Main Street Capital Corp (MAIN) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Main Street Capital second-quarter earnings conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

Today's conference is being recorded August 5, 2011. I would now like to turn the conference over to Ben Burnham with DRG&L. Please ahead.

Thank you, Alicia, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation second-quarter 2011 earnings conference call.

Joining me today on the call are Chairman and CEO, Vince Foster; President, Todd Reppert; and Dwayne Hyzak, Main Street's new Chief Financial Officer.

Main Street issued a press release yesterday afternoon that detailed the Company's quarterly financial and operating results. This document is available on the Investor Relations section of the Company's website, at www.MainStreetCapital.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 August 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, August 5, 2011, and therefore you will find that time sensitive information may 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 a reconciliation to the most most directly comparable GAAP financial measure.

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

Thanks, Ben, and thank you all for joining us today.

I will comment on the performance of our investment portfolio, discuss our recent dividend announcement, and conclude by commenting on the current investing environment and other recent developments. Following my comments, Todd will cover our second-quarter 2011 operational performance in more detail and our current liquidity position. Then Dwayne Hyzak, our recently promoted Chief Financial Officer, will comment on our same-quarter financial results, and then we will take your questions.

Our investment portfolio delivered strong performance for the quarter. Our investments appreciated during the quarter by $11.6 million on a net basis, with 39% of our investments appreciating during the quarter and 15% depreciating. And our marketable securities portfolio appreciated $0.5 million during the quarter as well. We finished the quarter with a net asset value per share of $14.24, a sequential increase of $0.34 a share from the first quarter.

Our Lower Middle Market portfolio companies ended the quarter with $50 million in cash on their balance sheets, and an average to conservative net debt to EBITDA ratio of 2.5 to 1 to our debt position, and 3.1 to 1 including all debt.

Yesterday we announced that our Board declared an increase in our monthly dividend payout to $0.135 a share, beginning with the October dividend. This brings our quarterly payout rate to $0.405 a share, an 8% increase over the fourth quarter of 2010 payout rate. This is our second dividend increase this calendar year.

We estimate that 13% of our second-quarter dividends will constitute long-term capital gains for cash purposes, and that 36% of our dividends for the six months ended June 30, 2011, will constitute long-term capital gains for tax purposes.

Our officer and director group has continued to increase their ownership of our shares, be it our Dividend Reinvestment Plan in open market purchases, investing over $410,000 in our shares during the second quarter and over $750,000 during the first two quarters in 2011.

Our Lower Middle Market transaction pipeline is consistent with the levels we've experienced over the last several quarters. The transactions we are working on involve valuations and structures that are in-line with our past Lower Middle Market investments. And I would characterize the environment as stable and our approach as conservative.

We continue to seek significant equity participation in our Lower Middle Market investments, and currently average a 35% fully diluted ownership position in these companies.

Our private placement investing, focused primarily on buying and opportunistically selling Middle Market leveraged loans, has been very active. Originations have been very strong. We've had several profitable assets generating long-term capital gains in cases where we have the requisite holding period for tax purposes, and have maintained a net unrealized depreciation position over the last several quarters of these investments.

This activity has been accretive to our earnings per share, which helps drive our dividend growth. It also postures us to rotate into self-originated Lower Middle Market investment opportunities as they arise.

We are pleased to announce the recent promotions of David Magdol to Chief Investment Officer and Senior Managing Director; and Curtis Hartman to Chief Credit Officer and Senior Managing Director. Their careers with Main Street date back to our predecessor funds over a decade ago, and we look forward to their continuing contributions to the firm's success.

With that I'd like to turn the call over to Todd Reppert, our President, to cover our operating results and liquidity position in more detail.

Okay, great. Thanks, Vince, and good morning, everyone.

As a management team we are very pleased to report a record quarter for Main Street in terms of both our financial results and also our portfolio growth. The second quarter of 2011 included new investments in roughly $61 million within the private placement component of the portfolio, plus $10 million in Lower Middle Market originations.

During the first quarter of this year we generated a relatively higher level of Lower Middle Market investments, and conversely in the second quarter the new investment mix favored private-placement investments, which demonstrates the flexibility provided by our diversified investment strategy.

Clearly, private-placement investments are an increasingly important part of our strategy and represented approximately 30% of our total investment portfolio at fair value at June 30.

$61 million of new private-placement investments made during the second quarter are earning a weighted average yield of approximately 11%, and included in investments in nine new portfolio companies.

The $10 million of Lower Middle Market originations made during the quarter consisted of income-producing debt and preferred equity investments in two companies, earning a weighted average coupon of approximately 12%.

Since quarter-end we have also closed $8.5 million in new portfolio investments in two companies, and approximately 90% of these new investments since quarter-end were in the form of interest-bearing debt.

Our overall portfolio performance remains strong and the portfolio continues to be diversified by issuer, industry, end-markets, and geography. We now have well over 70 portfolio companies across the Lower Middle Market and private-placement components of our investment portfolio.

During the first half of 2011, most of our portfolio companies continued to see both sequential and annual growth in metrics such as revenues, earnings, order flow and backlog, with the levels of such growth being highly dependent on specific factors for each company.

The equity component of our Lower Middle Market investment strategy is also paying off in the form of a significant increase in dividend income from portfolio equity investments and over $11 million of net unrealized portfolio appreciation during the second quarter. As a reminder, we have equity ownership in 92% of our Lower Middle Market portfolio companies, representing an average fully diluted equity ownership of 35%.

Due to the portfolio appreciation and certain other factors, Main Street's net asset value per share at June 30 increased to approximately 2.5% during the second quarter and also increased approximately 9% from year-end 2010.

Turning quickly to liquidity, Main Street's liquidity and overall capitalization remain strong and we are well-positioned to take advantages of new investment opportunities. As of today we have over $160 million of cash, marketable securities and idle funds investments. Approximately $130 million of this liquidity is positioned in marketable securities with relatively attractive yields, and absent a meaningful market change, we intend to hold these marketable securities until rotation into the portfolio is necessary.

Our marketable securities portfolio consists of relatively liquid interest-bearing debt investments currently earning a weighted average yield of approximately 8%.

The increase in our total liquidity from June 30 reflects approximately $15 million of private-placement portfolio repayments since quarter end, combined with roughly $10 million of net growth within the marketable securities portfolio.

During June 2011 we completed an expansion of our credit facility to a total committed capacity of $155 million, including increased commitments by all six existing lenders. At the same time we also extended the maturity of the facility by one year to September 2014.

We expect to periodically increase the capacity and number of lenders within this facility as needed to support our operational and investment activities. However, we will remain very focused on maintaining liquidity [attrition], lender diversity, and duration flexibility through all of our borrowing arrangements.

As of today we have $103 million borrowed under the credit facility, which currently bears a floating annual interest cost of around 2.7%. We also have $210 million of outstanding SBIC debentures, with a weighted average fixed interest cost of around 5%, and a remaining weighted average maturity of approximately 7 years.

The SBIC leverage component of our capital structure remains a strategic advantage, and I wanted to note that Main Street was recently honored by receiving the 2011 SBIC of the year award by the US Small Business Administration. This award recognizes the strength of our financial performance as an SBIC and our positive regulatory and compliance relationship with the SBA.

We also remain focused on managing Main Street's operating cost archer and generally target keeping our total cash, operating and administrative expenses at or below 2% of our assets. This is part of the operating leverage in being structured as an internally managed BDC. We believe our cost structure is very favorable versus comparable public and private investment funds. And our favorable cost structure and operating leverage allows us to deliver a greater proportion of our portfolio gross returns to our shareholders.

Lastly, I'm pleased to announce that yesterday our Board of Directors appointed Dwayne Hyzak as Main Street's Chief Financial Officer, in an addition to his ongoing portfolio responsibilities. Dwayne and I are going to continue to work together closely in connection with his new role, and I have a high level of confidence in the Dwayne based on the decade or so of experience we have together at Main Street.

With that I will turn the call over to Dwayne to cover our second-quarter financial results and certain key portfolio statistics.

Thanks, Todd.

For the second quarter of 2011, total investment income increased by approximately 85% over the comparable period in 2010, to a total of $16.1 million. This increase was primarily driven by increased amounts of interest income associated with higher levels of portfolio debt investment and interest-bearing marketable securities and idle funds investments, and increased dividend activity from portfolio equity investments.

The increase included approximately $500,000 of nonrecurring investment income associated with prepayments and repricing activity from debt investment, and a $300,000 special dividend from one portfolio investment company in conjunction with a third-party refinancing transaction.

Second-quarter 2011 operating expenses -- excluding share-based compensation expense -- increased by $2.4 million over the comparable period in 2010, to a total of $6.1 million. The operating expense increase was primarily due to higher amounts of interest expense as a result of the issuance of $65 million of additional SBIC debentures since the end of the second quarter of 2010, and increased borrowing activity under our credit facility. The increase also included higher accrued compensation and other operating expenses associated with higher levels of investment activity compared to the second quarter of 2010.

Distributable net investment income for the second quarter of 2011 increased by 99%, to $10 million or $0.43 per share, in comparison to distributable net investment income of $5 million or $0.33 per share for the same period in 2010.

Excluding the impact of approximately $0.02 per share of nonrecurring investment income from prepayments and repricing activity from debt investment, and approximately $0.01 per share from the special dividend as previously discussed, second-quarter 2011 distributable net investment income was $0.40 per share.

While the dollar amount of distributable net investment income increased 99% over the prior year, the per-share percentage increase was lower at 30% due to higher average shares outstanding associated with the two follow-on stock offerings completed in August 2010 and March 2011. All other 2011 per-share measures were similarly affected by higher weighted average shares outstanding.

Distributable net realized income for the second quarter of 2011 was $10.3 million or $0.44 per share, which represented an increase of $2.6 million in comparison to the second quarter of 2010.

During the second quarter of 2011 we recognized $17.8 million of unrealized appreciation in 39 portfolio company investments and $6.2 million of unrealized depreciation in 15 portfolio company investments.

The net change in unrealized appreciation for the second quarter also included approximately $500,000 of net unrealized appreciation in our marketable securities portfolio; approximately $2.1 million of net unrealized depreciation attributable to our SBIC debentures; and a net income tax provision of $2 million, principally related to deferred taxes on the net unrealized depreciation of portfolio investments held in our taxable subsidiaries.

Now, let me finish with a few portfolio statistics, all as of 6/30. In our Lower Middle Market portfolio we had 49 investments, representing approximately $336.4 million of fair value as of quarter-end. Consistent with our investment strategy, approximately 76% of our Lower Middle Market portfolio investment at cost were in the form of secured debt investment, and approximately 92% of those debt investments held the first lien security position.

The weighted average effective yield on our Lower Middle Market portfolio debt investment was 14.8%. As Vince mentioned, at the Lower Middle Market portfolio level the weighted average net senior debt to EBITDA ration was 2.5 to 1, or 3.1 to 1 including portfolio company debt, which is junior in priority to Main Street's debt position. We expect these portfolio level statistics should generally improve over time as the operating results of our portfolio companies grow and they naturally delever.

In our private placement investment portfolio, we had 23 investments representing approximately $133.3 million of fair value as of quarter-end that were generating a weighted average yield of approximately 11%. Main Street's private placement investments are primarily in the form of debt investment, and approximately 69% of our private placement investment at cost held the first lien security position.

Total portfolio fair value as of June 30 was approximately 110% of cost at the end of the second quarter. And we had 2 out of 72 portfolio investments on non-accrual status, representing approximately 1.6% of the total portfolio investments at fair value, and 3.7% at cost.

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

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. (Operator Instructions)

Bryce Rowe, Robert W. Baird.

Hi, just wondering if you guys could cover prospects for continued or increased dividend income on your equity portion of investments?

Yes, Bryce, this is Vince. You know, we think that's going to continue, because most of our equity investments are in LLCs protect -- which is tax-sufficient with respect to the portfolio company and its shareholders. And therefore the dividends that would normally go to the government -- or the cash that would normally go the government for federal income taxes, state income taxes, is distributed to the shareholders. And it ends up being dividends for us because we are -- we don't pay tax, so it's a real favorable structure.

And so as the economy recovers and their taxable income levels go up, the tax-based dividend should go up over time, in addition to any underlying growth that gives rise to normal dividends. So, we feel pretty bullish about the dividend levels continuing to up.

And Vince, what -- if we think about dividend coming off of those investments, what portion of those equity investments are paying dividends right now? Did I phrase that well?

Yes. Dwayne or Todd, what would you guess? I would guess half, but I don't have that stat in front of me.

I would actually -- we can look it up, but I think it's more than half probably now, just because as Vince said, the tax -- I mean, there's a chunk of them that just paying profit distributions because they've delevered and are sitting there with a very equitized balance sheet. I would say it's probably 50% to 70% of the equity investments are paying dividends at this point.

Yes, we will get that out and try to put it on our Investor presentation.

Vernon Plack with BB&T Capital Markets.

Thanks very much. And Dwayne, do you have -- I know that the facility now is $155 million; do you have access to that entire amount?

Yes, Vernon, this is Todd; I will take that one.

The answer is, yes, obviously the facility has a borrowing base, and that borrowing base would allow us to have access to the entire amount. I mean, that's a big piece of why we want it to go up is that we had excess borrowing base in it, you know, in excess of the limit we had on the prior amount of the facility. So we went up and more right-sized it to the borrowing base.

Okay, great. I noted, Vince, you mentioned at the beginning of the call that -- you talked about the opportunities and a consistent pipeline and consistent structure, and I believe labeled the current market as stable. But was interested, really, on the exit side of things as it relates to gain harvesting. You -- the fair value of the cost of the portfolio is above -- the fair value is above the cost. And I just wanted to know your thoughts in terms of any plans, or just what you're thinking in terms of maybe harvesting some of the gains that you have in the portfolio.

You know, since we are typically not the control equity investor, Vernon, we don't unilaterally drive that decision. We have some portfolio companies that if it were up to us, I think it would probably make sense to look to potentially exit. But the management teams are very bullish and really aren't interested in doing that right now for the most part.

We do have a couple at almost all times that are kind of in the market, and I think we have at least one, if not two, that they actually have a formal process ongoing now. Who knows if they close this, who knows when they close?

So our posture is we encourage it; we don't insist on it. Our relationship with our portfolio company management is really one of the most important things we have, and we kind of leave it up to them.

And structurally we are protected because as you get to the end of the investment, our warrants without exception have puts at fair value. So when we get to kind of year six, then we are in a position to at least exit our component of the investment. And so if you think about it, the class of 2005 investments, generally speaking that are still in the portfolio, we would be in a position to harvest some of those.

So I think they are going to happen. On an annual basis we are going to have one, two, three, four exits a year. It's really hard to predict a quarter. I would be surprised if we went the balance of this year without some real good visibility on it. So that's kind of how I would characterize it. It's going to happen, it's hard to predict when, and we are not in total control over it.

Sure. No, that's very helpful, thank you.

Robert Dodd with Morgan Keegan.

Can you just give us a little bit more color, if any, on the change, if any, on terms you are seeing in the Lower Middle Market in terms of how much equity you guys are looking to or expected to put in -- and then obviously in the two forms and any PIK ratios or anything like that -- is that anything shifted or beginning to shift in that segment of the market?

You know, it's probably the tale of two types of transactions.

I do think that in the sponsored transactions, where they were out -- you know, they've won an auction and they were out, in effect, trying to auction unit tranche or the sub-debt piece or the second-lien piece. If you participate in that market, which we generally don't, I think those terms are tightening.

I think -- and who knows what happened over the last 72 hours, but absent that, I think the market is getting more competitive and I think yields are kind of dropping

I think in the self-sponsored world where we like to operate, we really don't see much difference, we haven't seen much difference in over a decade. We are transacting at 4 to 5 times EBITDA.

I think one way to look at it is, if you look at the average debt levels of our portfolio of companies, 2.5 times to us, 3.5 times total -- we just aren't seeing much change there. And we tend not to participate in auctions, or at least wide auctions. We tend not to participate with the sponsors that are auctioning off the sub debt to the lowest provider -- lowest-cost provider.

Now, what that might translate into is, on occasion, we might go a quarter or two without seeing much activity. If we don't like what we see, we don't transact. We don't feel like we have a gun to our head, and instead we will focus on -- you know, in the secondary market.

(Operator Instructions). Matt Wilkinson with the State of Michigan Bureau of Investments.

I just had a question about the multiple securities that you guys hold. You said it's yielding about 8%. I take it that is corporate debt. Could you maybe just give us a little more color about that and kind of what the average corporate debt rating may be on the portfolio?

Sure. We are probably averaging about B+ on a S&P scale. We really like the single B pricing right now. As you get into the DD, we don't really see the risk/reward benefit, so we tend to stick with B. We avoid CCC, unless you get really compelling second-lean type terms; we will do it on occasionally. But far and away it would be B, B+.

And if you think about the historical default levels on that type of debt investment per S&P over the last 20 years, it runs about 4% or 5% with a recovery, given default velocity -- given default, of about 60%, 70% recovery. So you might end up losing 1.25% a year with that level of credit rating exposure, and we are pretty comfortable with that.

Of course, we haven't seen it -- the default statistics are a lot more than that right now, but over time it would probably be better than what we would typically experience in the Lower Middle Market.

Okay, and I guess the last thing, do you guys see ourselves needing to tap the equity markets again at the end of the year to do another secondary?

I think we would not make any predictions there, but the bottom line is, we are sitting on a lot of liquidity and we constantly balance the need for rotating that liquidity. Because if we just rotate the liquidity we've got, we've got a lot of runway, but that liquidity, a lot of it is at marketable securities earning a very nice return, so that's the balance. And I don't think we want to make a prediction there, but we will continue to monitor it and see what we think is the best thing for the company.

Charles Redding with BB&T Capital Markets.

I was wondering if you could just detail the prior three -- prior one of the prior non-accruals that was -- that exited or restructured in the period, and which was that?

Yes, the nonaccrual that went away this quarter was Hayden. And what happened in this quarter -- just based upon the continued monitoring of that investment -- we took the fair value to zero, and that's why when you look at the number of investments on nonaccrual, it went from 3 to 2 this quarter.

Okay, thanks a lot.

(Operator Instructions). Jim Stone with GSK Advisors.

Congratulations, gentlemen, for having such good performance. But I'm wondering if you could give us a little more global view in light of the current economy and the sense of stress test type of thing?

As you see what's happening in Europe, and the concern -- if Europe is to go under deep trouble, how would that impact you? And then conversely, if we into a double dip recession, how do you think that would impact your portfolio?

Well, thanks for asking that, because I did anticipate that and we did a little work on that. We talked with our portfolio managers last night and tried to get their current assessment of how their respective management teams feel right now, how's their third calendar-quarter going? And in general, we don't really see many signs of softness or weakening in terms of what has happened so far in the third quarter.

I think to a management team, no one really knows what to make of what's happened in the last 72 hours. And so I don't think anyone really has a reaction to it other than just kind of being concerned.

I think what we need to be careful of, the thing that would hurt us the most is if the commercial banks stop loaning to -- the way they are right now, to our space and we had to get other types of credit.

That's why Todd spent so much time talking about our liquidity, because we want to be postured to be able to survive that kind of a blow -- if the banks say when you get to end of facilities term we are not going to re-up, we are not going to refinance. Having a modest amount of leverage is very important to us, and so we are always trying to keep a step ahead of that and look for other sources of leverage, and I think that is what we would be focused on.

We are not as concerned about the asset side of the balance sheet in the case of a melt-down, it would be more the liability side, and making sure we are not in a position where we lose control over what we have to sell and when we have to sell it.

Todd or Dwayne, woudl you have anything to add on that?

When you asked about the stress test though, I would say that that is kind of the way we look at businesses for new investments right now. If you look at the last recession we just went through, that's a pretty good stress test for businesses, including Main Street. And we have got perfect hindsight on how they performed right now during that stress test.

So I think if you want to stress test Main Street, I would back into '08 and '09 and see how we did relative to the market during that time period. And I think if we went into a double dip, that's my view of how we would perform again.

I would add to that just because of where we are geographically, we are headquartered in Houston, we have a single location. We have a disproportionate amount of geographic concentration in and around the Gulf Coast and Texas, and so we can't help but have overweight exposure to the energy end-markets, the energy service end-markets, etc. And so I think our view might be impacted by that, is why I think this is a pretty good place to be located right now.

What about, if you could give us a little more insight on what is your exposure to Europe? Your portfolio companies in general, are they 10% involved with Europe, 20%? What is there, if any, involvement?

Well, it's very little. I would say it's probably in the 10% or lower range, simply because as a business-development company you have to have 70% of your assets at a minimum invested in US companies. And as an SBIC, when you have SBIC financing, which we do, that goes to 100%.

So we have almost no businesses that -- we have no businesses that are headquartered in Europe, and most of our businesses are just operated in North America. They might on occasion ship a product to Europe, but I would say it's very little exposure, almost nonexistent.

Well, [obviously] I didn't -- wasn't as concerned about where they were domiciled for the ownership, I was thinking about where they may actually be doing business, and you're saying that's certainly negligible?

Just because of the size of the businesses and the fact that they operate here, it's really very little.

And frankly if you look at, for the ones I'm pretty in depth on, the exports from they are manufactured in the US are going more to Asia right now than Europe. So I would say if you are talking about sales, Asia would be a bigger component than Europe, by a long shot.

(Operator Instructions). And Mr. Foster, I'd like to turn the conference back to you at this time.

Okay, thank you all for participating, and we will look forward to talking to you again in November. Bye.

Ladies and gentlemen, this concludes the Main Street Capital second-quarter earnings conference call.

If you'd like to listen to a replay of today's conference, please dial 303-590-3030 and enter the access code of 445-6963, followed by the pound sign. Thank you for your participation. You may now disconnect.