Stellus Capital Investment Corporation
Q1 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

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 First Quarter 2018 Results. At this time, all participants have been placed on a listen-only mode. This call will be opened for a question-and-answer session following the speakers’ remarks. This conference is being recorded, today, Tuesday, May 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.

[Robert Ladd:]

Thank you, Melanie, and good morning, everyone. Thank you for joining the call. Welcome to our conference call covering the year ended March 31, 2017. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements.

[Todd Huskinson:]

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 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.

[Robert Ladd:]

Thank you, Todd. As in past quarters my remarks will cover the following areas

[Operator:]

Thank you. [Operator Instructions] We'll go first to Christopher Nolan with Landenburg Thalmann.

[Christopher Nolan:]

Hi guys.

[Robert Ladd:]

Good morning, Chris.

[Christopher Nolan:]

On the non-accruals, the press release had two non-accruals – you've got Grupo Hima, what was the other one? Was it still Binder & Binder?

[Robert Ladd:]

Yes. It's the remainderman of the Binder & Binder position, which we could report the $100,000 remains was fully retired at the end of April.

[Christopher Nolan:]

Got you. And then the expenses increased particularly for management accruals and interest expenses. Can you give us any guidance as to where things could go in the second quarter for expenses?

[Robert Ladd:]

Just to make sure, we heard you, Chris, the question is about expenses, generally?

[Christopher Nolan:]

Yes.

[Robert Ladd:]

Okay, sure. One thing I'll note, I'll turn it over to Todd – but in the first quarter, our professional fees are higher than they are through the rest of the year – but Todd will address that. I think that's part of the increase.

[Todd Huskinson:]

Yes, that’s right, Chris. So I would say, the increase in this quarter and to some extent, the end of last year was related to the implementation of the auditing with Sarbanes-Oxley, which was led to increased audit fees, because they had to audit in our controls, plus, we had some consulting fees related to getting us prepared for that. So we'd expect that to be considerably less going forward. And including the first quarter of next year, we can have all of those same kind of fees. We would expect those to be less for that period as well. But that's it – everything else was relatively stable.

[Christopher Nolan:]

Great. And then finally, my last question. Rob, I missed it in your comments, where you mentioned the possible equity gain in the second quarter. What was that, please?

[Robert Ladd:]

Yes. We have one of our equity co-investments. We believe the business will be sold by the end of the quarter and the gain is – the expected gain is $2.6 million.

[Christopher Nolan:]

Great, that’s it from me. Thank you very much.

[Robert Ladd:]

Okay, thank you.

[Operator:]

We'll go next to Robert Dodd with Raymond James.

[Robert Dodd:]

Hi, guys. Congrats on the quarter. I mean, first a couple on – you had considerable dividend income in the quarter. I mean, I'm going to presume, unless you tell me otherwise, those were one-offs between Millennium Trust and Glori. Any indication those are going to be recurring, or whether it's just one-off receipts in Q1?

[Todd Huskinson:]

Yes, Robert. So this is Todd. So that was really related to Millennium Trust. And that – you could have another one of those in the future from there but it's not a recurring dividend that you should expect. So we don't have any knowledge that there will be another one, but it's possible that there will be.

[Robert Dodd:]

Right. And then – I mean, the Glori Energy was $900,000 as well, which is pretty sizable. Is that one, again, a one-off, or?

[Todd Huskinson:]

It was, yes, that was the – that was initially going to be the sale of that company. And so that was a one-off investment, a one-off opportunity.

[Robert Dodd:]

Got it.

[Robert Ladd:]

Robert, just a quick update on that. That was our one oil and gas position, and it's somewhat dated. So as we had projected last year, we thought we would sell those assets within 12 months, which we have. So all of the capital has been realized, there's a small stub, piece which is effectively cash of about $330,000. And after the business is wound up, that would also be distributed so that position is basically been fully realized.

[Robert Dodd:]

Got it, got it. And then, just on the leverage, as you said, obviously, you've got to modify the credit facility. Any indication from discussions so far, how that's going to go, guidance indications on what the costs of a new modified 2

[Robert Ladd:]

Yes. So we've had initial discussions or informal discussions with a couple of the banks, including the agent bank, and they've been received it positively. We're not expecting there could be a material change in the cost. And one thing that might be helpful, as I was commenting in my prepared remarks that what we think this new raising of the limit does is – allow someone like us to operate at 1

[Robert Dodd:]

Got it, got it. I appreciate that. And last one on that, obviously, the board has given approval. So in principle, that kicks in during the second quarter and next year and makes it available. Hypothetically, if shareholders don't vote to approve it, I mean – that the rules say either, right – you've got a board approval, so what would your position be if shareholders do? And I'm not saying I think – if shareholders do vote no on that?

[Robert Ladd:]

Yes. So first of all, we expect that we'll receive approval, it's a similar majority vote. We think – I’ve said its – we think it's very positive for shareholders, so we'll be working to make sure that they understand that. And if in some small case, it was not approved, we would think about it. But our plan is that because this is so positive for all of our shareholders that we would implement it then in the following April.

[Robert Dodd:]

Got it, got it. Thank you. That’s it from me.

[Robert Ladd:]

Thank you, Robert.

[Operator:]

And we’ll go next to David Miyazaki with Confluence Investment Management.

[David Miyazaki:]

Hello, good morning.

[Robert Ladd:]

Good morning, David.

[David Miyazaki:]

Just a couple of questions, one of the things, as I look at the 2

[Robert Ladd:]

Thank you, David. So as you pointed out, we're not thinking about anything close to 2

[David Miyazaki:]

Okay, well, I appreciate that. I think that we've seen a wide range of approaches to adopting this, in some cases, the math I laid out is pretty apparent for some of the peers in the industry. And yet, there's a great – there has been for some, a great rush to get this approved by the board and get the one-year clock started. So I appreciate you guys being thoughtful about this, and really thinking about what the incremental capital is doing for the shareholders, because I get that for some of the management teams 2

[Robert Ladd:]

David, we're losing you there, just at the end. There's the question of why seek a shareholder vote?

[David Miyazaki:]

No, no, no. If the shareholders said no, why would you still go forward with it in the year?

[Robert Ladd:]

Because we think it's in the best interest of the shareholder over time and so I would just say let’s focus on getting the shareholder vote, which is what we're up to. And again, we're optimistic that it will be approved because of all the positive reasons for it. And the other thing I'd say would be – with respect to your question about concerned about the sector – this may be a time when investors would differentiate between managers who use leverage responsibly.

[David Miyazaki:]

I certainly hope so, there's a lot differentiation that in my opinion, still needs to take place in the industry. But I would say that, if you ask the shareholders if this is what's good for them, and if they say no – and you go ahead and do it because you think it is good for them, that's not something that is going to instill a lot of confidence among your shareholder base. They kind us segues into my last question, with regard to capital allocation. So I think that you guys were patient and thought long and hard to get over, over NAV in your stock price and issued the equity above the book value which is a great capital allocation discipline, when that is oftentimes not followed in the industry. But subsequent to that equity offering and your stock, along with most of the industry trading below net asset value, it is troubling to me to see that you're utilizing a an aftermarket program, to issue incremental equity, even if it's a small amount, below net asset value, it kind of puts you on the capital allocation discipline. So could you kind of walk through why you would continue to do that?

[Robert Ladd:]

Sure, David, you are kind of cutting in and out. But I believe that the question is using our ATM program and potentially issuing shares below NAV. So – is that correct?

[David Miyazaki:]

Yes.

[Robert Ladd:]

So we issued a modest amount of shares that were slightly below NAV. As I recall, they were within 97% or 98% of NAV. And the approach we were taking and have been taking is that if we were using such an ATM program, that an average over time, such issuances would at least be at NAV or above. So again, it was a marginal difference. So that's the approach we've taken. And Todd, if you might remind me, I think the amount issued was very small.

[Todd Huskinson:]

Yes. I think it is about 300,000 shares for maybe $4 million of equity.

[Robert Ladd:]

So that is the approach we took.

[David Miyazaki:]

So, if you are working to a long-term average then of getting at net asset value to the ATM, or higher, is it safe to assume that when you look at your stock right now, 87-ish percent of net asset value that you're not interested in doing at this level or anywhere near it.

[Robert Ladd:]

That is correct. That is well said.

[David Miyazaki:]

One of the problems with crossing that line, just going below, for shareholders, it kind of creates a situation where we don't know where the line is anymore. And that's part of the hazard in how you communicate to us what your capital allocation policy is. So it's helpful if you just never crossed because then we just know, it's net asset.

[Robert Ladd:]

David, one thing, just if you go back to the question about leverage and shareholder approval. So ultimately, that decision that I'm describing would be the purview of our Board of Directors. But I'd try to give you a sense of what we're thinking as management. As you know, the benefit of the shareholder vote is that – whereas the board approval, the increased leverage capability takes place a year later, if our shareholders approve it, we'll would be able to – it would take effect immediately. In our case, the end of June. And that's why we are seeking the shareholder approval. Last thing I'd say is we're very optimistic we'll achieve it, and if we need to educate our shareholders why it's in their best interest, we're in the process of doing that. So – but thank you for your observations as well.

[David Miyazaki:]

Thank you for taking my question.

[Operator:]

We'll go next to Christopher Nolan from Ladenburg Thalmann.

[Christopher Nolan:]

Hi, assuming that you get the approval for the increased leverage at the June 28 Shareholder Meeting, should we expect the leverage ratio to start climbing in the third quarter? Or should we expect the unsecured debt offering then – I mean what sort of the plans for the second half of the year?

[Robert Ladd:]

Yes, Chris it is a good question. So the need for the capital, increased capital is out of ways. So a lot of it will depend on new investments that occur over the next three to six months. So, I think the more likely case would be the need for – the capital would come towards the end of the year. And then in terms of assuming that – we don't believe that the bank facility would increase materially in terms of the borrowing base. The borrowing base has been set. So that's why we think that most of this increase would come through senior unsecured notes. The issuance of those, I think, would be kind of the market creates the opportunity, so whereas the need for the capital probably wont come till say the fourth quarter, we may – look at note offering in the meantime, the reason is to capture what hope – what major lower rates than you'd see in the future. But in any event, that's the timing. And the note offering timing is not known at this point. We'll be watching the market and – but I'd say our goal is certainly by the end of the year to go to that point.

[Christopher Nolan:]

And have you done any sort of – I'm not going what David said earlier, from the same point that – as you increased leverage at certain point, your borrowing costs can go up, your yields can go down a little bit. You reached a tipping point where the return to shareholders actually go down. And can you give any sort of color in terms of the discipline? Or how are you balancing the amount of leverage going forward with the returns? I mean you have a particular ROE type of metric, an IRR-type of metric that you've had before that might change going forward? Any color on that would be helpful.

[Robert Ladd:]

Sure, sure. I think the rough math is as I said earlier to David, if you think of our portfolio yielding – it currently yield 11% on a weighted-average basis. So think of it as 10.5% to 11.5%., that's your income side. And the cost of borrowing on the margin today, it varies between 4s to – all into 6, including unsecured notes including the sales load, so we think there's a meaningful margin there. And every dollar of increased leverage again moderately taken down and deployed is accretive to our investors.

[Christopher Nolan:]

So and Rob, you're sort of thinking about 500 basis points-or-so spread and sort of the operating assumption at the moment?

[Robert Ladd:]

That's correct. And then, the other sources of income associated with the portfolio are one call protection if the loan pays off early, which enhances yield. And then two, the co-investment portfolio, neither of which are included in that weighted average yield that I described earlier. So that's the rough math. And again, this is without issuing any additional equity.

[Christopher Nolan:]

Okay. Thank you for taking my follow-up.

[Robert Ladd:]

Thanks for the questions, its very helpful.

[Operator:]

We'll go next to Chris Kotowski with Oppenheimer.

[Chris Kotowski:]

Most of mine were asked, but I was just wondering how much capacity do you have left? Is there any capacity left on the SBA? And how does that figure into your thinking about the 1

[Todd Huskinson:]

Sure, Chris. So with respect to the SBA debentures so we've recently taken down $40 million more, which gets us to $130 million of outstanding debentures. So there are $20 million remaining, which we plan to call a likely in the next 30 days or so. So we'll have obtained all of the possible leverage in the SBA. And then, in terms of the leverage quotient – so we think about them differently. So the leverage that I've been describing would be leverage, excluding the SBIC debentures, which as you know is excluded for both the regulatory as well as the various leverage covenants with credit facilities. So ultimately – and the reason we think about it differently is the long-dated nature of those debentures, which once they're pooled are a 10-year interest-only note. So we put those in a different category. Ultimately, we certainly would look at the total leverage of the enterprise, including those. But what we're thinking of, and as I mentioned in getting to 1

[Chris Kotowski:]

Okay. All right. That’s it from me. Well, I guess just one last thing, I mean everybody is worried that you're going to use the additional capacity to leverage in a suboptimal way or – but I mean isn't effectively a free option? I don't see what the downside is in having that available.

[Robert Ladd:]

We agree.

[Chris Kotowski:]

Okay, thank you.

[Operator:]

And we'll go next to Robert Dodd with Raymond James.

[Robert Dodd:]

Hi, actually my follow-up is about the…

[Robert Ladd:]

Okay. Thank you, Robert.

[Operator:]

And we have no other questions at this time.

[Robert Ladd:]

Okay. Thank you everyone for your support and we look forward to being on the phone with you in August and certainly come to Houston for our shareholders meeting, which will be held on Wednesday June 28.

[Operator:]

That does conclude today’s call.