Main Street Capital Corp (MAIN) 2017 Q2 法說會逐字稿

Greetings and welcome to the Main Street Capital Corporation Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mark Roberson, Dennard Lascar. Thank you, Mr. Roberson. You may begin.

Thank you, Brock, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's Second Quarter 2017 Earnings Conference Call. Joining me on the call today are 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 to detail the company's second quarter financial and operating results. This document is available on the Investor Relations section on the company's website at mainstcapital.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 11. Information on how to access the replay was 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 homepage. Please note that information repeated on this call speaks only as of today, August 4, 2017, and therefore, you're 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 SEC.gov. Main Street assumes no obligations 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 of GAAP measure 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, Mark, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend increase and a few other recent developments and conclude by commenting on our investment pipeline. Following my comments, Dwayne Hyzak, our President, and Brent Smith, our CFO, will comment on our second quarter financial results, recent originations and exits, recent announcements, our current liquidity position and certain key portfolio statistics and our operating expense ratio, after which we will take your questions.

We were pleased with our second quarter operating results. Our lower middle market portfolio, our primary area of focus, appreciated by $5 million on a net basis during the quarter, with 20 of our investments appreciating during the quarter and 17 depreciating. Our middle market loans, private loans and our other assets collectively appreciated roughly $7 million during the quarter. We finished the quarter with a net asset value per share of $22.62, a sequential increase of $0.18 a share over the first quarter. Our lower middle market companies continue -- collectively continue to exhibit very conservative leverage ratios on a relative basis, which Dwayne will cover in greater detail. Earlier this week, our board declared our fourth quarter 2017 regular monthly dividends of $0.19 a share in each of October, November and December of 2017, increasing our monthly payout rate by $0.005 a share. The ex-dates for these dividends are September 20, October 19 and November 20, respectively. This dividend increase represents the seventh consecutive year we have increased our regular monthly dividend to shareholders. Our board is nearing completion of a multiyear succession planning initiative with a particular focus on diversity. At our next board meeting in late October, we currently expect to announce the appointment of 2 independent directors who are both highly qualified, and who each bring unique areas of expertise and experience to our already highly experienced director group. On the Main Street personnel front, we have significantly expanded our investment team having recently added 6 new investment team members, including 2 experienced senior analysts, an internal transfer from our accounting group, and 3 full-time analysts. In addition, we recently onboarded 6 new additions to our internship program. Dwayne will comment on our recruitment and new hire efforts in more detail. We have originated new lower middle market and private loan investments at roughly $330 million so far this year for our investment portfolio. We're more or less on budget for the year at this pace. As of today, I would characterize our lower middle market investment pipeline as average to above average. We continue to seek and receive significant equity participation in our lower middle market investments, and as of quarter-end, we owned an average of a 37% fully diluted equity ownership position in the 99% of these investments in which we currently have equity exposure. We are pleased to report that our I-45 joint venture with Capital Southwest has continued to mature and they recently amended the credit facility to lower its costs and increase its advance rate, this will allow the joint venture to grow its portfolio above its $210 million current size. In addition, the HMS joint venture with ORIX has grown to $135 million and should be fully ramped by year-end. 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'd like to turn the call over to Dwayne to cover our performance in more detail.

Thanks, Vince, and good morning, everyone. We're pleased to report another quarter during which we grew both our total investment income and distributable net investment income and again generated distributable net investment income in excess of our monthly dividends. In addition, we also generated $11 million of net realized gains from our investment portfolio. Our second quarter operating results represent a GAAP return on equity of 13.9% for the trailing 12 month period and 13.6% on an annualized basis for the second quarter. Returns are in line with our stated long term goal of producing a return on equity percentage in the low to mid-teens. These returns also significantly exceed the dividend yields paid to our shareholders and illustrate the significant value that we are generating for our shareholders in excess of our dividend payments. We believe that these results also continue to illustrate the significant benefits of our investment strategy of investing both debt and equity in the lower middle market, which 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 a result of the historical growth in our dividends per share, our net asset value per share and our stock price.

As we've discussed in prior quarters, we believe that the primary driver of our long-term success has been and continues to be our focus on the under-served lower middle market and 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. Without this primary focus on the lower middle market, it would be very difficult to produce these returns for our shareholders. Despite what many industry participants say, there are significant headwinds and competition in the broader middle market, which we have also experienced in our middle market business. We have not seen the same negative trends in the lower middle market. As a result, we believe there is additional value associated with our investment focus on the lower middle market as our experience over the past 2 decades has shown us that the lower middle market is less correlated to the significant market fluctuations that can -- can exist in the broader middle market. As a result, despite the negative market commentary, we have continued to see attractive opportunities in the lower middle market in the second and third quarters. As a result of these continued attractive lower middle market opportunities, coupled with what we believe are growing attractive opportunities in our private loan investment strategy. We have continued to focus on growing our team of investment professionals. Since the beginning of this year, we have added 4 new members to our lower middle market investment team, 2 of which were participants in our internship program in 2016. And in the second quarter, we also added 2 experienced members to our middle market and private loan investment team. And consistent with the past several years, we currently have 6 interns working with us this summer across the firm and are excited about having this existing [hi-fi of] new additions to the team for future years.

Now turning back to our most recent operating results. Consistent with prior quarters, the contributions from our lower middle market portfolio continue to be well diversified, with 43 of our 75 lower middle market companies with equity investments having appreciation at quarter end and with 26 of these companies that are flow-through entities for tax purposes or 50% of our total investments in these types of entities contributing to our dividend income over the last 12 months.

In addition, we also have several equity investments in non-flow-through entities, which have contributed to our dividend income. We believe that 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.

We are pleased to report that our investment activity in the second quarter and our overall investment performance remain strong. Our investment activity in the second quarter included total investments in our lower middle market portfolio of approximately $56 million including investments in 3 new portfolio companies, which after aggregate repayments on debt investments and return of invested equity capital resulted in a net increase in our lower middle market portfolio of approximately $42 million. With a net increase in our middle market portfolio of approximately $55 million and a net decrease in our private loan portfolio of approximately $5 million. As a result, as of June 30, we had investments in 192 portfolio companies, that are 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 3% of our total investment income for the last 12 months and approximately 3% of our total portfolio fair value, with a 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 should yesterday, but I'll touch on a few highlights. Our lower middle market portfolio included investments in 75 companies representing approximately $932 million in fair value, which is approximately 14% above our cost basis. At a lower middle market portfolio level, the portfolio's median net senior debt-to-EBITDA ratio was a conservative 3.1:1 or 3.2:1 including portfolio company debt, which is junior in priority to our debt position. As a complement to our lower middle market portfolio, in our middle market portfolio, we had investments in 68 companies representing approximately $624 million at fair value. In our private loan portfolio, we had investments in 49 companies, representing approximately $380 million in fair value. The total investment portfolio at fair value at June 30 was approximately 105% of the related cost basis and we had 5 investments on nonaccrual status, which comprised approximately 0.2% of the total investment portfolio at fair value and 2.6% 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 17% for the second quarter over the same period in 2016 to a total of $50.3 million, primarily driven by an increase in interest income of approximately $5.6 million and increase in fee income of $1.4 million and an increase in dividend income of $0.4 million. We estimate that the amount of income that is either less consistent on a recurring basis or nonrecurring was approximately $1 million or $0.02 per share. Second quarter 2017 operating expenses, excluding noncash share-based compensation expense increased by $1.8 million over the second quarter of the prior-year to a total of $14.8 million. The increase is primarily related to a $0.6 million increase in compensation expense, a $0.9 million increase in general and administrative cost, which was in part, due to nonrecurring professional fees and other expenses related to certain potential new portfolio investment opportunities, which were terminated during the due diligence processes. And a $0.5 million increase in interest expense. These increases were partially offset by an increase of $0.3 million and costs reallocated to the External Investment Manager for services provided to it.

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 was, 1.7% on an annualized basis for the second quarter and 1.6% on a trailing 12-month basis. Excluding the nonrecurring professional fees and other expenses previously mentioned, our operating expense ratio for the second quarter was 1.6% on an annualized basis and 1.5% on a trailing 12-month basis. Our increased total investment income and the continued leverage of our efficient operating structure resulted in a 19% increase in distributable net investment income for the second quarter of 2017 to a total of $35.5 million or $0.63 per share, which exceeded our recurring monthly dividends paid for the quarter by approximately 14%. Our External Investment Manager's relationship with the HMS Income Fund benefited our net investment income by approximately $2.4 million in the second quarter of 2017, through a $1.6 million reduction of operating expenses or costs reallocated to the External Investment Manager for services we provided to it and $0.7 million of dividend income from the External Investment Manager.

We recorded a net realized gain of $11 million during the second quarter, primarily related to a net realized gain on the exit of one lower middle market investment, the partial exit of a lower middle market investment and realized gains from the other portfolio. As Vince discussed, we recorded net unrealized appreciation on the investment portfolio of $11.9 million in the second quarter, primarily related to a 5 -- to $5 million of net appreciation on our lower middle market portfolio, $4.6 million of net appreciation on our other portfolio, $3.6 million of appreciation on our External Investment Manager and $0.4 million of net appreciation on our private loan portfolio. This net unrealized appreciation was partially offset by $1.7 million of net unrealized depreciation on our middle market portfolio. Additional details for the change in our net unrealized appreciation can be found in our earnings release.

Our operating results for the second quarter of 2017 resulted in a net increase in net assets of $42.8 million or $0.76 per share. On a capital resources front, our liquidity and overall capitalization, remain strong. At the end of the second quarter, we had $21.8 million of cash, $252 million of unused capacity under our credit facility, and $88.8 million of incremental SBIC debentures capacity. Today, we have approximately $19 million of cash, $230 million of unused capacity under our credit facility and $75 million of incremental SBIC debentures capacity. We also continue to be pleased with the execution of our ATM equity issuance program. During the second quarter, we raised nearly $41 million in net proceeds, with an average sale price of $38.56 per share. As we look forward to the third quarter of 2017, we currently expect that we will generate distributable net investment income at $0.60 to $0.62 per share during the quarter. This estimate is $0.045 and $0.065 per share or 8% to 12% above our previously announced monthly dividends for the third quarter at $0.555 per share, or 5% to 9% above our recently announced increase of monthly dividends to $0.57 per share for the fourth quarter of 2017. As previously mentioned on our last quarterly earnings conference call, the expected per share difference between our distributable net investment income and net investment income due to our noncash restricted stock expense will return to a approximately $0.04 per share for the third quarter. As the restricted stock expense will be approximately $0.3 million lower than the second quarter due to the last remaining impact from a 4-year investing drain that was fully expensed by the end of second quarter. With that, I will now turn the call back over to the operator, so we can take any questions.

(Operator Instructions) Our first lesson today comes from Bryce Rowe of Baird.

Maybe a couple of topics here. First one is to the just get a little -- not modeling input from Brent, you guys mentioned some prepayment activity that helped drive fee income, I think it was fee income in the quarter. Just wanted to be clear that, that prepayment income was in fee income and not in interest income?

(inaudible), the accelerated activity was both interest and fee income. So during the third quarter, what we call kind of accelerated income, if you will. I think we had around $3 million during the quarter, total, and probably a 2/3 of that or $1.9 million was interest and the rest was fee income. So it's usually a combination of both fee and interest income.

Okay, that's helpful, thanks. And maybe Brent and Dwayne, perhaps you could touch on the growth in the middle market portfolio and the increase in the weighted average yield there. Just curious, what kind of opportunities you're seeing in that book? And what kind of yield you're seeing, have yields started to kind of creep back up and give you better opportunities in that middle market?

I'll start off on the first part of the question and then Nick Meserve that runs that portfolio will talk about kind of what he's seen in that market. But in terms of its growth during the second quarter, that's more of a function of -- as we receive exit proceeds from a lower middle market exit, generally, what -- unless, we coincidentally get lucky and there is a corresponding reasonably large lower middle market closing, generally, Nick will take those -- as opposed to just paying down the credit facility and earning 2% or whatever, Nick will take those proceeds and deploy them in the middle market. So that's why you see it spike up once in a while. Generally, correlated to exit proceeds. Would you hit [price] any differently, Dwayne?

No, I wouldn't.

And Nick, why don't you tell us the state of the market in terms of opportunities out there.

The overall market, you know, it's been fairly stable last 6, 12 months. I think it's got a little bit more competitive, so pricing has come down a little bit. Our overall yield has ticked up, mainly driven by repayments of some lower yielding stuff we've had in the books for 2 or 3 years, so if we take that fee income and also and recycle that money from a lower coupon name into a slightly higher coupon name that pushed up the overall average. But overall, I'd say, it's a fairly stable market right now. The repayment cycle's pushed a little bit slower than it was as you saw in the first quarter. So we're not having that much pressure on a repricing basis. We are seeing little more M&A activity here in the third quarter and it will pick up here through the rest of the year as well.

But most likely, Nick, it's going to be reinvesting prepayment proceeds and probably not, unless we have an unforeseen spike in liquidity because of an exit, we're probably not looking to really grow the portfolio, we're just going to be more opportunistic.

Exactly, there's also some weird timing of

[weep] and deals close late -- sorry, early second quarter, that's supposed to close late first quarter that's kind of -- if you look on the first and second quarter base, it's a little more smooth on a growth basis.

Our next question is from Robert Dodd of Raymond James.

On the -- obviously, it's a really good quarter, -- significantly exceeded the guidance you gave at the -- all the indications you gave at the end of that when you reported the first. Obviously, some of that was this -- you talked about the nonrecurring, maybe that was $0.02, about half of it. What else was it that kind of caught you by surprise in the second quarter and generated that excess earnings as to where you thought you were a couple of months back.

I would say it is primarily the additional activity from a repayment standpoint. Every quarter when we're doing this call, you know we're one quarter into the quarter, so depends on what happens in the second and third months of the quarter. You can see significant movement, I'd say the biggest movement or surprises we had were just the additional activity in those second and third months of the quarter versus what we were expecting when we had our last conference call. Brent, would you add anything else?

No -- I'd say [in Vince's] -- in his comments, but our private loans I'd say, we are probably a little bit ahead of where we thought we would be, so that also contributes to more investment income as well.

The private book loans are really little bit harder to predict. Generally, Nick will receive an inbound call, someone has maybe underwritten a deal and looking for 1 or 2 partners and he'll -- he'll have maybe a week to look at it or something like that and so that's -- those are kind of hard to predict.

Yes, everything about it is -- it's lumpy, and I appreciate that. So then certainly If I can -- obviously, at the analyst day you talked a lot about tax. I have no idea honestly, and you might give it the same response, now what's going to happen with tax, it seems even more up in the air than it was even a few months back, like whether anything's going to happen at all. So, a, just can you give us your thoughts on that and then b, it is that uncertainty, it certainly doesn't seem to be having any effect on the originations for lower middle market, et cetera. But you're hearing anything in that market segment and whether it's actually going to have any effect or people just pushed it aside and not worry about it?

Yes, I think, the prospects of comprehensive tax reform in most people's view is dead on arrival for the rest of the year and maybe you'll have something, it's not tax reform, but some type of tax bill that lowers the corporate rate and makes some other changes around the edges, maybe does something with repatriation of offshore funds, but none of that really is going to impact us or our constituents to a [great degree], I don't see people changing their behavior, I think, as an industry, Robert, and I -- I don't want to answer the question you didn't ask, but, as an industry we've been much more focused on our legislative agenda with respect to BDC modernization, getting an SBIC bill passed in the house and the appropriations bill has some really good language in it -- the house appropriations bill that cleared the committee, real good language in it on the [a, after fee] issue, which could reinstate us back into the indices. So we've had a lot of favorable activity the last 90 days, and tax has really has really been on the backburner. But the only thing I'd add about tax is, there seems to be a consensus now, listening to their remarks, Congressman Brady and others that there would be a carve-out for any interest expense nondeductibility for small businesses. In addition to the language, in his blueprint, that talked about a carve out for financial institutions. So that kind of issue or fear has seemed to have abated quite a bit.

(Operator Instructions) We have a follow-up question from Bryce Rowe of Baird.

Just wanted to ask one more. Appreciate all the commentary about the new hires and growth of the employee base. Maybe, Vincent, Dwayne, could you remind us, what the structure looks like right now of the kind of lower middle market investing team? And how you plan to grow that, whether it be by team or just within the individual teams as a part of that lower middle market group?

I'll let Dwayne to take his shot at it then I'll likely correct him, go ahead.

I say -- there hasn't been a lot of significant changes there. We've got a good core group of very experienced individuals that lead each of our lower middle market team. Our efforts for the last couple of years, have been and continue to be just supplementing those teams so that they can continue to do better job of covering the lower middle market broadly across the company in the -- across the country, we're doing a better job today than we were 2 years ago. And if we're successful and continue to add resources like we talked about in my comments, we're excited about being able to do a better job 2 years from now than what we do today. So it's really just continuing to focus on doing the same types of things from a transaction, deal structure and type of company standpoint. But just doing it with better coverage of the overall marketplace and doing it with a greater frequency than what we did in the past.

I would -- the only thing I would add is that we are, at least in my view, we are hiring more resources than we can currently deploy, because we want to train them and prepare them for the growth that we expect to have in the near term. So we're trying to what -- avoid a situation where we wait till we need someone and see who is available. We're going ahead -- and so our expense ratio, it ticked up, maybe 10 basis points as a result of that, but we think it's a good investment. So there are a lot of people running around, a lot of young people and a lot of training going on and I think that all bodes well for '18 and '19.

And to complement that Bryce, we talked about a private loan strategy and portfolio probably for last year, if not -- if not longer. That's another area, both through our lower middle market team and through Nick's team on the middle market side that we're really focusing on significantly and seeing significant activity and we think you'll continue to see that for the balance of this year and into 2018, as we look at our investment strategy going forward.

Okay, and then, you guys have what 4 or 5 lower middle market teams right now and then to Dwayne, where do you kind of see that maybe in a couple of years from now?

Well, what we're kind of experimenting with is, larger kind of super teams where you don't have, maybe, near-term visibility in a new Managing Director that would carve people off and have independent origination capabilities, so on Dwayne's team, you have probably the largest team. I would characterize that as kind of a super team. Whereas we have, if you are a newer -- if you're newer Managing Director, you'll spin-off and kind of have your own team and that might be smaller, so we're trying to -- we're letting the -- we're letting the skill set of the people we have dictate the form rather than vice versa. So we're still sticking with our 4 teams right now. Nick's team has grown significantly and the interesting dynamic that we have is, it's with respect to private loans, it's more of a jump ball for if -- if Dwayne sees one and has the bandwidth, he'd typically be leading it, and he might not be leading it. His team [won't] go ahead and execute it. Nick will be doing the same thing. So we're still -- where we're still little bit in flux, is do we have a third division that just does private loans. Hines would probably prefer that we go in that direction versus now. Nick is doing middle market and private loans, Dwayne and his team are doing lower middle market and private loans.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Great. Well, thanks for everyone's participation and we look forward to speaking to you again in November.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.