Capitala Finance Corp.'s Chairman and Chief Executive Officer, Joe Alala; and Chief Financial Officer and Chief Operating Officer, Steve Arnall. Capitala Finance Corporation issued a press release on May 6, 2019 with 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 sections 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, and thank you for joining us today. It is our pleasure to discuss our first quarter 2019 performance and address any questions you may have. Net investment income for the first quarter was $0.26 per share in excess of our quarterly distribution paid of $0.25 per share.

Consistent distribution coverage remains one of our highest priorities. I would also like to point out that since the IPO, we have paid $138 million in distributions and have never had a return of capital. Net asset value per share declined by approximately 2% during the quarter.

Stability and ultimately growth in net asset value per share is our highest priority. Asset quality continue to improve during the quarter. Non-accrual balances are at their lowest level since 2014 at 1.4% of the portfolio on a fair value basis.

Moreover, risk rated rebalance is currently representing 16% of the portfolio at quarter end or at their lowest level since early 2016. We continue to rebalance our investment portfolio, focusing on senior secured debt investments and reducing mezzanine and equity investments.

Since we started rebalancing in early 2016, first-lien debt investments as a percentage of the debt portfolio on a fair value basis, has increased from 45% to 69%. Mezzanine investments have decreased from 55% to 23% over the same time frame.

Our equity portfolio represents 12.8% and 20.5% of the investment portfolio on a cost and fair value basis at quarter end. During the quarter, we recognized a $5.9 million gain from the sale of our pending warrant in B&W Quality Growers, LLC.

Part of the rebalancing of our portfolio is the need to continue to monetize additional equity holdings and redeploy the proceeds into our senior secured debt investments.

By doing so we not only enhanced our net investment income and consistency of distribution coverage but we generally reduce the volatility of our NAV per share related to the higher level of equity investments. At this point, I'd like to ask Steve to provide some more color on first quarter financial results..

Thanks, Joe. Good morning and thank you for taking time to listen to our call today. Total investment income was $12.7 million during the first quarter 2019, $0.1 million higher than the first quarter of 2018.

Dividend income included a $1.3 million dividend from Nth Degree, while PIK income decreased by $0.4 million for the comparable periods, resulting from continued efforts to earn and collect cash interest as opposed to PIK. Total expenses for the first quarter 2019 were $8.5 million, an increase of $0.4 million from the first quarter of 2018.

Incentive fees increased $0.8 million for the comparable period, partially offset by lower base management fees and lower general and administrative expenses. Net investment income of $0.26 per share for the first quarter 2019 exceeded our distributions paid of $0.25 per share.

Consistent distribution coverage will always be an important measure of our performance. Net realized losses for the first quarter of 2019, totaled $5.8 million or $0.36 per share. We realized losses related to Velum Global Management, LLC $8.9 million. CableOrganizer Acquisition, LLC $1.8 million and Cedar Electronics Holding Corp.

$1 million, partially offset by a $5.9 million gain related to B&W Quality Growers. Net asset value per share was not negatively impacted by net realized losses during the quarter, as realized amounts were in line with our previously reported fair values.

The net decrease in net assets resulting from operations was $0.2 million or $0.01 per share for the first quarter of 2019 compared to a net increase of $0.1 million for the comparable period in 2018. Net assets at March 31, 2019 totaled $186.7 million or $11.61 per share, compared to $11.88 per share at December 31, 2018.

Stability in net value per share is another performance measure that will always be a priority. At March 31, 2019 we had $28.5 million in cash and cash equivalents. In addition, we had $25 million drawn and $89.5 million available on our senior secured credit facility priced at LIBOR plus 300 basis points.

During the first quarter of 2019, we prepaid all $15.7 million of SBA debentures outstanding for CapitalSouth Partners Fund II, L.P and relinquished the SBIC license. Regulatory leverage at March 31, 2019 was 0.81x compared to 0.72x at year end.

On November 1, 2018 our Board of Directors approved that the company be subject to a minimum asset coverage ratio of at least 150% to be effective as of November 1 2019. We do not anticipate a special shareholder meeting, but have begun planning for the reduced assets coverage to be effective in the fourth quarter of this year.

At March 31, 2019 our investment portfolio included 43 investments with a fair value of $455.4 million and a cost basis of $424.9 million. During the quarter, we invested $21.1 million across two new companies and seven existing portfolio companies.

Debt investments in two new companies totaled $14.2 million where first-lien structures had a weighted average yield of 11.1%. The weighted average yield on the entire debt portfolio at March 31, 2019 was 12.1%.

First lien debt investments on a fair value basis at March 31, 2019 comprised 53% of the portfolio while second lien and subordinated debt collectively represent 23.4%, equity and warrant investments represent 20.5% and our investment in Capitala Senior Loan Fund II represent 3.1%.

At quarter end we had one portfolio company on non-accrual status with a cost basis and fair value of $8.9 million and $6.5 million, respectively.

Our direct origination platform including our Dallas, Texas office opened earlier this year is focused on generating quality senior secured opportunities to satisfy the return profile of the Capitala platform including Capitala Finance Corp. At this time, we'd like to open the line for questions..

Thank you. [Operator Instructions] And our first question comes from Christopher Nolan with Ladenburg Thalmann. Please proceed..

Hi, guys.

The $1.1 million equity investment what was that related to please?.

Bear with me. These investments -- go to next question, Chris. I'll be right back to you..

No problem.

And you guys have one SBA license remaining or two? I think it's one, right?.

We have -- Chris its Joe. We have one. It is a subsidiary of the BDC and we have one that is a private fund outside the BDC..

And the private fund cannot -- its mutual exclusive for the BDC, correct?.

Yes it's not owned by the BDC correct..

Okay.

And then what's the plan -- or if you could share it -- with this SBA license for the BDC? Is that going to remain? Or is that going to pay down over time?.

Well, we currently have the SBIC 3-license in the BDC. It's active. Well as you'll see in our scheduled debt investments, it does have -- we have on the payback period, we have submitted a wind down plan to the SBA in how to retire that debt.

We're always in discussions with SBA about the new license and ability to receive a new license either within the BDC or even outside the BDC. We would prefer to keep one in the BDC. But we're in constant discussions with them. And if we ever are pursuing another one in the BDC, we will make that publicly available as soon as we can make that happen..

Got you.

So Joe, as the BDC SBA license winds down over time, what's the plan in terms of replacing that leverage?.

Well ask that question again Chris. Sorry..

Yes. What's the plan in terms of your leverage capital structure going forward? If I understood Joe correctly that the SBA license for the BDC will wind down over time. And given that you guys are guiding for higher leverage going forward just trying to get an understanding how you plan to fund it..

Well, from a leverage perspective, let me just offer this thought up to you.

We're at 0.81 at the end of the quarter, right?.

Right..

And 1.6 total leverage and the difference again being those SBA debentures. As we look at it, we understand we're on the high side of our peer group, but there are about seven BDCs that have total leverage at or about where we are.

And as we work with our bank lending group, we're still going to be mindful of how any additional leverage going forward impacts our ability to earn a dividend and deliver a stable NAV.

We’re continuing to move our portfolio more towards senior debt away from mezzanine and equity which should help support higher leverage levels which really was the intent behind this push to get this regulatory relief. And you can see the maturity of the SBA debentures in our investor presentation.

We really don't start seeing significant maturities due till -- until later in 2020 and into 2021. So it's going to be a collaborative effort as we move forward through the remainder of this year, working with our bank group and figure out how we properly consider a higher leverage amount for the company..

Great. Okay. That’s it for me. Thanks Steve. Thanks Joe..

Chris on your initial question, most of that equity was part of our investment in reliable asset management because of the main investment that we did in the first quarter. We did a first-lien investment where we coupled it with $900,000 of equity in that company..

Great. Thanks Steve..

You bet..

Thank you. And our next question comes from Ryan Lynch with KBW. Please proceed..

Hey good morning. Thanks for taking my questions. The first one, you mentioned that the realized losses this quarter were already reflected in book value via previously accrued unrealized losses taken. But if I look at the unrealized gains this quarter, it was only $1.5 million.

So that suggests that there are other unrealized losses taken across the portfolio.

Can you just talk about where those unrealized losses came from?.

Yes. Ryan, this is Steve. There's really a number of them. It's primarily -- one of them was AAE Acquisition -- was a part of that quarter-over-quarter. And we're really within the lower end of the middle market when we look at the kind of the valuation swings. We saw some equity movements up and down.

But other than AAE, it was really a lot of smaller movement that cumulatively kind of round out that difference. So we had one significant move in the rest of collectively worked pretty insignificant. And that really is related to softness in earnings..

Okay. And then on the big dividend from Nth Degree this quarter, can you just talk about what drove that company to make that big dividend? I know it's got a really nice fair value mark, and then it was actually marked up in this quarter.

So can you guys talk about what drove that dividend to be paid this quarter? And is there the potential for any more of those dividends in the future?.

Yes. This is Steve again. The company had been talking about paying a dividend probably six to nine months ago, and they were going to spread it over a number of periods. They're performing very well. I think the total distribution in the first quarter was $6 million where we got our pro rata share. And that was all out of earnings and profits.

And so, really it was just a payment to the equity holders resulting from really great performance by the company. In terms of what we're going to do in the future and future payments from them premature to even know that. But this is something that had been contemplated going back probably last summer.

And again that we're going to spread it over a several quarter time frame, but it is not being one larger payment in the first quarter this year..

Okay. And then, I know last year, maybe about a year ago, you guys talked about there were several companies who are in the process going -- equity company equity investments. These companies were in the process going to the sales process, and they looked to exit at some point.

I know you guys have done a pretty good job of reducing the equity exposure around 26% to currently around 20%, which still is fairly high at 20%.

Are you guys still looking to reduce the equity composure or composition of your portfolio? And any outlook on doing that throughout the year?.

Yeah. Ryan, this is Joe. I think if you look in our equity portfolio, it's really three, five names that are the bulk of the exposure there. The stronger ones keep getting stronger and they have become larger positions, that being Eastport and Nth Degree. Nth Degree is the one we just talked about the pay, their dividend from cash flow.

We do believe that Nth Degree will likely enter the market in the near future to try to monetize a sale of that company in some form of fashion. That's performed so well.

We just believe all the equity owners -- and which we are a minority one of those -- be at a tremendous gain in this opportunity, and we'll probably look to hit the very active M&A markets to monetize that. We do expect -- we do know bankers are talking to all of the top ones.

So they're probably going to market like we sort of forecast over the next quarter to several. One of the large holdings is actually publicly-traded. That's US Well Services. Unfortunately, the stock's down a little since IPO. They do have a plan in place to have much more awareness of the stock, and how it's differentiated from a lot of just U.S.

oil companies. This is a natural gas company. Our lockup -- sorry lockup, et cetera..

Half in May and half in November..

So a lockup does starting to expire soon. That's publicly-traded, so we can sort of follow that one. But I will say of the top five, remember, we did monetize B&W Growers last quarter. That was a top five ownership position.

So I'll say of all the top five, there is movement one being a public company that moves daily, but there's movement with those companies talking to bankers or potentially engaging bankers to pursue a monetization.

And that's really going to move the portfolio of those top five holdings versus the rest of the 15 names really don't contribute as much to the equity portfolio size as the top five names. But our goal is to have equity holdings down close to 10% of the portfolio value..

Okay. That’s helpful color. That’s all my questions. I appreciate your time today..

Thank you, Ryan..

Thank you. [Operator Instructions] Our next question comes from Ryan Carr with Jefferies. Please proceed..

Hi. Good morning, guys. This is Ryan Carr on for Kyle Joseph. Congratulations on the good quarter and meeting the dividend. So I had a question or a couple of questions on your yield. So looks like they expanded year-over-year. And I understand that the equity portion of your portfolio continues to wind down.

Can you give some color on that?.

I'd do equity and turn to the yield..

Ryan this is Joe. I'm going to start with the equity. We continue to focus on equity monetizations and rolling that into yield. If you look at our equity portfolios, really the top five names that are the bulk of that equity portfolio, that is really result of the stronger underlying small businesses getting stronger. We talked about Nth Degree.

Nth Degree paid a nice dividend from profits last quarter, which really -- is great for earnings. But if you take out the earnings -- correct me if I'm wrong Steve. If you take out the dividend, the special onetime dividend from Nth Degree, we still would have covered our earnings without that dividend, but it was nice to have that dividend.

We think the top five companies -- now one is a publicly-traded company called US Well Services. They're in market trying to get more coverage of the stock, more support for the stock. It just went public last year. The top five companies in our equity portfolio are talking and communicating with investment banking groups.

We believe there's some substantial unrealized appreciation in these equity positions. We are minority shareholders, but as a group, the shareholders we believe will seek to monetize these nicely appreciated assets in this very active M&A market.

So I do believe over the next quarter to several quarters, we should monetize a lot of these equity holdings. That way we can rotate those into first-lien debt yields and grow our earnings.

And that's really been our focus over the last few years and we do -- we're making progress slower than probably any of us would like, but we're seeing some really nice monetizations happen one last quarter B&W Quality Growers that we almost had a $6 million gain over the pending warrant. And we continue to want to monetize these.

We expect them to monetize over the next several quarters rotate that into yield and that's how we're going to grow our earnings. Steve is going to answer the yields..

Yes. If you look back over the last several quarters in the last year I mean, the yield on the total debt portfolio really is -- has changed a little bit, but it's remained relatively flat.

If you go to our website and look at the investor presentation on page 8, we list out there all of the deals that we've done for all of 2018 and the first quarter 2019. And if you look at those yields -- and that's what's keeping the portfolio -- total yield up in the 11% to 12% range.

And the deal we did in the first quarter for Reliable Asset Management at the time, we invested the money the yield was 11.2%. So we're seeing good opportunities that are senior secured and the pricing is appropriate. And it's supporting our NII, so real happy with the deal flow that we're looking at and the pricing that's coming with that.

Hopefully, that addresses your question. If you look at that page 8, it's a pretty good listing of what we've done over the last year and a quarter..

Yeah. That answers all my questions. Thank you guys..

You're welcome..

Thank you. And that concludes our Q&A session for today. I'd like to turn the call back over to Joseph Alala for closing remarks..

Thank you, operator. Thank you everyone. If you have any questions around all day, please contact us and we look forward to next quarter and providing another update at that time. Thank you..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day..