Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to Stellus Capital Investment Corporation’s Conference Call to Report Second Quarter 2018 Results. At this time, all participants have been placed on a listen-only mode.

The call will be opened for a question-and-answer session following the speakers’ remarks. This conference is being recorded, today, Wednesday, August 8, 2018. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Mr. Ladd, you may begin your conference, sir..

Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2018. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements, as well as an overview of our financial information..

Thank you, Rob. I would like to remind everyone that today’s call is being recorded. Please note that this call is the property of Stellus Capital Investment Corporation, and that any unauthorized broadcast of this call in any form is strictly prohibited.

Audio replay of the call will be available by using the telephone number and PIN provided in our press release announcing this call. I’d also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information.

Today’s conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these projections. We will not update our forward-looking statements, unless required by law.

To obtain copies of our latest SEC filings, please visit our website at www.stelluscapital.com under the Stellus Capital Investment Corporation link or call us at 713-292-5400. At this time, I would like to turn the call back over to our Chief Executive Officer, Rob Ladd..

First, portfolio, including asset quality; second, operating results; and lastly, outlook. We had solid portfolio growth during the second quarter of $68 million net of repayments. We ended the quarter with an investment portfolio at fair value of approximately $500 million.

During the quarter, we made $97 million of investments, at par in five new and four existing portfolio companies. The five new investments total $81.8 million at par value and 94% are first lien and have a weighted average yield of 11.2%. All the loans are at floating rates.

We had five repayments totaling $23.1 million and $7 million of amortization and other repayments. With respect to asset quality, it’s stable at a 2 on our investment rating system or on plan. Only 8% of the portfolio is marked at investment category of 3 or below.

In total, we have three loans on nonaccrual which are $6.3 million combined, representing 1.3% of fair value of the total loan portfolio. We continue to maintain good diversification with the largest industry sector at 12% of the total, which is software.

The average investment per company is approximately $9.6 million and the largest investment is $28.9 million, both at fair value. Finally, our portfolio continues to be weighted towards secured lending at floating rates. To this end, at June 30th, 90% of our loans were secured and 91% were priced at floating rates.

Also, 51 of the 52 portfolio companies are backed by a private equity firm. Now, I’ll turn the call over to Todd to discuss our operating results..

Thank you, Rob. We generate $0.33 per share of core NII during the quarter which was short of covering the dividend by just the $175,000. GAAP NII was $0.30 per share and included a capital gains incentive fee accrual of $522,000 or $0.03 per share.

This quarter, we adopted a new non-GAAP measure, entitled core NII per share, which is GAAP NII excluding any capital gains and incentive fee accrual. This accrual is an above the line expense related to below the line income.

Because unrealized gains are considered in calculating accrual but are excluded in determining whether it can be paid, it’s uncertain whether this fee will be paid. It’s important to note that continued improvement in asset values, both realized and unrealized is what necessitated the capital gains incentive fee accrual.

Life-to-date through June 30, 2018, on a combined basis, we have generated net gains, both realized and unrealized of $2.6 million. We also generated a realized gain of $1.1 million or $0.07 per share during the quarter, resulting in realized income on a GAAP basis of $0.36 per share, more than covering the $0.34 per share dividend for the quarter.

Finally, net asset value increased $0.14 per share during the quarter from $13.93 to $14.07, primarily due to the realized gain and appreciation on our portfolio. With that I’ll turn it back over to Rob to discuss the outlook..

Thank you, Todd. For the balance sheet of the third quarter, this is what we know. In July, we had a gain of $2.8 million on the realization on equity investment and also a $100,000 prepayment fee from a loan that recently paid off.

While activity is difficult to predict, we are expecting investments of between 20 and $40 million, and repayments in the same range during the remainder of the quarter, which would imply we’d be relatively flat.

Last quarter, I reported that our investment growth for the year-end was to get to $500 million of investment portfolio, which we of course reached by the end of the second quarter.

Given where we are now and the new leverage limits which I’ll discuss next, we are targeting to the end the year with a portfolio of between $520 million and $540 million.

Lastly, I would like to update you on the steps we have taken related to the recently passed legislation that allows BDCs to operate with greater leverage, increasing the regulatory cap from 1:1 to 2:1.

As you know, on June 28th, our shareholders approved an increase to 2:1 leverage and on August 2nd, our bank facility was amended to do decrease the asset coverage covenant to a 175%, which is the equivalent of allowing 1.33:1 leverage. In addition, we increased the size of our bank facility to $180 million from $140 million.

Our Board and we as management believe this increased leverage capacity is very positive for our shareholders, as I reported in our last quarter’s call. We plan to use the increased leverage moderately. Initially, it will allow us to operate at 1:1 leverage instead of the 0.7 to 0.821 where we’ve been operating.

This, along with the increased credit facility should allow us to grow our investment portfolio to approximately $600 million. With that, we will open it up for questions. Thank you..

[Operator Instructions] Our question comes from Christopher Nolan with Landenburg Thalmann..

Hey, Rob, on your comments just now, the 1:1 new leverage ratio target, if I heard you correctly, does that exclude SBA loans?.

Yes, it does..

And Todd, can you give us an operating expense run rate for the second half of the year? That might be helpful..

Sure. Yes, I would say, operating expenses we think are going to hold relatively stable for the remainder of the year. If you look at the next two quarters -- this quarter was a little bit light on evaluation fees and not a large number, but over the remainder of the year that will even out over the rest of year.

So, when I say operating expense, I’m also excluding interest expense, which has obviously been increased to the extent that we increased the portfolio. But, that would be my guess. I think, they’ll be relatively flat over the remainder of the year, similar to what they were in the first quarter..

Great. Final question on Abrasive Products & Equipment, which is one of your new nonaccruals, which is roughly $5 million cost.

Can you give a little update in terms of any resolution you might think about that?.

Yes. So, Chris, we typically don’t talk about private companies for reasons of their own privacy and where they operate in the marketplace. But, this is a company that is owned by a substantial private equity firm. And our expectation is that it’s -- should be marked properly and that ultimately we would expect a positive outcome.

And it was placed on nonaccrual because the interest was blocked by the first lien lenders..

Okay.

So, the interest was blocked by the first lien lenders, if I heard you correctly?.

Correct..

Thank you. Our next question comes from Robert Dodd with Raymond James..

Hi, guys. Some kind of housekeeping ones first and then, a big one. Just on that Abrasive Products, it’s in the Q marked as nonaccrual as of March 29th, but if I look at Q last quarter, it was about as nonaccrual then at March 31st.

So, what changed that? And was any income from that one couple of days reversed out this quarter?.

Yes. So, I think, it is effective April 1st, but because of loan repricing on March 29th, that’s the data. And so that would have been a small reversal..

Okay, got it. And then on nonaccruals, Grupo Hima, looking at footnotes, Grupo Hima is marked nonaccrual. Obviously Abrasive Products is marked as nonaccrual. What’s the third one. I can’t find it in the footnote..

Yes. It’s a company called Wise Products where we have a solid structure. Yes, I think it’s $500,000 or $600,000 fair value..

Got it. And then, last housekeeping one, what is the undistributed taxable income, i.e. spillover number, not the undistributed NII from the equity schedule but the taxable spillover..

So, at 12/31, our spillover was $435,000 I think, something along those lines. So, not a lot..

Last question, obviously looking at the Good Source Solutions, obviously excellent quarter in terms of deployments. That one pretty big loan, $28.5 million.

I mean, can you give us some color on -- what’s your target hold size because that one is -- your average exposure you gave, it’s much below that, concentrated positions just regardless of the quality of the company that you are lending do elevate some risk somewhat.

So, can you give us some color on what -- would we expect more large deals, or what’s kind of the view on how that’s going to be structured, particularly as the leverage goes up..

So, I think you should expect that our largest hold position has been where it’s been historically which is in the low 20s. This company is particularly, we had already been involved in the financing and were involved in its sale and refinancing, if you will, so a company we knew well, very well capitalized.

But I would say that it would be our expectation that we would have position sizes that would be in the low 20s, not in the high 20s. And as an example, you may see that position gets smaller with time. But we were there to get it closed at the time and over time we will be sizing positions like that to be smaller..

Our next question comes from Chris Kotowski with Oppenheimer..

I was just wondering, you mentioned the renegotiation of the bank facility.

And I was just wondering are the terms or rate different or was there a give-up for the banks accepting the higher level of leverage?.

Yes, Chris. So, the banks, our bank group is very supportive. And we actually brought in an additional bank as part of the group and some of the banks upsize. So, very supportive. There was really no additional cost related to the amendment of the -- we paid a fee for the increased commitment which is relatively modest.

There is one feature of the facility which I believe we have in the press release. So, the interest rate changed or stayed the same at LBOR plus 250. But if leverage for a quarter -- at the end of the quarter was at 1.1 or higher, then the spread would be from 250 to 275 for that following quarter.

So, no cost for the change, meaningful cost and very supportive group. But again, the covenant is 1.33:1, and so not largely higher. And I think the whole theme here was to allow the Company to operate at the 1:1 level..

And the trigger is at over 1:1, just on the incremental amount it goes to 275?.

No, it’s if the leverage in total was 1.1 or higher, not….

Oh, then it all goes to 275?.

Then, it would be the entire facility. That’s correct..

At this time, we have no other questioners in the queue. So, I’ll turn it back to Mr. Ladd for closing comments..

Okay, very good. Thank you, David, and thanks everyone for your support. We’ll look forward to speaking with you again November to cover the third quarter..

Ladies and gentlemen that concludes today’s presentation. You may disconnect your phone lines and thank you for joining us today..