Main Street Capital Corp (MAIN) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Main Street Capital Corporation's fourth quarter and year end 2008 earnings conference call. During today's presentation all parties will be in the listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions) . This conference is being recorded today, Thursday March 12, 2009.

I would now like to turn the call over Gus Okwu with DRG&E. Please go ahead.

Thank you. Good morning thank you for joining us for Main Street Capital Corporation fourth quarter and full-year 2008 conference call. Joining me on the call are Vince Foster, Main Street's Chairman and CEO and Todd Reppert, the Company's President and CFO. Main Street issued a press release last night with details of the Company's quarterly financial and year end operating results. This document is available in the investor relations section of the company's website at www.mainstcapital.com.

A replay of today's call will be available beginning one hour after the completion of the call until 11:59 pm Eastern time on Saturday March 21. The replay may be accessed by dialing 303-590-3000. The access code for the replay is 11126551 pound. Please note that information reported on this call speaks only as of today, March 12, 2009 and therefore you are advised that time sensitive information may no longer as of the time of any replay. I should also mention that our comments today will contain forward looking statements in the meanings of the Private Securities Litigation Reform Act of 1995.

Information about potential facts that could effect the Company's financial results are available in the footnote regarding non-GAAP measures of the Company's press release, and in the "Risk Factors" sections of the Company's filings with the SEC. I would finally advise you that this conference call is being broadcast live through an Internet Webcast system that can be accessed from the Company's web page at www.mainstcapital.com.

NowI'd like to turn the call over to Mr. Vince Foster.

Thanks, Gus. I'd like to thank you all for participating in today's call. I'll begin by providing an update on our investment portfolio, then discuss our dividend outlook for the remainder of the year, and conclude by commenting on our liquidity and the current investing environment. Following my comment s, Todd Reppert will cover our fourth quarter and full year financial results and we'll conclude with Q&A. Our portfolio performed consistent with our expectations for the fourth quarter. A few of our portfolio companies began to experience deteriorating demand for their products and services as one would expect in the current recessionary environment. Most of our companies remain fairly stable. Having said that, a few more companies began to experience revenue declines in the first quarter of this year, especially those that serve the energy end markets, we believe we are relatively well postured to face the current weak economic environment due to our strategy of generally not relying on bank or other third party debt financing when we structure our investments. As a result we have virtually no exposure to refinancing or interest blockage risk at the portfolio company level.

Five of our equity investments appreciated during the fourth quarter while nine depreciated. The net amount of depreciation during the quarter was approximately $2.9 million or just over 2% of our portfolio. As previously announced we closed 4 new investments during the quarter, totaling just over $13 million. Which makes us one of the more opportunistic investors in the lower middle market during the quarter.

Also as previously announced we exited our investment in transportation in general during the fourth quarter, consistent with our investment strategy and the way we intentionally structure our transactions, the Company used its free cash flow for the first several years following our investment to deleverage, which in turn gradually increased our equity value. After a sufficient amount of our debt was repaid a local bank refinanced the Company, retiring our remaining debt and redeeming our equity. This allowed us to realize a 23% cash and internal rate of return without having to sell the Company or otherwise find another equity sponsor. We expect this type of exit to continue as it has on a regular basis for the last several years.

Our dividend outlook for the remainder of the year remains unchanged. We expect to distribute between $1.50 and $1.65 per share this year with hitting the upper end of the range being a function of whether we recognize net realized capital gains during the year.

We declared our three monthly dividends relating to the second quarter last week the monthly declared were for $0.12.5 per share which equates to 1.50 annual rate. We currently expect that the entire second quarter dividend will consist of ordinary taxable income. We have an excellent liquidity position especially in the context of the current investing environment. We have current cash liquid investments of over 35 million as of today, and an unused bank credit facility of 30 million.

In addition, as previously announced we obtained access to an estimated incremental $60 million in low cost SBSC financing as a result of the stimulus bill. Assuming Congress continues to fund the SBSC program which through the end of 2009 with the legislation Obama just signed yesterday, I guess, this increase is effectively permanent.

We've begun the administrative process of receiving an irreplaceable commitment to draw a portion of the increased SBSC credit facility, which we expect will be finalized in the next few weeks. These three sources of liquidity leave us well postured to continue to opportunistically pursue sensible investments well into 2010. We are using an amount of our liquidity to repurchase our shares. We have repurchased just under 100,000 shares to date, pursuant to our previously announced repurchased program. And our officer, director group has been regularly increased in the ownership of our shares via the dividend reinvestment program.

The current investing environment we are seeing as favorable and challenging. It is favorable and that there fewer active providers of capital to the lower middle market. This is more pronounced in our geographic area. So where -- we're being presented with more opportunities for more sources than we've ever seen. At the same time it's challenging to determine which investment candidates have the earnings visibility in this economy to get us sufficiently comfortable that they can survive until the economy recovers without needing additional capital.

It's also challenging to price into the investment the risk associated with the economy, and its potential impact on a given company. Notwithstanding these challenges, we are working on several attractive deals and we expect to close 1 or 2 by the end of the second quarter.

We're exploring various initiatives designed to increase the amount of our third-party management fees which currently amount to $3.4 million per year. They're being generated by our wholly-owned management company. We are expending some G&A dollars as part of these activities but expect this investment to generate positive results. Fees from asset management activities will allow us to increase earnings in yield while using only modest amounts of our available capital.

With that I'd like to turn our call over to Todd to cover our financial results.

Thank you, Vince and good morning, everyone. Before I go into my prepared comments, I want to note that the 2008 Form 10K will be filed later today. We will also post an updated year-end investor presentation on our website that I'd welcome you to take a look at. I intend to cover a few high level items today, and focus on the results for the fourth quarter and full year. As Vince mentioned, we're beginning to see deterioration in earnings in certain portfolio companies, although the reduction in operating performance within the portfolio has not been significant to date. We expect the negative earnings trend to continue during 2009, as the economy experiences what will undoubtedly be a very difficult year. The keys for Main Street are to stay focused on managing our portfolio and to appropriately utilize our liquidity and capital flexibility.

With regard to managing the portfolio, our investment strategy has always been to invest in the first lien debt position with low leverage metrics and to maintain reasonable liquidity, both within our portfolio companies as well as on our separate balance sheet. At year end 2008 we had the first lien position in over 90% of our debt investments, we had a net debt to EBITDA ratio of around 2-to-1, over our portfolio and we had over 23 million of combined cash liquidity on our portfolio companies separate balance sheets. We believe our investments are well positioned and we will continue to work with our portfolio companies to manage through this economic cycle.

A strategy established when we started Main Street, a very manageable growth in both our portfolio and our dividends has positioned us with appropriate liquidity and flexibility to not only weather the current economic environment but also take advantage of an eventual cycle recovery. As we have noted for several quarters, we continue to expect slower portfolio growth in the near-term due to our focus on being highly selective and prudently deploying our existing liquidity. Investments today have to meet fairly strict internal hurdles regarding structure, industry and other factors which are all focused on risk mitigation given the difficult economy.

Let me now turn to the fourth quarter and full-year operating results, for the full year of 2008, total investment income increased approximately 39% over 2007. Fourth quarter total investment income increased approximately 22% over the comparable period of 2007. Both of these increases were driven by greater interest income from net growth in our debt investments as partially offset by debt investments on nonaccrual status. We continue to have very little non-cash or paid in kind interest income, so virtually all of our interest income is paid in cash on a monthly basis. The increases and total investment income were also significantly impacted by an increase in cash dividends from portfolio company equity investments, which approximated $3 million during 2008.

While we expect to receive cash dividend payments in 2009 and beyond, the amounts could vary significantly and will be dependent on portfolio company earnings and cash availability. It is reasonable to assume that cash dividends from portfolio companies will be lower during periods of greater economic stress like we expect during 2009. Consequently, we expect that total investment income and distributable net investment income could be lower during 2009 compared to 2008.

The distributable net investment income or distributable NII, for the full year 2008 was $1.21 per share and increased 66% from 2007. Fourth quarter distributable NII was $0.32 per share, an increase 10% over the comparable period of 2007. Distributable NII simply reflects net investment income before share based compensation expense which is a non-cash expense.

Fourth quarter and full year 2008 operating expenses included certain nonrecurring costs related to the voluntary reduction in the treasury based line of credit which increased interest expense by approximately $100,000, and certain first-time through costs related to the Section 404 Internal Control Requirements under Sarbanes Oxley. In addition, we are now breaking out on a separate income statement line item the reimbursement of the net overhead costs from the parent BDC entity to our wholly-owned investment manager. These reimbursed overhead cost our essentially employee compensation costs, rent, and other routine costs, net of the fees received for external investment management and advisory activities.

We project that our recurring general and administrative cost excluding share based compensation and interest expense will average around 700 to $725,000 per quarter. Our 2008 general and administrative costs, exclusive of interest and share based compensation were approximately 1.6% of average assets, which we believe reflects an appropriate level of cost efficiency.

Distributable net realized income for the full year of 2008 was 1.36 per share, and increase 9% over 2007. Fourth quarter distributable net realized loss was $0.08 per share principle due to the write-off of our investment in [WICKS,] which had been fully reserved in prior periods. The net realized gain for the year of 2008 represented realized gains from several successful exits completed during the year, partially offset by realized losses on two investments.

The $4 million change in net unrealized depreciation for the full year 2008 was significantly impacted by $2.9 million of accounting reversals for previously recorded unrealized appreciation or depreciation related to the realized gains and losses recognized during 2008. These accounting reversals are required to be reflected in the net unrealized depreciation for GAAP purposes but essentially represent an offset to the net realized gain recognized for the year. Excluding these accounting reversals during 2008, Main Street recognized gross unrealized appreciation on -- of 8.7 million on 13 investments and gross unrealized depreciation of 8.9 million on 9 investments as well as 900,000 of unrealized depreciation related to the affiliated investment manager. At December 31, 2008, the total fair value of our core portfolio was approximately 105% of the core portfolio at costs, which represents reasonable portfolio performance on the whole.

Now let me turn to liquidity and capital resources. We belive that our strong liquidity position and conservation capital structure remain distinct advantages in the current environment.

At December 31, 2008, we had approximately 40 million of cash and idle funds investments, which includes cash, plus highly liquid investments. Our three-year $30 million investment credit facility also remains undrawn and we are in compliance with all financial covenants. As discussed in our earnings release, we will also benefit from the SBIC borrowing capacity provided by the economic stimulus bill enacted last month. The stimulus bill immediately increased the debt cap for multiple affiliated SBIC funds from 137 million as indexed annually for inflation to 225 million.

While this increase in borrowing capacity will need to be shared among both SBIC funds managed by Main Street, we estimate that the increased cap will provide us with approximately $60 million of incremental borrowing capacity. We currently have 55 million of 10-year SBIC debt outstanding bearing fixed interest at 5.8% per year. In our view, the SBIC leverage including the recently increased borrowing capacity remains a strategic advantage. It has a long-term flexible structure and a very low fixed cost. Importantly, it also provides proper matching of duration and costs compared with our portfolio investments. The weighted average remaining duration of our portfolio debt investments is approximately 3.5 years compared to a weighted average duration of over 6 years for our SBIC leverage. This contractual duration analysis does not consider the ability to revolve or refinance our existing SBIC leverage into new 10-year tranches upon their maturity given our permanent equity capital structure.

Approximately 85% of the portfolio debt investments bear interest at fixed rates which is also appropriately matched by the low cost fixed rates applicable to our SBIC leverage. We have roughly an 800 basis point net interest margin when comparing the portfolio debt yield to the fixed cost of our debt. In addition, we estimate that the embedded value adjustment at December 31, 2008 for our SBIC debt facility will be in the range of $14 million if we had adopted the provisions of SFAS-159 related to accounting for debt obligation at their fair value.

December 31, 2008 our net asset value was 112.4 million or $12.20 per share. This represents a 5% decrease from NAV per share at year end 2007. I should also note that year end 2008 NAV per share was reduced by the accrual of $1.2 million for the January 2009 monthly dividend which was declared in December 2008.

Now let me cover a few key portfolio statistics as of December 31, 2008. We continue to provide these statistics for better transparency regarding important metrics related to our portfolio. Consistent with our investment strategy, approximately 84% of our investments at cost were in the form of secured debt investments. And over 90% of our debt investments held the first lean security position. A weighted average affected yield on our debt investments was 14%.

Main Street continues to hold meaningful equity positions and the vast majority of its portfolio companies with the average fully diluted equity ownership equaling 25%. The weighted average net senior debt to EBITDA ratio for the portfolio was 2.1 to 1 on the basis disclosed in the earnings release or 2.7 to 1, including portfolio company debt which is junior to Main Street's debt position. The portfolio debt to EBITDA ratios improved subsequently during 2008, principle due to new investments having lower leverage metrics consistent with our stricter underwriting criteria given the economic uncertainty. Lastly, the weighted average EBITDA to senior interest coverage was 3.4 to 1. All of these portfolio level credit metrics remain very favorable compared to the broader credit markets, which we believe reflects a lower underlying risk profile.

Now, I'm going to turn the call back to Nicole, so we may open the lines for Q&A.

Thank you, sir. (Operator Instructions). Our first question comes from the line of Vernon Plack with BB&T Capital Markets, please go ahead.

Could you confirm for me activity in the fourth quarter, I believe, that you mentioned you had 13 million in new investments? I'm wondering also about the total amount of repayments or exits.

We had one exit, the transportation general exit, and to quantify that that was probably in the neighborhood of $3 million.

Okay. So 13 million in terms of new investments and 3 million in terms of exits.

Right.

And nonaccruals, I know you had one nonaccrual at the end of Q3, Carlton Global. Is that the only investment that you still have on nonaccrual?

No, Vernon, at the end of the fourth quarter, the investment on nonaccrual is Hayden which is new for the fourth quarter on nonaccrual. And Carlton Global we fully reserve in the first quarter, wrote it down to zero. We don't classify that as nonaccrual. But it's fully reserved and we're in liquidation mode as I think we discussed in prior calls.

Okay. All right. Thank you.

Thank you. Our next question comes from the line of Robert Dodd with Morgan Keegan. Please go ahead.

Hi, guys. On the portfolio credit quality issue. Obviously the economy's bad, but looking at now the average rating is 2.4, it was 2.2 last quarter and before that, 2.0. Are there any particular companies -- Hayden is an issue now that having specific problems, or is that just a general trend down with economic sensitivity?

There's probably a couple of companies that are having a rougher time than others, what's happening is a lot of them are kind of working off backlog, if you will. It was kind of pre- the fourth quarter. And the issue's going to be the extent to which they can replace it and at what margin. Our Company that has a lot of exposure to new commercial construction in Vegas is having a tough time. That's about the only one that kind of stands out as one where we're spending a lot of time on, but everything else is for the most part hanging in there reasonably well given the environment.

Okay. Got it. And then --

Robert, just to clarify real quick, the rating scale that we have, one is the highest five is the lowest. Two going to 2.2, 2.4 is an improvement not a decrease. Some of that is being driven also by the fact that new investments come in at a 3 because they're hitting our original expectations when they're brand new.

Got it, yes. On the external fees you mention, you're trying to increase SG&A a little bit to get more income from your investment manager. What is it you're looking at doing there. You're proposing to stop managing more external funds or do some consulting. Can you give us some color on what you're considering in that area?

We have a few confidential initiatives we're working on. Essentially we have a -- we built up a very strong back office capability to help manage or oversee investments, and we think we could easily -- for example, the 3.3 million a year we received from managing the second SBIC, we had to build a big fixed overhead structure to be able to do that. And to be able to manage another similar fund, for example, would not require much at all in the way of additional overhead. So any fee income we received would just drop to the bottom line. And there's a lot of activity out there as you can imagine, people trying to raise alternative sources of capital. And at least in our geographic area, we kind of stand out as someone that's very capable in terms of being able to help administratively if someone is able to raise that capital. So we're having those kind of discussions with various investment banks, third-party manager groups, et cetera. So it's that type of thing, and in the G&A we're talking about expending this year is just some diligence G&A, legal G&A, et cetera, because there's setup time involved. We're pretty excited about the prospects there, and we expect to see some favorable activity in 2010.

Okay. Got it. Thank you.

Thank you. Once again, ladies and gentlemen, if there are any additional questions, please press the star followed by the one on your touch-tone phone. And as a reminder, if you are using speaker equipment, please lift your handset prior to pressing star 1. Our next question comes from James Altschul with Aviation Advisory Service .

I apologize if this question is superfluous, because I just started considering your company as a potential investment. I am currently a stockholder in two well known BDC's, and their focus is heavily, if not exclusively on loans arising from LBO and similar transactions, are you -- is your focus more on providing debt with a refinancing otherwise, to lower market or middle market companies, that need debt to expand and continue in business. Second are you seeing more opportunities because many of the banks to which some of your potential clients may turn are now basically out of the market?

Now, I mean the answer is yes to all of the above. We do provide expansion capital. We get involved a lot. We don't really provide a lot of capital to other sponsors that are trying to complete an LBO. So we view ourselves as more in the self-sponsored camp. So we generate our own investment opportunities. It could be expansion capital. Frequently, our transactions are really more appropriately recap type transactions, where a father would like to retire and sell the business to the son, the son doesn't have money, which is kind of obvious in a lot of situations, to accomplish that, so we'll team up with the son to provide the family the capital to help with that generational transfer. There could be a couple partners that started a business that's successful, they want to go separate ways, to your point the banks have a really hard time financing that type of activity, so I think you're right, where the banks kind of leave off. And in the lower middle market. That's anything more than asset base financing. Anything the company needs over and above that is where we would kind of kick in.

Thank you. Our next question comes from the line of Vernon Plack with B&C&T Capital Markets. Please go ahead.

Thanks again. I just wanted to make sure I heard you correctly confirm you think there's a good chance that net investment income for '09 will be lower than '08?

Yes, I think what the message is is that when you look at the interest income component of net investment income, that's going to be more of a function of the number of -- the size of the portfolio, it's the dividend component that we see as more volatile because we have some companies that had a really strong -- some really strong quarters for '08 and distributed dividends, we're not sure that they're going to be -- that we -- you shouldn't view them as necessarily recurring.

Vernon, the numbers we gave in the press release today are -- there's about $3 million of dividend income for the year in '08, came from equity investments. If you look at our total income, that's plus or minus 20% for the total income for the year. And that is equity distribution type income which as Vince said could be more volatile particularly if the earnings declined that we expect in '09 in these companies occurs.

And the other thing, Vernon. Our typical investment is into an LLC, and so on the equity side, the dividend income you receive initially is tax related. Typically these LLC agreements will provide that distributions will come out sufficient to cover the tax liability of the owner, and so as taxable income is volatile in light of those tax related dividends, in addition, we've received some dividend income over and above tax distribution related distributions. Or related dividends, so --

That's kind of the message we're trying to get across.

All right. And based on what -- how you feel right now, what you're seeing, are you expecting net portfolio growth this year or do you expect portfolio to be flat or down a little bit?

I think we definitely expect growth, and I -- if I had to pick a number it might be -- we did $13 million on a gross additions, roughly in the fourth quarter, I wouldn't be such if on average that happened, throughout '09.

Thank you.

Thank you. Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the one on your touch-tone phone. As a reminder if you are using speaker equipment, please lift your handset before making your selection. And there are no further questions at this time. I'd like to turn the call back over to Mr. Foster for closing remarks.

Great, well, again we thank you all for participating. And we will talk to you again in May.

Thank you, ladies and gentlemen, that does conclude our conference for today. Thank you so much for your participation. You may now disconnect.