Main Street Capital Corp

NYSE:MAIN

Earnings Call Transcript 2019-Q1

[Operator]

Greetings, and welcome to the Main Street Capital Corporation First Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

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

[Zach Vaughan, Investor Relations]

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's first quarter 2019 earnings conference call. Joining me on the call today are CEO Dwayne Hyzak; President and Chief Investment Officer, David Magdol; and Chief Financial Officer, Brent Smith. Main Street issued a press release yesterday afternoon that detailed 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 17.

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 reported on this call speaks only as of today, May 10, 2019 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 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 will turn the call over to Dwayne.

[Dwayne Hyzak, Chief Executive Officer]

Thanks, Zach, 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.

On today's call, I will start by providing a recap of our overall performance in the first quarter, commenting on the performance of our investment portfolio, discussing our recent dividend announcement and a few other recent developments, and I will conclude by commenting on our investment pipeline. Following my comments, David and Brent will provide additional comments on our financial results, recent originations and exits, our current liquidity position and certain key portfolio statistics. After which, we'll be happy to take your questions.

We're pleased with our operating results for the first quarter, a quarter during which we increased our total investment income and our distributable net investment income or DNII per share over the same period in the prior year, with our DNII exceeding our regular monthly dividends by approximately 16%.

In addition, we also generated a meaningful increase in our net asset value per share during the quarter. After the quarter-end, we completed our third investment grade debt offering, which provided a significant enhancement to our capital structure. We believe that these positive results continue to highlight the advantages of our differentiated investment strategy and operating structure, which together with the benefits of our recent debt capital markets activity have us very well positioned for continued success.

Looking specifically at the performance of our investment portfolio for the first quarter, our lower middle market portfolio appreciated by approximately $7 million on a net basis during the quarter with 23 of our investments appreciating and 19 depreciating during the quarter. Our lower middle market companies collectively continue to exhibit very conservative credit profiles on a relative basis, which David will cover in greater detail.

Our middle market and private loan portfolios collectively also appreciated by approximately $3 million on a net basis during the quarter due to the net impact of appreciation, primarily from the reversal of the market factors which had previously caused credit spreads to increase significantly in December, partially offset by depreciation from certain specific credit issues in these portfolios.

As a result, we finished the quarter with net asset value per share of $24.41, an increase in our net asset value per share for the quarter of $0.32 per share. Earlier this week, our Board declared our third quarter 2019 regular monthly dividends of $0.205 per share, payable in each of July, August and September a one half cent or 2.5% increase per month from the second quarter of 2019 and a 7.9% increase from the third quarter of prior year.

In addition, in April, our Board declared our June 2019 semi-annual supplemental dividend of $0.25 per share, a decrease of $0.025 per share from the previous supplemental dividend paid in December. In both cases, these dividends declared are consistent with our prior guidance and our previously announced plan for transitioning our semi-annual supplemental dividends into our monthly dividends over several years with this transition beginning in the second quarter. We continue to expect that this transition will take several years. And we remain confident that by the end of the transition period, we will be successful with our long-term goal of delivering growth in our total annual dividends at a level consistent with the historical dividend growth we have delivered to our shareholders.

Now turning to our investment activities for the first quarter and our current investment pipeline. We completed lower middle market investments of approximately $42 million in the first quarter. And as of today, I'd characterize our lower middle market investment pipeline as 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 fully diluted equity ownership position of 40% in the lower middle market investments in which we currently have equity exposure. We have also experienced increased third party interest in several of our existing lower middle market portfolio companies, and we believe that this interest could result in several attractive portfolio company exits over the next few quarters.

We continued our success in focusing our non-lower middle market investment portfolio growth on our private loan portfolio, with this portfolio growing by approximately $20 million on a net basis in the quarter coupled with a decrease of approximately $9 million in our middle market portfolio. As of today, I would characterize our private loan investment pipeline as above average.

And in closing, our officer and director group has continued to be regular purchasers of our shares, investing approximately $400,000 during the first quarter and owning Main Street shares valued at over $125 million at quarter end.

With that, I'd like to turn the call over to David.

[David Magdol, President and Chief Investment Officer]

Thanks, Dwayne, and good morning, everyone. We're pleased to report another quarter during which we grew our total investment income and distributable net investment income. We continue to generate distributable net investment income in excess of our monthly dividends and we produced a meaningful increase in our net asset value per share. We believe that our results illustrate the significant benefits of our unique investment strategy in the lower middle market. This strategy when combined with our efficient operating structure are complementary first lien debt investment strategies and our asset management activities, provide a value proposition that positively differentiates Main Street among our BDC peers.

This has been demonstrated through our consistent ability to generate premium total returns for our shareholders through the growth in our dividends per share, our increased net asset value per share and our stock price appreciation. Primary driver of our long-term success continues to be our focus on the underserved lower middle market. We see significant benefits from investing in both the debt and the equity securities in this segment of our business. Our equity investments closely align our interest with our portfolio company management teams and allow us to share in the public -- in the equity upside as our companies perform, while our first lien debt investments provide an attractive yield profile and significant downside protection. By size and scope, our lower middle market investments are the primary driver behind both our NAV growth and significant pre-tax net unrealized appreciation, contributing approximately $208 million or $3.33 per share. These equity investments also support growth in our total dividends paid to our shareholders through the dividend income we receive and the periodic realized gains upon the exit of these equity investments.

In addition, the unrealized appreciation and realized gains from these equity investments provides an offset against the inevitable credit losses that will be experienced when making investments in non-investment grade debt securities.

Turning back for our most recent operating results, the contributions from our lower middle market portfolio continue to be well diversified with 39 of our 68 lower middle market companies with equity investments having unrealized appreciation at quarter end.

58% of our companies that are pass-through entities for tax purposes contributed to our dividend income in the last 12 months and our total dividend income received from our lower middle market investments was over $30 million during this period of time. Notably, the dividend income received from our lower middle market investments has grown at a compounded annual rate of over 20% during the past five years. We believe that the diversity of our lower middle market portfolio is key when analyzing the benefits in this strategy. And we believe that this diversity provides visibility to the recurring nature of these benefits in the future.

Our investment activity in the first quarter included total investments in our lower middle market portfolio of approximately $42 million, 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 $14 million. We had a net decrease in our middle market portfolio of approximately $9 million and a net increase in our private loan portfolio of approximately $20 million.

As a result, at March 31st, we had investments in 183 companies, spanning across more than 50 industries. Our largest portfolio company represented approximately 2.6% of our total investment portfolio fair value at quarter-end and 2.7% of our total investment income for the last 12 months. The majority of our portfolio investments represented less than 1% of our assets and of our income. Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday, but I'll touch on a few highlights now.

Our lower middle market portfolio included investments in 70 companies, representing approximately $1.2 billion of fair value, which is over 20% above our cost basis. At the lower middle market portfolio level, the portfolios mean net senior debt to EBITDA ratio was a conservative 3.2 to 1 or 3.4 to 1, including portfolio company debt that is junior in priority to our debt position and the total EBITDA to senior interest ratio was 2.6 to 1.

In our middle market portfolio, we had investments in 55 companies, representing approximately $567 million of fair value. And in our private loan portfolio, we had investments in 58 companies, representing approximately $540 million of fair value. The total investment portfolio at fair value at quarter-end was approximately 109% of the related cost basis and we had six investments on non-accrual status which comprised approximately 0.9% of the total investment portfolio at fair value and 3.6% 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'll turn the call over to Brent to cover our financial results, capital structure, and liquidity position.

[Brent Smith, Chief Financial Officer]

Thanks, David. We are pleased to report that our total investment income increased by 10% for the first quarter over the same period in 2018 to a total of $61.4 million, primarily driven by an increase in interest income of $7.7 million, partially offset by a decrease in dividend income of $1.3 million and a decrease in fee income of $1 million. The change in total investment income includes a decrease of $1.3 million related to lower levels of accelerated income for certain debt investments and a decrease of $4.5 million in elevated dividend income that is considered to be less consistent on a recurring basis or non-recurring.

The first quarter 2019 operating expenses, excluding non-cash share based compensation expense, increased by $2.9 million over the first quarter of the prior year to a total of $19.5 million. The increase was primarily related to a $1.7 million increase in interest expense and an increase in compensation expense of $0.6 million, primarily relating to the increase in 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 1.5% for the first quarter on annualized basis and 1.4% for the trailing 12 months.

The combination of our unique investment strategy and leverage of our efficient operating structure resulted in a 6% increase in distributable net investment income for the first quarter of 2019 to a total of $41.8 million or $0.68 per share, which exceeded our recurring monthly dividends paid for the quarter by approximately 16%. The activities of our External Investment Manager benefited our net investment income by approximately $2.7 million through the allocation of $1.6 million of operating expenses for services we provided to it and $1 million of dividend income.

We recorded a net realized loss of $11.4 million during the first quarter, primarily relating to the realized losses from the partial exit of the middle market investment, the exit of a private loan investment, and a realized loss relating to the prepayment of certain SBIC debentures. Partially offsetting these realized losses was a realized gain relating to the exit of a lower middle market investment. The realized loss relating to certain SBIC debentures, which were repaid to manage their maturity dates and due to their higher interest rates, had a minimal impact on NAV, as it was primarily offset by the accounting reversal of the previously recognized unrealized depreciation, as the debentures were accounted for at fair value.

And as Dwayne discussed, we recorded net unrealized appreciation on the investment portfolio of $10.3 million during the first quarter, primarily resulting from $7.3 million of net appreciation on our lower middle market portfolio and $10.5 million of net appreciation on our private loan portfolio, partially offset by $7.4 million of net depreciation on our middle market portfolio. Our operating results for the first quarter resulted in a net increase in net assets of $41.4 million or $0.67 per share.

On the capital resources front, our liquidity and overall capitalization remained strong, as we had approximately $47 million of cash, $365 million of unused capacity under our credit facility, and $25 million of remaining SBIC debenture capacity for total liquidity of $437 million at the end of the first quarter. Currently, we have total liquidity in excess of $700 million, which is elevated as we issued $215 million of investment grade unsecured notes in April, with a five-year term and a fixed 5.2% coupon.

Due to the make-whole provision in our $175 million investment grade notes maturing this December, we used the net proceeds from the recent notes issuance to repay a portion of the outstanding balance under our revolving credit facility and will then reborrow under the facility to repay the $175 million notes upon maturity in December. We are pleased with this transaction, as the increase in our unsecured debt interest rate since our last investment grade notes issuance in November 2017 was significantly less than the increase in the interest rate under our secured credit facility over the same time period. We also believe providing additional long-term fixed rate debt capital enhanced our capital structure and has us well-positioned for the future.

We're also active under our ATM equity issuance program, raising approximately $35.3 million in net proceeds during the first quarter with an average sale price of $37.36 per share. As we look forward to the second quarter of 2019, we expect that we will generate distributable net investment income of $0.63 to $0.65 per share during the quarter. This estimate is $0.03 to $0.05 per share or approximately 5% to 8% above our previously announced monthly dividends for the second quarter of $0.60 per share, maintaining our conservative approach to our monthly cash dividends. This estimate is after the incremental cost of our recent investment grade debt offering, which we expect will increase our interest expense by approximately $0.01 per share in the second quarter when compared to our prior expectations.

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

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Leslie Vandegrift with Raymond James. Please proceed with your question.

[Leslie Vandegrift, Raymond James]

Hi. Good morning.

[Dwayne Hyzak, Chief Executive Officer]

Good morning.

[Leslie Vandegrift, Raymond James]

My question is -- I noticed in the press release, when you look at the lower middle market and middle market and private loan portfolios, each one of those had a slight incremental decrease in the average EBITDA portfolio companies in each. So is that due to a mix in each of those portfolios or is that changing from fourth quarter, or is that due to a bit of a contraction in EBITDA there?

[Dwayne Hyzak, Chief Executive Officer]

Yes. I would say that it's -- we have to look at it in a little bit detail -- a little more detail to give you a real precise answer. But I'd say it's more of a mix as you look at your movement in the portfolio as opposed to anything we're seeing that would be a a downward trend or decline in EBITDA in the underlying portfolio companies.

[Leslie Vandegrift, Raymond James]

Okay. Thank you. And then, on the dividend income decrease this quarter, was that -- again, was that due to a mix issue there of the equity of some of the repayments, or were some of the portfolio companies just simply paying a lower yield this quarter?

[Dwayne Hyzak, Chief Executive Officer]

I think if you look at our comments from last year's quarter and we kind of do this each quarter, we try to identify the parts of the income including dividend income that could be higher than we expect to be recurring or maybe some unusual activity. And if you look back at last year's comments, you would have seen that we had some elevated given an activity that we were trying to communicate may not be recurring in nature. So I think it's more just a comp or a comparison to last year's fourth quarter having some dividend income that was less recurring in nature that caused that decline on a year-over-year basis.

[Leslie Vandegrift, Raymond James]

Okay. Thank you. That's my question.

[Dwayne Hyzak, Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from the line of Tim Hayes from B. Riley FBR. Please proceed with your question.

[Tim Hayes, B. Riley FBR]

Hi, good morning guys. Thanks for taking my questions. My first one, you still have six investments on non-accrual, flat quarter over quarter. Is one of those still the MH Corbin investment that was placed on non-accrual last quarter or was that replaced with another one? I know that you had mentioned the expected resolution in the first half of the year. So just wondering if we can get an update there, if that indeed has not been replaced?

[Dwayne Hyzak, Chief Executive Officer]

Sure. Yes, MH Corbin actually came off of on non-accrual by the end of the quarter and it was replaced by one of our middle market investments SiTV. And so, that's why the numbers flat, but SiTV did replace them each quarter.

[Tim Hayes, B. Riley FBR]

Okay. Got it. And then, could you maybe just expand a little bit on why or what's going on with SiTV and what your outlook is that -- for that investment?

[Dwayne Hyzak, Chief Executive Officer]

SiTV's entered the bankruptcy, expecting a restructuring this quarter. It should be fairly quick and we'd expect that to exit before the end of 6/30. We like the investment long-term, but it needed a cash structure restructuring there, (inaudible) too much debt. So we expect that to be a result in the next two to three months.

[Tim Hayes, B. Riley FBR]

Got it. Okay. And then, I understand you may be limited in what you can say, but can you just expand on your comment around potential upcoming exits in the coming quarters? What's driving these events, and if you have maybe a rough estimate of the gains that these events could drive?

[Dwayne Hyzak, Chief Executive Officer]

Yes, so, as you have expected, we're going to be fairly limited in what we can say. But I think what we're trying to communicate there is that given the robust nature of the overall markets from an M&A standpoint, we have seen more inbound interest from third parties and that inbound interest has been a valuation levels or structures that are pretty favorable compared to our fair value marks. So we have engaged in discussions. Those discussions in each situation would be in different stages of the process, but we do expect that some of those activities would lead to exits over the next two quarters. So we would expect those exits as I tried to communicate in my comments to be favorable. So what that means for us is that they would be favorable in comparison to or historical fair value marks for those specific companies or those specific investments.

[Tim Hayes, B. Riley FBR]

Okay. Just to be clear though, did the current March, as of March 31st, they don't on these targeted companies you're talking about, they don't reflect any potential M&A in those valuations currently?

[Dwayne Hyzak, Chief Executive Officer]

I would say that they would each reflect the potential for M&A at different levels based upon where they are in the process. So some would be -- you would reflect fair values that are closer to what we expect the exit valuation to be. Others, if they're earlier in the process, will probably have a bigger delta between the fair value at 3/31 and what we would hope to realize from an exit standpoint.

[Tim Hayes, B. Riley FBR]

Okay, understood. That's helpful. Appreciate that. And then, I know you mentioned that the bulk of the unrealized appreciation was due to the reversal of 4Q market volatility, but would you be able to maybe size that for us?

[Dwayne Hyzak, Chief Executive Officer]

What I would say is that, that breakdown of that split between marketing credit is never perfect. So that's why we hesitate to give numbers that are real precise, but the way that we would categorize it is, if you looked at the private loan segment of the market, there would be a significant portion of that portfolio that the appreciation would reflect a reversal of the negative market impact from Q4. And I think if you look at the middle market, you continue to see some specific credit issues that have resulted in the depreciation in Q1. And we've seen the market recovery and fair values in the middle market portfolio to be slower to return in comparison to the private loan market or private loan portfolio.

[Tim Hayes, B. Riley FBR]

Okay. Thanks for that. And then, I'll just sneak in one more here. How would you describe the health of your borrowers today between the economy, rising input costs, potential trade wars, interest rates, shortage of labor or anything else, what do you think the biggest problem or problems they face today are?

[Dwayne Hyzak, Chief Executive Officer]

I would say overall, we would -- we have a positive view on the credit quality and the performance of the portfolio companies. Obviously, you look at our non-accruals and some of the comments that Nick gave, we do have certain companies that have very specific credit issues that they experience from time to time. But overall, the quality of the portfolio from our view -- our perspective continues to be very strong. If you were to look at some of the biggest issues that we likely hear on a consistent basis primarily from our lower middle market portfolio company managers, it would be the accessibility of quality labor at reasonable expense. I think we've mentioned that before over the last couple of quarters and I would say that across the portfolio, that's the thing that we would point as the most consistent concern or issue that our lower middle market portfolio company managers face.

[Tim Hayes, B. Riley FBR]

Got it. That helpful. I appreciate the comments, and thanks for taking my questions this morning.

[Dwayne Hyzak, Chief Executive Officer]

Thank you.

[Operator]

There are no further questions in the queue. I'd like to hand the call back to management for closing comments.

[Dwayne Hyzak, Chief Executive Officer]

Thank you all for joining us again this morning. We appreciate the questions and we'll look forward to talking to everyone again in a few months.

[Operator]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.