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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Main Street Capital Corporation, Second Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Zach Vaughan with Dennard Lascar Investor Relations. Thank you, sir. You may begin.
Thank you, operator, and good morning everyone. Thank you for joining us for Main Street Capital Corporation's second quarter 2019 earnings conference call. Main Street issued a press release yesterday afternoon that 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 mainstcapital.com.
We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company's homepage. A telephone and webcast replay of today’s call will be available beginning an hour or 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 09, 2019 and therefore you are advised that time sensitive information may no longer be accurate at the time of any 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 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 company's filings with the Securities and Exchange Commission, which can be found on the company's website or at sec.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’ll turn the call over to Main Street’s CEO, Dwayne Hyzak. Dwayne.
Thanks Zack, and thank you all for joining us today. Joining me for our call today with prepared comments are David Magdol our President and Chief Investment Officer; and Brent Smith our CFO. Also joining us for the Q&A portion of our call are 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 announcements and a few other recent developments and I will conclude by commenting on our investment activities and pipeline.
Following my comments David and Brent will provide additional comments on our financial results, our current liquidity position and certain key portfolio stats, after which we will 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 results of our performance, we again generated distributable net investment income or DNII 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 have us 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 though in our middle market portfolio.
Earlier this week our Board declared our fourth quarter regular monthly dividends of $0.205 per share payable on each of October, November and December, an 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 semi-annual supplemental dividends into our monthly dividends over several years, we currently expect to recommend that our Board declare a supplemental dividend payable in December of $0.24 per share, a reduction from June supplemental dividend rate of $0.25 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’ll 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 shoulders.
We are pleased that during the second quarter our asset management activities generated meaningful performance incentive fees for the first time and we're excited about the potential benefits 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 are 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.
In our comments last quarter we noted that we were experiencing increased third party interests in several of our existing lower middle market portfolio companies and this interest has resulted in two attractive lower middle market exits, one of 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 and officer group has continued to be regular purchasers 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 Dwayne and good morning everyone. We are 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 are complementary firstly in debt investment strategies and our asset management activities provided value proposition that positively differentiate 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, our increased 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 interests with our portfolio company management teams and allow us to share in the equity upside as our companies perform, while our first lien debt investments provide an attractive yield profile and significant downside protection.
By size and scope, our lower middle market investments are a primary driver behind both our NAV per share growth and our significant pre-tax net unrealized appreciation at June 30, contributing approximately $217 million or $3.46 per share.
Our lower middle market investment also support group in our total dividend paid our shareholders through the dividend income we received and the periodic realized gains upon exit from these equity investments. In addition the unrealized appreciation and realized gains from these equity investments provide an offset against the inevitable credit losses that will be experienced when making investments in non-investment grade debt securities.
Turning back to our most recent operating results, the contributions from our lower middle market portfolio continued to be well diversified with 40 of our 68 lower middle market companies with equity investments having unrealized appreciation at quarter end. 57% of our companies that have 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 provide visibility to the recurring nature of these benefits in the future.
As a result, at June 30 we had investments in 182 portfolio companies expanding 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 highlight.
Our lower middle market portfolio included 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 portfolios median net senior debt-to-EBITDA ratio was a conservative 3.3:1 or 3.7:1, including portfolio company debt, which is junior in priority to our debt position and the total EBITDA to senior interest ratio was 2.7:1.
In our middle market portfolio we had investments in 51 companies, representing approximately $520 million of fair value, and in our private loan portfolio we had investments in 62 companies representing approximately $595 million of 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 non-accrual status which comprised approximately 1.5% of the total investment portfolio at fair value and 4.4% of cost.
In summary, Main Street's overall investment portfolio continues to perform at a high level and continues to deliver on our long-term goals.
With that, I'll 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 2018 to a total of $61.3 million, primarily driven by an increase in interest income and partially offset by a decrease in dividend and fee income. The change in total investment income includes a decrease from prior year of $3.5 million, an elevated dividend income activity that is considered to be less consistent on a recurring basis or non-recurring and a decrease of $0.4 million related to lower levels of accelerated income for certain data investments.
Our operating expenses excluding non-cash 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 $0.67 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 through the allocation of $1.7 million of operating expenses for services we provided to it and $1.9 million of dividend income. As Dwayne 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.
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 $0.8 million of net depreciation on our private loan portfolio.
Our operating results for the second quarter resulted in a net increase in net assets of $38.3 million or $0.61 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 use 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 investment grade notes that mature in December.
Due to our elevated liquidity, we were less active under our ATM, equity issuance program during the second quarter, raising approximately $9 million in net proceeds with an average sale price of just under $39 per share.
As we look forward to the third quarter of 2019 we expect that we will generate distributable net investment income of $0.63 to $0.65 per share during the quarter. This estimate is $0.015 to $0.035 per share or approximately 2% to 6% above our previously announced monthly dividends for the third quarter of $0.615 per share.
With that, I will now turn the call back over to the operator, so we can take any questions.
Thank you. [Operator Instructions]. Our first question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Hi guys, congrats on the quarter. If I can ask you some kind of semi-macro questions since you got a large diversified portfolio, if we look at the lower middle market, if you can. If we can separate from lower middle market from the middle market and further down. On the lower middle market side, I mean 21 appreciated, 15 depreciated, that’s fairly even. What are the trends you’ve seen; obviously the ups were bigger than the downs. But what are the trends you've seen in kind of revenue growth or EBITDA growth from those businesses. Are there any determinable trends today versus say six months ago or anything like that?
Thanks Robert. I would say that there’s not a big change today compared to what there would have been in place six months ago. I think we continue to see bifurcation of companies that are performing really well and others that are either are not performing as well and I'd say where we see companies not performing as well, you know it’s more of a company specific issue than it is an overall, you know 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 you know kind of lower your growth. So I'd say that the – you know the path that we see is consistent with what we see in the past, but nothing that’s a you know material change or trend that we're saying versus six months ago. And I'll let David you add anything else that he’d have on his side.
No, I think versus six months ago I’d agreed with Dwayne that only trends we’ve seen in some of the companies like restaurants and such have struggled and retail and other industries have picked up.
Okay, got it. And on the middle market side, Dwayne you said depreciation with some specific credit issues. I mean the obvious question, is there any clustering at all in terms of the credit issues you are seeing in industries or just all over the place?
Yeah, I’d say consist with what David just said, you know there are some retail restaurant you know type situations where they faced 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 your one specific thing.
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. I mean any color you can give us on – I mean was it the start – a partial incentive feel or was this quarter kind of you know full incentive fees and we should expect it to remain steady-ish at that level or is that going to continue ramping up.
I would say that the incentive fees is always going to be very hard to predict, because it's going to be you know related to specific performance in that quarter. I think for the second quarter, it was just the first quarter that you know we earned and will be paid a meeting incentive fee. We have had periods in 2018 where we also had quarters that would have you know generated enough earnings there that would have justified an incentive fee, where just in the past you had agreed with the manager of that fund to waive those fees, whereas in in the second quarter of this year we're no longer waiving that fee and we earned and you know recognized a significance incentive fee in the second quarter.
Okay, 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 Robert’s first question there. You know we continue to see unrealized appreciation and stable EBITDAs in the lower middle market portfolio, but unrealized appreciation and EBITDAs trailing downward in the broader middle market portfolio. Does this trend in the middle market portfolio primarily reflect underlying credit quality?
I just want to make sure that that there is – you know when it relates to the depreciation there will be no technical factors involved or you know quotes or anything like that. And then, how would you characterize the health of the borrowers in a lower middle market portfolio versus the middle market portfolio.
Sure, so I'll get some initial comments and I’ll let Nick Meserve add some additional comments on the no-market. But as I think we try to address in the earlier comment, I think when we look at the middle market, depreciation we've had, you know it’s really you know related to several specific names.
I would say if you looked back over the last couple of quarters going back to the fourth quarter of 2018, you did have some technical movement. You know in the month of December that cause some movement from a fair value standpoint, but I would say that the issues we've had in Q1 and Q2 of this year were more specific credit issues and several specific names that we've been working through, you know really in the first, second and we’ll continue to do in the third quarter. So I would say it continues to be specific issues with individual companies, as opposed to something that is more, you know 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, you know the companies are performing well, the credit profiles are attractive and we can see the benefits of the cash flow generation and 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 he would add on the middle market said.
I think Dwayne covered it fairly well there and I would say it is a few specific instances and issuers that have really been the driver of that movement, you know from fourth quarter to today. I think the good news is we’ve mainly restructured most of those businesses at this point or will it through the third quarter, and so if look at kind of our names we are watching going forward. I think we’ve seen more upside than downside in the names that we might have some issues in.
Okay, that's helpful, I appreciate the comments there. And you know one of the credits I think that was put on nonaccrual last quarter was SiTV 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 the SOI in front of us. And then I think another investment was added to nonaccrual this quarter, so if you could get some color on which one that was and what happened there.
Yes, so SiTV we restructured that during the quarter and basically we took a realized loss in that position. We restructured it around $0.25 I believe, which was where it is today and going forward that business is down by the debt holders there, the small tip towards existing equity and the plan going forward is to more than likely monetize that asset through either an auction or a sale process.
And just to follow-up on the overall non-accrual status at the end of the second quarter, so SiTV as Nick just explained came off of non-accrual by June 30 and we added two new investments to non-accrual, one being Guerdon and the other being Joerns. Guerdon is a lower middle market portfolio company and Joerns is a middle market portfolio company.
And any comments around those two credits around non-accrual and what you know let to you guys putting them on and placing them on non-accrual.
So with Guerdon we had a specific issue related to a customer that led to the company going on non-accrual. We are working with the management team and other investors on trying to put the company in a better position for success and those discussions are ongoing.
Joerns is basically liquidity squeeze based on tradition of business from a sale model to more of a rental business and from a capital structure perspective you need to equitize in the debt. So that company entered bankruptcy in the second quarter, and we expect to exit here in 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.
[Operator Instructions]. Thank you. Our next question comes from the line of Michael Ramirez 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 that recently maybe you passed on a few deals, but just wondering have you seen anything in the market that 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 you know maybe the incremental impact here, net investment income going forward.
Yes, sure. I would say it’s hard to predict you know the last point, because it would all be depended upon what the opportunity was. But we are interested as you’ve heard us say in the past in growing that business and we're looking at opportunities to grow it, you know both from an M&A standpoint but also you know looking at avenues to grow it from an organic standpoint.
Where we sit today you know I wouldn't say that there's anything that is eminent, you know particularly on the M&A side. We remain active and we see the opportunities as they come, you know come about in the industry, but there's nothing that's in place right now that we would say is you know actionable in the near term, but we’ll 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 you know 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 has changed in this environment. So you know recently I guess most BDCs have been saying that we're getting close to the end of cycle and I know it's kind of repetitive; we've been hearing this for the last four or six quarters. But now coupled with like a lower interest rate environment and with a 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 just remained the same regarding your initial equity position.
Yeah, I wouldn’t say that there is a significant change there. We continue to want to be in position to provide very, very customized solutions to each opportunity, so the proposals and the structure 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 and continues to be the case today.
When we look at our most recent investments and the new opportunities we see in the pipeline, you know we continue to see opportunities that are consistent with the historical structure and profile that we pursued. We just need to find the right opportunities that you can – you find our solution tractive and that we can end up getting into the execution phase on. And I’ll let David add any anything else that he would want to cover there?
Nothing else to add.
Okay, great. Thank you guys.
Thank you.
Our next question comes from a line of Bryce Rowe with Robert W. Baird. Please proceed with your question.
Hi, good morning. I’m actually now affiliated with National Securities.
Good morning Bryce.
Dwayne and David, I was hoping maybe you could speak to the recent exits in the lower middle market portfolio and where those exit values compare to marks may be 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 is stacking up relative to marks you would have seen two to four quarters ago. Thanks.
Thanks Bryce. So the exits we had in the, you know we mentioned in our comments there were two. One was in the second quarter that was a portfolio company by the name of Earth Solutions. It’s a company that we’ve been in for a long time and have actually you know 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 say in the past, the fair value marks we had on that investment products have been going through that process, would have been conservative in comparison to the actual realized results.
So the transaction we had was not a material transaction for us, which is why you would not have seen us put out a press release, because our residual interest in the company 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 two quarters prior to that, it would have been about $1 million difference between the actual exit and the fair value.
The second exit that we had which was in the beginning of the third quarter was Lamb's Tire and Automotive, and it was also a company we have been in for a long time. It was a $6 million exit. You know 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 and the fair value, but it was also a transaction that we found very attractive you know from an 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 other activities we are seeing, you know kind of on an ongoing basis from an exit standpoint.
So on the incoming call question, Bryce we continue to feel a lot of incoming calls from strategic acquirers on our portfolio of companies. I'd characterize the activity as 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 are benefiting from a negative basis from the market that we're currently in.
And I assume just kind of consistent with your previous strategy that the preference would be to hold these lower middle market companies that are performing well for as long as you can, but clearly you got calls coming in and decisions being made from the management teams and with you all to monetize where it makes sense.
That one specific example, we had a call come in about three weeks ago on a company that we've not – had no intentions of selling. We enter in those discussions with management, and you know when we can see a valuation that we think is just, it far exceeds what we think we could get here to stay in the investment for you know a significant period of time, we have to have you know a real thoughtful discussion about whether we should exit or not, but certainly our belief and the reason we get in these investments is our long term hold is unmatched in the market and our ability to get benefit from the 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, Bryce.
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 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!