rated 4 involve a borrower performing materially below expectations and indicates that the loan’s risk has increased materially since origination or acquisition. In addition to the borrower being generally out of compliance with debt covenants, loan payments may be past due (but generally not more than 120 days past due). Delinquency of interest and / or dividend payments in anticipated. No loss of principal is anticipated. |
| Grade 5 | | Investments rated 5 involve a borrower performing substantially below expectations and indicates that the loan’s risk has increased substantially since origination or acquisition. It is anticipated that the Company will not recoup its initial cost and may realize a loss upon exit. Most or all of the debt covenants are out of compliance and payments are substantially delinquent. Loans rated 5 are not anticipated to be repaid in full and we will reduce the fair market value of the loan to the amount we anticipate will be recovered. |
The following tables show the distribution of our loan investments on the 1 to 5 investment risk rating scale at fair value as of June 30, 2023 and December 31, 2022:
| | | | June 30, 2023 | |
| Investment Performance Risk Rating | | | Investments at Fair Value | | | Percentage of Total Investments | |
| 1 | | | | $ | - | | | | - | % |
| 2 | | | | | | | | | 100.00 | |
| 3 | | | | | - | | | | - | |
| 4 |
| | | | - | | | | - | |
| 5 | | | | | - | | | | - | |
| Total | | | $ | | | | | 100.00 | % |
| | | | December 31, 2022 | |
| Investment Performance Risk Rating | | | Investments at Fair Value | | | Percentage of Total Investments | |
| 1 | | | | $ | - | | | | - | % |
| 2 | | | | | 50,254,550 | | | | 100.00 | |
| 3 | | | | | - | | | | - | |
| 4 | | | | | - | | | | - | |
| 5 | | | | | - | | | | - | |
| Total | | | $ | 50,254,550 | | | | 100.00 | % |
Debt Investments on Non-Accrual Status
As of June 30, 2023 and December 31, 2022, there were no loans in our portfolio placed on non-accrual status.
Results of Operations
The following discussion and analysis of our results of operations encompasses our results for the three and six months ended June 30, 2023 and 2022.
Investment Income
The following table sets forth the components of investment income for the three and six months ended June 30, 2023 and 2022:
| | | Three Months Ended June 30, 2023 | | | Three Months Ended June 30, 2022 | | | Six Months Ended June 30, 2023 | | | Six Months Ended June 30, 2022 | |
| | $ | 2,550,696 | | | $ | 390,083 | | | $ | 4,856,143 | | | $ | 400,156 | |
| Accretion of discount and fees (amortization of premium), net | | | 160,739 | | | | 9,508 | | | | 301,558 | | | | 9,508 | |
Payment in-kind interest
| | | 51,014
| | | | -
| | | | 62,587
| | | | -
| |
| Fee income | | | 131,250 | | | | 410,000 | | | | 131,250 | | | | 410,000 | |
| Total investment income | | $ | 2,893,699 | | | $ | 809,591 | | | $ | 5,351,538 | | | $ | 819,664 | |
We generate revenues primarily in the form of investment income from the investments we hold, generally in the form of interest income from our debt securities. Stated interest income represents interest income recognized as earned in accordance with the contractual terms of the loan agreement. Stated interest income from original issue discount (“OID”) and market discount represent the accretion into interest income over the term of the loan as a yield enhancement. Interest income from payment-in-kind (“PIK”) represents contractually deferred interest added to the loan balance recorded on an accrual basis to the extent such amounts are expected to be collected.
The Company also recognizes certain fees as one-time fee income, including, but not limited to, structuring fees.
For the three and six months ended June 30, 2023, total investment income was approximately $2.9 million and $5.3 million, which is attributable to $0.1 million and $0.1 million of fee income related to administrative and amendment fees and $2.8 million and $5.2 million of interest income, respectively. For the three and six months ended June 30, 2022, total investment income was approximately $0.8 million, which is attributable to $0.4 million of fee income related to structuring fees and $0.4 million of interest income. The increase in investment income during the three and six months ended June 30, 2023 in comparison to the three and six months ended June 30, 2022 is due to the increase in debt investments and the associated interest income increase.
Operating Expenses
Our operating expenses for the three and six months ended June 30, 2023 are comprised primarily of professional fees for legal, administration, audit, valuation and directors, our management fees and incentive fees. Our operating expenses totaled approximately $1.0 million and $2.1 million for the three and six months ended June 30, 2023, respectively. Our operating expenses for the three and six months ended June 30, 2022 are comprised of professional fees for legal, administration, audit and directors, and our management fees. Our operating expenses totaled approximately $0.6 million and $0.8 million for the three and six months ended June 30, 2022, respectively. The increase in expenses during the three and six months ended June 30, 2023 in comparison to the three and six months ended June 30, 2022 is due to incentive fees, which had not met the hurdle rate to be earned during the first year of operations and management fees, which increased due to the increase in debt investments.
Net Investment Income
As a result of approximately $2.9 million and $5.4 million in total investment income as compared to $1.0 million and $2.1 million in total expenses, net investment income for the three and six months ended June 30, 2023 was approximately $1.9 million and $3.3 million, respectively. As a result of approximately $0.8 million and $0.8 million in total investment income as compared to $0.6 million and $0.8 million in total expenses, net investment income for the three and six months ended June 30, 2022 was approximately $0.2 million and less than $0.1 million, respectively.
Net Realized Gains and Losses
Realized gains or losses are measured by the difference between the net proceeds from the sale or redemption of an investment or a financial instrument and the cost basis of the investment or financial instrument, without regard to unrealized appreciation or depreciation previously recognized, and includes investments written-off during the period. There was $210,767 and $210,767 net realized loss from the sales of an investment during the three and six months ended June 30, 2023, respectively. There were no net realized gains (losses) from the sales, repayments, or exits of investments during the three and six months ended June 30, 2022, respectively.
Net Change in Unrealized Appreciation / (Depreciation) from Investments
Net change in unrealized appreciation/(depreciation) from investments primarily reflects the net change in the fair value as of the last business day of the reporting period, including the reversal of previously recorded unrealized gains or losses with respect to investments realized during the period. We record current-period changes in fair value of investments that are measured at fair value as a component of the net change in unrealized gains (losses) on investments on the Statements of Operations.
Net unrealized appreciation and depreciation on investments for the three and six months ended June 30, 2023 and 2022 is comprised of the following:
| | | Three Months Ended June 30, 2023 | | | Three Months Ended June 30, 2022 | | | Six Months Ended June 30, 2023 | | | Six Months Ended June 30, 2022 | |
| Gross unrealized appreciation | | $ | |
| | $ | -
|
| | $ | | | | $ | - |
|
| Gross unrealized depreciation | | | | ) | | | (9,508
| )
| | | | ) | | | (9,508
| )
|
| Total net unrealized appreciation (depreciation) on investments | | $ | | )
| | $ | (9,508 | ) | | $ | | | | $ | (9,508 | ) |
The following table details net change in unrealized appreciation (depreciation) for our portfolio for the three and six months ended June 30, 2023 and 2022:
| | | Three Months Ended June 30, 2023 | | | Three Months Ended June 30, 2022 | | | Six Months Ended June 30, 2023 | | | Six Months Ended June 30, 2022 | |
| STIIIZY, Inc. (f/k/a Shryne Group Inc.) | | $ | 68,415
| | | $ | (9,325 | ) | | $ | 341,831
| | | $ | (9,325 | ) |
| Verano Holdings Corp. | | | (340,337 | ) | | | - | | | | 124,811 | | | | - | |
| MariMed Inc. | | | 30,864 | | | | - | | | | 30,863 | | | | - | |
| Dreamfields Brands, Inc. (d/b/a Jeeter) | | | 78 | | | | - | | | | 78 | | | | - | |
| PharmaCann, Inc. | | | (180,757 | ) | | | (183 | ) | | | (96,543 | ) | | | (183 | ) |
| Curaleaf Holdings, Inc. | | | | ) | | | - | | | | |
| | | - | |
| AYR Wellness, Inc. | | | (6,587 | ) | | | - | | | | - | | | | - | |
| Total net change in unrealized appreciation (depreciation) on investments | | $ | (477,241
| )
| | $ | (9,508 | ) | | $ | | | | $ | (9,508 | ) |
Financial Condition, Liquidity and Capital Resources
We generate cash primarily from the net proceeds of offerings of securities and cash flows from operations, including interest earned from the temporary investment of cash in U.S. government securities.
In addition, we expect to enter into a credit facility in the future. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. We are currently targeting a debt-to-equity ratio of 0.50x (i.e., we aim to have one dollar of equity for each $0.50 of debt outstanding).
Our primary use of funds will be investments in portfolio companies, dividend payments to holders of our common stock, and the payment of operating expenses. As of June 30, 2023 and December 31, 2022, we had cash resources of approximately $32.9 million and $35.1 million and no indebtedness, respectively.
To maintain its tax treatment as a RIC, the Company must meet specified source-of-income requirements and timely distribute to its stockholders for each taxable year at least 90% of its investment company taxable income. Additionally, in order for the Company not to be subject to U.S. federal excise taxes, it must distribute annually an amount at least equal to the sum of (i) 98% of its net ordinary income for the calendar year, (ii) 98.2% of its capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year and (iii) any net ordinary income and capital gains in excess of capital losses for preceding years that were not distributed during such years.
Dividends may also be distributed in accordance with the Company’s distribution reinvestment plan (“DRIP”), which provides for the reinvestment of distributions in the form of common stock on behalf of its stockholders, unless a stockholder has elected to receive distributions in cash. As a result, if the Company declares a cash distribution, its stockholders who have not “opted out” of the DRIP by the opt out date will have their cash distribution automatically reinvested into additional shares of the Company’s common stock. The share requirements of the DRIP may be satisfied through the issuance of common shares or through open market purchases of common shares by the DRIP plan administrator.
U.S. Federal Income Taxes
We elected to be treated, and intend to qualify annually to be treated, as a RIC under Subchapter M of the Code for federal income tax purposes. As a RIC, we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders from our tax earnings and profits. To obtain and maintain our RIC tax treatment, we must, among other things, meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any.
Critical Accounting Estimates
Basis of Presentation
The Company’s financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and pursuant to Regulation S-X under the Securities Act of 1933, as amended (the “Securities Act”). The Company follows accounting and reporting guidance as determined by the Financial Accounting Standards Board (“FASB”).
The preparation of financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions affecting amounts reported in our financial statements. We will continuously evaluate our estimates, including those related to the matters described below. These estimates will be based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. For additional information, please refer to “Note 2 – Significant Accounting Policies” in the notes to the financial statements included with this quarterly report on Form 10-Q. Valuation of investments is considered to be our critical accounting policy and estimates. A discussion of our critical accounting policy follows.
Investment Valuation
Investments for which market quotations are readily available will typically be valued at the bid price of those market quotations. To validate market quotations, we utilize a number of factors to determine if the quotations are representative of fair value, including the source and number of the quotations. Debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by the Adviser, as the Company’s valuation designee (the “Valuation Designee”), based on inputs that may include valuations, or ranges of valuations, provided by independent third-party valuation firm(s) engaged by the Adviser. Effective September 8, 2022, pursuant to Rule 2a-5 under the 1940 Act, the Board designated the Adviser as the Valuation Designee to perform the fair value determinations for the Company, subject to the oversight of the Board and certain Board reporting and other requirements.
As part of the valuation process, the Adviser takes into account relevant factors in determining the fair value of our investments, including: the estimated enterprise value of a portfolio company (i.e., the total fair value of the portfolio company’s debt and equity), the nature and realizable value of any collateral, the portfolio company’s ability to make payments based on its earnings and cash flow, the markets in which the portfolio company does business, a comparison of the portfolio company’s securities to any similar publicly traded securities, and overall changes in the interest rate environment and the credit markets that may affect the price at which similar investments may be made in the future. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the Adviser considers whether the pricing indicated by the external event corroborates its valuation.
The Adviser undertakes a multi-step valuation process, which includes, among other procedures, the following:
| • | With respect to investments for which market quotations are readily available, those investments will typically be valued at the bid price of those market quotations; |
| • | With respect to investments for which market quotations are not readily available, the valuation process begins with the Adviser’s valuation committee establishing a preliminary valuation of each investment, which may be based on valuations, or ranges of valuations, provided by independent valuation firm(s); |
| • | Preliminary valuations are documented and discussed by the Adviser’s valuation committee and, where appropriate, the independent valuation firm(s); and |
| • | The Adviser determines the fair value of each investment. |
We conduct this valuation process on a quarterly basis.
We apply Financial Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurement (“ASC 820”), which establishes a framework for measuring fair value in accordance with U.S. GAAP and required disclosures of fair value measurements. ASC 820 determines fair value to be the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. Market participants are defined as buyers and sellers in the principal or most advantageous market (which may be a hypothetical market) that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, we consider the principal market to be the market that has the greatest volume and level of activity. ASC 820 specifies a fair value hierarchy that prioritizes and ranks the level of observability of inputs used in determination of fair value. In accordance with ASC 820, these levels are summarized below:
| • | Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date; |
| • | Level 2 – Valuations based on quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or for which all significant inputs are observable, either directly or indirectly; and |
| • | Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. |
All of our investments as of June 30, 2023 and December 31, 2022 are categorized at level 3, and therefore, 100% of our portfolio requires significant estimates. Our investments may not have readily available market quotations (as such term is defined in Rule 2a-5 under the 1940 Act), and those investments which do not have readily available market quotations are valued at fair value as determined in good faith in accordance with our valuation policy. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Significant unobservable inputs create uncertainty in the measurement of fair value as of the reporting date. The significant unobservable inputs used in the fair value measurement of the Company’s investments may vary and may include the debt investments’ yield and volatility fluctuations. Significant increases (decreases) in discount rate in isolation would result in a significantly higher (lower) fair value assessment. Significant increases (decreases) in volatility in isolation would result in a significantly lower (higher) fair value assessment.
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 fluctuate from period to period. Additionally, the fair value of such investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that may ultimately be realized. Further, such investments are generally less liquid than publicly traded securities and may be subject to contractual and other restrictions on resale. If we were required to liquidate a portfolio investment in a forced or liquidation sale, it could realize amounts that are different from the amounts presented and such differences could be material.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected previously.
Other Contractual Obligations
We will have certain commitments pursuant to our Investment Advisory Agreement that we have entered into with SSC. We have agreed to pay a fee for investment advisory services consisting of two components: a base management fee and an incentive fee. Payments under the Investment Advisory Agreement will be equal to (1) a percentage of the value of our average gross assets and (2) a two-part incentive fee. See “Item 1. Business—Investment Advisory Agreement.” We have also entered into a contract with SSC to serve as our administrator. Payments under the Administration Agreement will be reimbursements to SSC for the costs and expenses incurred by SSC in performing its obligations, including but not limited to maintaining and keeping all books and records and providing personnel and facilities. This includes costs and expenses incurred by SSC in connection with the delegation of its obligations to a sub-administrator. The Company is not responsible for the compensation of SSC’s employees and overhead expenses. See “Item 1. Business—Administration Agreement.”
Common Stock
Our common stock began trading on the Nasdaq Global Market on February 4, 2022 under the symbol “SSIC” in connection with our IPO of shares of our common stock.
The following table lists the net asset value per share of our common stock, the range of high and low closing sales prices of our common stock reported on the Nasdaq Global Market, the closing sale prices as a premium (or discount) to our net asset value per share and dividends per share for each fiscal quarter since our common stock began trading on the Nasdaq Global Market. On August 9, 2023, the last reported closing sales price of our common stock on the Nasdaq Global Market was $8.76 per share, which represented a discount of approximately 39.5% to our net asset value per share of $14.49 as of June 30, 2023.
| | | | | | Price Range | | | | | | | | | | |
| Class and Period | | Net Asset Value(1) | | | High | | | Low | | | High Sales Price Premium (Discount) to Net Asset Value(2) | | | Low Sales Price Premium (Discount) to Net Asset Value(2) | | | Cash Dividend Per Share(3) | |
| Year Ended December 31, 2023 | | | | | | | | | | | | | | | | | | |
| Third Quarter (Through August 9, 2023) | | $ | * | | | $ | | | | $ | 7.65 | | | | * | | | | * | | | | * | |
| Second Quarter | | $ | 14.49 | | | $ | 9.19 | | | $ | 7.82 | | | | -36.6 | % | | | | % | | | - | |
| First Quarter | | $ | 14.29 | | | $ | 9.98 | | | $ | 8.25 | | | | -30.2 | % | | | -42.3 | % | | | - | |
Year Ended December 31, 2022(4) | | | | | | | | | | | | | | | | | | | | | | | | |
| Fourth Quarter | | $ | 13.91 | | | $ | 10.55 | | | $ | 9.57 | | | | -24.2 | % | | | -31.2 | % | | | - | |
| Third Quarter | | $ | 13.73 | | | $ | 10.74 | | | $ | 9.00 | | | | -21.8 | % | | | -34.5 | % | | | - | |
| Second Quarter | | $ | 13.64 | | | $ | 13.50 | | | $ | 7.80 | | | | -1.0 | % | | | -42.8 | % | | | - | |
First Quarter(5) | | $ | 13.61 | | | $ | 14.41 | | | $ | 12.57 | | | | 5.9 | % | | | -7.6 | % | | | - | |
(1) Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low closing sales prices. The net asset values shown are based on outstanding shares at the end of the relevant quarter.
(2) Calculated as the respective high or low closing sales price less net asset value, divided by net asset value (in each case, as of the end of the applicable quarter).
(3) Represents the dividend or distribution declared in the relevant quarter.
(4) On November 8, 2022, our Board of Directors approved a change to our fiscal year end from March 31 to December 31.
(5) Shares of our common stock began trading on the Nasdaq Global Market on February 4, 2022 under the trading symbol “SSIC.”
* Not determined at time of filing.
Shares of BDCs may trade at a market price that is less than the value of the net assets attributable to those shares. At times, our shares of common stock have traded at prices both above and below our net asset value per share. The possibility that our shares of common stock will trade at a discount from net asset value per share or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value per share will decrease. It is not possible to predict whether our common stock will trade at, above, or below net asset value per share.
Holders
As of August 9, 2023, there were approximately 2 holders of record of our common stock, which does not include stockholders for whom shares are held in “nominee” or “street name.”
Distributions
To the extent that we have income available, we intend to make quarterly distributions to our stockholders beginning after our first full year of operations. The amount of our distributions, if any, will be determined by our Board of Directors.
We have elected to be treated, and intend to qualify annually to be treated, as a RIC under Subchapter M of the Code, for U.S. federal income tax purposes, commencing with our taxable year ended March 31, 2022. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
To obtain and maintain RIC tax treatment, we must distribute (or be deemed to distribute) at least 90% of the sum of our: investment company taxable income (which is generally our ordinary income plus the excess of realized short-term capital gains over realized net long-term capital losses), determined without regard to the deduction for dividends paid, for such taxable year; and net tax-exempt interest income (which is the excess of our gross tax-exempt interest income over certain disallowed deductions) for such taxable year.
As a RIC, we (but not our stockholders) generally will not be subject to U.S. federal tax on investment company taxable income and net capital gains that we distribute to our stockholders. The discussion below assumes that we will qualify to be treated as a RIC for U.S. federal tax purposes each year.
We intend to distribute annually all or substantially all of such income. To the extent that we retain our net capital gains or any investment company taxable income, we generally will be subject to corporate-level U.S. federal income tax. We can be expected to carry forward our net capital gains or any investment company taxable income in excess of current-year dividend distributions, and pay the U.S. federal excise tax as described below.
Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current-year distributions into the next tax year. We will be subject to a 4% excise tax on a certain portion of these undistributed amounts. Please refer to “Item 1. Business — Material U.S. Federal Income Tax Considerations” for further information regarding the consequences of our retention of net capital gains. We may, in the future, make actual distributions to our stockholders of our net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. See “Item 1. Business — Business Development Company Regulations” and “Item 1. Business —Material U.S. Federal Income Tax Considerations.”
While we intend to distribute any income and capital gains in the manner necessary to minimize imposition of the 4% U.S. federal excise tax, sufficient amounts of our taxable income and capital gains may not be distributed and as a result, in such cases, the excise tax will be imposed. In such an event, we will be liable for this tax only on the amount by which we do not meet the foregoing distribution requirement.
We intend to pay quarterly distributions to our stockholders out of assets legally available for distribution. All distributions will be paid at the discretion of our Board of Directors and will depend on our earnings, financial condition, maintenance of our tax treatment as a RIC, compliance with applicable BDC regulations and such other factors as our Board of Directors may deem relevant from time to time.
To the extent our current taxable earnings for a year fall below the total amount of our distributions for that year, a portion of those distributions may be deemed a return of capital to our stockholders for U.S. federal income tax purposes. Thus, the source of a distribution to our stockholders may be the original capital invested by the stockholder rather than our income or gains. Stockholders should read written disclosure carefully and should not assume that the source of any distribution is our ordinary income or gains.
A return of capital is a return of a portion of your original investment in shares of our common stock. As a result, a return of capital will (i) lower your tax basis in your shares and thereby increase the amount of capital gain (or decrease the amount of capital loss) realized upon a subsequent sale or redemption of such shares and (ii) reduce the amount of funds we have for investment in portfolio companies. We have not established any limit on the extent to which we may use offering proceeds to fund distributions. However, our Board of Directors, including a majority of our independent directors, will be required to determine that making return of capital distributions from our offering proceeds is in the best interests of our stockholders based upon our then-current financial condition and our expected future growth prospects.
We made no distributions during the three and six months ended June 30, 2023 or the fiscal year ended December 31, 2022.
Dividend Reinvestment Plan
We have adopted an “opt out” dividend reinvestment plan for our stockholders. As a result, if we declare a dividend, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions. Stockholders who receive distributions in the form of shares of our common stock generally are subject to the same U.S. federal income tax consequences as are stockholders who elect to receive their distributions in cash.
Issuer Purchases of Equity Securities
We did not repurchase any of our equity securities during the three and six months ended June 30, 2023 or the fiscal year ended December 31, 2022.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Uncertainty with respect to the economic effects of the COVID-19 pandemic and political tensions in the United States and around the world (including the current conflict in Ukraine) have introduced significant volatility in the financial markets, and the effect of the volatility could materially impact our market risks, including those listed below. We are subject to financial market risks, including valuation risk and interest rate risk.
Valuation Risk
Our investments may not have readily available market quotations (as such term is defined in Rule 2a-5 under the 1940 Act), and those investments which do not have readily available market quotations are valued at fair value as determined in good faith in accordance with our valuation policy. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. 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 fluctuate from period to period, including as a result of the impact of the COVID‑19 pandemic on the economy and financial and capital markets. Because of the inherent uncertainty of valuation, these estimated values may differ significantly from the values that would have been used had a ready market for the investments existed, and it is possible that the difference could be material.
Interest Rate Risk
Interest rate sensitivity and risk refer to the change in earnings that may result from changes in the level of interest rates. To the extent that we borrow money to make investments, including under any credit facility, our net investment income will be affected by the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of rising interest rates, our cost of borrowing funds would increase, which may reduce our net investment income. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income.
As of June 30, 2023, 85.3% of our debt investments based on outstanding principal balance represented floating-rate investments based on PRIME and approximately 14.7% of our debt investments based on outstanding principal balance represented fixed rate investments.
Based on our Statements of Operations for the six months ended June 30, 2023, the following table shows the annualized impact on net income of hypothetical base rate changes in the PRIME rate on our debt investments (considering interest rate floors for floating rate instruments):
| Change in Interest Rates | | Interest Income | | | Interest expense | | | Net Income/(Loss) | |
| Up 300 basis points | | $ | 1,523 | | | $ | - | | | $ | 1,523 | |
| Up 200 basis points | | | 1,015 | | | | - | | | | 1,015 | |
| Up 100 basis points | | | 508 | | | | - | | | | 508 | |
| Down 100 basis points | | | (497 | ) | | | - | | | | (497 | ) |
| Down 200 basis points | | | (961 | ) | | | - | | | | (961 | ) |
| Down 300 basis points | | | (1,171 | ) | | | - | | | | (1,171 | ) |
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
In accordance with Rules 13a-15(b) and 15d-15(b) under the Exchange Act, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report on Form 10-Q and determined that our disclosure controls and procedures are effective as of the end of the period covered by this quarterly report on Form 10-Q.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the three months ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
We are not currently subject to any material legal proceedings, nor, to our knowledge, are any material legal proceedings threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. Furthermore, third parties may seek to impose liability on us in connection with the activities of our portfolio companies. Our business is also subject to extensive regulation, which may result in regulatory proceedings against us. While the outcome of any future legal or regulatory proceedings cannot be predicted with certainty, we do not expect that any such future proceedings will have a material effect upon our financial condition or results of operations.
There have been no material changes during the six months ended June 30, 2023 to the risk factors discussed in “Item 1A. Risk Factors” in our transition report on Form 10-K for the transition period from April 1, 2022 to December 31, 2022.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
| Item 3. | Defaults Upon Senior Securities |
None.
| Item 4. | Mine Safety Disclosures |
Not Applicable.
During the three months ended June 30, 2023, none of our officers or directors adopted or terminated any contract, instruction or written plan for the purchase or sale of our securities that was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) or any “non-Rule 10b5-1 trading arrangement.”
The following exhibits are filed as part of this quarterly report on Form 10-Q or hereby incorporated by reference to exhibits previously filed with the SEC:
Exhibit Number | Description of Exhibit |
| Articles of Amendment and Restatement of the Company(1) |
| Amended and Restated Bylaws of the Company(1) |
| Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* |
| Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* |
| Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* |
| Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* |
| (1) | Incorporated by reference to the Company’s annual report on Form 10-K/A, filed on June 30, 2022. |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on August 11, 2023.
| | SILVER SPIKE INVESTMENT CORP. |
| | |
| | By: | /s/ Scott Gordon |
| | | Scott Gordon |
| | | Chief Executive Officer (Principal Executive Officer) |
| | By: | /s/ Umesh Mahajan |
| | | Umesh Mahajan |
| | | Chief Financial Officer (Principal Financial and Accounting Officer) |
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