Joe Alala - Chairman and CEO Steve Arnall - CFO Jack McGlinn - COO.

Terry Ma - Barclays Mickey Schleien - Ladenburg Thalmann Vernon Plack - BB&T Capital Markets.

At this time I would like to welcome everyone to Capitala Finance Corp's Conference Call for the quarter ended September 30, 2014. All participants are in a listen-only mode. A question-and-answer session will follow the company's formal remarks.

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.capitalgroup.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, Jack McGlinn; 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 underlying assumptions are subject to numerous uncertainties and risks, including those disclosed under the Section titled Risk Factors and forward-looking statements and 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. Thank you for joining us and to go over our third quarter activity. We originated $86.7 million of gross deployments during the quarter, which resulted in $42 million of net deployment when you consider in the repayments. The weighted yield on our debt portfolio is 12.8%.

That compares to 13.4% prior quarter and I think you're seeing the trend of our 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 and we're still maintaining a very reasonable leverage ratio at the portfolio level is at 4.1X right now. The equity portfolio percentage is down to 27.5% based on the fair market value.

As we've mentioned we're trying to get that number to 20% and below and at IPO that number was at high 30%. So we're making great progress there. Our net investment income per share was 27% -- $0.27 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 and if you were 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 or 09/26/14, on October 3, announced conversion to monthly distributions and declared $0.16 per share for each of the months October, November, December. The October distribution was pain on 10/30/14.

We continue to have a robust pipeline of investment opportunities at similar yields to current levels and that's similar leverage rates at the portfolio level at current levels. We have filed an 8-K and also filed an 10-Q subsequent report and subsequent activity. Basically to date, we've invested all the proceeds from the bond offering in late June.

They're now completely invested. We did secure a revolving facility with ING. It's $50 million out of the gate and it has an accordion feature up to $150 million, that is at LIBOR plus $300 million. We did have a portfolio exit. Boot Barn had an IPO on October 30. It was on our books at fair value of about $9.2 million.

We do 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 and our fair value we had generated a 4.5 cash-on-cash return on that investment and a 76% IRR. We also exited on October 30, 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 and we've also opened an LA office.

At the beginning of the month we had very talented professional to get us some activities on the West Coast and we're very excited about that. So that will be our seventh full service offices on our direct origination platform.

And 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 10, 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 on 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 large investment phase. The 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 30, 2014, compared to $5.4 million for the same period 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 notes offering completed at the end of June and two; the lack of dividend income for the quarter. We had $0.1 million for the third quarter of this year versus $2.2 million in the same quarter last year.

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

That being said, in order to achieve our goal of covering our distributions for the 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 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 waver of $1.5 million and 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 30 of 2013.

Net realized losses were $3.1 million for the quarter ended September 30, 2014, compared to a gain 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 our realized appreciation was $0.2 million decrease for the quarter ended September 30, 2014, compared to an increase of $0.6 million last year. Our net increase and net asset resulting from operations for the third quarter 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 into September 30, 2014, again compared to $0.51 for the same period last year. Total net assets of $258.1 million of 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 rates notes outstanding, bearing interest rate of 7.13%. Lastly as announced on October 21, 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 and 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 trends we're seeing in the oveall 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 and 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 of the new investments was 11.3% bringing the overall debt portfolio to 12.8%.

We also had $44.7 million of realizations, including a full at par repayment at the 12%, $17.9 million senior loan to Worklife America. Full at par repayment of the 14% current, 2% pick 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 made a defensive buyout of the senior debt of Impresa.

This then allowed us to sell off our entire debt position to a third party where we received full value for the senior debt and a 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 are never satisfied with losses, this action allowed us to eliminate any further risk to our loan principal. On the gain side, we exit our equity investment in Take 5 Oil Change and realize 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 principal 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 third 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 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 involved in the portfolio, Joe 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 one of the epicenters of the housing and mortgage meltdown demonstrates a vigorous portfolio management and 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 regards 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. 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 comprise 16.9%.

The weighted average effective yield on our debt portfolio was 12.8% down from 13.4% and our internal weighted average risk rating 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 has 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 was only one change in non-accruals in Q3 and that was the addition of Precision Manufacturing back to the list. This is consistent with Q4 '13, but we've removed it from non-accrual 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 nonaccrual status as we continue to closely monitor the 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 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 and we're 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 and that office has already provided several new opportunities.

We're seeing 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 4X leverage range or better.

In addition, we're able to supplement our proprietary investment activity, by selectively investing some syndicated middle market deals into well established companies where we see superior risk reward characteristics. With that, I'll turn it over to Joe..

Thanks Jack. Thanks Steve and with that, operator we're ready to address any questions..

Thank you. [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 credits because we think those are providing better risk adjusted returns for us right now. And you'll definitely see a trend in the EBITDA at IPO a little bit over $8 million to $26 million now and we're able to maintain the same basically debt ratio at the portfolio level around 4X.

So we think we're sort of layering the credit cycle. We're restructuring the portfolio to reflect that reality. So we're focused on larger EBITDA companies.

Same portfolio leverage 4X you're going to sacrifice a little bit on the yield because they're larger investments and we're also moving more towards a senior sub debt mix of more senior credits in the portfolio just from where we are in the credit cycle, but we think it is the most prudent way to be investing right now and we're also continuing to focus on lowering those equity securities to -- and our goal is 20% and we think we can get there in the next quarter or two..

Okay. Great.

And can you maybe just give us some color on potential liquidity events that may be coming up?.

We 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 and 66% IRR.

We had a great one with Naples and I would say four out of our top five equity holdings are in the process of finding an exit opportunity and one of those is Boot Barn that happened and we're locked up for six months and as part of that IPO and then we've enjoyed seeing the stock appreciate since IPO and our market prior to IPO.

So that means three of the next five largest equity position in our portfolio are in discussions for a liquidity event and we do not control those. We're monitoring those actively and we feel we're confident that in the next quarter or two, those positions will monetize..

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?.

The $107 million really we've got two SBIC subsidiaries that we have to manage separately as well. So 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..

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

[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 -- the lock up ended in six months we will review that at the time. I think we're going to have some very nice equity monetizations over the next six months and I think we'll just address the situation at the time.

You maybe do full, may be 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 and we will have monetized a significant amount of our equity positions by that point in time..

Okay.

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 will be glad to talk to you one off if you would like. Basically the parent has the $80 million proceeds from the IPO and the $100 million from the bond offering. Everything else would be the SBIC subs that we can take for us one off if you would like to do that..

Okay.

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

Yes, we're looking to match the senior subordinated debt, the second liens all the way down and to the requirement to have first lien, bank loans in there. The advance rates probably started 50%. Worked themselves up to about 70%..

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

It's very flexible, but the advance rates vary. The only -- our flexible part is we've got to have a certain percentage of that foreign base needs to be first lien..

Right. And 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 on the regulatory leverage standpoint around the 0.7 to 0.8 range maximum.

If and when we can get that equity per concentrations and below 20%, I think it gives us stability to may be move up a little bit, but we were at 0.4 right now, so we've got capacity to take on additional leverage if the deal flow and the circumstances and the capital markets that our appetite, but 0.7..

But that excludes SBIC..

That excludes the SBIC. That was correct..

Okay. And 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, all our market is on….

Okay. So 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?.

No, we're just opening our seventh office and that's for our direct origination platform, that's a lot office. We currently do not have a deal flow problem. So I think we're sort of good from where we are now. We've hired a lot. We've added seven offices. We've got underwriting and for a lot of 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 and I think we're good now where we are..

Okay.

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 million to $40 million range, give or take..

Okay.

And 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 appropriately while we said in previous calls, we -- $30 to $40 million of net deployment is probably a benchmark we've established with you guys. So yes, absolutely..

Okay. Thank you..

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

We want to thank everyone for participating. Our phones are always open for future discussions if you want to call us. Our goal is definitely to as we mentioned before, is to cover our distributions from core NII and we're pursing that path and I think a bit part of that path will be to rotate all these equity positions and into yielding positions.

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

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