Stellus Capital Investment's (SCM) CEO Robert Ladd on Q2 2014 Results - Earnings Call Transcript

Aug.13.14 | About: Stellus Capital (SCM)

Stellus Capital Investment Corporation (NYSE:SCM)

Q2 2014 Earnings Conference Call

August 12, 2014 11:00 AM ET

Executives

Robert Ladd – Chairman, President and Chief Executive Officer

Todd Huskinson – Chief Financial Officer, Secretary and Treasurer

Analysts

Robert Dodd – Raymond James & Associates, Inc.

Greg Mason – Keefe, Bruyette & Woods, Inc.

Operator

Good morning, ladies and gentlemen, and thank you for standing-by. At this time I would like to welcome everyone to Stellus Capital Investment Corporation's Conference Call to report Second Quarter 2014 Financial Results.

At this time, all participants have been placed on a listen-only mode. The call will be opened for a question-and-answer session following the speakers' remarks. The conference is being recorded today, Tuesday, August 12, 2014.

And it is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Mr. Ladd, you may begin your conference.

Robert Ladd

Okay. Thank you, Joe. Good morning, everyone and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2014. Joining me this morning is Todd Huskinson, our Chief Financial Officer who will cover important information about forward-looking statements, as well as an overview of our financial information.

Todd Huskinson

Thank you, Rob. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of Stellus Capital Investment Corporation and any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and pin provided in our press release announcing this call.

I’d also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today’s conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these projections.

We will not update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.stelluscapital.com under the Stellus Capital Investment Corporation link or call us at 713-292-5400.

At this time, I’d like to turn the call back over to our Chief Executive Officer, Rob Ladd.

Robert Ladd

Thank you, Todd. We're pleased to report a number of accomplishments during the quarter that improved the company's capital position. As we previously reported, on June 20, we received a license to operate an SBIC. Since that time, we've received a commitment from the SBA the amount of $32.5 million.

We issued $25 million of 6.5% unsecured bonds. The proceeds of which were used to reduce the outstanding amount under our credit facility, which allowed us to contribute loans in cash of the SBIC's regulatory capital.

We established an at-the-market equity capital program, under which we issued approximately $3.3 million of common equity during the [Technical Difficulty] exercise the accordian feature of our credit facility which increase the size of the facility from $135 million to $150 million.

Our pipeline is active. We're seeing a number of interesting opportunities. Nevertheless, our origination activity during the second quarter was modest. We made $11 million in investments in one new portfolio company and follow-on for four existing portfolio companies.

During the same period we received $25.9 million of repayments in sales of investments of which about $300,000 represents amortization on existing loans. This activity brought our portfolio down to $281 million as of June 30, from $297 million at March 31. At this point I like to share some information about our investment portfolio. As of June 30, we had 27 portfolio companies with total investment of approximately $281 million, the debt portfolio makes up almost all of the total.

The weighted average yield on the debt portfolio was approximately 10.9% at June 30, up from 10.7% as of March 30. From a risk rating perspective, our weighted average rating is slightly above two, which means performing as expected on a one to five scale. 24 or 90% of our investments are rated at two, two are rated at three, and one rated at four.

We have one non-accrual loan of – during the quarter, which represents approximately 3% of our loan portfolio at fair-value. And 23 of the 27 companies in the portfolio are backed by traditional private equity sponsor.

As previously stated we remain focused on meeting our goals which are one, generating sufficient income to cover our dividends, two, maintaining high asset quality, and three, selectively growing the portfolio in a diversified manner.

With that I'll turn it over to Todd to cover the financial results.

Todd Huskinson

Thanks, Rob. Our total investment income for the quarter was $8 million, most of which was interest income. Operating expenses totaled $4.3 million for the quarter and consistent with base management fees of $1.3 million and incentive fees of $900,000. Fees and expenses related to our borrowings of $1.4 million, including commitment and other loan fees. Administrative expenses of $300,000 and other expenses of $400,000.

Net investment income for the quarter was $3.7 million or $0.31 per share. Net increase in net assets from operations totaled $2.7 million or $0.22 per share. As of June 30, 2014 our portfolio included approximately 18% first lien debt, 36% second lien debt, 43% mezzanine debt and 3% equity investments at fair value.

Our debt portfolio consisted of 47% fixed rate loans and 53% floating rate investments. Our average portfolio company investment was approximately $10.4 million. And our largest portfolio company investment was approximately $22.3 million.

Additional information regarding the composition of our portfolio is included in the MD&A section of our 10-Q that was filed yesterday morning. With respect to liquidity at June 30, 2014, we had $91 million borrowed into our credit facility and $87 million borrowed into that facility as of August 1, 2014.

Our unsecured bonds had carrying value $25 million, which matures on April 30, 2019. Since June 30, we made one follow-on investment. On June 31, 2014, we invested $2 million in a mezzanine debt and $137,000 in the common stock of SQAD, which brings the investment portfolio to approximately $283 million and average investment per company to $10.5 million as of August 1, 2014.

And with that I will turn the call back over to Rob.

Robert Ladd

Thank you, Todd. And Joe, you may begin the question-and-answer session please.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) We'll move along to our first question from Alison [Technical Difficulty].

Unidentified Analyst

Hey, good morning, guys. Just a quick question on how you're thinking about the – using the available capital that you have – the at-the-market program and the SBA leverage. (inaudible) that $32.5 million commitment and kind of how you're thinking about using that kind of growth going forward in the next few quarters?

Robert Ladd

Sure, Alison. So, with respect to the ATM program or the at-the-market equity program, we do intend to use it, utilize it over time. We're sensitive about the price that we would net to the company. As you may recall, we do have authority again for this year to issue equity below an EV. And but we're sensitive that that price would ideally not really be meaningfully below an EV.

And I think that beauty of those programs is to [Technical Difficulty] fits into the capital needs versus a one-time issue which is more than you might need at that time.

With respect to the SBIC debentures and leverage, we do have authority to use $32.5 million that we mentioned previously, and of course, the loans need to fit under the SBIC guidelines or SBA guidelines, but we certainly have access to the $32.5 million that I mentioned previously. And we view that for the moment as the way to grow the portfolio in total. We're nearly fully invested as a business with respect to the non-SBIC portfolio so this is a way for us to grow the portfolio in total and without raising additional meaningful equity, that (inaudible).

Unidentified Analyst

Great, thanks. And just one follow-on; do you have exemptive relief that's going to allow you to not include the leverage gained in the SBIC under your total leverage ratio?

Robert Ladd

Yes, we expect to the notice period was – of yesterday, so something no one made a comment. We would expect to receive that authority as early as today.

Unidentified Analyst

Great. Thanks very much.

Robert Ladd

Yes, thank you.

Operator

And we'll move along to our next question from Robert Dodd with Raymond James.

Robert Dodd – Raymond James & Associates, Inc.

Hi, guys. On the pipeline, obviously, you characterized that as active and then obviously the amount deployments in Q2 were not that large. I mean, can you give us anymore color on that type of – and are you seeing cycle stretch out since it is taking longer to close, or is it, when the pipeline works through the process more and getting turned down either because of the terms of credit quality or can you just give us a little bit more color on the intersection between active versus your order deployments, what was the process?

Robert Ladd

Yes, sure. Carriages, what I've said that the pipeline is robust, let’s say much more or so now or less few weeks than it was coming into the second quarter – during the second quarter. If you look back for – to the fourth quarter of last year, the first quarter of this year, and the second quarter of this year, our total originations added about – I'm sorry, average is about $30 million per quarter.

So, I think, we have a little bit of skewing what was happening – so I think, I look at it over a longer period of time, so we're on a reasonable pace of, again, on average $30 million of gross originations per quarter. Then, in particular right now, our pipeline is quite active, which is what I meant to refer to you as we in this quarter and we're looking towards the fourth quarter.

So we're seeing, again, these are a little bit lumpy in the cycle that we've not seen a meaningful change in the business, lot of M&A activity, which drives most of what we're doing. And we were cautiously optimistic for the number of things in the works that we'll be able to continue to close deals, both in the end of this quarter as well as more into the fourth quarter.

Robert Dodd – Raymond James & Associates, Inc.

Okay. And just kind of the follow-up on that, actually you said, on the average origination is about – so the average repayments for the (inaudible) of the same three quarters is about $20 million, a little bit higher than that in Q2 and Q1, fell down in Q4. I mean, is that average of $20 million repayments called $10 million net portfolio, is that kind of the ballpark you would expect to see in the long run quarter-over-quarter, obviously it varies a lot, but..

Robert Ladd

Yes, so good question. So I think, in the second quarter we had indicated, we knew one company that was being sold and the amount of that was just $10 million. There was another sale that happened for a long that we have was $12.5 million, it was not expected.

So just as a foreshadowing for the current quarter, we do not know of any payoffs and don’t know any payoffs in the fourth quarter, but again, we can be surprised as we've been in the past. So I would expect the payoffs to probably be less frequent, less in amount, and I would expect therefore the gross originations to be probably closer to $20 million net, if not higher per quarter. And then Robert, I would just qualify that with, again, at the BDC level, nearly fully invested.

As you look at leverage at the BDC level, targeting about 0.7 or so to one leverage. And so, the growth from here will come more to the SBIC entity, where with exemptive relief we can take the leverage sales of business up to 1:1 in total, so again, that's kind of a key to the growth from here without raising meaningful additional equity.

Robert Dodd – Raymond James & Associates, Inc.

Got it. And then if I can have one more on that to kind of – in the SBIC type assets, typically especially your mix for – again, on that numbers, how much senior we would expect to see somewhat higher yields of coupons for the type of assets that typically qualify for that vehicle. I mean, is that fair to say that that’s what you're looking at, or would you be focusing more on senior, the SBIC probably slightly higher your coupons, but….

Robert Ladd

Yes. So, I think, in terms of rate expectation, as you look over what we've been closing more recently, the yields have been, at least, this is for the portfolio in general have been, at least, that the average yield that we show as the portfolio levels. And I think that’s right that typically companies that would fit under the small business or small enterprise definition could have slightly higher yields.

The portfolio that's in there currently is about on average of what we have as a portfolio in total. But I think that that’s right. It could be slightly higher in the SBIC in terms of yields, and maybe a better way to say it is overall, we think that the yield that we have is a portfolio that's likely to stay, is to be stable, and it could be slightly higher.

Robert Dodd – Raymond James & Associates, Inc.

Okay. Thank you very much.

Robert Ladd

Thank you, Rob.

Operator

(Operator Instructions) Question from Greg Mason with KBW.

Greg Mason – Keefe, Bruyette & Woods, Inc.

Great. Good morning, everyone. First, since the SBIC is kind of the growth capital here for your business, what percentage of your forward pipeline can fit into that even if not exact percentage, how is that splitting into the SBIC?

Robert Ladd

Sure. And I think, Greg, it may be a better way to describe it is that for us it would be – more predictive would be that of the direct originations we've had kind of like today at SBIC or SCMs ticker symbol. Roughly 40% of what we've been doing would fit, now this is before we have the license.

So, I would say, 30% to 50% of what we're looking at can fit and the pipeline that we're looking at there are certainly number of deals that do fit. So an odd [ph] matter, perhaps, which one is close. So I think beginning of this week certainly are seeing opportunities that will fit into SBIC.

Greg Mason – Keefe, Bruyette & Woods, Inc.

Okay, great. And as – talk about one of your goals is covering a dividend, I think, last quarter, the – with the fee waiver stopping this year, you talked about that you would kind of consider the year on a full basis and potentially ways, these aren’t necessary to cover the dividend. Just curious if your thoughts have changed any, as you’ve seen some of the developments this quarter?

Robert Ladd

Yes, so no change in our approach with respect to the incentive fee. The one thing I may have mentioned before is, we think it’s reasonable to include realized gains in that calculation, because those typically for us are along we paid off or pays off early that otherwise would have been interest income above the one. But with that footnote, we expect you to maintain that approach. And as an example, for the first quarter, although we were entitled to 887, we paid ourselves 475.

Greg Mason – Keefe, Bruyette & Woods, Inc.

Got it, great. That does it. Thank you.

Robert Ladd

Okay. Thank you, Greg.

Operator

(Operator Instructions) And at this time, we have no further questions.

Robert Ladd

Okay. Thank you, Joe. We'll wrap up the call and, again, thank you, everyone, for being on the call. We'll look forward to speaking with you in about 90 days.

Operator

That concludes today's conference. We thank you for your participation.

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