Logan Ridge Finance Corp (LRFC) 2015 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Capitala Finance Corporation's conference call for the quarter ended March 31, 2015.

(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.Capitalagroup.com under the Investor Relations section. The hosts for today's call are Capitala Finance Corporation's Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer, and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall.

Capitala Finance Corporation issued a press release on May 11, 2015 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 historical information, including statements regarding the Company's goal, beliefs, strategies, future operating results, and cash flows. Although the Company believes these statements are reasonable, actual result 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 like the to turn the meeting over to Joe Alala.

Thank you, operator. Good morning, everyone. Thanks for joining us. Some highlights from the first-quarter investment activity; we had $67 million of gross investments, $57 million of that was debt, and 61% of that debt was senior secured. Our yield on Q1 debt investments is 13.3%, as compared to 10.5% in prior quarter. The yield on the aggregate debt portfolio at 3/31/15 was 12.6%, up from 12.5% at year-end.

Leverage at the portfolio Company levels from Q1 debt investments was 1.8 times. Leverage on the aggregate entire portfolio as of 3/31 is 3.7 times. That is compared to 3.8 times at year-end. The EBITDA at portfolio Company level, $33 million at the end of the first quarter compared to $30 million at the end of the year.

This demonstrates our strong direct origination platform, the majority [of the deals] we have been reviewing and closing are non-sponsored, deals, and in fact, many of these deals are not even represented by an investment banker, continuing to show the strong proprietary deal flow from our direct origination platform. Net asset value per share at March 31 was $18.35. There have been some confusion around this in conjunction with our share offering. Steve will address that shortly.

Net investment income was $4.8 million, or $0.37 per share, while net realized gains totaled $9.3 million, or $0.72 per share. During the quarter, we declared $0.97 of distributions per share and paid $0.52 share. $0.50 of this was a special distribution declared in March, payable over the remainder of the year in 10 $0.05 per month increments. As we reported on May 4, the current distribution yield on our common stock at par is 13.5%.

Equity investments are now down to 18% of the investment portfolio, based on March 31 fair values, down from 23% at year-end. The subsequent activity to the -- following the quarter as we completed a successful equity offering above NAV, which we issued 3.5 million shares, netting $64.1 million of proceeds. At this point, I would like to turn the meeting over to Steve for some additional comments on our operating financial performance.

Thanks, Joe. Good morning. As previously mentioned, on May 11, we filed a press release with our first-quarter 2015 earnings. In addition, we also posted a first-quarter 2015 investor update to our website, providing additional details about the Company, the investment portfolio, and other financial-related strategies. Now I would like to take a few minutes to highlight a few items within the earnings release, which can be found on the Investor Relations section of our website.

During first quarter of 2015, total investment income was $14 million, an increase of $1.6 million over the same period in 2014. Total interest, fee, and PIK income was $5.1 million higher in the first quarter of 2015 compared to 2014, but was partially offset by $3.4 million less dividend income. Total expenses for the first quarter of 2015 were $9.2 million compared to $6.7 million last year.

The increase is attributed to, one, an increase in interest and finances fees of $2.4 million related to the notes offering in June of 2014; two, an increase of $0.5 million in Management fees net of the waiver; and was partially offset by, three, a decrease of $0.3 million related to lower incentive fees earned during the first quarter of 2015 compared to 2014.

Net investment income totaled $4.8 million, or $0.37 a share, for the first quarter of 2015 compared to $5.7 million, or $0.44 per share, for the same period last year. Management remains focused on covering distributions with core net investment income, recent equity exits, and subsequent rotation into debt investments. Coupled with continued investments, investment activity in the lower and traditional middle market will position us to accomplish this objective.

Net realized gains were $9.3 million, or $0.72 per share, for the first quarter of 2015, compared to $1.2 million for the same period in 2014. During the quarter, we realized gains related to KBP Investments of $9.3 million, a partial realization of the sale of Boot Barn shares for a gain of $3.3 million, partially offset by a $3.4 million loss related to Precision Manufacturing LLC, an investment that had a fair value of $0 at December 31, 2014.

The net change in unrealized appreciation was a decline of $4.3 million, or $0.33 per share, for the first quarter of 2015, compared to a decline of $5.7 million for the same period last year. It should be noted, though, that $7.6 million of this decline related to the realization of net gains for the period by a reduction of previous unrealized appreciation. Most importantly, the remainder of the portfolio actually appreciated approximately $3.3 million during quarter.

The net increase in net assets resulting from operations during first quarter 2015 totaled $9.9 million, or $0.76 per share, compared to a net increase of $1.2 million, or $0.09 per share, for the same period last year. Total net assets of $238.2 million at March 31, 2015 equate to $18.35 per share compared to $18.56 per share at the end of the year.

In the prospectus supplement for our recently completed offering of 3.5 million shares, we included an estimate of NAV as of April 7, 2015, the date of the offering. That estimate was a range of $17.68 to $17.73 per share, but it included distributions of $0.47 per share declared on April 1, 2015, payable during the second quarter of 2015. The range included in the supplement, only applied to the offering, demonstrated an above NAV issuance of shares and was not intended as an estimate for March 31, 2015 NAV.

From a liquidity standpoint, we have cash and cash equivalents of $32 million at March 31, 2015 compared to $55.1 million at December 31, 2014. SBA debentures outstanding at March 31, 2015 totaled $192.2 million, with an annual weighted average interest rate of 3.51%. In addition, the Company has $113.4 million of notes outstanding bearing a fixed interest rate of 7.125%. Lastly, the Company has $65 million available under its senior secured revolving credit facility. At this point, I'd like to turn the call over to Jack for a few comments on investment portfolio.

Thanks, Steve. As Joe mentioned, we are very pleased with our first-quarter gross deployments of $67.2 million, where the yield on debt investment was 13.3%, which helped raise our overall debt portfolio yield to 12.6%. Significant activity included a $20 million subordinated debt investment into B&W Quality Growers, at a 14% cash rate, along with warrant participation; at $15 million senior secured term debt investment into [Portrait and Innovations] at a 12% cash rate; a $15 million senior secured debt investment into Community Choice Financial at a float rate of LIBOR 100 plus 13%; the $10 million investment into the Senior Liquid Loan Fund; and $7.2 million in three follow-on debt financings.

The $34.6 million of repayments included the following activity. A $17.6 million payment from our KBP investment, that included the repayment of $8.3 million of 10% preferred equity and $9.3 million of realized gain on the exit from the investment. The investment realized a 41.2% IRR and over a 3 times cash-on-cash. There was $4 million from the sale of a Boot Barn stock and $12 million repayment of 12% subordinated debt from AE Wireless.

As of the end of the fourth quarter, the Capitala portfolio consists of 54 companies, with a fair market value of $518.9 million, on a cost basis of $484 million. Senior debt investments represent 35% of the portfolio; senior subordinated debt, 45%; the Senior Liquid Loan Fund, 2%; and equity warrant value of 18%.

On a cost basis, equity investments comprise 11.1%. The 18% equity composition is one-half of what it represented at time of IPO so we are very happy to have delivered on one of our key objectives, of monetizing our equity gains so we can rotate them into interest-bearing debt investments.

In regards to portfolio quality, we continue to maintain a sub-2 internal weighted average risk rating at 1.88. Currently, we have no investments on cash non-accrual status, and we continue to have one portfolio debt investment on PIK non-accrual. This investment has a cost basis of $13.1 million and a fair value of $10.6 million.

As an update on our investments in the energy space, we continue to closely monitor our five investments that represent 11.8% of the total investment portfolio at fair value. These fair values are marked at approximately 87% of cost at quarter-end, slightly lower than the 89.5% at year-end. All of the five investments continue to be current on their interest payments.

In regards to market conditions, we have experienced a good uptick in deal flow, and have several proprietary deals that are currently in the diligence phase. As evidenced by our first-quarter performance, we have also seen improvement in pricing and we are hopeful that the increase in transaction volume will allow this to continue. With that, I will turn it back to Joe.

Thanks, Jack. Thank, Steve. With that, operator, we are ready to address questions.

(Operator Instructions)

Our first question comes from Terry Ma with Barclays. Your line is open.

Hey, guys. Can you give us a little color on the Senior Liquid Loan Fund -- what type of returns or yield you're targeting in that vehicle, and also how big you intend to grow that?

Terry, this is Joe. Right now, we have allocated $10 million of the $20 million in this Senior Liquid Loan Fund that we're co-managing with Kemper. We do forecast double-digit yields when it is fully deployed.

Just to make sure: This is a Senior Liquid Loan Fund. These assets have multiple quotes, are highly liquid, and quoted at the end of each close of business day. We've hired a very talented portfolio manager from Apollo to manage that for us. We expect no more than 20% allocation to this type activity from equity, but we are very far from that right now.

Got it. How soon do you expect capital and leverage to be fully deployed in that?

Related to the offering, we would hope that we could invest the proceeds from the offering in one to two quarters. From a leverage standpoint, we have got a revolver that we could draw on, to fund new deals. That will probably be another one to two quarters as well, to draw the facility to fund new deals; so, sometime in the third quarter.

Okay. Got it. And what about for the Senior Liquid Loan Fund? I think you guys committed $10 million. You guys haven't put any leverage on that. All the assets are cash right now?

That was funded on the last day of the period. That will change during the quarter, and we will provide much more disclosure on that in our June 30 10-Q, as we have assets due within the fund itself.

Okay. Got it. That's it for me. Thanks.

Thank you, Terry.

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

Thanks very much. Looking at the yield on new investments for the quarter at 13.3% -- which is very good -- is that what we can expect going forward?

We do have a very strong direct origination activity here. To hit a -- where most of this is senior debt, where you are having non-sponsor activity, and where you are not -- in some of these deals, there's not even investment bank involved, so we are negotiating directly with the borrower, without advisors. This is one of those quarters that are just can show what -- if the direct origination platform is hitting on all cylinders -- what it can produce.

I am not sure that we are able to produce this, at this level, with so much senior debt and such low portfolio leverage at under 2 times, on a consistent basis. This is just -- we will have quarters where our direct originations will produce these results, but it is hard to find senior secured debts with 61% being senior secured at 13.3% rate and under 2 times leverage, when the EBITDA is over $30 million. And I just think -- we really want to focus on this -- we are not chasing yield by doing higher-leverage deals at the portfolio level. We are earning these yields by our direct originations, sourcing proprietary deals that are non-banked and non-equity-sponsored.

Okay, great.

Steve, what are you expecting? This is a question that we get a lot in terms of -- with the balance sheet, with the cash that you have right now, what are you hoping that NII will approximate or match the dividend?

Good question. The way we are looking at it for this past quarter is the pre-incentive fee, NII, increased by $1 million over the fourth quarter of last year, or $0.07. It is the first quarter we've actually earned an incentive fee since the second quarter of last year, related to the notes offering. And that's [all $1.2 million].

The key to future coverage of the distribution will be tied to successful deployment of these equity offering proceeds in a reasonable time frame at proper risk-adjusted pricing. Rest assured that management is focused on this metric, and it is a high priority internally. So, beyond that, I am not sure I can give you much further clarity or guidance.

Okay. Thanks.

Thank you. Our next question comes from Mickey Schleien with Ladenburg. Your line is open.

Good morning, Joe and Steve. I just wanted to back up and ask you about the broader market. The first quarter was generally tough, with lack of M&A volume, and loan issuance was down pretty sharply on lack of refinancing. So, the backdrop seems to be pretty tough.

I am wondering what your base case scenario is for the balance of the year -- whether you expect volumes to pick up. And if you do, what's the catalyst for that?

We just came off one of the best origination quarters we've had since being public. I would say our pipeline right now is consistent with that type activity. I think what is happening, and this is specific to Capitala, is all the multiple offices that we opened over the past 12 to 18 months are really starting to hit their stride. We are finding a lot of opportunities and, at least this quarter, and our forecast for the balance of the year, is we will continue to have strong originations, and I think we're going to get this high-quality, risk-adjusted pricing that we're able to pull through our system.

Joe, given what you just said, where the local offices are driving deal flow, what level of EBITDA companies are they talking to, or looking to talk to, that perhaps is a less volatile space than the more liquid markets? What size of company are you targeting?

That's a great question. At IPO, our average EBITDA was right around $9 million, and that was primarily coming from these SBIC subsidiaries. The average EBITDA now through Q1 is $33 million. So, we've actually grown to a nice-size, lower-middle-market/traditional middle-market EBITDA Company; and our debt has continued, at the portfolio level, to decline since IPO. We are at 3.7 times now through our debt.

So, we are able just to find these great deals through our direct origination platform, and I really do think, now, that it takes time for these offices to hit their stride. We opened these offices, a lot of them, in late 2013, early 2014; LA -- later 2014. They're starting to hit their stride, and we are finding a lot of opportunities out there.

Okay. That's great.

One last question: We saw spreads widen in the fourth quarter in the more liquid markets and they contracted in the first quarter. Any comments you could give us on refinancing risk in the Capitala portfolio?

I don't think we've really seen much of a change there. It has been -- at the portfolio level, it has been pretty solid. There is some efforts in some of the portfolio companies to continue to refinance with the low-priced senior debt, but that's not unusual. Again, there just hasn't been a big change from quarter to quarter.

Any thoughts on opportunities in the oil and gas world, given where we are at with oil today?

We had -- we have seen a couple opportunities there. To be honest, we just haven't been really aggressive in that space, based on where our portfolio is now, and the additional scrutiny in that space. So, no, we haven't been real active there.

Okay. Thanks for your time.

Thank you, Mickey.

Thank you. Our next question comes from Christopher Nolan with MLV & Company. Your line is open.

Hey, guys. What is the peak debt-to-equity ratio you guys are targeting now?

1.75-ish.

Steve, are you guys planning to do -- (multiple speakers) -- I'm sorry. What's that?

From a regulatory standpoint, we will probably stay in the 0.75 range, which -- we are at 0.54 at the end of the quarter. But from a total standpoint, we're certainly north of 1.

Great. And to leverage the equity raise, what are you planning? Another baby bond or any thoughts on that?

First, the next debt dollars will come from our credit facility, which we paid down post-offerings. We've got availability on our line first, at LIBOR 300, so that will be our next dollar of leverage.

Great. Then, in terms of growing the SLF, and I know you had earlier questions on this, but what is the pace of growing the equity investment in -- or Capitala's direct investment in the SLF going forward, on a quarterly basis?

Right now, we had originally planned deployments on a quicker pace, but I think we will probably get there a quarter or two; and once we do that, we would like to double our commitment to that product.

So, Joe, you are talking about taking your $10-million investment and possibly increasing it to $20 million by the third quarter?

Yes, exactly.

Great. Okay. Thanks for taking my questions.

Thanks, Chris.

Our next question comes from Chris York with JMP Securities. Your line is now open.

Good morning, guys, and thanks for taking my questions. You have done a good job exiting some of your equity positions over the last couple quarters. In terms of a target portfolio, what would you expect equity investments to be as a percentage of the portfolio, maybe on a normalized basis?

Chris, this is Steve. Somewhere at or below 20% is probably a good target number. Quarter to quarter, year over year, it may bounce around, depending upon activity and opportunities. But from a benchmarking standpoint, I would say at or below 20%.

Yes, it will definitely be below 20% on a cost basis right now because we make sure we structure it that way. But, again, we have exited some of the big gainers, and we are developing a couple other ones in the portfolio, and we hope they continue to increase in value. So, from a value standpoint, it might go above 20%, but that would be good news.

Got it. Sure.

Then, in terms of your position with Boot Barn, do you expect to exit this position when the lock-up expires this quarter?

Our lock-up expires at the end of the quarter. We have some activity in the portfolio, and we will make that decision at the time. But it is nice having that opportunity out there.

I think we want to see what kind of capital gains that we have at the end of the quarter, and then review our taxable situation and make the optimal decision that will both adhere to the tax issues as a BDC, but also to the recycle and special dividend issues that may come on out [from two].

Got it. Then, lastly, Joe, as a BDC with some of the most, what I think is, extensive experience operating SBICs, I'm curious to get your opinion on progress on the Hill to increase the family of funds limit to $350 million?

As you know, I'm very involved in the SBIA, and this is the first time that the same party has controlled both sides of Congress. And I think the word -- and I have been asking about -- that best describes it is encouraging. Things in Congress -- it is always hard -- but encouraging is the word.

That would increase the limit from $225 million to $350 million. We are always in constant communications with the SBA; and once that limit were to increase, if it were to increase, we would apply for another license immediately.

Great. That's it for me. Thanks, guys.

All right, thank you.

(Operator Instructions)

Our next question comes from Greg Mason with KBW. Your line is now open.

Great. Good morning, guys. My questions have been touched on a little bit with Chris and Vernon's questions, but it stems around NII covering the dividends. On the equity portfolio that you have now, outside of Boot Barn, what is your opportunity to exit some of those additional equity opportunities, since that could be a meaningful driver of getting NII up?

Several of our equity positions have been in the portfolio for a period of time that make them close to a monetization. I do think we will have additional capital gains.

The hard thing is, these are private companies. And the deals -- sometimes they take longer, or they readjust right before closing and get delayed.

But I do think there's an opportunity in the existing portfolio of equity securities to have significantly more capital gains this year. With that, we could blend it of further special dividends and recycling into more yield.

Okay. Great. Then, just on the commentary around seeing a lot of new proprietary deal flow from your local markets that you opened up, it seems to me like, for that size a company, non-sponsored deal in those local markets, the bank is probably the primary competitor. Why are the banks not doing those deals, or what are you seeing out of the competitive environment for those local, non-sponsored deals?

What we are seeing is, sometimes a bank is in the deal. They're bringing us in the deal. That's a lending bank, not an investment bank. So, we have a structure -- a really nice, crafted solution for the transaction and get our pricing.

Other times, we are sourcing these deals not even from a bank; maybe from a law firm or an accounting firm, something direct. There is no investment bank involved or no sponsor involved, so we are able to get above-market pricing on those opportunities. And I think having these seven offices is abling us to get really deep in these regional deal communities and find these opportunities.

I'd just add to that, but I think certainty to close has been an important issue for business owners, even more so over the last quarter or so. I think we have all seen a lot of transactions that have fallen apart, and re-trading on pricing and stuff. And I think we have a good reputation out there for getting deals done at the -- at pretty much the rates that we talked about at the beginning of the deal, subject to diligence. So, I think our reputation has helped us in closing a lot of those deals.

We are still seeing warrant participation in a lot of our deal activity, at this side.

Great. Thanks, guys. Appreciate it.

Thank you.

Thank you. Our next question comes from [Walter Janus], who is a private investor. Your line is open.

Yes, good morning. To follow up the previous question on monetizations, on page 13 of your investor presentation, you list the current equity investments, and the cost basis and fair value. Other than Boot Barn, which we have talked about, are any of those near in a position to monetize this year, or do all of them require some kind of special event like an IPO or something in order to put in the monetization category?

These opportunities -- and we are looking at the page you are referring to -- the most important thing is last -- the quarter prior to Q1 is -- our largest investment listed on this page did monetize. These companies will typically not see an IPO, for the majority of these companies, for an exit. They will typically be arranged, third-party sales. We are aware, when these companies, through our involvement, have entered negotiations or have hired an investment bank to pursue alternatives.

With that, we do think a lot of this portfolio will seek to monetize in this year, because a lot of these companies have been in our portfolio for several years. And you can see, because we put the cost basis and the fair value, that a lot of these companies have nice, significant unrealized gains in there, so the owners of these companies would seek to monetize that in this good environment.

I do think several more of these will be candidates to monetize in 2015. That's why we really are saving our Boot Barn decision to see what happens, because we could really do some things that can optimally use these exits to really both recycle the equity into yield and pay maybe additional special dividend.

Okay. And just a clarification: On the overallotment on the follow-on offering, I take it there were no additional sales of stock in the overallotment; is that correct?

That is correct.

Okay. And finally, in the last conference call, you talked about several of companies on the watch list -- On-Site Fuel, SSCR, Print Direction, Market E's, Sparus Holdings, Source Recycling -- do you have any updates on any of those, either on a positive sense or a negative sense as to how they're doing?

Yes, I think we have made some good progress on the bulk of those that you just mentioned. And some of those -- again, I think I talked pretty extensively about On-Site Fuel last time, and I think we have seen some real good progress from our new management team there. I think, for SSCR, we are entering the peak of the suntan lotion season, and the early results there have been encouraging.

Again, our efforts there, and the management teams that we have invested in, is paying off, and we have seen some stability. They definitely remain on the watch list, and we continue to support them. But I think, for the most part, we are encouraged in the performance.

Okay. How about Market E's? You indicated that the largest investor had a control position on the Board. If that resolves in our favor, would that result in perhaps a capital gain or something of that sort?

Yes, I can't comment too much on Market E's at this point. It is an ongoing monitoring. It is on the watch list. I can't comment too much about the current status of it.

Okay. And Immersive Media Tactical Solutions -- you wrote down a little bit farther in the quarter -- wrote that issue down to about 80% of cost. Is there a problem there or something else?

There has been a -- that was almost entirely a government contracting business when we first got into it. It had several contracts that they were operating under. Those have now rolled off. And because of the situation with the government and just a slowdown in the contracting and some of the dollars being placed, they have shifted their strategy and are looking for more commercial work.

So, there has been quite a lag as they rotate out of their government business and into their commercial business. We have had to be patient with them as they make that transition. The EBITDA has also gone down significantly from the peak. So, that's -- our valuation reflects that. So, I wouldn't say it is trouble; it's a shift in strategy. It is going to take some time.

Okay. Thank you.

Thank you.

Thank you. I'm showing no further questions. I would like to turn the call back to Joe Alala for closing remarks.

Thank you, everybody, for participating in the call. We did update our latest non-deal road shows on our website. It has a lot more detail about the activity, and feel free to use that. But thank you, everyone. If you have any further questions, our phones are always open. Thank you.

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