Main Street Capital Corp (MAIN) 2017 Q4 法說會逐字稿

Greetings, and welcome to Main Street Capital Corporation's fourth 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. Thank you. You may begin.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's Fourth Quarter and Full Year 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 Capital issued a press release yesterday afternoon that details the company's fourth quarter and full year financial and operating results. This document is available on the Investor Relations section of 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 March 2. 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 home page. Please note that information reported on this call speaks only as of today, February 23, 2018, 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 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, Mark, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcement 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 fourth quarter and full year financial results, recent originations and exits, 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 fourth quarter operating results. Our lower middle market portfolio, our primary area of focus, appreciated by $34 million on a net basis during the quarter, with 34 of our investments appreciating during the quarter and 14 depreciating. Our middle market loans, private loans and our other assets ended the quarter collectively essentially flat from a valuation standpoint compared to the end of the third quarter.

We finished the quarter with a net asset value per share of $23.53, a sequential increase of $0.51 over the third quarter. After excluding the impact of the semi-annual supplemental dividend paid during the fourth quarter, our net asset value increased $0.79 per share during the quarter.

Our lower middle market companies 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 second quarter 2018 regular monthly dividend of $0.19 a share in each of March, April and May of 2018, maintaining our first quarter monthly payout rate. The ex-dates for these dividends are March 20, April 19 and May 18, respectively. We expect to ask our board to declare a semi-annual supplemental dividend to be paid in June, similar in amount to the $0.275 a share that we paid last December.

Earlier this year, we issued a press release to provide an update on our board's multi-year management succession planning process. We announced that Dwayne would be named our CEO during the fourth quarter with me continuing as full-time chairman. This is an exciting development for our organization, as we demonstrate our historical ability to promote from within. This creates additional opportunities for our people to take on greater responsibilities and accelerate their professional development. From an industry perspective, it's important to note that the new responsibilities and positions resulting from our planning process will not involve any change to our investment strategies or processes.

We've originated new lower middle market and private loan investments of roughly $60 million so far this year in 2018. As of today, I would characterize our lower middle market investment pipeline as 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 -- on average a 39% fully diluted equity ownership position in the 97% 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 $800,000 during the fourth quarter.

With that, I'd like to turn the call over to Dwayne to cover our performance in more detail.

Thanks, Vince. Good morning, everyone. We're pleased to report another quarter and another year during which we grew our total investment income and distributable net investment income both in total and on a per share basis, and again generated distributable net investment income in excess of our monthly dividends.

In addition, as a result of our unique focus on investments in both debt and equity in the lower middle market, we were also able to grow our net asset value per share and generate over $16 million of net realized gains on our total investment portfolio, primarily due to the successful exits of several of our lower middle market investments.

We're also pleased that our operating results represent a GAAP return on equity, or ROE, of 13.3% for the full year and 18.1% on an annualized basis for the fourth quarter.

Returns are in line with our stated long-term goal of producing an ROE percentage in the low to mid-teens. We believe that these results illustrate the significant benefits of our investment strategy of investing in both debt and equity in the lower middle market, which, combined with our efficient operating structure and other complementary investments and asset management activities, 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 growth in our dividends per share, our net asset value per share and our stock price.

At each year-end period, we ought to take a few minutes to look back on our history and recap the benefits that our unique investment strategy and efficient operating structure have enabled us to deliver to our shareholders. Since our IPO over 10 years ago through the end of 2017, our operating performance has allowed us to grow our recurring monthly dividends per share by 73% and paid cumulative total dividends to our shareholders of over $21 per share or over 140% of our IPO price of $15 per share.

Our shareholders have also benefited from significant stock price appreciation. These benefits for our shareholders represent an annual rate of return of approximately 20% per year during the 10-year period since our IPO through the end of 2017, which we believe compares very favorably to other investment options over this time period.

As we've discussed on our prior conference calls, we believe the primary driver of our long-term success has been and continues to be our focus on the underserved 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.

Given our view of the significant value associated with our focus on the lower middle market, we are pleased that despite the competitive market conditions that most of our peers are facing in the current environment, we have continued to find attractive new investment opportunities in the lower middle market that match our historical investment profile.

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 44 of our 68 lower middle market companies with equity investments having unrealized appreciation at year-end and with 26 of these companies that are flow-through entities for tax purposes, or 52% of our total investments in these types of entities, contributing to our dividend income during 2017.

We also have several equity investments in C corporations, which have contributed to our dividend income. In addition to the positive contributions from our equity investments in 2017, in the first 2 months of 2018, we've successfully exited our investments in 2 companies generating total realized gains on these equity investments of approximately $13 million.

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.

Now turning specifically to our investment activity in the fourth quarter and our investment portfolio at year-end. Our investment activity in the fourth quarter included total investments in our lower middle market portfolio of approximately $14 million, which after aggregate repayments on debt investments and return of invested equity capital, resulted in a net decrease in our lower middle market portfolio of approximately $29 million.

We had a net decrease in our middle market portfolio of approximately $6 million and a net decrease in our private loan portfolio of approximately $18 million. As a result, at December 31, we had investments in 186 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 4.6% of our total investment income for the year and 4.1% of our total investment portfolio fair value at year-end, with the majority of our portfolio investments representing less than 1% of our income and our assets.

Additional details on our investment portfolio at year-end are included in the press release that we issued yesterday, but I'll touch on a few highlights. Our lower middle market portfolio included investments in 70 companies, representing approximately $948 million of fair value, which is approximately 22% above our cost basis.

At the lower middle market portfolio level, the portfolio's median net senior debt to EBITDA ratio was a conservative 2.8:1 or 3.3:1 including portfolio company debt, which is junior priority to our debt position.

As a complement to our lower middle market portfolio, in our middle market portfolio, we had investments in 62 companies, representing approximately $609 million of fair value. In our private loan portfolio, we had investments in 54 companies, representing approximately $468 million of fair value.

The total investment portfolio at fair value at year-end was approximately 108% 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 2.3% 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 19% for the fourth quarter over the same period in 2016 to a total of $55.8 million, primarily driven by an increase in interest income of approximately $7.1 million and an increase in dividend income of $2.4 million. The total investment income includes an increase of $2.7 million, related to interest income that is considered to be either less consistent on a recurring basis or nonrecurring when compared to the same period in 2016, and an increase of $1.1 million, primarily related to higher accelerated prepayment, repricing and other activity for certain debt investments when compared to the same period in 2016.

Fourth quarter 2017 operating expenses, excluding noncash share-based compensation expense, increased by $1.8 million over the fourth quarter of the prior year to a total of $15.8 million. The increase was primarily related to a $1 million increase in interest expense, a $0.5 million increase in compensation expense and a $0.5 million increase in general and administrative costs. These increases were partially offset by an increase of $0.2 million in costs we allocated 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 1.5% on an annualized basis for the fourth quarter, unchanged from the same period in the prior year. Our increased total investment income and the continued leverage of our efficient operating structure resulted in a 22% increase in distributable net investment income for the fourth quarter of 2017, to a total of $40 million or $0.69 per share, which exceeded our recurring monthly dividends paid for the quarter by approximately 21%.

Our External Investment Manager's relationship with the HMS Income Fund benefited our net investment income by approximately $2.5 million in the fourth quarter of 2017 through a $1.6 million reduction of our operating expenses for costs we allocated to the External Investment Manager for services we provided to it and $0.9 million of dividend income from the External Investment Manager.

We recorded a net realized loss of $11.7 million during the fourth quarter, primarily related to the net realized losses on 2 middle market debt investments along with a net realized loss on the exit of a lower middle market investment. And as Vince discussed, we recorded net unrealized appreciation on the investment portfolio of $36.4 million in the fourth quarter, primarily related to $34.2 million of net appreciation on our lower middle market portfolio, $1.6 million of net appreciation on our other portfolio and $2.5 million of appreciation on our External Investment Manager. This net unrealized appreciation was partially offset by $1 million of net unrealized depreciation on our middle market portfolio and $0.9 million of net depreciation on our private loan portfolio.

We estimate that approximately $15 million of the net appreciation relating to our lower middle market portfolio was the result of the impact of the tax reform passed at the end of 2017 on our equity valuations.

In addition, approximately $18 million of the net appreciation relating to our lower middle market portfolio was due to the increase in the value of our equity investment in CBT Nuggets. This unrealized appreciation was primarily due to an increase in the value of certain cryptocurrencies that CBT owns. Additional details for the change in our net unrealized appreciation can be found in our earnings release.

Our operating results for the fourth quarter of 2017 resulted in a net increase in net assets of $61.4 million or $1.05 per share.

On the capital resources front, our liquidity and overall capitalization remain strong. At the end of the fourth quarter, we had $51.5 million of cash, $521 million of unused capacity under our credit facility and approximately $54 million of incremental SBIC debenture capacity, for a total liquidity of approximately $600 million. Currently, we have approximately $68 million of cash, $472 million of unused capacity under our credit facility and $44 million of incremental SBIC debenture capacity.

In November, we issued $185 million of investment-grade unsecured notes for the 5-year term in a fixed 4.5% coupon. We believe providing additional long-term, fixed-rate debt capital in a rising interest rate environment significantly enhance (sic) [enhances] our capital structure and has us well-positioned for 2018 and 2019.

We also continue to be pleased with the execution of our ATM equity issuance program. During the fourth quarter, we raised nearly $33 million in net proceeds, with an average sale price of $40.22 per share.

As we look forward to the first quarter of 2018, and taking into account the impact from 2 fewer days of interest income during the first quarter when compared to the fourth quarter, which we estimate has a $0.01 to $0.02 per share negative impact to net investment income, we currently expect that we will generate distributable net investment income of $0.63 to $0.64 per share during the quarter. This estimate is $0.06 to $0.07 per share or approximately 10% to 12% above our previously announced monthly dividends for the first quarter of $0.57 per share, maintaining our conservative approach to our monthly cash dividends.

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

(Operator Instructions) Our first question comes from the line of Robert Dodd with Raymond James.

A couple of simple ones to start with, and then I'll hop back in the queue. On the tax, last quarter, Vince, you gave us a lot of color on what the tax implications could be for the business. Obviously, we've seen the NAV benefit already. The bill, obviously, passed after that call. Were there any surprises in that bill versus what you were expecting? And anything that changes the color? Or should we just take what you told us last quarter as pretty, for lack of a better term, definitive on what you think the impacts are?

Yes, I would say, nothing material. The equipment expensing of new and used equipment that I think was retro to like September 27 of last year, that's something we hadn't factored in. So in other words, if we do a new asset deal, Robert, as opposed to a stock deal, where it's taxable and we get a step-up, we can expense on day one any of the equipment that gets placed in service that's depreciable. And it's all used when you do an asset deal with an existing company, and that's a pretty amazing result. That's mostly going to impact our new deals as opposed to our old deals. So I would say nothing material.

Okay, great. And then on the -- after the end of the quarter, you mentioned that $13 million realized gain on 2 lower middle market investments. There's -- as far as [whether there's a DST order level] you have a senior position, and there's some other BDCs that have junior debt that you have a senior position in. That, as far as I know, there's been a restructuring or a resolution of that. You had it marked at 80% last quarter, if I remember roughly. We obviously don't have the K yet. The story that I've seen is that the final dissolution is more like 20% for the senior. So any color on that? And is that going to have any -- how big of an offset would that be against the $13 million you've generated in gains so far this year?

Yes. Robert, thanks for that question. Nick Meserve is on point on that, and he is going to respond.

Yes. So on GST, this is a mid-2014 transaction for us. And like you said, we're in the senior debt. If the short term performs as expected, then -- it really ran into some liquidity issues in late '17, and it filed for bankruptcy. As we went through the process, we really didn't see any long-term value for our position, so we ended up selling to another lender in January, right around our mark for 12/31 and also a little above our mark for 9/30. [So ending] result really ends up with a $3 million realized loss. On a cash-on-cash basis, we're basically flat when you include the interest we received from 2014 capped at a 0% [IRR] out there.

But the 20% number was -- ended up being a bad number, they got reported. Wasn't that (inaudible)?

Correct. It's a -- technically an accurate number based on some bankruptcy filings, but I would not expect the long-term recovery for the senior debt here to be 20%. (inaudible) Based on a range of the bankruptcy filing of what the end valuation was.

And in our case, the 20% was materially different than what our actual realized amount was. So [we made considerable revaluating] the first week of January.

Got it. Perfect. I'm going to kind of break my [mold]. On -- small business optimism has just hit base -- I mean, January another high. It's a 30-year high. The outlook is an all-time high, and that data goes back for the NFIB to the '70s, I think. You -- and they're all pointing to, it's a good time to expand, not only in that index. Nobody seems particularly worried about labor costs or inflation. What's the tone you're hearing from your existing lower -- obviously you can do new deals, but is there an increased appetite for your lower middle market business to be expanding and doing add-ons, expanding plan, expanding headcount and anything like that?

Yes, I would say, Robert, that our -- the view that our portfolio company has is generally consistent with what you described. So I think we continue to see good opportunities there. Clearly, you've got to be cautious about some of the items that you refer to. But we continue to work with our companies to maximize the opportunities. If you looked at our fourth quarter new activity in the lower middle market, while it was smaller than what we would've hoped, 2 of the companies that were involved in that, both were existing lower middle market companies that completed acquisitions. So I think that when you look at it, both we and our portfolio companies are optimistic about what should come to bear in 2018 and '19, and we're trying to help them take advantage of those opportunities.

Got it. Appreciate it. If I -- one tiny little (inaudible). On CBT Nuggets, you mentioned cryptocurrency. So is it possible to give us an idea how much of the fair value mark of the equity -- obviously the appreciation was due to the crypto -- but how much of the equity value in that would be essentially a result of the crypto that they own?

Yes. So Robert, I think, Brent, in his comments, gave the fourth quarter impact, and I would say that, that fourth quarter impact represented the vast majority of the value they had in the valuation. So clearly it's something that has a lot of volatility, and we benefited from that volatility in the fourth quarter, but there's not a lot of additional value in their valuation from cryptocurrency above the $17 million that I think Brent covered in his comments.

Right. That's correct.

Our next questions come from the line of Doug Mewhirter with SunTrust Robinson Humphrey.

First, a bigger picture question for Vince or Dwayne or both. So it seems like in the BDC space, no one really wants to be kind of in the middle anymore and maybe they want to be like really big and do bank deals -- type deals, but I've also seen sort of increased sentiment -- and this is just all sort of based on secondary conversations about the lower middle -- how the lower middle market looks attractive because it's less efficient, and I'm sure you've heard these same conversations 100 times. I mean, are you seeing any more push in the lower middle market, especially from these smaller private funds and from the sponsors and SBIC funds because it seems like it's a sort of the last bastion of low competition and nice spreads? Or has it been relatively steady?

Well, I think, if there is an attractive $7 million visibly growing EBITDA company, I think it's fair to say -- Dwayne, you're closer to this than I am, but you're attracting -- if there's a well-run auction, you're attracting more bids now than you were a few years ago. If it's a slow-growing, kind of value-oriented $7 million EBITDA company, there has -- there's not much more appetite because these funds have temporary capital, and they have to buy stuff that they're confident they can add on to and sell. So where we have a competitive advantage is, we can come in, pay a lower valuation for the slower growth company and not have much competition, if any, because we don't have to worry about exiting in 48 or 60 months. We can hold forever, use the cash, enjoy the deleveraging power of the cash flow to have our equity appreciate. So that's what we're focused on. We're not going to be competitive. We found a nice company recently that -- was it about that size in EBITDA? -- and we came in about 7x. And it was a growth-oriented company, and we were told the -- and this bodes well for our existing companies -- we were told that you needed to be a 10 multiple to make the next round. So we just don't expend much energy on those deals. We'll participate and give an indication briefly, but we're not going to chase them.

And the other thing I would add and you've heard us talk about this in the past is that it's not just being active in the lower middle market. Our combined approach of debt and equity and being a very willing partner on a minority basis really is different when you look at other people in the marketplace. So the deals that fit us, fit us extremely well, and there's not many other people in the U.S. that can provide the combination of debt and minority equity. So for the right transaction, we continue to see great opportunities and our structure gives us a significant advantage as opposed to just having to compete on valuation.

Both answers are very helpful there. Maybe a financial question -- or a balance sheet-type question. Your stock's come off the peak a little bit, as have all BDCs. I know you have an active ATM at the market program. Have you, I guess, adjusted your algorithms or your trading instructions at all because the stock is a slightly less attractive valuation? Or is it still so far above the threshold that you're basically, sell as much stock as you need to based on your investment pipeline, and the valuation zone really isn't in an area where you would make any of those kind of adjustments?

No, we absolutely take valuation into account. So we -- it's a tool we think is important. It's an important part of our strategy. In an ideal situation, we'd issue enough shares in a year to replicate the dividends that we paid, and we'd be able to synthetically retain our earnings using that. That's about how we've used it. We could have sold a lot more. Brent gives the desk daily instructions. And a typical day might be within certain valuation parameters 5% of the volume. And would you add any more color to that? I mean, the answer is we're going to definitely modulate based upon where the stock's trading, and we've done that, and we've been out of the market for several days, and we didn't like where the stock was trading.

Yes. I mean, the good thing is, that we've talked about before, we control when we sell. So it's very easy to start, stop or change any parameters. And we've been very active in that regard. So I think, obviously, as Vince said, the stock price will determine how much we're willing to sell. But long term, we still do believe in the benefit of the permanent capital, especially as it relates to our lower middle market strategy, and we do expect to be in the ATM program, but we'll do so on a very guarded and carefully thought-out process.

That's helpful. My last question relating to interest rates. A lot of your lower middle market first-lien loans, some of them are fixed or sort of semi-fixed, but at a relatively high coupon. So you get a pretty nice spread off of LIBOR, even with LIBOR being up. But that being said, now that LIBOR has crept up and your funding costs have crept up a little bit, is that sort of feeding back into the lower middle market debt conversations? Or is sort of the clearing rate of your first-lien coupon still in that sort of 10% to 12% range?

Yes, I would say in general it's still in that range. What I would say that we have done for the last couple of years, which you would not have seen us doing 4, 5 years ago is that just from a negotiating standpoint with our companies as we look at new investments is, giving them an option of a fixed versus floating and letting them pick between the two. We look at that as something that was good from a market competition standpoint, but at the same time, as you said, it allowed us to have some of our lower middle market debt portfolio being floating rates, given the current interest rate environment and the outlook going forward. But outside of that change, I would not say that we have seen a significant shift in our strategy or approach as it relates to the interest rates on our lower middle market debt investments.

(Operator Instructions) And it seems that we have no questions at this time. I'd like to turn the floor back to management for closing comments.

Great. Thanks for joining us, and we'll talk to you again in a couple of months.

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