Q2 2020 Main Street Capital Corp Earnings Call
Greetings and welcome to the main Street capital Corporation's second quarter earnings Conference call.
At this time, all participants are in listen only mode.
Brief question answer session will follow the formal presentation.
If anyone should the car operator assistance during the conference. Please press star zero on your telephone keypad <unk>.
As a reminder, this conference is being recorded.
At this time wed like to turn the conference over to exact Laundrettes Dennard Lascar Investor Relations. Please go ahead.
Thank you operator, and good morning, everyone.
Thank you for joining us for main Street capital Corporation's second quarter 2020, <unk> earnings Conference call.
Richard issued a press release yesterday afternoon, the details the company's second quarter financial and operating results.
This document is available on the Investor Relations section of the company's website.
I mean, it's cheap capital Dot com.
A replay of todays call will be available we're getting an hour. After the completion of the color and will remain available until August 14th.
Information on how to access the replay was included in yesterday's earnings release.
We also advise you that this conference call is being broadcast watch 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 August 720, 20, and therefore, you're advised that time sensitive information may no longer be accurate at the time of any replay listening or transcript breeding.
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 make or similar expressions.
These statements are based on management's estimates assumptions or projections as of the data 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 <unk> 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 <unk> Dot Gov.
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 a 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 there's not been independently verified.
Now I'll turn the call over to Mainstreet, CEO Dwayne heat shock.
Thanks Jack.
Good morning, everyone and thank you for joining us today.
Joining me for holiday with prepared comments or David Mandell, <unk>, President and Chief investment Officer, and Brad Smith, our CFO.
Also joining us pretty Q. I portion of our call. Our net reserve are managing director and head of our middle market investment group and Jason Beauvais, Our general counsel.
Oh, that's the main street hope, it's you and your loved ones have been able to stay safe and healthy.
Recognized at the last six months have been a very challenging time for everyone and that's significant uncertainty continues to exist about the near term and long term impact other Kobe 19 pandemic, our society economy, and the eventual timing for the returned to normal.
Despite these challenges we remain committed to and focused on generating long term value for our fellow shareholders.
Given the ongoing impact to the pandemic similar to last quarter's call I will start todays call with some comments regarding the pandemics impact.
Well, then commoner <unk> performance in the second quarter.
Some developments within our asset management business.
Our recent dividend announcement.
Our investment activities in current investment pipeline.
And several other updates.
Following my comments data and Brown will provide additional comments, our investment strategy investment portfolio and financial results after which we'll be happy to take your questions.
Since our last conference call, we've continued to prioritize the health and well being of our employees and the management teams are employees of our portfolio companies.
We greatly appreciate the efforts of these individuals and we continue to be very pleased with their efforts and activities since the beginning of the pandemic.
These individuals have historically been a key strength for our firm and they give us significant confidence in our ability to continue to maximize our opportunities and the current environment and in the future.
But economic environment since our last cost continued to be very challenging and in many cases likely more challenging than most people envisioned in the early days in the pandemic.
We believe that the performance across most of our portfolio companies has stabilized and we continue to feel good about the overall quality of our investment portfolio.
We're also pleased that despite the ongoing impacts of the pandemic. We've continued to have success executing on new investments in both our lower middle market and private loan strategies.
We recently enhanced our already strong liquidity position with our $125 million bond offering in July.
And we remain confident that are very conservative capital structure and significant liquidity position will allow us to continue to manage through the current challenges and to successfully execute on the opportunities that exist with our portfolio companies and our pipeline of attractive lower middle market private loan investment opportunities.
We're also very pleased with our recent announcement of the agreement under which we would become the solar investment advisor to HMS income fund.
We believe that this transition is a natural progression of our historical role with HMS and we're excited about positioning that front for the future well also executing our overall strategy to grow our asset management business within our internally managed structure and continuing to provide this unique benefit to our main street stakeholders.
Now turning specifically to our results for the second quarter.
These results reflect the negative impact of a pandemic on the overall economy, most specifically and the decrease amount of dividend income, we realized from our equity investments and in an increasing the number of investments on nonaccrual status at quarter end and the number of investments that are underperforming consistent with the results being experienced across the broader market.
We are confident that the decrease in dividend income is a temporary issue, which will recover as the impacts of the pandemic subside and our investment team continues to maintain significant focus on working through the underperforming investments to realize the best possible outcome for our stakeholders.
Despite the impact of these items as a result of our diversified investment portfolio together with the advantages of our differentiated investment strategy. The alignment of our interest with our aluminum market portfolio company management teams are efficient operating structure and alignment of interest with our shareholders combined with our conservative capital structure and strong liquidity position.
We believe that we're well positioned to whether the current market conditions and provide a favorable outcome for all of our stakeholders and we remain comfortable with our commitment to maintaining a stable monthly dividend payment level going forward.
To that end earlier this week, our board declared our fourth quarter 2020 regular monthly dividends of 20 and a half since per share payable on each of October November and December and amount that is unchanged from our monthly dividends for the third quarter.
Now turning to our investment activities in the second quarter and our current investment pipeline, we completed lower middle market investments of $85 million on the quarter, including an investment in one new company.
And as of today, our characterize our lower middle market investment pipeline as average.
Included in this investment pipeline are several follow on investments in existing portfolio companies as these companies execute on various attractive opportunities.
Despite the impact of the pandemic, we continue to be very active in our alumina market strategy and we have several new investment opportunities in the pipeline that we expect to complete in the near future.
More importantly, based upon historical expense it experiences over the last two decades as the industry, leading partner for lower middle market companies and their management. James We expect that are very unique debt and equity investment offering combined with our ability to be a long term to permanent partner to these companies will result in a significant increase in new opportunities as the economy begins to recover.
During the second quarter, we continue to successful focus of our non lower middle market investment growth on our private loan portfolio, resulting in this portfolio growing by $9 million on a net basis in the quarter well, our middle market portfolio decreased by $25 million.
As of today are characterized our private loan investment pipeline as average.
When looking at the performance of our investment portfolio during the quarter and since quarter end. We're pleased with the performance across most of our portfolio companies has stabilized, allowing us to begin the recovery of the unrealized depreciation we experienced in the first quarter due to the pandemic.
And in closing or offer CERN director group has continued to be regular purchases of our shares investing approximately $1.2 million during the second quarter.
On a collective basis, our director and Officer Group owns main street shares valued at approximately $103 million at quarter end.
With that I will turn the call over to David.
Thanks, Duane and good morning, everyone.
As Dwayne highlighted in his remarks, although this was a challenging quarter for main street as we in our portfolio company partners continue to respond to the unexpected negative impacts created by the pandemic overall, we saw stabilization and modest improvement across our portfolio company investments.
And our lower middle market portfolio, we work closely with our portfolio company management teams and assessing and responding to the rapidly changing market conditions.
We very much appreciate how tirelessly our portfolio company partners work to support our joint investment interest during these difficult times.
We've been extremely pleased with the proactive unresponsive nature of our portfolio company executives and are very grateful for their partnership approach.
Despite the challenging environment, our intentional and diversified investment strategy has served us well.
Folio is diversified by end market industry vintage and security type.
This diversification has been the cornerstone of our philosophy over our nearly 13 years as a public company as it should benefit of our permanent capital structure.
Most notably because of the season nature of our lower middle market portfolio, our portfolio company leverage in this segment of our business remains modest with the median net senior debt to EBITDA ratio of 2.7 to one and the median total EBITDA the senior interest expense ratio of 2.8 to one.
As of June Thirtyth, we had investments in 177 portfolio companies spanning across more than 50 industries.
Our largest portfolio company represented approximately 3% of our total investment portfolio fair value at quarter end and 3.7% of our total investment income for the last 12 months.
Further the vast majority of our portfolio investments represented less than 1% of our assets and our income.
During the second quarter at the contributions from our lower middle market portfolio continued to be well diversified with 41 of our 68 lower middle market companies with equity investments, having unrealized appreciation at quarter end.
In the most recent quarter, our dividend income received from our portfolio companies with significantly lower than the same period of last year.
This was expected and consistent with what we have experienced in prior periods of market disruption as our portfolio companies with our support choose to maintain maintain cash for liquidity purposes, instead of making distributions.
As cash continues to build at the portfolio company level and market conditions improve we're confident that will benefit from increased distributions in future periods.
Our lower middle market investment activity in the second quarter included investments of approximately $85 million, including an investment of $49 million in one new lower middle market investment.
After aggregate repayments of debt principal and return of invested equity capital from several lower middle market investment resulted in a net increase of $40 million in our lower middle market portfolio.
During the quarter, we fully exited our lower middle market debt and equity investments in IDXX broker, realizing a gain of $9.3 million, resulting in a total internal rate of return of approximately 15.8% and 1.9 times money invested our cumulative debt and equity investments.
At quarter end, our lower middle market portfolio included investments and 69 companies, representing approximately $1 billion, a fair value, which is 158% of our cost basis.
As we've discussed on previous conference calls given our a favorable view of the lower middle market private loan opportunities that exist today, we're primarily focused our investment activities on these segments of our business with our middle market activities focused on highly selective investments with the intent to shrink the middle market portfolio on a relative basis.
[music].
And our private loan portfolio, we had investments and 64 companies representing approximately $654 million at fair value and during the quarter. We had a net increase in this portfolio of $9 million.
In our middle market portfolio, we had investments in 44 companies, representing approximately $410 million at fair value and during the quarter. We had a net decrease in this portfolio of $25 million.
The total investment portfolio at fair value at quarter end was approximately 100% of the related cost basis, and we had 11 investments on nonaccrual status, which comprised approximately 1.9% of the total investment portfolio at fair value and 6.3% it cost.
Turning to the outlook for the remainder of 2020, we intend to focus our efforts on continuing to support our existing portfolio companies, well thoughtfully, making investments, primarily a new lower middle market and private loan opportunities.
Our ability to provide flexible debt and long term equity solutions are always a key differentiator.
Cost and lower middle market.
During the current environment, our ability to provide term sheets that speak for 100% the outside debt and equity capital to close the transaction is particularly important for smaller privately held business owners and their advisors.
Our investment Committee has worked together for nearly 20 years in prolific times and in times of mid market dislocation.
We're confident that we'll be able to prudently deploy capital with very attractive risk adjusted return profile for the remainder of 2020 and in 2021 in an effort to create significant shareholder value with our new investment activities.
With that I'll turn the call over to Brent to cover our financial result capital structure and liquidity position.
Thanks, David our total investment income in the second quarter decreased over the same period in 2019 total at 52 million, primarily driven by a decrease in dividend income, which as David mentioned has been negatively impacted by the Covidien 19 pandemic and a decrease in interest income primarily due to the lower LIBOR rate.
The decrease in dividend income is consistent with our commentary from our first quarter earnings call, where we stated that we expected the decline as our portfolio companies generally decided to take a conservative approach and maintain additional liquidity due to the significant uncertainty associated with a pandemic as the cash flows of some of our portfolio company.
These were negatively impacted to varying degrees due to covert 19.
Our operating expenses, excluding noncash share based compensation expense decreased by one point fourmillion over the same period of the prior year say totaled 17.9 million.
Primarily related to a decrease in cash incentive compensation levels, partially offset by an increase in deferred compensation expense due to the increase in the fair value of our deferred compensation plan assets during the second quarter the ratio of our total operating expenses, excluding interest expense as a percentage of our average total asset.
It was 1.4% for the second quarter on annualized basis at 1.2% on a trailing 12 month basis.
Activities of our external investment manager benefited our net investment income by approximately 2.2 million during the second quarter two the allocation of $1.8 million of operating expenses for services provided to it and point 4 million of dividend income.
We recorded a net realized loss of 8.6 million during the second quarter, primarily related to that related to their realized losses from the exit of three middle market investments, partially offset by net realized gain related to the exit of to lower middle market investments and a partial exit of another lower middle market investment.
We recorded net unrealized appreciation on the investment portfolio of 6.5 million during the second quarter, primarily relating to 11.7 billion of net appreciation on a private loan portfolio 8.2 million of net appreciation on our middle market portfolio and 7.5 million of appreciation.
Relating to our external investment manager.
Partially offsetting the net appreciation was 16.4 million of net depreciation on our lower middle market portfolio, and 5.2 million as net depreciation on or other portfolio.
Our operating results for the second quarter resulted in a net increase in net assets, a 43.4 million or 66 cents per share.
Our overall capitalization and liquidity remains strong as our total liquidity is currently in excess of 600 million. We were pleased to be able to enhance our current liquidity position. Our recently issuing 125 million follow our outstanding investment grade notes that mature in April 2024, and using those proceeds to.
We pay a portion of our revolving credit facility. This follow on to the investment grade notes was an addition to the 75 million follow on we executed this past December and continues to illustrate the support of our institutional debt investors. The follow on was issued at a yield to maturity of approximately 4.4% and brought the total amount.
Out of notes outstanding to 450 million.
We also raised approximately 26 million a net proceeds enter ATM equity issuance program further enhancing our capital structure. Overall, we continue to fill that our conservative leverage continued access to capital as strong liquidity has us well possession to not only continue to successfully navigate through this challenging period, but to also be.
Opportunistic and terms on investment opportunities in the market.
As we look forward to the third quarter and consistent with the second quarter, we're not providing guidance for distributable net investment income due to the ongoing impacts of covert 19, and the related uncertainty that's still exist in relation to the overall economy and the operating results of our portfolio companies, however, consistent with the SEC.
Second quarter financial results, we expect that our distributable net investment income will be below our monthly dividends, primarily due to continued lower level of dividend income from our lower middle market equity investments with that I'll now turn the call back over the operator, so it can take any questions.
Thank you will 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 press star to view later move your question from the Q.
Participants using seeker equipment, maybe necessary to pick up your handset before pressing the star case.
Please ask one question and one follow up and re queue for additional questions. One moment. Please hold we pull for questions.
Thank you. Our first question is coming from the line of Robert Dodd with Raymond James.
Hi, guys.
Next is on the quarter weathering a quarter if I can hold on the dividend income obviously it was down year.
Frankly, a lot less than I thought it would be I believe the.
I remember the commentary about portfolio companies.
Sending cash but for the last recession back in 2008, 2009 and recognize the portfolio is very different today than it was that but can you give us any any color on back then it was down 50%.
Can you give us any color on was the dividend income from those properties of the 68.
But it was was it concentrated from.
Couple was there anything or.
About that because I mean, a baby good number but I think it may have exceeded your expectations as well give you did better than your.
No I.
Indications so last quarter, so any additional color that.
Share Robert So what I would say is as you've heard to stay in the past you even kind of in a non cobot type environment dividend income as always that the harder as part of our income stream to predict.
So it's it's one that as we look at kind of you for periods. You always has the most uncertainty associated with it what I always say in the second quarter. I think we were pleased with the dividend income amounted. It was as you said less than what it was in in the first quarter and definitely down less than what it was in prior quarters.
Say the composition of it while it there are a few names that make up the a significant portion of dividend income.
I didn't say that the concentration this quarter was materially different than what it was in prior quarters.
Obviously, the smaller amount, but do you have a number of companies that have continued to perform well despite the cobot environment and given what we've always talked about with our lower middle market companies going into this situation. This cobot time period with modest amounts of leverage as they continue to perform.
They do continue to generate significant cash flow and we do see some of these companies continue to payout dividend income as we look forward to the next couple of quarters, good thats going to be the near the biggest variable for us when you look at our net investment income performance is how how well those companies can continue to perform and then how many companies that were contributing to dividend income pre code.
Good how many of them can you will start contributing again in either Q3 or Q4.
Well I appreciate that color, though.
On on H. bass, and I realize that might be.
Is that Andy.
Obviously that that.
Buys be agreement if at all guys will be one of the largest single sources of income to make so can you.
Main shelters and dividend coverage can you give us any color on on is is the intention adds as it sounds, especially right now to maintain precisely the same strategy on base.
Best with maintenance and duplicate.
To a degree that domain portfolio open though is that because as you mentioned that positioning the funding for the future is there going to be any change there that could impact the income to a two main and main shelves.
Yeah, Robert what I would say there is that as we sit here today, we didnt do not expect any changes to the strategy on the HMS income side, obviously, that's not something that is our own decision. That's something that we'll have to work with the HMS board on your long term going forward, but as we sit here today and look at the opportunities that we have in that the opportunity that we believe we.
We can deliver to HMS income fund.
We do not expect changes from the from the historical strategy going forward.
Got it. Thank you. Thank you Robert.
Thank you.
Next question is from the line of Bryce Rowe with National Securities. Please proceed with your question.
Thanks, Thanks, good morning to everyone.
Robert Robert asked my dividend question I wanted to ask.
You all about.
The proposed rule here for the acquired fund fees and expenses I.
I know that you all are very much involved in that regulatory process. So wanted to get your view of of that proposal.
No what what may happen from a from a regulatory perspective to.
Get through the 60 day comment period.
And what kind of what maybe regulatory next steps might be to really get get us to the next level as a as an industry. Thanks.
Sure. Thanks. Thanks, Bryce is as you know Vince our executive Chairman has always been very involved you from an industry is ramped standpoint, and kind of the regulatory activities. He typically would give our response there but this morning. He was invited to testify at the congressional oversight Committee hearing regarding the main street lending program. So he is not able to join us, but we do have.
Jason Beauvais, our general Counsel, who also worked extensively with dance on those activities all it let Jason give the update on apathy pave right as you can imagine we we view the proposed at the at that the changes that came out this week as extremely positive.
And the big step toward getting BDC back into the indices.
As you know our industry have been working on an area that the fix since 2014, and we're very pleased with the FCC could tick this action.
We're still digesting the 650 page document they put out on Wednesday, but we fully expect to work with the other bdcs and Thats the way to comment at appropriate on the proposed rules.
Right that is that when you look at it is definitely should be a positive even if we don't get inclusion in the indexes and there's a bunch of 40 act funds out there that are that are not.
Index based that if this helps them participate in being shareholders are the BDC industry overall, it net net it's going to be a positive.
Yes, totally totally agree and was curious I don't know Dwayne or Jason.
In terms of communication with with Russell or even S&P.
Now that now that this proposal is out there I mean, what what are what are next steps with those organizations for them to.
Propose that fit the Bdcs get re included in the in the index.
Which obviously is a step above and beyond what the proposal.
Says now.
Yeah, I would say that price with the activities are obviously very recent we've not heard of any you activity with any of those entities, obviously that would be a next big staff. Once you get that you are the new rule.
Faster approved but we're not aware of any significant activities, there and lets Jason those or something else no I'm not them, although as you probably noticed bryce the rose a little different than we've been pushing the last eight years six years.
We've always ask for BDC to be excluded from the rule and the FDC did something a little different and put at 10% threshold on exclusion for ban and so we're not asking hopefully that works for the Russell and S&P indexes are indices them, but yet like Twain said, it's we haven't had its going to gauge it.
Okay.
I wanted to I wanted to follow up on the on the HMS question.
And just curious.
With with with that relationship kind of potentially fully coming within within main in terms of the whole advisory relationship.
Will there be a change in how how that gets accounted for within within your income statement.
Obviously now you're you recognizing some level dividend income and then an offset to to general and administrative expenses. So just curious if we'll just see essentially a doubling of both of those since the.
The full relationship is coming in house.
Yeah, Bryce what I always said, we don't expect a change in the accounting or the financial reporting what out what we do expect is that the fee income into our subsidiary you. Obviously go up as we.
Pickup the full advisory fee as opposed to historically picking up 50% of that advisory fee. We will likely have you. Some additional DNA costs, but I think they will be less than the incremental fee income. So net net we would expect to see our dividend income from eight from the advisory entity to to increase going forward post.
Posed to us becoming Thats all advisor.
Okay. Okay.
And then one more if I could.
Yes, Dwayne Glenn you talked in your premiered prepared remarks about.
Good good activity within the lower middle market, even even in the second quarter, but but within the pipeline just curious what.
What pricing is look like now that we've kind of moved beyond. This this co that environment are you seeing.
Better better pricing or are you or is it more kind of the combination of.
Relatively stable pricing and better structure.
Yes, Brian I'll give some initial comments and I'll, let David you add to it but I would say youre not just in a lower middle market, but across each of our investment strategies. In this environment. We are seeing some better pricing, whether you're looking at the debt opportunity or the equity opportunity, but I would say that the biggest than if it is the types of deals that were working on the lower minimum.
Market I.
I would say that we would describe them as fitting our structure a lot better so at some of its structure a lot of its alignment of interest with with the owner operator in the management team decided that it would be my initial comment on the lower middle market side on the private loan middle market, you also thinking or you're seeing some benefit on pricing, but I think we're most excited about generally kind of lower.
Leverage attachment instrumented investment standpoint, and definitely more ability for us to influence the structure to be more beneficial to us that than it would have been six or 12 months ago. David you want add on some additional comments on lower middle market on the pricing.
On the margin it can be better, but it's not remarkably impacted what I'd say that to me our ability to transact and to prevail and some of these processes are is our enhanced in the current environment.
The idea of are coming in with Noncontingent financing on transactions, we do a term sheet for debt and equity is particularly powerful in this type of environment, whereas.
Gosh beginning of the year. It was this a little bit different because people are price out the equity and debt separately and that was more competitive world. So today, just a certainty to close is really I think could help with our close ratios, but just to add on its eight and I think you've heard it both in mining Davids comments, but we are excited about the opportunities we're seeing.
Thank you are your teams at least the senior members of the games are starting to travel again, obviously youve hard to say in prior quarters or at least last quarter. When we talked about the impact decoded. One of the concerns you had was the ability to get out and meet in person would that the owners of these businesses in their their management teams, which is critical to our underwriting on aluminum market side.
But we are getting out and doing that and where we're looking forward to you to executing on those opportunities here in Q3 in Q4.
Excellent. Thanks, Thanks for the time, thank you Bryce.
Thank you as a reminder, you mean press star one to ask a question at this time.
The next question is from the line of Kenneth Lee with RBC Capital markets. Please proceed with your question.
Hi, Thanks for taking my question I was wondering if you could just talk about any kind of amendment activity they saw within the quarter within your portfolio. Thanks.
Sure.
What I would say on that and in these numbers aren't perfect. Because you never really know what precisely the driver of every amendment is but across the portfolio. We had about 30 of our companies go through some type of an amendment in the second quarter. Those amendments had varying degrees of of changes could have been either.
You know some movement of interest from cash to pick it could have been.
Other relief from a from a cash amortization or other principal.
Payment requirement or it could have just been some relief on on financial covenants, such a wide range of activities that we're undertaking undertaken through those those amendments and what I would say is that you heard me say this last quarter and even prior to that when we looked at companies that have underperformed. Our goal is to always have let's not be that you the sole source of real.
So all those activities would have come with some some contribution from the other parties involved in the capital structure, whether it's the management team, making concessions from a personal standpoint, or whether it's a private equity group and our in our middle market and private loan portfolios contributing cash interest will support the business are taking other steps to.
Maybe just to be supportive of the company in conjunction with our with our flexibility.
Great very helpful and just one follow up if I may wondering if you could just share with us any updated estimate.
Undistributed taxable income thanks.
Sure.
Our our spill over at the end of the second quarter was approximately 35 million for 54 cents per share.
Great. Thank you very much.
Thank you Ken.
Thank you. This now concludes our question and answers segment ill turn it back to management for closing remarks.
Thank you everyone for joining us today, we will continue to do everything we can't on our side to navigate this uncertain environment and continue to create value for our shareholders. We hope everyone stays as safe and healthy as possible and we'll look forward to talking again, a few months.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.