Logan Ridge Finance Corp (LRFC) 2014 Q3 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 September 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 dot capitalgroup dot com under the investor relations section.

The host for today's call are Capitala Finance Corps' Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer, and Secretary; and Chief Financial Officer, Steve Arnall. Capitala Financial Corp issued a press release on November 10, 2014, with the 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 historically 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 and aligned assumptions, and are subject to numerous uncertainties and risks, including those disclosed under the section 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 like to turn the meeting over to Joe Alala.

Thank you, operator. Good morning, everyone, and thank you for joining us. To go over our third quarter activity; we originated $86.7 million of gross deployments during the quarter, which resulted in a $42 million of net deployments when you consider in the repayments. The weighted yield on our debt portfolio is at 12.8%. That compares to 13.4% prior quarter.

I think you're seeing the trend of we're actually pursuing larger EBITDA deals. Our average EBITDA in the portfolio now is $26 million at IPO approximately a year ago, the average EBITDA was slightly over $8 million. We're still maintaining a very reasonable leveraged ratio at the portfolio level. It is at 4.1X right now.

The equity portfolio percentage is down to 27.5% based on a fair market value. As we've mentioned, we're trying to get that number to 20% and below. At IPO, that number was at high 30s in percent. We're making great progress there. Our net investment income per share was $0.27 cents per share at $3.5 million.

Just a reminder that the interest on our baby bonds is approximately $2.2 million or $0.17 per share. If you're just to add that back on the timing of the raise and deployment, that would have been about $0.44 per share of earnings. Our net asset value is $258 million at the end of the quarter; which represents $19.89 per share. We did pay a $0.47 per share distribution on 9/26/14.

On October 3rd, announced conversion to monthly distributions and declared $0.16 per share for each of the months October, November, December. The October distribution was paid on 10/30/14. We continue to have a robust pipeline of investment opportunities at similar yield to current level. It is at similar leverage rates at the portfolio level, at current levels.

We have filed an 8K, and also filed in the 10-Q subsequent report -- or subsequent activity. Basically to date, we've invested all of the proceeds from the bond offering in late June. They're now completely invested. We did secure a revolving facility with ING. It's at $50 million out of the gate. It has an accordion feature up to $150 million. That is at LIBOR plus 300.

We did have a portfolio exit. Boot Barn had an IPO on October 30th. It was on our books at fair value of about $9.2 million. We do have 600,000 shares of Boot Barn as of yesterday. It was trading $18.70, I believe. People can do the math. But based on the IPO at our fair value, we had generated a 4.5 cash-on-cash return on that investment; and at 76% IRR.

We also exited on October 30th, Naples Lumber & Supply Co. This had been a long investment for us that we had to completely impair during the recession as part of when we were in the SBIC funds. We did exit that and generated a $1.4 million gain and a very solid, over 2X return on that investment. We have also opened an L.A. office at the beginning of the month.

We hired a very talented professional to get us some activities on the West Coast. We were very excited about that. That would be our 7th full service offices on our direct origination platform. At this point, I would like to turn the meeting over to Steve Arnall for some additional comments and talk about financial performance.

Thanks Joe. Good morning. As previously mentioned on November 10th, we filed a press release with our third quarter 2014 earnings. I would 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 third quarter of 2014, total investment income was $11.2 million, a 27% increase over the same period in 2013. The increase was attributed to higher interest and dividend income resulting from a larger investment base. Dividend income for the third quarter of 2014, was $2.0 million lower than in 2013.

Net investment income totaled $3.5 million for the quarter ended September 30th, 2014, compared to $5.4 million for the same period last year. Net investment income per share was $0.27 for the third quarter of 2014, compared to $0.42 for the same period last year.

Net investment income for this quarter was adversely impacted by one, interest and amortization expense for the quarter related to the notice offering completed at the end of June; and two, the lack of dividend income for the quarter. We had $0.1 million for this third quarter of this year versus $2.2 million in the same quarter last year.

As we stated in previous calls, it is our goal to cover our distributions with core and net investment income. We believe our distribution rate is sustainable. But we'll continue to build our income string for the longer term through prudent investment decisions and the development of the most optimum capital structure for the Companies.

That being said, in order to achieve our goal of covering our distributions with core net investment income, we need to continue to rotate out of equity and benefit from a fourth quarter of income on investments made during the quarter -- the third quarter of 2014, as well as investments made during the fourth quarter of this year.

Total expenses for the quarter ended September 30, 2014, were $7.6 million compared to $3.4 million last year. The increase of $4.2 million is attributed to, one, again interest and amortization of $2.2 million on the notes offering from June of this year.

Two, an increase in management fees net of the waiver of $1.5 million. Three, other expense increase of $0.7 million, noting that 2013 results did not reflect a full quarter of operating expenses as the IPO was completed on September 30th of 2013.

Net realized losses were $3.1 million for the quarter ended September 30, 2014, compared to a gains of $1.9 million for the same period last year. During the quarter, we exited our debt investment in Impresa Aerospace Holdings, LLC at a loss of $5.2 million partially offset by a $2.1 million gain on the exit of our investment in Take 5 Oil Change, Inc.

The net change in unrealized depreciation was $0.2 decrease for the quarter ended September 30, 2014, compared to an increase of $0.6 million last year. Our net increase and its net asset resulting from operations for the third quarter of 2014 totaled $0.3 million down from $7.9 million last year.

On a per share basis, the net increase in net assets resulting from operations was $0.02 for the quarter ended September 30, 2014; again, and compared to $0.61 for the same period last year.

Total net assets of $258.1 million on September 30, 2014 equates to $19.89 per share compared to $20.71 at the end of 2013. From a liquidity standpoint, we have cash and cash equivalents of $107.6 million at December 3 -- September 30, 2014 compared to $101.6 million at December 31, 2013.

SBA debentures outstanding at September 30, 2014 totaled $192.2 million with an annual weighted average interest rate of 3.51%. In addition, the Company has $113.4 million of fixed rate Notes outstanding bearing an interest rate of 7.13%. Lastly, as announced on October 21st of this year, the Company entered into a senior secured revolving credit arrangement with ING Capital.

The facility initially provides for borrowing up to $50 million. It may be increased up to $150 million pursuant to its accordion feature. The facility matures on October 17, 2018. At this point, I would like to turn the call over to Jack McGlinn for a few comments on our investment portfolio and the trends we're seeing in the overall investing market.

Thanks Steve. During the quarter, we netted $42 million of new investments. We were pleased to originate $86.7 million of gross new investments, including six new company investments totaling $73 million. These investments were in the large well established companies where weighted average EBITDA was $66 million.

The total funded debt ratio was right at four times. We also completed five add on investments totaling $13.7 million. The weighted average interest rate for the new investments was 11.3% bringing the overall debt portfolio yield to 12.8%.

We also had $44.7 million in realizations including a full at par repayment at the 12%, and $17.9 million senior loan to Worklife America. Full at par repayment of the 14% current and 2% PIK subordinated loan to MJC Holdings; and a $15.8 million buyout of our senior and subordinated debt in Impresa Aerospace.

As discussed in our last call, we had a made a defensive buyout of the senior debt of Impresa. This then allowed us to sell off our entire deposition to a third party where we received full value for the senior debt and at discounted value on our subordinated debt that resulted in a $5.2 million realized loss; $2.3 million, which had already been impaired as of Q2.

While we were never satisfied with losses, this action allowed us to eliminate any further risks to our loan principle. On the gains side, we exited our equity investment in Take 5 Oil Change; and realized a $2.1 million gain netting for the quarterly realized loss of $3.1 million.

As our Press Release earlier today touched on, our direct origination platform provides us with opportunities to participate in the equity upside of many of our investments. This upside allows us to both mitigate potential losses of principle and provide realized gains upon exit. It is also worth noting that these equity participations can provide significant dividend income as experienced in every quarter since our IPO through the second quarter.

During the quarter however, Capitala only realized a minimal amount of dividend income. As many of these positions are minority, equity, or warrants, we cannot predict the level of dividends we will receive in any quarter. But we do expect to continue to see dividend payments from our portfolio companies over time.

In regards to subsequent events involving the portfolio, Jim has already mentioned the great news that Boot Barn has had a very successful IPO that resulted in further appreciation from our previous quarter's mark. I would also like to highlight that we successfully exited both our subordinated debt and warrant holdings in Naples Lumber.

This pre-recession investment in a company, and one of the epicenters of the housing and mortgage meltdown demonstrates a vigorous portfolio management. Patience can result in value preservation and gains for our shareholders. It is our experience and long history to invest in the lower middle market companies that helps us produce attractive risk adjusted returns.

In regard to unrealized appreciation and depreciation for the quarter, there were some significant movements in both directions related mostly to equity holdings. The fluctuations however, only amounted to a net appreciation of $200,000.00.

As of the end of the third quarter, the Capitala portfolio consists of 50 companies with a fair market value of $445.1 million on a cost basis of $387.5 million. Senior debt investments represent 30.6% of the portfolio; senior subordinated debt, 41.9%; and equity warrant value of 27.5% down from almost 36% at IPO.

On a cost basis, equity investments comprised 16.9%. The weighted average effective yield on our debt portfolio was 12.8% down from 13.4%. Our internal weighted average of risk weighting moved up slightly from 1.73 to 1.8.

In regards to the yield decrease, while we've seen some yield compression, the bigger factor for us ahs been related to increasing the amounts of investments in the larger middle market companies where rates are lower on a risk adjusted basis as well as additional senior debt investments. There is only one change in nonaccruals in Q3 and that was the addition of Precision Manufacturing back to the list. This is consistent with Q4 '13, but we had removed it from non-approval status as of Q1 when a forbearance agreement was entered into.

There was the anticipated improved financial performance related to an increase in the sales backlog. Due to some operational issues as well as delayed shipments on the backlog, we thought it best to put it back on nonapproval status as we continue to closely monitor credit. The Precision subordinated loans of $3 million at par are being carried at a fair value of $1.9 million.

The combined fair market value of all of the nonaccruals at September 30, 2014 is $7.8 million or 1.8% of the portfolio. Our dedicated portfolio monitoring team is staying very active in the portfolio. We are using third party resources to supplement portfolio management where needed.

In regards to market conditions; while it continues to be a competitive market, we continue to see a robust pipeline of directly originated deals from our proprietary multi-office origination platform. We are pleased to announce the recent opening of our first West Coast office to further enhance that proprietary deal flow. That office has already provided several new opportunities.

We have seen an increase in deal flow over Q2 and some stabilization of both yields and purchase prices while we've continued to see reasonable debt structures in the forex leverage range or better. In addition, we were able to supplement our proprietary investment activity by selectively investing in some syndicated middle market deals into well established companies where we see superior risk and reward characteristics.

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

Thank you, Jack, and thank you, Steve. With that, operator, we are ready to address any questions.

Thank you, ladies and gentlemen. (Operator Instructions) Our first question comes from Terry Ma with Barclays. Your line is open.

Hey, guys. Can you maybe just talk about the increased focus on larger EBITDA deals in this current environment? Also, what that can mean for yield trends in your portfolio going forward?

Well, I think we're focusing on larger EBITDA credit because we think those are providing better risk adjusted return for us right now. You'll definitely see a trend in the EBITDA at IPO at right -- a little bit over $8 million to at $26 million now. We're able to maintain the same basically debt ratio at the portfolio level around 4X.

We think we're sort of later in the credit cycle. We're structuring the portfolio to reflect that reality. We're focusing on the larger EBITDA companies same portfolio leverage at 4X. You're going to sacrifice a little bit on yield because they are a larger investment. We're also moving more towards a senior sub-debt mix of more senior credit in the portfolio just for where we are in the credit cycle.

We think it is the most prudent way to be investing right now. We're also continuing to focus on lowering those equity securities to -- our goal is 20% and under. We think we can get there in the next quarter or two.

OK, great. Can you maybe just give us some color on potential liquidity events that may be coming up?

We've had a nice one with Boot Barn. We had a great one that sort of gets overlooked here with Take 5. We made three times our money on that one in a 66% IRR. We had a great one with Naples. I would say four out of our top five equity holdings are in the process of finding an exit opportunity.

Now one of those Boot Barn because that happened. We are locked up for six months as part of that IPO. Then we have enjoyed seeing the stock appreciate since IPO and at our market prior to IPO. That means three of the next five largest equity positions in our portfolio are in discussions for a liquidity event.

Now, we do not control those. We are monitoring those actively. We feel confident that in the next quarter or two, those positions will monetize.

OK, I got it. I just want to make sure I heard this right. You guys had about $107 million in cash on the balance sheet at the end of this quarter. But did you say you guys had run through that already for originations?

To $107 million, really and we have got two SBIC subsidiaries that we have to manage separately as well. That cash really is between our parent company and the two SBIC subs. What we said was the proceeds that the parent from the bond offering through our earnings release the other day have been deployed.

We've still got some cash available to invest through the SBIC subs, but the proceeds from the Notes offering have been deployed.

OK, I got it. That's it for me, thanks.

Thank you.

(Operator Instructions) Our next question comes from Mickey Schleien with Ladenburg. Your line is open.

Yes, good morning, gentleman. Joe, are you planning to monetize the Boot Barn common shares after the lock up depending obviously on the stock price?

We will, and when we -- the lock up ends in six months. We will review that at the time. I think we are going to have some very nice equity monetizations over the next six months. I think we will just address the situation at the time.

You maybe do full and maybe do partial. But if we're looking at monetizing three out of our largest five equity positions in the next quarter to two, that dovetails closely when this lock up will expire with Boot Barn. We will have monetized a significant amount of our equity positions by that point and time.

OK. Steve can you tell us how much cash and investments are held in the SBIC subsidiaries? Or, do you want me to follow up later?

Yes, follow up with me later. I mean, it is -- I will be glad to talk to you one-off, if you'd like. Basically, the parent has the $80 million proceeds from the IPO and a $100 million from the bond offering. Everything else would be at the SBIC stuff. But we can type that math up for you one-off, if you'd like to do that.

Talking about the new credit facility, can you give us a sense of what sort of investments it will accept as collateral? What are the advanced rates in that facility?

Yes, I mean, we're looking to manage the senior subordinated debt; the second liens all the way down and to the requirement to have first lien bank loans in there. The advanced rates probably start at 50% and work themselves up to about 70%.

It's flexible in terms of the collateral that it will accept?

It's very flexible. But the advanced rates vary. They're the only --

Sure.

--Non-flexible part is we've got to have a certain percentage of that foreign base needs to be first lien.

Right. What portion of your investments could you --? I'll ask that later on. Can you tell me what your target leverage is including SBA debentures?

I would say for us right now, we probably will want to be from a regulatory leverage standpoint around a 0.7 to 0.8 range maximum. If and when we can get that equity per concentration down below 20, I think it gives us the ability to maybe move up a little bit. But we're at 0.4 right now. We've got capacity to take on additional leverage, if the deal flow and the circumstances, and the capital markets fit our appetite. But 0.7 --

But that excludes the SBIC.

That excludes the SBIC. That is correct.

OK. One last question; is the [Market E] senior secured debt on nonaccrual? The [SOI] doesn't show it as it is. But I think it might be because of the numbers that you've given us.

Yes, that all of Market E is on [9 point].

OK. The footnote there is incorrect. All right, those are all of my questions. Thank you.

Thank you.

Our next question comes from Vernon Plack with BB&T Capital Markets. Your line is open.

Thanks, and most of my questions have been answered. Joe, are you planning on adding any additional offices at this time?

We just opened our seventh office. That's for our direct origination platform, that's a lot of offices. We currently do not have a deal flow problem. I think we are sort of good for where we are now.

We've hired a lot. We've added seven offices. We've got underwriting of portfolio people we've added. I would think we would not add another office until in the future when we started growing assets at the [BDC] again. I think we're good now where we are.

OK. How much cash do you want to keep on the balance sheet?

Yes. I think that's a good question. I think now that we have the -- sorry, Vernon. Now that we've got the facility in place, I think we can be a little bit more aggressive in preserving cash in the balance sheet.

I don't have a specific number in mind. But certainly somewhere well below $100 million and probably in the $20 to $40 million range, give or take.

OK. Given the cash that you have on the balance sheet, how soon do you hope to put that to work the next quarter, two, or three?

I think that's appropriate. We've always said --

OK.

-- In previous calls, we -- $30 to $40 million of net deployment is probably a benchmark we've established with you guys. Yes, absolutely.

OK, thank you.

Thank you. I'm showing no further questions. I will now turn the call back over to Joseph Alala for closing remarks.

We want to thank everyone for participating. Our phones are always open for a future discussion, if you want to call us. Our goal is definitely to, as we mentioned before, it is to cover our distributions from [core] NII.

We are pursuing that path. I think a big part of that path will be to rotate out of these equity positions and into yielding positions.

We're, as you'll see, we're making great progress there. We thank you all for your questions and your time today. We look forward to the next earnings call. Have a great day.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect. Everyone have a great day.