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Edited Transcript of CPTA earnings conference call or presentation 9-May-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Capitala Finance Corp Earnings Call

Charlotte, North Carolina Jun 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Capitala Finance Corp earnings conference call or presentation Tuesday, May 9, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jack McGlinn

Capitala Finance Corp. - COO & Director

* Joseph B. Alala

Capitala Finance Corp. - Chairman and CEO

* Stephen A. Arnall

Capitala Finance Corp. - CFO

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Conference Call Participants

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* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst

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Presentation

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Operator [1]

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At this time, I would like to welcome everyone to the Capitala Finance Corp.'s conference call for the quarter ended March 31, 2017. (Operator Instructions)

Today's call is being recorded and a replay will be available approximately 3 hours after the conclusion of the call on the company's website at www.capitalagroup.com under the Investor Relations section.

The hosts for today's call are Capitala Finance Corp.'s Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer, and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall.

Capitala Finance Corp. issued a press release on May 8, 2017 with details of the company's quarterly financial and operating results. A copy of the press release is available on the company's website.

Please note that this call contains forward-looking statements that provide information other than historical information, including statements regarding the company's goals, beliefs, strategies, future operating results and cash flows. Although the company believes that these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements.

These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled Risk Factors and Forward-Looking Statements in the company's quarterly report on Form 10-Q. Capitala undertakes no obligation to update or revise any forward-looking statements.

At this time, I'd like to turn the meeting over to Joe Alala.

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Joseph B. Alala, Capitala Finance Corp. - Chairman and CEO [2]

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Thank you, operator. Good morning, everyone. Thank you for joining us.

Net investment income covered distributions for the first quarter and included a $1 million waiver of incentive fees. Since the waiver was announced in early 2016, $3.7 million of incentive fees have been permanently waived. In addition, there are currently $3.8 million of incentive fees that have been earned, expensed, but not yet paid by the BDC to the external manager as a result of the lookback/clawback feature.

Net asset value per share decreased slightly during the quarter to $15.71 from $15.79 per share at year-end. We successfully exited our investment in Medical Depot in January, generating a $5 million gain on our equity investment.

Subsequent to quarter end, we exited our equity investment in MJC Holdings, netting a realized gain of $4.5 million. The proceeds from these 2 exits generated $9.5 million in capital gains or $0.60 per share. These cap gain proceeds will be reinvested into yielding assets to contribute to NII growth.

Platform and BDC liquidity provides us the dry powder to make investments in proper risk-adjusted capital structures. The investment strategy continues to now focus on more first lien and unitranche structures, where we are in a higher position on the balance sheet, where we also continue to seek equity participations in all new investments.

We continue to evaluate opportunities to refinance our baby bonds that are callable in June and seek ways to lower our overall cost of capital by lowering the cost of these bonds. Moreover, we continue to have an active dialogue with the SBA on the ability of the BDC to apply for a new SBIC license and to draw more SBA leverage from the SBIC program. We currently have approximately $70 million of SBA leverage unused under the family of funds of $350 million limit of aggregate loan commitments to any one manager.

At this point, I'd like to turn the meeting over to Steve and Jack to provide additional comments on our performance.

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Stephen A. Arnall, Capitala Finance Corp. - CFO [3]

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Thanks, Joe. Good morning. As previously mentioned on May 8, we filed a press release with our first quarter 2017 earnings. I would invite you to visit the Investor Relations portion of our website to learn more about the company, to review quarterly investor updates and to automatically receive email notifications of company financial information, press releases, stock alerts or other corporate filings.

During the first quarter of 2017, total investment income was $14.8 million or a $2.6 million decrease from the same period in 2016. Interest fee and PIK income were $1.8 million lower in the first quarter of 2017 compared to 2016, while all other income, mostly dividend income, was $0.8 million lower during the first quarter of 2017 compared to 2016.

Total expenses for the first quarter 2017 were $8.6 million compared to $10.0 million in 2016. Interest and financing fees decreased by $0.4 million, management fees decreased by $0.2 million and incentive fees net of the waiver decreased by $0.8 million.

Net investment income totaled $6.2 million or $0.39 per share for the first quarter of 2017 compared to $7.4 million or $0.47 per share for the same period last year.

Net realized gains totaled $4.8 million or $0.31 per share for the first quarter of 2017 compared to net losses of $2.3 million for the same period in 2016.

Net unrealized depreciation for the first quarter of 2017, including the written call option depreciation, was $6.2 million compared to depreciation of $9.3 million the previous year. $4.8 million (sic - see press release - $5 million) of this amount related to the realized gains during the quarter, while the remainder of the portfolio collectively depreciated by $1.4 million (sic - see press release - $1.2 million).

The net increase in net assets resulting from operations during the first quarter of 2017 totaled $4.9 million or $0.31 per share compared to a decrease of $4.2 million or $0.27 per share for the same period last year.

Total net assets of $249.5 million at March 31, 2017 equate to $15.71 a share compared to $15.79 per share at December 31, 2016.

From a liquidity standpoint, we had cash and cash equivalents of $40.6 million at March 31, 2017 compared to $36.3 million at December 31, 2016. SBA debentures outstanding at March 31, 2017 totaled $170.7 million with an annual weighted average interest rate of 3.29%. In addition, the company has $113.4 million of notes outstanding, bearing a fixed interest rate of 7.125%.

Lastly, the company has $44 million drawn and $76 million available under its senior secured credit facility and a regulatory leverage ratio of 0.63x at quarter end.

At March 31, 2017, the company's balance sheet and future net investment income will not be materially impacted by changes in short-term interest rates. Please see Form 10-Q for detailed information about the company's interest rate sensitivity.

At this point, I will turn the call over to Jack.

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Jack McGlinn, Capitala Finance Corp. - COO & Director [4]

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Thanks, Steve. During the first quarter, we had gross deployments of $21.7 million, mostly related to the new investment in Currency Capital that included a $16 million first lien debt investment at LIBOR plus 11% and a $2 million equity coinvestment.

Repayments amounted to $33 million, which included full repayments from Medical Depot, a $21 million payment, including a $5 million gain, $5 million for Emerging Market Communications and $4.8 million for Brock Holdings.

Total net realized gains for the quarter amounted to $4.8 million, while total unrealized appreciation was $6.2 million, mostly related to the reversal of the Medical Depot gain.

As of the end of the first quarter, the Capitala portfolio consists of 51 companies with a fair market value of $532.5 million, on a cost basis of $509.3 million. First lien secured debt investments represent 44.3% of the portfolio, second lien debt 11.4%, subordinated debt 25.5%, and equity warrant value of 18.8%.

On a cost basis, equity investments comprised 10.5% of the portfolio. The total weighted average yield on our debt portfolio remained at 13.2%.

In regards to portfolio quality, we continue to maintain a sub-2 internal weighted average risk rating at 1.99, while average leverage at the portfolio remained at 4.2x. At the end of the ...

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Operator [5]

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Ladies and gentlemen, please stand by. Your conference will resume momentarily.

(technical difficulty)

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Jack McGlinn, Capitala Finance Corp. - COO & Director [6]

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Sorry for that. Just finishing up, at the end of the quarter, there were three investments on nonaccrual with a fair value and cost basis of $18.7 million and $30.7 million, respectively, which represents a -- 3.5% of the portfolio on a fair value basis.

Subsequent to quarter end, we successfully exited our equity investment in MJC Holdings, receiving $5.5 million from our $1 million initial investment, resulting in a $4.5 million realized gain. In addition, we were repaid in full on our $15 million second lien debt investment in Nielson & Bainbridge.

At this point, operator, we'd like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Mickey Schleien of Ladenburg.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst [2]

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Wanted to ask about Print Direction, its sales were down pretty meaningfully year-over-year. Just wanted an update on what the issues are there? And how is it that it's valued at 60% of cost, but it's still performing?

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Jack McGlinn, Capitala Finance Corp. - COO & Director [3]

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Yes, so Print Direction, I mean, there has been consolidation in that market that has impacted them. They've had some customer attrition that have affected the sales. So we've been working on bringing down the cost structure there. We have depreciated that asset. It has had enough liquidity to stay current through the period and we're continuing to work on it. But we have had some issues there.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst [4]

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Jack, on the flip side, On-Site is marked above par, but it's on nonaccrual, does that reflect some sort of call protection? And do you expect it to be removed from nonaccrual soon?

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Jack McGlinn, Capitala Finance Corp. - COO & Director [5]

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No, it's more of a liquidity situation there, as we've discussed over last several calls. I mean, that's been a long-term restructure. We continue to improve operations there. We actually had some substantial revenue growth, which has tied up some liquidity.

So they haven't been able to make interest payments, so we continue to keep it on nonaccrual. And I'm still hopeful that we can return that to a performing asset, hopefully this year. But again, the part of the problem now is that it's growing again and that's taking up some capital. So.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst [6]

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Okay. And just a couple of balance sheet questions. I assume much of your cash is in the SBIC, which reduces your capital efficiency. What does the backlog look like for SBA qualified deals?

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Stephen A. Arnall, Capitala Finance Corp. - CFO [7]

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I'll answer the cash part, Mickey. We've got fair amount of cash at the parent too with the Nielson & Bainbridge and some other assets that have repaid. So we've got pretty good platform liquidity not just in the SBIC subs, but also at the parent. So I guess, now we'll just maybe address the global issue of deal flow and pipeline.

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Jack McGlinn, Capitala Finance Corp. - COO & Director [8]

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Yes, I mean, the pipeline has opportunities for SBA investments, so that's not an issue. I think probably just overall, while the deal flow has been good, we haven't seen as much in the way of deals that really we're interested in at this point.

We are trying to look for more first lien opportunities, and we've seen an ample amount of kind of the traditional sub-debt opportunities, but it's behind a lot of senior debt and we haven't been comfortable going down that path. So we've been -- we continue to be patient and look for the right risk-adjusted returns on these.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst [9]

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Just a follow-up with Steve then. If there is cash at the parent then why -- at least at the end of the quarter, where did you maintain balances on the credit facility?

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Stephen A. Arnall, Capitala Finance Corp. - CFO [10]

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Well, the way the facility is structured sometimes it's not advantageous to make payments on that with the way the interest rates are set up and the features within the document itself. We talk with IMG on an ongoing basis and work with them and keep that flexibility out there.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research and Supervisory Analyst [11]

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Okay. And my last question is just if Joe could repeat what he said about, I think you said something about refinancing the unsecured notes, but I was scribbling and I didn't catch it.

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Joseph B. Alala, Capitala Finance Corp. - Chairman and CEO [12]

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I just mentioned they're callable in June, and we're looking at ways to always lower our average cost of capital through either bonds or an additional SBIC license, which has very low cost of capital, if we were able to proceed and obtain another license in this calendar year. So we're always looking at ways to lower our cost of capital.

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Operator [13]

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(Operator Instructions) And I'm showing no further questions at this time.

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Joseph B. Alala, Capitala Finance Corp. - Chairman and CEO [14]

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Well, thank you, everyone, for your time. If you have any further questions, we are around all day and tomorrow. So look forward to hearing from you. Thank you.

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Operator [15]

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Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone, have a great day.