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Edited Transcript of MAIN earnings conference call or presentation 2-Nov-18 2:00pm GMT

Q3 2018 Main Street Capital Corp Earnings Call

HOUSTON Nov 19, 2018 (Thomson StreetEvents) -- Edited Transcript of Main Street Capital Corp earnings conference call or presentation Friday, November 2, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent D. Smith

Main Street Capital Corporation - CFO & Treasurer

* David L. Magdol

Main Street Capital Corporation - Vice Chairman, CIO & Senior MD

* Dwayne Louis Hyzak

Main Street Capital Corporation - President, COO, Senior MD & Director

* Nicholas T. Meserve

Main Street Capital Corporation - MD

* Vincent D. Foster

Main Street Capital Corporation - Co-Founder, Chairman & CEO

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Conference Call Participants

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* Christopher Robert Testa

National Securities Corporation, Research Division - Equity Research Analyst

* Jason Michael Arnold

RBC Capital Markets, LLC, Research Division - Director in the Equity Research and Senior Equity Research Analyst

* Leslie Shea Vandegrift

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

* Mark Roberson

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Presentation

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Operator [1]

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Greetings, and welcome to the Main Street Capital Corporation Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mark Roberson, Dennard Lascar, Investor Relations. Thank you. You may begin.

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Mark Roberson, [2]

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Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's Third Quarter 2018 Earnings Conference Call. Joining me on the call today are Chairman and CEO, Vince Foster; President and Chief Operating Officer, Dwayne Hyzak;-- and Chief Financial Officer, Brent Smith. Both David Magdol, Chief Investment Officer; and Nick Meserve, Managing Director and Head of Middle Market, are in the room and available for questions.

Main Street issued a press release yesterday afternoon that details the company's third quarter financial and operating results. This document is available on the Investor Relations section of the company's website at mainstcapital.com. A replay of today's call will be available beginning an hour after the completion of the call and will remain available until November 9. Information on how to access the replay was included in yesterday's release. 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. Please note that information reported on this call speaks only as of today, November 2, 2018, 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 and 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 Vince.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [3]

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Thanks, Mark, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcements and a few other recent developments and conclude by commenting on our investment pipeline. Following my comments, Dwayne Hyzak, our President; and Brent Smith, of our CFO, will comment on our third quarter financial results, recent originations and exits, our current liquidity position and certain key portfolio statistics and other recent developments, after which, we will take your questions.

We are very pleased with our third quarter operating results. Our lower middle market portfolio, our primary area of focus, appreciated by $26.3 million on a net basis during the quarter with 30 of our investments appreciating during the third quarter and 13 depreciating. Our middle market loans, private loans and our other assets collectively appreciated by $9.7 million on a net basis. We finished the quarter with a net asset value per share of $24.69, a sequential increase of $0.73 a share over the second quarter. Our lower middle market companies collectively continue to exhibit very conservative leverage ratios on a relative basis, which Dwayne will cover in greater detail.

Earlier this week, our board declared our first quarter 2019 regular monthly dividends of $0.195 a share in each of January, February and March, maintaining our fourth quarter monthly payout rate. The ex dates for these dividends are December 28, January 17 and February 20, respectively.

6 years ago, we declared our first supplemental or special dividend of $0.35 a share. At the time, we have been operating as a public business development company, or BDC, for 5 years and were primarily making lower middle market debt and equity investments. Like most BDCs, we've operated as a regulated investment company, or RIC, for tax purposes and have had to adhere to strict earnings payout rules to minimize taxes, thus, diminishing our ability to retain earnings. During those initial 5 years, Main Street consistently generated substantial but variable realized gains from exited equity investments. These gains presented us with 2 options to comply with a RIC payout requirements: one, either pay out the realized gains as realized with obvious dividend fluctuations due to the volatility of such gains; or two, distribute the gains as periodic or supplemental special dividends. We chose the latter by paying an annual supplemental dividend in such amount as to provide several years of forward visibility to the projected recurrence of such supplemental dividends.

In mid-2013, we decided to make the supplemental dividend semiannual, paid in June and December. We have continued this practice through the December 2018 dividend we declared last month. We are now in a position due to the size, diversity and maturation of our business model to begin the conversion of our supplemental dividends into regular monthly dividends. We envision making this transition over the next 5 years such that by the end of the transition period, our monthly dividend payout rate will be at least $0.05 per month higher than our current payout rate or at least $0.60 on an annualized basis, while concurrently, our supplemental dividends of $0.55 per year will be reduced incrementally and fully absorbed into our monthly dividends. In addition to completing the absorption of the supplemental dividends into our monthly dividends, our long-term goal over the transition period will be to continue to grow our total annual dividends at a level consistent with what we have delivered in the past. We believe that this transition will make our dividend policy easier to understand and follow, allow all third-party stock price services to correctly indicate and reflect our dividend yield and more clearly align the dividend yield reflected by our new regular monthly dividends with our goal of generating best-in-class returns on our equity. This will also enhance our ability to retain a portion of our realized gains through various taxable entities while still growing our dividends. So to launch this process, we'll be asking our board to increase our second quarter regular dividend payout rate to $0.20 per month beginning in April 2019 and decreasing our June 2019 supplemental dividend to $0.25 per share from the $0.275 per share rate in December 2018.

We've originated new lower middle market and private loan investments of roughly $578 million so far this year, including lower middle market originations of $85 million in the third quarter. As of today, I would characterize our lower middle market investment pipeline as above average. We continue to seek and receive significant equity participation in our lower middle market investments. And as of quarter end, we own on average a 39% fully diluted equity ownership position in the 99% of these investments in which we currently have equity exposure.

Our officer director group has continued to be regular purchasers of our shares, investing approximately $0.5 million during the third quarter.

With that, I'd like to turn the call over to Dwayne to cover our performance in more detail.

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [4]

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Thanks, Vince. Good morning, everyone. We are pleased to report another quarter during which we grew our total investment income and net investment income over last year, both in total and on a per-share basis, and generated a record quarterly net increase in net assets or GAAP net income. We are also pleased that our operating results represent a GAAP return on equity, or ROE, at 15.6% for the trailing 12-month period and an annualized 18.6% for the quarter ended September 30. Results which exceed our stated long-term goal are producing an ROE percentage in the low to mid-teens.

We believe that our ability consistently generate increases in both our net investment income and net asset value per share and deliver a superior return on equity continues to illustrate the significant benefits of our unique investment strategy in the lower middle market, which, combined with our efficient operating structure and other complementary investment and asset management activities, provides a value proposition that differentiates Main Street from other yield-oriented investment options and generates the premium total returns realized by our shareholders.

We believe the primary driver of our long-term success has been and continues to be our primary focus on the underserved lower middle market and specifically our investment strategy of investing in both debt and equity in the lower middle market and acting as a sponsor and a partner to the management teams of our lower middle market portfolio companies and not just a financing source.

Each quarter, we try to highlight different aspects of our unique investment strategy. Today, I'm going to discuss how our efforts over the last few years to organically grow our internal investment resources, along with an increased focus on our marketing activities in the lower middle market, has allowed us to significantly exceed our budget for lower middle market originations in 2018 and has positioned us for additional success in the future. Since the end of 2014, we have effectively doubled the internal investment professionals we have executing our lower middle market strategy, significantly expanding our ability to execute this strategy. As a result of these additional resources, coupled with our unique debt and equity investment strategy, our long-term partnership approach with our portfolio companies that is facilitated by our permanent capital basis of BDC and the large addressable market for lower middle market investments, we are experiencing a record year for lower middle market originations.

Through September 30, we have originated $288 million of lower middle market investments for our Main Street portfolio and have clear visibility to several additional investments in the fourth quarter. We are also confident that our marketing efforts have continued to expand and strengthen our relationships within the lower middle market, providing us significant comfort regarding our current expectations for origination in 2019. This expected continued growth in our lower middle market portfolio, coupled with favorable opportunities we see for our private loan and middle market strategies, allows us to maintain our belief that the continued growth of our business through a combination of new equity issuance and modest debt capital issuance is in the best interest of our shareholders.

Now turning back to our third quarter operating results. Consistent with prior quarters, the contributions from our lower middle market portfolio continue to be well diversified with 41 of our 69 lower middle market companies with equity investments having unrealized appreciation at quarter end and with 30 of these companies that are flow-through entities for tax purposes are 59% of our total investments in these types of entities contributing to our dividend income in the last 12 months. We also have several equity investments in C corporations which have contributed to our dividend income.

We believe that the diversity of our lower middle market portfolio is very important when analyzing the benefits from our lower middle market strategy, and we believe that this diversity provides visibility to the recurring nature of these benefits in the future.

Now turning specifically to our investment activity in the third quarter and our investment portfolio at quarter end. We completed total investments in our lower middle market portfolio of approximately $85 million, which after aggregate repayments on debt investments and return of invested equity capital, resulted in a net increase in our lower middle market portfolio of $56 million. Our middle market portfolio was effectively flat with a net increase of $3 million, and we had a net decrease in our private loan portfolio of $27.5 million.

As a result, at September 30, we had investments in 182 portfolio companies that are more than 50 different industries across the lower middle market, middle market and private loan components of our investment portfolio. Our largest portfolio company represents less than 3% of our total investment portfolio fair value with the majority of our portfolio investments representing less than 1% of our assets.

Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday, but I'll touch on a few highlights. Our lower middle market portfolio included investments in 70 companies, representing over $1.1 billion of fair value, which is 19% above our cost basis. At the lower middle market portfolio level, the portfolio's median net senior debt-to-EBITDA ratio was a conservative 3.1:1. As a complement to our lower middle market portfolio, in our middle market portfolio, we had investments in 58 companies, representing approximately $608 million of fair value. And in our private loan portfolio, we had investments in 54 companies, representing approximately or $491 million of fair value.

The total investment portfolio as a whole continues to perform at a high level, and our lower middle market, middle market and private loan investments generated over $27 million of net unrealized appreciation during the quarter. And we had 5 investments on nonaccrual status, which comprise approximately 1.2% of our total investment portfolio fair value and 3.5% at cost.

In summary, Main Street's 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.

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Brent D. Smith, Main Street Capital Corporation - CFO & Treasurer [5]

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Thanks, Dwayne. We are pleased to report that our total investment income increased by 13% for the third quarter over the same period in 2017 to a total of $58.3 million, primarily driven by an increase in interest income of $6.5 million and an increase in fee income of approximately $1.5 million, partially offset by a decrease of $1.6 million in dividend income. The total investment income includes an increase of $2 million related to higher levels of accelerated prepayment, repricing and other activity for certain debt investments, partially offset by a decrease of $1.7 million in dividend income that is considered less recurring when compared to the same period in 2017.

Third quarter 2018 operating expenses, excluding noncash share-based compensation expense, increased by $2.7 million over the third quarter of the prior year to a total of $18 million. The increase was primarily related to a $1.5 million increase in interest expense and a $1 million increase in compensation expense. The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, was 1.5% on an annualized basis for the third quarter compared to 1.5% during the same period in the prior year. Our increased total investment income and the continued leverage of our efficient operating structure resulted in a 10% increase in distributable net investment income for the third quarter of 2018 to a total of $40.2 million or $0.66 per share, which exceeded our recurring monthly dividends paid for the quarter by approximately 16%.

The activities of our External Investment Manager and its relationship with HMS Income Fund benefited our net investment income by approximately $2.7 million in the third quarter through a $1.6 million reduction of our operating expenses for costs allocated to it for services provided and $1.1 million of dividend income from the External Investment Manager.

We recorded a net realized gain of $9.2 million during the third quarter, primarily relating to the realized gains from the exit of 3 lower middle market investments and activity relating to the other portfolio. Partially offsetting these gains was a realized loss related to the restructuring of a middle market investment. We recorded net unrealized appreciation on the investment portfolio of $36 million during the third quarter, primarily resulting from $26.3 million of net appreciation on our lower middle market portfolio, $7.5 million of appreciation on our External Investment Manager, $1.3 million of net appreciation on our other portfolio and $0.8 million of net appreciation on our middle market portfolio. Additional details for the change in our net unrealized appreciation can be found in our earnings release.

Our operating results for the third quarter resulted in a net increase in net assets of $68.7 million or $1.13 per share.

On the capital resources front, our liquidity and overall capitalization remained strong. At the end of the third quarter, we had approximately $50 million of cash and $430 million of unused capacity under our credit facility for total liquidity of approximately $480 million. Currently, we have approximately $45 million of cash and $365 million of unused capacity under our credit facility for total liquidity of approximately $410 million.

We also raised approximately $18.5 million in net proceeds under our ATM equity program during the third quarter with an average sale price of $39.71 per share.

As we look forward to the fourth quarter of 2018, we expect that we will generate distributable net investment income of $0.63 to $0.65 per share during the quarter. This estimate is $0.045 to $0.065 per share or approximately 8% to 11%, above our previously announced monthly dividends for the fourth quarter of $0.585 per share, maintaining our conservative approach to our monthly cash dividends.

With that, I will now turn the call back over to the operator so we can take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Leslie Vandegrift with Raymond James.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [2]

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First off all, just -- I missed it there at the end of your prepared remarks, the issuance for the quarter through the ATM. I heard the average price but not how many shares.

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Brent D. Smith, Main Street Capital Corporation - CFO & Treasurer [3]

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Yes. It was approximately $18.5 million, and the average price was $39.71. And I believe the number of shares...

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [4]

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Just under $0.5 million.

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Brent D. Smith, Main Street Capital Corporation - CFO & Treasurer [5]

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Yes. I believe that's approximately correct.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [6]

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Perfect. And then you were talking about -- or you mentioned the 5 non-accruals. Are they the same ones from last quarter? No change there?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [7]

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Yes. That's correct. There's no change in the investments of our nonaccrual.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [8]

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Okay, perfect. And on the middle market investment, you mentioned in the prepared remarks that there was one that had a loss in the quarter from a restructure. Which investment was that?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [9]

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(inaudible) was the realized loss in the middle market.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [10]

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Okay. And then finally, really appreciate the outlook on the dividend, I mean, the supplemental over to regular payments. I think everyone else would agree with that. On -- but because you did that obviously, I assume that the spillover income level is at least healthy right now. What is -- do you have that number now before you pay the next supplemental in December?

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Brent D. Smith, Main Street Capital Corporation - CFO & Treasurer [11]

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Yes. At the end of the third quarter, the spillover was approximately $68 million.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [12]

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All right. Perfect. And then just on market outlook, you guys are definitely in a different lane than most of the other BDCs. You have your niche -- 3 niche portfolios on those. And given the increased leverage that other BDCs in the States are doing and leverage on the markets in general seeming to heat up, have you noticed any of your portfolios benefiting from that? You have been more for the lower middle market versus maybe the private loan or the middle market portfolios seeing more competition there?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [13]

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Yes. I wouldn't say that we really see an impact in our portfolios just because of the leverage. I think most of the BDCs that have announced they're going to access the leverage actually haven't received any benefit yet. So to date, we would say that the impact on the market hasn't really been anything. It remains to be seen longer term what impact it could have. But I think our view is that if there is an impact, it will be marginal, just given the different focus we have on our side versus most of the other BDCs.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [14]

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And remember that the first step was getting board and/or shareholder approval. The second step is once you've obtained that is to go back to your bank group and get your covenants amended, if you can, to try to accommodate some or all the additional leverage. So that's kind of the second phase the BDCs are working through now with some success, but it's still a work in process.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [15]

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Okay. And then just finally on your lower middle market portfolio. So far in the fourth quarter, what are originations and repayments looking like for pace?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [16]

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Yes. So we have not announced all the activity yet. But if you look at the net originations for the lower middle market, it's just over $35 million on a net basis. And then on the private loan, it's just over $30 million. And the middle market is effectively flat.

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Operator [17]

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Our next question comes from the line of Tim Hayes with B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [18]

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And I apologize if I missed this, I jumped on just a tad late. But should we expect that eventually all dividends will be in the form of monthly dividends? Or do you expect to always maintain a supplemental dividend?

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [19]

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No. I mean, if we can help it, we'd like to completely eliminate the supplemental. For tax reasons, if you have a huge gain, theoretically, your choices are really limited. If you either have to distribute it out, you basically have until you file the tax return of the year subsequent to recognizing the real big gain. Or there's a mechanism where you can retain the gain, pay the tax and pass on the tax credit to your shareholders. That would kind of be the last resort. But if we can help it, we'd like to just go back to the regular monthly dividends, not have specials. And I think everything's -- our dividend policy and yield is going to be a lot easier to understand that way.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [20]

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Got it. Okay. And so should it be the kind of scenario where over the next several quarters, I guess starting in 2Q '19, that we start seeing more of that supplemental gradually shift into the monthlies?

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [21]

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Yes.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [22]

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Okay. Got it. And then obviously, it's a good marketing tool and hopefully will help with devaluation of the stock. But would you say that at the margin this move reflects an increased confidence you have in your ability to realize gains from your portfolio companies?

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [23]

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Yes. I think so. Dwayne?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [24]

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Yes. I think it's more -- Vince touched on this on his comments, but our portfolio is growing. It's more diversified today. And if you have tracked our performance in the last couple of years, you would see a growing spread between our DNII and the monthly dividend. I think through the year-to-date, 9/30, it's just over $0.30. So we very -- we feel very comfortable about that spread. And that, combined with our approach of being a very long-term investor in the lower middle market where if we had our choice, we'd rather keep our best companies as opposed to have them leave the portfolio through an exit. Those factors really gave us the confidence that we think we can make this change in the dividend with moving the supplemental into the monthly, and at the same time, maintain the historical growth rate that we've had on a total dividend basis. And that's our goal over the next 5 years is to achieve that transition into a monthly only but maintain the consistent growth and the total dividends on a year-to-year basis.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [25]

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I would add, too, I think that, implicitly, when you have those 2 big special dividends or semiannual dividends a year, you might be inclined to take an exit of a nice company where you otherwise wouldn't want to when we really want to remove any incentive from having to sell some or all of our appreciation in the given company or companies. And I think this will help in that regard. And that really wasn't always the case, if you go back 8 or 10 years ago.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [26]

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Okay. Yes. That's really helpful. And then another question. I believe I actually may have asked this on the last conference call. But how has the flow of the potential M&A and portfolio sales and some advisory opportunities been? Are you seeing deals that fit your credit standards or return hurdles and with BDC is kind of trading at depressed multiples, especially over the past several weeks, are you seeing an inflow of more opportunities?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [27]

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Yes. So you touched on a couple of different questions there, so we'll try and address each one of them. But if we don't do it is ask a follow-up.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [28]

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Yes. I apologize for that.

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [29]

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That's okay. I would say on the exit front, we do have, as we always do, some amount of exit activity. I think you probably wouldn't be surprised that given where valuations are, in general, that for certain companies that if the management team or the other equity holders want to take a look, it's a pretty good time. So I do think that we have several companies that are in somewhere in the process of looking at an exit. And if those transactions happen, we're going to be in a position where we think the exit will be a very good exit for us. But again, it's not something that Main Street would be pushing. It would be more collectively on a company-by-company basis with the management teams and with the other owners of the business. Looking at that, I think you also asked a question about just the overall market. And as we mentioned earlier, David Magdol, our Chief Investment Officer, is with us. So I'll let him give some commentary on the new origination side of things on the lower middle market.

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David L. Magdol, Main Street Capital Corporation - Vice Chairman, CIO & Senior MD [30]

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Sure. So on a year-to-date basis, we are obviously seeing a lot more activity on our booked volume on the lower middle market side. We're also seeing that as a result of improved marketing efforts over time, and the lower middle market is just seeing increased deal flows as a result. So if you look at it year-over-year, our incoming yield volume is up by 15% to 20%. What's more important than the actual number of transactions we're seeing is the quality of the transactions. We've attended now about 40 meetings. We'll expect to attend 40 meetings on go-to individual markets through conferences and through meeting with intermediaries and referral sources, and that just really increased the deal volume that's coming in. So we expect that to continue to translate to new originations over time.

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [31]

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And Tim, I think your last question was around some color on the asset management business. And I think consistent with our commentary over the last couple of quarters, we remain very interested in looking at new opportunities. There's always some level of dialogue between us and third parties about new asset management opportunities. I would say, as we sit here today, there's not a material update in terms of something being closer to the finish line in terms of us having new opportunity, but it's something we're very interested in. And we continue to look at opportunities as they come to us from time to time.

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Operator [32]

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(Operator Instructions) Our next question comes from the line of Christopher Testa with National Securities Corporation.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [33]

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Just wanted to just touch on the dividend policy change and just see what the philosophy has been regarding that. I mean, is it just sort of that a lot of BDCs don't get as much credit as they might deserve for the supplemental dividends even if they're regulars? So you guys think maybe it will get shares a better valuation? I'm just wondering just what was the underlying thing that drove that.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [34]

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Well, Chris, we've never really liked doing it. I think early on when the industry was newer and we were a newer participant and we were smaller, the fear was if you -- if your regular monthly dividends comprise both operating earnings and gains and you paid that out, you would be criticized potentially for not earning your dividend with operating income, right. You put yourself in an impossible situation. And we wanted to be -- we want to really highlight our ability to earn our dividends through operating earnings. And therefore, that was kind of the history of, well, it's best with these -- we don't want to retain gains and go through the brain damage of passing our credits to our largely retail shareholder base and explain to them how to claim it on their tax return. It's been done in the past by other BDCs. We didn't want to do that. So we kind of felt painted into a corner. And so we said, "Well, the least worst alternative is to do the semiannual specials." We've never liked it. We don't like the name. I think it's confusing. We have to send out reminders. There's 2 dividends in December coming up and 2 ex dates, and it really kind of gets confusing. So we -- when you think about where we are now compared to 5 or 6 years ago, we didn't really have the middle market business. The middle market business, the private loan business is that stream of income doesn't generate gains, right. The asset management business doesn't really generate material gains. And so we think we're in a position now and we have a demonstrated track record that if some of our dividends, going forward, consist of a small amount of gain in operating earnings, I think our shareholder base understands, and we won't be criticized for "not" earning our dividends. So kind of for all those reasons, we think the time is right to do away with it. And we'll do away with it over a multiyear period.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [35]

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Got it. Okay. No. That's great detail. And you guys in your prepared remarks had given some good color on the expansion of your investment team as it pertains to the lower middle market. So my question will be how much bigger do you think the lower middle market book could get before you'd have to make any more material hires at kind of a senior level there?

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [36]

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I think we've touched on before that we think the lower middle market opportunity is huge. If you look at some of the materials we publish and we -- you've touched on before, we think there's upwards of 150,000, 175,000 companies that fit the size that we look at. Not all those companies will be a fit for us because there's something about their operations that wouldn't be attractive or they're not in the market, but we do think it's a very, very large robust market. So as we look at our ability to continue to grow there, we think that we have kind of long-term visibility to continue growth. The key for us is to add resources. That's why we've been focused on that for the last number of years. We continue to be extremely focused on it going forward, and we think we've got a structure in place with very well-defined process, procedures and approach to the market. We think as we add resources, we can onboard them in a very reasonable amount of time and make them very productive members of the team. I do think, over time, we will look to add more senior resources. We have not done that to date, but it is something as we look at the significant opportunity in the lower middle market, it is an opportunity we have as we look at our growth opportunities over the next 2 to 5 years.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [37]

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So one way to think about it is if you run a lower middle market team now, you are your own workout person. You are your own administrative support person in terms of your valuations, et cetera, et cetera. And so we think adding senior resources to help out administratively that might have specialized workout skills or specialized administrative skill set, so we can -- we really wanted the lower middle market people originating, dealing with their companies, being proactive board members, et cetera and try to take some of the administrative burdens away. So that's -- in that context, you'll see some senior resources coming in. Or if we have a new business line -- Nick Meserve was a senior resource we brought in to help jump-start our middle market and private loan practice. But fundamentally, we want to take people off campus and train them our way. And we're able to generate new hires off campus in the low double digits, and we've had really good retention. So that implies double-digit growth without even doing larger deals, and we are starting to do somewhat larger deals. David, do you have a comment?

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David L. Magdol, Main Street Capital Corporation - Vice Chairman, CIO & Senior MD [38]

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I'll just add one thing. If you look at our total headcount in the lower middle market today versus 4 years ago, it's approximately double. The thing that gets lost sometimes in translation is we train people to do things the Main Street way. We're not only equity. We're not only debt. We've got to train people to get a unique skill set. So the seasoning of that staff that we have today are our more valuable resources because they can translate and understand how to identify, execute and manage that portfolio. That is an outside resource. If we look outside, we're either hiring someone with an equity skill set or a debt skill set. Very rarely can we find someone with both. So I think we've got lots of expansion internally.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [39]

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Okay. That's great detail. And also something we've seen, I guess, in the larger market, especially as with the 9/30 quarter, is that there has been a more favorable trend in volume that's gone more towards LBOs and M&A versus the dividend recap the markets become accustomed to the past several years. So I'm just wondering if you've seen favorable kind of use of capital trends in terms of the loan demand in the lower middle market as well.

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [40]

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I'd say in the lower middle market, the types of transactions we're executing on are largely consistent with what we've done in the past. We haven't seen a significant change there. Nick, is there any commentary you'd add on the middle market?

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Nicholas T. Meserve, Main Street Capital Corporation - MD [41]

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Yes. The middle market side, we've seen a lot less repricings. And I'd say the dividend recap, we've seen a lot less of that than the LBO and new acquisition models.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [42]

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Okay. Got it. And last quarter, I know that Vince shared, made comments on AFFE. And since then, obviously, Ares and Apollo have kind of filed a formal petition with the SEC investment management division to get BDCs exempt from this as they definitely deserve to be. Just wondering if you have any additional insight on -- just terms of the timing. Obviously, the SEC doesn't really move at the speed of lightning with many things. So just wondering if there was anything that you could add since that filing.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [43]

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Sure. Yes. The good news is that the filing made by the group that Ares and Apollo are a part of is coordinating its efforts in communicating with the similar activities of SBIA, and we have regular joint calls to try to kind of divide and conquer and try to figure out what legislative pressure we can bring to bear, regulatory pressure, et cetera and industry pressure to highlight this issue. And from the -- I was on the last call that we had, and I believe that, that -- we -- I think the consensus says that, that filing triggers an informal 120-day period, during which you can expect the SEC to review and respond with questions, most likely request more detail. And so we're kind of prepared -- preparing for that event. I think this is going to be a long drawn-out process relative to the SEC saying, "Good idea. Here is your class order." So we're probably looking at probably several quarters of work to try and to primarily educate the SEC staff. And of course, there's clearly members of the staff that are favorably disposed towards giving us a solution, and there's others that probably remain to be convinced. That's kind of what my understanding is. And so it's consensus building. It's educating, communicating, providing data, et cetera. So there's a lot of work to do, but I think we're pretty optimistic that hopefully by this time next year, we might have something done. That's kind of my personal opinion and hope.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [44]

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Got it. And just curious, I know you had mentioned there's probably some staff members there at the SEC that are maybe not so amenable to this. Playing devil's advocate, I mean, what is the actual opposition for this? Like I've never really understood why BDCs were not exempt from this, and I never understood what this was seeking to gain. I mean, just what do you think the actual opposition to this would be? I'm just curious.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [45]

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You -- so let's assume you and I form an externally managed BDC. Its only asset, we can't really do this, but assume we could, would be Main Street. We charge 2% and 20% for owning Main Street, which is internally managed. Wouldn't it -- it would be reasonable for us to have to tell our new shareholders that there is kind of a fund-of-fund or compounding fee effect if we were to do that relative to your ability to go out and own Main Street yourself, right. So that's the fundamental goal is to communicate when there is a second round of fees like a fund-of-funds -- fund-of-fund vehicles you see commonly in private equity right. So I think that's the overriding concern, and it's difficult to communicate. And we're a prime example of an internally managed BDC. If a mutual fund has a Russell 2000 benchmark fund that's -- after we manage a pass or what have you and it were -- it happened to own Main Street, they have to take part of my salary and gross up their advertised cost of the fund. I mean, it doesn't really make any sense. So really trying to figure out along the continuum where did the internally managed and externally managed BDCs really -- where is the right place to stop the line and cause disclosure? Maybe there's another type of disclosure within the body of our filing or the filings of the mutual funds that hold BDCs, and so it's -- there is a lot of work to do. It's -- so it's not a fundamentally bad or unreasonable rule, right. It's just -- it doesn't appear to -- appears to be inequitably applied to us, such that we get kicked out of the indices. So -- and I think it's more education, and I think it's more when we say that AFFE, us being -- the AFFE rules curtails capital flows in small businesses because of the relative lack, absence of institutional investors. We have to prove that. We have to back that up, and guys like you can help.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [46]

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Got it. Okay. No. That's great detail...

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [47]

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You just can't say -- and expect them to say, "Okay," right. So that's the work we have to do.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [48]

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Got it. Yes. I would not expect them to just say okay to a policy change.

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Operator [49]

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Our next question comes from the line of Jason Arnold with RBC.

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Jason Michael Arnold, RBC Capital Markets, LLC, Research Division - Director in the Equity Research and Senior Equity Research Analyst [50]

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I was just curious if you can comments on, industry-wise, if you feel like there's any real kind of pending opportunities in any specific industries or industries where you feel like your exposure might be a little bit lighter than you would like it to be? Any bigger-picture color there would be great.

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Dwayne Louis Hyzak, Main Street Capital Corporation - President, COO, Senior MD & Director [51]

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Yes. I don't think we have any specific industry where we think we're light or we would go out and intentionally, you try and find new opportunities. Our model is more opportunistic. We're more focused on what is the transaction, what are the existing equity owners and management team. What are they trying to accomplish as opposed to saying, "We need go out and target this specific industry." So I wouldn't say that there is one that we're looking for more exposure to specifically. We do look at it on the flip side. And if there's new industries that we find unattractive or out of favor or if we had kind of an overweight position when we look the diversity of our portfolio, you may have the inverse of what you're asking, but not on the new origination side.

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Jason Michael Arnold, RBC Capital Markets, LLC, Research Division - Director in the Equity Research and Senior Equity Research Analyst [52]

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Okay. Maybe conversely, is there, I guess on that note, any industries that you just say, "Hey, we've got more here than we need right now." Or that we maybe need to whittle down, just kind of to your comments there?

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [53]

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Yes. I'll just say as we get further along in a robust economy, we've got our eyes open to industries that have had a lot of progression over the last while in both multiple expansion and earnings expansion. So I'd just say we're being very cautious on looking at multiple-year types of our earnings flows that we can make sure we're not overpaying for something in a robust market.

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Operator [54]

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We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

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Vincent D. Foster, Main Street Capital Corporation - Co-Founder, Chairman & CEO [55]

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Great. Again, as always, thanks for joining us, and we look forward to speaking to you again in late February.

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Operator [56]

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Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.