Main Street Capital Corp (MAIN) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Main Street third-quarter earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded Friday, November 5, 2010.

I would like to turn the conference over to Ben Burnham with DRG&L. Please go ahead, sir.

Thank you, Sharnay, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation's third-quarter 2010 earnings conference call. Joining me today 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 that details the Company's quarterly financial and operating results. This document is available on the Investor Relations section of the Company's website at www.mainstcapital.com.

A replay of today's call will be available beginning about an hour after the completion of the call and will remain available until November 12. Information on how to access that replay is included in yesterday's press release. We also advise you that this conference call is being broadcast live through an Internet webcast system that can be accessed on the Company's webpage.

Please note that information reported on this call speaks only as of today, November 5, 2010, and therefore you will find that time-sensitive information may no longer be accurate as of the time of any replay listening.

Our conference call today will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on Management's estimates, assumptions and projections as of the date of this call, and they are not guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties, and other factors including, but not limited to the factors set forth in the Company's filings with the Securities and Exchange Commission.

During today's call, management will discuss non-GAAP financial measures. Please refer to yesterday's press release which can be found on the Company's website for reconciliation to the most directly comparable GAAP financial measures.

And now with that, I'd like to turn the call over to Vince.

Thanks, Ben. And thank you all for joining us today. I will provide an update on the performance of our investment portfolio, discuss our dividend outlook and conclude by commenting on the current investing environment and other important recent developments.

Following my comments, Todd will cover our third-quarter 2010 financial and operational performance, discuss our liquidity position and we will then take your questions.

We were pleased with the performance of our investment portfolio during the quarter. Our portfolio of company investments appreciated during the quarter by $3.7 million on a net basis, with 19 of our investments appreciating during the quarter and 8 depreciating. We finished the quarter with a net asset value per share of $12.73, an increase of $0.52 a share from the second quarter.

Turning to our dividend outlook, we expect to declare monthly dividends for January, February and March 2011 next month. We expect to keep the dividend unchanged at $0.125 per month, equal to $0.375 for the first quarter of 2011.

We currently estimate that approximately 24% or $0.27 per share of our year-to-date dividends through September 30, 2010 will be characterized as long-term capital gains for tax purposes.

We also estimate that we will be in an undistributed or carry-over taxable income position of roughly $1 million as we enter 2011.

Our [officer/director group] has continued to increase their ownership of our shares via our dividend reinvestment plan acquiring over 19,000 shares during the quarter.

We have been expecting for some time that as year-end approached, the intended expiration of the Bush era tax cuts -- or given the intended expiration of the Bush era tax cuts, that our transaction activity would accelerate, and that has finally happened. We are working to complete six transactions for which we have executed term sheets by year-end.

We also invested $10 million during the quarter in privately-placed debt investments and another $12 million subsequent to September 30. We exited one privately-placed investment during the quarter for a small gain.

Also during the quarter, after being approached by representatives of the New York Stock Exchange, we applied for and were approved to list on the NYSE. We began trading on the NYSE last month, under our legacy ticker symbol, MAIN.

Also during the quarter, the SBIC pooling price set a record low fixed-rate to investors of 3.215%. This translates into a 3.6% fixed-rate to us after taking into account SBA fees. We had earlier this year drawn $45 million in SBA leverage that priced at the fixed rate in the September pooling.

For over a year, I have made references in my remarks about various initiatives we have been exploring to increase our fee income by leveraging our platform. Last week, we signed an agreement to provide investment management assistance to a BDC that is in the registration process. Assuming among other conditions that their registration statement is declared effective by the SEC, we will be in a position to discuss this opportunity in more detail on our next call.

At this point, I can say that we are very excited about this opportunity. For this and other reasons, we recently filed for and were granted registration by the SEC to become a registered investment advisor.

With that, I would like to turn the call over to Todd to cover our financial results.

Okay, great. Thanks, Vince. During the third quarter of 2010, we significantly increased our liquidity position through an accretive follow-on stock offering, the expansion of capacity under our credit facility and through additional SBIC borrowings.

The stock offering was completed in August at a meaningful premium to our NAV per share and added approximately $46 million to both our liquidity and equity capitalization.

The expansion of our credit facility which closed in September provides several benefits to Main Street including the following -- an increase in the total committed facility size to $85 million from $30 million, higher advance rates applicable to eligible investments, the addition of three new participants further diversifying our lender group, an extension of the maturity date for the credit facility to September 2013, and lower interest rate pricing to 2.5% above LIBOR with no contractual floor. The credit facility also has an accordion feature that allows us to expand its total capacity to $150 million subject to certain conditions.

During the third quarter, we borrowed $35 million of additional SBIC debentures through our SBIC subsidiaries. As Vince mentioned, we locked the interest rate on all of our 2010 SBIC debenture borrowings at a very favorable rate of 3.6%, including annual SBA fees for their ten-year term.

Therefore, at September 30, we had over $100 million of total cash and cash equivalents, marketable securities and idle funds investments, no borrowings under our new credit facility and $45 million of remaining debt capacity through the SBIC program.

As Vince noted, we are seeing a heightened level of qualified new investment opportunities moving towards the end of the year. We currently have six executed term sheets for new core portfolio investments, representing over $45 million of total investment that are in the due diligence or documentation phase of completion.

In addition, we continue to opportunistically invest in privately-placed debt investments and have invested $12 million in that portion of our portfolio, subsequent to the end of the quarter.

While the pace and timing of new originations is always difficult to predict, we expect that our favorable liquidity position and strong investment pipeline will allow us to grow our investment portfolio, as well as our distributable net investment income, during the remainder of 2010 and into 2011.

We also continue to be pleased with the relative performance of our portfolio on the whole. The majority of our portfolio companies continue to see modest growth in revenues, earnings, order flow and backlog, albeit at levels still below those generated prior to the recession.

Total portfolio fair value equals approximately 109% of cost as of September 30 and we had two loans on non-accrual status representing 2.7% of the portfolio at fair value, and 3.7% at cost. At September 30, our net asset value was approximately $238 million or $12.73 per share, which represents a 4% increase over June 30, and a 6% increase over year-end 2009.

Now moving to a few comments regarding the third-quarter operating results. For the third quarter 2010 total investment income increased approximately 100% over the same period in 2009. This increase was principally driven by Main Street Capital II's contributions subsequent to the January 2010 Exchange Offer, as well as higher levels of interest income from growth in our debt investment portfolio.

Comparisons to the third quarter of 2009 are also impacted by a special dividend received from a portfolio company, which increased income by approximately $0.08 a share for that period.

Third-quarter 2010 operating expenses increased by $2.3 million, compared to the same period of 2009, primarily due to interest and other operating expenses related to Main Street Capital II's subsequent Exchange Offer.

Main Street Capital II's Exchange Offer continues to be an accretive acquisition and has positively impacted our 2010 results. Distributable net investment income for the third quarter of 2010 was $0.30 per share, which increased from $0.28 per share in the same period of 2009.

Excluding the impact of the non-recurring special dividend received in the third quarter of 2009, distributable NII per share increased 50% on a year-over-year basis.

While the dollar amount of distributable net investment income increased 73% over the prior year, the per-share increase was lower due to higher average shares outstanding given the two 2010 follow-on stock offerings, as well as the shares issued to complete the Exchange Offer. All other 2010 per-share measures were similarly affected by the higher weighted average shares outstanding.

Distributable net realized income for the third-quarter of 2010 was $0.21 per share, compared to $0.30 per share during the same period of 2009. The $1.5 million net realized loss for the third quarter of 2010 principally related to the sale of our investment in Advantage Millwork, which was partially offset by realized gains on the sale of a few private placement and marketable securities investments.

During the third quarter, we recognized $4.6 million of unrealized appreciation in 19 portfolio company investments, and just under $1 million of unrealized depreciation in eight portfolio company investments.

The net change in unrealized appreciation for the quarter also included $1.6 million of accounting reversals, related to the net realized loss previously mentioned, and $3 million in unrealized appreciation from the fair value adjustment of SBIC debentures issued by Main Street Capital II.

Now let me finish with a few portfolio statistics all as of September 30 that are also summarized in the earnings release.

Consistent with our investment strategy, approximately 78% of our core portfolio investments at cost were in the form of secure debt investments, and approximately 86% of those debt investments held the first lien security position.

The weighted average effective yield on our core portfolio debt investments was 14.9%, and Main Street holds equity positions in 90% of its core portfolio companies with an average fully diluted equity ownership of 34%.

At the portfolio level, the weighted average net senior debt-to-EBITDA ratio was 2.6 to 1 or 3.4 to 1, including portfolio company debt, which is junior in priority to Main Street's debt position. In addition, the portfolio-level weighted-average EBITDA to senior interest coverage was 3.1 to 1.

In the private placement portfolio, we had 10 debt investments representing approximately $38 million of fair value as of September 30 that were generating a weighted average yield of approximately 13.5%

With that, I'll turn the call back to the operator so that we may take any questions.

Thank you, sir. We'll now begin the question-and-answer session. (Operator Instructions). Robert Dodd, Morgan Keegan.

On the outlook portfolio, I mean, are you getting any feedback from your portfolio companies regarding early repayment of debt or accelerated equity buybacks or anything like that in terms of them refinancing at more favorable rates now given the lending environment?

Yes, Robert, that's a good question. What we continue to see, and we've seen it for over a decade, is that when you're in sub-$5 million EBITDA land where we -- generally, where we live, senior cash flow debt is really not available and really hasn't been available. Really, it even wasn't impacted too much by the credit crisis.

On occasion, a few lenders will stop by and talk to our senior lenders and say, they might be interested in dipping down below $5 million in EBITDA. But, it's really had no significant impact and no momentum.

Because we have a significant equity position in these companies, we are not really -- we are kind of agnostic if it were to happen because the value of the equity would go up if you lower the cost of debt financing. But having said that, we haven't seen it, we don't expect to see it, haven't seen it again in a decade.

What we do see is when the companies delever to the point of about, let's say, one times, one and a half times EBITDA and there's asset coverage, not necessarily ABL type of coverage, but asset coverage, then a bank might move in and take us out. But generally, that's three, four years into the investment.

Okay. Following on from that, what about the, given the -- kind of improving trends there, what's the outlook for dividend to you from your portfolio company?

I think the outlook is excellent because they are becoming taxpayers again. Most of our entities are LLCs and at a minimum contractually have to pay out 35%, 40% of their taxable income to the equity holders of which we are a significant equity holder.

So we expect to see a steady increase in tax-related dividend payments coming to us. Dividends over and above the 40% of taxable income are rare. They do happen but they are rare because generally our management teams would rather take that excess cash flow and delever as opposed to pay dividends. But yes, we expect to see that as a flowing, increasing source of dividend income for us on a GAAP basis.

Okay, great. Thanks.

(Operator Instructions). Vernon Plack, BB&T Capital Markets.

Todd, I wanted to make sure that -- you may have mentioned this number and these numbers but I may not have gotten them. What were the total amount of investments during the quarter and the total amount of repayments and exits?

Yes. It will be in our cash flow statement, but the total amount of investments was probably in the $14-million range.

Okay.

And maybe $14 million to $15 million. And the repayments were in the $10 million to $12-million range.

Okay.

So it was a pretty light quarter on both fronts.

All right.

Obviously we think, based on what we've said, the fourth quarter will be stronger albeit weighted towards the end.

Sure. And did I hear you correctly? Did you say that distributable net investment income on a per-share basis will be higher in the fourth quarter versus the third quarter?

No. I don't think I've said that in my comments. Obviously, to the extent we close some additional transactions in the fourth quarter we do think that number will be higher and we certainly expect to close transactions.

What I'd tell you is that because of the timeline, I think that the bigger impact from the stuff going on right now or the new investments that we are making right now will be in 2011.

Okay. So what did you say? Just so that I am clear. You mentioned something about -- I think net interest income being higher at some point, and I just want to make sure I understood what you said.

I think all I was saying was based on -- we go in cycles to raise capital and deploy capital --.

Sure.

I don't have a long term plan in that regard, and all I'm saying is that we are positioned with a very favorable liquidity position right now, which we expect to deploy into a favorable investing environment, and grow our portfolio and distributable net investment income over the next one to four quarters.

Okay, great. Thank you very much.

Sure.

Jim Stone, PSK Advisors.

Good morning, gentlemen. In terms of what you are saying, the comment you just made of one to four, are you saying that in general you're looking to do a raise per year?

No, I don't think we are saying that. We have -- in terms of our remaining SBA debentures, we can draw on our unused credit facility and our current liquidity, we have enough capital to -- depending on exits which sometimes we can control, sometimes we can't, to take us well into next year.

I wouldn't be surprised if we didn't do an offering next year and I wouldn't be surprised if we did. It just depends on how quickly and profitably we can deploy this capital.

Okay, but I'm just wondering as a philosophy, it seems you are talking about in essence, a raise once per year, maybe it's an 18-month cycle, you know whatever but --.

Yes. I think if we continue to see good opportunities for investments, what you can expect us to do is draw down on our revolving credit facility once we are maxed out on the SBA facility, draw down on that and then repay it with an equity raise when the stock price is favorable in the follow-on investment or the follow-on environment is favorable, and then use that revolving credit facility to build back up again. So, yes, an every 12 to 18-month cycle is probably a reasonable assumption at this point.

Okay. Next question. The distributable net operating, if I heard the numbers correctly, seems to be lower than what was actually distributed. And I'm wondering if I heard correctly and if I am, what does that imply about the future distributions?

Right, that's a good question. You have to start with our capital gain policy. When we generate a capital gain, we have the option as a BDC-regulated investment company to retain the capital gain and distribute, in effect, a tax credit, pay the taxes on it and distribute a tax credit to the shareholders, or distribute the capital gain. And our policy is, is and has been to distribute the capital gains.

We have significant appreciation in the portfolio. The portfolio appreciated $3.6 million or almost $0.20 a share during the quarter. So the way I look at it is, we will never -- since our policy is to distribute capital gains and our intent is to harvest capital gains on a regular basis, our dividend almost by definition, will always be more than our net investment income because our dividend is equal to our net investment income plus our capital gains.

The way I manage the company, the way I look at it is we earned $0.30 of net investment income during the quarter, the portfolio appreciated another approximately $0.20 that is available to harvest sometime in the future, and we distributed $0.375.

I think the important metric is which way the portfolio is heading in terms of appreciation or depreciation. And also, whether or not we are able to exit these investments at or close to how we have them marked, and we have had a history of being able to do that. So it's kind of complicated but I hope that --

Right.

I hope that sheds some light on it.

I do. I appreciate the clarification and keep up the good work. Thank you.

Thank you.

JT Rogers, Janney Montgomery Scott.

Hi, good morning. Just had a couple of questions. First, I'm sorry if I missed this, but what kind of yields or returns are you seeing on new investments coming down the pipeline?

Well, because we are still using our SBA facility and because we are doing generally a combination of debt and equity and we don't like to use a lot of [pick], we are governed by an SBA ceiling of 14% interest. And to give us ourselves some cushion there in case there is some extra fees down the road, we stay in that 12%, 13%-coupon range. It's a fixed rate of interest, almost always that we charge, and that really hasn't changed in years. So we've kind of been in that 12%, 13%.

The actual economic yield on the debt investment depends on whether or not the equity component is a warrant, which creates OID which increases the yield. It depends on fees, how much we are capitalized, depends on whether or not the equity component is straight equity.

So what you'll see is our yield. Our economic yield is a couple of hundred basis points, wouldn't you say, Todd, above our coupon, typically.

Yes, which that doesn't include the equity component which obviously stand on average (multiple speakers) --

That's just on fixed income.

On average, we have 34% and that's a blend of direct equity plus warrants. So I think, JT, to answer your question, we are seeing it in the same range as we have been seeing it forever and probably won't see a big change in our market, and the real push back and forth becomes how much equity do we own in these companies just to get in the market.

Okay, great. Then I was wondering if you all had an update on HR 3854, if you are hearing anything in terms of progress on expanding the FDIC license?

What we hear from our trade association is that they expect on the next Congress to enact something they think that -- now, who knows what happened after last week. I mean, I don't think it has hurt the prospects but the committee maybe get repopulated and -- particularly in the House.

But I think what they are predicting is that within the next 24 months, we are going to get some legislation that would increase the present cap of $225 million to maybe as high as $325 million, maybe a little higher. And they might stair-step it where if you have two or more license, that might be $250 million or $275 million; if you have three SBIC licenses, it might go up to the full $325 million or $350 million.

That's what we're hearing from our trade association as they talk to their contacts on the Hill. So there seems to be bipartisan support, at least there was before the election. But given everything else Congress had to work on, this hasn't really been a high priority.

Great, thanks. And then just this last question. I don't know how much you can talk about it now. But how is the investment management business going to work for you all providing assistance to other BDCs?

Yes. The way it's going to work is that we are -- obviously, we are an internally-managed fund, we are an internally-managed BDC. And so if to the degree that this contract that we entered into actually go live -- actually goes live, which means the counterparty becomes declared effective by the SEC and begins to raise capital, we will manage that capital for them for a fee. And the way to think about it is our internally-managed BDC will be an external manager for that externally-managed BDC, if you follow me.

And typically the market for that is a 2/20 type of compensation structure, 2% of the assets under management per year, 20% incentive fee over hurdle. I think almost all of the externally-managed BDCs are under a formula fairly close to that and this would be too. And then we would not be entitled to the entire 2/20, we would be entitled to a component of it in exchange for making investment recommendations etc.

But we're very excited about it. And of all the conversations we've had over the last year with other parties, that wanted to tap into some of the expertise we've built here. This seems to us to be the best fit and the most exciting and could really have a material impact on us if things go as expected.

Brian Harvey, Ladenburg Thalmann.

Good morning, Vince. My question was actually the same regarding that arrangement. It sounds like you'll be taking some fees and potentially some upside in the 2/20 arrangement, so you won't be contributing equity, just expertise?

That's correct. The way this works is that there are some expenses we will incur, sub-million dollars, let's say, that get reimbursed when -- because the Company doesn't, it's really not allowed to reimburse prior to it raising capital, etc. And I think on a net basis, we could potentially have zero investment in it.

And will we add more resources? It depends. I mean, to the degree that the capital under management that we're assisting and advising really grows, yes, we'll have to add some resources but it would be more on the SG&A front.

Okay. And that's what I was looking for. Thank you.

You bet.

George Berman, JP Turner & Company.

Good morning, gentleman. Thanks for taking my call.

You bet.

A couple of questions. First, how do you derive at the valuation of your investments? I understand that most of your companies are not publicly-traded.

That's true. So our valuation process, which is discussed at length in our 10-Q, I guess, which will be filed today, is as follows.

The portfolio company management team that originates and operates the investment and eventually exits the investment for us here, we have three autonomous teams, will come up with a valuation of the debt and the equity on a quarterly basis. That valuation is reviewed by the senior management here, which is Todd and I, the guys in our accounting staff.

Secondly, it's reviewed by our audit committee and then our full Board. It's also reviewed by Grant Thornton, our external auditor. They bring in their valuation services group to review the work.

And then on top of all that -- well, we have a big four accounting firm whose valuation group provides us valuation services to add comfort to the process both to our Board, our Management, and the external auditors.

So there are several eyes that look at it. It's like painting the battleship. As soon as the process ends, it almost starts again for the next quarter.

And in general right now for most of the companies, we're valuing the businesses very similar to how we are buying them. We try to buy them currently at four to five times EBITDA. We believe once we've sponsored them, diligenced them, tried to improve, professionalize them a little bit, that value is enhanced. But we're pretty reluctant to take the multiple up and instead our valuations really fluctuate based upon the EBITDA performance of most of the companies.

The original or the management team of those individually invested companies is autonomous though, correct?

We have worked together and they are our employees. But, yes, they work in three different autonomous teams that manage most of the portfolio company investments.

The portfolio company investments, they have their own management team. You would essentially either extend a loan or put some equity in.

No, our companies absolutely have their own management teams that operate the companies.

Right.

I was talking about -- but they don't really get involved in their own valuation. Our management team that oversees those investments gets involved in the valuation.

And the exit strategy most likely would be if the individual company is then sold to a larger entity or do you have IPO exit eventually also?

No, I think the exit strategy primarily is that if you -- when you go back to Todd's leverage characteristics that he talked about, on average, the companies are leveraged about two and a half times their EBITDA to us, and so our debt will be exited if you will through the cash flow of the company. It might take three years, it might take seven years. At some point, we kind of don't care because we're collecting a nice rate of interest. And then once that company delevers or that leverage is replaced by much cheaper bank debt, then the company is in a position through its own cash flow to redeem our equity.

So if you've looked at most of our exits, it's really the company recapitalizes itself and takes us out of the debt and the equity without the need for us to go sell the company.

Now, on occasion, we'll have an offer from a larger company to buy one of our companies and we have done that. And once in a while we will conduct an auction, and hire an advisor and sell one of our companies to maybe another financial sponsor. Generally, our companies are going to be too small to have an IPO exit.

Although, we've had situations where a newly-public company that wanted to consolidate its industry would take its IPO proceeds and buy one of our companies. But generally, when we underwrite these transactions, it's to not need to rely on a sale of the company in order for us to have a nice exit and have a nice return.

Vernon Plack, BB&T Capital Market.

Yes, hi, Vince. Just wanted to get some thoughts on -- I'm looking at the investment philosophy going forward in terms of core assets versus your marketable -- the marketable securities.

And what are you thinking there? I think I heard Todd mention that there was I think $12 million that you have already invested this quarter. Just maybe a few comments would be helpful.

Sure. The nomenclature gets a little confusing so let me clarify it. What you are referring to as our core is really the investments generally that are held by the SBICs. They are self-originated deals that we have financed, smaller businesses, etc.

The marketable security bucket is really just for example on how we invested our follow-on proceeds to earn a decent yield as opposed to zero on the cash pending it being invested in the first bucket. And the private placements are very similar to the first except -- again, what we are seeing is a somewhat larger company who has to renew a credit facility and the original providers of that credit might have been a CLO that's not in a position to renew it, it might have been (inaudible) company, it might have been a bank, and they have to go to the private placement market.

We will participate in a club deal and three or four or five of us will provide that company $25 million, $50 million worth of financing. We're taking a similar -- it has a similar credit profile, it has a similar yield. It doesn't have the equity component but it's a highly attractive asset class right now and it literally comes to us. And we think it diversifies the first bucket, Vernon, because these are larger companies, more resilient.

These companies do in fact have the ability to exit, be an IPO, maybe refinance us or not. A lot of these companies might have a single-B credit rating, a double-B, and some of them are unrated. But we have the ability to see those credit characteristics improve fairly rapidly, see some appreciation in the investment which we've harvested.

So to answer your question, in terms of philosophy going forward, if that market continues to be available for us, we like it and we are going to continue to invest in it. I'm not sure it's going to be available. If we go back to '07-type of credit environment, that's not an attractive asset class and we won't participate in it. But you're seeing such good companies offering such compelling rates that we really think it's in our best interest to deploy capital there.

Okay. Thank you.

Yes.

Thank you. (Operator Instructions). And I am showing no other questions at this time. I'll turn the call back to management for any closing remarks.

Okay, well, we thank you all again for your participation and we will talk to you on the next call. Thank you.

Thank you. Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and you may now disconnect.