Logan Ridge Finance Corp (LRFC) 2020 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the Capitala Finance Corp.'s conference call for the quarter ended September 30, 2020. (Operator Instructions) Today's call is being recorded, and a replay will be available approximately 3 hours after the conclusion of the call on the company's website at www.capitalagroup.com under the Investor Relations section.

The hosts for today's call are Capitala Finance Corp.'s Chairman and Chief Executive Officer, Joe Alala; and Chief Financial Officer and Chief Operating Officer, Steve Arnall. Capitala Finance Corp. issued a press release on November 3, 2020, with the details of the company's quarterly financial and operating results. The copy of the press release is available on the company's website.

Please note that this call contains forward-looking statements that provide information other than historical information, including statements regarding the company's goals, beliefs, strategies, future operating results, and cash flows. Although the company believes 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 the 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. Please go ahead.

Thank you, operator. Good morning, and thank all of you for joining us today.

As noted in our third quarter earnings release, we were successful in executing on a number of topics mentioned in prior calls. One of the key areas of focus was to decrease leverage. During the third quarter, we repaid $59 million of SBA debentures and repurchased $2.2 million of our 6% baby bonds. The result was a total debt-to-equity ratio of 1.99 at September 30, 2020, down from 2.64 at June 30, 2020, and 2.72% at March 31, 2020. In summary, we have reduced leverage over 27% since the end of the first quarter of 2020 and during a pandemic.

Stability of NAV per share remains a key measure. For the second quarter in a row, NAV per share increased to $39.99 per share at September 30, 2020, up 3% from the prior quarter and up 6% since March 31.

Our investment portfolio continues to improve from a credit quality perspective. Debt investments rated 3 and 4 collectively account for 8.4% of the portfolio on a fair-value basis, the lowest percentage in over 4 years. We currently have 3 debt investments on nonaccrual and a risk rated 4 with a fair value of $18 million, down from 8 investments or $42.9 million at the end of the first quarter. Equally as important is that we currently have 4 investments, risk rated 3, our internal watch list, totaling $5.6 million, down from 7 investments or $39.3 million at the end of the first quarter.

Cash balances are approximately $44 million at quarter end. We anticipate using a portion of this cash to equitize an SBIC subsidiary, giving us access to low-cost, long-term, fixed-rate capital to be used to make investments in the lower middle market and grow our net investment income. Subsequent to quarter end, we are pleased to have closed on a senior secured credit facility. This line will provide liquidity for new investment activity and general working capital.

Distributions remain suspended for the fourth quarter of 2020. We understand the importance of resuming the payment of quarterly distributions. Utilization of our dry powder for new investments, including equitizing an SBIC subsidiary, will help us grow net investment income and generate future distributions.

Looking ahead, we are in a great position from a liquidity standpoint, both at Capitala Finance Corp. and across our entire platform. Our direct origination platform and underwriting team are in various stages of reviewing investment opportunities in the lower middle market. We approach the end of the year with a lower levered company, a senior secured debt portfolio, stability of NAV per share, and are working to resume quarterly distributions in 2021.

At this point, I'd like to ask Steve to provide some comments on quarter results.

Thanks, Joe. Good morning, everyone.

Total investment income was $6.7 million during the third quarter of 2020, $3.4 million lower than the third quarter of 2019. Interest and fee income declined by $2.1 million, resulting from a decline in average debt investments outstanding.

Dividend income declined by $1.2 million, as 2019 included $0.8 million dividend from a portfolio company and $0.3 million from Capitala Senior Loan Fund II, which was wound down during the second quarter of 2020.

Total expenses were $6 million for the third quarter of 2020 compared to $7.1 million for the third quarter of 2019. Interest and financing expenses declined by $700,000, resulting from lower average debt outstanding, while base management fees declined by $0.3 million, resulting from a decline in total assets.

Net investment income totaled $0.7 million or $0.27 per share for the third quarter of 2020, compared to $3 million or $1.11 per share for the third quarter of 2019.

Net realized losses totaled $12.3 million for the third quarter of 2020, but did not have a material impact to NAV per share, as realized amounts were in line with previously reported fair values. During the third quarter of 2020, we converted our Class B common shares of U.S. Well Services Incorporated for Class A tradable common shares. While the conversion to this new security generated a realized loss of $6.2 million, the number of shares and our continued equity ownership in U.S. Well Services remain unchanged.

Net unrealized appreciation totaled $14.8 million or $5.46 per share for the third quarter of 2020, compared to net unrealized depreciation of $1.3 million for the comparable period in 2019. The net increase in net assets resulting from operations totaled $3.4 million or $1.24 per share for the third quarter of 2020, compared to a net increase of $1.7 million for the comparable period in 2019.

Net assets at September 30, 2020, totaled $108.4 million, or $39.99 per share, compared to $54.84 per share at December 31, 2019. At September 30, 2020, we had $43.7 million in cash and cash equivalents. Also, as of September 30, 2020, total and regulatory debt-to-equity was 1.99 and 1.15, respectively.

During the third quarter of 2020, we repaid $59 million of SBA debentures, $19 million that matured on September 1, 2020, and $40 million that was to mature on March 1, 2021. In addition, we repurchased approximately $2.2 million of our 6% notes through our repurchase program.

Lastly, subsequent to quarter end, we've announced a new senior secured credit facility. The $25 million line will provide liquidity to fund lower middle market investments and provide general working capital.

At September 30, 2020, our investment portfolio included 36 investments with a fair value of $280.2 million and a cost basis of $283.2 million. First-lien debt investments on a fair value basis at September 30, 2020, comprised 66.7% of the portfolio, second lien debt represents 13.4%, and equity/warrant investments represent 19.9%. At September 30, 2020, we had three debt investments on nonaccrual status totaling $18 million on a fair value basis, compared to $23.9 million at June 30, 2020.

As Joe mentioned, we're in various stages of review on a number of investment opportunities, and our pipeline is very active.

At this point, operator, we'd like to turn it over for questions.

(Operator Instructions) Your first question is from the line of Christopher Nolan with Ladenburg Thalmann.

Steve, what was the driver for the realized losses, aside from the U.S. Wells conversion?

I'm looking, one second. Yes, mostly California Pizza Kitchen.

Great. On a strategy basis, I noticed that you guys, according to my estimates, made roughly $250,000 in new investments in the quarter and had about $10 million in repayments, and you're deleveraging. Is the strategy going forward to further deleverage?

Chris, Joe here. We're -- we've been talking about deleveraging. I think we've done a really good job of deleveraging for -- to under 2.X GAAP leverage. We are sitting on cash. We do have a new revolver in place now. We see the best way to really grow and accrete earnings is through investing through another SBIC subsidiary.

Currently, the cost of capital, when issued through an SBIC, is around 1%, slightly over. Long term, it's fixed. It's very attractive financing. We received a green light, as mentioned in prior calls, in I think April, May of this year, to pursue another SBIC license. We are in constant contact with the SBA. Although we don't control their time line, our goal has always been to receive a subsequent SBIC subsidiary in Q4 of this year. And we hope that's still the case. We don't control the time line. But the SBIC III and the BDC have performed, as we have mentioned, over the past 2 quarters.

So we're confident it's coming our way. We just don't control the time line. And that is really accretive to growing our earnings and producing dividends.

Chris, this is Steve. On that line, with the repayment we made on September 1, we've only got $6 million due on March 1 in SBA debentures maturing. We'll decide, sometime before that date, whether we want to repay any of the remaining bonds, but they don't mature until 2022, beyond that. So, to be determined.

Yes. My thinking is this, is right now, the stock price is trading roughly 22% of NAV per share. And I saw in the quarter that there really wasn't any incremental investments, and possible strategy could be simply just to deleverage the balance sheet -- and you're not paying a dividend also -- delever the balance sheet, take it to cash. And with that, the valuations in the stock price will go up and you can fight another day, as it were.

Well, Chris, this is Joe again. As a platform, we have actually been very active investing. We'll probably have the most active quarter as a platform Q4 of this year as we've had in the prior many years. We really prefer to invest our liquidity at the BDC through a new SBIC subsidiary. That way, we can really enhance earnings growth and future distributions. But we have no intention of just not being active in providing capital to small businesses. We're very active on [spending] pools of capital in our platform, and we expect the BDC to be active, too, in the future.

Got it. And then I guess, final question. Any consideration for share repurchases?

Not right now. Good question, but not at this point. We talk to our Board about that on a quarterly basis, but not at this time.

Your next question is from the line of Kyle Joseph with Jefferies.

Congrats on the progress in terms of credit performance, as well as the delevering. So Joe, you talked about your pipeline being active. I just want to get a sense for the deals in that pipeline, how they look on spreads and terms and how that compares to kind of deals you were seeing pre-COVID.

That's a -- Kyle, that's a great question. The deals we're seeing now, it really depends some on the size. I think the largest company is $20 million plus in EBITDA and the smallest is $5-ish million of EBITDA. I will say the pricing is materially better unless there's a few industries, maybe some tech or health care, that pricing is probably about the same. But in general, pricing is better, almost double-digit first-lien yields. Sometimes we're -- a few deals we're actually getting warrants, penny warrants in the deals.

We're very excited about the pipeline that's closing, and we've already closed 2 or 3, and this is outside of the BDC. We've right closed 2 or 3 and expect to close 3 to 7 more by the end of the year or early next year. And as soon as the BDC begins investing again, which we expect that to be through a new SBIC subsidiary, it can begin co-investing in these deals immediately. And that is -- so we have an active pipeline, all first-lien, some equity co-invest, some warrants, penny warrants. So it's a very good pipeline right now that's in the lower middle market.

Got it. Very helpful. And then I guess a question for Steve. Obviously, your NII has been choppy. There's a lot going on. There's a pandemic and everything. But just in terms of modeling going forward, ex kind of the deployments through the SBIC, is this a decent run rate in terms of the NII right now? Are there some headwinds or tailwinds you'd highlight versus the level we saw in the third quarter?

I think that's a reasonable run rate, taking all things into consideration. We've got some portfolio companies that are performing very well. It depends on whether we get taken out or not, you know, debt repaid. So I think from a modeling standpoint, that's a reasonable assumption in the short term. But again, longer term, as Joe mentioned, the real growth in NII comes when we can access some of that lower-cost capital and invest that money in the [longer] market.

Got it. Very helpful. And nice work to turning it around.

There are no further questions.

Thank you, everyone, for your time today. I'm sure everyone's watching the news. It's one of those interesting days. But we're here all day. Please contact us with any further questions, and we'll be here watching the news and working hard for you. Thank you for your participation thank you for your participation.

Thank you for your participation. This concludes today's conference call. You may now disconnect.