Stellus Capital Investment Corporation

Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Stellis Capital Investment Corporation third quarter 2020 results conference call. At this time, all participants have been placed in a listen-only mode. The call will be open for question and answer session following the speaker's remarks. This conference is being recorded today, Friday, October 30, 2020. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellis Capital Investment Corporation. Mr. Ladd, you may now begin your conference.

Okay, thank you, Ryan, and good morning, everyone. Thank you for joining the call. Welcome to our conference call covering the quarter-ended September 30, 2020. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements and then later 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 Stellis 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 can 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.stelliscapital.com under the Public Investors link or call us at 713-292-5400. This time, I'd like to turn the call back over to our Chief Executive Officer, Rob Ladd. Okay. Thank you, Todd.

At the outset, I'd just say having now gone through Thank you, Rob.

From an operations standpoint, we generated net investment income of 27 cents per share, which more than covered our regular third quarter distribution of 25 cents per share. Core net investment income, which includes taxes for the third quarter, was 29 cents per share. In addition, valuation on our portfolio increased by approximately 2.1 million, or 11 cents per share, and this, along with realized gains of 1 cent per share, resulted in total earnings for the quarter of 39 cents per share. Normally, we would have declared a single quarterly distribution of 25 cents per share, which would have resulted in a 14 cent per share increase in net asset value for the quarter from $13.34 to $13.48. However, to complete the distribution of spillover income from 2019 in a timely manner, consistent with maintaining our qualification for taxation as a regulated investment company, and to eliminate our liability for a corporate-level U.S. federal income tax, we are required to declare an additional $0.31 per share of distributions by September 15th. As a result, net asset value declined to $13.17 per share at the end of the quarter. I'd like to note that these distributions constitute all remaining distributions for the year, so our fourth quarter net asset value will not be further reduced by distributions paid in the fourth quarter. And with that, I'll turn it back over to Rob. Okay. Thank you very much, Todd.

I'd like to now cover the following areas, our portfolio and asset quality, liquidity, and outlook for the balance of the quarter, and then discuss dividends. So with respect to portfolio and asset quality, again, I'm pleased to report that most of our portfolio companies' operations are stable and managing well in the current environment. Robert Thomsen Ladd and no loans have been added to non-accrual status since April 1st. We continue to maintain good diversification with the largest industry sector at 18% of the total at fair value. September 30th, the average investment for companies is about $9.4 million and our largest investment is $21.6 million, both numbers at fair value. And 62 of the 66 portfolio companies are backed by private equity firms. We are seeing interesting opportunities as the world has gotten a little bit clearer and we're beginning to invest selectively. During the third quarter, we made investments in two new and three existing portfolio companies, which totaled about $19 million. We also received repayments of $40 million, including four full repayments and a number of partial repayments, several of which were revolver repayments. As a result, we ended the quarter with an investment portfolio at fair value of $622.4 million in 66 portfolio companies, down from $641 million at June 30. From a capital management standpoint, working closely with our bank group, we extended the revolving period of our $230 million bank facility from March 2021 all the way to September 2024. with a final maturity of September 18, 2025. Additionally, we amended certain covenants and conditions of the facility, including an increase in the maximum allowable leverage to 1.5 to 1. As of today, our remaining unfunded commitments are approximately $31 million, and we have cash and revolver capacity of approximately $63 million, and this excludes cash into venture availability at our SBIC subsidiaries. at the SBIC subsidiary level, we have investing capacity for new investments from cash and or to ventures that are approximately $40 million. So very good liquidity overall and meaningful capacity to make new investments. For the balance of the fourth quarter, we estimate that we'll have new investments at least equal to the amount of repayments and equity realizations We think that number could be as much as $30 million. And if it's helpful, we think that these repayments and realizations, if they occur, would have a positive impact on NAB over the marks of September 30th. I'd like to conclude this morning's call by covering dividends. As a reminder, we declared a regular dividend in September for the fourth quarter of $0.25 per share. and a special dividend of $0.06 per share, both payable at the end of December. This brings total declared dividends in 2020 of $1.15 per share and brings live-to-date declared dividends of $10.91 per share. Subject to approval by our board, we expect to be back to you regarding the first quarter dividend of 2021 by mid-January. which would return us to our normal timing for declaring dividends. In other words, in the first month of the quarter. And with that, I'll open it up for questions. Thank you. Ryan, you may open up the Q&A session.

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Pecking for any questions, that is star one now. We will take our first question today, and that is from Bryce Rowe with National Securities. Please go ahead with your question.

Great. Good morning, and thank you for taking questions here, Rob and Todd. Maybe first I can start on the liquidity profile Todd, just curious, how much cash is sitting in the SBIC right now and was wondering if you possibly anticipate drawing the ventures to fund some of this potential activity here in the fourth quarter?

Sure. Thank you, Bryce. So we have roughly... Robert Thomsen Ladd DeVentures, they're in SBIC2 as well. And so I think the way to think about it is we have a pipeline, as Rob had mentioned, is full, and we have a lot of interesting opportunities, a number of which are SBIC qualifying. And so I think we would use a combination both of the cash that's in SBIC1 as well as drawing DeVentures and SBIC2 to fund that activity.

That's great information. Great info. And then wanted to maybe, Rob, we've talked about this in the past, but maybe get your updated thoughts around it. So you obviously had the good fortune to amend and extend the credit facility here in the most recent quarter. And one of those amendments, I guess, included the requirement by that bank group to have the 2022 baby bonds redeemed by March of 2022 ahead of their maturity later in the year of 2022. So I'm just kind of curious how you're thinking about the potential redemption of those bonds. I know we're still a good year away from, year plus away from needing to do that. Robert Thomsen Ladd, William Todd Huskinson,

Yes, so as a reminder, we have $49 million of unsecured notes that mature in September of 22. So there's 18 months left in, two years left, but 18 months left in pursuant to the bank requirement. And so, as I said earlier in the year, one of our goals in the second half of 2020 would be to possibly have a new fixed income offering. So we've been patient, and as you know, a number of companies raised Robert Thomsen Ladd, William Todd Huskinson, Vince Gwon credit agreement that we want to be patient about this. So it may be that this moves into 2021 as an event, but we'll certainly take care of this in advance of the March 22 date through a combination of new offering and certainly meaningful liquidity we've developed. Don't expect any difficulty in being able to do that.

Great. That's all I had for now. Thank you.

Okay. Thanks very much, Russ.

You're welcome. Thank you. We'll move on to our next question, and that is from Christopher Nolan with Leidenberg Thalman. Please go ahead with your question.

Hey, guys. Hey, Rob, I noticed that on a fair value basis, the portfolio is sort of increasingly favoring first lien debt, lower second lien debt. Is that a trend that we should see continuing going forward, or is it just sort of opportunistically?

Thank you, Chris. This has been a rotation that we've now been working on over the last two to two and a half years, so you should expect it to continue. It would be unlikely we would participate in any mezzanine financings. We are looking at some second liens where we think they have the right capital structure and owner and So, but you should expect the vast majority of our investing at this point will be first lane unit tranche debt. And then hopefully we always try to purchase a small piece of equity at the same time. So, that's going to comprise most of the portfolio going forward.

Great. And then my follow-up question is actually for Todd. The interest income was slightly up quarter over quarter. but the portfolio investment volumes were down and the yields seemed to be flat. What was driving the, I would think the interest income would have gone down with all that but stayed relatively steady. I'm just trying to see why.

Yeah, you know, Chris, I don't know that there's a specific reason other than fee income, you know, so we had a number of payoffs in the quarter as Rob mentioned and and had some additional fee income. And some of that fee income is included up in the interest income line item as well. So that's likely what's driving it.

Got it. Okay. That's it for me. Thanks, Chris.

Yeah.

Thank you, Chris. Thank you. We'll move on to our next question. That is from Robert Dodd with Raymond James. Please go ahead with your question.

Hi, guys, and congratulations on the quarter. First, maybe for Todd, and then a question for you, Rob. Based on where you stand today on estimated spillover kind of going into 2021, can you give us any count on, obviously, your dividend for 2020 that taxes was essentially driven by, you know, having to distribute spillover. So what's the minimum amount Distribution Requirements for 2021 as spillover stands today. And, you know, is that consistent with obviously the current base dividend? If not, what discussions have been had as to how you want to handle that?

Yeah, thank you, Robert. So I guess one of the things that I'll tell you and the crew that we've learned is it's difficult to predict spillover income until 2021. until the end of the year, of course. And so, you know, I think what I can tell you is there's still, I would expect there's still to be meaningful spillover, spillover income from 2020 to 2021. You know, maybe not quite as much as the current year, but I still think, I guess what I would say is it's still meaningful, still meaningful income spilled over to 2021. I'm not sure if the current dividends either normal dividends would cover it or there would need to be something special, just don't know that.

Okay, that's to add to your point. It is hard to predict, you know, almost a year ahead. So, Rob, on the market, obviously you talk about that, you know, activity is improving. What are you seeing in terms of, if you can, you know, quality of deals, terms, pricing, and what industries are making up more of perhaps more of your phone call, not necessarily ones you've considered, but can you give us any color about between different industries that are coming up? Do the terms vary considerably by industry type, etc.? Any color would be really helpful.

Sure, Robert. So as I said earlier, you were seeing a number of interesting opportunities. You know, we've always been very selective in our investing and, you know, continue probably even more selective than ever. But what we found are those businesses that are really business to business continue to do well. And as a result, most of our portfolio continues to do well. and then there are the companies that we're seeing part of this flow we're seeing are those that are doing very well during COVID-19 related to social media and other aspects and technology and applications. So I'd say that a great deal of activity that's helpful in our pipeline is over 10 companies that we're looking at today and

various stages of diligence.

So it's businesses that have done well throughout the COVID period are expected to do well, knowing that the COVID pandemic impact is not over. And then, you know, very active private equity world. And, you know, we operate in the lower middle market, which would have an average EBITDA of probably between $10 and $20 million. In terms of the quality of the transactions, the ones that we're looking at are excellent in terms of the capital structures. And as you've seen over the last few years, the minimum equity check in a company would be at least 40% of the capitalization and more typically 50%. So the capitalization structures continue to be good, strong. We only are involved in transactions that have meaningful covenants. I'd say pricing did increase certainly during the summer months, but we're getting pretty close now for an attractive opportunity really to close the pre-COVID levels. It could be some slight margin improvement, but the closer to pre-COVID levels than not. So we're encouraged and pretty reflected in the Robert Thomsen Ladd, Investors were certainly cautious, and today we're in a much more robust environment. I think also to be fair that there is some additional interest between now and 1231 for tax reasons. We're seeing some businesses that are likely to be sold and closed by the end of the year where people can at least lock in what they think is the capital gains tax rate. So that's increasing activity as well.

I appreciate that kind of one tiny part of that. Of those 10, I mean, depending on the election result, which hopefully we'll know next week, if it goes one way, capital gains taxes might not change. If it goes the other way, there could be a change. So is some of that pipeline contingent on an election result? Or do you just think once... Robert Thomsen Ladd, William Todd Huskinson,

Thank you. We'll move on to our next question, and that is from Ryan Lynch with KBW. Please go ahead with your question.

Hey, good morning. Thanks for taking my questions. I kind of wanted to follow up on some of Robert's questions regarding kind of the pipeline that you guys are seeing. I know you mentioned you're starting to see a big increase in opportunities, but can you clarify, are opportunities in the pipelines that you guys are seeing Just a big increase from what you were seeing this summer, which, you know, had very little deal activity. Are you starting to see a pipeline and opportunities in the market return to what we saw kind of pre-COVID?

You know, Ryan, it's a good question. I would say pre-COVID. And again, it's hard to tease out a little bit, might be the desire to get something closed at the end of the year. I think that's skewing it a little bit. But, you know, there are a number of businesses and sectors in the country that are doing well. And private equity firms are acquisitive. And, you know, some would be adding to an existing platform. So I'd say certainly our pipeline is about as good as it's been in some time. This could also be the impact of somewhat of a pent-up demand or people have not been investing since the March to September or August time frame. So I think you've got some of that that's skewing it. Maybe the best way to say it is, you know, approaching much more normalcy to where we were pre-COVID in terms of activity.

Okay. Got it. And then, you know, from an investment philosophy standpoint, do you guys expect to change the way you guys are looking at new deals, whether it's specific industries, specific credits, where you guys invest in the capital structure, given that, well, we're still kind of in the thick of things, in the middle of a downturn, you know, hopefully that will be over sooner rather than later, we'll be coming out, and the investment philosophy, you know, some can make, should be, or could be different, you know, before you go into a cycle, or when you're kind of a cycle's elongated, you should, you know, doing more defensive, hiring the capital structure, type of investing, but then in the bottom of the cycle or potentially coming out of the cycle, you can get more aggressive, more secondly, more cyclical industries. Do you guys anticipate shifting your focus at all to kind of go with that philosophy, or is it just too early in the downturn just to do anything like that? Mm-hmm.

Robert Thomsen Ladd, William Todd Huskinson, Vince Gwon Another thing I'd say is that our underwriting philosophy has been really since the beginning, going back almost 20 years as a group, pretty stellar, is that we try to underwrite any company for that there is a recession. Maybe not the first quarter, but certainly within the first 18 months or so or two years. So we're underwriting the companies if we have a recession and Robert Thomsen Ladd, William Todd Huskinson, and I would just say this, if we were looking at something that was tied to a cycle in its industry, the leverage would be low from the start, regardless of the time we would enter it. So again, they're very selective, but if it's helpful, we are seeing really nice, interesting companies, good owners, good management teams, a track record through the COVID. One thing we'll be cautious about how much of this really good performance in this business is tied directly to COVID and therefore what's the effect after COVID is the effect is much less. So having that lens on at the same time.

Okay. Yeah. Makes sense. Those are all my questions. I appreciate the time today.

Yeah. Thank you, Ryan.

Thank you. At this time, there are no further questions. I will now turn the conference back over to Mr. Ladd for any closing remarks.

Okay. Thank you. Thank you, everyone, for your support and listening in today. And we look forward to speaking with you in the spring. And, again, we expect to be back to you in January with more news about the dividends for next year.

Thank you, ladies and gentlemen. This concludes today's conference. All participants may now disconnect.