Earnings Call Transcript - MAIN Q1 2025

Operator, Operator

Greetings and welcome to Main Street Capital’s First Quarter 2025 Earnings Conference Call. All participants are currently in a listen-only mode, and a question-and-answer session will take place after the formal presentation. This conference is being recorded. It is now my pleasure to introduce Zach Vaughan. Thank you. You may begin.

Zach Vaughan, Introduction

Thank you, Operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s first quarter 2025 earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdal, President and Chief Investment Officer; and Ryan Nelson, Chief Financial Officer. Also participating in 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 first 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 May 16th. 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, May 9, 2025, and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Today’s call will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, or similar expressions. These statements are based on management's estimates, assumptions, and projections as of the date of this call, and there are no guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties, and other factors, including but not limited to the factors set forth in the company’s filings with the Securities and Exchange Commission, which can be found on the company’s website or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law. During today’s call, management will discuss non-GAAP financial measures, including Distributable Net Investment Income or DNII. DNII is Net Investment Income or NII, as determined in accordance with the U.S. Generally Accepted Accounting Principles or GAAP, excluding the impact of non-cash compensation expenses. Management believes that presenting DNII and the related per-share amount are useful and appropriate supplemental disclosures for analyzing Main Street’s financial performance since non-cash compensation expenses do not result in net cash impairment to Main Street upon settlement. Please refer to yesterday’s press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Two additional key performance indicators that management will be discussing on this call are Net Asset Value or NAV and Return on Equity or ROE. NAV is defined as total assets minus total liabilities and is also reported on a per-share basis. Main Street defines ROE as the net increase in net assets resulting from operations divided by the average quarterly NAV. Please note that certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. Now I’ll turn the call over to Main Street’s CEO, Dwayne Hyzak.

Dwayne Hyzak, CEO

Thanks, Zach. Good morning, everyone, and thank you for joining us. We appreciate your participation on this morning’s call. We hope that everyone’s doing well. On today’s call, I will 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 recent investment activities and current investment pipeline, and several other noteworthy updates. Following my comments, David and Ryan will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure, liquidity, and our expectations for the second quarter, after which we’ll be happy to take your questions. We are pleased with our performance in the first quarter, which resulted in an annualized return on equity of 16.5%, DNII per share that continued to exceed the dividends paid to our shareholders, and a new record for NAV per share for the 11th consecutive quarter. We believe that these continued strong results demonstrate the sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies, the unique contributions of our Asset Management Business, and the continued underlying overall strength and quality of our portfolio companies. Additionally, we appreciate the continued support we received from our long-term lender relationships, as evidenced by the recent amendments and extensions of both our corporate facility and our SPV credit facility, which Ryan will discuss in more detail. As a result, we continue to maintain very strong liquidity and a conservative leverage profile, providing us significant flexibility in the current uncertain market. We continue to be encouraged by the favorable overall performance of the companies in our diversified lower middle market and private loan investment portfolios, and remain confident that these strategies, together with the benefits of our Asset Management Business, our significant available liquidity, and our cost-efficient operating structure, will allow us to deliver superior results to our shareholders. And despite the significant current market uncertainty associated with tariffs and geopolitical events, we continue to be confident in the ability of our portfolio companies to successfully navigate the current environment, which David will discuss in more detail. Our favorable results in the first quarter, combined with our positive outlook for the second quarter, resulted in our recommendations to our Board of Directors for our most recent dividend announcements, which I will discuss in more detail later. Our NAV per share increased in the quarter primarily due to the impact of net fair value increases in our investment portfolio and the accretive impact of our equity issuances, which Ryan will discuss in more detail. The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of strong dividend income contributions and significant net fair value appreciation in our lower middle market equity investments. Over the last few quarters, we have commented about the increased interest we have been receiving from potential buyers in certain lower middle market portfolio companies. We are pleased to announce that yesterday we closed the exit of our investments in one of our portfolio companies, Heritage Vet Partners, at a realized gain of over $55 million and a meaningful premium to our March 31st fair value. Similar to the significant realized gain we recognized in the fourth quarter of 2024 on the exit of our equity investment in Pearl Meyer, we believe our investment in Heritage Vet Partners is another great example of the highly unique benefits of our lower middle market investment strategy, which resulted in significant benefits for both Main Street and our Heritage Vet Management team partners. The benefits for Main Street included significant dividend income, fair value appreciation, and the realized gain resulting in best-in-class returns on our equity investment, in addition to the opportunity to back this best-in-class management team by funding all of their growth initiatives with follow-on Main Street debt investments, which provided us highly attractive interest income. We look forward to sharing additional details on this realization in the near future. Now, turning back to the first quarter, our lower middle market investment activity resulted in a net increase in our lower middle market investments of $57 million, and our private loan investment activity resulted in a net increase in our private loan investments of $26 million, which David will discuss in greater detail. Given our conservative capital structure and strong liquidity position, we remain very well positioned to continue the future growth of our investment portfolio. We are excited about the current opportunities we are seeing in our lower middle market investment strategy. We’ve also continued to produce positive results in our Asset Management Business. The funds we advised through our external investment manager continue to experience favorable performance in the first quarter, resulting in significant incentive fee income for our Asset Management Business for the 10th consecutive quarter and together with our recurring base management fees, a significant contribution to our net investment income. We remain excited about our plans for the external funds that we manage as we execute our investment strategies and explore other strategic initiatives, and we are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund and about our strategy for growing our Asset Management Business within our internally managed structure. As part of our efforts to grow our Asset Management Business, we are very pleased that MSC Income Fund, a BDC advised by our external investment manager and our largest Asset Management Business client, has been successful in growing its investment portfolio with a portion of the liquidity obtained through its listing on the New York Stock Exchange and its public equity offering in January. We are also pleased with the fund’s favorable performance in the first quarter and we remain excited about the opportunity for significant future benefits to both the fund’s shareholders and our Asset Management Business from the listing and equity offering. Based upon our results for the first quarter, combined with our favorable outlook in each of our primary investment strategies and for our Asset Management Business, earlier this week our Board declared a supplemental dividend of $0.30 per share payable in June, representing our 15th consecutive quarterly supplemental dividend and an increase in our regular monthly dividends for the fourth quarter of 2025 to $0.255 per share. The third quarter regular dividends are payable in each of July, August, and September, and represent a 4% increase from the regular monthly dividends paid in the third quarter of 2024. The supplemental dividend for June is a result of our strong performance in the first quarter and will result in total supplemental dividends paid during the trailing 12-month period of $1.20 per share, representing an additional 40% paid to our shareholders in excess of our regular monthly dividends and a current total yield we are providing to our shareholders of approximately 8%. We currently expect to recommend that our Board continue to declare future supplemental dividends to the extent DNII significantly exceeds our regular monthly dividends paid in future quarters and we maintain a stable to positive NAV. Based upon our expectations for continued favorable performance in the second quarter, we currently anticipate proposing an additional supplemental dividend payable in September. Now turning to our current investment pipeline, as of today, I would characterize our lower middle market investment pipeline as average with several new investments targeted to close before quarter end. We believe that the unique and flexible financing solutions that we can provide to lower middle market companies and their owners and management teams and our differentiated long-term to permanent holding periods represent an attractive solution to the needs of many lower middle market companies, and despite the current broad economic uncertainty, we are confident in our expectations for favorable lower middle market investment activity over the next few months. We also continue to be pleased with the performance of our private credit team and the significant growth they have provided for our private loan portfolio and our Asset Management Business, and as of today, I would characterize our private loan investment pipeline as average.

David Magdal, President and Chief Investment Officer

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe that our strong first 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 continues to be positive, which contributed to our attractive first quarter financial results. Due to the heightened level of concern and uncertainty in the market regarding the potential negative impacts from tariffs and consistent with our practices in other times of heightened market uncertainty, we have been and remain in regular contact with our lower middle market portfolio companies to support them and discuss the proactive actions they are taking to address the current implications and potential challenges in the current market. To date, we have seen limited negative impact on the overall portfolio and we believe that our relationships with best-in-class managers and partners at the lower middle market portfolio companies, along with our intentionally highly diversified investment strategy and portfolio, will continue to serve us well as it has over the past two decades during times of market disruption. Each quarter, we try to highlight key different aspects of our investment strategy and differentiated approach that allow us to consistently produce best-in-class results. For today’s call, I’m going to spend some time discussing our private loan investment strategy, which is the second largest part of our investment portfolio and is the primary driver of our Asset Management Business. We believe this is a particularly timely topic, given the recent public listing of MSC Income Fund, which focuses all of its new investment activities on investments in our private loan investment strategy. Over the last several years, we have grown the size and capabilities of our private loan investment team significantly. This has resulted in significant growth of our private loan investments, both on Main Street’s balance sheet and to the third-party advisory clients that we manage through the external manager. As a reminder, our private loan strategy targets investments in the senior secured debt of private equity-sponsored businesses. These investments are primarily originated by our internal investment professionals through strategic relationships they cultivate and maintain with a select group of private equity firms and their capital markets intermediaries. Our private loan investments are typically first-lien debt investments with attractive yield profiles and favorable terms. As of quarter end, 99.9% of our private loan secured debt investments were first-lien loans and 97% bore interest at floating interest rates, which had an attractive weighted average yield of 11.4%. Most of our private credit peers focus on the larger upper-middle market part of the leveraged loan market. We intentionally focus on the smaller end of the market, where we believe the opportunity exists for us to lead or co-lead the vast majority of our private loan investment, and whereby we are able to directly manage the due diligence process, loan documentation, and post-investment lender interactions with the borrower. We believe our niche focus on the smaller end of the market is less competitive and allows us to earn more attractive risk-adjusted returns for Main Street’s investors and for the investors and the funds we manage. Main Street has also benefited from our ability to utilize our private loan investment strategy to grow our Asset Management Business. Through our external investment manager, our private loan strategy effectively allows Main Street to leverage our investment professionals’ time and our platform to benefit from the attractive and highly recurring fee-based income that we receive from third-party clients while at the same time providing highly attractive investment opportunities and returns for those clients. Now, turning to the overall composition and results from our investment portfolio as of March 31st, we continue to maintain a highly diversified portfolio with investments in 189 companies spanning across numerous industries and end markets. Our largest portfolio companies, excluding the external investment manager, represented only 3.2% of our total investment income for the trailing 12-month period and 3.7% of our total investment portfolio fair value at quarter end. The majority of our portfolio investments represented less than 1% of our income and our assets. Our investment activity in the first quarter included total investments in our lower middle market portfolio of approximately $86 million, including investments of $62 million in two new lower middle market portfolio companies, which after aggregate repayments on debt investments resulted in a net increase in our lower middle market portfolio of $57 million. Driven by the capabilities and relationships of our private credit team, we also made $138 million in total private loan investments, which after debt repayments and other investment activity resulted in a net increase in our private loan portfolio of $26 million. At the end of the first quarter, our lower middle market portfolio included investments in 86 companies, representing $2.6 billion of fair value, which was 31% above our related cost basis. We had investments in 90 companies in our private loan portfolio, representing $1.9 billion of fair value. The total investment portfolio at fair value at quarter end was 18% above our related cost basis. In summary, Main Street’s investment portfolio continues to perform at a high level and deliver on our long-term goals. Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday.

Ryan Nelson, CFO

Thank you, David. To echo Dwayne’s and David’s comments, we are pleased with our operating results for the first quarter, which included a new record for NAV per share for the 11th consecutive quarter and favorable levels of NII per share and DNII per share. Our total investment income for the first quarter was $137 million, an increase of $5.4 million or 4.1% compared to the first quarter of 2024, but down $3.4 million or 2.4% from the fourth quarter of 2024. Interest income decreased by $2.1 million year-over-year and fell by $11.9 million from the fourth quarter of 2024. This decrease from the previous year was mainly due to an increase in investments on non-accrual status and a decline in interest rates on our floating rate debt investments, primarily from decreases in benchmark index rates, partially offset by increased net investment activity compared to last year. The decrease from the fourth quarter was mainly due to the impact of increased investments on non-accrual status, reduced net investment activity, and lower interest rates on our floating rate debt investments, also primarily due to declines in benchmark index rates. Dividend income rose by $13.2 million compared to a year ago, with this gain coming after a $1.2 million decrease in unusual or non-recurring dividends, and increased by $11.5 million from the fourth quarter, which included a $300,000 increase in unusual or non-recurring dividends. The growth in dividend income reflects the ongoing strength of our lower middle market portfolio companies. Fee income decreased by $5.7 million from last year and by $3 million from the fourth quarter, driven by a decline in exit, prepayment, and amendment fees from investment activity, alongside lower closing fees on new and follow-on investments. Prepayment and other nonrecurring fee income dropped by $3.5 million from a $1.2 million decrease in the fourth quarter of 2024. The first quarter featured reduced levels of less consistent or non-recurring income compared to both the first quarter of 2024 and the fourth quarter of 2024, including dividends from our equity investments and accelerated prepayment, repricing, and other related activities associated with our debt investments. Collectively, these items totaled $2.4 million, which was $2.2 million or $0.03 per share lower than the average of the previous four quarters, $5.2 million or $0.06 per share lower than the first quarter of 2024, and $1.3 million or $0.01 per share lower than the fourth quarter of 2024. Our operating expenses increased by $5.4 million compared to the first quarter of 2024 and decreased by $2.9 million from the fourth quarter. The rise in operating expenses from the previous year was primarily driven by increases in interest expense, general and administrative costs, and share-based compensation expenses, partially offset by a reduction in cash compensation-related expenses. The decrease in operating expenses from the fourth quarter of 2024 was largely due to lower interest expenses and compensation-related costs, partially offset by decreased expenses allocated to the external investment manager. The growth in interest expense from a year ago was mainly due to an increase in the weighted average rate on our unsecured debt obligations and higher average borrowings to finance part of the growth of our investment portfolio, partially offset by a reduction in the weighted average interest rate on our credit facilities, resulting from declines in benchmark interest rates. The decrease in interest expense from the fourth quarter of 2024 was primarily influenced by a reduction in our average outstanding borrowings and a lower weighted average rate on our credit facilities because of decreases in benchmark interest rates. The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.2% for the quarter on an annualized basis and 1.3% for the trailing 12-month period and remains among the lowest in our industry. Our external investment manager contributed $7.8 million to our net investment income during the first quarter, a decrease of $800,000 from the same quarter last year and down $900,000 from the fourth quarter of 2024. The manager concluded the quarter with total assets under management of $1.6 billion. During this quarter, we recorded net fair value appreciation, including net realized losses and net unrealized depreciation on the investment portfolio of $33.6 million. This increase was driven by net fair value appreciation in our lower middle market investment portfolio, partially offset by net fair value depreciation in our external investment manager, our private loan investment portfolio, and middle market investment portfolio. The net fair value appreciation in our lower middle market portfolio was largely driven by the continued positive performance of certain of our portfolio companies. The net fair value depreciation of our external investment manager was primarily caused by decreases in the valuation multiples of publicly traded peers, which are used as benchmarks for valuation purposes. The net fair value depreciation in our private loan portfolio was influenced by increases in market spreads, partially offset by specific portfolio company performance. The net fair value depreciation in our middle market portfolio was similarly dictated by specific portfolio company performance. We incurred net realized losses of $29.5 million in the quarter, primarily stemming from the exit or restructuring of several longstanding underperforming investments, partially balanced by a realized gain on the exit of a private loan equity investment. We finished the fourth quarter with investments on non-accrual status, accounting for 1.7% of the total investment portfolio at fair value and approximately 4.5% at cost. Net asset value or NAV increased by $0.38 per share from the fourth quarter and by $2.49 or 8.4% compared to a year ago, reaching a record NAV per share of $32.03 at quarter end. Our regulatory debt-to-equity leverage, calculated as total debt excluding our SBIC debentures divided by net asset value, was 0.67 times and our regulatory asset coverage was 2.48 times, both of which remain more conservative than our long-term target ranges of 0.8 times to 0.9 times and 2.1 times to 2.25 times, respectively. With our liquidity position in mind, we were less active in our at-the-market program during the first quarter, generating net proceeds of $5.1 million from equity issuances. In April, we amended our corporate credit facility, reducing the interest rate by 10 basis points before fulfilling certain conditions and by 22.5 basis points after, raising our total commitments by $35 million and extending the maturity to April 2030. Additionally, we also amended our SPV credit facility by decreasing the interest rate by 40 basis points and extending the maturity to September 2030. After accounting for the capital activities in the first quarter of 2025 and the recent credit facility amendments in April 2025, we started the second quarter with strong liquidity, including cash and availability under our credit facilities exceeding $1.3 billion, with only one near-term debt maturity of $150 million due in December 2025. We maintain that our conservative leverage, strong liquidity, and continued access to capital are significant strengths that have historically benefited us and position us well for the future, enabling us to continue executing our attractive investment strategies. As mentioned last quarter, given our current level of liquidity, we expect to fund our new net investment activity in 2025 primarily through a greater reliance on debt financing, and therefore, we anticipate leverage to continue increasing throughout the year. However, we expect to maintain more conservative leverage levels compared to our long-term targets. Returning to our operating results, DNII per share for the quarter was $1.07, down $0.04 from DNII per share in the first quarter last year and decreased by $0.01 from the DNII per share in the fourth quarter. Looking ahead, we foresee headwinds on top-line earnings related to possible decreases in floating market rates and potential tariff impacts, but given the strength of our underlying portfolio, we expect favorable earnings in the second quarter of 2025 with an anticipated DNII of at least $1.03 per share, with the possibility for upside driven by portfolio investment activities during the quarter and favorable outcomes amid current market uncertainties. I'll now turn the call back over to the Operator for any questions.

Operator, Operator

Thank you. Our first question is from Robert Dodd with Raymond James. Please proceed.

Robert Dodd, Analyst

Hi, guys. I appreciate the commentary on the strength of the portfolio companies, but can you be any more expressive maybe on what tariff exposure you have in the portfolio? I mean, obviously, you don’t have, like, international businesses in there, but is there offshore manufacturing of some parts or anybody who’s particularly exposed to imported raw materials or anything like that? Any color you can give us on that front on what the overall feel for the exposure is there?

Dwayne Hyzak, CEO

Sure, Robert. Good morning and thanks for the question. We’ve talked about this before in the past, but if we look at our portfolio and I’ll split the comments between lower middle market and private loan, because we just have more visibility into the lower middle market portfolio companies given our position as a significant equity owner there. But most of our companies, particularly in the lower middle market, are U.S. businesses. They’re manufacturing in the U.S. They’re selling to U.S. customers. They’re buying or purchasing from U.S. vendors. So we look at the lower middle market portfolio as a whole and think that we’ve got some limited exposure there. As you would expect us to be doing, and as David, I think, commented in his script, we have been and continue to talk frequently with the management teams of our lower middle market portfolio companies to understand their risk and then help them collectively with us figure out ways to mitigate that risk. And as we went through that process, our view is that in the lower middle market, somewhere close to a high single-digit percentage, and I give you that number as a percentage based upon looking at the portfolio a couple of different ways, looking at it by actual portfolio count, looking at it on both a cost or fair value basis. So on each of those different metrics, it would be a high single-digit percentage that we think has meaningful exposure to tariffs. And as you said, we think that the most significant exposure impacts would be from those companies that are directly importing finished goods. So the good news on that side is we have some exposure there, but it is fairly limited and we think it’s very manageable. When we look at the portfolio more broadly, we would say that there’s probably another 10% to 20% that has some level of exposure. And that’s not specific to Main Street. We just think that’s the result of the global nature of the economy and business today. If you’re in industrial businesses, manufacturing, services related to industrial businesses, you’re going to have some exposure. So we look at that and say that those companies have some level of direct or indirect exposure to tariffs. But one of the things that we always look at is that just having exposure to tariffs on its own does not necessarily mean that there’s going to be a negative result or impact. It just means that those companies that have that exposure, you have to be taking steps to mitigate it. And that’s where we take comfort in the fact that our management teams of our portfolio companies have been through this type of a scenario before. If you look back at the COVID-19 pandemic time period and the resulting supply chain issues and inflation that came out of it, they’ve been through that. So we have the view that our management teams have dealt with this type of a scenario before and we’re confident that they’re going to do a good job in mitigating the risk, whether that means pushing through price increases or finding alternative sourcing. So we feel pretty good about where we sit, but we do acknowledge that we have some level of exposure there when you look across the portfolio. On the private loan and middle market side, really the private loan side, because that’s where the remainder of our portfolio really sets outside of lower middle market. I’d say it’s similar. Most of these companies are also predominantly U.S. companies. So we think that the risk is a little bit similar to what we have on the lower middle market side. We do take comfort in the fact that we are largely first-lien senior secured lenders. So you’ve got a lot of cushion in the capital structure beneath our position to help us mitigate our risk there and we’re actively working with the portfolio companies and the private equity sponsors, similar to lower middle market, to understand what that risk is. So when we look at the companies on that side of our portfolio that have meaningful direct exposure, the way we would quantify it is it’s a handful of companies. We’ll also note that a couple of those companies are already on non-accrual and or they’ve had significant fair value depreciation. So when we look at our results from an income standpoint or from a NAV or fair value standpoint, we think the fact that we’ve already got those on non-accrual and some fair value depreciation further mitigates the risk to some extent. So similar to the lower middle market, just because they have the exposure doesn’t mean that they’re going to have significant negative impact. So we look at trying to understand what those companies are doing to mitigate the risk, again, either through pushing through price increases or looking for alternative sourcing or other activities to mitigate it. But while we do have some risk there, we think it is still limited and we feel good about the manner in which our management teams and portfolio companies should be able to mitigate that risk. Obviously, if the situation becomes more significant or more negative than it is today or if the time period gets drawn out, obviously, that risk could change in the future. But as we sit here today, I think we feel pretty good about our risk and the steps that our portfolio companies are taking to mitigate it.

Robert Dodd, Analyst

Thank you for that helpful information. Regarding the private loan pipeline, I would describe it as average. It appears to be focused on slightly larger, more sponsor-backed companies. We've noted that M&A activity is subdued at the moment. So, why is the pipeline still average? In this environment, average seems favorable. Can you explain why your pipeline remains somewhat average despite the current volatility and the muted M&A market?

Dwayne Hyzak, CEO

Sure. Robert. I’ll give a few comments and I’ll let Nick, who as you know, leads our private business, I’ll let him add on. But I’d say the reason we view it as average today is we’ve got a large portfolio there and we’re seeing a number of those companies that despite the uncertain environment, their businesses are doing well and they’re having opportunities to grow, whether that’s acquisition or organic, and they’re coming to us and they’re looking for additional add-on loans or debt investments from us to help them facilitate that growth. So I think that’s part of the reason we have it at average. We’re also continuing to see a number of new investment opportunities that we think despite the current uncertain environment, we think they’re underwritten correctly, they’re priced correctly, and all things being equal, if the transaction closes, we’ll continue to find those opportunities attractive from a new portfolio standpoint. But I’ll let Nick add any additional color he wants to add to that.

Nick Meserve, Managing Director

Yeah. Robert, I mean, I think, you are right. It is a muted M&A environment. But with that is also less repayments. I think from the pipeline perspective, it is average. I think we’re seeing both new deals and add-ons. The add-ons in the portfolio have increased over the last two years to three years as the number in the portfolio has increased. But I think what’s TBD still is going to be some of the uncertainty is do some of these transactions close or not? I think we’ll know more in the next three months or six months of where does the tariff noise go? Do we actually close and finish those transactions or do they get pushed out a little bit?

Mark Hughes, Analyst

Yeah. Thank you. In thinking about your kind of non-recurring income items, the dividend through investments, I think, you’ve got some variability there. Is there any concern that those might slow down? Are the portfolio companies perhaps going to be a little more conservative with their balance sheets or is that not so much of an issue?

Dwayne Hyzak, CEO

Good morning, Mark, and thank you for your question. We always have some level of concern regarding dividend income, as it tends to be the most variable aspect of our income streams. However, as I mentioned previously, many of our low middle market companies are performing exceptionally well and have maintained strong performance over an extended period. Their capital structures are conservative, with limited leverage, allowing them to generate significant cash flow. This cash flow is increasingly being distributed to us and other equity holders through dividends. We monitor this closely, understanding that if the economy were to decline significantly for an extended time, dividend income could be at risk. Nonetheless, looking at our current portfolio and the positive results we are observing, along with the ongoing discussions we have, the companies are still performing well despite the uncertainty in the market. We anticipate continuing to receive substantial dividend income from these companies at least through the second quarter.

Mark Hughes, Analyst

Yeah. And then you obviously described a nice attractive, what, $55 million gain here in the second quarter. And I think in earlier calls, you had alluded to the fact that there were some potential realizations in the pipeline. Is there more to come? Anything you’ve got visibility for? Or is it just kind of business per usual?

Dwayne Hyzak, CEO

I would say it’s mostly business as usual. There will always be some level of activity in the lower middle market portfolio with over 80 companies. There is ongoing activity. After the very attractive realized gain we had in late December with Pearl Meyer, and the gain in the second quarter, those are the two significant exit activities we’ve discussed. Both companies are excellent. While we are a bit sad to see them go, the realized gains and returns from an equity investment perspective are top-notch. When the opportunity arises, and if our partners and the management teams of those companies wish to pursue a transaction, we will support them in achieving the best outcome. Those are the two main transactions we've focused on in the past few quarters. I would say things have returned to a more normal level regarding exit activity expectations.

Mark Hughes, Analyst

And one other question. You’ve got a long holding period, obviously, with your equity investments. When you get to a period like this in the economy, does that create opportunity for you that you can look at something that perhaps is maybe a little more exposed or experiencing a little more volatility because you’ve got a longer horizon, or alternatively, you tighten things up, and certainly, you want to stay as disciplined as you have been historically. But does this create opportunity where others don’t step in, but you have the potential to do so?

Dwayne Hyzak, CEO

Absolutely. Our perspective has always been to maintain a conservative capital structure and a significant amount of liquidity, enabling us to be active in the market during both prosperous times and periods of uncertainty. For instance, we executed transactions with Pearl Meyer in May 2020 and Heritage Vet Partners in December 2020 during the COVID pandemic when many firms were inactive due to travel restrictions and in-person meetings. We seized those opportunities that aligned perfectly with our strategy and formed strong partnerships with the management teams of those businesses. Both transactions were beneficial not only for us but also for the management teams involved. Moving forward, we intend to remain active, even amidst ongoing market uncertainty, as long as there is mutual interest in transacting. Our primary goal is to partner with top-notch individuals and management teams in the lower middle market, which we find highly attractive and will continue to pursue. I'll let David share any additional insights he may have.

David Magdal, President and Chief Investment Officer

I think Dwayne covered most, but the last thing I’d add is that with the seasoned nature of our portfolio, those companies are naturally have less leverage than the rest of the portfolio and those managers are waiting for opportunities and times. They’re tracking acquisition targets over extended periods of time, having been in the industry to their partners for a very long period of time. So, we do see more activity in those portfolio companies on doing strategic acquisitions and we’re putting growth capital into the companies when the opportunity is right.

Cory Johnson, Analyst

Hi. This is actually Cory Johnson on for Doug. So, you mentioned wanting to bring leverage up, but perhaps not to your target range. Could you just talk maybe a little bit about the pace of how you expect it to maybe trend throughout this year and like, what might be around the high mark are you looking to get maybe towards about around the low end of your target range?

Dwayne Hyzak, CEO

Sure, Cory. Thanks for joining us and thanks for the question. I’d say that it’s hard to really give a time period or even an amount of leverage we’ll get to at the end of the year. It’s obviously going to be highly dependent upon the investment activity, which as we just talked about could be more uncertain or more muted, both on the lower middle market side and the private loan side, just given what’s going on in the economy. But I’d say the guidance we are giving is that, as we execute growth of the portfolio, both lower middle market and private loan, our plan is to utilize more of our debt capacity as opposed to additional equity issuances over time to increase that leverage ratio so that it moves more in line with our range and continue to be conservative, but moving in the direction of increasing leverage to be closer to the target range. But again, the timing and the ability to do that is primarily going to be dependent upon the pace of new investment activity. Thank you again, everyone, for joining us this morning. We appreciate the continued support of our shareholders, and we look forward to having everyone join us again for our next call in August after the release of our results for the second quarter.

Operator, Operator

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