Joe Alala - Chairman and Chief Executive Officer Jack McGlinn - Chief Operating Officer, Treasurer, and Secretary Steve Arnall - Chief Financial Officer.

John Hecht - Jefferies Chris Kotowski - Oppenheimer Christopher Nolan - Ladenburg Thalmann Ryan Lynch - KBW Chris York - JMP Securities.

At this time, I would like to welcome everyone to Capitala Finance Corp’s Conference Call for the Quarter Ended June 30, 2017. All participations 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 Web site 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 August 07, 2017 with details of the Company's quarterly financial and operating results.

A copy of the press release is available on the Company's Web site. In addition, the Company posted a prerecord podcast of its quarterly results August 07, 2017 on its Web site.

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 flow.

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 Reports on Form 10Q. 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. We do have a new format podcast has posted yesterday reviewing the results. Today, I want to review with you some thoughts and plans as it relates to our current and future financial performance and address any questions you may have.

We are pleased with lowering our cost of capital during the quarter. We refinanced $130 million of baby bonds that were at 7.125% with two offerings; one, a $75 million five year non-call two year baby bond at 6%; and two, a $52.1 million five year convertible offering at 5.75%.

We also renewed and extended our senior secured line of credit, expanding the accordion feature to $200 million and providing for a step down rate of about 25 basis points in the facility when certain conditions are met. No new investments were made during the quarter $6.5 million in add-ons were made. The pipeline remains good.

We are cautious in underwriting as we maybe the approaching the later stages of a credit cycle. Our focus is on first-lien unitranche investments as evidenced by activity over the last 12 months. Over the last 12 months, five out of our last six new investments have been unitranche or first-lien.

Repayments and exits have provided us significant liquidity to be active in the lower middle market when we find deals that are properly priced for risk adjusted returns. We also have the liquidity to fund all Company obligations, including distributions. Management and the Board are taking a long-term view related to the distribution policy.

We will focus on NAV per share improvement in generating a return on equity that exceeds our quarterly distributions. To do this, our expanded portfolio group will work diligently to improve the performance of investment on non-accrual status.

In addition, we expect to monetize additional equity positions, generating capital gains and providing additional liquidity to reinvest into first-lien unitranche credits that provide safer yields. We added three investments to our non-accrual list during the quarter, Cedar Electronics, Print Direction, Kelly’s Transport.

At this point, I would like to turn the call over to Jack to provide a brief update for each Company currently on non-accrual status.

Jack?.

Thanks, Jim. First, I would like to review the three non-accrual companies from the prior period. On-site deal services, as discussed before, continues to be a long-term turnaround. This is placed on non-accrual back in Q3 of 2015. And we’ve been heavily active in business since we had a complete management restructuring back then.

We continue to see improvement in the business. And as mentioned in previous calls, I'm still hopeful that we can begin to recognize some current pay interest by the end of this year. American Exteriors, similarly, was placed on non-accrual in Q4 of 2015 as a long-term turnaround. It’s the relatively small investment where we get senior debt security.

The business has been stable during the year. Sierra Hamilton is a last for energy investments to be restructured. As announced as a subsequent event, via a restructuring, our first lien debt was converted into equity ownership. As of this date, Sierra is no longer on a non-accrual list.

The Company continues to improve performance in what has been a relatively stable pricing environment. We are hopeful that we’ll be able to see future appreciation of our equity position like we have with the successful restructure of US Well Services.

The three companies we’ve added the non-accrual during the second quarter are all fluid situations, involving turnaround and/or restructure activity. That being said, there is limited detail that we can provide as there’re multiple parties involved in each situation.

Cedar Electronics with June 2015 subordinated debt investment and the sponsored backed add-on acquisition. Integration issues and market softness created underperformance. While the Company preserves liquidity, our sub-debt position is on non-accrual.

We’d not foresee any changes in the situation until we have better visibility in the fourth holiday sales season. Print Direction, one of the investment that dates back to 2005, the commercial printing industry continues to be very competitive and the market has become commoditized.

As mentioned on our private call, the Company has been experiencing customer attrition and that issue recently escalated. We have a process of restructuring the business and transforming it to more of a marketing services provider, but this will be a long-term effort. Kelly’s Transport was a March 2014 investment where we are in a first lien position.

Overcapacity in the U.S. transportation industry, during the last year, has created softness in operating results. And the Company has been working to right-size the business. During this effort, we are being supported in preserving liquidity and we are hopeful that performance will improve moving into 2018.

On the positive side, we realized a strong $4.5 million gain on our MJC Holdings exit, and continue to see appreciation in many of our equity investments, including Eastport, Nth Degree, Burgaflex, LGS -- LJS, Burke, and as previously mentioned, our restructured equity position in US Well Services.

And with that, operator, we open the line up for questions..

[Operator Instructions] And our first question comes from John Hecht of Jefferies. Your line is now open..

I guess first question and you highlighted onsite American Exterior and then Sierra Hamilton as companies that you're turning around. I’m wondering with onsite American Exterior, they’re no longer on non-accrual.

How much, I guess, interest will you be able to accrue from those in the second part of this year? And with Sierra Hamilton, is there any chance for equity -- distributions to the equity level? What I’m really looking at, I guess, is you bridge yourself back to being able to support your dividend.

How much liquidity do you guys think you need to deploy at what types of rates? And then what type of improvement on your NPA performance do you need to get before you’re comfortable that you can carry your dividend?.

And so, John, those three companies that you mentioned are still on non-accrual. I think you said that are off non-accrual, but they are….

No, I think it was -- the commentary was that there’s some sort of light at the end of the tunnel that they may go off of non-accrual in….

Again, on onsite, I’m hopeful that by the end of the year that we will be able to restart receiving some interest and that’s going to have to ramp up over time. So I don’t also think it will be a meaningful contributor. It will not be -- I don’t refract it won’t be a meaningful contributor to Q4 income.

And then as we get it started again, if we can, that will ramp up over 2018. I can’t tell you the extent of that. American Exteriors is such a small investment that even if we turned on the interest there, it won’t be real meaningful.

And then Sierra Hamilton, correctly, is not on non-accrual as of today, it was at the end of the quarter but that is a -- it's being converted to an equity position. I don’t foresee any equity distributions on that that will be an appreciation and we’ll probably exit before we see meaningful distributions out of that.

So does that help you with those?.

It helps though. So I guess the second part of the question is, maybe you could conceptually bridge us back, and you do have quite a bit of liquidity borrowing capacity. Should we just think about this as a situation where you’re going to focus on working through the non-performing assets, but don’t expect any yield on those.

And therefore, the way you get to get back to covering the dividend is going to be deployment of excess capital here?.

John, this is Steve. As it relates to NII, near term, NII will not cover distribution and that’s mainly due to the drag associated with all the liquidity that you referenced and through the impact of these non-accrual loans in the next few quarters.

We’re taking a long-term view to rebuild NII; one, we are concerned about where we are on the credit cycle and the diminishing number of quality, and I emphasize quality number of deals for consideration; two, our unwillingness to chase yield in that regard; three, our expectation to realize additional equity monetizations that we can be -- that can be redeployed into debt securities; and four, we have intentions to equitize an additional SBIC license at some point in the future.

And fortunately, our liquidity position does give us the opportunity to accomplish all those goals. But again, we're taking a long-term view here, in the near-term NII will not cover the distribution..

Your next question comes from Chris Kotowski of Oppenheimer. Your line is now open..

I guess, as you look at the non-accruals, is the issue more softness in the economy or kind of pervasive weakness or is it -- that it was just the nature of the industry is that their investing in that that these are all somehow secularly challenged companies?.

Each one is unique, and how it goes about. I’ve been having gone through several cycles now, in my professional career, I feel that right now larger companies are reaching for growth and that is impacting some of our lower middle market companies as they do that.

But again each one has unique, as I mentioned; with Cedar there were some integration issues on an acquisition; Kelly’s, the transportation industry had a cyclically down year; Amazon, has been affecting that market. So there’re specific things, at this point I would say, there is increased competition from larger entities, but each one is unique..

And I guess what could you -- can you say anything about the rest of the portfolio and how you feel about the asset quality among the other names? Are there any situations that we should be particularly attuned to?.

I don’t think rather than just looking through our valuations that would indicate and we continue to monitor all the companies in the portfolio, and they are all lower and middle market companies that experience issues from time-to-time. So there’re always ups and downs and we keep close eye on them.

And that’s what we went through with some of the non-accrual this period where there were plans in place to improve the profitability or operations of the business. There was indicated sponsor support to back that and in some cases, the sponsor backed out of their commitment to move things forward.

And then the debt has to strangely take steps to support the business and move it forward more than equity add-on. So sometimes we expect to see companies improve, based on our plan and that plan doesn’t materialize and we don’t get the equity support that we though we’re going to get and it can quickly change.

So that’s subway to deal with on a daily basis. And again, we’ve moved through many cycles and we’ll fight through it again..

Thank you. And your next question comes from Christopher Nolan of Ladenburg Thalmann. Your line is now open..

Well, the increase in -- mostly related to AAE acquisition LLC?.

That’s correct, yes..

And then it was part of the unrealized depreciation charge just a true-up for NAV offsetting the realized gain?.

Can you ask that again, Chris, I am having hard time hearing you?.

Yes, the unrealized depreciation charge of $9.1 million, was part of that just a true up for NAV to offset the realized gain?.

That’s correct..

Okay..

Yes, MJC Holdings, at least $4 million of it..

And then the decrease in the portfolio volume. Should we see this as a continuing trend given the comments that we are like DNA cyclical downturn, so you guys might be holding back in terms of your portfolio deployment.

Should we expect lately from the second half of the year for investment portfolio volumes to decrease?.

We still have very active pipeline. We have moved more to a first lien unitranche focus out of the last 60 deals have been in that structure. We are active on -- we still find some quality deals. We are active and we were issuing term sheets in that unitranche first-lien space, sometimes we’re beaten on pricing.

So we are not sacrificing too much as far as really starts on structure versus pricing, but sometimes we’re actually loosing on pricing that we just can’t compete with. We are not pursuing unsecured loans, mezzanine loans that are out there.

There are many in our pipeline but we are choosing not to participate in those loans, even though they’re yielding 10% to 12%, sometimes 13%, is because the structure in the market now, on a consistent basis, is those security positions are behind three, four sometimes even five turns of senior leverage above them.

And we’re choosing not to participate in those structures. We do expect to close several more deals this year they will be in the first-lien unitranche type structure. But we are being very cautious in what we are pursuing, really focused on structure over pricing.

But there is a point where the pricing is so low that we, as BDC, cannot pursue it and it make sense. So that’s sort of where we are. We still have six full service offices. We have eight full service originators. We’re seeing a lot of deals. We’re just being very cautious.

And we’re spending a lot of time and have added a lot of resources to the portfolio side of the business. We really believe focusing on that can really improve our NAV and contribute to NII over the next near term..

Final question is, I estimate on a cost basis, your non-accruals are roughly 14% to 15% of the total portfolio value.

Is business start affecting your advanced rate for your bank revolver?.

Not at this time, no. Good question..

Thank you. And our next question comes from Doug Greener [indiscernible]. Your line is now open..

Can you just give us some more color on the pipelines for new investments? And what I am really trying to understand is, you don't want to chase yield, have bit of caution over credit quality. There is just several more quarters of lack of activity. What’s the plan for all the liquidity? Thanks..

Get it back to pipeline. We do have an active pipeline. We are focused on the first-lien unitranche. We do have internal rates that we want to hit. We're not going to peruse an L-S 50 unitranche that’s just product that we cannot go out and compete, and it cover cost to capital.

But there are definitely first-lien unitranches and where we can get on our blended structure rate and security 8.5% to 11.5%. We are pursuing those. We expect to close more of those this calendar year. What we don’t want to do is to chase a structure that has too much inherent risk in it.

And definitely do not want to get into trouble credit this late in the credit cycle. So we're choosing to be very liquid. Liquidity gives you many options. We do still have a lot of nice positive events in the portfolio. We still have over $54 million of appreciated equity positions. And the larger ones are getting stronger.

To Jack's point, the companies are doing well are doing very well, and those equity positions are appreciating. So we just don’t want to be so short-term focused that we try to force a yield into a structure that does not make sense that’s why we continue talk about risk adjusted pricing.

And I think Steve want to answer to more questions about your liquidity -- what else we would do to liquidity. That was a pipeline answer.

What was the second part of your question, Doug?.

Just if what the plan is for liquidity if the first lien activity is just, like we saw this quarter for several quarters?.

Well, I mean to Joe’s point on the deal flow, I think that was a good answer there from rest of liquidity, as noted. We’ve paid down the line. So we’ve got capacity on our line and reduced liquidity to do that subsequent to quarter end.

And as I mentioned earlier, we do have a desire equitize an additional SBIC license, if and when that gets moved forward..

Thank you. And our next question comes from Ryan Lynch of KWB. Your line is open..

My first question just has to do with the dividend. In the past, you have to waive incentive fees in order to support the dividend at its current level. This quarter, there was no incentive fee earned. I'm not sure if there’s going to be much incentive fees earned over the next couple of quarters.

But are you guys still committed to waiving an incentive fees to the extent necessary to support the dividend at the current level? And when I look at the current dividend level, with the NAV decline this quarter, that’s about 10.4% dividend yield, return.

Is it 10.4% dividend yield, is that a reasonable return that we should expect you guys to be able to generate in today's environment?.

Let me cover the dividend, first, if I may. As you know, we announced our distributions that are approved by the Board, the first day of each calendar quarter. So we're in the middle of Q3 and that was announced in early July. Our next announcement will be in early October for the fourth quarter of '17.

I think it’d be inappropriate for me to really give you any guidance on any future levels of distributions. However, I’ll tell you, we're taking a long-term view as Joe mentioned in his opening, relative to our distribution policy with our Board.

And the focus is really on rebuilding NAV and generating a return on equity in excess of the distributions. As it relates to the waiver, I’ll let Joe comment on that because it really falls back on manager..

As far as waive, we’ve waived million since we first announced it early 2016. We always want to look at the waiver as an alignment vehicle but we also need to realize that you have to have a cohesive team to address some issues. So we did experienced some slight professionals in ’15 and ’16 when we began waiving fees.

We have recently, over the past few months, re-staffed six to seven people that we just announced last week or two. And we actually have plans to add more to the portfolio side. So we will always look at the waiver in sort of a best interest mindset.

But sometimes the best interest is to commit more resources to maybe the portfolio and doing things that’s going to grow NAV and ultimately grow earnings versus waiving fees and been short-term focus. So we’ll look at it. But like you said, we didn’t have any fee to waive this quarter. But we’ll look it at on a quarter-by-quarter basis.

But ultimately, we got to make a decision on what is the best use of our limited resources and how is that ultimately going to affect our NAV and our earnings, because you don’t want to be short sighted there..

And then going back to the specific dividend, I don’t expect you to comment I guess on future dividend. But I mean, if you just look at, from an earnings standpoint, that’s a 10.4% yield that you guys had to generate from an NII perspective.

So in today’s environment with compressing spreads you guys moving up to unitranche loans, as well as the credit issues.

I mean can you -- is it reasonable to expect Capitala to generate 10.4% earnings, NII earnings yield, going forward?.

I thing I’m going to go back to my earlier answer regarding NII that we’re really taking a longer term view here. Well, your question makes sense. And I am inclined to say yes. But again, we’re taking a longer term view here and we’re trying to tackle this in several phases which is prudent investing with the liquidity.

I think, if we have some patience there, I think we can find good deals that will provide the yields to support what you just said. But we’re not going to chase yields to do that.

And I think having some more monetizations of equity and providing additional liquidity again turning the equity security into a yielding debt security, all these things collectively get us back to what you’re asking is, can we earn that coverage through NII, I think the longer term answer is, yes. This is going to take some time..

And then moving to just the underwriting process and maybe even portfolio management. I mean, in the past, maybe two years ago, call it, some of the credit issues were primarily surrounding energy investment as you look at the current non-accruals today, is a pretty wide variety of mix of different industries.

And Jack you talked about there are couple, maybe one-off type events that resulted in these individual companies going on non-accrual. But if you step back and look at several different investments in several different industries on non-accrual today.

So I just wanted to have you guys give some commentary on, are there any changes that you guys are internally reviewing about the investment process that can help prevent some of these non-accruals, going forward? I know you guys hired, I think, six new folks a month ago or so, so any commentary or color if you can provide on the investment process.

How you guys are internally looking at that, given the current non-accrual situation, any improvements you guys are looking to make to that?.

I'm going to answer the first part and then Jack to the second part. The first part is, and this goes back to your comment on fee waiver. It is always unintended consequence of sometimes pursuing what you think is a right action.

When we begin waive of fees, we did lose significant loss of professionals in both underwriting and portfolio that mainly occurs in the '15 through when we start hiring again last December. So we did have a drain of talent, a lot of people that had underwritten some deals, were no longer at the firm.

So we have overhauled our entire investment process from underwriting to, which is involved of active portfolio management. And we did that and we beefed-up all the thresholds that we just announced. And we've changed all our internal processes. And big part of the change we have add bodies to it to make it work which we have done.

But we have basically changed all of our processes, improved and added the bodies to and then committed the resources to them.

And with that, what would you add to that Jack?.

Yes, there are specific things in underwriting that we're highly attuned to. Again, you alluded this to some of the oil and gas deals. So we're much more concerned about any kind of commodity pricing risk as we go forward.

We will reduce the total amount of investment that we do in anyone deal, which has been an issue in at least two of the deals we’ve done in the past. So there are couple of things, specifically, that we're looking at and have been built into underwriting. So we won’t go down those.

But again, we're dealing with small or middle market companies and we're dealing with the economy that through different periods and we held on to a company that sold lumber in South Florida for five, six years and had a positive return, return of all our capital in a equity gain on it, because we were patient in support of the business.

And sometimes it's not pretty on a quarter-by-quarter basis, but this is what we do for living. There are small businesses and you have to drive the ups and the downs with them. So again, I would say more than those we are very actively engaged at a management level really and some of these are activity participating to improve the business.

So it's very hands-on focus and that's why you see a lot of the equity appreciation. Sometimes there is some risk involved in these things and sometimes it pays-off and other times, we have to work hard for our money..

And then just one small question. You mentioned moving to some more first lien unitranche loans in the quarter. And I know you said you're doing some of the lower yielding unitranche plus 500-ish loans.

Just curious what sort of pricing are you guys seeing in the first lien unitranche deals that you guys are actually putting in your book today?.

This is Joe, and what’s unique is we do have a very robust pipeline of activity. If you look at that the unitranche first lien loan we’ve done over the past 12 months, they’ve all been double digit yields, even when we did earlier this year, actually that warrant was attached to it.

I expect the current pipeline that will still be double digit yields in the unitranche first lien that’s not maybe high 9s, but those opportunities are out there. And it’s just -- you got to look harder for them, you got to make sure the structure is right. Again, we’re not sacrificing structure for pricing.

But I think we can achieve that 9% to 11% pricing in the first line unitranche product and we do believe that we’re in the later stages of a credit cycle. And as you know, when the credit cycle does reset, it rests fairly quickly. And then I believe the pricing environment and the structure environment get substantially better.

And we want to make sure we do have liquidity from when that happens. So that’s really -- we’re focused on maintaining high level liquidity, focus on quality deals, focus on enhancing the non-performing investments. So we’re focused on the right things.

We just got to execute, and I think, we ultimately can grow NAV and ultimately can have NII cover our distribution. It just going to take some time..

Thank you. And our next question comes from Chris York of JMP Securities. Your line is now open..

Most of them have been asked.

But how should investors reconcile your comments about an objective of stabilizing NAV with your comments, that over the near term, that investment income more [Indiscernible] the dividend?.

Well, I think the question was have you addressed NAV and when you foresee the short-term, NII not covering distributions. I think we’re looking at a long-term rising on this. And also, we do have substantial equity positions that can be monetized.

And we do expect that those monetizations and recycled into yield that’s how we get back to NII covering the distribution. But we have about $100 million of equity securities with $50 million so of that being appreciated. The top positions continue to appreciate, because their underlying names are performing very strong.

And also, if we fix these non-performing sell those, monetized those and put those into yields. That’s really, when you look at on a long-term basis, we get there. It’s just on a short term basis -- we’re not going to have the NII to cover the distribution..

And then thinking about how the stock may behave today, where it was trading as of yesterday’s close.

How are you thinking about buyback of shares today given that you do have low leverage?.

We’ve talked about that internally. And I think for now, it’s our desire to invest our liquidity into debt and to equity; again, to help improve NAV per share and to help rebuild NII; again, through debt investments and then the equity investments help into appreciate NAV. So that’s our short-term focus.

We’ll continue to revisit that internally as the markets speak, if you will, but that’s where we are right now..

And then may be Jack last one here from me. It appears you made an add-on investment to AAE. And then you’ve already talked about the rate that was adjusted from cash to cash to PIKs.

So may be just comments about the performance of this investment?.

That was a -- we did a partial recapitalization to support that business. They’ve been through a market downturn in the prior year in the Gulf area, it was a very slow economy last year, slowest the country. The Company has been stable, but needed some support largely in regards to the asset valuations of the business.

And again, without getting into too much detail, it needed some capital support. We have an opportunity to provide that. We got a nice equity upside by providing that in what has been a pretty stable business as things improve.

So that’s just some support that we are providing to the business, and we think we got a nice potential upside out of providing that..

Thank you. And I'm showing no further questions at this time. I would like to turn the conference back over to Joe Alala for any closing remarks..

Thank you, everyone for your time. We are around all day if you want to contact us directly. Thank you..

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