Greetings, and welcome to the Main Street Capital Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan at Dennard Lascar Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s third quarter 2023 earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer, and Jesse Morris, Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of the call is, Nick Meserve, Managing Director and Head of Main Street’s Private Credit Investment Group. 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 10. 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 homepage. Please note that information reported on this call speaks only as of today, November 3, 2023, 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…

Thanks, Zach. Good morning, everyone, and thank you for joining us today. We appreciate your participation on this morning's call. We hope that everyone's doing well. On today's call, I'll provide my usual updates regarding our performance in the quarter, while also providing updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, our current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and leverage, and our expectations for the fourth quarter, after which we'll be happy to take your questions. We are pleased with our performance in the third quarter, which was highlighted by an annualized return on equity of 17.9% for the quarter, which increased our return on equity for the trailing 12-month period to 18.2%. Our performance included continued strength in the underlying performance of the majority of our lower middle market and private loan portfolio companies and significant contributions from our asset management business. We believe these results demonstrate the continued and sustainable strength of our overall platform, the strong current investment income generating capabilities of our existing investment portfolio, and the unique benefits provided by the equity investments in our lower middle market investment portfolio and by our asset management business, both of which also contributed meaningful fair value appreciation in the quarter. We are also pleased that our investment pipeline and our lower middle market investment strategy has improved, and we expect higher levels of new lower middle market investment activity over the next few months. This improved investment pipeline, together with our conservative liquidity position and capital structure, which we significantly enhanced during the quarter, provide us a continued favorable outlook for the fourth quarter. Our DNII in…

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe our strong third quarter financial results continue to demonstrate the strength of Main Street’s platform, our differentiated investment approach, and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio companies continued to be positive, which contributed to our attractive third quarter financial results. As we have discussed in the past, the largest portion of our investment portfolio and the primary driver of our long-term success has been and continues to be our focus on the underserved lower middle market, and specifically our strategy of investing in both the debt and equity in lower middle market companies. Our view on the attractiveness of investing in the lower middle market remains unchanged, and we expect this to continue to be our primary area of focus in the future. Each quarter, we try to highlight key aspects of our investment strategy and differentiated approach. For today's call, we thought it would be useful to spend some time on the support we provide to our lower middle market portfolio companies. In addition to our normal ongoing activities to support our lower middle market portfolio companies, we specifically want to highlight an annual event we host for the leaders of our lower middle market portfolio companies, our seventh annual Main Street Presidents' Meeting. For those of you who are not familiar with our Presidents' Meeting, it is an annual event Main Street hosts for which we invite our lower middle market portfolio company leaders to Austin for a two-day event to network and relationship build, share best practices, learn from each other, and benefit from being part of Main Street’s portfolio. Based on post-event feedback we receive from our lower middle…

Thank you, David. As Dwayne and David mentioned, we are pleased with our offering results for the third quarter. Our total investment income for the third quarter was $123.2 million, representing an increase of $24.9 million, or 25%, over the third quarter of 2022, and a decrease of $4.3 million, or 3.4%, from the second quarter of 2023. As we highlighted in our earnings release, total investment income for the third quarter did not include meaningful levels of dividends and accelerated prepayment or other activity that are considered less consistent or non-recurring. The aggregate, these items were $4.6 million below the average of the prior four quarters, comparable to the third quarter last year, and were $6.1 million lower than the second quarter of 2023. Interest income increased by $24.4 million, or 32%, over a year ago, and $2.1 million, or 2.2%, over the second quarter. The increase in interest income over the second quarter was driven primarily by increases in benchmark index rates and net investment activity, partially offset by reduced accelerated OID income and the impact of an increase in non-accrual investments. The increase in interest income over the prior year was driven primarily by increases in benchmark index rates and net investment activity. Dividend income increased by $1.8 million, or 9.1%, over a year ago. Dividend income decreased by $4.4 million, or 17%, from the second quarter, largely from a reduction in elevated non-recurring dividend income. The income decreased $1.3 million from a year ago and $2 million from the second quarter, driven by reduced closing fees resulting from lower investment activity in a lower middle market portfolio in the quarter. Our operating expenses increased by $5.1 million, over a year ago, largely driven by increases in interest expense and compensation-related expenses, partially offset by an increase…

Thank you. [Operator instructions] First question comes from Bryce Rowe with B. Riley Securities. Please go ahead.

Thanks. Good morning. I wanted to, Dwayne, first just kind of ask about your comments around the more muted lower middle market portfolio growth in the third quarter and then prospects for some improvement in portfolio activity, lower middle market portfolio activity. What's driving the increased pipeline, if you could comment on that?

Sure, Bryce. Good morning and thanks for the question. Thanks for joining us today. I would say when you look at the lower middle market, and you've heard us say this in the past, we find that part of our market, our investment strategies, by far the most attractive, but the negative about the market is it can be lumpy. In the third quarter, we had some of that lumpiness come through. We had a number of transactions we were working on that, for one reason or another, did not make it through to a closing. So, that resulted in the muted activity in the quarter. We continue to have a favorable view, optimistic view about our expectations long-term for the lower middle market. I think we try to give guidance in our comments that you should expect to see some near-term investment activity as well as more normal investment activity over the next couple of months as you look at us closing out the fourth quarter and moving into the first quarter. So, not anything from our standpoint to be overly concerned about, but it was a lower than expected amount of investment activity originations in the third quarter specifically.

Okay, that's helpful. You also kind of commented on potential exit activity within the lower middle market portfolio picking up here. What's driving that? Is it M&A? Is it kind of idiosyncratic based on a lower middle market portfolio company owner seeking liquidity? Just curious on that.

Yeah, I'd say, Bryce, it'd be more the latter. It'd be things that are specific to the individual portfolio company. As you've heard us say in the past, and you can see in our results, both in the dividend income that our lower middle market companies are producing, as well as the fair value increases that we're having, the companies are performing at a high level. So, when you look at that type of performance, they will attract interest from third parties that could lead them to explore an exit opportunity, or there could be other activities specific to the portfolio company or to its existing ownership, its management team that lead them to take a look at an exit. So, I'd say there's nothing specific that applies to all the opportunities. But as we started noting last quarter and wanted to reiterate this quarter, we are seeing more activity there, and we do expect that a number of those initiatives or those activities could result in some favorable exits over the next couple of months.

Got it. Okay. And one last one for me. On the closing of the second private loan fund, can you help size that up for us?

Sure, Bryce. So, when you look at it, our goal is that our second private fund would be larger than the first. Just as a reminder, the first one was $100 million of equity. You can effectively double that with leverage to get to a $200 to $215 million total portfolio size. We, with our first closing here, were successful in closing with about $65 million of equity capital. We're going to continue to raise capital in that fund going forward, just like we would have done on the first fund. So, we hope that the fund long-term will end up being greater than $100 million, but the process will play out over the next couple of quarters and determine how much success we are with the size on the equity commitments. And then just like fund one, our plan is to put leverage in place that will effectively double the assets relative to equity by the use of a debt or a leverage facility.

Got it. Okay. Thanks a bunch. Thank you. Appreciate it, Bryce.

Next question, Robert Dodd with Raymond James. Please go ahead.

Hi, guys, and congrats on the quarter. When you look, you're concerned about some of the deals not closing in the quarter. I mean, you said there wasn't anything you were concerned about, but was there any kind of theme? Was it final due diligence kind of fell through or people latched it up, the ask on the price or any kind of color you can give us on what the trigger points were on the ones that fell through?

Sure, Robert. I'll give some color, then I'll let David add on anything that he has from his perspective. But I'd say it wasn't anything consistent across the transactions that didn't make it across the finish-line. But as you've heard us say in the past, we're dealing with individuals, not institutions in terms of the counterparty transactions. And they can and will have stuff that changes on their side from a personal standpoint. In my view of one of the transactions, that's exactly what it was. He had a view of what a transaction, a desirable transaction would be. And I'd say that view over time changed as we went through our process. The other difficulties we've had, no big surprise, I think, to people, we continue to be very disciplined in our underwriting approach, not anything different than what we've done in the past. But we always maintain a very disciplined approach. And in this current environment, when you look at the economic uncertainty, whether it's actual historical results as we go through due diligence, or if it's the visibility to the future expectations and future results, you're seeing more volatility. And as we go through the diligence process, we have to deal with that volatility in terms of how we value and structure the final transaction. And that could lead the transaction not to move forward. So those would be the two examples I'd point to. I'll let David add any additional comments he has on his side.

Yeah, Robert, we were always conscious of our origination budget and trying to drive towards closings. In this quarter, we had some lumpiness. A couple of the examples were one had a safety issue that came up during our diligence. Another one had some financial diligence relative to historical and projections that ultimately we couldn't get comfortable underwriting to. So when we see those things, while we're anxious to have closings and put more assets on the books, we're just going to be disciplined about making sure we're making good prudent investments like we have historically. And that leads to some quarters that are lumpier than others, nothing to take away as far as themes.

Got it. Got it. Thank you. This one's kind of sort of what would you hearing preliminarily, if anything, on budget outlooks for '24? Obviously, these are small, but if I'd asked you this 10 years ago, I don't think most of your portfolio companies had budgets, so to speak. But you've been much more rigorous over the years in terms of encouraging those kind of those processes. So are you hearing on anything on that front about 2024, more moderate, more of the same, anything that's coming through so far?

Sure, Robert. As you said, our companies, all of them will go through some level of budgeting process for the next year. Most of them will go through a multi-year outlook or expectation planning process. Most of our companies are likely right in the middle of that process for 2024 today. So we don't really have information to point to coming out of those budget, 2024 budget discussions. But what I would point you to, and David talked about this in his comments, not specifically the 2024 expectations, but the fact that we just hosted our president's meeting for our lower middle market companies. And the data point I would give you is that coming out of that meeting, the overall mood, sentiment, expectations from the group broadly is very positive. I think companies are doing well, despite all the challenges and all the headwinds that you hear about in the broader business community or just the overall economy, these companies are doing well. And they're concerned about the same uncertainties that everybody else is. But if you look at their expectations in terms of discussions with customers and their ability to drive operational improvements or efficiencies and manage all the parts of their business that drive value, I would say that they all have a fairly optimistic view, which is why we look at it. And we always leave that meeting very, very encouraged. But I'd say this year we left the meeting maybe more encouraged than we had in the past. And again, I'll let David, if he has any comments he wants to add as a response there, as in terms of what we heard from president's meeting.

I'd say that the only thing that is always interesting to talk to our portfolio company execs about is their specific drivers within each industry, because we have so many industries represented. It is a, generally what you're hearing in the economy probably overlays with our portfolio companies. The great news is because they're small, they can be nimble and react quickly to the changes that they're seeing. So there was a lot of discussion with those that might have some headwinds in their industry, what they're doing proactively to position themselves, and others are still seeing good, robust activity and capitalizing on that.

Got it. Thank you. And I really appreciate the call. And again, congratulations on the government of this quarter.

Next question, Mark Hughes with Truist Securities. Please go ahead.

Yeah, thanks. Good morning. The incentive fee income from the fund management business, I think, up nicely year over year. Is that at a reasonable run rate? Was there something unusually good this quarter? Or is this kind of if the market stays in a particular groove, this will be a decent run rate for you?

Sure, Mark. If you look at our asset management business, one of the things that I would remind the group is that that business from an investment strategy standpoint is primarily focused on our private loan strategy. So when you look at Main Street's results, you can kind of read through to the results that we're seeing in the funds or the clients we have on the asset management business. So if you look at our results at Main Street in this quarter, you did not see a lot of non-recurring, unusual one-time items. It was, from our perspective, a very clean quarter from that perspective. So I would say that you should expect the results that we had in our asset management business would follow the same nature of income and earnings. So when we look at the third quarter, the incentive fees were down a little bit from the second quarter, but we feel like it's a really good base level of incentive fees, assuming the market continues to perform the way it has and we don't see degradation or issues across the portfolio, which we're not seeing today. So we feel really good about the quarter and we feel good about what that means from a look-through standpoint into the incentive fees we're getting off the asset management business.

And then did you give any indication of kind of the underlying EBITDA or revenue growth for your portfolio companies, the lower middle market companies?

We didn't, Mark. That's not a stat that we typically publish.

Okay, very good. And I think you -- I'm not sure whether you were touching on your pipeline in terms of potential new investments, but I think you would also suggest that your opportunity for fair value appreciation through maybe some divesting activity, that that was elevated. Could you talk a little bit more about that? What needs to happen for that to come through?

Sure, Mark. If you look broadly at our changes in fair value, both in this quarter, and I'd say for the last couple of quarters, we're seeing the results of a number of companies that are just performing at a high level, specifically in the lower middle market. Some of those companies have completed acquisitions over the last 12 or 18 months, as you may recall us saying in prior quarters, and those acquisitions have been integrated well, they're performing well, they're realizing the synergies, and you're seeing the results of those strategic, valuable acquisitions come through the company's quarterly results, and then you see it come through our fair value. So that would be a big driver. When you look at the exit activity, I would say one thing from our perspective, which we may not control the outcome because we're just one of the equity owners, we don't own control or drive all the final decisions of these individual lower middle market portfolio companies, but in general, if we're going to be motivated or inclined to sell, it's likely going to be at a premium to our fair value. Otherwise, all things being equal, we're likely going to be more inclined to hold the investment. We have permanent capital, our desire is to have a very, very mature, diversified, broad portfolio. So all things being equal, if we had control over everything, we would maintain our best companies forever, unless somebody was going to pay us a significant premium to what we think is worth as of today. So that may not directly answer your question, but I think we feel good about where we have our portfolio companies valued overall. We specifically feel good about where we have them valued in the context of them going through an exit or sell process.

Thank you. Appreciate it.

[Operator instructions] Next question comes from Vilas Abraham with UBS. Please go ahead.

Hey, everyone. Thanks for the question. Maybe just to follow on Mark's question a little bit. On these add-on acquisitions that are driving some of the fair value appreciation through the realization of synergies, is the momentum for that dynamic going to continue for the foreseeable future? And one of the key drivers here as you think about your fair value marks for the next few quarters?

Sure, I'll give you a couple of comments. I'll let either David or Jesse add on, because they're involved in a couple of the companies that are executing acquisition growth strategies. But just to kind of go backwards a little bit, if you had been looking at us, talking to us five, six years ago, acquisition growth strategies for our portfolio companies, while we had some, it was not a significant activity for most of our companies. It's something that we long had viewed as an opportunity. And we started in our president's meeting five, six years ago, really talking about the opportunity to pursue growth through acquisitions and started educating our companies on how and why they should at least consider it, clearly not forcing them to do it, but at least should consider it. As a result of that, and as a result of the just the high quality of the companies and management teams that we have in the portfolio over the last couple of years, really, COVID was a time period where it really accelerated. We started seeing more of our companies embrace acquisition growth opportunities. So when we look at it, we've got a number of companies that, as I said, have been executing those acquisitions, not just closing the acquisition, but integrating and optimizing the synergies. And they've done a lot of that. And we continue to have some of those same companies continue to explore additional acquisitions. But we also have a broader group, some companies that have not executed acquisitions in the past that have very attractive strategic acquisitions that we're helping them work through. And we hope to have a closing again, sometime over the next one to three months. And if we're successful there, we wouldn't execute that acquisition both for our benefit or for the portfolio company, without the viewpoint that it'll be a significant value creator from a fair value standpoint and an ultimate equity valuation for when that company's ever sold. So I know that's a lot there, but I'd say it's just, we have been and continue to encourage our companies to pursue that. And we've seen really, really good results over the last couple of years from that initiative.

So I'll just add one thing on the fair value comment. There are two big inputs that Dwayne talked about. One are the accretive acquisitions. The second are the exit activities. When we're doing our fair value marks, we're marking them to what we think is a fair value at that moment in time. When we do run a process, the job on a process, if there is an intermediary involved, is to go out there and find the outlier and to get to the top of a range of expected outcomes. As time goes on, we get further through that and we have incoming calls, we hope to exceed the fair value marks that we have. So when we see activity, we're hopefully able to appreciate and get that outlier type of valuation that also helps obviously with the fair value.

Okay. And then that final mark will happen after the transaction closes?

At closing. Yeah. When you see the realized transaction, go through the financial statements.

Okay. Okay. Great. That's all very helpful, color. Can you guys talk about the, just to pick up there, non-accruals for the quarter? Any color around what was happening there with that credit or credits that I think were in the private loan book?

Yeah. There were two that off the top of my head were private loan. One was middle market. I'd say these are companies that we had been writing down from a fair value standpoint the last couple of quarters as those companies had dealt with specific operating company performance issues to the credit of the sponsors. They continue to be supportive and we continue to work with the private equity sponsors in each of those transactions and the other participants in the capital structure. But the non-accrual status and the fair value depreciation that we've recorded just represents the underlying operating performance challenges that those companies have had specifically. So nothing that's systematic or broad-based. It's very, very specific to the operating performance of those companies in this quarter that were moved to non-accrual.

Okay. Thank you, guys. I'll hop back in the queue.

This concludes our question and answer session. I would like to turn the floor back over to management for closing comments.

We just want to thank everyone again for joining us this morning and we'll look forward to talking to everyone again in mid to late February. Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.