Q4 2019 Earnings Call

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Greetings and welcome to main Street Capital Corporation fourth quarter earnings Conference call.

This time, all participants are lost only mode.

The brief question answer session will follow the formal presentation.

If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.

As a reminder, this conference is being recorded.

It's now my pleasure to introduce your host Sackful on West Dennard Lascar Investor Relations. Thank you Jack you May now begin.

Thank you operator, and good morning, everyone <unk>.

Joining us for main Street capital Corporation's fourth quarter 2014 earnings Conference call.

Mainstreet issued a press release yesterday afternoon, the detailed the company's fourth quarter financial and operating results.

This document is available on the Investor Relations section of the company's website <unk> S T capital.

A replay of todays call will be available we're getting an hour after the completion of the call nor right available until March six.

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Information on how to access to report was acquired in Yesterdays release.

We also advise you that this conference call as being broadcast washed 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 February 20 years 2020, and therefore, you're advised the time sensitive information may no longer be accurate at the time, we're going to replay listening or transcript <unk>.

Today's call will contain forward looking statements.

These forward looking statements can be identified by the use of words, such as anticipates believes expects intends well sure may or similar expressions.

These statements are based on management's estimates assumptions or projections.

The data this call or no guarantees of future performance.

Actual results may differ materially from the results expressed or implied in these statements as a result of risks on certain since you use 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, where FCC dotcom.

Mainstreet 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.

It was derived from third party sources, and there's not been independently verified.

Now I'll turn the call over to Mainstreet CEO Duane.

Thanks, Zack and thank you all for joining yesterday.

Joining me for a call today with prepared comments or David Mandell, our president and Chief investment Officer, and Brent Smith, our CFO.

Also joining us for the Q a portion of our call our Vince Foster our executive Chairman and Mr. are 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 fourth quarter and I will also comment on some current activities our asset management business.

Discuss our recent dividend announcement and other recent developments and I will conclude with some remarks, our investment activities at our current investment pipeline.

Following my comments, David and Brett will provide additional comments, our investment strategy investment portfolio and financial results after which we'll be happy to take your questions.

We're pleased that for the fourth quarter and full year, we again generated distributable net investment income or D. and I I per share in excess of my regular monthly dividends exceeding the monthly dividends paid in the fourth quarter by approximately 7%.

Four year by approximately 10%.

During the quarter, we continue to focus our efforts on sourcing transactions and the lower middle market that are consistent with our historical investment profile and executing against our previously stated goal of growing our private loan investment portfolio, while being highly selective with new investments in our middle market portfolio.

Despite our successes in 2019 or actual results were below our stated long term goals within our OE return on equity at 8.5%.

And as a result, we executed on our core principle of maintaining alignment between our management team and our shareholders by reducing the amount of incentive cash compensation paid to our executive and senior management team when compared to prior years.

We continue to believe that the advantages of our differentiated investment strategy diversified investment portfolio efficient operating structure and the alignment of interests with our shareholders combined with our conservative capital structure and strong liquidity position have is very well positioned for long term growth and continued future success.

Over the past several months, we've taken significant steps in our ongoing efforts to organically grow our asset management business and we expect to be in position to announced a new strategic initiatives in this part of our strategy in the near future.

We also continue to be to actively review Bible acquisition opportunities as we evaluate multiple options to grow our asset management business.

Earlier this week, our board declared our second quarter 2020 regular monthly dividends of 20.5 cents per share payable in Egypt April may and June.

The amount that is unchanged from our monthly dividends for the first quarter and representing a 2.5% increase from the second quarter of prior year.

Consistent with our prior practice and as part of the execution of our plan to absorb our semiannual supplemental dividends into our regular monthly dividends. We currently expect to recommend that our board declared a supplemental dividend payable in June of 23 cents per share representing a decrease of one cents from our December 2019 dividend.

We continue to expect that our dividend transition plan will take several years with the also been timing and outcome of this transition impacted by the level of our investment originations and repayments the performance of our investment portfolio.

And changes in the overall interest rate environment and the overall economy.

Now turning to our investment activities in the quarter and our current investment pipeline, we completed lower middle market investments of over $36 million in the quarter and as of today I would characterize our lower middle market investment pipeline a significantly above average.

We continue to be focused on maintaining 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.

And our comments over the last few quarters. We noted that we are experiencing increased third party interest in a few of our existing lower middle market portfolio companies.

These activities activities have continued and he is ongoing activities could result in additional attractive exits over the next few quarters.

We also continued to successful focus of our non lower middle market investment growth on our private loan portfolio, resulting in this portfolio growing by over $71 million on a net basis in the quarter, while our middle market portfolio decreased by over $18 million.

As of today, I would characterize our private loan investment pipeline as average.

In closing our offer CERN director group has continued to be regular purchases of our shares investing approximately $600000 during the quarter and owning main street shares valued at over $143 million at quarter end.

With that I will turn the call over to David.

Thanks, Dwayne and good morning, everyone.

The year end provides a good opportunity to look back in our history and recap the benefits of our unique investment strategy and efficient operating structure and discuss how those factors have enabled us to deliver attractive returns to our shareholders over an extended period of time.

Since our IPO over 12 years ago, we have increased our monthly dividends per share by 86% and we have declared cumulative total dividends to our shareholders of over $28 per share were 189% of our IPO price of $15 per share.

As we've previously discussed we believed that the primary drivers of our long term success have been and continued to be are focused on investing in both debt and equity investments in the underserved lower middle market.

Our third party asset management business and related economics, which directly benefit our shareholders our industry, leading low cost structure and the strong alignment of interest that exist between our management team and our shareholders to the meaningful stock ownership, we have throughout our organization.

Most notably in uniquely are lower middle market strategy provides attractive leverage points and yields on our first lien debt investments also allowing us to be a true partner to the management teams of our portfolio companies door equity ownership positions.

In short we believed that we have significant downside protection through our first lien debt investments, while still benefiting from significant upside potential with our equity investments.

As a result of this strategy in 2019 were able to generate approximately $13 million of net realized gains and approximately $35 million of dividend income from this segment of our business.

Given our success lower middle market. We're pleased that we continue to find attractive new investment opportunities in the market.

Ability to provide customized capital solutions for the predominantly family owned businesses that exist in the lower middle market has been and continues to be a strong differentiator for us in the marketplace.

In 2019, Mainstreet invested in five new lower middle market portfolio companies.

This pace was slower than what we expect to achieve in any given annual period of time that said, our origination volume can be lumpy in lower middle market and to ready reiterate what Dwayne mentioned in his opening remarks as of today, we would characterize our lower middle market pipeline a significantly above average.

We look forward to making press announcements in the very near future about some exciting new investments that we currently have in the final stages of completing.

As a part of our constant effort to provide value to our lower middle market portfolio companies. We hosted our fourth annual Mainstreet Presidents day that last fall.

For those of you and maybe unfamiliar with Presidents' day is the main street hosted event, which we invite the majority of our lower middle market portfolio company leaders to share best practices.

Current from each other and benefit from being part of the broader mainstream portfolio.

You bet continues to improve each year, we received very positive feedback from a lower middle market portfolio company executives.

Topics covered in our most recent meeting included industry oriented workgroups sales generation techniques cyber security briefings and other timely matters that are top of mind for our portfolio company executives.

12 years ago, we could not have imagined we'd be able to build this type of collaborative community events and bring such robust benefit to our portfolio company.

As a result, our portfolio companies have done business together referred business to each other and made friendships that are invaluable.

One other example of topics covered the President's day is voluntary participation in a cost savings initiative that we undertook approximately two years ago.

With our platform of 69, lower middle market companies each can benefit from Bruce group savings in several expense category that will be difficult for our companies to replicate on the wrong.

Some examples include savings for travel shipping small parcels and insurance.

As Mainstreet continues to grow we're excited to provide our lower middle market portfolio companies the opportunity for participate in this highly effective annual event.

Now turning to our current investment portfolio as of December 31st we had investments in 185 portfolio companies spending across more than 50 different industries.

Our largest portfolio company represented 5.1% of our total investment income for the year and 2.8% of our total investment portfolio fair value at year end.

The majority of our portfolio company investments represent less than 1% of our income and our assets are lower middle market portfolio included investments and 69 companies, representing approximately $1.2 billion, a fair value, which is approximately 20% above our cost basis.

The contributions from our lower middle market portfolio continued to be well diversified with 40 of the 69 lower middle market companies, having unrealized depreciation at year end and 35 of these companies contributed to our dividend income in 2019.

In the past 12 months, we successfully exited for lower middle market companies, which generated a net realized gain of approximately $13 million.

At the lower middle market portfolio level. The portfolio's median net senior debt to EBITDA ratio as a conservative 2.8 to one and the total EBITDA to senior interest ratio was 2.9 to one.

As a complement to a lower middle market portfolio, we had investments in 65 companies in our private loan portfolio, representing approximately $690 million, a fair value and our middle market portfolio, We had investments at 51 companies, representing approximately $520 million at fair value.

As we've discussed on previous conference call, given our favorable view of the lower middle market and private loan opportunities that exist today, we have primarily focus our investment activities on these segments of the business with our middle market activities focused on highly selective investments instead of a growth oriented strategy with the intent to shrink the middle market portfolio on a relative.

Basis, compared to our lower middle market in private loan portfolios.

As a result during 2019, we increased our private loan portfolio by 33% and decreased our middle market portfolio by 6%.

The total investment portfolio at fair value at year end was approximately 107% of the related cost basis, we had eight and based investments on nonaccrual status, which equaled 1.4% of the total investment portfolio at fair value and 4.8% at cost.

Additional details our investment portfolio at year end are included in the press release, we issued yesterday.

With that ill turn the call over to Brent to cover our financial result 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 60.6 million, primarily driven by an increase in dividend income.

The change in total investment income is after a decrease of point 4 million related to lower levels of accelerated income for certain debt investments when compared to the fourth quarter of last year. The overall increase investment income is also after the negative impact to interest income from lower LIBOR rates when compared to the fourth quarter.

If last year.

Our operating expenses, excluding noncash share based compensation expense increased by 3.7 million over the same period of the prior year to a total of 18.6 million primarily related to an increase in interest expense and increase in compensation expense.

The increase in compensation expenses, primarily due to an increase in the fair value of our deferred compensation plan assets, which is an expense that is solely based on the public stock market price movement of these assets. It has no impact on our net income due to the offsetting unrealized appreciation on those same deferred compensation plan asset.

Yes.

And a net decrease in the nonrecurring expense reduction or benefit to income that was recorded relating to the conversion of a cash bonus into a noncash restricted stock grants.

The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets was 1.2% for the fourth quarter on an annualized basis and 1.4% for the full year.

The combination of our unique investment strategy and leverage of our efficient operating structure resulted in distributable net investment income of 42.1 million or 66 cents per share, which exceeded our monthly dividends paid for the quarter by approximately 7%.

The activities of our external investment manager benefited our net investment income by approximately 2.8 million due the allocation of 1.7 million of operating expenses for services are provided to it and 1.1 billion of dividend income.

We recorded a net realized losses point 9 million during the fourth quarter, primarily relate to the realized loss for the restructure of in middle market investment, partially offset by a realized gain related to the exit of a private loan investment.

We recorded net unrealized depreciation on the investment portfolio of 23.5 million, primarily resulting from 10.8 million of net depreciation related to our middle market portfolio.

6.9 million of net depreciation on our lower middle market portfolio.

6.9 million of net depreciation on our private loan portfolio at 3 million of net depreciation on or other portfolio, partially offset by 4.2 million appreciation relating to our external investment manager.

Our operating results for the fourth quarter resulted in net increase in net assets of 16 million or 25 cents per share.

Our overall capitalization and liquidity remains strong as our total liquidity was approaching 500 million at the end at the year during the fourth quarter, we repaid or 175 million investment grade notes that matured in December and we were also very pleased to be able to increase our 250 million investment grade debt issuance from this past.

April by 75 million.

The additional 75 million was issued at a yield to maturity of 3.95% and brought the total issuance to 325 million, representing our first index eligible investment grade debt deal and what we view as an important capital markets milestone.

We also raised approximately 35 million net proceeds under our ATM equity issuance program during the fourth quarter with an average sale price of nearly $43 per share.

As we look forward to our expected results for the first quarter of 2020 and taking into account the impact from the decline in LIBOR rates that occurred during 2019, which we estimate as a net as a negative net impact of approximately four cents per share in the upcoming first quarter, but compared to the.

First quarter of last year, and taking into account our expected origination and repayment activity. We expect that we will generate distributable net investment income 60 to 263 cents per share during the first quarter of 2020.

This estimate is they have to one and a half cents per share or approximately 1% to 2% above our previously announced monthly dividends for the first quarter of 61, and a half cents per share with that I'll now turn the call back over the operator, so we can take any questions.

Thank you well now be conducting a question and answer session. If you like to ask a question. Please press star one on your telephone keypad and the confirmation tone indicate your line is in the question Q.

You mean fresh start to feel like to move your question from the Q.

From this that are using speaker equipment, and maybe 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 question.

One moment, please help me poll for questions.

Thank you and your first question is from the line of Robert Dodd with Raymond James. Please proceed with your question.

Hi, guys.

First well both questions really relate to the same thing kind of cobot 19th with.

Can you give us any color on any discussions you've had with your portfolio companies, primarily on the lower middle market side, Oh, let's say.

About no not that exposure, because obviously that that domestic companies, but that supply chain exposure.

That's any.

Any particular areas, where they do have supply chain to to China, I'm, particularly if its who by province.

And if there's any concentration in supply chain that touches on China in any of your businesses.

Yes. Thanks, Thanks, Robert what I would say is as you touched on our lower middle market portfolio is largely domestic us based companies and not only the U.S. base most of their vendors and customers as we've talked about in the past are also going to be.

Predominantly us based we have had conversations with our portfolio companies on this topic and I would say that the current expectation is the impact is not overly significant definitely not as significant as you might see from the broader market a broader economy. We do expect that as the issue continues to play out and works its way through all the stuff.

Hi change issues that we will have some impact, but again I think we look at the impact and think it will be less significant on our side than it would be for the overall economy I.

I think the areas, where you would expect to see more impact would be areas, where you got your heavy electronics, that's an area, where I think we would you expect to see some of the impact first but again I think we're in a more of a wait and see.

Position until it's got until the supply chain issues really work their way through.

Got it I appreciate that and then I mean.

Sort of tied to the same to you characterized a yellow middle market pipeline.

Significantly above average and I mean, you had said today, but that may have been last week.

Do you think is is this kind of noise, you think likely to have any impact on that already the increasing it because again family owned businesses, maybe retirement planning or reducing as people decide to say on hands and kind of wait things out a little bit.

Yeah, I would say, it's again I think it's a little bit of a wait and see I would say our current pipeline as I said in my earlier comments is significantly above average you know the pipeline today is very robust obviously the impact of Corona virus in the indirect impacts to supply chain is something that we have to take into consideration as we work through our due diligence.

Processes.

But I would say that the characteristics of our current pipeline is consistent with the types of companies that we've executed historically in the lower middle market. So going back to my earlier response here a lot of something we have to watch you. It's not something that has a significant an impact as you might see from a broader economy standpoint.

And then if I take one follow up to that since its still at the same topic on the potential for four exits and again, it's very early days, but.

Have you seen anything over the last week of any of that typically when when there's an ex it's always that you know M&A private equity whatever somebody coming into to take in many cases one of these businesses.

It at all in all a whole variety of things, but has there been any movement on that that you've seen so fall I mean literally days into this but.

Yes. It today, we have not so again it is it'll be interesting to see how things play out over the coming weeks, but as we sit here today, we have not seen immaterial impact on that front either okay. Thank you. Thanks, you're welcome thanks for the questions.

The next question coming from the line of Bryce Rowe with National Securities. Please proceed with your question.

Thanks, Good morning warning.

Well, obviously you highlighted the asset management initiative that you you hope to talk about here in the near future.

Yeah, obviously, you are probably a bit constrained and what you can say, but I am curious.

You know, how how comfortable will that will that be to the to the HMS situation is it that it had a deviation from that and Tony any kind of color around around that asset management initiative would be would be helpful. Sure. So as you expected rise we're going be limited on what we can say, but.

As we've talked about for a number of years, we've been actively looking for ways to grow our asset management business. It's a core part of our overall strategy. So I'd say the most recent.

Yes, we've made is that we work through the process of looking at what we could do on a new private fund so it would be different than what we would do with that you with an agent Master. If we were to do something from an M&A standpoint from a.

From a BDC industry standpoint, it will be different from that but I'd say, we're kind of into prelaunch stage of looking at what we can do on the private new private fund that we would put in place in terms of the goals. Obviously, it's the goal is to grow our asset management business to continue diversified the funds that we manage I when I would say that the size of the opportunity will.

It would be dictated by what happens after we get through this this pre launch phase that we're in today.

Okay.

That's helpful.

A couple of a couple more questions number one you, obviously highlighted incentive comp being down here in the fourth quarter.

Could you remind us when we when we think about incentive comp inherent Harris said or are we target that that you had.

And that it really doesnt change year on year out or does that fluctuate on a on an annual basis.

I would say it fluctuates on an annual basis based upon what's going on in the marketplace. The overall economy and specifically in our portfolio.

So obviously, that's kind of on an annual year to year basis, I would say long term. The are are we targets. Our goals you do not move as much. So I'd say that our goals continue to be consistent with what weve given in the past I think long term, we expect to be in that in that same range from an ROI, we standpoint, which would be something in that you have a 10 plus percent.

Good to mid teens range. So I think long term, we continue to believe that we can achieve those types of our we goals or targets, but I do think our year to year basis, you do adjust that based upon what's going on and that in the current to current time period.

Got it okay.

And then lastly, you. This is kind of been an ongoing trend with the middle market portfolio shrinking in absolute dollars and in relative and private loan growing is there.

Is there any any way to think about.

The middle market portfolio, well continue to shrink.

You talked about it in terms of relative there in your prepared remarks, but just curious.

When you kind of see that going.

Over the over the next couple of years in terms of maybe absolute and relative terms and so what I would say that you've heard me say this before in general when you compare the middle market opportunities to the private loan opportunities. We believe we're seeing more attractive opportunities in the private loan space, that's largely dictated by what we believe or better.

A better terms, whether thats legal documentation or kind of legal protections or if its name the ability to be closer to the company, where there is closer to the sponsor closer to the management team or disclosure you overall to the business in terms of what you can do from an underwriting or a due diligence standpoint, I wish I think our position today continues to be what it's been for the last couple of.

For years, we all things being equal we favor the private loan opportunities above the middle market.

That being said as you've also heard to stay in the past to the extent, we see good opportunities in the middle market and we feel like there is acceptable terms, whether it's legal docs or otherwise you'll continue to see us take opportunities as they come up in the middle market, but in general you'll continue to see us move more towards the private loan opportunities in a way.

From the middle market opportunities.

Okay. That's great. Thanks, Thank you.

Thank you as a reminder to ask a question today Press Star one.

The next question would be coming from the line of Kenneth Lee with RBC capital markets. Please proceed with your question.

Hi, Thanks for taking my question just want to get your sense. If you have any updated thoughts on expectations for for leverage.

Over the near term under the current conditions. Thanks.

Yeah. This is Brent I'll take that question are we ended the year on a total debt to equity at 0.73 times and on a regulatory basis, just over 0.5 time, so consistent with our historical track record, we're maintaining a conservative leverage profile I believe that our intent is certainly due to maintain that going forward, we don't have.

Any initiative to significantly increase.

Leverage as we move forward and I think it's a prudent to do so given the uncertain economic environment.

Okay very helpful and just one follow up if I may.

Just on the the funding costs.

And that's probably recently issued some notes and just given the become interest rate levels do you expect any further changes in terms of your funding mix going forward. Thanks.

I would say generally I'm not I think one thing, we'll probably do is utilized revolver I'm a little bit more in 2020, if you recall when we did the investment grade notes offering.

The first one in April of last year, we use us proceeds to repay the revolver. So on the on the whole on the balance of 2018, we had a lower revolver balance than we typically do so I'd expect to have a higher revolver balance, which I think will be good to have some more variable rate a floating rate debt obligations out there, but generally speaking.

We expect to maintain conservative.

The leverage profile in a in a mix of the debt and equity going forward.

Got you very helpful. Thank you very much.

Thank you.

Our next question follow up from the line of Robert Dodd with Raymond James. Please proceed with your question.

Hi, guys, Yes, just a follow up on the asset management business I mean, just.

And again, you can say much but would you expect the accounting treatment to be the same hypothetically, if you're getting fees from that would it show up as a dividend and then then a cost offset kind of a akin to HMS. So would that be so is that something about the contemplated structure.

That would that diff, that's kind of treatment.

Robert I would expect that the AD the benefit to main street in the goal. We have is really to grow that asset management business and it would come in and in the form to us from a benefit standpoint, largely through the near the asset management fees similar or consistent to what you what we receive on the on the HMS front.

Got it thank you.

Thank you Robert.

Thank you.

At this time as this will conclude our question and answer session and I'll turn the call back to management for closing comments.

We thank everyone for joining US again this morning, and we'll look forward to talking after our first quarter results for our issued thank you.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may now disconnect your lines that have a wonderful day.