Stellus Capital Investment - Earnings Call - Q4 2024

Transcript

Operator (participant)

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 financial results for its fourth fiscal quarter ended December 31st, 2024.

At this time, all participants are on a listen-only mode, and a question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. This conference is being recorded today, March 5th, 2025. 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 (CEO)

Yes, thank you, Ali. Good morning, everyone. Thank you for joining the call. Welcome to our conference call covering the quarter and the year ended December 31st, 2024. Joining me, as usual this morning, is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements and then start off our discussion.

Todd Huskinson (CFO)

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 any 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. Now we'll cover our operating results for the quarter, but we'd like to start off with our life-to-date activity.

Since our IPO in November 2012, we've invested approximately $2.6 billion in over 200 companies and received approximately $1.6 billion of repayments while maintaining stable asset quality. We've paid over $288 million of dividends to our investors, which represents $16.69 per share to an investor in our IPO in November 2012, which was offered at $15 per share.

Turning to our current operating results, in the fourth quarter, we generated $0.35 per share of GAAP net investment income and core net investment income of $0.37 per share, which excludes estimated excise taxes. Net asset value per share decreased $0.09 during the quarter due to net unrealized depreciation on our investment portfolio and reduction of spillover income offset by net realized gains on our investment portfolio, primarily related to one equity investment.

Our ATM program was active during the quarter, and we issued 441,754 shares for $6.1 million in shares at an average gross price of $13.86 per share. All issuances were above net asset value. Regarding portfolio and asset quality, we ended the quarter with an investment portfolio at fair value of $953.5 million across 105 portfolio companies, up from $908.7 million across 99 companies as of September 30th of 2024. During the fourth quarter, we invested $76.5 million in nine new portfolio companies and had $33 million in other investment activity, all at par.

We also received three full repayments totaling $46.9 million and received $15.6 million of other repayments, both at par. We also received one full equity realization and one material partial realization that generated proceeds of $6.5 million and realized gains of $5.5 million. At December 31st, 98% of our loans were secured and 95% were priced at floating rates. The average loan per company is $9.5 million, and the largest overall investment is $21.2 million, both at fair value. All but one of our portfolio companies are backed by a private equity firm.

Overall, our asset quality is on plan. At fair value, 24% of our portfolio is rated a one or ahead of plan, and 21% of the portfolio is marked in an investment category of three or below plan, meaning not meeting plan or expectations. Currently, we have loans to seven portfolio companies on non-accrual, which comprise 5.4% of the fair value of the total loan portfolio. With that, I'll turn it back over to Rob to discuss the overall outlook.

Robert Ladd (CEO)

Very good. Thank you, Todd. As we look ahead to the first quarter of 2025, I'll cover portfolio growth, equity realizations, and dividends. The active fourth quarter has continued into the first quarter of 2025. As of last Friday, we have funded an additional $47 million, bringing our portfolio to $1 billion for the first time in our firm's history. We expect that level to maintain and probably finish the quarter at the $1 billion number.

As Todd noted earlier, we had realized equity gains in the fourth quarter of $5.5 million. We expect we'll see more equity gains in 2025 with approximately $4-$5 million by June 30th. As a reminder, in our equity co-invest business, we have equity co-investments across 92 companies with a cost basis of $59 million. We believe over time that we should see meaningful uplift from here. Our historical results would indicate realizations in excess of two times our cost.

Finally, regarding dividends, we declared the dividend for the fourth quarter, I'm sorry, for the first quarter of 2025 at a rate of $0.40 per share, again, payable monthly. We do expect that level of dividend, again, $0.40 per share payable monthly, to continue into the second quarter. Based on spillover or previous year's earnings that have not been distributed, we would expect this level to continue throughout the year. Of course, all of this is subject to board approval. With that, we'll open up for questions. Ali, please begin the Q&A session, please.

Operator (participant)

Thank you. At this time, we'll be conducting our question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question key. You may press star two if you would like to remove your question from the key. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pool for questions. Thank you. Our first question is coming from Sean-Paul Adams with Raymond James. Your line is live.

Sean-Paul Adams (Equity Research Analyst)

Hey, guys. Good morning.

Robert Ladd (CEO)

Good morning.

Sean-Paul Adams (Equity Research Analyst)

Good morning. When it comes to discussions about potential tariff impacts to companies within the portfolio and also discussions about potential changes in credit quality, what are your thoughts on leverage going into 2025 and 2026 and just the potential concerns about the magnification of that potential credit risk?

Robert Ladd (CEO)

Yeah, good morning. Good question. As you know, we're operating at a lower leverage level than we've normally operated. Our target regulatory leverage is one to one, and GAAP would be two to one, but we're certainly at a lower level than that now. I'd say I think we continue to shoot for that target leverage. We're certainly cautious about the uncertainty that's being created by the executive branch of the government.

I think that at this point, we'd like to, so to speak, wait and see the impact of what's happening. We're certainly cautious about what that could mean. We certainly have most, substantially all, of our businesses are based in the United States, but some would touch government activity. Some would have activities cross-border. We're certainly cognizant of that. I think we're in a wait-and-see attitude, but cautious, as you say.

Sean-Paul Adams (Equity Research Analyst)

Perfect answer. Thank you.

Robert Ladd (CEO)

Thank you.

Operator (participant)

Thank you. Our next question is coming from Christopher Nolan with Ladenburg Thalmann. Your line is live.

Christopher Nolan (Analyst)

Hey, guys.

Robert Ladd (CEO)

Good morning, Chris.

Christopher Nolan (Analyst)

Rob, could you give us a little thoughts in terms of, given all the outlook information you gave, which is always appreciated, do you think the first quarter EPS will cover the dividend?

Robert Ladd (CEO)

We do not have it quite for sure, but probably not fully covered. We will see what the balance of the quarter looks like, but probably not. It would be close. I think part of this is we look at the dividend and we look at earnings. One, we have substantial earnings from the past that have not been paid out. That is helpful in effectively covering. We look at it over time. As I mentioned, we are likely to start seeing some equity realizations kick in that will be helpful. I think as a technical matter, Todd, we probably will not quite cover in the first quarter.

Todd Huskinson (CFO)

Yeah, that's right, Chris. We think we'll be off by a few cents, and that general trend may kind of continue throughout the year, just given kind of the rate environment and the spread environment.

Christopher Nolan (Analyst)

Gotcha. On the topic of spreads, what was the driver for the decrease in investment yields in the first quarter?

Robert Ladd (CEO)

In terms of spreads, maybe as a macro thought, as we started 2024, we were seeing spreads in the sixes, and as we end the year, seeing spreads in the fives. Probably that's one factor. Two, SOFR did decline quarter-over-quarter, and then probably some impact again for some additional non-accruals, Chris. The good news is it's in excess of 10% currently.

Christopher Nolan (Analyst)

On the topic of leverage, your leverage is just so low. I mean, what's the thought here in terms of your leverage seems to be artificially low. The EPS outlook doesn't quite cover the dividend, and you're in a tightening spread environment. Why don't you just increase leverage a little bit?

Robert Ladd (CEO)

Yes. That could counterbalance the first question. As I say, we're targeting a one to one, being cautious about it. You may see that happen over time this year. There are some different ways to achieve that leverage, but more to come.

Christopher Nolan (Analyst)

Gotcha. Final question. I know you paid off part of an SBA maturity in the first quarter of 2025. Are you guys going to re-up for more SBA lending capacity?

Robert Ladd (CEO)

Yes, we are. We're moving forward with a third license. Thanks for noting that. After 10 years, our first license debentures are starting to come due. We did prepay the first debenture payment in mid-February of roughly $16 million. We're in the process of obtaining, hopefully, a third license, and we'll continue that program along the way.

Christopher Nolan (Analyst)

Great. Thank you very much.

Robert Ladd (CEO)

Yeah. Thank you, Chris.

Operator (participant)

Thank you. Our next question is coming from Eric Zwick with Lucid Capital Markets. Your line is live.

Robert Ladd (CEO)

Good morning, Eric.

Eric Zwick (Analyst)

Thank you. Good morning. Yeah, good morning. I wanted to start first on the pipeline. You obviously had some nice, excuse me, new origination activity in the fourth quarter. It seems like you're off to a good start here in the first quarter as well. Maybe just quantitatively, can you maybe kind of update us on kind of where the pipeline stands today relative to 90 days ago and additionally kind of what that mix looks like between new versus add-on opportunities?

Robert Ladd (CEO)

Yes. I'd say that, again, very busy fourth quarter and really the last month or two of the fourth quarter. Really through the first two months this quarter, we're on a pace that would be exceptional. I think we've seen a little bit of slowness, but continued activity. As you know, our platform is a three-plus billion-dollar platform overall.

Our investment teams are seeing a number of deals every week. I think good pipeline, good deal flow. Probably not expecting the same level every month that we had in the first two. I'd also say, following question about new investments versus follow-on. The follow-ons are very helpful. They come in two ways. One would just literally be a new follow-on to the same company.

Alternatively, or in addition to that, we'll have delayed draw term loans where someone is tapping an existing commitment that's been made. This is helpful in that it's already in place and everything's been negotiated. It comes in both ways. I'd say the quantum of that is probably two-thirds are new transactions and roughly a third would be follow-ons or draws under DDTLs.

Eric Zwick (Analyst)

Great. Thanks. Appreciate the color there. Just a reminder, in terms of most of the delayed draw term loans you have, do the companies need to meet some sort of financial hurdles to be able to draw on that, or are they at the discretion of the company? Just remind me how those are typically structured.

Robert Ladd (CEO)

Right. They're typically structured that they're a true commitment, but they are subject to certain tests. One, it would be are they in compliance with all the covenants. They typically would have, in addition to that, what's known as an incurrence test. The leverage quotient at the time they draw would have to be similar to the time when the loan first closed, keeping the leverage at where we started out. In addition to that, excuse me, you could have what needs to be used for a certain purpose. Typically, it's for an acquisition or some expansion.

Eric Zwick (Analyst)

Yep. That makes sense. Okay. Then transitioning to the spillover, I think you mentioned it in the prepared remarks with regard to the dividend and having some ability to support the dividend in the near term. With that, can you remind us of where the dollar level of the spillover is this quarter or at the end of the fourth quarter?

Todd Huskinson (CFO)

Yeah. Eric, we had $45 million of spillover at the end of the year. That is kind of what we are working against during 2025.

Eric Zwick (Analyst)

Gotcha. Perfect. Thank you. That's all for me today. I appreciate it.

Todd Huskinson (CFO)

Thank you, Eric.

Operator (participant)

Thank you. Our next question is coming from Paul Johnson with KBW. Your line is live.

Robert Ladd (CEO)

Good morning, Paul.

Paul Johnson (Analyst)

Good morning. Thanks for taking my question. Just a little bit more on the just kind of tariff risk in general, higher level. Have you guys run any sort of analysis or assess the portfolio in any way in terms of just kind of how much of the portfolio might be at risk of any of the tariff issues ongoing, as well as just exposure to maybe kind of government services or any sort of anecdotal data points you'd be able to provide?

Robert Ladd (CEO)

Sure, Paul. We've certainly analyzed it or been looking at it. It would appear that the impact from tariffs would be more than the impact from the government kind of exposure, probably like a two to one there. Our rough estimate is that it probably could be up to 10%. I mean, it depends how you grade them and what actually happens. At this point, it would not appear to be material in terms of the overall activity. As I said at the outset, we're going to wait and see what really comes through from what's said at the government level and what actually ends up happening.

Paul Johnson (Analyst)

Got it. Appreciate that. Last one, on the realized gains this quarter, was there any additional markup at all from those investments that were exited in the fourth quarter?

Robert Ladd (CEO)

Yes. At the top of the end of the number, but it was a few million dollars. We have one equity position that is continuing to grow. In addition to the partial realization, its value was increased as well.

Paul Johnson (Analyst)

Got it. Great. Thank you very much. That's all for me.

Robert Ladd (CEO)

Okay. Thank you, Paul.

Operator (participant)

Thank you. As we have no further questions on the line, I will now hand the call back over to Mr. Ladd for any closing comments.

Robert Ladd (CEO)

Okay. Great. Thank you. Thank you, everyone, for your support of our company. We look forward to getting back with you in early May as we discuss the first quarter.

Operator (participant)

Thank you, ladies and gentlemen. This concludes today's conference, and you may disconnect your lines at this time. We thank you for your participation.