Main Street Capital Corporation
Q1 2021 Earnings Call Transcript

Published: 7 May 2021

[Zach Vaughan:]

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's First Quarter 2021 Earnings Conference Call. Main Street issued a press release yesterday afternoon that details the company's first quarter financial and operating results. This document is available on the Investor Relations section of the company's website at mainstcapital.com.

[Dwayne Hyzak:]

Thanks, Zach. Good morning, everyone, and thank you for joining us today. We appreciate you taking the time to join us. We hope that everyone is doing well and staying healthy and safe. Joining me 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'll provide my normal updates regarding our performance in the quarter, while also providing updates on our overall capital structure and liquidity position, our asset management activities, our investment activities and current investment pipeline, our recent dividend announcement and several other updates. Following my comments, David and Brent will provide additional comments on our investment strategy, investment portfolio, financial results and future expectations, after which we will be happy to take your questions. We are pleased with our first quarter results, which we believe illustrate our portfolio companies continued recovery from the impacts of the COVID-19 pandemic.

[David Magdol:]

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, during the first quarter, we experienced continued general improvement in the operating performance and results of our portfolio companies with many returning to or exceeding their historical levels of revenue and profitability. However, some industries, particularly those industries that experienced most significant negative impact for the pandemic, are just now beginning to show signs of recovery. The continued improvement in the operating performance for the majority of our portfolio companies resulted in another increase in our NAV per share in the quarter. This increase is a direct benefit of our long-term strategy of maintaining an investment portfolio that is well diversified by end market, industry vintage and security type. This diversification has been the cornerstone of our philosophy over our 20 years plus of investment history and will continue to be key to our investment strategy in the future. Over the last year, the COVID-19 pandemic provided a significant stress test for our portfolio and our investment strategies. While this was a strenuous time for us and our portfolio company operating partners, we're pleased to have seen our investment strategy serve us well during this period of time.

[Brent Smith:]

Thanks, David. Our total investment income in the first quarter increased by 12% over the same period in 2020 to a total of $62.8 million, primarily driven by an increase in dividend income, partially offset by decreases in interest and fee income. The change in total investment income includes a net increase of $0.7 million, primarily related to higher levels of dividend income that is generally considered nonrecurring, partially offset by lower levels of accelerated income for certain debt investments considered nonrecurring. Our operating expenses, excluding noncash share-based compensation expense, increased by $3.9 million over the same period of the prior year to a total of $20.7 million, primarily related to an increase in compensation expense in the quarter. $1.3 million of the increase in compensation expense related to the change in the fair value of our deferred compensation plan assets, as there was a significant benefit or reduction to compensation expense in the first quarter of last year. The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, was 1.3% for the first quarter on an annualized basis. The activities of our external investment manager benefited our net investment income by approximately $3.6 million during the first quarter to the allocation of $2.4 million of operating expenses for services we provided to it and $1.2 million of dividend income. This increase from the first quarter of last year is a result of Main Street taking over as a sole adviser in October 2020 to the HMS Income Fund since we named the MSC Income Fund. We recorded a net realized loss of $15.7 million during the first quarter, primarily relating to the realized loss from the restructure of a lower middle market debt investment that was previously on nonaccrual, which resulted in a further improvement in our nonaccrual stats, and we ended the first quarter with 6 investments on nonaccrual status, down from 7 at year-end, comprising approximately 0.8% of the total investment portfolio at fair value at approximately 2.9% at cost. In addition, we recorded realized losses related to the exit of a middle market debt investment and the exit of an equity investment in the other portfolio. We recorded net unrealized appreciation on the investment portfolio of $19.5 million during the first quarter, primarily related to $9.4 million of net appreciation on the lower middle market portfolio, $2.5 million of net appreciation on our private loan portfolio, $5.6 million of net appreciation on our middle market portfolio, $0.million of appreciation relating to our external investment manager and $1.6 million of net appreciation on our other portfolio. Our operating results for the first quarter resulted in a net increase in net assets of $57.3 million or $0.84 per share. Our overall capitalization and liquidity remained very strong as our total liquidity is currently in excess of $800 million. In January, we issued $300 million of investment-grade notes with a cash coupon of 3% and a maturity in July 2026. Due to our excess liquidity position, during the first quarter, we only raised approximately $3.5 million in net proceeds under our ATM equity issuance program. We were also very pleased to have further enhanced our liquidity position by recently extending our revolving credit facility in April, with an increase in total commitments to $855 million, including increases from several of the long-term participants in the facility. We continue to believe that our conservative leverage, strong liquidity and continued access to capital are significant strengths that have us well positioned for the future. As we look forward to the second quarter, we expect that we will generate distributable net investment income of $0.59 to $0.62 per share. With that, I will now turn the call back over to the operator so we can take any questions.

[Operator:]

Our first question is from Robert Dodd with Raymond James.

[Robert Dodd:]

Congratulations on the quarter. A couple of questions. I mean first, on David's comments to anybody. Dividends picked up, obviously, in 2020. Is it identifiable how much of that was maybe, for lack of better terms, spillover from 2020 because businesses maybe did better than they expected earlier in the year versus kind of ongoing dividend kind of sustainable run rate?

[Dwayne Hyzak:]

Yes, Robert, what I would say on the question about the dividends is as we identified in our comments and in our press release, there was one large dividend from a company that was related to an exit of our investment there that we would clearly say is nonrecurring since we exited that investment. But I think the other investments, while there may be some quarter-to-quarter volatility and some increases from time to time in the dividend income that comes from those companies, the other large dividend pairs we had in the quarter represented -- all represented long-term contributors to our dividend income. So while you do have some quarter-to-quarter volatility, we don't think it's nonrecurring or unusual. You do see it get elevated, but it's really hard to say how much of that would be spillover or carryover from the prior year.

[Robert Dodd:]

Got it. Got it. I appreciate it. And then on the comment -- the low middle market pipeline about average, is it another identifiable question? I mean there's the potential for tax changes, which you also mentioned in the prepared remarks. And historically, that does tend to drive greater activity. Is that all already showing up in the above-average pipeline? And if the potential tax changes firm up, what's the time scale that the potential sellers, entrepreneurs, et cetera, come to you one versus getting it closed before, so the end of the year if the tax has changed next year?

[Dwayne Hyzak:]

Yes, Robert, what I would say on that question is when you look at the current pipeline, I would say that we don't think there's a lot of tax-related planning that's included in that pipeline. The current pipeline, as we said in our comments, includes a number of follow-on investment opportunities in existing companies, which, as you've heard us say in the past, we find very attractive. So we're excited about that activity, and that would be an elevated portion of our current pipeline when you look at the lower middle market activity. But I wouldn't say the other activity to date includes a lot of tax planning or tax strategies in relation to potential increases in tax rates going forward. Historically, when we look at other time periods where you've seen this type of a change in the administration and the tax changes that may come with that, it's typically going to be the second half of the year. So I think we're starting to see new investment activity that's coming at the front end or the top of our funnel that likely includes the beginnings of that tax planning, but I wouldn't say that it's in the existing pipeline that we expect to execute on over the next couple of months.

[Robert Dodd:]

Got it. Great. One more, if I can. On DNII, I mean, I appreciate the guidance you gave. Dwayne, you gave comments about eventual growth of the monthly dividend. I mean is there a rule of thumb on -- does DNII have to not only consistently exceed the dividend? But is there a margin you'd like to see before dividend increase would be, obviously, it's a Board question, but you're on the Board before the dividend increases would be potential? Or is it just -- if it can be sustainably covered, it's on the table?

[Dwayne Hyzak:]

Yes, Robert, I would say it's the latter. It's more -- it's having a really high level of confidence about the sustainability of the DNII levels. I think we feel really good about the DNII that we've produced in Q4 and Q1. But as we said earlier, it does include some volatility, specifically on the dividend income side. So I think we really want to see that dividend income become more predictable and more consistent as its contribution to the DNII as well as you hope to have continued improvements or contributions on the interest income side from continued growth in our investment originations. And when we see those 2 items come into play, I think that's when you'll see us look at increasing the monthly dividend. Historically, we've always said that our goal was to have DNII cover the monthly dividend by 5%. That's kind of been a long-term goal we've had, but I think it's really, as we sit here today, it's really getting into a more consistent visibility or practice on the receipt of dividend income from our portfolio companies. It's going to be the biggest driver going forward.

[Operator:]

Our next question is from Kenneth Lee with RBC Capital Markets.

[Dwayne Hyzak:]

I'm not sure if you can hear us. But we can't hear you if you're trying to ask us a question.

[Operator:]

We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.

[Dwayne Hyzak:]

We just want to say thank you again to everyone for joining us this morning for the conference call, and we look forward to talking to you again here in a few months.

[Operator:]

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.