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Main Street Capital (NYSE:MAIN)

Q3 2013 Earnings Call

November 08, 2013 10:00 am ET


Ben Burnham - Vice President of Investor Relations Counsel

Vincent D. Foster - Chairman, Chief Executive Officer, President, Member of Credit Committee and Member of Investment Committee

Dwayne Louis Hyzak - Chief Financial Officer, Senior Managing Director and Treasurer


Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Robert J. Dodd - Raymond James & Associates, Inc., Research Division


Good morning, ladies and gentlemen, and thank you for standing by. And welcome to the Main Street Third Quarter Earnings Call. [Operator Instructions] This conference is being recorded today, November 8, 2013. I would now like to turn the call over to Ben Burnham with Dennard-Lascar. Please go ahead.

Ben Burnham

Thank you, Craig, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation Third Quarter 2013 Earnings Conference Call. Joining me today on the call are Chairman, President and CEO, Vince Foster; and Chief Financial Officer, Dwayne Hyzak.

Main Street issued a press release yesterday afternoon that detailed the company's quarterly financial and operating results. This document is available on the Investor Relations section of the company's website at

A replay of today's call will be available beginning about an hour after the completion of the call, and will remain available until November 15. Information on how to access the replay is included in yesterday's press release. We also advise you that this conference call is being broadcast live through an Internet webcast that can be accessed on the company's web page. Please note that information reported on this call speaks only as of today, November 8, 2013, and therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening.

Our conference call today 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 and similar expressions. These statements are based on management's estimates, assumptions and projections as of the date of this call, and they are not guarantees of future performance. Actual results may differ materially from the results expressed or implied from 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 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 and distributable net realized income. Please refer to yesterday's press release for reconciliations 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.

Vincent D. Foster

Thanks, Ben, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcement and our dividend outlook, highlight our origination activity and conclude by commenting on our lower middle market pipeline. Following my comments, Dwayne will cover our operating performance in more detail and comment on our third quarter financial results, our current liquidity position and certain key portfolio, our metrics. After which, we will take your questions.

Our investment portfolio produced solid results for the third quarter. Our lower middle market investments appreciated during the quarter by $14 million on a net basis, with 21 of our investments appreciating during the quarter and 14 depreciating. Our middle market and private loan investments appreciated by roughly $1 million during the quarter. We finished the quarter with a net asset value per share of $20.01, a sequential increase of $1.29 a share over the second quarter. Our lower middle market companies ended the quarter with a $115 million of cash on their balance sheets. They also continued to exhibit very conservative leverage and debt service coverage ratios, which Dwayne will cover in greater detail.

We are pleased to report, we recently announced that our board declared an increase to $0.165 a month in our monthly dividend rate effective for the first quarter of 2014. We expect to ask our board to declare our semiannual supplemental dividend in the $0.20 to $0.25 a share range within the next 2 weeks.

During the course of our last conference call, I referenced our spillover taxable income of $46 million at June 30. As of September 30, we estimate that our spillover taxable income remained at a consistent level at $45 million. In order to manage potential increases in this amount, stay in compliance with the regulated investment company tax rules and reduce the 4% federal excise tax payable on the spillover amount that carries over into next year, we expect to ask our board to set the payment date of our next semiannual supplemental dividend in late December. We continue to expect that we will pay semiannual supplemental dividends going forward for the next few years, in addition to our regular monthly dividends.

Earlier this year, we reported to our shareholders via Form 1099 that over 46% of our 2012 dividends were taxed at the highly favorable 2012 tax rates on long-term capital gains. We currently expect that 100% of our regular monthly dividends paid in February and March and 61% and 72% of our dividends paid in April and August, respectively, will be taxed at the favorable 2013 rates on long-term capital gains. We're extremely pleased to once again deliver this level of tax efficiency to our taxpaying shareholders.

I'd like to turn now to originations. Our lower middle market originations for the quarter totaled $75 million on a gross basis and $68 million on a net basis. Our private loan originations were $7 million on a net basis, and our net middle market originations were at negative $55 million for the quarter, as we rotated out several of these positions to fund higher-yielding lower middle market and private loan originations. As of today, our lower middle market transaction pipeline is very healthy and this is after our pipeline has been reduced by several recently announced closings; specifically, we've announced new portfolio investments in Travis trailers, AM3 Pinnacle and Glowpoint since our last conference call.

We continue to seek and receive significant equity participation in our lower middle market investments. And as of quarter end, we maintained an average of a 33% fully diluted equity ownership position in the 94% of these investments in which we currently have equity exposure.

Our officer director group has continued to purchase shares via our dividend reinvestment plan, investing over $700,000 via this program during the third quarter. And our officer director and senior management group owns $75 million of our shares.

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

Dwayne Louis Hyzak

Thanks, Vince. We are pleased to report another quarter with operating results that are consistent with our long-term goals of generating sustainable growth in our recurring investment income and continued appreciation of our net asset value per share.

For the third quarter, our total investment income increased by 29% over the same period in 2012 to $29.7 million. This increase was primarily driven by a $5.8 million increase in interest income, associated with higher levels of portfolio debt investments, and a $900,000 increase in dividend income from our portfolio equity investments.

Third quarter 2013 operating expenses, excluding noncash share-based compensation expense, increased by $3.3 million over the third quarter of prior year to a total of $10 million. The operating expense increase included a $2 million increase in interest expense, resulting primarily from our issuance of 10-year notes in April of this year and a higher average outstanding balance on our credit facility when compared to prior year.

We also incurred higher compensation-related expenses of $700,000 and higher other general and administrative expenses of $600,000 in comparison to prior year. Our noncash share-based compensation expense in the third quarter increased by $1.5 million over the same period of prior year, primarily due to $1.3 million of nonrecurring expense associated with the accelerated vesting of unvested shares restricted stock as part of the retirement of our former executive Vice Chairman.

The ratio of our total operating expenses, excluding interest expense and excluding the nonrecurring portion of our noncash share-based compensation expense, as a percentage of average total assets, which we believe is a key metric in evaluating our operating efficiency, was 1.6% on an annualized basis for the third quarter of 2013, which is consistent with this metric from the third quarter of 2012 and which continues to compare very favorably to other BDCs.

Our low-cost, internally managed operating structure allows us to deliver a greater portion of our gross portfolio returns to our shareholders, and we believe that it provides for greater alignment of interest of our management with the interest of our shareholders.

As a result of our total increase -- our increased total investment income and the continued leverage of our beneficial low-cost operating structure, distributable net investment income for the third quarter of 2013 increased by 21% over the third quarter of the prior year to $19.6 million or $0.53 per share, again exceeding our monthly dividends paid for the quarter with an excess this quarter of over $0.06 per share or 14%.

Our distributable net realized income in the third quarter was $11.8 million or $0.32 per share, which includes the impact of $7.8 million of net realized losses. These net realized losses include approximately $3 million of net realized losses on our investment portfolio and a non-investment portfolio loss of $4.8 million on the prepayment of certain of our SBIC debentures. In conjunction with our efforts to optimize the maturity dates of our oldest SBIC debentures, we prepaid $63.8 million of SBIC debentures during the third quarter. A portion of these SBIC debentures has historically been accounted for in a fair value basis, and as a result of that fair value accounting, we recorded a realized loss of $4.8 million during the third quarter on these prepayments. This realized loss was offset by the reversal of previously recognized unrealized appreciation on the SBIC debentures and as a result of prepayment of these SBIC debentures, had no net impact on our net increase and net assets for the third quarter.

As previously discussed by Vince, we had total net unrealized appreciation of $14.5 million on the investment portfolio during the third quarter of 2013. The operating results for the third quarter of 2013 resulted in a net increase in net assets from operations of $28.1 million or $0.76 per share. As a result of our increase in net assets from operations for the third quarter and the impact of our accretive follow-on equity offering in August, our net asset value per share at quarter end was $20.01 per share or an increase of $1.42 or 8% from December 31, 2012.

On the capital resources front, we took several steps during the third quarter to improve our liquidity, our access to capital for continued growth and our overall capitalization, including the completion of our follow-on equity offering in August, the prepayment of $63.8 million of our most mature SBIC debentures, as previously mentioned, and the amendment and restatement of our credit facility in September. As a result of these activities, on September 30, we had $17.6 million of cash, $20 million of marketable securities and $279 million of unused capacity under our credit facility. Today, we have approximately $26 million of cash, $17 million of marketable securities and approximately $265 million of unused capacity under our credit facility, providing a significant capacity for future growth. The improvements in the credit facility included increase in total commitments to $445 million, representing an expansion of $62.5 million; an increase in the number of lenders to a diversified lending group of 13 lenders; and a reduction in both the interest rate and the unused fees under the facility. In addition, the facility is now available to us on a revolving basis for the full 5-year period through the maturity date in September 2018.

The previously-discussed prepayments of our most mature SBIC debentures extended the weighted average remaining duration for our existing SBIC leverage to approximately 6.8 years as of September 30 and move the next scheduled maturity date from 2014 to 2017. At quarter end, we had $161.2 million of SBIC leverage outstanding, which bears a weighted average fixed interest rate of approximately 4.3%. In September 30, we've issued new SBIC debentures totaling $20 million, and we expect to access the remaining $43.8 million available to us under the SBIC program over the next 2 quarters.

We continue to explore various financing sources to support our future operational and investment activities, and we remain focused on maintaining significant liquidity and matching the expected duration of our borrowing arrangements with our investment assets.

As we look forward to the fourth quarter of 2013 and consider our current investment portfolio, we expect that our investment strategy, our diversified investment portfolio and our low-cost operating structure, will result in fourth quarter 2013 distributable net investment income per share of $0.54 to $0.55 per share or $0.01 to $0.02 higher than our distributable net investment income for the third quarter.

Now, let me finish with a few portfolio statistics, all as of September 30. Our investment portfolio as of September 30 continues to be extremely diversified with investments in 158 companies across our lower middle market, middle market and private loan portfolios. These companies are diversified across over 50 different industries, and the portfolio continues to be well diversified by end market, geography and vintage. We believe that this portfolio diversification adds significant protections to our investment portfolio, recurring investment income and cash flows and provide significant benefits to our shareholders.

In our lower-middle market portfolio, we had 62 investments, representing approximately $636 million of fair value, or greater than 25% above the cost basis of approximately $504 million. Consistent with our investment strategy, approximately 74% of our lower middle market portfolio investments at cost were in the form of secured debt investments, and approximately 89% of those debt investments held the first lien security position. The weighted average effective yield on our lower middle market portfolio debt investments was 14.9%.

As Vince mentioned, we continue to hold equity positions in 94% of our lower middle market portfolio companies, with an average fully diluted equity ownership position of approximately 33%. We believe that these equity ownership positions provide significant value to our shareholders and they are the primary driver behind our significant net unrealized appreciation of over $3 per share and our growing levels of dividend income.

At the lower middle market portfolio level, the portfolio's median net senior debt-to-EBITDA ratio was 2.2:1 or 2.3:1, including portfolio company debt, which is junior in priority to our debt position.

Based upon our internal rating system, with the rating of 1 being the highest and 5 being the lowest, and with all new investments entering the rating system with an initial 3 rating, the weighted average investment rating for our lower middle market investment portfolio was 2.2 on September 30, which is unchanged when compared with the rating at the end of the prior quarter.

In our middle market portfolio, we had investments in 83 companies, representing approximately $391 million of fair value that were generating a weighted average yield of approximately 7.9%. Our middle market portfolio investments are primarily in the form of debt investments, and approximately 92% of our middle market portfolio debt investments at cost held the first lien security position. The weighted average EBITDA for the 83 companies in the middle market portfolio was approximately $85 million.

In our private loan portfolio, we had investments in 13 companies, collectively totaling approximately $87 million in fair value. The weighted average EBITDA for the 13 companies in the private loan portfolio was approximately $52 million. Our private loan portfolio investments are primarily in the form of debt investments, and all such debt investments held the first lien security position. The weighted average annual effective yield on our private loan portfolio debt investments was approximately 12.0%. The total investment portfolio at September 30 was approximately 114% of the weighted cost basis, and we have one portfolio investment on non-accruals status and one fully impaired portfolio investment, which, together, represent approximately 0.4% of the total investment portfolio at cost.

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

Question-and-Answer Session


[Operator Instructions] And our first question does come from the line of Bryce Rowe with Robert W. Baird.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

A couple of questions here, and the first one is kind of around just optimal leverage levels. Obviously, we've seen the debt-to-equity ratio come down on an overall basis, including the SBA, into the low 50% range. So trying to get a feel for where you see cost taking that leverage level?

Vincent D. Foster

Yes, we're going to fund the next round of investments with debt. What really happened is we had the SBA debentures that were 7, 8, 9 years old coming due, and we wanted to refinance those. It was not completely clear how to do that in terms of timing, et cetera, with SBA. It was kind of a new issue to us, a new issue to them. And so we went ahead and did the equity offering. It turns out we could go ahead and repay those debentures themselves. We ended up kind of with a temporary lower debt level than we think is optimal. But I think you'll see us return to normal leverage levels. There's not -- we haven't had a change of philosophy. It's just kind of the coincidence of those 2 things.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just around, I guess, that repayment with the SBA, obviously, you frame it as a re-optimization of the duration of the SBA debentures.

Vincent D. Foster

Yes, and rates as well.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

And rates as well. I mean, are they -- is the SBA sensitive to the rate side of that equation? Does it need to be with the duration optimization? Is that being narrowed?

Vincent D. Foster

They are rate-insensitive. It's just a -- it's a market mechanism, and the sensitivity is more around -- it's really not sensitivity, it's just trying to come up with a protocol for someone like us who's relatively unique who is in a refinancing position as opposed to having a permanent fund. It's unusual on the program to refinance.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Right, okay. And then I guess last question, more technical, I assume the draws so far this quarter, it hasn't pulled yet and no pull in early March. Is that correct?

Vincent D. Foster

That's correct. Either early March or early April, I don't remember. So we're just -- we're borrowing at about 1% until then.


[Operator Instructions] And our next question does come from the line of Robert Dodd with Raymond James.

Robert J. Dodd - Raymond James & Associates, Inc., Research Division

Just looking at the lower middle market where you've seen, obviously, a high level of activity so far and there's still quite a bit of pipeline. Are you seeing anything change -- obviously, I mean, change in terms of term. I mean, we've heard of a bit further up in the middle market private equity, but for somewhat larger companies. It's -- some of the multiples never got quite aggressive. I mean, that's not normally the strategy plan, but is any of that creeping down into some of the transactions you're all looking at in terms of basically at this pricing being mature. It doesn't look like, obviously, on the leverage levels, but any color you could give us on that?

Vincent D. Foster

That's a good question, Robert, and it's really not a function of the overall market. But as we've kind of commented on in the past, when you are transacting with a $3 million or $4 million EBITDA company, you can get that transaction completed at -- maybe in between 4.5x and 5x EBITDA for your enterprise value. As you start looking at a $7 million, $8 million, $9 million EBITDA company, then you're probably transacting at, like, 5.5x level. And so we've had some enterprise value creep probably less than a multiple. That's what we've noticed and that's kind of always been the case, and we've expected that. And what you hope you're getting as an offset for that slightly higher price is a higher-quality company, less team and dependency in management, less customer concentration, stuff like that. I haven't seen any impact to point of view in terms of the overall "market."

Dwayne Louis Hyzak

I agree with Vince. The other thing to always remember, Robert, that our structure is highly unique. We are providing both the debt and equity. We're not just competing with people on a pure leverage buyout or other kind of change of controlled transaction. You put this in a different part of the market from a competitive standpoint because there's a significantly fewer number of players that will provide that highly structured solution.

Robert J. Dodd - Raymond James & Associates, Inc., Research Division

Yes, absolutely. Understood. Just kind of a follow-up on that, with a pretty strong pipeline, obviously, this year, that doesn't seem or make changes obviously to be kind of accretive in terms of things needing to be done by the end of the year. So do you expect things to just kind of -- we'll have a solid Q4 and maybe not have the step change, Q4 to Q1, in terms of activities that we've seen last year?

Vincent D. Foster

Yes, I think if you are a seller, Robert, the difference between transacting in December and January is merely a few months deferral in paying your capital gains tax. The capital gains tax is now at 23.8% for those dollars. So having to pay it in December versus maybe a quarter or 2 later, depending on how they make their estimated payments and file the returns, that doesn't really change anything. Actually, what we really like to do is transact around the quarter end or year end so you don't have short-period tax returns and interim accounting accruals and difficulty in measuring working capital and stuff like that. So you'll see a lot of activity for us attempted to be transacted around quarter end.


And at this time, there are no further questions. I would like to turn the call back over to management for any closing comments.

Vincent D. Foster

Great. Well, thank you all for joining us, and we look forward to speaking to you again early next year.


Thank you. Ladies and gentlemen, that will conclude the conference call for today. We do thank you for your participation. You may now disconnect your lines at this time.

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