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 Fourth Quarter 2019 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, Tuesday, March 3, 2020.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..

Thank you, Samantha. Good morning everyone and thank you for joining the call.

Welcome to our conference call covering the quarter and year ended December 31, 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'd 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 Public Investors link or call us at (713)-292-5400.At this time, I'd like to turn the call back over to our Chief Executive Officer, Rob Ladd..

Thank you, Todd. We'll begin by discussing our operating results followed by a review of the portfolio, including asset quality and then the outlook. Todd will now cover our operating results first..

Thank you, Rob. For fiscal year 2019 we more than covered the dividend of $1.36 per share with realized income of $2.30 per share, which included $19.6 million of net realized gains or $1.07 per share.Core net investment income was $1.32 per share and GAAP net investment income was $1.23 per share.

As a reminder, the core investment, net investment income calculation is non-GAAP and excludes the capital gains, incentive fee accrual and excise taxes.Net asset value increased $45.8 million from $224.8 million to $270.6 million, due primarily to our equity offering in March 2019.

On a per share basis, net asset value increased from $14.09 to $14.14, due primarily to net gains of $0.22 per share.

Finally, of our $1.36 per share of dividends paid in 2019, approximately 60% were characterized as long term capital gain, and therefore taxable to our investors at the applicable long term capital gains rate.Turning to the fourth quarter, we covered our distributions of $0.34 per share through realized income of $0.38 per share, which included realized gains of $0.02 per share.

GAAP net investment income was $0.36 per share, impacted by the reversal of $1 million of previously recorded capital gains incentive fee accrual. Core net investment income was $0.32 per share.

As a reminder, it excludes the impact of capital gains, incentive fee and excise tax.Net asset value decreased $0.26 per share during the quarter from $14.40 to $14.14, due primarily to unrealized appreciation on our debt portfolio.And with that, I'll turn it back over to Rob..

Okay, thank you Todd. I'd like to cover the following areas. I’d like to today review portfolio and asset quality and then turning to outlook.So really, this is the seven full years like today's review.

So since our IPO in November 2012 we've invested approximately $1.3 billion in 117 companies and have received approximately $820 million of repayments, while maintaining stabilized quality.

To-date we have paid over $141 million of dividends to our investors, which represents $10 per share to an investor from our IPO in November 2012, which was at $15 per share.Now turning to portfolio and asset quality, we ended the year with an investment portfolio at fair value of approximately $629 million across 63 portfolio companies, which is up from approximately $505 million across 57 companies at December 31, 2018.During 2019 we invested $251 million in 17 new and 12 existing portfolio companies and received approximately $128 million of repayments, so total net portfolio growth of approximately $124 million for the year.Our portfolio continues to be weighted towards secured lending at floating rates.

At December 31, 96% of our loans were secured and 93% were priced at floating rates. This move is coincided with greater first lien and unitranche lending.

We continue to make good diversification with the largest interest rate sector at 15% of the total, the average investment per company is $10 million and the largest investment is $21 million, both measured at fair value.59 of the 63 portfolio companies are backed by a private equity firm.

Overall our asset quality is stable at a two on our investment rating system or on plan. 11% of our portfolio is rated a one or ahead of plan, and 11% of the portfolio is marked at an investment category of three or below.

In total, we have two loans that are non-accrual which comprise just under 1% of fair value of the loan portfolio.Now, turning to outlook. Part of our strategy has been to invest in the equity of our portfolio company in a modest way in order to generate realized gains sufficient to offset losses over time.

As our business has matured over the last seven years, we've begun to see somewhat regular realized gains from the portfolio.

During 2019, we generated $19.6 million of net realize gains, and since year end we've had $1.3 million of realized gains.Also since year end we have funded $35 million at par in two new portfolio companies and we received a $12.5 million and full repayment of one investment, which brings the portfolio to approximately $650 million.

We’ve identified likely fundings of approximately $13 million by quarter end and repayments of $15 million. So we’ll likely end the quarter about where we are today.Beyond this quarter, I’d like to comment on some headwinds in the business. First as you know, we've had a falling LIBOR rate from which most of our loans are priced.

The 90 day rate was 195 basis points at December 31; yesterday it was about 1.24%. We do have LIBOR floors, which on average are at about 1% and recently we've been structuring loans with floors higher than that level.Second, as we rotated the portfolio to more first lane and unitranche lending, our yield has decreased.

This should result in a lower risk profile though. And third, we’ve seen a limited impact from sourcing from China so far.

Certainly the longer term impact in the portfolio of the coronavirus or COVID-19 is something we're studying very carefully.Finally on a positive note, in addition to the $1.3 million realized gain that was received in January, we're expecting an additional $4 million of realized gains for the year.And with that, I’ll open it up for questions.

Samantha, you may begin the question-and-answer session..

Thank you [Operator Instructions]. Our first question will come from Robert Dodd with Raymond James..

Hi guys. If I could, on the China sourcing supply chain, I mean, can you – you gave a little color there on seeing limited impact so far. It’s obviously very early.

Could you tell us how far you are through the process of maybe evaluating that, not just quite obviously talking to the companies, but evaluating how significant maybe secondary impacts could be or anything like that?.

Yes, good morning Robert.

So, as we are studying it carefully and talking with the companies, we certainly have less than a dozen companies that have some direct supplier demand exposure to China, although so far though the tariff process has been a very limited impact.And then, question – so our bigger question though would be, if this becomes more pervasive and starts to impact, has an impact on the U.S.

economy and travel and the way one operates in business, it could have more of an impact.

We've identified a couple of companies that actually would benefit from the virus situation in the states, but we hope it doesn't come to that.So again, we are still evaluating it Robert, but I’d said that if it continues and certainly has more of an impact on the way business is done in the State, it could be impactful, but I would think as a general matter, most of our exposure by design of course is based in the United States..

Got it, thank you for that. On the LIBOR floor issue, you know obviously the feds just cut. There – I think you said [inaudible] posted at one that you’ve been. Can you give us a little bit more color on what percentage in your portfolio actually has floors and when you’re a one and when you say you have structuring higher floors.

How much higher we've been able to get in the pretty competitive market?.

Sure, so with respect of the existing floors, many are higher than 1%, but that's an average number and I'd say very few, less than 5% had no floors and we’ll maybe double check that while I’m talking.

So most – every loan we have has a floor, and then we do have still some fixed rate loans, although it's by design has become a smaller percentage just as we’ve gone to more secured lending.In terms of the market today, so I think going back to Labor Day or so, we started structuring LIBOR floors generally at 150 and some higher at 175 and we've tried to be disciplined also about the spread too, which is relevant.So we've reached the point we would say in terms of absolute return, that these are important parts of structuring deals, that there is better rate below which you know we wouldn't go.

So I think if you thought about our recent investing and likely investing during this year, the floors will be higher and certainly all on yield while looking for what is the all-in return for a loan..

Got it, I appreciate that. And then if I can, one more. On the markdowns in the fourth quarter, it looks like protecting America [ph].Is there anything that you can tell us about the driver that.

I mean, I think a home security company – we've seen other home security companies, not in your portfolio, but elsewhere in the market place occasionally have issues over the last few years.

I mean is there something structurally changing in that market that's creating incremental problems?.

Yes. So again as you know, we don't really comment about specific companies in the portfolio for privacy reasons, but I would say as a general matter that the security monitoring business, there has been a technological change over time and it’s certainly impacted incumbent type businesses, so that's probably the most I should say at this point..

Okay, I appreciate it. Thank you..

Yes, thank you Robert..

Thank you. Our next question will come from Christopher Nolan with Ladenburg Thalmann..

Good morning Chris..

Hey guys. What are you thinking about leverage given you know LIBOR is going down.

So where should we expect leverage to start to drift up to?.

Yes, and this would be Chris as it relates to our company itself, not portfolio companies..

Yes..

Yes, so I would think of it as in our targeted leverage from a regulatory calculation would be at one-to-one, which we’re not at today, but certainly achieving to get to one-to-one, and then when you put our debentures, certainly the leverage will be higher, so that’s the targeted number at this point..

Great! And Rob, is the Coronavirus the expectation of a slowing economy and all the other factors, is that changing how you are looking to expose the industry exposure for Stellus.

Are you looking to favor certain sectors less than others? How does that affect your thinking?.

Yes, so one thing I might mention is that we, if you go back a couple of years when the tariff discussion was active, we purposely did not invest in a couple of very interesting companies that we thought would be impacted by the tariffs, so we've been mindful of since that point of monitoring and limiting exposure or impact to China.

But of course a number of businesses in the United States are ultimately affected because of the supply chain. That may not be their business, but someone they do business with.

So as a general matter, we try to be certainly cautious in this area.And then as we think about investing now, like we had an opportunity this last week that we reviewed and that we thought nicely and even if there was a larger impact on the U.S. economy, that it would have very little impact on such business.

So it's certainly informing or investing at this point and so I think it would certainly be a little bit more cautious in thinking through how is the business impacted if it becomes more pervasive..

Great! That’s it for me. Thank you..

Yes, thank you..

Thank you. Our next question will come from Ryan Lynch with KBW..

Good morning..

Good morning..

Hey, I wanted to follow up on the question regarding your leverage. So the one-to-one regulatory leverage, it's kind of a target you guys have had for a bit ever since really the two-to-one leverage was approved.

And so I'm just wondering though, in this environment where LIBOR has clearly, significantly changed from where you initially set that leverage target, which obviously puts pressure on your portfolio yield to operate earnings, I'm just curious why has there been I guess no change to your regulatory leverage target.And also, I know you guys don't provide kind of a total or GAAP leverage target, which would include that SPA debentures, but again as LIBOR has been headed in the wrong direction and the fed cut today, you know it's going to continue that way, do you plan on adding on more total leverage with the SBIC debentures versus you know – and still maintain you know kind of the same regulatory leverage?.

Yes, thank you Ryan. So as a general matter, on total leverage I would think of it more in the two-to-one relationship.

This would include the SBIC debentures, and so one a very positive aspect of our funding base is that under our second license, which as you know was obtaining this past summer, the new debentures are very likely to be lower than the first trench or the first 150 and that cost we think is roughly in the low 3% and maybe more, and whereas the first trench was in the high threes.So, if you think about an ideal source of funding for us today, is to begin to fully utilize the second license debentures, so this could cause leverage to get higher through that mechanism.As it relates to regular way leverage, regulatory leverage, we’ll certainly look at taking the target above one-to-one.

I’d say that we would be mindful about state of the economy, and we would – so that’s part of the principal concern and typically the regulatory leverage is more governed by your bank facility, where typically this would be trailing for most everyone in the industry where the covenant for your bank facility would be lower than the 2:1 regulatory cap.So any change I think about that one-to-one target would be done and worked closely with our bank, who by the way who have been very supportive and increased our facility from 180 to 220 this past year.

So hand-in-hand with them, we could consider a higher targeted leverage..

Okay, yeah that makes sense. Certainly your outlook on how the U.S. economy is, you know going to fare, as well as trying to lease some cushion in your credit facility leverage, you know it totally makes sense.I did have one question on the coronavirus as well. So given that this is ever evolving, every day it's a very fluid situation.

It's probably difficult to understand the impact to your portfolio of companies today, and that may be completely different in a week or two depending on how those things spreads.

So could you just give some insight as to the process and steps that you guys are taking to monitor your portfolio companies and how they are performing, because the data you know that they are going to be reporting to you from a financial standpoint is going to be on a lag and is not really going to show probably the real impact that we're having, sort of in real time.So can you just provide some insight of the process and steps that you’re taking to kind of actively manage and understand what's happening in your portfolio companies closer to a real time perspective?.

Sure, and this would be a good, maybe as a background about our portfolio monitoring generally. So our investment teams are in constant contact with portfolio companies, both management teams and owners.

This will be a continuous process throughout each quarter and then certainly at the end of each quarter we have a full debrief about how the portfolio companies are doing.

So think of investment teams constantly being in contact with portfolio company management and their owners.As it relates to the specific question, we've been reaching out to the portfolio companies who we think could be impacted and receiving – you know starting a receive data back, everyone's evaluating I think real time.

So I think certainly by the time we have our first quarter call in early May, we'll have much better information to share with you.So again, I think its real time, and we have constant dialogue with portfolio companies. So both, obtaining and understanding information will be – will not be a challenge..

Okay, I understood. Those are all my questions. I appreciate the time today..

Okay, thank you Ryan..

Thank you. At this time I am not showing any further questions in the queue. I would like to turn the call back over to Mr. Ladd for closing remarks..

Yes, and one thing I might just add before we close out is Robert’s question about LIBOR floor. So just – we finalized that while we've been talking. So just as our floating rate exposures, we just have two that do not have LIBOR floors.

So in a sense essentially all do.Anyway, I think that’s in an hour [ph] and we thank everyone for their support for our company, just finishing our seventh year and we look forward to speaking with everyone in early May. Thank you..

This concludes today's call. Thank you for your participation and you may now disconnect..