Main Street Capital Corp (MAIN) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Main Street Capital fourth-quarter earnings conference call. (Operator Instructions). This conference is being recorded today, Friday, March 9, 2012.

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

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

Joining me today on the call are Chairman and CEO Vince Foster, President Todd Reppert, and Chief Financial Officer Dwayne Hyzak.

Main Street issued a press release yesterday afternoon 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.MainStreetCapital.com. If you would like to be added to the Company's e-mail list to receive press releases, please call 713-529-6600.

A replay of today's call will be available beginning about an hour after the completion of the call and will remain available until March 16. Information on how to access the replay is included in yesterday's press release. We also advise you that this conference call is being broadcast live through an Internet webcast that can be accessed on the Company's webpage.

Please note that information on this call speaks only as of today, March 9, 2012, and therefore you are advised that time-sensitive information may longer be accurate as of the time of any replay listening.

Our conference call today contains 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 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 directly-comparable GAAP financial measures.

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 comment on the performance of our investment portfolio, discuss our recent dividend and portfolio company exit announcements, and conclude by commenting on the current investing environment. Following my comments, Todd will cover our fourth-quarter and calendar 2011 portfolio activity in more detail and our current liquidity position, then Dwayne will comment on our fourth-quarter and calendar 2011 financial results, after which we will take your questions.

Our investment portfolio continued to deliver strong performance during the fourth quarter. Our investments appreciated during the quarter by $12.4 million on a net basis with 38 of our investments appreciating during the quarter and 15 depreciating. And our marketable securities portfolio appreciated by $900,000 during the quarter.

We finished the quarter and the year with a net asset value per share of $15.19, a sequential increase of $0.70 a share over the third quarter.

Our lower middle market portfolio companies ended the quarter with $56 million in cash on their balance sheets and averaged a very conservative net debt to EBITDA ratio of 2.2 to 1 through our debt position and 2.6 to 1 including all debt.

Earlier this week, we announced that our Board declared an increase in our monthly dividend payout to $0.14 a share, beginning with the April dividend. This brings our quarterly dividend payout rate to $0.42 a share, an 8% increase over the second quarter of 2011 payout rate.

This was also our second dividend increase with the last 12 months. We've increased our quarterly dividend payout over 27%, or $0.33 a quarter, since the time of our 2007 IPO and have never decreased our dividend payout, demonstrating a commitment to sustainability and growth in our dividends.

We made a separate announcement earlier this week regarding our two portfolio company exit events, which will contribute to produce a significant long-term capital gain that will flow through to our shareholders during the 2012 tax year. At this point, we can predict with a high degree of confidence that over 80% of our second-quarter dividends will be taxed at the maximum 15% rate for long-term capital gains. In addition, 26% of our calendar 2011 dividends qualify for the maximum 15% rate for long-term capital gains.

Turning to our dividend outlook going forward, we estimate that we began 2012 with spillover taxable income from 2011 of roughly $8 million, or $0.30 a share. We further estimate that we will continue to be able to earn or exceed our current dividend payout rate. Accordingly, we currently expect to ask our Board to declare increases in the third- and fourth-quarter dividends equal to the increase in the second quarter that we just announced.

Our officer director group has continued to increase our ownership of our shares via our dividend reinvestment plan and open market purchases, investing over $670,000 in our shares during the fourth quarter and over $1.8 million during calendar 2011.

Our lower middle market transaction pipeline is consistent with the levels we have experienced the last several quarters. However, the size of the individual transactions we are reviewing is somewhat larger. I would characterize the environment as stable and our approach as proactive.

We continue to seek significant equity participation in our lower middle market investments and, as of year-end, averaged a 34% fully-diluted equity ownership position in these roughly 50 companies.

Our private placement investing activity, focused primarily on buying and opportunistically selling middle-market leveraged loans, continues to grow. Originations have been opportunistic, and we continue to see attractive yields and structures. This activity continues to be accretive to our net investment income per share, which again helps drive our dividend growth.

With that, I would like to turn the call over to Todd Reppert, our President, to cover our portfolio activity and liquidity position in more detail.

Great. Thanks, Vince. Good morning, everyone.

We are pleased to report another record quarter for Main Street in terms of our financial and operational results. In total, 2011 was clearly a milestone year for Main Street in many respects.

Our fourth-quarter 2011 investment activity included investments totaling $81 million within both the lower middle market and private placement components of our portfolio. For the full year of 2011, we closed just over $240 million in total portfolio investments.

The ability to invest in both the lower middle market and private placement components of our investment strategy provides us with capital deployment flexibility and diversifies our investment options to address various market conditions. Private placement investments continue to be an attractive and accretive component of our investment strategy and represented approximately one-quarter of the total cost basis for our investment portfolio as of year-end 2011.

Our overall portfolio performance remains strong, and the portfolio continues to improve its diversification by issuer, industry, end markets, and geography. At year end, we had investments in 81 portfolio companies across both the lower middle market and private placement components of the portfolio. The largest portfolio company investment represents around 3% of our total assets, and the majority of our portfolio investments represent less than 1% of our total assets.

This increasing diversity adds structural protection to our portfolio, our income, and our cash flow, which translates into structural protection for our shareholders.

During 2011, most of our portfolio companies experienced sequential quarterly and annual growth in metrics such as revenues, earnings, and backlog, with the level of such growth being highly dependent upon specific factors for each company. To some degree, those operating trends are reflected in the improving portfolio company credit statistics that Vince referenced in his comments. Based on the current economic outlook from our portfolio companies, we expect the improved underlying trends to continue during 2012.

As Vince touched on, the equity investment strategy within our lower middle market portfolio is a major differentiating advantage for Main Street. It has been paying off in the form of significant year-over-year increases in dividend income from portfolio equity investments and over $35 million of net unrealized portfolio appreciation during 2011. We expect a healthy merger and acquisition market during 2012, which will likely convert some of the embedded unrealized appreciation within our portfolio into realized investment gains.

During the fourth quarter of 2011, and now into 2012, we have announced several portfolio investment exits that were completed at a premium to our previous fair-value determinations and which collectively generated meaningful net realized gains.

Due to net investment income and excessive dividends paid, net appreciation within the portfolio and two accretive equity offerings, Main Street's net asset value per share increased significantly, or approximately 16%, during 2011.

On the capitalization front, Main Street's liquidity and overall capitalization remains strong, and we are well positioned to take advantage of new investment opportunities. As of today, we have approximately $54 million of cash, which is primarily held at our SBIC subsidiaries, and also maintain over $110 million of marketable securities investments.

Our marketable securities investments are made up of relatively liquid interest-bearing debt investments, currently earning a weighted-average yield of approximately 7.7%. On a net basis, we have liquidated a portion of the marketable securities portfolio since year-end and have realized net gains on these exits based on favorable market conditions. We are also in discussions to further expand and improve our existing $235 million, three-year credit facility, and are always exploring diverse financing alternatives that can benefit the Company without creating undue risk.

As of today, we have just over $100 million borrowed under our credit facility, which is bearing annual interest at approximately 2.8%. While we expect to utilize various financing sources to support our future operational and investment activities, we remain very focused on maintaining liquidity cushion, lender diversity, and duration flexibility within our various borrowing arrangements.

We also continue to monitor the relative matching of fixed- and floating-rate debt investments with a relative amount of fixed- and floating-rate borrowing arrangements, in order to create natural match funding on our balance sheet.

We currently have $225 million of outstanding SBIC debentures with a weighted-average fixed interest cost of around 5% and a remaining weighted-average maturity of just under seven years.

In addition to the focus on liquidity and capital flexibility, we remain focused on maintaining a very low operating cost structure, which we view as a significant structural advantage. During 2011, Main Street's total cash operating and administrative expenses remained below 2% of our average assets. This ratio improved during 2011 from the prior year and should continue to improve in 2012 and beyond.

This part of the operating leverage in being structured as an internally-managed BDC and our cost structure is clearly favorable compared to most other comparable public and private investment funds. This cost structure and operating leverage allows us to deliver a greater proportion of the gross portfolio returns to our shareholders.

As previously noted, 2011 was a milestone year for Main Street in many respects. On top of various qualitative accomplishments, we were able to meaningfully grow the per-share amounts related to our income, our dividends, and our net asset value. We are pleased that this high level of corporate performance translated into a 27% total return for our shareholders during 2011, which significantly exceeded all comparable benchmark indexes.

With that, I'll turn the call over to Dwayne Hyzak, Main Street's CFO, to cover our detailed financial results and certain key portfolio statistics.

Thanks, Todd.

As Vince and Todd previously mentioned, we are happy to report significant increases in total investment income, net investment income, and net asset value for the fourth quarter and year ended December 31, 2011.

Total investment income for the fourth quarter and the year increased by approximately 68% for the quarter and 81% for the year over the same periods in 2010 to a total of $19.7 million for the quarter and $66.2 million for the year. These increases were primarily driven by increased amounts of interest income associated with higher levels of portfolio debt investments and interest-bearing marketable securities investments, increased dividend activity from portfolio equity investments, and increased fee income due to higher levels of transaction activity.

The increase in investment income in the fourth quarter also included an increase of approximately $1.1 million of investment income associated with higher levels of accelerated prepayment and repricing activity for certain debt investments.

Fourth-quarter 2011 operating expenses, excluding non-cash share-based compensation expense, increased by $2.5 million over prior year to a total of $7.2 million. The operating expense increase was primarily due to higher interest expense as a result of the issuance of $40 million of additional SBIC debentures since December 31, 2010, and increased borrowing activity under our credit facility. The increase also included higher accrued compensation and other operating expenses related to the significant increase in investment income and portfolio investment activity compared to the fourth quarter of 2010 and expenses associated with certain strategic initiatives.

Distributable net investment income for the fourth quarter of 2011 increased by 79% to $12.5 million, or $0.48 per share, in comparison to $7 million, or $0.36 per share, for the same period in the prior year. Our distributable net investment income for the quarter and the year exceeded our dividends paid and resulted in estimated spillover taxable income of approximately $7.9 million, or $0.30 per share, at December 31, 2011.

While the dollar amount of distributable net investment income increased by 79% over the prior year, the per-share percentage increase was 33%, due to the higher average number of shares outstanding compared to the corresponding period in prior year, primarily due to the impact of the March and October 2011 follow-on stock offerings. All other 2011 per-share measures were similarly affected by the higher weighted average shares outstanding.

Distributable net realized income for the fourth quarter of 2011, which included a $900,000 gain on the exit of a portfolio company equity investment, was $13.4 million, or $0.51 per share, which represented an increase of $6.4 million, or a percentage increase of 191%, in comparison to the fourth quarter of 2010.

As Vince mentioned, during the fourth quarter of 2011, we recognized $15.2 million of unrealized appreciation in 38 portfolio company investments and $2.8 million of unrealized depreciation in 15 portfolio company investments.

The net change in unrealized appreciation for the fourth quarter also included $900,000 of net unrealized appreciation on investments in our marketable securities portfolio, approximately $900,000 of accounting reversals of net unrealized depreciation related to realized gains recognized during the fourth quarter, and approximately $600,000 of net unrealized appreciation attributable to our SBIC debentures.

As of year-end, approximately 11.5% of the limited partnership interest of our subsidiary SBIC, Main Street Capital II, were not owned by Main Street. We are happy to report that in the first quarter of 2012, we have completed the acquisition of an additional 8.5% of the limited partnership interest and we expect to acquire the remaining 3% before the end of the first quarter. These acquisitions are accretive to both net investment income and net asset value, and we believe the elimination of this minority interest provides better clarity in our financial reporting to our shareholders.

Now let me finish with a few portfolio statistics, all as of December 31. In our lower middle market portfolio, we had 54 investments, representing approximately $429.1 million of fair value as of year end, or approximately 18.4% above cost. Consistent with our investment strategy, approximately 75% of our lower middle market portfolio investments at cost were in the form of secured debt investments, and approximately 93% of those debt investments held the first lien security position.

The weighted average effective yield on our lower middle market portfolio debt investments, as of December 31, 2011, was 14.8%. We hold equity positions in 94% of our lower middle market portfolio companies, with an average fully diluted equity ownership position of approximately 34%. As Vince previously mentioned, at the lower middle market portfolio level, the weighted average net senior debt to EBITDA ratio was 2.2 to 1, or 2.6 to 1 including portfolio company debt, which is junior in priority to Main Street's debt position.

We expect that these portfolio-level statistics on a same-store basis should generally continue to improve over time, based upon the continued favorable operating performance of our portfolio companies and as our companies naturally delever.

In our private placement investments portfolio, we had 27 investments, representing approximately $132.9 million of fair value as of quarter end, that were generating a weighted average yield of approximately 10.6%. Main Street's private placement investments are primarily in the form of debt investments, and approximately 69% of our private placement debt investments at cost held the first lien security position, with most of the remaining investments representing second lien secured investments.

Total portfolio value as of December 31, 2011, was approximately 113% of the related cost basis, and we had one portfolio investment on non-accrual status, representing approximately 0.1% of the portfolio investments at fair value and 1.1% at cost.

Based upon our internal investment rating system, with a rating of one being the highest and five being the lowest, the weighted average investment rating for our portfolio -- investment portfolio was unchanged from prior quarter at 2.2, and we had four portfolio companies improve their rating and no portfolio companies decreased their rating from prior quarter.

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

(Operator Instructions). Robert Dodd, Morgan Keegan.

Two quick ones, if I can, and then a more detailed one -- well, sort of quick. You commented on units and emerging signs of M&A activity, and maybe that converting some unrealized gains into realized. Can you give us a bit more color? I mean, are our portfolio companies in active discussions, or is that just a perception of how you think the market is heating up at this point?

Both. We have -- for the first time in 2011, we've had what I'd call regular-way private equities firms contact us about their having an interest in some of our companies not really as merely add-ons, but as platform companies.

When you go back, Robert, to our statistic about having, in effect, shared control, 34% average ownership, it really isn't our unilateral decision, and so we kind of leave it up to the management team when we talk about it, but we do.

Having said all that, we note a lot of activity that we really haven't seen before and we do have active discussions underway.

Great. And then, on -- you said 38 companies appreciated, 15 depreciated. Was there anything, any particular theme among those companies that did -- where you did lower the valuation and depreciate some of the value in the fourth quarter? Is it economic? Is it more company specific? Is there any particular theme you can give us?

No. It's really EBITDA volatility with no particular trend in mind.

I mean, we take a pretty disciplined approach on valuation and we take kind of a trailing -- in general, a trailing 12-month EBITDA, and so if we're -- as we add another quarter -- so for example, for the fourth quarter, as you add Q4 2011 and you drop off Q4 2010, you might have had a real nice maybe aberationally high Q4 quarter that you are dropping off and you are adding a new one that could be impacted by weather, higher fuel prices.

It just -- we don't get too worried about it. We don't really go to the mat with our valuation consultants trying to keep the values more stable. We just kind of let the math fall out as it is, and that's why you see some of that volatility -- but as you can see, it's all fairly minor.

Yes, absolutely. Great. The last one for me, kind of more detailed, can you give us any kind of -- obviously you've got a deal now on the third-party investment advisor where you -- where they will function as the advisor to a potentially quite large fund. Can you give us any color on expenses that you guys are going to have to incur ahead of revenue for that?

And also, [next] question is, how are you going to go about deal allocation between a fund that potentially could have a lot of available capital, so if you pro rata it on available capital, I mean, is there a risk that a disproportionate number of -- size of the deals are going to get allocated to your advisee rather than the in-house portfolios? Can you give us any color there?

Sure. Good question. Todd, why don't you take that?

Okay, so Robert, what you're referencing is the HMS Income Fund that we filed a registration --

Yes.

-- statement on. So the short answer is, we really don't have any costs related to that right now, other than just some minor travel and some administrative costs. We had a little bit of that in the fourth quarter because that is when we started it up and filed our registration statement.

Our partner in that has agreed to cover a certain amount of the costs up to a certain level and then we would start splitting, but I really feel like the cost side of things is going to be relatively limited. The allocation question is a good one, and it is one that we have been -- obviously have considered heavily relative to doing this.

The short answer is for more syndicated like debt investments, we feel like we could pretty easily solve both sides of the equation, what we need from a diversification standpoint and what they need from a diversification standpoint, without much effort. So it really comes down to the lower middle market investments.

And really, that will take SEC exemptive relief, probably similar to what you've heard from other people for those types of investments. That will be kind of a long process, and the SEC will somewhat dictate how the allocation works.

But in general, we would view it as the independent members of both boards are likely going to have some say on the relative allocation, and it will not be solely based on relative available capital. It'll take into account a lot of different things. Our expectation is that Main Street would continue to get its fair share and probably, in most cases, a majority of all those activities, even if we do share some with HMS.

Robert, I guess what I would -- just to be a little bit more specific, the -- I think we told our Board to be thinking about maybe our maximum exposure of out of pockets in and around the $0.01 a share range, as I recall, Todd, something like that.

Yes, I think that is right.

And the allocation of investment opportunities as it relates to lower middle market is more of a 2013, 2014, and beyond phenomenon.

Right now as we invest, we have to go out and find for about one-third of our deals co-investors because we (multiple speakers) this action. It's too big for us and it's -- it magnifies the difficulty of making sure you have the right co-investor, making sure they show up and close.

So there really is some upside in the lower middle market side of the equation with having a captive co-investor, so it just make things much more efficient on our side.

Okay, good. Got it. Thank you.

Vernon Plack, BB&T Capital Markets.

Thanks. Vincent, I know that the portfolio is well diversified across many different industries, but I wanted to, given the -- given all the experience and expertise that you have in this particular industry, just some thoughts in terms of the opportunities that you're seeing and how you feel about the energy and energy-related businesses at this point.

We certainly see a lot of that activity, given where we are.

What's interesting is that activity really isn't as geographically focused as it used to be. I mean, we're just as easily -- we're just as easy to see someone come in here that is focused on the Marcellus in Pennsylvania, the Bakken, the Eagle Ford, or some of these emerging plays. And so, they're kind of all over the U.S.

What -- I think what we have a bias towards is that companies that are able to generate recurring revenue where their income stream is not really commodity price dependent, it's not really hydrocarbon-type dependent gas versus oil, versus liquids, you know, a pipeline integrity inspection, that type of thing we're pretty attracted to as opposed to the opposite end of the spectrum, project finance to build a pipeline or to drill a well or something like that. That's not something really we've ever considered doing.

So -- but we are mindful of it because I would say, Dwayne, you are probably on the ground as much as anyone else. It is a high proportion of the opportunities we are seeing. Do you have any comments on that?

Yes, Vince covered a lot of it, but clearly there is a lot of interest in this space, and the exit we had in the first quarter of part of our investment in Drilling Info was directly in that space and was a marketed deal that had a tremendous amount of interest. And it just shows you the amount of interest that the investment community has in that space.

Okay. Looking at how the portfolio is diversified, [strictly] from a geographic standpoint there is obviously a large concentration in your headquarters area and the surrounding area, as you lay out in your presentations, and to a less degree the upper Midwest and the Northeast and the Southeast. Can we expect a shift over time to a more balanced mix, or should we continue to expect the bias that the current portfolio shows?

Well, we really kind of place a priority over the quality of the company and the quality of the management team, and geography is secondary.

But where we really have a competitive advantage is where there is an area of the country with very little generalist capital that is interested in basic industry type of investing. That's why in the Pacific Northwest, for example, we found a particular need, whereas in and around the Chicago area, it's more competitive. There's other sources of financing.

There's very limited pools of financing down here in our area or along the Gulf Coast. You go to Dallas, however, and there's probably more, and so it's -- and the pools of capital come and go, right?

There could be someone that launches a fund. They've got a two- or three-year investment activity where we've seen them be very active. It's happened in Houston a couple of times. They come and they spend a lot of money, then they go away. You know, they didn't get their returns or something happened to their fund.

So, it's just a very dynamic scenario, but we're bound to be geographically concentrated in and around here because of our reputation and because of the relative lack of competitors down here.

Okay, thanks.

(Operator Instructions). Mickey Schleien, Ladenburg Thalmann & Company.

Yes, I wanted to follow up on the asset allocation question. The tone of your comments seem pretty upbeat with respect to 2012. I was curious whether that may allow you to perhaps rotate into some different sectors where, in the past, you may have had underexposure, with potentially more tolerance for risk on a go-forward basis.

Yes, I don't really think that we would be -- if we saw an equity opportunity that did not involve debt, that has not really interested us in the past, and I think it will continue to not interest us.

I think really our investment criteria is pretty stable. It was really pretty stable through the last economic cycle and as we're emerging. One reason for that is it's important that we have a consistent message out there to the intermediaries and other representatives that are out and, in fact, finding opportunities for us. If we were to continue to change what we were looking at or change our focus geographically or industry or what have you, these individuals would have, and firms, would have a hard time, and probably would not continue to choose us as a favorite in terms of someone that can complete a transaction, provide the debt, provide the equity necessary to complete it, then it doesn't really have a financing contingency.

And so, we really hesitate, I think, to change that message, so we've really been pretty consistent and I imagine we're going to continue to be, so it's worked pretty well for us.

Mickey, I think what we were commenting on was more on the healthy M&A market for some of our equity positions.

I mean, obviously in 2008 and 2009 we had some of the same equity positions we have now, and we would not be sellers nor would there be really a lot of bona fide buyers back then, either. So it's really just more looking at the cycles relative to harvesting some of the embedded gains on the equity versus changing the underlying strategy of what we're investing in.

Fair enough. Dwayne, a couple of housekeeping questions. When can we expect you to file the K?

Yes, the 10-K will be filed immediately after this conference call, so you'll have it here in a few minutes.

Okay. And in anticipation of that, what percentage of the investment portfolio is in equity or equity derivatives on a fair value basis?

I'm not sure I have that number at my fingertips, Mickey, but I can certainly see if we can find it, and I'll try and give you that information before the call is over.

(Operator Instructions). I am showing no further audio questions at this time. I will now turn the call back over to management for any closing remarks you may have.

Okay, I think -- we'll get back to you, Mickey, with that figure. And thank you -- we want to thank everyone for joining us and look forward to seeing you, I guess, in about another 60 days. Bye.

Ladies and gentlemen, that does conclude our conference call for today. If you'd like to listen to a replay of today's conference call, please dial one 800 -- I'm sorry, please dial 1-303-590-3030, using the access code 451-5791. We'd like to thank all of you for your participation and you may now disconnect.