Main Street Capital Corp (MAIN) 2013 Q2 法說會逐字稿

Welcome to the Main Street Capital Corporation second quarter earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions.

(Operator Instructions)

This conference is being recorded today, August 9, 2013. I would now like to turn conference over to our host, Mr. Ben Burnham. Please go ahead, sir.

Thank you, Richard, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation second quarter 2013 earnings conference call. Joining me today on the call are Chairman, President, and CEO, Vince Foster, 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. If you would like to be added to the Company's email list to receive press releases, please call Dennard Lascar Associates at 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 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 the on this call speaks only as of today, August 9, 2013, and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay listening.

Our conference call today will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar expressions. These statements are based on management estimates, assumptions, and projections as of the date of the call, and they are not guarantees of future performance. Actual results may differ materially from these results, 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 which can be found on the Company's website or at www.sec.gov. Main Street assumes no obligation to update any of these statements unless required by law.

During today's call, management will discuss non-GAAP financial measures including distributable net investment income and distributable net realized income. Please refer to yesterday's press release, which can be found on the Company's website, for a reconciliation of these measures to the most directly comparable GAAP financial measures. Certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. 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 announcements and our dividend outlook, highlight our origination activity, and conclude by commenting on the current investing environment in our markets. Following my comments, Dwayne will cover our portfolio performance in more detail and comment on our second quarter financial results, our current liquidity position, and certain key portfolio statistics, after which we will take your questions.

Earlier this week, we announced that John Jackson joined our Board as an Independent Director, and we feel fortunate for being able to attract an accomplished executive of his caliber to our Board. We also announced to the concurrent retirement of Todd Reppert from our Board. While no longer serving as a Director, Todd will continue to manage our SBIC subsidiaries with me while he also launches a new private investment initiative, with which we fully expect to be involved. We've been extremely fortunate to have benefited from Todd's Board service over the last six years and look forward to our continued close association.

Our investment portfolio delivered a high level performance during the second quarter. Our lower middle market investments appreciated during the quarter by $9 million on a net basis, with 21 of our investments appreciating during the quarter and 4 depreciating. Our middle market private loan and other investments depreciated by $1.2 million during the quarter. We finished the quarter with a net asset value per share of $18.72, a sequential increase of $0.17 a share over the last quarter. Our lower middle market companies ended the quarter with $120 million in cash on their balance sheets and continued to exhibit very conservative leverage and debt service coverage ratios.

We are pleased to report that we recently made distributions a $0.155 and $0.20 a share in July, respectively, representing our regular monthly and semiannual supplemental dividends. We expect to ask our Board to declare our fourth quarter monthly dividend within the next two weeks. We currently expect to raise our monthly pay-out rate to $0.16 a month from the current $0.155 in either the fourth quarter or the quarter after that, which would be the first quarter of '14. During the course of our last conference call, I referenced our spillover taxable income of over $40 million at March 31. As of June 30, we estimate that our spillover taxable income was $46 million. In order to reduce this amount, to stay in compliance with the regulated investment company tax rules, and reduce the 4% federal excise tax payable on the spillover amount that carries over into 2014, we expect to ask our Board later this year to declare our next semiannual supplemental dividend of at least $0.20 a share, payable on or around year end. We continue to expect that we will pay semiannual supplemental dividends going forward for the next few years, in addition to our regular monthly dividends.

Earlier this year, we reported to our shareholders via Form 1099 that over 46% of our 2012 dividends were taxed at the highly favorable 2012 rates on long-term capital gains. We currently expect that 100% of our regular monthly dividends paid in February and March of this year will be taxed at the favorable 2013 tax rates on long-term capital gains. We are extremely pleased to once again deliver this level of tax efficiency to our taxpaying shareholders.

I would like to turn now to originations. Our lower middle market originations for the quarter totaled $30 million. On combined net basis, middle market and private loans produced $91 million of originations. Our middle market originations were disproportionately high during the quarter, as we accelerated investing activity to invest the proceeds of our 10-year note offering in April. As of today, our lower middle market transaction pipeline is very healthy and this is after our pipeline has been reduced by several recently announced closings. Specifically, we announced the closings of an add-on financing for Daseke, and initial investment in Garreco, American Shooting Centers, and Southern RV, which we announced this morning. We also expect to announce other investment later this month along with a successful exit of a lower middle market investment we have held for several years.

We continue to seek and receive significant equity participation in our lower middle market investments and as of quarter end, maintained our average of a 33% fully diluted equity ownership position in the 93% of these investments in which we currently have equity exposure. Our officer director group has continued to purchase shares via our dividend reinvestment plan, investing $500,000 via this program during the second quarter. Our officer, director, and senior management group own $100 million of our shares. With that, I'd like to turn the call over to Dwayne Hyzak, our Chief Financial Officer, to cover our portfolio performance in more detail.

Thanks, Vince. We are pleased to report another strong quarter with results consistent with our long-term goals of generating sustainable growth and recurring income to support our dividends, and continued appreciation of our net asset value per share. For the second quarter, our total investment income increased by 33% over the same period in 2012 to $27.8 million. This increase was primarily driven by a $6.4 million increase in interest income, associated with higher levels of portfolio debt investments, and a $1 million increase in dividend income from portfolio equity investments. Second quarter 2013 operating expenses, excluding non-cash share-based compensation expense, increased by $2 million over the second quarter of 2012 to a total of $9.4 million. The operating expense increase included a $1.4 million increase in interest expense, resulting primarily from our issuance of $92 million of 10-year notes in April.

We also incurred higher compensation and related expenses of $200,000, primarily due to increases in personnel and higher other general and administrative expenses of $400,000 in comparison to 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 1.6% on an annualized basis for the second quarter of 2013, compared to 1.9% on an annualized basis for the second quarter of 2012. This metric continues to compare very favorably to other BDCs and is approximately one-third of the same metric for externally-managed BDCs of size similar Main Street. This low cost, internally-managed operating structure allows us to deliver a greater portion of the gross portfolio returns to our shareholders, and we believe that it provides for greater alignment of interest of our management with interest of our shareholders. Due to our increased total investment income and the continued leverage of our beneficial low-cost operating structure, distributable net investment income for the second quarter of 2013 increased by 38% over the second quarter of the prior-year, to $18.4 million or $0.53 per share, and exceeded our dividends paid for the quarter by over $0.06 per share, allowing us to grow our estimated spillover taxable income to $1.33 per share as of June 30, 2013.

While the dollar amount of distributable net investment income increased by 38% over the prior year, the per-share percentage increase was approximately 8%, 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 June and December 2012 follow-on stock offerings. All other second quarter 2013 per-share measures were similarly affected by the higher weighted average shares outstanding. As Vince previously discussed, during the second quarter of 2013, we had total net unrealized appreciation of $6.1 million. The operating results for the second quarter of 2013 resulted in a net increase in net assets from operations of $24 million or $0.69 per share. As a result of our increase in net assets from operations for the second quarter, our net asset value per share at quarter end was $18.72, or an increase of $0.17 from the prior quarter. On capital resources front, our liquidity and overall capitalization remains strong.

As of June 30, 2013, we had $41.2 million of cash and $157.5 million of unused capacity under our credit facility. The credit facility currently includes total commitments of $372.5 million after we expanded the credit facility by $85 million during the quarter through increases from four lenders and the addition of one new lender, resulting in a diversified lending group of 10 lenders. This facility is available to us through September 2017, unless further extended. At quarter end, we continue to have $225 million of SBIC leverage outstanding which bears a weighted average fixed interest rate of approximately 4.8% and matures 10 years from original issue date. The weighted average remaining duration for the existing SBIC leverage is approximately 5.9 years as of June 30, 2013.

We also have $92 million of 10-year notes outstanding after our first notes offering in April, which further diversified our capital base and provided us an additional long-term source of financing. These notes bear a fixed interest rate of 6.125%, mature in April 2023, and may be redeemed in whole or in part, at any time at our option on or after April 1, 2018. We continue to explore various financing sources to support our future operational and investment activities, and we remain focused on maintaining significant liquidity and matching the expected duration of our borrowing arrangements with our investment assets. As we look forward to the third quarter of 2013, we expect that our investment strategy, diversified investment portfolio, and low-cost operating structure will result in third quarter 2013 distributable net investment income per share of $0.53 to $0.55 per share, or zero to $0.02 higher than our distributable net investment income in the second quarter.

Now, let me finish with a few portfolio statistics, all as of June 30. Our investment portfolio as of June 30 continues to be extremely diversified with investments in 164 companies across our lower middle market, middle market, and private loan portfolios. These companies are diversified across approximately 50 different industries, and the portfolio continues to be well diversified by end market, geography, and vintage. We believe that this portfolio diversification adds significant protections to our investment portfolio, recurring investment income, and cash flows and provide significant benefits to our shareholders. In our lower middle market portfolio, we had 58 investments representing approximately $555 million of fair value, or greater than 25% above the cost basis of approximately $440 million.

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 94% of those debt investments held a first lien security position. The weighted average effective yield on our lower middle market portfolio debt investments was 15.1%. We continue to hold equity positions in 93% of our lower middle market portfolio companies with an average fully diluted equity ownership of approximately 33%. We believe that these equity ownership positions provide significant value to our shareholders, and they are the primary driver behind our significant net unrealized appreciation of over $3 per share and our growing dividend income. At the lower middle market portfolio level, the portfolio's median net senior debt-to-EBITDA ratio was 1.9 to 1, or 2.3 to 1, including portfolio company debt, which is junior in priority to our debt position.

Based upon our internal investment ratings system, with a rating of 1 being the highest and 5 being the lowest, the weighted average investment rating for our lower middle market investment portfolio was 2.2 on June 30, 2013, which is unchanged when compared with the rating at the end of the prior quarter. In our middle market portfolio, we had investments in 95 companies, representing approximately $445 million of fair value that were generating a weighted average yield of approximately 7.9%. Our middle market portfolio investments are primarily in the form of debt investments, and approximately 92% of our middle market portfolio debt investments, at cost, held a first lien security position. The weighted average revenues for the 95 companies in the middle market was approximately $577 million.

In our private loan portfolio, we had investments in 11 companies, collectively totaling approximately $79 million in fair value. The weighted average revenues for the 11 companies in the private loan portfolio was approximately $309 million. Our private loan portfolio investments are primarily in the form of debt investments, and all such debt investments held the first lien security position. The weighted average annual effective yield on our private loan portfolio investments was 12.2%. The total investment portfolio [for value] at June 30, 2013, was approximately 112% of the related cost basis, and we have one portfolio investment on non-accrual status and one fully impaired portfolio investment which together represent approximately 0.7% of the total investment portfolio at cost.

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

Thank you, sir. We will now begin the question-and-answer session.

(Operator Instructions)

Vernon Plack from BB&T Capital Markets.

Thanks. Dwayne, the $1.33 estimated spillover taxable income as of June 30, is that net the $0.20 semiannual supplemental dividend that was paid in July?

Vernon, that's a great question. It is not. That number is before that distribution. That number, if you were to pro forma for that, would be less than $0.20 paid in July.

Vince, I like to hear some color on the level of activity that you are anticipating in the lower middle market for the back half of this year. I know that many have spoken in terms of the fact that they're expecting business to pick up, activity to pick up. I was curious in terms of whether or not you're thinking the same thing? Should we see deal activity pick up in the back half?

Good question. Yes, I think it's going to pick up in the back half, although we just had a whole rash of closings here. I do think there's more activity. I do think that in general the Q4 2012 [mortgaged] the future because of the low tax rate was expiring. I think a lot of us had very slow first quarters. In our shop, we spent the second quarter rebuilding the pipeline, which precipitated in all the closing activities we've recently announced. We continue to have an above-average pipeline, so we're going to have a strong last half of the year.

We seem to have gotten on a semiannual level of closing activities. We filled the pipeline. We tend to close them at the same time and then the teams go out and rebuild the pipeline. I don't know if we're going to have as strong a fourth quarter as the third quarter, but we're going to have a very strong third quarter. It seems like we're back to normal levels of activity in general. I don't really see a lot of seasonality. I think it's just a matter of freeing up resources and evaluating the opportunities that are out there and getting your fair share.

(Operator Instructions)

JT Rogers, Janney Capital Markets.

Sorry if you already touched on this. I just got on the call. I was wondering if you had an update on HMS fund?

Not too much of an update really. They are raising capital at about a $5 million or $6 million a month run rate on a combined debt and equity basis. To me that translates into maybe $0.01 of earnings next year at this run rate. We expect run rate to go up, but if it doesn't, we're not expecting a material contribution next year. But it will be positive. It's just been slow going there. That's about all we can really say at this point because we're not really involved in the fund-raising.

That helps. Then, I guess another topic that you guys are deeply involved with, I was wondering if there is any movement on the expansion of the FDIC program?

Yes. We're pretty encouraged by the movement. There's bills that have been introduced at the committee level in the Senate and the House. There's been committee markup action. There's recently a house hearing. I believe last week. We are scheduled to go up, I believe next month, as an industry association for a day of lobbying, et cetera.

I'm attending a lunch with the primary author of the Senate bill, so I'm encouraged. I don't think there's any particular opposition anywhere. It's just finding a bill that we can attach this legislation to that is not in the context of a bunch of other more controversial amendments being added at the same time, and in the whole thing being shut down. Our lobbyist efforts are more tactical at this point, trying to figure out how to get the thing passed, when not a lot of legislation is getting passed. But we're encouraged that both parties and both chambers and the administration and the professionals at SBA all seem to be in agreement that this makes sense. It's just a matter of how it gets done.

Thanks for that detail. One last item. I apologize if you touched on this earlier. Just generally where do you guys broadly see the macro environment moving? Are you seeing improvement? Is it more of the same flat revenue with EBITDA expansion? I was just wondering what your thoughts are.

Yes. I think things are pretty flat. I think the lower middle market companies are holding their own, and our appreciation is coming primarily from deleveraging. That's the beauty of our model. When you 33% average equity position, as a dollar of debt is paid back, 33% of it increases your equity value. That's where we're seeing the pick up. But we're not seeing a lot of organic growth. Our companies aren't particularly interested, for whatever reason, in acquisitive growth.

It's very, very stable for probably 70% to 80% of the companies. Then, on the two ends of the barbell, you're always going to have a few that are struggling for whatever reason, and a few that are experiencing rapid growth. But on average, it's remarkably calm. We're continuing to enjoy appreciation primarily through delevering. Would you re-characterize that at all, Dwayne?

No, I agree 100% The low leverage levels allow that free cash flow to continue to deleverage and generate the appreciation.

Yes.

And I think all things considered, it's a pretty good result. Thanks for taking my questions.

(Operator Instructions)

Allen Young from RC Management.

I just wondered if you could touch on the competitive environment, broadly speaking, currently maybe over the last six months. And specifically, how that translate into yields you're getting on your new investment, and maybe in the changes in covenants?

Sure. The lower middle market, our addressable market, we [stayed] as companies generally having anywhere from $3 million to $15 million in EBITDA. Clearly, as you move up the food chain, you have more competition. The quality of the companies is higher. They're relatively more attractive and the total yields you can expect is coming down, but it's probably fair to say there's less risk of volatility associated with the cash flows in those companies. We see entrance pop up. They raise a fund and deploy the capital. They may or may not show up with another fund. There's always some competition in the lower middle market.

What we haven't really seen is the banks coming in and being more aggressive. We haven't really seen that in years. In talking to some other lenders, they continue to be much more interested in doing the day-to-day banking, having the revolving facilities, 401K, credit cards, other things like that, rather than tackling us or competing with us head-on by providing two or three times cash flow and in senior debt to our level of companies. I'd call it competitive environment, pretty stable on average, but as you get deep into that $10 million to $15 million EBITDA category, it's always been more competitive. It's always hard to say if it's more or less. You've probably seen more than me.

I have to say, it's no different than it has been. But it is definitely more competitive as you move up the scale from an EBITDA size stand point.

We're always able to get the covenants that we're seeking in the lower middle market. I would say we haven't seen much change there. Where you're seeing changes in covenants is in the middle markets out of the portfolio, where you're seeing the re-emergence of covenant-like structures. It seems like yields have bottomed out and are maybe bouncing along the bottom. They'll tick up and then they'll flatten out again. But the structures will continue to be as aggressive as the investors allow. The CLOs have been pretty aggressive and haven't pushed back a lot on some of the covenant-like structures. That's where you're seeing some of the structural loosening. But we don't see it in the lower middle market or really, the private portfolio.

Great. Thank you.

I show no further questions in the queue at this time. I'd like to turn it back to management for any closing remarks.

Great. Thank you all for joining us, and we look forward to speaking to you again in early November. Bye.

Ladies and gentlemen, this does conclude the Main Street Capital Corporation's second quarter earnings conference call. You may now disconnect and thank you for using ACT Conferencing.