Main Street Capital Corp (MAIN) 2016 Q2 法說會逐字稿

Greetings, and welcome to Main Street Capital second-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Ken Dennard. Thank you. You may begin.

Thank you, Matt, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's second-quarter 2016 earnings conference call. Joining me on the call today is Chairman and CEO, Vince Foster; President and Chief Operating Officer, Dwayne Hyzak; and Chief Financial Officer, Brent Smith.

Main Street issued a press release yesterday afternoon that details the Company's second-quarter 2016 financial and operating results. This document is available on the Investor Relations section on the Company's website at ww.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 16.

Information on how to access the replay is included in yesterday's release. We also advise you that this conference call is being broadcast live through the internet and can be accessed on the Company's home page. Please note that information reported on this call speaks only as of today, August 9, 2016 and therefore, you are advised that time sensitive information may no longer be accurate at the time of any replay listening or transcript reading.

Today's call 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 or similar expressions. These statements are based on Management's estimates, assumptions and projections as of the date of this call and there are no 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, 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. Please refer to yesterday's press release 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'll turn the call over to Vince.

Thanks, Ken. And thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcement and some noteworthy developments related to our capital-raising activities and capital structure and conclude by commenting on our investment pipeline.

Following my comments, Dwayne Hyzak, our President; and Brent Smith, our CFO, will cover operating performance in more detail, commenting on our second-quarter financial results, originations and exits, our recent announcements, our current liquidity position and certain key portfolio statistics and our expense ratio, after which we will take your questions. We were very pleased with the overall operating results our investment portfolio delivered during the second quarter. Our lower-middle-market portfolio, our primary area of focus, appreciated by $1.8 million on a net basis, with 22 of our investments all appreciating during the quarter and 14 depreciating.

Our middle-market loans appreciated by $4.1 million during the quarter on a net basis, and our private loans depreciated by $2.6 million during the quarter. We finished the quarter with a net asset value per share of $21.11, a sequential decrease of $0.07 per share over the first quarter. Before giving effect to the $0.275 share semiannual supplemental dividend paid in June, our NAV per share for the second quarter increased sequentially by $0.205 per share over the first quarter.

Our lower-middle-market companies collectively continue to exhibit highly concerted leverage ratios on a relative basis, which Dwayne will cover in greater detail. Last week our Board declared our fourth-quarter regular monthly dividends of $0.185 per share in each of October, November and December of 2016, representing a sequential increase for the quarter of $0.015 per share over our third-quarter dividend payout rate. The [exit dates] for these dividends are September 19, October 18 and November 17, respectively.

As I mentioned in June, paid a semiannual supplemental dividend of $0.275 per share. 2016 represents our fifth consecutive year of supplemental dividends, beginning with the 2012 dividend declared in the fourth quarter of that year. We currently expect to ask our Board to declare our next semiannual supplemental dividend to be paid in the fourth quarter in the range of $0.25 to $0.30 per share.

Primarily as a result of our realized gain in the second quarter and the exit of our equity investment in SambaSafety, we currently estimate that 50% to 75% of our third-quarter regular dividends will be taxed as or similar to long-term capital gains from federal income tax purposes as it relates to our individual shareholders. Last year I mentioned we were going to try out a new form of equity capital raising relative to the retail oriented overnight offerings we've historically utilized in an effort to improve the overall efficiency of our equity capital-raising activities. So late last year we implemented a $1 million ATM or at-the-market program.

This initial tranche was completed in early June of this year, which we followed by implementing a new 1.5 million-share tranche which commenced in mid-June. Combined through today, the ATM program has raised just over $54 million in net proceeds and involved the issuance of 1.7 million shares. We have been pleased with the execution to-date of the program and intend to continue utilizing the ATM alternative, assuming continued favorable execution and market conditions.

Therefore absent an unexpected need for proceeds, we would not expect to utilize an overnight or other follow-on equity alternative in the near future. We are also very pleased to have announced in our press release yesterday that we've received our third SBIC license. The third SBIC represents a significant milestone for Main Street, and we believe it will contribute meaningfully to our long-term growth and capital plans.

As of today, I'd characterize our investment pipeline as about average, and we would expect a solid Q4 from a lower-middle-market origination perspective. We continue to seek and receive significant equity participation in our lower-middle-market investments, and as of quarter-end, yield an average of a 35% fully diluted equity ownership position on the 99% of these investments in which we currently have equity exposure.

Our officer/director group has continued to be regular purchasers of our shares investing approximately $1.4 million during the second quarter. With that, I would like to turn the call over to Dwayne to cover our portfolio performance in more detail.

Thanks, Vince, and good morning, everyone. We are pleased to report another quarter during which we generated distributable net investment income in excess of our recurring monthly dividends and continued favorable performance from our lower-middle-market portfolio. We believe that our unique investment strategy, hooked primarily on the underserved lower-middle-market, combined with our efficient operating structure, continue to provide a value proposition that differentiates Main Street from other yield-oriented investment options and generates the premium total returns realized by our shareholders.

As we've discussed in prior quarters, we believe the primary driver of our long-term success has been and continues to be our focus on the underserved lower-middle-market. Specifically, our investment strategy of investing in both debt and equity in the lower-middle-market and acting as a sponsor and a partner to the management teams of our lower-middle-market portfolio companies, and not just a financing source. Over the last few quarters, we provided some highlights on different aspects of our focus on the lower-middle-market to demonstrate the significant benefits of our unique investment strategy.

Specifically, in our conference call comments over the last two quarters we've discussed the benefits of our equity investments and lower-middle-market companies as illustrated by the results from the exits of our equity investments in Southern RV and SambaSafety. As we have previously discussed, these two exits generated significant realized gains which on a combined basis totaled over $43 million. What we haven't discussed in our prior calls is that in addition to the benefits of these realized gains and the years prior to these exits, our historical investments in these companies included highly attractive debt investments that we believe provide value that is significant and unique to our lower-middle-market investment strategy.

This value is evidenced by the fact that in both cases we were able to maintain debt investments in these companies through the exit dates with interest rates of low teen percentages on our first lien secure debt positions, with modest EBITDA leverage ratios and with a significant enterprise value supporting our debt investments, as evidenced by the valuations resulting from these recent exits. We believe that we are able to maintain these debt investments in high quality companies by providing a flexible approach on the debt investments and by expressing our interest in investing additional capital in the business to facilitate future growth.

Our approach allowed portfolio companies to execute on the growth plans and navigate the potential future industry and business cycles without unnecessary concerns about their capital structure. We believe that the risk/reward relationship evidenced by the debt investments is highly attractive and is reflective of the types of debt investments that are available to us as a result of our lower-middle-market investment strategy. In addition, we believe that these investment opportunities are generally not otherwise available in the broader market.

We also believe that our investments in these portfolio companies are great examples of the value generated by our position in the lower-middle-market as a trusted partner for these companies and not just a financing source. Consistent with prior quarters, we want to highlight that the contributions from our lower-middle-market portfolio continue to be well-diversified, with 44 of our 73 lower-middle-market equity investments having appreciation at June 30, and with 27 companies in our lower-middle-market portfolio or approximately 60% of our investments in flow-through entities for tax purposes, contributing to our dividend income over the last 12 months.

In addition, we also have several equity investments in non-flow-through entities which has contributed to our dividend income over the last 12 months. We believe the diversity of our lower-middle-market portfolio is very important when analyzing the benefits from our lower-middle-market strategy and we believe that this diversity provides visibility to the recurring nature of these benefits in the future.

Now turning specifically to our investment portfolio at quarter-end and our investment activity in the second quarter, we are pleased to report that the overall portfolio performance remains strong. Our investment activity in the second quarter included total investments on our lower-middle market-portfolio of over $62 million, primarily as a result of our investments in three new portfolio companies, which after aggregate repayments on debt investments and return of invest-to-equity capital resulted in a net increase in our lower-middle-market portfolio of $30 million.

We had a net increase in our middle-market portfolio of approximately $14 million and a net increase in our private loan portfolio of $28 million. As a result, at June 30, we had investments in 199 portfolio companies that are in more than 50 different industries across the lower middle market, middle market and private loan components of our investment portfolio. The largest portfolio company represents less than 5% of our total investment income and less than 3% of our total portfolio fair value, with the majority of our portfolio investments representing less than 1% of our income and our assets.

Additional details on our investment portfolio at quarter-end are included in the press release that we issued yesterday, but I will touch on a few highlights. Our lower-middle-market portfolio included investments in 74 companies representing approximately $866 million of fair value, which is approximately 19% above our cost basis. At a lower-middle-market portfolio level, the portfolio's median net senior debt to EBITDA ratio was a conservative 2.9-to-1 or 3-to-1, including portfolio company debt, which is junior in priority to our debt position.

As a compliment to our lower-middle-market portfolio and our middle-market portfolio, we had investments in 81 companies representing approximately $612 million of fair value, and in our private loan portfolio we had investments in 44 companies representing approximately $299 million in fair value. The total investment portfolio after value at June 30 was approximately 105% of the related cost basis and we had eight investments on nonaccrual status, which comprised approximately 0.5% of the total investment portfolio at fair value and 3.7% at cost.

In summary, Main Street's investment portfolio continues to perform at a high level and continues to deliver on our long-term goals. With that, I will turn the call over to Brent to cover our financial results, capital structure and liquidity position.

Thanks, Dwayne.

We are pleased to report that our total investment income increased by 4% for the second quarter over the same period in 2015 to a total of $42.9 million. Interest income increased by approximately $0.6 million. Dividend income increased by $2.5 million, and fee income decreased by approximately $1.3 million when compared to the prior year.

The amount of income that is less consistent on a recurring basis was approximately $0.7 million or $0.01 per share in the second quarter of this year, compared to approximately $1.8 million or $0.04 per share in the second quarter of 2015. Second-quarter 2016 operating expenses, excluding noncash share-based compensation expense, increased by $0.6 million over the second quarter of the prior year to a total of $13 million.

The increase was primarily related to a $0.6 million increase in interest expense and a $0.2 million increase in general and administrative expenses and compensation related expense. These increases were partially offset by a $0.2 million increase in the amount of cost allocated to our external investment manager. The ratio of our total operating expenses excluding interest expense as a percentage of our average total assets, which we believe is a key metric in evaluating our operating efficiency, remains constant at 1.4% on an annualized basis for the second quarter and continues to compare very favorably to other BDCs and other yield-oriented investment options.

Our increased total investment income and a continued leverage of our efficient operating structure resulted in a 4% increase in distributable net investment income for the second quarter of 2016 to a total of $29.9 million or $0.58 per share, exceeding our recurring monthly dividends paid for the quarter by over 7%. Our external investment manager's relationship with HMS Income Fund benefited our net investment income by approximately $2 million in the second quarter of 2016. Through a $1.4 million reduction of our operating expenses for cost reallocated to the external investment manager for services provided to it and $0.6 million of dividend income from the external investment manager.

We reported a net realized gain of $15.5 million during the second quarter, primarily relating to our realized gain due to the exit of SambaSafety, a lower-middle-market investment, partially offset by realized losses related to the exit and restructuring of certain middle-market and private loan investments. As Vince discussed, we recorded underlying depreciation on the investment portfolio of $2.6 million in the second quarter, primarily relating to $4.1 million of net appreciation on our middle-market portfolio and $1.8 million of net appreciation relating to our lower-middle-market portfolio.

This net appreciation was partially offset by net depreciation relating to our private loans portfolio of $2.6 million and $0.9 million of depreciation relating to our external investment manager. Additional details for the change in our net unrealized appreciation can be found in our earnings release.

Looking forward to the third quarter of 2016 and consistent with the information provided on the last earnings conference call, we wanted to provide an update regarding the market movement relating to our middle-market portfolio. The overall middle-market debt investments has continued to improve during the third quarter. Based on our static middle-market portfolio as of June 30, 2016, not taking into account any new investments or sales or repayments during the third quarter and based on quoted market prices for underlying middle-market debt investments, our middle-market portfolio has generated approximately $3.5 million to $4 million in net unrealized appreciation through this point in the third quarter.

Our operating results for the second quarter of 2016 resulted in a net increase to net assets of $30.9 million or $0.60 per share. On the capital resources front, our liquidity and overall capitalization remains strong. At the end of the second quarter we had $18.7 million of cash, $1.6 million of marketable securities and $205 million of unused capacity at our credit facilities.

Today, we have approximately $20 million of cash, $0.6 million of marketable securities and $226 million of unused capacity under our credit facility. As Vince mentioned in regards to our capital structure, we are also very pleased to now have access to additional long-term attractively priced fixed rate debt capital through our third SBIC license, which significantly enhances our available capital. As we have previously noted in prior communication since our IPO in 2007, the available capital to us under the SBIC program is very attractive as it aligns very well with our primary investment strategy of focusing on providing long-term debt and equity capital to lower-middle-market companies.

And just to follow-up on our ATM equity program, as Vince stated we have been very pleased with its execution, as we have raised over $54 million in net proceeds since we started the program last November. The flexibility of the ATM program provides realtime liquidity to better correlate to the timing of our investment activity. In addition, the net proceeds per share under the ATM program is significantly higher than the net proceeds per share under our last overnight equity offering in March of 2015.

As we look forward to the third quarter of 2016, we currently expect that we would generate distributable net investment income of $0.57 to $0.59 per share during the quarter. This estimate is $0.03 to $0.05 per share above our previously announced monthly dividends for the third quarter of $0.54 per share.

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

Thank you.

(Operator Instructions)

Our first question comes from Bryce Rowe from Robert W. Baird. Please go ahead.

Thank you. Good morning.

Vince, Brent, and Dwayne -- appreciate the commentary on the aftermarket program and would concur that it's been an efficient use or efficient way to raise equity capital. Do you guys anticipate continuing to use it at the pace that we have seen here recently after you would capitalize or equitize that third SBIC license? Curious if you would use the SBA debentures first and maybe slow down on the ATM program? Or do you think that it will continue to drip in as we move forward? Thanks.

Bryce, I'm glad you brought that up. With respect to the third license, in order to get the $125 million of incremental debt you need to contribute $62.5 million of equity. That lines up pretty well with the $54 million net that we've raised. So, I think what we want to signal is, when we -- we use relatively modest tranches. So the first one, we dip our toe in the water with 1 million shares. Second one we did 1.5 million. We are in no hurry to complete that. Correct me if I'm wrong, it's about halfway done.

Correct.

So, would you see us do a third one this year?

Probably not. I think we are just going to take an opportunistic approach. The way we run the business is, we really start with the availability under the revolver. And we want to use the revolver as a revolver, and not have the thing fully drawn or anywhere near fully drawn. So, as our capacity -- Brent mentioned it's about $225 million or --

Yes.

We don't want to take too much more of that down probably. It depends on net originations and keeping your availability under the revolver. And yet we will use the third SBIC license as quickly as we responsibly can, to the degree we have SBIC-eligible investments. So, that's the view.

That's great. Maybe a follow-up.

Vince, you talked about the pipeline, at least on the lower-middle-market side, being quote unquote average. But expecting an active fourth quarter. I assume that would mean a bit of a slow down here, third quarter, since you pulled through some activity in the second quarter? And then again a pick up in activity in the fourth quarter?

Yes, I think that's right. It really shouldn't be seasonal, but we are seeing seasonality in the business where you have more activity probably in Q2 and Q4 than you do in Q1 and Q3. Q3 maybe because of summer vacations; trying to get all of the professionals on both sides all geared up through documentation, through diligence and everything is just more challenging. But people get their kids back in school, we can convert more and more of the pipeline. So I think it's just normal seasonality. Would you have any different view, Dwayne?

No, I agree 100% with that.

That's great. Thanks, guys. Appreciate it.

Thanks, Bryce.

Our next question comes from Christopher Nolan from FBR; please go ahead.

The eight non-accruals -- are they the same six from last quarter with additions, or have things changed around?

There were two new additions this quarter, which is Permian Holdings and Larchmont. Both were added to the nonaccrual this quarter.

And Vince, can you give a little color on what you view as the energy sector these days?

Yes, we are, again, taking an opportunistic approach. We have done a couple of minerals deals. They were modest, highly opportunistic. You are seeing assets become available that normally you wouldn't see or we wouldn't see. And so if something is highly attractive, and it needs to be highly attractive; given the volatility and the space, we will certainly look at it.

But I wouldn't see our exposure coming up. What I would tell the guys is, if you see an energy asset you want to add, you better kick someone off the bus to make room for it, because the bus is pretty full. I don't see really the energy exposure going up. I don't think the participants in our revolver would like to see the energy exposure go up. We are on opportunistic rotational basis there.

Would you say anything different?

No, I agree.

Quick follow-up: given your comments in terms of wanting to fill up a third SBA sooner rather than later, is part of the strategy to -- if you have a maturing investment to basically roll that investment into the SBA, if it's SBA compliant if it works for that? Or would you look at new investments?

No, you are not allowed to -- in other words, we couldn't drop an asset that we currently own down into the BBC entity or in the [rik] down into the SBIC. So, it's only for new originations. There is related party rules, et cetera, and prohibitions. It would all be new stuff.

Thank you.

Our next question comes from Leslie Vandegrift from Raymond James. Please go ahead.

Good morning. Most of that stuff -- most of my questions have been answered.

Just a quick one on the industry exposures. Specifically on retail stores -- last quarter in the Q we saw about 4% in specialty retail and then possibly some stores in that leisure and equipment exposure, and others. Just what you guys are seeing on how the retail stores are doing right now? And what is your June 30 exposure to those specific sector investments?

Yes, Leslie, thanks for the question.

Consistent with what we had discussed in general on some retail exposure on some of our prior calls, I think what we have seen in the retail sector is maybe a slowdown in growth and more of a flat quarter-over-quarter, month-over-month-type performance. We have not seen significant or material declines. I think we are pretty happy with that.

There is, I would say, in the middle market there's been more movement from a market valuation or the bid [as can] point, which has pushed down the fair values at least in one case, in a retail name where clearly the market is viewing the retail sector more pessimistic. The more pessimistic view is impacting that valuation. But overall, we would say flat-type performance as opposed to a historical growth or a decline.

Brent, you want to give the color on the percentage?

Yes, the $634 million total portfolio. Our specialty retail is consistent at 4%.

All right, perfect. Thank you, guys. Appreciate it.

Thank you.

Our next question comes from Doug Mewhirter from SunTrust. Please go ahead.

Good morning. This is actually Matya Rothenberg on for Doug. Thank you for taking my questions.

No problem.

So, we have been hearing comments about increased competition in the lower middle market. I know you mentioned seasonality, can you tell me a little bit more about what you are seeing?

I think that when we look at the competition in the lower middle market, we looked at it two different ways. Our lower middle-market companies are typically in the $3 million to $15 million EBITDA range and I think our average size, our median size, is in the $6 million to $7 million range at this point. So, with respect to those size companies, unless they exhibit a lot of growth or they are in a really hot space like software as a service or something like that, we continue to not see a lot of competition other than maybe a private equity firm looking at that size company as an add-on or bolt-on to an existing investment. With respect to those size companies representing platform investments, which how we look at them, it's not all that competitive for the most part.

Now, if that median size of $7 million goes to $17 million, you will see more competition. It's kind of linear. But I will say that for certain sectors they are definitely more competitive than probably -- I don't know, over maybe the last 12 to 18 months than we have seen in the last 10 years. And that's probably here to stay as funds are going downmarket, if you will, to pick up industries that they are very excited about. You just won't see us with a lot of those companies.

So if we look at a software as a service company, rather than paying 15 times EBITDA for a $7 million company, which we are not going to do, we might exit for that, which we have done. We will go look at the $1 million dollar EBITDA companies, we'll continue to go downscale even more for those hot-type industries where we have some experience and find them attractive.

Our strategy is continuing to stay off the radar and with the smaller companies that we view as platforms rather than add-ons. That is very attractive to the founders or the sellers and their families; and what is really, really attractive is the fact that we represent permanent capital and we don't have a financing contingency about. We can write the whole check. We don't have an exit strategy that we are underwriting to, but it's meant to be kind of a permanent investment. Unless and until the Management team thinks it makes sense to sell.

Understand. Thank you for those comments.

Could you also comment on your unrealized losses this quarter? Was that the credit issue or mainly a reversal?

Yes, the majority of the unrealized net appreciation/depreciation this quarter was accounting reversal; the largest piece was related to the Samba exit. We had a significant size gain on Samba of almost $29 million. So obviously the accounting reversal is the largest aspect of the total amount you see in our income statement. And as we walked through earlier, the true -- excluding the accounting reversal -- the true net unrealized appreciation, we walked through those earlier, but that was mainly driven by the middle market of around $4 million and the lower middle market, which was $1.8 million.

We can also point you to some disclosures in our earnings release and our MD&A and the10-Q that breaks down the difference between the true change and unrealized appreciation/depreciation, as well as the impact of the flips, just to give you more color on that.

Okay. Thank you. That's all I have for now.

Our next question is from Jonathan Reichek from Friedberg Investments. Go ahead.

Good morning, guys.

Good morning.

I have a question regarding crude oil -- the consensus seems to be that supply and demand will come into balance at the end of this year or early next year, which should lead to an increase in prices and then an increase in activity levels here. So, as activity starts to return to normal levels, you guys have had to mark down some of your energy investments. What kind of upside is there to NAV as some of your energy companies start to return to a normal level of profitability?

Yes, Jonathan. I think when you look at that, it's hard to form a really defined view on what we think will happen in that area. In response to your point, I do think that, to the extent there is improvement, even if it's modest -- the impact would be more significant if there is significant improvement -- but even modest improvement we believe will be a significant positive for all the oil and gas investments. It's hard to quantify what that would mean in dollars.

Generically, we can tell you that over the last six to seven quarters -- six quarters going back to December 31 of 2014, we've had over $50 million of net depreciation specifically on oil and gas companies. A lot of that depreciation is obviously directly correlated to the decline in commodity prices. When you look at it, getting back to where we started, you're looking at $50 million of depreciation or a $4 share of NAV.

Okay. Thank you.

You're welcome.

Our next question is from Mickey Schleien from Ladenburg Thalmann.

Good morning, everyone.

Vince, can you remind us -- has there been any public disclosure about whether -- when or if HMS Income Fund will list.

What has been publicly disclosed, Mickey, is that after the fundraising phase is concluded, the Board would seek to -- I forget the language, seek to explore a liquidity event in 5 to 7 years. Now, obviously they could do something sooner than that. They could do something later than that. But they are still in fundraising mode now. A listing would be -- probably would be relatively far off. I don't think they will list while they are continuing to fund-raise.

I think the next important milestone would be concluding the fundraising period and then -- you are right, the focus will then be on what kind of liquidity event makes sense given its size and its investment model, et cetera.

Is there any guidance on when the fundraising phase is expected to end?

I don't think they provided guidance. But if I had to guess, I would say, when I look at what the competition has done and list, and based on kind of reading body language, et cetera, I would bet that it would be -- guess that it would be sometime in 2017.

Okay. Appreciate that, Vince. Thank you very much.

You bet.

Our next question is from Christopher Nolan from FBR. Please go ahead.

Brent, as a quick follow-up -- for the DNII guidance, is it still a $0.03 per share adjustment to get to reported NII.

No, it's $0.04. Last quarter we guided to that as a forward-looking measure. We expect the difference to be approximately $0.04.

Great; and what is the spillover income?

The spillover income at the end of June 30 was approximately $49 million.

Thank you.

Thank you. There are no further questions at the moment. I would like to turn the floor back to Management for any closing comments.

Great. I appreciate all the participation on the call and we look forward to talking to you again in early November. Bye.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.