Joseph B. Alala - Chairman, President & Chief Executive Officer Stephen A. Arnall - Chief Financial Officer John F. McGlinn - Chief Operating Officer, Secretary & Treasurer.

Terry Ma - Barclays Capital, Inc. Vernon Chester Plack - BB&T Capital Markets Mickey M. Schleien - Ladenburg Thalmann & Co., Inc. (Broker) Christopher Nolan - MLV & Co. LLC Chris J. York - JMP Securities LLC Greg M. Mason - Keefe, Bruyette & Woods, Inc..

At this time, I would like to welcome everyone to the Capitala Finance Corp. Conference Call for the Quarter Ended March 31, 2015. 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.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; Chief Operating Officer, Treasurer and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall. Capitala Finance Corp 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 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 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. Thank you 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 portfolio company level from Q1 debt investments was 1.8x, leverage on the aggregate entire portfolio as of 3/31 is 3.7x that is compared to 3.8x at year-end.

And 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. I think this demonstrates our strong direct origination platform.

The majority of the deals we've been reviewing in closing are non-sponsor 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 has 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 per 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.

This subsequent activity 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'd 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 through our website providing additional details about the company, the investment portfolio and other financial-related trends.

Now, I'd 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 the first quarter of 2015, total investment income was $14 million, an increase of $1.6 million in 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 2015 were $9.2 million, compared to $6.7 million last year.

The increase is attributed to, one, an increase in interest and financing fees of $2.4 million related to the notes offering in June of 2014.

Two, an increase of $1.5 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 in 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 investment activity in a 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 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 zero at December 31, 2014.

The net change in unrealized depreciation 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 the quarter.

Net increase in net assets resulting from operations during the first quarter of 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 asset 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 this 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 a $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. With a yield on debt investments was 13.3% which helped to raise our overall debt portfolio yield to 12.6%.

Significant activity included a $20 million subordinated debt investment in the B&W Quality Growers at a 14% cash rate along with warrant participation, a $15 million senior secured term debt investment into Portrait Innovations at a 12% cash rate, a $50 million senior secured debt investment into Community Choice Financial at floating rate of LIBOR 100 plus 13%, the $10 million investment into 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 Investments that included the repayment of the $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 3x cash on cash.

There was $4 million from the sale of the Boot Barn stock and $12 million repayment of 12% subordinated debt from A Wireless. As of the end of the fourth quarter, the Capitala portfolio consists of 54 companies with a fair market value $518.9 million on a cost basis of $484 million.

Senior debt investments represent 35% of the portfolio, senior subordinated debt 45%, Senior Liquid Loan Fund 2%, and equity warrant value of 18%. On a cost basis equity investments comprised 11.1%.

The 18% equity composition is half of what it represented at the time of IPO, so we're 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 costs at quarter end, slightly lower than the 89.5% at year-end.

All of five investments continue to be current on their interest payments. In regards of marketing conditions we've 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. Thanks, Steve. And with that, operator, we are ready to address questions..

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

Hey, guys.

Can you give is a little color in the Senior Liquid Loan Fund? What type of return or yield you're targeting in that vehicle and also how big you intend to grow that?.

Yeah, Terry. This is Joe. Right now, we've 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's fully deployed. And just to make sure, this a Senior Liquid Loan Fund.

These assets have multiple quotes, highly liquid and quoted at the end of each close of business day, and we've hired a very talented portfolio manager from Apollo to manage that for us, and we expect no more than 20% allocation to this type activity from equity, but we're very far from that right now..

Got it.

And how soon do you the leverage – capital and leverage to be fully deployed in that?.

Related to the offering, we would hope that we could invest the proceeds we're operating in one to two quarter. From a leverage standpoint, we've 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 facilities 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. I think 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'll provide much more disclosure on that in our June 30 10-Q because we have assets, too, within the fund itself..

Okay, got it. That's it from me, thanks..

Thanks Terry..

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

Thanks very much.

And looking at the yield on new investments for the quarter, 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. We are having non-sponsor activity and where you're not – in some of these deals, there's not even investment bank involved so we're 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'm not sure that we were able to produce this at this level with so much senior debt and such low portfolio leverage at under 2x on a consistent basis.

I think this is just a – we will have orders where our direct originations will produce these results. But it is hard to find senior secured debts with 61%, meaning senior secured at 13.3% rate and under 2x 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're earning these yields by our direct originations sourcing proprietary deals that are non-bank and non-equity sponsor..

Okay, great. And 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?.

Yeah, good question. The way we're looking at 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's the first quarter we've actually earned an incentive fee since the second quarter of last year related to the notes offering, that's over $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 timeframe at proper risk-adjusted pricing. Rest assured that management is focused on this metric and it's a high priority internally. So beyond that, I'm 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..

Yeah. Good morning, Joe and Steve. I just wanted to back up and ask you about the broader market. 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'm wondering what your sort of 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?.

I think 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're finding a lot of opportunities. And I think 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 sort of 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?.

Yeah. That's a great question. So at IPO, our average EBITDA was right around $9 million..

Yeah..

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're 3.7x now through our debt.

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

Okay, that's great. And 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's been – at the portfolio level, it's been pretty solid. There is some efforts in some of the portfolio companies to continue to refinance with low price senior debt, but that's not unusual. Again, there hasn't been a big change from quarter-to-quarter..

And any thoughts on opportunities in the oil and gas world given where we're at with oil today?.

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

Okay. Thanks for your time..

Thank you, Mickey..

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

Hi, guys.

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

1.75-ish..

And, Steve, are you guys planning to do....

And so from....

I'm sorry, what's that?.

From a regulatory standpoint, we'll probably stay in the 0.75x range, which were at 0.54x at the end of the quarter. But from a total standpoint we're shortly of north of 1x..

Great.

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

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

Great.

And then in terms of growing the SLF, I know you had earlier questions on this, but what is the pace of growing the equity investments 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'll 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're talking about taking your $10 million investment and possibly increasing it to $20 million by the third quarter..

Yeah exactly..

Great. Okay, thanks for taking my questions..

Thanks, Chris..

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

Good morning guys and thanks for taking my questions. So you've done a good job exiting some of your equity positions over the last couple quarters.

In terms of 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. I think 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%..

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

Got it. Sure.

And then in terms of your position with Boot Barn, do you expect to exit this position when the lockup expires this quarter?.

Our lockup expires at end of the quarter. We have some activity in the portfolio and we'll sort of make that decision at the time, but it's nice to have a net 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 sort of taxable situation and make the sort of – 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 out from that, too..

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

Well, as you know, I'm very involved in SBIA and this is the first time that the same parties control both sides of Congress. And I think the word, and I've asking about it, that best describes it is encouraging. Now, things in Congress is always hard but encouraging is the word that would increase the limit from $225 million to $350 million.

We're 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 from me. Thanks, guys..

All right. Thank you..

Thank you. 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 dividend.

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 can be a meaningful driver of getting the NII up?.

Several of our equity positions have been in the portfolio for a period of time that make them close to a monetization, and I do think we'll have additional capital gains. The hard thing is these are private companies and the deal 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 and with that, we could blend it of further special dividends and recycling into more yield..

Okay, great. And 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 of company non-sponsored deal in those local markets, the bank is probably the primarily 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?.

So what we're seeing is sometimes the bank is in the deal. They're bringing us in the deal as a lending bank, not an investment bank. So we have a structure, a really nice sort of crafted solution for the transition and getting our pricing.

Other times, we're sourcing these deals not even from a bank, maybe from a law firm or an accounting firm or something direct. There is no investment bank involved or no sponsor involved, so we're able to get sort of above-market pricing on those opportunities.

And I think having these seven offices is enabling 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 over the last – even more so over the last quarters. So I think we've all seen a lot of transactions that have fallen apart and re-trading on pricing.

I think we have good reputation out there for getting deals done 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..

And we're still seeing more 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 Jennis (29:31) who's 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've 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 the monetization category?.

These opportunities, and we're looking at the page you're referring to, I think the most important thing is last – the quarter prior to Q1 is our largest investment listed on this page didn't monetize. These companies – or we'll typically not see an IPO for the majority of these companies for an exit.

They will typically be arranged third-party sales and we are aware when these companies through our involvement have entered negotiations or have hired an investment bank to pursue alternatives.

And with that, we do think a lot of this portfolio we'll 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 in the fair value, that these companies have – 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.

So, I do think several more of these will be candidates to monetize in 2015, and 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 exists to really both recycle the equity into yield and pay maybe additional special dividend..

Okay.

And just 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 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?.

Yeah. I think we've 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've seen some real good progress from our new management team there.

I think for SSCR, we're entering the peak of the Suntan Lotion season and the early results there have been encouraging. So again, I think our efforts there and the management teams that we've invested in is paying off and we've seen some stability. They definitely remain on the watch list and we continue to support them.

But I think for the most part, we're encouraged in the performance..

Okay. How about Market E's? You indicated the largest investor at 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?.

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

Okay.

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

There's been – that was almost entirely a government contracting business when we first got into it and they had several contracts that they were operating under. Those have now rolled off.

And because of the situation with the government and just kind of 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 kind of rotate out of their government business and into their commercial business, so we 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 won't say it's troubled; it's a shift in strategy and it's going to take some time..

Okay. Thank you..

Thank you..

Thank you..

Thank you. I am 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 show on our website. It has a lot more detail about the activity and feel free to use that. But thank you everyone and 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..