Barings BDC Inc (BBDC) 2012 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Triangle Capital Corporation's conference call for the quarter ended June 30, 2012. All participants are in a listen-only mode. A question-and-answer session will follow the Company's formal remarks. Today's call is being recorded and a replay will be available approximately two hours after the conclusion of the call on the Company's website at www.tcap.com under the Investor Relations section.

The hosts for today's call are Triangle Capital Corporation's President and Chief Executive Officer, Garland Tucker and Chief Financial Officer, Steven Lilly. I would now like to turn the call over to Mr. Garland Tucker.

Good morning, everyone and thank you for joining us for our second-quarter 2012 earnings call. Before we begin, I would like to ask Sheri Colquitt, our Vice President of Investor Relations, to provide the necessary Safe Harbor disclosures. Sheri?

Thank you, Garland. Good morning. Triangle Capital Corporation issued a press release yesterday afternoon with details of the Company's quarterly financial and operating results. A copy of the press release is available on our website.

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

These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under our section titled Risk Factors and Forward-Looking Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and quarterly report on Form 10-Q for the quarter ended June 30, 2012. Each is filed with the Securities and Exchange Commission. TCAP undertakes no obligation to update or revise any forward-looking statements and now I will turn the call back over to Garland.

Okay, thank you, Sheri and again, welcome to everyone for today's call. We are very pleased once again to have strong quarterly results to discuss with you. Before we get into the substance of today's call, I would like to note that Brent Burgess, our Chief Investment Officer, is unable to be with us as he is traveling. Aside from Brent's absence, we will follow our customary format, which is for me to discuss some highlights for the quarter and then for Steven to provide more detailed information about our financial results and liquidity, our capital markets activity and our investment activity during the quarter. At the conclusion of these prepared remarks, Steven and I will be happy to answer any questions that you may have.

First, most of you probably saw that we increased our quarterly dividend to $0.50 per share in June, which was a year-over-year increase of $0.06 per share, or 13.6% over the second quarter of 2011. Obviously, we were very pleased with such a meaningful dividend increase and we were equally pleased that our net investment income of $0.52 per share was once again comfortably in excess of our dividend.

As you know, one of our fundamental operating strategies is to earn the dividend and by that, we mean our net investment income needs to exceed our dividend on a long-term basis. As of June 30, 2012, our cumulative dividends paid on a per-share basis since our IPO totaled $8.48 and our cumulative net investment income per share for the same period totals $8.77. These results indicate continuing success in achieving this important dividend coverage ratio.

Another very significant operating metric is our efficiency ratio, which we calculate as SG&A expenses as a percentage of total investment income. For the quarter ended June 30, 2012, our efficiency ratio was 17.2%. TCAP continues to have one of the very best efficiency ratios in the BDC industry.

As internally managed BDC, we have demonstrated that, as our Company grows, a greater percentage of each incremental dollar of revenue can fall to the bottom line as dividends. In addition, our low efficiency ratio demonstrates our commitment to operating in the most cost-effective manner possible.

From a macro basis, we believe the BDC business model is continuing to earn a reputation as a yield-oriented investor-friendly vehicle, which can provide investors with the certainty of current income and the potential for long-term capital appreciation. Like other yield-driven industries, which developed over multiple market cycles, most notably REITs and MLPs, we believe that well-managed BDCs can provide investors an excellent return over a long period of time.

Turning briefly to our operating highlights, from an investment perspective, the second quarter was very active for us. We closed seven new portfolio company investments totaling $112.5 million and we have announced five new investments subsequent to quarter ending totaling $42 million. Our portfolio continues to perform well with an average debt yield of 15% and with $3.6 million in realized long-term gains during the quarter bringing our total net long-term gains since IPO to $10.4 million.

So before I hand the call off to Steven, I would like to close by saying that we continue to believe that the lower middle market is an exceptionally attractive place to operate and that Triangle is well-positioned to continue to deliver attractive returns to our shareholders by focusing on what we do best, finding high-quality businesses where we can add value both from an operating and a financial perspective. And with that, I would like to turn the call over to Steven.

Thanks, Garland. During this portion of the call, I will discuss our financial results for the quarter and I will also touch briefly on our capital markets and investing activities since our last call. As most of you know, yesterday, after the market closed, we filed our earnings release and 10-Q. During the second quarter, we generated total investment income of approximately $22 million, which represented a 34% increase over the $16.4 million of total investment income during the second quarter of last year.

The increase in investment income was primarily attributable to a year-over-year increase in the size of our investment portfolio. Of the $22 million of total investment income or total revenue, approximately $1 million was related to one-time fees, which, on a per-share basis, is very much in line with our historical experience. Our total operating expenses during the second quarter of 2012 totaled $7.9 million consisting of interest expense and other financing fees and G&A.

For the three months ended June 30, interest and other financing fees totaled $4.1 million as compared to $2.8 million for the second quarter of 2011. The increase of $1.3 million was primarily due to a $1.2 million increase in interest and financing fees related to our senior notes or baby bond issue, which was done in March of this year.

The $331,000 increase in general and administrative expenses was primarily attributable to increased salary and compensation costs, as well as increased non-compensation costs, which were driven in part by an expansion in our operating team, which increased from 17 professionals during the second quarter of last year to 21 professionals during the second quarter of this year.

Net investment income for the quarter was $14.1 million, or $0.52 per share, as compared to recurring NII of $0.46 during the second quarter of 2011. As you will recall, in the second quarter of 2011, we recognized approximately $0.09 of one-time nonrecurring fees, which we called out to the market at that time.

During the second quarter of 2012, we recorded total realized gains of approximately $3.6 million associated with the exit from four portfolio investments. During the quarter, we recorded net unrealized appreciation within the portfolio of approximately $1 million. As a result of our operating activities, our net increase in net assets from operations was $15.6 million for the three months ended June 30, 2012, or $0.57 per share, as compared to $14.5 million, or $0.78 per share for the period ended June 30, 2011.

At quarter-end, our total investment portfolio had a fair market value of approximately $598 million, representing an increase of approximately $189 million from June 30, 2011. And finally, our net asset value per share as of June 30, 2012 was $15.21 representing an increase of $0.53 per share since December 31, 2011.

From a liquidity standpoint, as of June 30, 2012, we had approximately $94 million of cash onhand, $75 million available under our existing senior credit facility and a little more than $10 million of undrawn SBA debentures for a total liquidity amount of $180 million. You may recall that during the first quarter of 2012, we completed a common stock offering with $77 million in net proceeds and a public bond offering of $67 million in net proceeds. Those transactions put us in a very strong liquidity position going into the second quarter where, at the time, we had a very robust investment pipeline. As a result, we were able to fund our investment activity during the second quarter while still maintaining more than adequate liquidity from a balance sheet standpoint.

In our first-quarter earnings call, we mentioned that we were in the early stages of potentially expanding our $75 million senior credit facility. That process is continuing and we believe we will be in a position to announce an expansion to our senior credit facility sometime this fall, likely before our third-quarter earnings call in early November.

The contemplated expansion of our senior credit facility is expected to provide us with additional attractively-priced capital that we believe will provide us with sufficient liquidity to continue executing our business plan.

I should note that, from a balance sheet perspective, Triangle has reached a size where it is appropriate to include at least some amount of what we would call permanent bank financing in our capital structure. So I think you can reasonably expect to see that as part of our expanded senior credit facility. However, I will reiterate a comment that I made last quarter, which is to say that we are still very focused on maintaining our conservative credit profile, which we believe is a hallmark of any prudently capitalized BDC.

This is the point in the call when I would normally turn things over to Brent for some color surrounding our investment activity for the quarter. So in his absence, I will give you a high-level overview of our activities and then Garland and I will be happy to answer any specific questions you have.

As Garland mentioned, the seven new investments we made during the second quarter totaled just over $112 million and the five new investments that we have announced subsequent to quarter-end totaled $42 million. So I won't spend much additional time on these other than to say that the 12 new investments were made across 10 different industries.

Including the effects of our recent investment activity, we currently have 74 portfolio companies across 30 industries, which we believe provides us with significant diversification from an operating standpoint. I will also note that our two second quarter -- that two of our second-quarter investments, TrustHouse Services Group and Plantation Products, were recapitalizations of companies that have been in our investment portfolio since 2008 and 2010 respectively.

In both of these instances, our portfolio companies had the opportunity to make attractive acquisitions, which provided us an opportunity to invest additional capital. These companies are well known to us and we have been very pleased with their performance since inception and we are excited about their prospects going forward.

The weighted average yield on our debt investments was 15.0% as of June 30, 2012 as compared to 15.1% as of March 31, 2012, which is perhaps the best indication that our investment structures continue to be relevant to companies in our target market. We continue to be very pleased with the performance of our investment portfolio, as well as the portfolio's overall credit quality. During the first half of the year, we removed one company from non-accrual status, American De-Rosa Lamparts, a $5.4 million investment and placed that Company back on full accrual due to its improved operational status.

We also placed one smaller company, Equisales, a $3.2 million investment, on non-accrual status during the second quarter. As a result of this activity, our non-accrual rate as of June 30, 2012 represented 0.5% of our total portfolio on a fair value basis and 1.6% of our portfolio on a constant basis.

Our high-level thoughts on the general investment climate are that the lower middle market will continue to remain active during the second half of the year as generational sellers seek to lock in gains ahead of the Presidential election and also potential tax uncertainties, which clearly lie ahead.

So in conclusion, as Garland mentioned at the outset of the call, we continue to believe that the lower middle market is a very fragmented, but also a very large segment of the market where we can continue to increase our marketshare by offering investment structures which are attractive both to financial sponsors and high quality management teams. And with that, I will turn the call over to Garland for any concluding comments before we take questions.

Thanks, Steven. I think the most meaningful comment I can make at this point is to assure you that we intend to continue doing just what we have been doing. In very simple terms, we invest in companies that have reasonably conservative capital structures, that generate steady cash flow and which have exceptional management teams with significant ownership.

We read the same headlines that you do about the uncertainty of the financial markets in Europe and the continuing economic struggles in the US. However, we believe the subordinated debt investments in the lower middle market continue to offer very attractive risk-adjusted returns and historically the fluctuations in interest rates for our type of financing have been much less volatile than those experienced by the broader debt markets. So again, we had another great quarter and we very much hope that our call in November will be equally as positive. With that, operator, you can now open the call up for questions.

(Operator Instructions). Robert Dodd, Raymond James.

Thank you. Hi, guys. Excellent quarter. On the deployments number, obviously, through the last four months, if we include the July numbers, you have put $160 million in capital to work. Obviously, you have still got liquidity, but how much of that do you think are things that have been in the pipeline a long time and have just -- or been pulled forward maybe from the back end of the year? And obviously what I am trying to get at is what kind of run rate can we expect? I assume it is not the level you have seen very recently.

Robert, thanks. It's Steven. Yes is the short answer to your question. There were some -- in certain quarters, sometimes things get delayed and in certain quarters, things, as you indicated, get pulled forward and I think we certainly experienced some of that in the last four months as you indicated. Clearly, when we went to the equity markets in the first quarter and also the bond market in the first quarter, we, as I mentioned on the call, had a fairly robust pipeline and those things have cycled through.

As we look at the second half of the year, as you know, we really do try to shy away from giving specific forecasts because frankly it is just difficult, if not impossible, for us to know ourselves. But one thing I think that you might allow in your forward estimates would be, as we move through the second half of the year, given the size of the portfolio now, it would certainly be reasonable to expect some repayments would occur between now and the end of the year. Obviously, very difficult for us to handicap the timing of those, but we probably had a little less of that activity over the last three or four quarters than we normally would expect. So deployments have been significantly in excess of repayments for the last several quarters and at some point that needs to probably balance out in a portfolio. Garland, would you add anything to that?

Robert, I would just say that I guess the caveat we give every quarter is that it is very difficult to project debt deployment levels and that caveat would be just as true this quarter as any other quarter for the reasons that Steven has given. Even when net deployments are as robust as they have been this year so far, we are still only dealing with just a relatively handful of deals and it doesn't take much movement in either direction with a number of deals or in repayments to change that number. So the answer to what the future deployment rate looks like is unfortunately we honestly won't know until we get there.

Understood, guys. On pricing, if I can, obviously it has been very stable. You are talking about 15%, 15.1% a year ago. I mean are you seeing any change in other terms? I mean I am just a little surprised it has been so solid given, as you talked about at the analyst day, you have moved your mix toward slightly bigger, private equity partners and obviously the pricing seems to be sticking very, very well. Are you seeing changes on multiples or covenants or anything else or upfront fees? I mean is there anything else shifting around or is all that sticking as well?

Well, it is probably good, Robert, that Brent is not with us today with that question because he would probably tell you how, in the transactions that he looks at on an early stage basis with many of our investment professionals, that things are all over the map. But it is true, as transactions have moved through the investment funnel, if you will, here, that we have been very thankful that we have been able to maintain the pricing that we have and also maintain the equity positions that we have and the investments we have made.

I don't think we have seen any noticeable change certainly in upfront fees in terms of moving away from the sort of old norm of about 2% plus or minus. And in covenants, we haven't seen any meaningful change there either. So again, the percentage of investments on which we close as compared to all of the ones that we look at and evaluate is, as you well know, very, very small, sort of a single-digit percentage. So that does help us I think in terms of what actually gets into the portfolio.

Okay, great. Thank you. Last question if I can on credit, Equisales, can you give us an indication -- obviously, it has gone on to non-accrual now. It looked a little stressed last quarter. Can you give us an idea if you have got any probability of that coming back onto accrual or what the timeline is going to be? And then same kind of question, I mean looking at who are to me looked a little stressed last quarter. Venture Technology Group did, but it is marked up this quarter, so things have clearly improved there. Can you give us any more color on that?

Did you want to go, Garland?

Robert, this is Garland. I will give you just a word on Equisales. The company continues to have problems. I think the starting point is the size of the investment and the fact that it originally was a $6 million investment and I think it's --- we are prepaid on half of it, so it is fortunately down to a relatively small number. But the Company continues to have problems. We don't know what the outcome is. Their senior bank is working constructively with the sponsor and the company to try to pull out of the operating hole that they are in. But, at this stage, it is too early to tell. Their business -- basic business model remains the same and it could turn out to be just fine, but, at this stage, we honestly don't know. You are correct. I mean the message that we are sending by going on non-accrual is it has continued to have problems and we don't know the outcome at this stage. But we are happy that the size of the investment is what it is.

Yes, Robert and then on Venture Technology Group, you are accurate in the slight move positive this quarter. Still in the same zip code I think I would say in terms of relative fair value today versus cost and that company, as we mentioned on the last call, lost their sort of biggest customer soon after the investment was made. No fraud or anything like that, just one of those things that can and does happen sometimes on a customer that delayed a large project.

But they are, we think, doing the right thing, so to speak and still producing some cash flow. So we are obviously getting paid and hope that will continue, but it is just one of those situations that you try to work through. But thankfully that is not a large investment for us either from a total portfolio standpoint, but we are -- it is slightly better this quarter than it was last quarter, so we are thankful for that.

Got it. Thank you.

Great, thank you, Robert.

Mickey Schleien, Ladenburg.

Good morning and thank you for taking my questions. I have two. The first one is how much downside in cash flow do you think your portfolio companies can withstand in a downcycle of the economy without putting your subdebt servicing at risk? And what level of GDP contraction would it take to get there?

Mickey, it's Steven. I will try to give -- for a call like this, it is a very, very precise question, so forgive me at the outset to answer you a bit in generalities. As we said before, the average fixed charge coverage that our portfolio companies have has really, since our IPO, has been basically plus or minus 1.5 times and the things that would impact in a downturn the Company's ability to maintain that would be frankly more what the amortization is of senior debt that might be in front of us in the capital structure. And as you well know, certainly if there is downward pressure, many banks would work with their clients and their customers to alleviate some of that amortization.

So lots of things can happen. It truly is a case-by-case basis, but we like the fact that we enter our investments with such a strong fixed charge coverage ratio. So that, I think as you look back at our credit quality versus perhaps some others in the space, we have had a really nice, low non-accrual rate and high repayment and then gain rate as well.

In terms of overall GDP and how that might impact our specific portfolio, that is just unfortunately I think tough, if not impossible for us to really connect those dots of how these companies function in their respective markets. But when we run our downside cases before we make investments, we run scenarios where typically we would cut EBITDA by somewhere in the 40% to 50% range and look at what happens. And in those situations, it is clearly not always a pretty picture, but it is one where we think we can get our money out over time and have certain covenant discussions and those types of things. It would be bumpy, but we would protect principal.

So all those things combined have made us feel pretty good about the portfolio. Probably the best way to look at it, I would say, is from a historical basis of what we went through in the portfolio and the results we generated through the downturn. Does that help answer your question? I know I didn't get all the way there on the GDP piece.

No, that is very helpful. And just one quick follow-up. Your Company really is quite different from most of the other BDCs at least that I cover with respect to the amount of operating leverage that you have been delivering. But you have had a very solid year so far, and a lot of growth, and I am just trying to get a handle on how much more operating leverage could there be in the sense of with this pace of portfolio growth, clearly I think you would need to continue to add employees and can we expect this leverage ratio to continue to improve or are we at some sort of maximum level at these current ratios?

Well, I will give you a quick fall there and then Garland may well add something to it. But first just in terms of investment pace, we did have one of those quarters where everything kind of went right, so to speak, in terms of timing. But if you were to compare back to the first quarter for example of this year, we only closed about, on a net basis, $30 million, or excuse me, $40 million of investments on a total gross basis. So it was -- I wouldn't expect this investment pace to continue for us at the same rate that it did in the second quarter.

In terms of operating leverage, we really do believe that the internally structured model or the internal BDC model is not only just more shareholder-friendly, but it is frankly just, we think, a much better way to operate so you can experience that type of operating leverage that you mentioned in your question.

Clearly, we are running sort of mid-60%s in terms of percent or NII margin. The example we float around sometimes internally, if you make a $10 million investment at 15% interest and you have got $1.5 million a year of revenue off of that investment, even if you were to go hire one person for each new investment that we make and pay that person $0.5 million a year, then you have got a 65% cash flow margin on those incremental investments. And you clearly don't need to staff at that level.

So I think we really do like the leverage that we get, but when you are running at a mid to high teens efficiency ratio as compared to an industry that operates on that same basis somewhere between 35% and 40% of revenue for G&A as compared to revenue, at some point, you are not going to take it much lower. So we want to be cognizant of that, but Garland, I will let you add a couple thoughts too.

I think I certainly wouldn't change anything that Steven said and I think we have got enough of a history that you can look back and see, even though we only have 21 people total now percentagewise, that has grown as the Company has grown and given that we very much intend to stay down in the lower middle market end of the market, as we have growth opportunities, that is going to mean we will add people.

But I think the important thing from a shareholder's standpoint is -- or two things really, you can look back and see that there has been significant operating leverage and with the internally managed model, at least shareholders have a chance to benefit from leverage, which they don't have -- operating leverage -- which they don't have with the external model.

So our primary commitment is to staff appropriately and to continue the investment quality we have had and in meeting those two objectives, if we can continue to deliver for shareholders some operating leverage, that is absolutely something we intend to do but the first two come first.

Thank you for your time today.

Mickey, thank you.

John Hecht, Stephens.

Good morning, guys. Congrats on another good quarter. Some of this is a little bit redundant because you commented on that the strength in originations this quarter might have been just that the timing of all the deals came together in a coincidental fashion. But you had high originations, your repayment activity was high. Would you attribute this all to this potential tax policy change or is there potential secular trends that are evolving that might just suggest that overall capital deployment and middle-market M&A activity might be just starting to increase in the cycle?

Well, John, it is hard to say how much is driven precisely due to the election and potential change in the tax laws. It is a conversation people like to have. And so when you sit down with sponsors and you sit down with management teams, usually some portion of the discussion does revolve around that. I think for us, probably more than that specifically was we just had a very well-timed quarter and as you well know because you followed us for quite some time now, this has -- in the last eight quarters, this is overwhelmingly the largest deployment quarter that we have had and by a fairly wide margin.

So it is I think just really more timing than anything. We feel very fortunate that we raised money in the first quarter, sort of mid to late in the first quarter. From a timing standpoint, we just couldn't have been more well-treated from that standpoint. So it is just tough to say how much. I mean certainly there is some activity and people talk about it, but there is no way we could say, gosh, 50% of our volume this quarter was due to that, would you say, Garland?

Yes, I would just echo what Steven says. I am not sure we are in the best -- I mean I am not sure we would recognize secular trends, but I don't think we have seen anything that we think is a strong trend. The quarter turned out to be very good for the reasons Steven mentioned, but all those reasons were peculiar to a handful of deals and the fact that we didn't have substantial repayments. We hear all the talk about the apprehension and the tax rates and the uncertainty and all that, but I don't think we sense that that is just driving our market.

Okay, that is good color. Second, on the portfolio trends, obviously stable to positive credit particularly in terms of non-accruals. But can you comment on revenues, EBITDA margin trends and have you seen any fluctuations lately just with all the mixed economic data we are getting and any particular companies or sectors that you have invested in?

Just overall, it has been, and you can imagine, with 70 companies, we see plenty of variation. We have had some with substantial growth and some with some declines. But overall, the portfolio is relatively flat, which I think in this economy is -- in the overall economy is probably not surprising and maybe is fairly reassuring, but no significant changes overall.

Okay. And then consistent yields in the portfolio and then just wondered if you could comment on leverage, the leverage in recent deals I guess the last quarter and thus far into this quarter. Has there been any significant changes in those?

John, it's Steven. No, there really hasn't. We think amazing is probably not too strong an expression that if you look back over the originations that we have had on an annual basis, quarterly basis, since IPO, our total leverage has averaged between 3, 3.25 times. Again, these are averages, of course, so be a little careful with it, but fixed charge has been kind of between 1.45 and 1.55. And then the most gratifying thing is the average EBITDA in our portfolio of companies has increased from kind of just shy of $10 million on average to something just slightly north of $15 million, $15.1 million or $15.2 million. So we are just very pleased to be able to be more relevant to companies in the lower middle market because our balance sheet is bigger and also being able to be relevant to companies that are slightly larger than the ones that we were working with at the time just before and just after the IPO, but still very, very much being in the heart of the lower middle market where we just really enjoy operating.

Thanks. I appreciate the color.

Thank you. We appreciate the questions.

Greg Mason, Stifel Nicolaus.

Steven, at the investor day, you talked about a goal of hopefully getting a credit rating in the next 12 to 18 months. I wanted to see if you have officially started any of the dialogue with the rating agencies yet and if you are getting any feedback from that aspect?

Greg, thank you for the question. We have not formally started that process with the rating agencies. We've, as we mentioned at the investor day, done some background or stayed work and we would expect in the second half of this year to begin some of those conversations. It is one of those things that we would certainly hope, like many of our brethren in the space, that when we are rated, we would have the opportunity to earn an investment-grade rating. But we are certainly gratified with how the bond offering that your firm led earlier this year has traded and I think they are trading right around either 6.5 or 6 5/8 today. So we are very pleased with that and what that may portend in terms of future cost of capital for us whether we are rated or not. But it is something we will continue looking at on that same timeline.

All right, great. And then based on just your last comments of where you are now looking at companies with EBITDAs of $15 million, are you seeing any pressure on the amount of equity coinvestment you are able to make in these companies? You have talked in the past that that has really been one of the keys to your strategy is having equity in every single investment because you never know which ones are the big winners and losers when you start out. So has that equity changed as you have moved upmarket just slightly?

No, it really has not. And again, we should be, as I say, be a little careful with averages on average so to speak and if you have one company with significant EBITDA, that can move the needle obviously for the whole portfolio in terms of how things close and when they close, but we are still very much in those four buckets that we described at the analyst day and on that presentation on our website of where we like to look with having transactions with larger sponsors, smaller sponsors, sort of fun list of sponsors or family offices and then where Triangle in certain cases is the institutional capital in a company. The blend of those four types of investing activities really give us the ability to have equity or some type of upside in almost 90% of our portfolio companies. So we are very much very consistent with that strategy in the second quarter.

Great, thank you. And then one final question just to make sure I am thinking about this right. I know people are talking about operating leverage and can they get better from the 17% efficiency ratio, but even if the percentage doesn't get better, it would still seem like $0.83 of every dollar is falling to the bottom line. That can still be accretive in growing earnings as you deploy capital. Am I thinking about that correctly?

Well, I think partly, but keep in mind you have got to have -- there is some interest costs there. When we talk about efficiency ratio, that is G&A only to be consistent with how other companies would report that same statistic. So once you layer in the interest burden for any company in the space, you probably get lower than that. Our NII margin has been comfortably in the 60%s for years now and we just feel good about that, but it is not an incremental $0.80 to $0.85 of every dollar I don't think. Were you going to add something, Garland?

Yes, I think your thought is right that even if we are unable to significantly improve the efficiency ratio, the shareholders -- if we are able to roughly maintain it, that is a pretty significant benefit to shareholders compared to what an external structure would have delivered to them. So I guess we have been able to deliver the benefits so far. If we can just -- if we can improve it, that would be great; but if we can hang onto it, that is still preserving that significant spread that clearly exists at this point. And certainly we'd like to -- don't know any reason why that shouldn't be a goal and it is a goal for us to at least continue with.

Great, thank you, guys.

Thanks, Greg.

Vernon Plack, BB&T Capital.

We have talked a lot this morning about efficiencies and as you continue to grow the business, I know that your portfolio is diversified across the country. Have you thought at all about having a physical presence, an office location in any other areas than Raleigh?

Vernon, this is Garland. It is absolutely something we have thought about and talked about from the earliest stages. I wouldn't at all say that we would never do that, but I can tell you why we have resisted the idea and why we continue to think it is probably unlikely that we would. I'd say the first thing is we have been able to grow our presence if you look at the slide that we use in our presentations of our geographical distribution.

We arguably have a national reach at this point operating from one office and the reason we have I guess been pretty insistent to date on not opening a branch is that, with only currently 21 people, if you were an individual stuck out in a branch and I guess I've said internally I wouldn't want to be that person out at the branch. If I was in a company that was as small as 21 people I would want to be physically located where the decisions were made and be a part of the process.

The trade-off is that to have a national reach like we do and operate out of Raleigh, there is an awful lot of travel involved and you would eliminate some of that if you had branch offices. What you would give up is the benefit of having the key deal people all around the table once a week, which we think has been very, very important to us in delivering the kind of investment and the kind of credit quality we have.

So I guess I'd go back to the starting point. We would not say we would never do it, but we don't see it anytime soon and it might well -- and hopefully -- I would personally hope we would never have one, but I wouldn't say we would never.

Okay. And as you continue to grow and expand the business, are there thoughts -- I don't know how you feel about the amount of deal flow that you are seeing. Are you comfortable with the amount of deal flow? Are there deals that perhaps you are not seeing that maybe if you were perhaps either staffed a little bit better or better connected per se in the marketplace that you would see more deals or do you feel as though you are really seeing all the deals that you need to see at this point?

Vernon, this is Garland again. I will answer that. Steven can chime in if he has any different thoughts. I would say that we probably -- we certainly to date have never been in a position and I would guess probably never will be in a position to say we are satisfied with deal flow because there are times even in the past quarter, which is awfully good, that we have said, well, gee, are we going to have enough deal flow or whatever.

But I think the overall sort of high-level position we are in, and I know we have said this before, but I think it is really an important point is we feel like we are in an ideal situation right now. There is no question in our minds that we are infinitely better known as a provider of mezzanine capital in the lower middle market than we were when we went public. There is no question about that. And we are better known by sponsor groups, but the good news is that we, even though from every measure we can see, we are the biggest most active consistent provider of mezzanine capital to the lower middle market, but even if that is true, we don't even come close to dominating our market.

So we have made real progress in getting our name out there and having these relationships, but absolutely there are deals that we don't see and that we want to be on the short list for every good sponsor and we are not yet at that point. We've made a lot of progress and we feel like we are ahead of everybody else that we view as competition down in our market, but the good news is we have got a lot of runway ahead of us and if we can continue making progress in getting on the short list of sponsors, we think we can continue growing.

Vernon, I would love to improve on that answer, but I can't. So what he said.

Okay, all right. Thank you very much.

Thanks so much.

[John Ellis], Private Investor.

Good morning, gentlemen. I am so happy with you that perhaps words can't express it. I have been with you three years. You may remember I visited your Company about three years ago. And at that visit, my last question to you was what do you worry about when you go home at night and your answer was one word. Inflation. How would you answer that question today?

Well, the first thing we would say, John, is we are thankful that that concern was not realized in the last three years.

Yes, I think we all are.

Yes. Certainly, as you would look at our Company and the types of things that we try to do from a balance sheet, management standpoint and a revenue standpoint, we have a balance sheet that today is 100% fixed at about 5.25% interest rate weighted average and we have the revenues coming in that are about 96%, 97% fixed at a weighted average debt yield of 15%. So that fixed spread of roughly call it 10 percentage points or 1000 basis points is really a nice form of ballast for us were we to enter an inflationary environment.

The same headlines that you read are the ones that we read about rates staying low for certainly the near to intermediate term and the yield curves are relatively flat in the period. So it is not an overarching concern for us in the near term for the business, but it is certainly I think you could tell by our actions, we are trying to be sure that we have a balance sheet that is very well-prepared were that to happen. So we don't get caught kind of looking the wrong way, if you will.

And your average deals are three to five years, right?

Right. Our average commitment period is approximately five years. On a weighted average basis, it is probably about 5.1, 5.15 years. But the average transaction life is between 2.5 to 3 years.

Okay, fine. Is deflation at all on your screen?

No, at least not mine personally. Garland may have a different answer. I think our government sort of bet the farm that, at some point, our country will need to have inflation as its friend of some sort to get us out of the mess we are in collectively. But, Garland, you may have a different opinion.

No, as to what we worry about, I don't think we worry any more, but hopefully no less now than we have in the past. I mean when we are making investments in smaller companies, which we always have and we are shooting for mid to high teens total returns, I mean you know by definition we are taking significant equity-like risks and that has been true since we started. It is true for the mezzanine space and so I think I guess I would say two things. I think there is always a danger that somehow inadvertently we take our eye off the ball and stop doing what we have been doing in the past and we are committed not to do that.

And then the second thing that has been a very important part of our strategy and is even more significant today is the diversification of the portfolio over 70 investments over some 30 industries that, as we have grown, that diversification -- as the portfolio has grown, that diversification has grown and we think that is very important. Right now, credit quality is as good as it reasonably -- I mean certainly at the very low end of the range of what we have experienced or what any BDC has experienced and for that --.

In terms of non-accruals.

In terms of non-accrual. And for that -- that could change significantly with just a handful of investments. We don't see that in the portfolio now, but I hope we continue to worry about it because it's something we certainly realize when we make these investments that we are taking significant risks in order to achieve the significant returns we expect to make. And so far, we have done that prudently and we know the key factors in our strategy and we are committed not to change those. So I think --.

So you're looking out to 2014 as sort of the guarantee by the Federal Reserve as the low interest rate environment continuing?

Well, I would say we don't spend a lot of time thinking about or worrying too much about the macro issues. As I mentioned I think in one of my comments that the interest rate on mezzanine investments really historically going way back before we existed and certainly during our life as a mezz investor, the rates don't tend to bounce around like the short-term rates do either up or down and so we don't -- I mean we do worry about the tone of the overall economy, but whether short-term rates happen to tick up a bit, it is hard to imagine them ticking down any from where they are now, but if they happen to tick up a bit, we wouldn't be -- I don't think it would affect us necessarily too much.

Well, thank you very much for your excellent work. You are by far the best BDC I own in terms of performance. So I am not going anywhere.

Well, thank you.

Thank you very much.

Good day.

Bob Martin, Individual Investor.

You parse non-accruals into two categories unlike other BDCs giving detail on PIK non-accruals. I have no idea if you are breaking data into two parts that others lump into one or if you are providing transparency that others lack. Can you give me some detail?

Bob, this is Steven Lilly. We hope it is the latter; although I will confess to you that we have not done a canvassing of the entire industry to see how other people -- how everybody else has disclosed that. We do know there are certain folks who choose not to disclose PIK non-accrual. Really the litmus test for us is when we draft the 10-Q, we try to draft it in a way placing ourselves in the position of the reader and the investor and ask ourselves what questions we would find helpful and what information we would find helpful.

So we are hopeful that it adds a layer of transparency to give again anyone reading the Q as much detail as possible in the portfolio. Specifically on the company that you mentioned that is on PIK non-accrual, Home Physicians is the name of it and that account is continuing to pay from a cash standpoint and we are thankful for that but it has had some operational issues.

So I think the thing that we take most comfort in is, even if that account and Garland alluded to this earlier in his comments, even if that account were to go on full non-accrual, given the amount by which we are overearning our dividend, we would be able to absorb that loss of revenue, if you will and still be in a position to earn more than the dividend going forward.

So we hope that we have done the right things in terms of taking that into account with our dividend level and also hope that we are being as transparent as we can. But I can't unfortunately comment on what everybody else is doing in the space.

Thank you. I will try to get apples-to-apples numbers and that is difficult with BDCs. Did you have OID income that was accrued in Q2?

We do have OID income that is accrued in really every quarter for us given the way the accounting rules work. We did not have any what we would call overly significant OID this quarter versus any prior quarter. It was very much in line with our historical experiences and I think maybe what you might be touching on there, Bob and we appreciate it is were we to have overly significant one-time fees or nonrecurring fees in the form of OID or some other fee, we would -- we certainly have historically called that out to the market and we would expect to do so. Again, just trying to think of things that people would find meaningful as they evaluate our performance.

Okay. I do want to thank you for your transparency. You provided detail on PIK income dollars received in Q1 and Q2. In Q1, you accrued close to $3 million in PIK income and received less than $600,000. Whereas in Q2, you received more than $2 million in PIK income and accrued $3 million, is that correct?

Yes, I think those numbers are correct.

That variety, that oscillation concerns me. Can you give me some color?

Sure. Per the accounting rules, we recognize PIK income in what we would call the top part of our P&L or income statement as companies -- as that accrues in their interest rate. It is not received in cash at the time, but it does accrue. And then the reconciling item, so to speak, is what you mentioned, which when companies prepay their PIK or if a company repays all of its principal amount, they then repay the PIK as well because it accrues to additional principal over time. And so it fluctuates on a quarterly basis really based on the repayment activity that we have that we experience in the portfolio.

I can tell you, Bob, it is something that we track very closely every quarter and every year and we share that information with our Board every quarter and every year and we look at it on, as you just did and that is why we disclosed it that way, both a gross and a net basis. But we have typically found that the net exposure that we have to PIK interest on an annual basis tends to average between $1 million and $2.5 million a year, which is one of the reasons we hold back a little bit extra cash on our balance sheet to be sure that we have sufficient liquidity and sufficient funding if we enter a period where companies do not repay and therefore bring down that PIK number.

So hopefully we are doing the right things. It has we think been a positive boon to us in operating in the lower middle market to capture those additional interest rates, but also trying to recognize that PIK income is less certain than cash, but maybe more certain than a potential equity gain. So it has a place in our way of investing, but just want to be sure that we are tracking it very closely. But does that help?

It does help. Thanks for your answers.

Great, thank you so much. We appreciate you participating.

With that, I am showing no further questions in queue. I'd like to turn it back to Mr. Tucker for any concluding comments.

All right. Thanks again to everyone for being on the call and we look forward to talking to you in three months. But in the meantime, if you have any questions, feel free to call Steven, Brent or me or Sheri. Thanks again.

Again, thank you, ladies and gentlemen, for your participation in today's conference. You may now disconnect. Have a great day.