Q2 2019 Earnings Call
Greetings and welcome to the main Street Capital Corporation second quarter 2019 earnings Conference call.
At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation.
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As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host backbone Dennard Lascar Investor Relations. Thank you Sir you may begin.
Thank you operator and good morning.
Thank you for joining us for main Street Capital Corporation second quarter 2019 earnings Conference call.
Main Street issued a press release yesterday afternoon, a detailed the company's second quarter financial and operating results.
This document is available on the Investor Relations section of the company's website at Maine as Ti capital Dot Com.
We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company's home page.
A telephonic and webcast replay of today's call will be available beginning an hour. So after the completion of the call.
Information on how to access the replay features were included in yesterday's release.
Please note that information reported on this call speaks only as of today August nine 2019, and therefore, you are advised that time sensitive information.
May no longer be accurate at the time of replay listening or transcript reading.
Today's call will contain forward looking statements.
Many of these forward looking statements can be identified by the use of words, such as anticipates believes expects intends will should may or similar expressions.
These statements are based on management's estimates assumptions and projections as of the date of this call and there are no guarantees of future performance.
Actual results may differ materially from those from the results expressed or implied in these statements as a result of risks uncertainties and other factors, including but not limited to the factors set forth in the Companys filings with the Securities and Exchange Commission, which can be found on the company's web site or at SCC Dot Gov.
Main Street assumes no obligation to update any of these statements unless required by law.
During today's call management will discuss non-GAAP financial measures, including distributable net investment income.
Please refer to yesterday's press release for 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 has not been independently verified.
And now I will turn the call over to main Street CEO Dwayne Hyzak joint.
Thanks, Zack and thank you all for joining us today.
Joining me for our call today with prepared comments are David Magal, our president and Chief investment Officer, and Brent Smith, our CFO .
Also joining us for the Q and a portion of our call our Vince Foster our executive Chairman and Nick Meserve, our managing director and head of our middle market investment group.
On today's call I will start by providing a recap of our overall performance in the second quarter, commenting on the performance of our investment portfolio.
Discussing our recent dividend announcement and a few other recent developments and ill conclude by commenting on our investment activities and pipeline.
Following my comments.
David Brown to provide additional comments on our financial results, our current liquidity position and certain key portfolio stats.
After which we'll be happy to take your questions.
We were pleased with our operating results for the second quarter a quarter during which the continued execution of our differentiated investment strategy and the leverage of our efficient low cost operating structure facilitated continued favorable operating performance and financial results.
As a result of our performance, we again generated distributable net investment income.
Our DNA NII per share in excess of our regular monthly dividends.
Exceeding our regular monthly dividends by approximately 12%.
We believe that the advantages of our differentiated investment strategy and efficient operating structure.
Combined with our conservative capital structure and significant liquidity position.
He is very well positioned for continued future success.
Looking specifically at the performance of our investment portfolio in the second quarter.
Our lower middle market portfolio appreciated by over $11 million on a net basis.
With 21 of our investments appreciating and 15 depreciating.
Our lower 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 approximately $12 million on a net basis.
Primarily due to the impact of depreciation from certain investments with specific credit issues that we have been working through and our middle market portfolio.
Earlier this week, our board declared our fourth quarter regular monthly dividends of 20.5 cents per share payable on each of October November and December and amount that is unchanged from our monthly dividends for the third quarter.
And a 5.1% increase from the fourth quarter of prior year.
Consistent with our prior guidance and our previously announced plan for transitioning our semiannual supplemental dividends into our monthly dividends over several years.
We currently expect to recommend that our board declared a supplemental dividend payable in December of 24 cents per share.
A reduction from our June supplemental dividend rate of 25 cents per share.
We continue to expect that this transition will take several years and we remain confident that by the end of the transition period, we will be successful with our long term goal.
Of delivering growth of our total annual dividends at a level consistent with the historical dividend growth, we have delivered to our shareholders.
We are pleased that during the second quarter, our asset management activities generated meaningful performance incentive fees for the first time and we are excited about the potential benefit of these incentive fees in future quarters.
We are also pleased that we recently expanded our executive management team with the addition of Jesse Morris as our newly hired executive Vice President and Chief operating Officer and are excited about integrating Jesse into our team over the next few months.
Now turning to our investment activities in the quarter and our current investment pipeline.
We completed lower middle market investments of approximately $32 million in the quarter.
And as of today, I would characterize our lower middle market investment pipeline as average.
Our second quarter activity and our current pipeline.
As a result of our maintenance of 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 last quarter. We noted that we are experiencing increased third party interest in several of our existing lower middle market portfolio companies.
And if interest has resulted in two attractive lower middle market exits one in the second quarter and one at the beginning of the third quarter.
And we believe that these ongoing activities could result in additional attractive portfolio company exits over the next two quarters.
We also continued our success in focusing our non lower middle market investment portfolio growth on our private loan portfolio with this portfolio growing by approximately $54 million on a net basis in the quarter.
Coupled with a decrease of approximately $41 million in our middle market portfolio.
As of today, I would characterize our private loan investment pipeline as above average.
And in closing our director an officer group has continued to be regular purchases of our shares investing approximately $1.5 million during the quarter and owning main street shares valued at over $144 million at quarter end.
With that I would like to turn the call over to David.
Thanks, Duane and good morning, everyone.
We're pleased to report another quarter during which we grew our 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.
This strategy when combined with our efficient operating structure, our complementary first lien debt investment strategies, and our asset management activities provide a value proposition that positively differentiates main street, among our BDC peers.
This has been demonstrated through our consistent ability to generate premium total returns for our shareholders through the growth in our dividends per share are an increase net asset value per share and our stock price appreciation.
Primary driver of our long term success continues to be our focus on the underserved lower middle market.
We see significant benefits from investing in both the debt and the equity securities in this segment of our business.
Our equity investments closely align our interest with our portfolio company management teams and allow us to share in the equity upside as our company's performance, while our first lien debt investments provide an attractive yield profile and significant downside protection.
By size and scope, our lower middle market investments, our primary driver between both our historical and a fee per share growth and our significant pretax net unrealized depreciation at June thirtyth, contributing approximately $217 million or $3.46 per share.
Our lower middle market investments also support growth in our total dividends paid to our shareholders through the dividend income we receive and the periodic realized gains upon exit from these equity investments.
In addition to the unrealized depreciation and realized gains from these equity investments provide an offset against the inevitable credit losses that will be experience 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 continued to be well diversified with 40 of our 68 lower middle market companies with equity investments, having unrealized unrealized appreciation at quarter end.
57% of our companies that are pass through entities for tax purposes contributed to our dividend income in the last 12 months.
And our total dividend income received from our lower middle market investments was approximately $29 million. During this period of time, representing a 22% compounded annual growth since the year ended 2017.
We believe the diversity of our lower middle market portfolio is critical when analyzing the benefits from this strategy and we believe that this diversity provides visibility to the recurring nature of these benefits in the future.
As a result at June Thirtyth, we had investments in 182 portfolio companies spanning across more than 50 industries.
Our largest portfolio company represented approximately 2.6% of our total investment portfolio fair value at quarter end and 3.7% of our total investment income for the last 12 months.
The majority of our portfolio investments represented less than 1% of our assets and of our income.
Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday, but I'll note a few highlights.
Our lower middle market portfolio include investments in 69 companies, representing approximately $1.2 billion of fair value, which is over 20% above our cost basis.
At the lower middle market portfolio level. The portfolio's median net senior debt to EBITDA ratio was a conservative 3.3 to one.
Our 3.7 to one including portfolio company debt, which is junior in priority to our debt position.
And the total EBITDA to senior interest ratio was 2.7 to one.
In our middle market portfolio, we had investments in 51 companies, representing approximately $520 million of fair value and our private loan portfolio. We had investments in 62 companies representing approximately $595 million at fair value.
The total investment portfolio at fair value at quarter end was approximately 109% of the related cost basis.
And we had seven investments on nonaccrual status, which comprised approximately 1.5% of the total investment portfolio at fair value and 4.4% of costs.
In summary main streets overall investment portfolio continues to perform at a high level and continues to deliver on our long term goals.
With that I will turn the call over to Brent to cover our financial results capital structure and liquidity position.
Thanks, David we are pleased to report that our total investment income increased over the same period in 2018 to a total of 61.3 million, primarily driven by an increase in interest income and partially offset by decrease in dividend and fee income.
The change in total investment income includes a decrease from prior year of $3.5 million and elevated dividend income activity that is considered to be less consistent on a recurring basis are nonrecurring and a decrease of $2.4 million related to lower levels of accelerated income for certain debt investments.
Our operating expenses, excluding noncash share based compensation expense increased by $1.4 million over the same period of the prior year to a total of $19.3 million primarily related to an increase in interest expense related to our $250 million investment grade debt issuance in April .
The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets was 1.4% for the second quarter on an annualized basis and 1.3% for the trailing 12 months.
The combination of our unique investment strategy and leverage of our efficient operating structure resulted in distributable net investment income of 42 million or 67 cents per share, which exceeded our monthly dividends paid for the quarter by approximately 12%.
The activities of our external investment manager benefited our net investment income by approximately $3.6 million to the allocation of $1.7 million of operating expenses for services, we provided to it and $1.9 million of dividend income.
As Wayne discussed the increase in dividend income is primarily due to incentive fees earned.
We recorded a net realized loss of $2.6 million during the quarter, primarily related to the realized loss from the exit of a middle market investment, partially offset by a realized gain relating to the exit of a lower middle market investment.
And as Dwayne discussed we recorded net unrealized appreciation on the investment portfolio of $3.2 million, primarily resulting from $11.5 million of net appreciation on our lower middle market portfolio and $3.8 million of appreciation relating to our external investment manager, partially offset by $11.4 million of net depreciation on our middle market portfolio and point $8 million of net depreciation on our private loan portfolio.
Our operating results for the second quarter, resulting in a net increase in net assets of $38.3 million or 61 cents per share.
Our overall capitalization and liquidity remains strong as our total liquidity was in excess of $600 million at the end of the second quarter. As we previously discussed on our first quarter earnings conference call. Our liquidity is elevated due to the $250 million of investment grade notes, we issued in April as we used the net proceeds to repay a portion of the outstanding balance under our revolving credit facility and we then expect to re borrow under the facility to repay the $175 million.
As we look forward to the third quarter of 2019, we expect that we will generate distributable net investment income of 63 to 65 cents per share during the quarter. This estimate is one and a half to three and a half cents per share or approximately 2% to 6% above our previously announced monthly dividends for the third quarter of 61, and a half cents per share.
With that ill now turn the call back over to the operator, so we can take any questions.
Thank you we will now be conducting a question and answer session.
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Thank you. Our first question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Hi, guys. Congrats on the quarter I mean, if I, if I could actually see some kind of.
Semi macro question since you've got us a a large diversified portfolio. If we look at the the lower middle market night. If you. We can if we can say lower middle market for the middle market and private debt on the lower middle market side. I mean, 21 appreciated 15 depreciated Ah that few then that's fairly even I you see one of the trends you've seen obviously the ops were bigger than the dance, but what what are the trends you've seen in kind of revenue growth EBITDA growth from those businesses is there any and then any.
Determinable trends today versus say six months ago or anything like that.
Thanks, Robert I would say that there is not a big change you know today compared to what they would have been in place you know six months ago I think we continue to see.
Bifurcation of companies that are performing really well and others that are that are not performing as well and I'd say, where we see companies not performing as well as more of a company specific issue than it is an overall your broader industry issue I think we've always pointed to these companies that we have in the lower middle market being mature companies that exhibit kind of lower.
Growth, so I'd say that the path that we see is consistent with what we've seen in the past.
But nothing that said.
A material change or trend that we're seeing versus six months ago.
And I'll, let David add anything else that you'd have on his side no I think versus six months ago I would agree with Wayne only.
Trends, we've seen or some of the companies like restaurants, and such have struggled and retail and other industries. It picked up.
Okay got it and then on the middle market side.
When you said either depreciation with some specific.
Credit issues I mean, the obvious question is there any clustering the tool in terms of the credit issues you are seeing in industry. So just.
All over the place.
Yes, I'd say consistent with what David just said there are some.
Your retail restaurant type situations, where they face the headwinds that David was referring to but outside of that.
I'd say that the issues have been more company specific and spread across multiple industries as opposed to being one specific theme.
I appreciate that color and one more if I can on the asset management business. I mean, you talked about this last quarter in terms of expectations, but.
Meaningful performance incentive fees.
And any color you can give us on I mean was it was it.
The start of a partial incentive fee or was this quarter kind of you know.
Full.
Incentive fees and we should expect it to remain steady issue at that level or is that going to continue ramping up.
Yes, I would say that the incentive fees are going to be very hard to predict because it's going to be.
So related to specific performance in that quarter I think for the second quarter. It was just the first quarter that we earned and will be paid a meaningful incentive fee we had had periods.
In 2018, we also had quarters that would have.
Generated enough earnings there that would have justified and incentive fee would just in the past you had agreed with our the manager of that of that fund to waive those fees, whereas in the second quarter of this year, we're no longer waving that fee and we we earned and.
Recognize a significant incentive fee in the in the second quarter.
I appreciate it thank you.
Thank you.
Our next question comes from the line of Tim Hayes with B. Riley FBR. Please proceed with your question.
Hey, Good morning, guys just wanted to follow up on Roberts.
First question there, we continue to see unrealized depreciation and stable EBITDA is in the lower middle market portfolio, but unrealized depreciation and ebitdas trailing downward broader middle market portfolio does this trend in the middle market portfolio, primarily reflect underlying credit quality I just want to make sure that there's when it relates to the depreciation there were no technical factors involved there or quotes or anything like that and then how would you characterize the health of the borrowers in the lower middle market portfolio versus the middle market portfolio.
Sure. So I'll give some initial comments and I'll, let Nic reserve you add some additional comments on the middle market, but as I think we.
As we tried to address in the earlier comment I think when we look at the middle market.
Depreciation we've had it's really related to several specific names I would say if you look back over the last couple of quarters going back to the fourth quarter of 2018, you did have some technical movement.
In the month of December that caused some movement from a fair value standpoint, but I would say that the issues Weve had in Q1 and Q2 of this year were more specific credit issues.
In several specific names that we've been working through.
Really in that in the first second and we'll continue to do in the in the third quarter. So I would say it continues to be specific issues with individual companies.
As opposed to something that is more broad based I think we've covered in the lower middle market that we continue to be very pleased with the overall quality of the portfolio. The companies are performing well the credit profiles are attractive and we can see the benefits of the cash flow generation and the the positive results from those companies in our dividend income. So we continue to be very pleased with the overall performance of that portfolio I'll, let Nick add anything else you would add on the middle market said, Glenn covered it fairly well there I would say it is a few specific instances of issuers that have really been the driver that movement from fourth quarter to today I think the good news is we mainly restructure both those businesses this point or will it through three quarters or through the third quarter.
And so we've looked at our kind of our our Dave's, we're watching going forward.
I think we see more upside than the downside in the names that we might have some issues and.
Okay. That's helpful. Appreciate the comments there and one of the credits I think that was put on non accrual last quarter was to be and I think you talked about potentially restructuring that investment and looking to exit that soon could we get an update there and maybe what the Mark was since we don't have to that so I in front of US and then and I think another investment was added to non accrual this quarter.
So if you could just give some color on which one that was and what happened there.
Yes, so ESI TV, we restructured that during the quarter and basically we took a realized loss position restructure around 25 cents I believe which was.
Where it is today.
And going forward that business, though about the debt holders there was a small tip towards existing equity.
And the plan going forward is to support more than likely monetize that asset through a.
An auction or a sale process.
And just a follow up on the overall non accrual status at the end of the second quarter. So ESI TV as Nick just explain came off of non accrual by June Thirtyth, and we added two new investments to non accrual one being garden and the other being churns goods.
Lower middle market portfolio company in journeys is a middle market portfolio company.
Any comments around those two credits their ads non accrual and what.
Led to you guys, putting them on placing them on non accrual.
So with garden, we had a specific issue related to a customer.
That led to the company going on non accrual were working with the management team and other investors on trying to put the company in a better position for success in those discussions are ongoing.
No assurances basically liquidity squeeze based on tradition of business from a sale model to more of a rental business.
And then from a capital structure perspective need to Equitize and the debt that the company entered bankruptcy in the second quarter and we expect to exit here. The next 15 to 30 days with the restructured balance sheet.
Got it okay I appreciate the comments and for taking my questions. This morning.
Thanks, Tim.
As a reminder, if you would like to ask a question press star one on your telephone keypad. One moment. Please while we report for additional questions.
Thank you. Our next question comes from the line of Michael the marriage with Suntrust.
Please proceed with your question.
Thanks, Good morning, guys. Thanks for taking our questions.
Good morning.
I guess first on the asset management business. It seems I've recently, maybe you passed on a few deals but just wondering have you seen anything in the market. It seems attractive to you and additionally could you help us better understand your long term strategy sort of thinking on M&A for this business.
And frankly, maybe possibly maybe incremental impact to your net investment income going forward.
Yes, I would say, it's hard to predict the via the last point because it would all be dependent upon what the opportunity was.
But we are interested as you've heard us say in the past and growing that business and we're looking at opportunities to grow it both from a year from an M&A standpoint, but also looking at avenues to grow it from an organic standpoint, where we sit today I wouldn't say that theres anything that is imminent, particularly on the M&A side.
We remain active and we see the opportunities as they come come about in the industry, but there's nothing that's in place right now that we would say is actionable in the near term, but we will continue to be active and look at opportunities as they come about because as we said before we do.
Want to grow that business. We think it's something that is very significant for us from a benefit to the company and to the shareholders and we want to find ways to continue to grow that business longer term.
Okay, great. Thanks for that.
Maybe one more on your lower middle market strategy, maybe how that sort of change in this environment. So.
Recently, I guess, most bdcs have been saying they were getting close to the end of cycle and I know that's kind of repetitive. We've been hearing is for less for six quarters, but now coupled with like a lower interest rate environment and with the strong economy are you seeing new investment lower middle market companies sort of asking to take on a greater portion of debt relative to equity or has your strategy frankly does remain the same.
Regarding your initial equity position.
Yes, I wouldn't say that there is a significant change there we continue to want to be in position to.
Ill provide very very customized solutions to each opportunity so that the proposals in the structures that we pursue.
In the lower middle market are going to be very specific to the opportunities that we see and I would say that's always been the case in continues to be the case today. When we look at our most recent investments and the new opportunities we see in the pipeline.
We continue to see opportunities are consistent with the historical structure in profile that we pursued and we just need to find the right opportunities that can you find our solution attractive and that we can end up getting into the execution phase on and I'll, let David add anything else that he would want to want to cover there.
Nothing else.
Okay, great. Thank you guys.
Thank you.
Our next question comes from the line of Bryce Rowe with Robert W. Baird. Please proceed with your question.
Hi, good morning.
Actually no affiliated with National Security.
Morning, Brian .
Dwayne and David I was I was hoping maybe you could speak to.
The the recent exit and the lower middle market portfolio, and where those exit values compared to Mark's maybe two or four quarters ago.
And then if you could also comment on.
Third party interest in some of your existing lower middle market companies and you know how that I guess interest to stacking up relative to tomorrow. She would have seemed to two to four quarters ago. Thanks.
Thanks, Bryce of the Axis, we had and the you know that we mentioned in our comments. There were two one was in the second quarter that was that a portfolio company by the name of our solutions. It's a company that we have been in for a long time and it actually kind of had partial exits on a number of prior occasions. So this was our third exit transaction and consistent with what you've heard us.
You say in the past the fair value marks we had on that investment.
Prior to them going through that process would have been conservative in comparison to the actual realized results. So the the transaction. We had was not a material transaction for US which is why you would not have seen has put out a press release, because our residual interest in the company was was fairly small, but it was a gain of $2.3 million in the second quarter and if you compare that to our mark.
You know from from two quarters prior to that it would have been about a million dollar difference between the actual exit in the fair value at a second actually we had which was in the beginning of the third quarter.
It was lambs turn automotive I mean, it was also a company we have been in for a long time, it was a $6 million or exit.
That exit activity had been ongoing for a longer period of time. So I would say you wouldn't have as large of a delta between the exit value in the fair value, but it was also a transaction that we found very attractive from a overall valuation standpoint, but also just from the standpoint of comparison of the exit value versus our fair value and I'll, let David give some color on the you know the other activities, we're seeing kind of on an ongoing basis from an exit standpoint.
So on the incoming call question Bryce, we continue to field a lot of incoming calls from strategic acquirers our portfolio companies.
I'd characterize the activity is consistent with recent past, but more than historical in a market, where we've got a lot of credit availability and such but certainly we're benefiting from on an exit basis from the market that we're currently in.
Excellent and I assume just kind of consistent with.
Your your previous strategy that.
The the preference would be to hold these lower middle market companies that are performing well.
Forward for as long as you can but but but clearly you've got you've got calls coming in and decisions being made from the management teams and with you all too.
To monetize where where it makes sense.
That one specific example, we had a call coming in about three weeks ago on a company that we've not had no intentions of selling we enter those discussions with management and.
When we can see a valuation that we think is just.
Far exceeds what we think we could get if we were to stay in the investment for.
A significant period of time, we have to have.
Real role.
Thoughtful discussion about whether we should exit or not but certainly our belief and the reason we get these investments as a long term hold is unmatched in the market and our ability to get benefits and a dividend income and the interest income over an extended period of time is our preference, but we have to look to our partners and take these incoming calls very seriously.
Excellent. Thank you all for the comments I appreciate it.
Thank you Chris.
Thank you we have no further questions at this time I would now like to turn the floor back over to management for closing comments.
Thank you to everyone again for joining us this quarter and we'll look forward to talking again in 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.
Okay.