Main Street Capital Corp (MAIN) 2020 Q1 法說會逐字稿

Greetings, and welcome to the Main Street Capital Corporation First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Zach Vaughan, Dennard Lascar Investor Relations. Thank you. You may begin.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's First Quarter 2020 Earnings Conference Call. Main Street issued a press release yesterday afternoon that details the company's first quarter 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 an hour after the completion of the call and will remain available until May 15. 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, May 8, 2020, 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 of companies, was derived from third-party sources and has not been independently verified.

And now I'll turn the call over to Main Street's CEO, Dwayne Hyzak. Dwayne?

Thanks, Zach. Good morning, everyone, and thank you all for joining us today. Joining me for our call today with prepared comments are David Magdol, our President and Chief Investment Officer; and Brent Smith, our CFO. Also joining us for the Q&A portion of our call are Vince Foster, our Executive Chairman; and Nick Meserve, our Managing Director and Head of our Middle Market Investment Group.

Given the significant and unprecedented impacts to our society and economy over the last few months, the content for today's call will be a little different than our historical calls as we'll provide some details regarding the impact to date of COVID-19 on our business and the businesses of our portfolio companies and our collective responses.

For today's call, I will start off with initial comments regarding the impact of COVID-19. I will then comment on our overall performance and results in the first quarter, our dividend announcements and future plans, our investment activities and current investment pipeline and our investment portfolio, before I conclude with comments regarding recent share purchases by our senior management team and Board of Directors. Following my comments, David and Brent will provide additional comments on our investment strategy and additional details on our investment portfolio and financial results, after which, we'll be happy to take your questions.

We want to start by saying that all of us at Main Street hope that you and your loved ones are safe and healthy. We recognize that the last few months have been a very challenging time for everyone and that the near-term future continues to include significant uncertainty. We send our thoughts and best wishes to those individuals that have been most negatively impacted by the COVID-19 pandemic, and our most sincere gratitude to those individuals who have sacrificed and risked their personal safety for the benefit of others and whose efforts are allowing us to collectively work through this difficult time.

As we've previously communicated in our press releases in March and April, since the beginning of the COVID-19 impacts, we have placed significant focus on and attention to the health and safety of our employees. Our employees at Main Street are critical to our historical and future success and our ability to consistently generate our best-in-industry returns for our shareholders. We have been extremely fortunate at Main Street that our employees have been safe and healthy throughout the last few months. We implemented our remote working arrangements in mid-March and have successfully maintained our full operating capacities throughout the pandemic. We are greatly appreciative of the efforts of our employees, and the strength of our team gives us significant confidence as we look forward to the future.

For those of you that have been long-term investors in and followers of Main Street, each quarter, you have heard us discuss our primary focus on our lower middle market strategy and its related benefits. Our belief that this strategy is very unique in comparison to other investment firms, and our conviction that this strategy is the biggest driver to our ability to create value for our shareholders.

One of the core tenets of our lower middle market strategy is the strength and quality of the management teams of these portfolio companies and our strong alignment of interest with these individuals as our partners. In our investment underwriting processes, we focus more attention on evaluating these individuals as our future long-term partners than any other aspects of our underwriting or due diligence processes. We've also maintained a very consistent approach of aligning our interest directly with these individuals through our typical investment structure, and we believe this alignment is a significant strength and source of value for us and our shareholders.

Throughout the last few months, as our Main Street investment teams have been extremely active in working with our portfolio companies, the strength of these portfolio company management teams has never been more evident or more valuable to us. We are extremely appreciative of the diligent efforts and proactive actions taken by our portfolio companies, and we are more confident than ever in our core philosophies of both selecting the right individuals to partner with and ensuring a strong alignment of interest with these individuals.

Now turning specifically to our results for the first quarter. The unprecedented effects of the COVID-19 pandemic on our economy have proved to be very challenging. Our first quarter results reflect the negative impact of the adverse economic effects of the pandemic on market conditions and the overall economy, most specifically in the amount of unrealized depreciation we experienced in our investment portfolio. Fortunately, our intentional strategy of maintaining a conservative capital structure and significant liquidity position has allowed us to manage through the challenges to date, support our existing portfolio companies and continue to execute on new investment opportunities on a highly selective basis. In addition, we continue to believe that our highly diversified and mature investment portfolio will prove to be very beneficial as we work through the current environment. David and Brent will provide details on each of these points in their comments.

Despite our challenging first quarter, as a result of our diversified investment portfolio, together with the advantages of our differentiated investment strategy, the alignment of our interest with our lower middle market portfolio company management teams, our efficient operating structure and alignment of interest with our shareholders, combined with our conservative capital structure and strong liquidity position, we believe that we are well positioned to weather the current market conditions and provide a favorable outcome for all of our stakeholders. And we remain committed to maintaining a stable dividend payment level going forward.

To that end, earlier this week, our Board declared our third quarter 2020 regular monthly dividends of $0.205 per share payable in each of July, August and September, an amount that is unchanged from our monthly dividends for the second quarter. As discussed in our mid-April press release, due to the challenges and uncertainty created by COVID-19 and our desire to maintain a conservative approach to our dividends and to preserve liquidity to support an active and opportunistic approach to new investments, based upon our recommendations, our Board agreed to suspend our semiannual supplemental dividend indefinitely. We believe this suspension is prudent and in the best interest of all of our stakeholders and is supportive of our commitment to maintain a stable dividend payment level going forward through our recurring monthly dividends.

Now turning to our investment activities in the first quarter and our current investment pipeline. We completed lower middle market investments of $66 million in the quarter, including investments in 2 new companies. And as of today, mainly due to the impact of COVID-19, I would characterize our lower middle market investment pipeline as below average. Despite the impact of COVID-19, we continue to be very active in our lower middle market strategy, as evidenced by our recent announcement of our $49 million investment in Pearl Meyer in late April. We also have several new investment opportunities in the pipeline and expect to continue to execute on new investments in the near term.

More importantly, based upon our historical experiences over the last 2 decades as the industry-leading partner for lower middle market companies and their management teams, we expect that our very unique debt and equity investment offering, combined with our ability to be a long term to permanent partner to these companies, will result in a significant increase in our lower middle market opportunities as the economy begins to recover. Given the current environment, we continue to focus on maintaining a disciplined and selective approach to new investment opportunities, and we remain confident in our ability to originate new investments consistent with our historical investment profile.

During the first quarter, we continued the successful focus of our non-lower middle market investment portfolio growth on our private loan portfolio, resulting in this portfolio growing modestly on a net basis in the quarter, while our middle market portfolio decreased by over $30 million. As of today, I would characterize our private loan investment pipeline as slightly below average, but growing, given the reduction in the number of competitors with the liquidity and access to capital necessary to continue to be active in the current market.

When looking at the performance of our investment portfolio during the quarter, and specifically, our lower middle market portfolio, we are pleased that the vast majority of these companies were either deemed essential or critical or were able to maintain full operating capacity on a remote work arrangement basis. As a result, these companies have been able to maintain a significant level of operations despite the various stay-at-home and shelter-in-place mandates, helping them navigate this difficult time period.

And in closing, as a testament to the positive views our officer and director group continues to have regarding the strength of the Main Street platform, this group has continued to be regular purchasers of our shares, investing approximately $1.1 million during the first quarter, specifically including significant purchases by the executive and senior management team and our Board during March when our stock price experienced the most significant negative impacts from COVID-19. On a collective basis, our director and officer group owns Main Street shares valued at approximately $68 million at quarter end or over $80 million today.

With that, I will now turn the call over to David.

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, this was a challenging quarter for Main Street as we and our portfolio company partners prepared for and responded to the sudden and unexpected negative impact created by COVID-19. Despite this negative impact, our intentional and purposeful diversified investment strategy has served us well during this time. It has been the cornerstone of our philosophy over our nearly 13 years as a public company and a benefit of our permanent capital structure.

We believe our diversification by issuer, industry, end market, vintage and geography provides our shareholders attractive structural benefits. Some of these benefits come from our ability to be a long term to permanent capital provider, as evidenced by the fact that 22 of our lower middle market companies have been in our portfolio for longer than 8 years, including 12 relationships lasting longer than a decade. Our long-term holding period results in a very conservative capitalization for the vast majority of our lower middle market companies, and we benefit from strong relationships with the management teams of our portfolio companies where oftentimes, we are minority equity investors.

As of March 31, our investment portfolio had investments in 193 portfolio companies spanning across more than 40 industries. Our largest portfolio company represented approximately 3% of our total investment portfolio fair value at quarter end and 4.4% of our total investment income for the last 12 months. Most notably, the majority of our portfolio investments represented less than 1% of our assets and our income. Main Street's overall conservative capitalization allowed us to focus on our portfolio company needs instead of having to specifically turn our attention to our own capital structure during this time of market dislocation.

Since early March, we've been working very closely with our lower middle market portfolio companies in assessing and responding to the rapidly challenging market conditions resulting from COVID-19. Our strong alignment of interest by being significant equity investors alongside our lower middle market portfolio company executives proved powerful as we and our portfolio company partners worked tirelessly to support our portfolio company interests. We've been extremely impressed with the proactive and responsive nature of our portfolio company executives and are grateful for their partnership. We are highly confident that their actions are the direct result of our portfolio company managers being material equity owners of their respective companies as opposed to just being salary employees.

In many instances, the management teams voluntarily reduced their compensation, made tough operating decisions, including furloughing long-term employees, and several of our portfolio company managers offered to put in their own equity capital to support their businesses. These actions give us an extremely high level of respect for these executives and significant comfort that their decisions are in the best interest of their companies. Over 90% of our lower middle market investments were either deemed as essential businesses or able to continue to operate on a full or limited basis during these uncertain times, which we expect will mitigate some of the detriment these businesses would have otherwise incurred.

During the first quarter, the contributions from our lower middle market portfolio continued to be well diversified, with 98% of our debt investments in this segment of our business representing first-lien debt positions and 40 of our 70 lower middle market companies with equity investments maintaining unrealized appreciation at quarter end. 62% of our companies that are passed through entities for tax purposes contributed to our dividend income in the last 12 months. We believe that our investment philosophy, investing in both the first-lien debt investments as well as the equity securities of our lower middle market portfolio companies, provides an attractive financing option for our partners and provides a very desirable investment structure for us when compared to other models or strategies available in the market.

During the first quarter, we continued to take advantage of our liquidity and capital structure to make attractive, strategic investments focused on our lower middle market and private loan portfolios. Our investment activity in the first quarter included total investments in our lower middle market portfolio of approximately $66 million, including investments totaling $56 million in 2 new lower middle market portfolio companies, 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 $9.4 million. Total investments in our private loan portfolio were approximately $66 million, including $41 million of new and $25 million of follow-on investments, which, after aggregate repayments, resulted in a net increase in our private loan portfolio of $4.4 million. And we had a net decrease in our middle market portfolio of approximately $32 million.

Our lower middle market portfolio included investments in 70 companies, representing approximately $1.2 billion of fair value, which is over 18% above our cost basis. The fair value of our lower middle market portfolio company equity investments was approximately 162% of the cost of such equity investments with most of these investments capitalized with conservative leverage ratios. In our private loan portfolio, we had investments in 63 companies, representing approximately $629 million of fair value. And in our middle market portfolio, we had investments in 48 companies, representing approximately $418 million of fair value. Our total investment portfolio at fair value at quarter end was approximately 99% of the related cost basis, and we had 10 investments on nonaccrual status, which comprised approximately 1.3% of the total investment portfolio at fair value and 5.3% at cost.

Turning to the outlook for the remainder of 2020. We intend to focus our efforts on continuing to support our existing investments while thoughtfully investing capital primarily in new lower middle market opportunities. As a matter of historical context, some of our most successful lower middle market investments were initiated in the wake of the 2002 to 2004 recession and the 2008-2009 financial crisis. During these uncertain times, Main Street's unique and differentiated lower middle market strategy provides particularly attractive value proposition to our prospective portfolio company partners. Our ability to provide flexible debt and long-term equity solutions are always a key differentiator for us, but the current environment is a particularly good time for us to put new money to work in our core market comprised predominantly of privately owned, closely held businesses to have a specific reason to transact.

As other lenders struggle with capital availability and private equity investors act overly opportunistic in this environment, they tend to be unresponsive to the marketplace. This dynamic can provide an environment for our type of solution to particularly thrive as an attractive alternative. Our investment committee has worked together for nearly 20 years in more prolific times and in times of market dislocation, and we are excited for the opportunity to create significant shareholder value in 2020 and 2021. To that end, we continue to see attractive new lower middle market investment opportunities, and we are cautiously optimistic that we will be able to prudently deploy capital with attractive risk-adjusted return profiles during the remainder of 2020.

As I've mentioned in the past, we continue to deemphasize new investment activity in our middle market segment of our investment portfolio in favor of private loan opportunities, but we intend to opportunistically put capital to work in a select number of attractive private loan and middle market names as opportunities present themselves and other debt investors are forced by the lenders to seek liquidity from their portfolios and sell existing investments at attractive discounts to par. Since the first quarter, we have selectively closed investments that fit that criteria. These investments, when purchased at attractive prices, should provide above-average investment returns in future quarters as they approach maturity.

Finally, during these times of market volatility, we are also grateful for the deep relationship sets we have built over time with so many referral sources over the past 20 years, which we believe will serve us particularly well in finding attractive risk-adjusted return opportunities as the year progresses.

With that, I'll turn the call over to Brent to cover our financial results, capital structure and liquidity position.

Thanks, David. Our total investment income in the first quarter decreased over the same period in 2019 to a total of $56.2 million, primarily driven by a decrease in dividend income and interest income as both areas were negatively impacted by COVID-19. The change in total investment income is after an increase of $2.4 million related to higher levels of accelerated income for certain debt investments when compared to the first quarter of last year.

Our operating expenses, excluding noncash share-based compensation expense, decreased by $2.8 million over the same period the prior year to a total of $16.8 million, primarily related to a decrease in cash incentive compensation levels and a decrease in deferred compensation expense due to the decline in the fair value of our deferred compensation plan assets.

The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, was 1.1% for the first quarter on an annualized basis. This low-cost percentage highlights our unique internally managed structure in alignment with our stakeholders. Our ability to leverage our efficient operating structure during this challenging environment offset a significant portion of the decline in investment income and resulted in distributable net investment income of $39.4 million or $0.61 per share. The activities of our External Investment Manager benefited our net investment income by approximately $2.3 million through the allocation of $1.6 million of operating expenses for services we provided to it and $0.7 million of dividend income.

We recorded a net realized loss of $22.4 million during the first quarter, primarily relating to the realized losses from the exit of a lower middle market investment and the partial exit of 2 other lower middle market investments. We recorded net unrealized depreciation on the investment portfolio of $211.6 million, primarily resulting from the impact of COVID-19. The net unrealized depreciation includes $72.2 million of net depreciation relating to our middle market portfolio, $68.4 million of net depreciation on our private loan portfolio, $45.6 million of net depreciation on our lower middle market portfolio, $12.9 million of depreciation relating to our External Investment Manager, and $11.3 million of net depreciation on our other portfolio.

Our operating results for the first quarter resulted in a net decrease in net assets of $171.4 million or $2.66 per share. Our overall capitalization and current liquidity remains strong as our total liquidity is approximately $500 million. Early during the quarter and prior to the impacts from COVID-19, we raised approximately $4 million in net proceeds under our ATM equity issuance program. Moving forward, we expect to be active under the program at conservative levels as we continue to believe that funding our new lower middle market equity investments with permanent capital is appropriate, and we believe our ability to continue to raise equity is another important differentiating factor for Main Street. Overall, we feel that our conservative leverage, continued access to capital and strong liquidity has us well positioned to not only continue to successfully navigate this challenging period, but to also be opportunistic in terms of investment opportunities in the market.

As we look forward to the second quarter, due to the ongoing impacts of COVID-19, a significant amount of uncertainty exists in relation to the overall economy and the operating results of our portfolio companies. And as a result, there's an increased level of uncertainty related to our expected operating results. Therefore, we are not providing our typical guidance for distributable net investment income for the second quarter. However, and as we previously mentioned in our press release in mid-April, we do expect that our distributable net investment income will be below our monthly dividends for the second quarter. Specifically, we expect a decline in the dividend income from our equity investments as the cash flows of some of our portfolio companies have been negatively impacted to varying degrees. And in general, our portfolio companies are appropriately taking a conservative approach in managing their overall liquidity during this period of uncertainty.

In addition, we expect a decrease in our interest income, primarily due to the additional decline in LIBOR rates that occurred during the first quarter and a decrease in our fee income due to our decreased origination activity during the pandemic as we continue to manage our capital and liquidity in a very conservative manner.

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

(Operator Instructions) Our first question is from Matt Tjaden with Raymond James.

First question, I guess, kind of in broad strokes, were there any industries in the quarter or post quarter end that were more hit by COVID and the pandemic effects than was expected beyond kind of the usual suspects like leisure, retail, restaurants and so forth?

Yes. Matt, thanks for the question. I would say that no huge surprises outside of the industries that you referenced that you would expect they would have been significantly impacted. I'd say that if you look for outliers, it would have been more geographic, where you had stronger shelter-in-place or stay-at-home mandates that required companies to shut down either totally or to a greater extent. So I'd say that would have been the outlier. Outside of that, I would say it would be the industries that you expected to be impacted.

Okay. What about in terms of -- can you give any scale as to whether or not there were any amendment relief requests in the quarter or post quarter end and whether or not that has accelerated through the first month of the quarter?

Yes. I would say there's been some activity there. And I would say most of the activity has been around deferrals on a temporary basis for either interest or some type of principal repayment. I would say our approach, which is consistent with what I think it would have always been, is that if there's a request there, we're looking for the company and its equity investors to do something in tandem with this or as part of that request. They've got to do something, whether that's cost-cutting internally at the company if they're owners of the business and they're also management or if it's a private equity group, and our private loan or middle market portfolio is making some other concession to go along with that request.

Matt, was there anything else?

My apologies. Last question, just briefly on the LMM portfolio. Could you give any scale as to whether or not companies have been applying for the Paycheck Protection Program? And if so, how many have applied and kind of what the receivable rate has been on such?

Thank you. So what I would say on the PPP loan program, yes, I think given our primary focus on the lower middle market and the profiles of these companies, which would be a profile, given the size and scale of the companies both from an EBITDA and revenue standpoint and from an employee standpoint, it's safe to assume that a significant number of our companies would be eligible for the PPP loan program.

I would also say -- or I'd also remind people that we are typically the minority equity investor in most of our lower middle market companies. And in these situations, it's not another institutional investor, another private equity group that's the majority owner. It's typically going to be individuals. And most commonly, it will be individuals that are on the management team. So for these companies, when you look at their application for the PPP loans, ultimately, it's not solely our decision on whether they decide to access the loans. And I would also say that in these companies' cases, clearly, they've been impacted by COVID-19. And I think in situations where the companies have been more significantly impacted, these PPP loans are a very positive source of liquidity to help those companies through the issues associated with the pandemic.

The other thing that I think we'd point out is that PPP loans are just part of the stimulus opportunities that are out there. And I would say that the vast majority of our companies are not just in the loan middle market but also in the private loan and middle market portfolios. We believe that they should be and we believe that they are actively evaluating all these programs, including some of the programs under the payroll tax areas. We can either see credits or look for deferrals. There's also a number of state and local opportunities that our companies are exploring. And then you also have a reinstatement of the tax -- your net operating loss carryback that can provide significant benefits to our company. So we expect they are kind of acting on all these opportunities. And when we can, we're helping them evaluate the opportunities.

(Operator Instructions) Our next question is from Kenneth Lee with RBC Capital Markets.

Just one on the valuation process. Presumably, most of the net unrealized losses in the quarter were driven by widening credit spreads. But just wondering what -- if you could just frame out for us how much of any of the idiosyncratic COVID-19-related adjustments were factored in into the valuation?

Yes. Ken, I would say, as part of our valuation process, we definitely would have been looking at the impacts of COVID across the portfolio, both in the lower middle market and our private loan middle market portfolios. And I think that, as you would probably expect, the impact of COVID-19 was very significant, and that's reflected in the marks that we have. In our earnings release and our 10-Q, you'll be able to see the details by portfolio. I think the impact of credit spreads was most impactful on the middle market and private loan portfolios. And specifically, in the private loan portfolio, we think there's a significant portion of that unrealized depreciation that as spreads recover, and we've already seen some recovery here in the first part of the second quarter, we should see some of that depreciation come back to us in terms of flipping back into unrealized appreciation.

Got you. Very helpful. And then one follow-up, if I may. Just given the uncertainty, the economic uncertainty, wondering if you could just give us any kind of thought on potential trends for dividend income that you could be receiving from your LMM portfolio within the near term?

Thanks, Ken. Yes, I would say, probably not a surprise to anybody given the impacts of COVID-19, all companies, including the companies in our lower middle market portfolio, are taking a very hard look at liquidity. And they're making sure that they've got a capital structure and liquidity position that is conservative enough to withstand or kind of work through the challenges associated with COVID-19. So when you look at our lower middle market companies and I think if you look at our first quarter results, you would have seen that impact coming through in the dividend income that we received from our portfolio companies. And I think we expect that you'll continue to see that for the second and third quarters. And the long-term kind of results will be really dictated by how long this COVID-19 pandemic last and how long a lot of these shelter-in-place and stay-at-home mandates last.

Our next question is from Michael Ramirez with SunTrust.

I apologize if I missed this or it was discussed earlier. I'm just curious how much of your interest income collected during the quarter was classified as PIK? And how does that compare to last quarter?

Yes. Our PIK interest was around 2% this quarter. It had increased by about not quite 1% during the quarter as we agreed to work with several of our companies to let them switch to PIK for a certain amount of -- certain period of time as we kind of work through this pandemic.

Okay. So that -- I believe last quarter, it was about 2%. So relatively flat, I believe, I guess?

Yes. I think it was around -- it was like 1.8%, I believe, last quarter. I believe it might be closer to 2.5% this quarter. So it wasn't a huge jump overall percent.

Okay. That's fair. A follow-up, if I may. So it's quite understandable that you're not going to provide your usual guidance, but thanks for the color regarding around the dividends, interest income and fees. Just curious, maybe more of a high level. With the uncertainty of portfolio of future prospects and ability to pay interest income and dividend and the fees you could collect on your origination, what are your thoughts about sort of temporarily possibly moving towards a variable dividend policy?

Michael, I think if you look at our actions over the last month or so, we've taken steps to not recommend our Board that we continue to pay the semiannual supplemental. And I think with that action and our current position across the portfolio and our current spillover income position, I think at least for the next couple of quarters, we feel really good about our ability to maintain a stable monthly dividend. That's our plan and our intent. I think, again, if the COVID-19 pandemic issues last longer, we'll obviously have to reevaluate that over the next couple of quarters. But I think given everything that we're looking at today kind of across all factors, we feel pretty good about that monthly dividend. And that's what we were trying to communicate in our previous comments.

This concludes the question-and-answer session. I will turn the floor back to management for closing remarks.

We thank everyone for joining us again for our conference call. We look forward to talking again in a few months here, and we hope everyone remains as safe and healthy as possible. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines. Have a great day.