At this time, I would like to welcome everyone to Capitala Finance Corp Conference Call for the Quarter Ended September 30, 2019. 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; and Chief Financial Officer and Chief Operating Officer, Steve Arnall. Capitala Finance Corporation issued a press release on November 4, 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 the 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, 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 undertake 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, everyone. I'd like to offer a few comments related to our third quarter results. Discuss some recent developments just at end of the quarter and then turn it over to Steve to provide more insight into the quarter and then we will address any questions you may have.

Net investment income $0.18 per share. Net asset value per share $9.40. As we look at the risk in our portfolio at September 30, 2019, a couple of observations. We currently have two credits with a risk rate of three and on a fair value basis are 6.9% of the total portfolios. The lowest level since our IPO in 2013.

Non accrual balances on the fair value basis totaled $15.8 million or 4.3% of the total portfolio. Our portfolio team continues to actively manage the entire portfolio focusing on reduction and watch loan credits. Since we changed our investment strategy in 2016, the BDC has invested approximately $331 million in debt investments.

80% of which were first lien structures, all of which are performing as expected. We continue to rebalance our investment portfolio focusing on senior secured debt investments and reducing mezzanine and equity investments. First lien debt investments represent 59% of the portfolio at September 30, 2019, compared to 36% at March 31, 2016.

We are confident that this strategy long-term will produce a more stable net investment income in support of quarterly distributions and ultimately a superior return on equity. Our equity portfolio represents 14.7% and 21% of the investment portfolio on a cost and fair value basis at quarter end.

Part of the rebalancing of our portfolio is the need to continue to monetize additional equity holdings and redeploy the cash proceeds into senior secured debt investments. We anticipate a significant reduction in our equity investment by the end of the year.

Platform liquidity will allow the platform including CPTA to be active investors in the lower-middle market. We have several deals under terms and expect to close them prior to an end of the year. Subsequent to quarter end, we have had several announcements that I would like to address.

First, we hired an additional Business Development Officer based in Charlotte, excited to have Chris join us. Second, we are in the market for additional resources across our platform as we prepare to be active investors in the lower-middle market. We expect to hire many professionals across the platform over the next several months.

Lastly, we announced recently a strategic partnership with the Mitsui USA where they have purchased a minority non-controlling interest in the management company. This is a significant milestone for the platform and will benefit the BDC.

Mitsui will provide the firm with substantial resources for growth of our credit and equity strategies, including Capitala Finance Corp. At this point, I would like to ask Steve to provide some additional color on financial results..

Thanks Joe. Good morning and thank you for participating in our call today. Total investment income was $10.1 million during the third quarter of 2019; $1.4 million lower than the third quarter of 2018.

Interest and fee income declined by $2.2 million for the comparable periods, resulting from a decrease in our investment portfolio, as well as the impact of two new non-accrual investments.

Dividend income for the third quarter of 2019 totaled $1.2 million and included $0.3 million distribution from Capitala Senior Loan Fund -II, as well as $0.8 million for Micro Precision, LLC. Total expenses for the third quarter of 2019 were $7.1 million, a decrease of $0.5 million from the third quarter of 2018.

Interest and financing expenses decreased by $0.2 million, while base management fees declined by $0.3 million. Net investment income of $0.18 per share for the third quarter of 2019 was below the $0.25 of distributions paid. Consistent distribution and coverage will always be an important measure of our performance.

Since IPO, however, we have paid cumulative regular distributions of $138 million and never had a return of capital. Net unrealized depreciation totaled $1.3 million or $0.08 per share for the third quarter of 2019, compared to depreciation of $22 million for the comparable period in 2018.

The net increase in net assets resulting from operations totaled $1.7 million or $0.11 per share for the third quarter of 2019, compared to a net decrease of $11.9 million for the comparable period in 2018. Net assets at the September 30th, 2019 totaled $151.9 million or $9.40 per share, compared to $11.88 per share at December 31st, 2018.

At September 30th, 2019, we had $62.8 million in cash and cash equivalents. In addition, we had zero drawn and $114.5 million available on our senior secured credit facility priced at LIBOR plus 300 basis points. Regulatory leverage in September 30th, 2019 was 0.84 compared to 0.72 at December 31st, 2018.

On November 1st, 2018, our Board of Directors approved that the company be subject to a minimum asset covered ratio of at least 150% to be effective as of November 1st, 2019, so that change is now effective.

We're in the final stages of amending our senior secured credit facility and will publicly announce the amended line once the process is complete. At September 30th, 2019, our investment portfolio included 40 investments with the fair value of $371.4 million in a cost basis of $359.6 million.

During the third quarter, we invested $13.9 million across two companies, two new companies and four existing portfolio companies, all of the investments were debt 95% of which were first lien.

The weighted average yield and the new debt investments during the quarter was 10.6%, while the weighted average yield of the entire debt portfolio at September 30th, 2019 was 11.5 %. First lien debt investments on a fair value basis at September 30th, 2019 comprised 59.3% the portfolio.

While second lien and subordinated debt collectively represented 16.0%, equity and warrant investments represented 21%, and our investment in Capitala Senior Loan Fund II represented 3.7%.

Please refer to our third quarter or investment update, investor update on our website for additional information regarding the trends in our portfolio composition since we change our investment strategy back in early 2016.

At quarter end, we have four portfolio companies on non accrual status with the cost basis and fair value basis of $25.8 million and $15.8 million respectively. During the quarter, the subordinated debt investment in [Biology] Incorporated and the first lien debt for CableOrganizer Acquisition, LLC were placed on non accrual.

Our direct origination platform is focused on generating quality senior secured opportunities to satisfy the return profile of the Capitala platform including Capitala Finance Corp and we expect several deals currently under terms to close prior to year end. At this point, we'd like to open it up for questions..

[Operator Instructions] Our first question will come from the line of Christopher Nolan with Ladenburg Thalmann. Your line is open. Please go ahead..

Hey, guys.

What's the leverage outlook for the next couple of quarters given you have now past the one-year mark?.

Chris, this is Steve. Until we get our line finalized and announced, I'm hesitant to give guidance. I think we're 0.84 at the end of September. Now that we've got a little bit of runway room there we will be very thoughtful as we use our line to fund new deals. But I am hesitant to give you a guide until we get that finalized and announced..

But do you think it will increase?.

Possibly so yes from a regulatory perspective..

Okay and then on capital structure, most your capital right now is fixed rate given the change in the yield curve.

Any changes, any thoughts in terms of how the capital structure might change?.

In the short term, no. I think as we look at potentially looking at SBIC subsidiaries down the road, we may look at repaying some of those debentures. But in the short term, I don't see any change in the make up the capital structure now..

Finally, on Mitsui, what's resources for growth are they providing, the external manager?.

This is Joe. Yes, the resource is basically working capital at the manager level.

We own a significant acquisition of talent now of hiring people which we've already hired one business development person last month and we're in the market for six to ten professionals over the next few months to keep continued building out the investment team of the firm with this working capital investment..

Our next question comes from the line of Kyle Joseph with Jefferies. Your line is open. Please go ahead. .

Good morning, guys. Thanks for taking my questions. Just wanted to get your sense on yield in the context of your new set or not really-- not new anymore, but your or senior focused strategy and combine that with where rates are.

What sort of pressures are you seeing?.

Well, I would say on the yield side, it's definitely and even in the lower middle market where we operate. You've seen a compression over the last quarters on sort of first lien or unitranche lending.

What we have done to sort of enhance that and formed this senior loan fund where we can bifurcate our own unitranche directly originated loans and sort of blend up our yield through the JV that we've have in place with Kemper.

So that's how we've addressed some of the yield compression but we have definitely seen in the lower middle market some yield compression over the last several quarters, especially on equity sponsor activity. But as you know, we do both non sponsor and equity sponsor activity.

The compression has not been that bad on the non sponsor lending that we participate in. And also I would say even though there has been yield compression, we're still able to get to the nice structures. So there hasn't been sort of lasting structure over those quarters to correlate with the lowering of the yields.

So we're still finding good structures but the yields are lower. And we're -- the best way we've been able to own balance sheet effect that is through our JV that we formed..

Got it, that's good color, thanks, Joe.

Next question for me, we saw --it sounds like two investments go on non accrual, I believe those are legacy strategy investments, but just stepping back wanted to get your sense of the broader portfolio and how things are performing and how that compares to three months ago or a year ago and essentially to get your sense of where --how the economy is doing?.

Yes. This is Steve, Kyle. I think if you look at where we are at September 30th, one of the key measure works we try to share with everybody is where our risk grade-three investments which are kind of the watch loans.

And we had one upgraded to it to, through this period board reflects -- in September we have two investments that are risk graded three and it's just the lowest, that's the lowest point we've had since we went public back in 2013. So we feel like from that perspective that's a good metric.

While we've got four investments on non-accrual, I think the portfolio groups actively working on all of those.

And I think there's --there will be some resolution to those prior to year-end and we'll just share that with you and that becomes appropriate, but it certainly feels like from a risk profile perspective, the portfolio is in a much better spot, metric really worse been over the past several quarters and even several years.

And that's a byproduct of what Joe mentioned, the investments that we've made the $330 million of debt investments we've made since we changed our strategy that our first lien generally first lien in nature are performing as expected. So that's that trends probably through the rest of the portfolio.

And we'll just continue to work through these legacy positions as you mentioned. And it's just taking longer than we thought, but it feels like we're in a much better spot than we've been in previous periods..

Thank you. And it looks like we have follow up question from the line of Christopher Nolan with Ladenburg Thalmann. Your line is open. Please go ahead..

What percentage of the debt portfolio is floating currently?.

60%.

And on the comment that you guys had in terms of a major realization in the fourth quarter, major equity position I mean any color you can provide on that? Will there be an 8-K that goes out before the end of the quarter? I mean anything you can say on that..

Yes. Good question, Chris. I know you'd appreciate we can't comment on that as it's end market but clearly when that transaction takes place we will follow a press release, possibility 8-K to announce that, yes, for sure..

Thank you and I am showing no further questions at this time. And I would like to turn the conference back over to Joe Alala for any further remarks. End of Q&A.

Thank you everybody for your time today. Steve and I and Kevin are here all day. If you want to call with any follow up questions. And we look forward to hearing from you. Have a great day. .

Ladies and gentlemen, this concludes today's conference. Thank you for participating. And you may all disconnect..