Main Street Capital Corp (MAIN) 2012 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. (Operator Instructions). Today's conference is being recorded August 3, 2012.

I would now like to turn the conference over to Ben Burnham of DRG&L.

Thank you, Alicia, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation's second-quarter 2012 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.MainStCapital.com. That's MainStCapital.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 August 10. 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 reported on this call speaks only as of today, August 3, 2012, and therefore you are advised 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 comment on the performance of our investment portfolio, discuss our recently announced dividend increase and our dividend outlook, highlight our origination activity, and conclude by commenting on the current investing environment.

Following my comments, Todd will cover our second-quarter portfolio activity in more detail and our current liquidity position, then Dwayne will comment on our second-quarter financial results, after which we will take your questions.

Our investment portfolio continued to deliver strong performance during the second quarter. Our lower middle market investments appreciated during the quarter by $13.5 million on a net basis with 21 of our investments appreciating during the quarter and five depreciating, and our middle market investments appreciated by $1.1 million during the quarter.

We finished the quarter with a net asset value per share of $16.89, a sequential increase of $1.17 a share over the last quarter.

Our lower middle market portfolio companies ended the quarter with $80 million in cash on their balance sheets and averaged a very conservative net debt to EBITDA ratio of 1.9 to 1 through our debt position and 2.2 to 1 including all debt.

Earlier this week, we announced that our Board declared an increase in our monthly dividend payout to $0.15 per share, beginning with the October dividend. This brings our quarterly dividend payout rate to $0.45 a share, an 11.1% increase over the fourth quarter of 2011 payout rate. This was also our third dividend increase so far in 2012.

We have increased our quarterly dividend payout by over 36% from $0.33 per quarter at the time of our 2007 IPO and have never decreased our dividend payout or made a return of capital distribution, thus continuing our commitment to sustainability and growth in our dividends.

Our spillover taxable income is estimated to be $27 million at June 30, 2012, or $0.87 a share. We further estimate that this amount will grow to roughly $30 million by year end.

There's a limitation under the Internal Revenue Code rules for regulated investment companies under which we have elected to operate to avoid corporate-level income taxes as to how much spillover income we can accumulate. The limitation is a percentage of our dividends in the period following the spillover. At the projected $30 million level, we are approaching that limit.

As a result, we expect to ask our Board to approve a special dividend that would be paid at year end to materially reduce the spillover balance. We estimate that this would equate to a per-share amount of at least $0.25.

If our current operating performance continues, we would likely ask our Board to approve similar future special dividends as well.

We made an announcement in March 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. We estimate that 50% of our dividends paid during the first half of calendar 2012 will be taxed at the maximum 15% rate for long-term capital gains. In calendar 2011, as a reminder, 26% of our dividends qualify for the 15% rate for long-term capital gains.

I would like to turn now to our second-quarter originations, where our middle market activity significantly outpaced our lower middle markets. Part of this imbalance was intentional due to the cash flow created by the two significant exit events in the first quarter that I just referenced and by our equity follow-on that we just completed. We do not expect the relative split in originations to be this skewed in coming quarters.

Our office or director group has continued to increase their ownership of our shares via our dividend reinvestment plan and open market purchases, investing over $625,000 in our shares during the second quarter and over $1 million during the first half of 2012.

Our lower middle market transaction pipeline is reasonably consistent with the levels we have experienced over the last few quarters. I would characterize the environment as stable in terms of transactional activity. We continue to see significant equity participation in our lower middle market investments and, as of quarter end, continued to average a 33% fully diluted equity ownership position in these companies.

Our middle market investing activity continues to grow, as previously discussed. We continue to see attractive risk-adjusted yields and acceptable structures.

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

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

We are very pleased to report another strong quarter which reflects our long-term strategy of realizing sustainable growth in earnings and dividends per share, while also generating meaningful growth in NAV per share.

Our second-quarter 2012 investment activity included total gross investments of approximately $163 million, including investments in three new lower middle market companies and 22 new middle market companies. We also received approximately $50 million in total cash payments and exit proceeds during the quarter, which primarily related to the middle market component of the portfolio.

Since June 30, we have exited -- or excuse me, executed three term sheets for new lower middle market investments and have closed approximately $12 million of net middle market investment activity.

I'm also pleased to report that our overall portfolio performance remains strong, and the portfolio continues to improve its diversification by issuer, industry, end markets, and geography. At June 30, we had investments in over 130 portfolio companies that are in approximately 50 different industries across both the lower middle market and middle market components of our portfolio.

The largest portfolio company investment represents just over 2% of our assets, and the majority of the portfolio investments represent less than 1% of our assets. This increasing diversity adds structural protection to our portfolio, our revenue sources, and our cash flow, which translates into structural protection for our shareholders.

Our portfolio companies are performing well so far in 2012 with most of the portfolio experiencing growth in operating metrics such as revenues, earnings, and backlog. These operating trends are reflected in the improving lower middle market portfolio company credit statistics that Vince referenced in his comments, as well as our net portfolio appreciation during the first six months of the year.

The equity component of our investment strategy remains a significant differentiating advantage for Main Street. It has been paying off in the form of meaningful dividend income received on portfolio equity investments and also drove most of the $15 million of net portfolio appreciation recognized during the quarter.

This portfolio appreciation, combined with underdistributing our net realized income and an accretive equity offering, allowed us to grow our NAV per share by over 11% during the first half of 2012. This follows 16% growth in our NAV per share for all of 2011 and demonstrates our ability to execute on one of our key strategies related to growing NAV per share.

On the capital front, Main Street's liquidity and overall capitalization remains strong. As of today, we have over $43 million of cash and cash equivalents, which is almost all held at our SBIC subsidiaries, and approximately $9 million of marketable securities.

In June, we completed a follow-on stock offering which raised $93 million of net proceeds after offering costs, and the offering was priced at a 43% premium to the latest recorded NAV per share at that time.

We also recently expanded our total commitments under our three-year credit facility to approximately $287 million and currently have around $195 million of unused capacity under that facility. While we continue to explore various financing sources to support our future operational and investment activities, we remain focused on maintaining liquidity cushion and duration alignment within all borrowing arrangements.

We also have $220 million of outstanding SBIC debentures with a weighted average fixed interest cost of around 5% and a remaining weighted average maturity of just over six years.

In addition to maintaining ample liquidity and capital flexibility, we remain focused on maintaining a low-cost operating structure, which we view as a significant structural advantage. During the second quarter of 2012, Main Street's total operating and administrative expenses remained around 1.9% of our average assets, which is approximately half of the same metric for the BDC industry as a whole. This low-cost, internally-managed operating structure allows us to deliver a greater proportion of the gross portfolio returns to our shareholders.

We estimate that our efficient cost structure generates around a 25% to 30% increase in our distributable net investment income when compared to a BDC industry average cost structure.

In summary, Main Street continues to perform at a high level and deliver upon our long-term goals of sustaining and growing our earnings, dividends, and book value per share. We are pleased that this high level of corporate performance has translated into a high level of total return for our shareholders.

With that, I'll turn the call over to the Dwayne to cover our financial results and certain key portfolio statistics.

Thanks, Todd.

As Vince and Todd previously mentioned, we are happy to report significant increases from the prior year in both total investment income and distributable net investment income, significant appreciation of our investment portfolio, and a significant increase in net asset value per share for the second quarter ended June 30, 2012.

Total investment income for the second quarter increased by 29% over the same period in 2011 to a total of $20.8 million for the quarter. This increase was primarily driven by increased amounts of interest income associated with higher average levels of portfolio debt investments.

The increase in investment income in the second quarter included an increase of approximately $400,000 in investment income associated with higher levels of accelerated prepayment activity for certain portfolio debt investments and marketable securities investments in comparison to the second quarter of 2011. The total amount of investment income for the second quarter of 2012 from such prepayment activity was approximately $900,000, or $0.03 per share.

Second-quarter 2012 operating expenses, excluding non-cash share-based compensation expense, increased by $1.3 million over the second quarter of 2011 to a total of $7.4 million. The operating-expense increase was primarily due to higher interest expense as a result of increased borrowing activity under our credit facility and the issuance of $10 million of SBIC debentures subsequent to the second quarter of 2011.

The increase also included higher accrued compensation and other operating expenses related to the increases in investment income and the investment portfolio, compared to the second quarter of prior year.

The ratio of our total operating expenses, excluding interest expense, as a percentage of average total assets, which we believe is a key metric in evaluating our operating efficiency, was 1.9% on an annualized basis for the second quarter of 2012, compared to 2.3% on an annualized basis for the second quarter of 2011 and 2.2% for the year ended December 31, 2011. We believe that this metric compares very favorably to other asset management firms.

Due to our increased total investment income and the leverage of our low-cost operating structure, distributable net investment income for the second quarter of 2012 increased by 33% to $13.4 million, or $0.49 per share, in comparison to $10.1 million, or $0.43 per share, for the same period in the prior year. Our distributable net investment income for the second quarter exceeded our dividends paid by $0.07, and we estimate that our cumulative spillover taxable income is approximately $27.3 million, or $0.87 per share, as of June 30, 2012.

While the dollar amount of distributable net investment income increased by 33% over the prior year, the per-share percentage increase was 14% due to the higher average number of shares outstanding compared to the corresponding period in the prior year, primarily due to the impact of the October 2011 and June 2012 follow-on stock offerings.

All other second-quarter 2012 per-share measures were similarly affected by the higher weighted average shares outstanding.

Distributable net realized income for the second quarter of 2012 decreased by 2% in comparison to the second quarter of prior year to a total of $10.1 million, or $0.37 per share. This decrease was primarily due to a $3.4 million realized loss on the exit of a lower middle market portfolio investment that had been fully impaired in prior periods, partially offset by the higher level of distributable net investment income during the second quarter of 2012.

As Vince previously mentioned, during the second quarter of 2012 we recognized $15.1 million of net unrealized appreciation on our portfolio investments and marketable securities and out of funds investments. This increase included net unrealized appreciation totaling $13.5 million in our lower middle market portfolio resulting from appreciation on 21 portfolio companies and depreciation on five portfolio companies.

In addition to the appreciation in our lower middle market portfolio, our middle market investment portfolio appreciated by $1.1 million and our other portfolio investments and marketable securities and out of funds investments appreciated by $500,000.

The net change in our unrealized appreciation for the second quarter also included approximately $2.4 million of accounting reversals of net unrealized appreciation related to exits of portfolio investments and exits of marketable securities and out of funds investments during the second quarter and approximately $1.8 million of unrealized depreciation related to our FDIC debentures held by our wholly-owned subsidiary, Main Street Capital II.

The operating results for the second quarter of 2012 resulted in a net increase in net assets from operations of $24.2 million, or $0.88 per share, or an increase of 37% compared to the corresponding period in the prior year. This increase was after a reduction for a tax provision of $1 million primarily related to deferred taxes of $600,000 on the net unrealized appreciation on the equity investments held in our taxable subsidiaries.

As a result of our increase in net assets from operations for the second quarter and the accretive impact of our follow-on equity offering in June 2012, our net asset value per share increased by 7.4% from March 31, 2012, and by 11% from December 31, 2011, to a total of $16.89 per share as of June 30, 2012.

Now let me finish with a few portfolio statistics, all as of June 30. In our lower middle market portfolio, we had 54 investments, representing approximately $423.6 million of fair value, as of June 30, or approximately 24.3% above the cost basis of approximately $340.8 million. Consistent with our investment strategy, approximately 78% of our lower middle market portfolio investments at cost were in the form of secured debt investments and approximately 95% 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 June 30, 2012, was 15%. We hold equity positions in 91% of our lower middle market portfolio companies with an average fully-diluted equity ownership of approximately 33%. The fair value of our lower middle market portfolio equity investments as of June 30, 2012, was approximately 208% of the cost of such equity investments.

As Vince previously noted, at the lower middle market portfolio level, the weighted average net senior debt to EBITDA ratio was 1.9 to 1, or 2.2 to 1 including portfolio company debt, which is junior in priority to Main Street's debt position, representing sequential improvement over the prior quarter in the credit stats for the lower middle market portfolio.

We expect that these lower middle market portfolio level statistics, on a same-store basis, should continue to generally improve over time as these companies naturally delever. This deleveraging has the additional positive impact of increasing the fair value of our equity investments in these companies.

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 lower middle market investment portfolio was 2.1 on June 30, 2012, which is consistent with the weighted average investment ranking on March 31, 2012.

During the second quarter, we had five portfolio companies improve their rating and three portfolio companies decrease their rating.

In our middle market portfolio, we had investments in 77 companies, representing approximately $343.4 million of fair value as of the quarter end that were generating a weighted average yield of approximately 8.7%. Main Street's middle market portfolio investments are primarily in the form of debt investments, and approximately 91% of our middle market portfolio debt investments at cost held the first lien security position.

The weighted average revenues for the 77 companies in the middle market portfolio was approximately $519 million.

The total investment portfolio fair value at June 30, 2012, was approximately 112% of the related cost basis, and we had no portfolio investments on non-accrual status and one fully-impaired portfolio investment, representing approximately 0.2% of the total investment portfolio at cost.

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

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

Thanks very much, and I was interested in the portfolio mix. Right now, I think, on a cost basis you're at about 50-50 between lower middle market and middle market, if you look at just those two pieces of your portfolio. I was curious in terms -- are there any, at least, self-imposed limitations or thoughts in terms of what the mix may look like going forward?

Vernon, this is Vince. That's what I tried to address here.

I mean, I think clearly the originations in Q2 were highly skewed towards middle market for a couple of reasons. One, we had a large amount of cash lodged in our SBIC subsidiaries from those two exits, and then the next quarter we had another close to $100 million come in, and rather than wait to deploy that capital lower middle market, we put it to work in the proper place in the portfolio.

So, will that get rotated into the lower middle market or will the lower middle market originations catch up? It's hard to say, but that was clearly kind of a coincidental and unusual event that both of those would coincide within 90 days of each other or less, so that's really the reason.

And again, I don't think we have a self-imposed limit. Clearly the middle market is important. It's a critical differentiating factor, and do we panic if it went from 50/50 to 60/40 or 40/60? Not particularly, but I would say that it shouldn't be a lot different than it is now in the future, plus or minus probably 10%.

Okay, that's helpful. And my follow-up question deals with one of your -- one of the big positives for Main Street is the low-cost structure, and the number that you've pointed out, the 1.9% in terms of operating expenses as a percentage of average total assets, I'm curious in terms of your thoughts in terms of just how much more efficient can you get?

Vernon, the way we're looking at that is I think we can continue to get more efficient. We have a five-year plan where -- the five-year plan that we give to our Board, that's the first number I go to to try to see how much more operating leverage we have.

What is -- so the answer is it can continue to go down, but what will really drive it down is if we can -- again, it depends on how the accounting works because there's some strange things that happen in 40 Act accounting, but to the degree our third-party asset management activity gears up and that fee income comes in and either is accounted for as a reduction in SG&A or if it's kind of forced fee income, that's the real opportunity to drive that down. Todd, would you say that any differently, or Dwayne?

I think there's a practical limit to how efficient you can get and be responsible as an investor.

So I wouldn't say that 1.9% goes to 1%, but I do think if we look out at our five-year plan, as Vince referenced, and just in general for our planning, I do think we think that percentage can continue to get a little better as we go along. But I don't think you will see the same type of move that you've seen from when we went public to now.

Okay. Thanks very much.

Robert Dodd, Raymond James.

Hi, guys. Thanks for all the color. Just getting back to that third party, you applied for exemptive relief a couple days back with one of those relationships.

Can you give us any color on how the lack of that right now is affecting any of your investment decisions, if it is? And can you give us an idea of -- the follow-up, I guess, is, what's the timeline for getting that relief and having full [ex] ability again on where you put capital?

Well, I mean, the relief you're talking about is our ability to co-invest with HMS Income Fund, which is the nonlisted BDC joint venture we have with Hines.

And that's going to probably be a while before we get that approved, and that's really just so we can allocate a portion of some lower middle market activity due to some 40 Act restrictions to HMS, which is part of what our understanding with them is.

So that's really all there is to that. I mean, it's really not any more exciting or complex than that. And that was our intent all along.

So on the HMS front, they are now effective. I think we'll have this disclosure in our 10-Q, but that fund is effective with the SEC. It has signed its first selling agreements and it is beginning to do the fundraising process. Those tend to have a slow ramp to them, if you've studied that space, and so we don't expect, at least as to how it impacts our earnings from the fee stream, we don't expect that to be a material contributor to our earnings for -- at least until the middle of 2013. And in fact, we've agreed to conditionally waive our fees, just as Hines has, until as the ramp period comes really for the first 12 months of that fund's existence.

So I think long term, that can be a real contributor with a real high return on equity, but in the near term it's not going to have a huge impact, and long term, all the co-investment does is really gives us the right to jointly co-invest in lower middle market opportunities.

Okay, great. Thank you.

(Operator Instructions). I'm showing no further questions in the queue at this time. I'd like to turn the conference back to management for any closing remarks.

Great. With that, we'll conclude the call. Thank you all for joining, and we'll talk to you again in November.

Ladies and gentlemen, this concludes our conference for today. If you'd like to listen to a replay of today's conference, you may do so by dialing 1-800-406-7325 or 303-590-3030, and entering the access code of 455-5064 followed by the pound sign. Thank you for your participation. You may now disconnect.