Q3 2019 Earnings Call
Yes.
That's available operator will be with you momentarily.
Thank you for calling income converting the next available operator will be with you momentarily.
[noise]. Thank you for calling income conferencing. The next available operator will be with you momentarily.
Yeah.
Thank you for calling income converting the next available operator will be with you momentarily.
Yes.
Thank you for calling income conferencing. The next available operator will be with you momentarily.
Yes.
Thank you for calling income converting the next available operator will be with few momentarily.
Yes.
Hey.
Thank you for calling income converting the next available operator will be with you momentarily.
Yes.
Thank you for calling income converting the next available operator will be with you momentarily.
Yes.
Yes.
Thank you for calling income converting the next available operator will be with you momentarily.
Yes.
Thank you for calling income converting the next available operator will be with few momentarily.
Yes.
Thank you for calling income converting the next available operator will be with you momentarily.
The conference I remember neighbors.
Yes, and they know.
That's gone, namely.
Yes, maybe just yes.
What's gonna take off or.
Hey.
Yes.
Mr Brown.
Hi, which conference or you're calling in for today.
There's daily.
Its main study can be lumpy.
Hey, hard time understanding with the speaker phone.
Oh.
Yeah.
Who's the host.
Great.
<unk>.
Okay and what's your.
Yeah, Hey.
Great.
Yeah.
Yeah.
You know.
Uh huh.
Thank you stand by for the conference there sorry about that.
Thank you today.
That's that's a appreciating and 17 depreciating.
Hello Middle market companies collectively continue to exhibit very conservative credit profiles on a relative basis, which David will cover in his comments.
Our middle market and private loan portfolios collectively depreciated by $10.7 million on a net basis.
Merely due to the impact of depreciation from certain investments with specific credit issues that we've been working through in our middle market portfolio.
Earlier this week, our board declared our first quarter 2020 regular monthly dividends of 20.5 cents per share payable in each of January February and March and amount that is unchanged from a monthly dividends for the fourth quarter and representing a 5.1% increase from the first quarter of 2019.
Consistent with our prior guidance and our previously announced plan for transitioning our semiannual supplemental dividends into our monthly dividends over several years. We also recently declared a supplemental dividend payable in December of 24 cents per share a decrease of one cents from our June supplemental dividend.
We continue to expect that our dividend transition will take several years with the ultimate timing of this transition impacted by the performance of our investment portfolio. The overall economy and changes in the overall interest rate environment.
And we remain confident that by the ended the transition period, we will be successful and delivering on our long term goal of growing our total annual dividends.
Now turning to our investment activities in the quarter in our current investment pipeline.
We completed lower middle market investments of approximately $25 million in the quarter and as of today I would characterize our lower middle market investment pipeline as above average.
Our third quarter activity and our current pipeline are the results of our maintenance on a disciplined and selective approach to new investment opportunities and we remain confident in our future ability to continue to originate new investments consistent with our historical investment profile.
Our comments over the last few quarters whenever that we're experiencing increased third party interest in several of our existing lower middle market portfolio companies and as interest resulted into attractive exits in the third quarter.
We believe with these ongoing activity should result in additional attractive exits over the next two 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 $32 million on a net basis in the quarter.
In addition, our middle market portfolio grew by approximately $26 million.
As of today, I would characterize our private loan investment pipeline as above average.
And in closing our office or in director group has continued to be regular purchases of our shares investing approximately $500000 during the quarter and owning main street shares valued at over $154 million at quarter end.
With that I will turn the call over to David.
Thanks to win and good morning, everyone.
We're pleased to report another quarter during which we grew our net total investment income and distributable net investment income while continuing to generate distributable net investment income in excess of our monthly dividends.
We believe that our results illustrate the significant benefits of our unique investment strategy in the lower middle market, which when combined with our complementary first lien debt investment strategies and our asset management activities provide the value proposition that positively differentiates mainstreet, among our BDC peers.
This has been demonstrated through our consistent ability to generate premium total returns for our shareholders to the growth in our dividends per share our increased net asset value per share and our stock price appreciation.
The 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 equity upside as our portfolio companies perform well our first lien debt investments provide an attractive yield profile and significant downside protection.
Each quarter, we try to highlight different aspects of our unique investment strategy.
This quarter, we like to highlight several points related to the benefit of our lower middle market investment strategy as illustrated by several recent exit of equity investments.
During 2019, we fully exited four of our lower middle market equity investments.
All of these exits resulted in realized gains in which which in aggregate totaled approximately $14 million.
When you compare our realized gains on these exits to the fair value marks two quarters and four quarters prior to exit the actual value achieved on the exit of these investments exceed exceeded the fair value marks by approximately 5% two quarters prior to exit and by over 40% four quarters prior to exit.
In the third quarter of 2019, we exited two of our lower middle market equity investments. Both exits resulted in realized gains with these gains totaling almost $8 million.
The exit from our investment in land ventures. During this past quarter generated or realized gain of approximately $6 million and a cumulative 11% internal rate of return and a 2.2 times money invested on our cumulative debt and equity investments.
The full exit of our equity investment in content. During this past quarter generated realized gains over the life of the investment of $2.6 million and a cumulative 22% internal rate of return at 2.8 times money invested on our cumulative debt and equity investments.
Despite both investments experience experiencing volatility in profitability and valuation over our 11 million year investment period, we ultimately achieve very attractive return profiles.
We believe these examples support our competitive advantage of being long term investors participating in both the debt and the equity in our lower middle market companies and the advantage of being able to hold investments for extended periods of time despite market volatility.
We also believe the related comparison of these realized gains to our prior fair value estimates are helpful. When evaluating that fit the current fair value estimates for our overall portfolio.
Finally, as Dwayne mentioned earlier, we continued to get inbound interest in various lower middle market companies and we currently have several other attractive potential portfolio company exit opportunities that we hope to complete in the next two quarters.
Hi size and scope are lower middle market investments, our primary driver hi, both our historical any the per share growth and our significant pre tax net unrealized depreciation at September thirtyth, contributing approximately $212 million or three dollarsthirty five cents per share.
Our lower middle market investment also support growth in our total dividends paid to our shareholders through the dividend dividend income, we received and the periodic realized gains upon the exit from these equity investments.
In addition, the unrealized depreciation and realized gains from these equity investments provide an offset against the inevitable credit losses that will be experienced when making investments in non investment grade debt securities.
Turning back to our most recent operating results the contributions from our lower middle market portfolio continues to be well diversified with 40 of our 67 lower middle market companies with equity investments, having unrealized appreciation at quarter end.
66% of our companies that are passed 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 approximately $33 million. During this period of time, representing a 28% compounded annual growth rate since the year ended 2000.
17.
We believe the diversity of our lower middle market portfolio is critical when analyzing the benefits from this strategy. We believe that this diversity provides visibility to the recurring nature of these benefits in the future.
At September Thirtyth, we had invested 182 portfolio companies spending across more than 50 industries.
Our largest portfolio company represented 2.6% of our total investment portfolio fair value at quarter end and 4.9% of our total investment income for the last 12 months.
The majority of our portfolio investments represented less than 1% of our assets and our income.
Additional details our investment portfolio quarter end are included in the press release that we issued yesterday, but I'll note ill note a few highlights.
Our lower middle market portfolio included investments and 68 companies, representing approximately $1.2 billion, a fair value, which is over 20% above our cost basis at the lower middle market portfolio level. The portfolio's median net senior debt to EBITDA ratio was a conservative 3.1 to one.
Were 3.2 to one including portfolio company debt, which is junior in priority to our debt position and the total EBITDA to senior interest ratio was 2.9 to one.
And our private loan portfolio, we had investments and 62 companies, representing approximately $630 million, a fair value and in our middle market portfolio. We had investments in 52 companies, representing approximately $550 million a fair value.
Total investment portfolio at fair value at quarter end was approximately 100%, 108% related cost basis, and we had seven investments on nonaccrual status, which comprise approximately 1.6% of the total investment portfolio at fair value and 4.4 at cost.
With that I'll turn the call over to Brent cover our financial results capital structure and liquidity position.
Thanks, David We're pleased to report that our total investment income increased over the same period in 2018 to a total of 60.1 million, primarily driven by an increase in dividend income and partially offset by a decrease in fee income the change in total investment income includes a decrease of 1.9.
9 million related to lower levels of accelerated income for certain debt investments when compared to the third quarter of last year.
Our operating expenses, excluding noncash share based compensation expense increased 5.4 million over the same period of the prior year to a total of 18.5 million primarily related to an increase in interest expense and partially offset by a decrease in compensation expense.
The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets was 1.2% for the third quarter on an annualized basis at 1.3% for the trailing 12 month period.
The combination of our unique investment strategy and leverage of our efficient operating structure resulted in distributable net investment income of 41.6 million or 66 cents per share, which exceeded our monthly dividends paid for the quarter by approximately 7%.
Activities of our external investment manager benefit our net investment income by approximately 2.6 million through the allocation of 1.7 million of operating expenses for services, we provided to it and 1 million of dividend income.
We recorded a net realized loss of 5.9 million primarily relating to the realized losses from the restructure and exit of to middle market investments, partially offset by realized gains relating to the exit of to lower middle market investments.
And it's Dwayne discussed we recorded net unrealized depreciation on the investment portfolio of 7.7 million, primarily resulting from 12.2 million of net depreciation relating to our middle market portfolio, partially offset by 2.7 million of net appreciation on our lower middle market portfolio.
$1.5 million of net appreciation on our private loan portfolio and point 8 million of appreciation relating to our external investment manager.
Our operating results for the third quarter resulted in a net increase in net assets of 33.9 million or 54 cents per share.
Our overall capitalization and liquidity remains strong as our total liquidity was approximately 650 million at the end of the third quarter.
As we previously discussed following our investment grade debt issuance in April of this year, we will re borrow under our revolving credit facility to repay the 175 million investment grade notes that mature in December .
Due to our elevated liquidity, we were again less active under our ATM equity issuance program during the third quarter, raising approximately $9.3 million net proceeds with an average sale price exceeding $42 per share.
As we look forward to the fourth quarter of 2019 and taking into account the impact from the recent interest rate cuts, which we estimate will have a negative impact of approximately two cents per share during the fourth quarter based on our floating rate loan portfolio as of September Thirtyth, we expect that we will generate destroy.
Total net investment income of 63 to 65 cents per share. This estimate is one and a half to 3.5 cents per share or approximately 2% to 6% above our previously announced monthly dividends for the fourth quarter of 61, and a half cents per share with that I'll now turn the call back.
For the operator, so we can take any questions.
Thank you we will now begin ducking your question answer session.
If you'd like to ask your question you May press Star one on your telephone keypad confirmation tomo indicate your line is in the question Q.
You May press Star too if you would like to remove your question from the Q.
For participants shooting speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Please ask one question and one follow up question and then re queue for additional questions.
Our first question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Hi, guys out all the lower middle market portfolio could you give us any color on kind of growth that you're seeing I mean, obviously had a a lot of portfolio companies.
The revenue EBITDA or anything like that in terms of.
In terms of trends that you're seeing them and if there are the weaker industry areas and that sort of semi.
Related to that I think the tone change too and I think last quarter.
Middle market pipeline was about average this quarter, which it's above average any color on what the drivers would then if there's any industries the have become.
More attractive or more active.
Sure. Thanks, Thanks, Robert I'll get a couple of comments and I'll, let let David add on I'd say when you look at the existing lower middle market portfolio continues to perform at a.
Favorable level, if you look at revenue and EBITDA performance with increases or decreases at the portfolio level I'd say, it's consistent with what has been for a long time. So it's a continued positive performance in the and the actual results I would say if you're seeing any any increased.
Uncertainty or pessimism, it's more in the outlook I think if you talked to a subset of our companies, particularly those that are in more cyclical industries, there probably more pessimistic about the outlook today than they would have been three or six months ago. We just haven't seen that come through in their actual results yet to add a significant extending the portfolio continues to perform at a at UBS.
Positive level.
Anything to that David or just to your point about the pipeline.
The is lumpy business and last year, we closed 10 portfolio company new investments.
Because they're only 10, it's lumpy and how it falls in the quarter. So at any one time, we might see more or less activity right now I'd say that the pipeline like Duane characterize it's above average and were optimistic about closing some some deals in the near term.
Okay got it. Thank you and then just one more on on the.
Hmm.
That if I remember like from Quark orders I think that dividend was a little.
No this quarter than it has been with with that anything related to.
Incentive fees HMS, so a anything like that that the flowing to you may be paying a slightly smaller dividend this quarters, it's marginal so.
Yeah, right I would say that the vast majority of that variances all incentive fees, we had a nice incentive fee that we recognized and recorded in Q2 in that that decrease on a relative basis quarter over quarter in Q3.
Got it. Thank you. Thank you.
As a reminder, ladies and gentlemen, it is star one to ask your question. Our next question comes from the line of Bryce Rowe with National Securities. Please proceed with your question.
Hi, great. Thanks, Good morning warning.
Dwayne and and David I'd I wanted to ask about dividends within the income statement, obviously, it's taking a.
Nice nice share.
Total revenue and it's been pretty consistent so far throughout 2019.
You've got.
From what I can tell one one company that said it accounted for.
And then maybe it maybe a quarter, 20% to a quarter of those of those dividends. So far this year.
So I wanted to I wanted to understand kind of what what visibility you might have into.
Dividend payments coming from those lower middle market equity investments and if you can.
Kind of foresee when you might have a shift from one company, taking a relatively large portion of that dividend income to to another company kind of stepping in to to provide that dividend income.
Yeah, right price what I would you stand response of the question as you as these lower middle market companies maturing de lever.
As long as they're continuing to perform they naturally have more cash flow thats available for dividend or distribution purposes.
So we have we do have one company that has contributed.
To a significant amount of dividend income in the year to date period, but we also have a number of companies that are contributing to dividend income on a consistent basis and that's that's the thing that we really take a lot of comfort and as that Theres, a hey, a group of companies that have continued to de lever and perform and are now becoming consistent meaningful contributors to our given.
Net income on a recurring quarterly basis, and that's what gives us a lot of comfort when we look at the portfolio as a whole and the sources of that dividend income each quarter going forward.
Okay. That's helpful.
Maybe a maybe a question on the non accrual flows.
Obviously, you stated total total number of nonaccrual investments at seven.
I was curious if there is change within within those seven quarter to quarter. If he had one come in in one one or two go out.
Yes, that's correct accounts stay the same but we had one move out in one move in so journeys was on non accrual.
Last quarter, but it went through a restructuring so it was removed from the non accrual this and that American addiction centers was added to non accrual during during the third quarter.
Okay.
And then maybe one one more for your brand just you may note of the lower incentive compensation.
Accrual here in the in the third quarter, they push compensation expense down down a bit quarter over quarter.
That is that a function of weaker weaker volumes weaker credit quality trends what's.
What's driving that and any any kind of forward look on what they mean that what that might look like in the fourth quarter would be helpful. Thanks.
Yes, what I would say that theres, a number of factors that contribute to the it to the instead at the declining part of it is impact of interest rates part of it is specific names that.
You have had performance issues, namely the non accrual that.
The brand touched on so those are contributing factors I think when we look forward is it's always hard to predict.
How much incentive fee income you will have I think when you look forward.
Oh, I'm, sorry, the comp I'm sorry.
Go ahead, I'm, sorry, yes, I misunderstood the questions. Okay, right I mean, sorry, like that incentive compensation accrual I basically when we accrued that every quarter and we look at the overall financial results of obviously this year, we haven't quite met our OE target and other factors to do some middle market crash.
Specific issues as well as lower.
Originations are lower middle market, so we adjust our incentive accrual.
Each quarter based on a year to date performance. So you're looking for the fourth quarter ultimately will depend how the fourth quarter shakes out and have a full year.
Shakes out generally speaking I would expect our compensation level.
Are you a little bit higher than the third quarter, but it should not be materially higher.
Okay, exactly what I needed. Thank you sure. Thanks Bryce.
This concludes today's question answer session I'd like to turn the call back to management for closing remarks.
Well, thank everyone for joining us today, and we look forward to talking gathered to everyone again in late February .
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.
Yeah.