Logan Ridge Finance Corp (LRFC) 2014 Q2 法說會逐字稿

At this time, I would like to welcome everyone to Capitala Finance Corp's conference call for the quarter ended June 30, 2014.

(Operator Instructions)

Today's call is being recorded and a replay will be available approximately three hours after the conclusion of the call on the Company's website at www.capitala group dot com under the Investor Relations Section.

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

Capitala Financial Corp issued a press release on August 12, 2014, with the details of the Company's quarterly financial and operating results.

A [company] 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 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 would now like to turn the meeting over to Joe Alala.

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

We had a very solid quarter, again, at Capitala Finance Corp. We originated $22.6 million in gross deployments during the quarter, $13.2 million net. The yield on this portfolio is very good at 13.4 % on the debt. Our net investment income of $5.6 million or $0.43 per share. The net income of $6.2 million or $0.48 per share. NAV $264 million at $20.34 per share. The Board declared a dividend of $0.47 per share, record date 09/12/14. Payable date 09/26/14. We also completed a [notice] offering that netted the Firm $109 million in proceeds. And we did that with less than one year after going public.

We continue to have a very robust pipeline of deal activity. And I think what the trend is showing us, the very favorable trend, if you look where we are from 12 months ago. Basically, our weighted average yield on debt, you know, 12 months ago is 13.8. It's currently at 13.4% so not a lot of compression there.

The funded debt to EBITDA at the portfolio level over the same period is right around 4%. I think what is key over the past 12 months; the trend is our average EBITDA at the portfolio level is almost doubled. A year ago our average EBITDA was slightly over $9 million. At the portfolio level, we currently are over $17 at the portfolio level.

So, same weight average yield, same fund to debit to EBITDA, a doubling in the size of EBITDA; I think that shows a - our trends in the portfolio, overall health, shows our model continues to work with our direct origination platform.

Our total portfolio yield a year ago was 8 1/2%. So you'd have to include the equity in that. Our current yield now is about 9 1/2%. We forecast to cover our dividend from net interest income, we need to be at 10 1/2% at the portfolio level. And the big difference here between our weighted average yield at the loans versus the portfolio level is our equity.

We've been working hard over the past year to reduce our equity as a percent of our portfolio. A year ago, it was approximately 39% at IPO; it was approximately 36%. It currently is approximately 31%. And we forecast if we get the equity as percent of the portfolio, which we talked about on the road show back in last September, 20% under that we should be able to cover our dividends out of net interest income.

And then have these recurring, non-recurring events that we continue to have, continue to happen. And with that, we could pay special dividends and do some spillover income. So, we feel very strong about our portfolio.

We've done a tremendous job, I believe, at keeping our yields up in a very competitive market, keeping our funded debt constant, increasing the size of the EBITDA at the portfolio level. And we continue to source a very robust pipeline as we found the 8-K the first three weeks in July we invested over $22 million in our lower middle-market platform. An average yield on those loan securities at 14.4%.

So, there operations are working. We continue to add to underwriting in the portfolio side of the business and we're continuing to add business development professionals. So we feel very good about the portfolio and where we are three quarters after IPO.

And with that, I'm going to turn it over to Steve Arnall, CFO to give more details about the financials.

Thanks, Joe. Good morning.

As previously mentioned on August 12, we filed a press release with our Second Quarter, 2014 earnings. I'd like to take a few minutes to highlight a few items within that release, which can be found on the Investor Relations Section of our website.

During the Second Quarter of 2014, total investment income was $12 1/2; a 52% increase over the same period last year. The increase was attributable to higher interest and dividend income resulting from a larger investment base. Dividend income for the Second Quarter of 2014 was 3.3 million compared to 443,000 last year.

Net investment income totaled $5.6 million for the quarter ended June 30, 2014 compared to $4.7 million for the same period last year. Net investment income per share was $0.43 for the Second Quarter of 2014 with no comparable number for 2013.

We're pleased with our $0.43 per share of net investment income earned for the Second Quarter of 2014 especially in relation to the $0.47 dividend paid on June 26 of this year. It should be noted that Second Quarter 2014 net investment income coupled with realized capital gains totaled $0.47 per share.

As we stated in previous calls, it is our goal to cover our dividends with net investment income. To achieve this goal, we will continue to invest our recent [votes] offering proceeds and we will continue to transition our portfolio concentration from equity to debt.

As Joe previously mentioned, 69% debt and 31% equity at June 13th - 30th, 2014 compared to 64% and 36% respectively at September 30 of last year.

Total expenses for the quarter ended June 30, 2014 with $6.9 million compared to $3.6 million in 2013. The increase of $3.3 million is attributed to one, a second quarter incentive fee of $1.4 million, two, an increase in management fees net of the waiver of $1.0 million and three, other expense increase of $0.8 million noting that 2013 results were prior to the formation transaction.

These expenses are in line with our internal models. Net realized gains were $1.5 million dollars for the quarter ended June 30, 2014 compared to $0.4 million for the same period last year. The net change in unrealized appreciation was 1$16,000 increase for the quarter ended June 30, 2014 compared to an increase of $6.6 million last year.

Our net increase in net assets resulting from operations during the Second Quarter of 2014 totaled $6.2 million, down from $11.6 million for the same period last year. On a per-share basis, the net increase in net assets resulting from operations was $0.48 per share for the quarter ended June 30, 2014 and is not comparable to the same period last year.

It should be noted that the 2013 results were significantly impacted by $6.6 million in unrealized appreciation mostly related to two equity investments. Total net assets of $263.9 million at June 30,2014 equate to $20.34 per share compared to $20.71 per share at the end of 2013.

From a liquidity standpoint, we have cash and cash equivalents of $165.5 million at June 30, 2014 compared to $101.6 million at December 31, 2013. During the quarter ended June 30, 2014, the Company closed on a notes-offering netting $109.2 million in proceeds. The proceeds from the offering will allow us to continue to invest in middle-market and lower middle-market opportunities as previously mentioned by Joe.

SBA debentures outstanding at June 30, 2014 totaled $192.2 million with an annual, weighted average interest rate of 3.51%.

And with that, I'd like to turn the call over to Jack for a few comments on our investment portfolio and trends in the overall investing market.

Thanks, Steve.

During the quarter we originated $22.6 million new investments. We have two new company investments totaling $14.4 million. Those of these investments were into large, well established companies. We also completed four add-on investments totaling $8.2 million.

The weighted average interest rate for the new investments was 11.3%. We also had $9.4 million of realizations including one repayment of an $8 million, 12% interest rate senior loan. So overall, net new investments was over $13 million in Q2.

Capitala also realized $3.3 million in dividend income from six different portfolio companies. As reported in our recent 8K, Capitala has had significant investment activity since the end of the Second Quarter. By mid-July, we enclosed $26.5 million of new investments; $24.7 million of that was into debt investments with a weighted average interest rate of 14.4%.

As of the end of the Second Quarter, the Capital Portfolio consists of 45 companies with a fair-market value of $405.6 million on a cost basis of $347.7 million.

Senior debt investments represent 31.8% of the portfolio. Senior subordinated debt, 37.4% and equity warrant value of 30.8%. On a cost basis, equity investments comprise 18.5%. The weighted average effective yield in our debt portfolio is 13.4%, down from 13.8% and our internal weighted average rating remained at 1.73.

There is no material change in non-accruals in Q2. We currently have four securities from three portfolio companies on non-accrual status. The combined fair market value of these companies at June 30, 2014 is $5.6 million or 1.4% of the portfolio. We continue to remain very active in supporting non-accrual companies.

In regards to market conditions, while there's a competitive market, we continue to see a robust pipeline of directly originated deals from our proprietary, multi-office origination platform. In addition, we were able to supplement our proprietary investment activity by selectively investing in some syndicated deals into well-established companies where we see superior risk adjusted returns.

We continue to balance this activity as demonstrated by our Q2 and subsequent July activity.

With that, I'll turn it back to Joe.

Thank you, Jack. Thank you, Steve.

With that, I think we will open it up to questions and sit here and answer anything you have to ask.

(Operator Instructions).

Our first question comes from the line of Vernon Plack from BB&T Capital Markets. Your line is open.

Thank you.

Joe, I was interested in your thoughts regarding continued expansion of staffing. Are there any plans to open up any additional offices any time soon? And are you still looking to add people?

Vernon, great question.

We've added a lot to both the portfolio management and to the underwriting side in the past few months. We're now seeking to expand our offices. If you look at our current, sort of, direct origination offices, they're mainly in the south. We do have a lot of activity on the West Coast so we are actively seeking to open a West Coast office. And we do have a lot of activity sourcing in the Northeast. And we're actively seeking to open a Northeast office.

I think our goal is to have those open by the end of the year or early next year at the latest.

OK. And I'm also interested in how - and Jack, you addressed this a little bit. But how does the competitive landscape today look compared to 90 days ago. Have there been any changes?

I don't think there's been anything real significant in the way of changes in the last 90 days. I think this year seems to be more competitive than last year. But I don't think it's - I don't see it getting worse at this point.

And one thing I would add to that is if you look at our activity since IPO, especially our sort of you know, sub-$20 million EBITDA activity is we haven't done a lot of traditional equity sponsor activity. That's a very competitive market. Pricing's very competitive. Leverage ratios have increased significantly.

We are continuing to source these unique deals as growth capital and non-equity sponsored activity and that's why we're able to you know, keep our weighted average yields at such high levels. You know, 14% first quarter, year to date in the third quarter, 14% and then the second quarter is 11% but we didn't close a lot of those sort of smaller, sub-$20 million loans in the second quarter.

Yeah, and Joe, you mentioned that the average EBITDA has increased from about $9 million to $17 million. Interested in the leverage levels on those companies; has that - where has that trended?

Well, a year ago and at IPO our leverage was right under four. It's like 3.8 to 3.9. We currently - our leverage level is at 4.2 so a little bit of increase but not nearly the type of increase as far as the EBITDA growth.

I mean, you're doubling your EBITDA, more or less the same weighted average yield. We sacrificed 40 basis points on that. But you know, EBITDA's [dull] in your leverage...

OK.

And your leverage ratio, you're going from 3.8 to 4.2, I mean, it shows the robustness of our sourcing activity.

OK. All right. Thank you.

Thank you, Vernon.

Thank you. Our next question comes from the line of Terry Ma from Barclays. Your line is now open.

Hey, guys. Just wanted to go back to the weighted average EBITDA again from $9 million to $17 million. Can you maybe just give a little more color on what's driving that? Is that more by choice? Or what is it?

Yeah, I think it's where we continue to have our traditional lower, middle-market activity, which has historically been our SBIC activity. And we define it sort of $20 million, $30 million under an EBITDA. What we have also done is begin to participate in some of these broadly syndicated deals, the ones that we find very attractively priced given the size with low leverage, you know, stronger EBITDA companies.

And we're doing that because evening lower middle-market deals, sub-$30 million EBITDA, equity sponsor activity. We're seeing that trend become very competitive and the leverage ratios to increase significantly. For example, a $7 million EBITDA Company and a traditional equity sponsor buy out, we're seeing some activity on the mezzanine side behind three turns of senior debt and they're getting 10% to 9% yield. That's on a $7 million EBITDA company.

We choose not to participate in that type of activity right now. We don't think that's a risk-adjusted basis is priced correctly. So we have found some very good uni-tranche and other activities in the sort of middle market syndicated loan market, better yields, better leverage attachment points, much more dynamic and bigger companies and we believe are better risk adjusted returns.

OK. Got it.

And can you maybe just talk a little more about the absolute yield you're seeing on these broadly syndicated deals relative to smaller, $20 million $30 million ones that you did?

I mean, last quarter, a lot of it was - the broadly syndicated and our average yield was $11.3 million but I think our bogey that we're seeing and it all depends on the specific opportunity. You know, it's looking sort of 9% to 11%. And like I said, we're seeing some sub-$10 million EBITDA companies with close to five turns of total leverage where the mezz and those transactions are sub-10% priced. We are choosing not to participate in that activity right now.

Got it.

And can you maybe just talk a little more about your pipeline and what that looks like in terms of this split for debt and equity?

They would largely be comprised of debt investments, at this point. As Joe mentioned before, we're you know, managing down that equity component so it is largely debt investments and both a mix of senior and sub-debt investments.

OK. Got it. That's it for me.

Thank you. Our next question comes from the line of Mikey Schleien from Ladenburg. Your line is now open.

Yes. Good morning.

Several questions. Could you tell me first how much fee income you recognized in the Second Quarter?

The income kind of vetted in there with dividend income. We had $3.3 million. (Inaudible) have the income broken out separately.

OK. I'll follow up.

If I can get back to you on that, Mikey?

OK. Talking about dividend income, it's very healthy when you look at in relation to the equity portfolio. You know, very attractive yields. Is that sustainable or what's driving that? I know you said it was dividends from six companies but just holistically, you're talking about some very strong returns there.

Well, I think this - that goes back, Mikey to our recurring, non-recurring activities. One of the positives of having 30% in equity securities is you do have a lot of that activity which has produced a nice dividend income and capital gain.

But again, our goal is to cover our dividends from our net interest income. And just by reducing our rotating - our equity from 30% down to 20% and under in the portfolio, we can do that and continue to have recurring, non-recurring events. And that is our goal. We're working very hard.

Unfortunately, a lot of these equity positions are minority positions where we cannot control the timing of those exits. But a lot of them are in that stage of their life cycle that the equity sponsors or controlled equity in those situations will seek to monetize either going public, which we're aware of some pursuing that and just selling the company.

So, we hope to get that 30% down to 20% and under very soon and I think you'll see that we're continuing to keep out weighted average yields up and we'll just cover our dividend from our earnings.

Are there dividend recaps that are driving the numbers that we've seen in the last couple of quarters?

There have been recaps, there've been special dividends. More so in previous quarters than this quarter. This quarter was no significant activity like that in previous quarters as we previously disclosed. We did have some dividend activity.

OK. And in terms of deal flow for the Second Quarter, can you break out what portion - I know you had a couple of deals that were syndicated, the TGIFriday and the US Wells, but apart from that, how much was directly originated and what - and how much was sponsored?

Well, I think what you'll see in the Second Quarter are true, direct originated deals. They close three weeks after the end of the quarter. So that's why we filed the AK. Those are non-sponsored deals, directly sourced through our direct origination platform and very attractive yields at an average of 14.4%.

And one of those was a senior uni-tranche deal yielding 16%. And the other one was a blended sort of debt deal yielding right at 14%.

OK. I understand.

Lastly, I see that you added to the impress aerospace position. I think you're a little bit higher in the balance sheet and that seems to be one of your distressed assets marked at 80% so I'm trying to understand your strategy there and what's the outlook for that company?

Yeah. I mean, the strategy there and the investment you saw was a move up the balance sheet just to kind of solidify our position and it'll give us some more flexibility in working out of that situation.

What are the headwinds that they're confronting there? Is it government spending? Or something else?

It's customer related, customer concentration and just working through some kind of legacy issues there.

OK. That' sit for me. Thanks for your time.

Thank you.

Thank you.

Thank you. (Operator Instructions).

Our next question comes from the line of Troy Ward from KBW. Your line is now open.

Hey, great. Good morning, guys, this is [Greg].

Just wanted to talk I think you just touched on this on one of your last comments. But the goal of reducing equity in the portfolio, obviously that can go down as you grow your debt assets with your available capital. But what do you see as your likelihood of monetizing some of these equity investments as additional way to roll the equity off the portfolio and kind of what's the time frame on some of those, if you're willing to give it?

Well, you know, again, we don't control but we do - we are monitoring these companies and have obviously, access. We're aware of some filings to go public. And we think that should happen if the markets hold up in the Fourth Quarter.

On that one, that's a larger deal that would be a very nice gain for us. And we have some private equity sponsor activity that have hired investment bankers, have engaged investment bankers to monetize their investment which would monetize our investment.

Even though we don't control that decision, we think those are fourth quarter, first-quarter events assuming all the markets hold up, which you know, we don't believe they would not. And what we really need to do, Greg, is we need to rotate just 50 million out of equity, 45- to 50 million, depends on what your re-deployment is and that gets you to covering our dividend from earnings from our net interest income. And that's approximately a third of our equity securities.

And if those events happen that I just described, that would be equivalent or more than that to rotate out and get into a yielding product.

That's great color. Thanks.

And then your discussion on opening new offices. Is that potentially moving some people you know, out of Charlotte out to those areas? Are you looking to hire new people in those geographies? And if it's hiring new people, how do you maintain kind of your corporate culture that you built there and your underwriting processes that you've developed.

Yeah, and that's a great question. You know, basically we do have all the core operations of underwriting and portfolio are maintained in Charlotte. And you know, all the most recent hires have been to increase that staff.

What we do when we open these regional offices is we actually hire somebody locally because we want to have someone with a local book of business. So, in all our six offices, all those hires were someone local and in - and sort of plugged into that deal flow in that market.

So when we go out to the West Coast and we go out to the Northeast, we will hire people from other mezzanine, private equity, [BVC] shops that are already in that market, bring a great book of business. The culture thing, you know, we spend a lot of time. That's why these hires are slow. I mean, it takes on average 6- to 12-months for us to pull the trigger on a new partner in a regional office.

And we do try to best minimize those issues going in. But we're - we spent a lot - we've been working on the New York and west coast office already for a couple of quarters and we're doing a good job of sourcing those partners. But they will plug into Charlotte to do the underwriting and then post close all the portfolio monitoring.

But we want them local to that market because we find that's how we get the strong deal flow from those regions.

Great. Thanks, guys.

Thanks, [Greg].

Thank you. And at this time I'm not showing any further questions. I would now like to turn the call back over to Joe Alala for any closing remarks.

Well, thank you, thank you, everyone for your questions. We are working hard here. We're 3/4 into being public. We've made some great strides. I think we're keeping our margins healthy. We're growing the EBITDA, which is making a stronger portfolio and we are focused on definitely covering our dividends from our net interest income.

And we will be able to do that as soon as we can rotate some of these equity securities into yielding product and will continue to grow. So, we got some healthy liquidity, very strong pipeline of deal flow and we think next quarter will be another good quarter.

With that, thank you.

Ladies and gentlemen. Thank you for participating in today's conference. This does conclude the program and you may all disconnect.

Everyone, have a great day.