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 2019 Results. At this time, all participants have been placed on a listen-only mode.

The call will be open for a question-and-answer session following the speakers’ remarks. This conference is being recorded today, Friday, August 9, 2019. 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..

Okay. Thank you, Cody. Good morning, everyone and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2019. 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 would 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 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 Public Investors 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..

Thank you, Todd. We will begin by discussing our operating results followed by a review of the portfolio, which will include asset quality and then we will talk about the outlook. Todd will cover operating results first..

Thank you, Rob. We are pleased to report another quarter of solid earnings which we generated realized income of $0.43 per share, including gains of $2.7 million or $0.14 per share, which exceeded our $0.34 per share dividend by $0.09.

GAAP and core net investment income are both $0.29 per share which was short of our distributions for the quarter by $0.05. It’s important to note that this was our first full of dividends after our secondary offering of 2.9 million shares that was completed in March.

Total realized income year-to-date includes $12.9 million of realized gains at $1.29 per share which exceeds our distributions of $0.68 per share for the same period. Net asset value increased $2.3 million over the quarter primarily due to the issuance of underwriters’ over-allotment in April for our secondary offering in March.

Net asset value per share decreased slightly from $14.32 to $14.29. With that, I will turn it back over to Rob..

Okay, thank you, Todd. I would like to cover the following areas, portfolio and asset quality and outlook. With respect to the portfolio and asset quality, we ended the quarter with an investment portfolio at fair value at $531.1 million across 57 portfolio companies.

During the second quarter, we invested $50 million in par value in 4 new and 3 existing portfolio companies and received $37 million of repayments and realizations.

Our portfolio continues to be weighted towards secured lending and floating rates at June 30, 95% of loans were secured, of which 70% were first lien and 91% were priced at floating rates. This move to more senior lending is resulting in lower coupons. However, we expect it will also result in stronger asset quality over time.

We continue to maintain good diversification with the largest industry sector at approximately 17% of the total portfolio. Our average investment per company is $9.4 million and our largest investment is $22.6 million both of those figures are at fair value. 52 of the 55 companies are backed by a private equity firm.

81% of our total investment portfolio is rated at a category of 2 or better, which means on plan or ahead of plan. We did have one loan go on non-accrual during the quarter, which now results in 4 loans on non-accrual, which comprised 4.8% of the fair value of our total portfolio. This is up from about 1.7% in the prior quarter.

We do not believe this is an ongoing trend at this time and in fact, one older non-accrual may come off during the third quarter. Now, turning to outlook, as we discussed on last quarter’s call and is reflected in our current yield, we are expecting lower overall yield in the loan portfolio.

This is driven by lower LIBOR which you have seen and a continued rotation to first lien unitranche type loans. Since quarter end, we funded $33.9 million or debt at par in two new portfolio companies.

We have identified a likely fundings of approximately $40 million to $50 million over the balance of the quarter and expect potential repayments of approximately $30 million during the same period. As we have mentioned in our last few calls, part of our strategy has been to invest in the equity of our portfolio company’s in a modest way.

In order to generate realized gains. As the business has matured over the last six and half years we began to see somewhat regular realized gains from our portfolio effecting 2017 we generated $4.6 million in such gains. In 2018 we had $5.3 million of such gains. And as Todd has reported earlier thus far in 2019 we generated $12.9 million of gains.

And we are also aware that we may have an additional $7 million of potential gains by the balance of this calendar year. As a result of these realized gains we believe it is likely now that the dividends paid from August forward will be characterized as long-term capital gains for tax purposes. And with that I will open it up for questions.

Thank you and Cody please open up the Q&A session..

Absolutely. [Operator Instructions] We will take our first question from Robert Dodd with Raymond James. Please go ahead..

Hi, guys. A couple of questions on the non-accrual side and I appreciate you cover – don’t think as a trend, but one, Protect America, obviously you put it on non-accrual I think June 28 you said towards the end of the quarter.

So, can I assume first contributed a full quarter of income and was then placed on non-accrual? And then I guess the question it’s one of your second lien was the non-accrual event a result of blocking, I mean, you still got a single end that you got it marked it at 85, which looks pretty healthy.

So, what’s – can you give us anymore color about precisely how that came apart with – came to play out whether it was a material deterioration of the business, in which case the marks looks on the lot versus the structure that led to the non-accrual..

Yes, Robert for sure. So, let me Todd and I will cover that together. So with respect to the company, of course this is a privately held company, so we are careful about what we discuss, but I would say that there was some activity that would have caused us to think that it was certainly a better rated loan and that activity changed.

We don’t think the fundamentals of the company have deteriorated. With respect to interest for the quarter, there was a partial payment, but the majority of the interest was not accrued in the quarter..

Okay, got it..

That’s what led to the pricing on non-accrual..

Got it. Just trying to scoop on that second, then either comment about that one of your older non-accruals may come back in the third quarter, I was going to presume that probably means we fact optical since its marked pretty basically at cost now and it’s been improving over the last couple of quarters.

Is there any particular trend that’s leading to that, I mean obviously it’s been worked through over a period of time and we have seen that go through, but is there any particular trigger that still needs to happen for that to go on back on to accrual?.

So, I would say as a general matter would either be the improvement through the payment of interest or would be the payoff of the loan..

Okay, got it. Thank you. Yes, fair enough.

When we look at the portfolio as a whole, can you give us any obviously, it’s been kind of the theme this quarter concerns and I think that’s been not your profile especially and there has been a mixed message from BDC, some seeing EBITDA slowing on average in portfolio company some seeing growth stable and can you give us any kind of what you are seeing purely maybe on the accruing side of the portfolio survey?.

Yes, it’s a good question Robert. So one of the things we would look at is question of procession it is kind of a national recession coming or has it started to occur so we are not seeing that in the portfolio companies we would say that which is true been true for a number of years now that if we have a problem it’s company specific.

So we are not seeing that trend downward in EBITDAs of the portfolio companies. So in fact year-over-year coming in the first quarter which we be measuring the calendar year it is actually up and I think our best estimate for the so far this year is flat extra up so not any big not seeing any concerns in the portfolio it is a general matter..

Got it, got it. Appreciate it.

And then as the subsequent events as you said if you deployed 33 I think you've had not any repayments yet any call have you had any call saying you going to get repaid or anything like that any indication about repayments in the third quarter?.

Sure, sure.

So the number that I have expressed is approximately $30 million which we think is likely we that would be best estimate always could be more those we would think more likely than not and in terms of the funding I think the same but it is always the case repayments end up being more sudden then the new funding but we think again those are best estimates 40 to 50 on new funding and 30ish million on repayments..

Got it. I appreciate it and that’s all my questions. Thanks..

Yes, thank you Robert..

Thank you. We will now take our next question from Christopher Nolan with Ladenburg Thalmann..

Good morning Chris..

Hi Rob.

Rob, Protect America I assume that’s roughly $0.02 a share per quarter is that right?.

Yes, Chris let me just calculate it here..

Okay.

And then on a follow-up on to Robert’s question on Refac is it correct that the fair value of the credit actually went up quarter-over-quarter I thought I saw that between looking – comparing the queues, please go ahead?.

Yes, no that’s correct. And that would hopefully be a reflection of what we think the outcome is..

Okay.

So, on the face of it I mean that could be a harbinger to a positive resolution for Refac?.

Yes..

Okay, great.

Going forward giving everything that you are seeing we are seeing [indiscernible] that is I am seeing portfolio deterioration in multiple BDC it’s not isolated SCM how are you guys planning in terms of incremental investments and given that you have a low leverage ratio going forward I mean is it all going to first lien or what’s the thoughts around that?.

Yes. So, first of all with respect to our portfolio, we don’t think there has been a material deterioration in fact as an example there is we know the risk grade 3 is likely to come off in the third quarter to risk grade two. So we connect this Protect Americas like a delta shift, but I think it’s one company hopefully that’s helpful.

We report if we have otherwise in the third quarter, but that’s our view for now. In terms of what’s informing our investing going forward, so Chris there is lot of concerns about it. Global economy is slowing which can impact U.S.

companies and Chris, we are more likely than not insulated from that we approach our investing and always have us to the companies we invest in survival recession and so what are the characteristics of those companies that could survive a recession so that’s the lens we always had.

I would say it’s a general matter we are probably more cautious than we have been if you go back 6 months so we are having more cautious lens that’s so our rotation to more secured and now 70% first thing which is the highest percentage we had in the portfolio would be indicative of that the new fundings we are looking at in this quarter, I think all but one is the first lien.

So, I think that’s another approach we take. You may recall that last year we didn’t approve a couple of robust environment and couple of deals we thought might be impacted by the trade situation this is early before there was a consensus. So again I think of this as approaching the market cautiously.

Having said that, when we find a good company its being well capitalized by a high-quality owner and it’s well structured we are interested, so we remain active in the market and that’s of course why we have an interest in pipeline that I reported on earlier..

I appreciate that..

Yes, Chris, one thing going back to your question about the impact to Protect America, Todd is going to respond on that..

Yes, so Chris, you are right, it’s a little over $0.02 a share so, $475,000 a quarter which is about $0.25 a share. .

Thanks Todd. I guess sort of my final thing would be as we are going into the sort of choppy economic period, how well positioned do you think the PE sponsors of many of these companies are to inject more capital to backstop these companies if things get choppy economically.

From your perspective, are the private equity firms sort of fully deployed or they have plateaued, what is your sense there please?.

Yes, Chris, it might be helpful in terms of how we approach that. And then I think the answer as a general matter is going to be company-specific. So, as we approach new investment, we are one assuming that it’s a high-quality owner and in our case those are mostly private equity firms, those capable investors.

Second thing we look at is the status, what’s their fund size, where are they in the fund life, what’s the dry powder so that’s part of the calculus we use.

So, it doesn’t mean we didn’t fund the last investment in front, but we are also mindful of that very good sponsors that we work with also retain dry powder regardless of their investing pace to support portfolio companies. And so we would expect that to be the case and with all the firms we deal with.

And so again I think in terms of where their fund life is and dry powder just a function of where they are in that lifecycle of the fund, but people that we work with have that mentality and we would expect and we have seen historically that’s very much the case.

So this is of course the benefit of providing capital to well-capitalized and smart private equity investors and so going through a period that we might go through this is very helpful..

Great. Okay, thank you for the color. That’s it for me..

Thank you..

Thank you. We will move on to our next question from Ryan Lynch with KBW..

Hey, good morning. Thanks for taking my questions.

Just have two of them – just wanted a clarification, you said you are expecting about $40 million to $50 million on investments over the balance of the third quarter, you guys have already done $34 million quarter-to-date, so is that saying that you guys are actually expecting $70 million to $80 million for the full third quarter?.

Good morning, Ryan. Yes, that’s correct..

Okay. And then just one more sort of clarification, I believe you said there could be $7 million potential realized gains that you guys could hope to achieve through the remainder of the year.

One did I get that number correct and two, those $7 million of potential realized gains, are those already reflected in the fair values of those investments today meaning to say you actually become realized or actually no change in book value, those gains would just now be crystallized or is that potential upside to the fair value of any of those investments today?.

Yes, Ryan. So first of all you are correct that’s what we said about $7 million. And I would say that not all of that is reflected in the current marks and partly because one of the opportunities has come up since the books have closed effectively.

So I think one we are accretive to now and to of course they will be realized which means that we'll book them as such..

Okay that’s all for me this morning. Appreciate your time..

Yes, thank you Ryan..

Thank you. We will take our next question from Chris Kotowski with Oppenheimer & Company.

Yes, good morning.

Your income tax expense $340,000 is kind of unusually high what is the explanation for that? And what should we factor in kind of going forward?.

Yes, excuse me Chris this is Todd So the primary thing is driving that as is excise tax so we had $9 million of spillover little over $9 million of spillover income at the end of 2018 and so we are now accruing excise tax on that during the year..

So that will be a quarterly run rate as long as you have that level of spillover..

Yes, some of it was accrued from prior period so I would say think about $9 million as 4% so for the year that’s about $400,000 of total excise tax for the year so some what like going forward..

And accounting question why do you approve it all in one quarter and why in the second quarter is that a seasonal or a tax year thing should one forward going forward just expected through the year or?.

Yes no it’s just an accrual for product for prior year’s spillover. So it is just larger than normal but will be accruing the amount related to the current spillover on a quarterly basis going forward so that’s why was larger in the quarter..

Okay.

So did one should some of that goes down to 75,000 to 100,000 something like that?.

Yes, that’s right..

Okay, that’s it for me. Thank you..

Thank you..

Thank you. We will now take a follow up from Robert Dodd with Raymond James..

Actually Chris just asked most of my question but when we look – as we look at in the 2020, you had $9 million of spillover obviously the M18 right now looking at 19 with obviously the M18 right now looking at 19 with over realized gains that you could be looking at ballpark $20 million in realized gains totaled this year, which obviously flow in a spillover and left that in blockers etcetera, so what also realized gains that have occurred so far this year or that you expect how many are at the wick versus shielded from becoming an incrementally higher excise tax liability next year?.

Yes, Robert. So I would say the majority of that is going to be included in the spillover and then there will be a larger excise tax going forward. And one of the things we are kind of Chris’ question is considering do we need to accrue some of that as we go along since its related to 2019, but the tax is not paid until 2020.

So you are right, that is the majority of that will be in spillover for this year..

I think it’s the right time to [indiscernible]..

That’s about right..

Well, it’s roughly 2.7 so far is not in the spillover [indiscernible]..

Okay, got it. Thank you..

Okay. Thank you, Robert..

Thank you. And that does conclude today’s question-and-answer session I would like to turn the conference back over to management for any additional or closing remarks..

Okay, thank you everyone for joining and questions and your support of the company and we look forward to updating you on the third quarter on our call in November. Bye-bye..

Thank you. That does conclude today’s conference. Thank you all for participation. You may now disconnect..