Harvest Capital Credit Corporation
Q3 2019 Earnings Call Transcript

Published: 8 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Harvest Capital Credit Corporation Third Quarter 2019 Earnings Call. At this time all participants lines are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would not like to hand the conference over to your speaker today - speaker William Alvarez, Chief Financial Officer of Harvest Capital Credit Corporation. Thank you. Please go ahead, sir.

[William Alvarez:]

Okay. Thank you, Nora. Good morning everyone and thank you for participating in this conference call to discuss our financial results for the third quarter ended September 30th 2019. I am joined today by our Chairman and Chief Executive Officer Joseph Jolson and by Richard Buckanavage, our Managing Director and Head of Business Development.Before we start, I'll provide a disclaimer regarding any forward looking statements that we make during his presentation. This presentation contains forward looking statements which relate to future events or Harvest Capital Credits future performance or financial condition. These statements are not guarantees of future performance, condition or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result a number of factors, including those described from time to time in our filings with the Securities and Exchange Commission. Harvest Capital Credit undertakes no duty to update any forward looking statements made herein.Now I'll turn the call over to Joe.

[Joseph Jolson:]

Thanks, Bill. We showed some improvements in the third quarter results as our investment portfolio has now grown for the third consecutive quarter and by it's up almost 22% from December year end of last year.Our progress on resolving our four and five rated credits however has been frustratingly slow. We do remain optimistic that the roughly $12 million and currently non-interest earning assets will be contributing to our net investment income sometime during the next year.We also completed the most recent 250,000 shares stock repurchase authorization recently and in total have bought nearly 8% of the shares outstanding during 2019 and more than 9% of the shares outstanding since inception. And as everyone knows, these purchases at the price levels are immediately accretive to net asset value and net investment income per share. I'll have Bill go through some of the financial results from the quarter and then Rich will discuss the current investment environment and then I'll make some closing remarks. Bill?

[William Alvarez:]

Okay. Thanks, Joe. Net investment income for the quarter was $1.1 million or $0.18 per share compared to $1.6 million or $0.25 per share in the third quarter of 2018. net investment income decreased by $0.5 million in 2019 as compared to 2018 as a result of a decrease in investment income of $1 million as a result of a lower income earning portfolio and lower effective yield at September 30th 2019 compared to September 30th 2018 offset by a decrease of $0.5 million expenses in the 2019 period as compared to 2018.Net loss for the quarter was $1 million or $0.70 per share compared to net income of $0.6 million or $0.10 per share in the third quarter of 2018. The decrease in net income principally resulted from the company recording lower investment income as a result of a lower income earning portfolio and lower effective yield and an increase in unrealized depreciation offset by lower operating expenses as previously mentioned.Reflecting on the nine months ended September 30th 2019, net investment income was $2.7 million or $0.43 per share compared to $2 point - compared to $4.5 million or $0.69 per share in the nine months ended September 30th 2018. The $1.8 million decrease in the nine months of 2019 primarily resulted to the temporary [ph] recording $2.8 million of lower investment income as a result of a lower income earning portfolio and lower effective yield, offset by lower expenses of $1.1 million for the nine months ended September 30th 2019.Net loss for the nine months ended September 30th 2019 was $0.9 million or $0.15 per share compared to net income of $3.5 million or $0.55 per share in the nine months ended September 30th 2018. The $4.4 million decrease was primarily attributable to a $2.8 million decrease in investment income, $3.2 million increase in the change in unrealized depreciation, offset by a $0.6 million positive change in net realized gains and a decrease in expenses of $1.1 million.We recognized fee amortization – fee amortization income of $182,000 and $666,000 in the three and nine months ended September 30th 2019 compared to $308,000 and $974,000 in the comparable 2018 three and nine month periods.The higher fee amortization in 2018 resulted from several balloon payment exits where greater fees were earned in 2018 compared to 2019. Our fees are deferred until they're either earned, amortized income over the life of the investment using the effective yield method or fully recognized when an investment pay off occurs.In addition, we also recognized other income of 46,000 and 288,000 in three and nine months ended September 30th 2019 compared to 241,000 and 318,000 in a comparable 2018 three and nine month periods. As a result our fees and other income will fluctuate quarter to quarter depending on portfolio activity.As of September 30th 2019 the fair value of our portfolio was $115.6 million with a cost basis of $123.1 million reflecting $7.5 million of net unrealized depreciation in the portfolio at the end of the quarter.As of September 30th 2019, we had a debt balance of $65.1 million consisting of $36.3 million of bank debt and $28.8 million of 2022 notes for debt to equity ratio approximately 95% compared to approximately 58% at December 31 2018.At quarter end we had $17.8 million of cash and approximately $3.8 million of undrawn capacity on our $55 million credit facility. Our cash and borrowing capacity provides us with sufficient liquidity in order for us to execute our business plans for 2020.As of quarter end, our net asset value was $11.52 per share, down $0.78 per share from December 31 2018, principally as a result of paying $0.74 per share in distributions for the nine months ended September 30th 2019 compared to $0.15 decrease in net assets from our nine months of 2019 operations and enhanced by $0.11 of accretion due to shares repurchased during 2019.On May 3rd 2019 the Board of Directors authorized an open market stock repurchase program to repurchase up to 250,000 shares in the aggregate of the company's common stock in the open market. At September 30th 2019 the company purchased 210,533 shares under the May 2019 repurchase program and subsequent to September 30th the remaining 39,467 shares were acquired completing the repurchase plan.Now I want to turn the call over to Rich for some further discussion on the investment environment.

[Richard Buckanavage:]

Thank you, Bill. The current state of the market in which we compete continues to be competitive, although credit spreads, leverage levels and covenant structures have been fairly stable since the start of the year.The access to additional leverage which went into effect and May continues to provide us with an enhanced competitive position in order to compete for a larger percentage of unit tranche financings that we decide to pursue.While we continue to pursue both senior and junior secured debt investments, pursuing a larger percentage of unit tranche investments better positions us to achieve one of our more important strategic objectives which is to increase our average transaction size, given that unit tranche financings tend to be substantially larger than standalone mezzanine investments.We continue to be encouraged by our ability to identify attractive investment opportunities. During the third quarter, our investment activities include both new investments, as well as additional capital deployment and existing portfolio of companies. In the aggregate, we closed approximately $14.6 million in debt commitments and $600,000 of equity investments across two new and three portfolio companies bringing our portfolio to 26 investments.Subsequent to quarter end, we increased our senior term loan to Northeast Metals by approximately $1.6 million in order to refinance the company's existing line of credit that was maturing in early 2020.As we look forward to the remainder of 2019, we remain optimistic regarding our current pipeline. We currently have five mandated transactions totaling approximately $27.6 million. Many of these financings are expected to close by year end. However. given the expected timing of these closings which is weighted towards the back end of the fourth quarter these mandates are not likely to contribute meaningfully to this quarter's income but will provide us solid earnings momentum for Q1 2020.With that, I'd like to turn the call back over to Joe.

[Joseph Jolson:]

Thanks, Rich. As Rich just mentioned we have a strong pipeline of mandated deals that are progressing towards closing in the next three months. 2019 new investment levels have recovered back to a run rate of about $60 million compared to doing only $19 million for all of 2018. At the current level we should be fully invested sometime in the third quarter of 2020 depending on the timing of selected pay offs of non-interest earning investments which is $24 million which equates to 21% of total investments, have been a major drag on our net investment income in the last year or so.In particular, the redeployment of any and all of the current fair value dollars invested in our four and five rated credits that total a little less than $12 million and we have about $8 million invested in two very successful investments in the equity that there could be a liquidity event sometime next year.Those different investments are not contributing to net investment income so there's quite a bit of upside, we think once we get fully invested in terms of further net investment income growth into 2021 by redeploying that capital.Our current risk rating continues to creep a little higher in the third quarter to 2.51 from 2.44 in the June quarter. The benefit from the renewed growth of impacting this metric is somewhat lagged by our valuation policy of holding our new investments at cost and at a two rating or if warranted [ph] a lower rating for the first six months after closing.At the end of September roughly $26 million or 22% of our total investments were in this category and would have otherwise pencilled to a one risk rating at that time. As a result of this dynamic, as well as the resolution prospects for our four and five rated credits, we do remain optimistic that the 2.51 risk rating could improve materially in the next six to 12 months.Once the redeployment of our asset capacity has - I'm sorry - while the redeployment of our asset capacity has been taking longer than we would have hoped a year ago, we have made good progress in the last three quarters of growth. And if you take it from the low point at the end of January our portfolio is up almost 30% since then through the end of September.Growth could have been faster if we were willing to increase our credit risk exposure or reduce our targeted IRR is below 10% on average both of which we have not been willing to do. By maintaining that discipline and assuming we continue to make steady progress with our key initiatives we believe we can cover our current dividend by the middle of next year, hopefully in the second quarter, with further upside potential ahead from additional growth in the redeployment as I mentioned of the non-interest earning investments detailed earlier.In closing, I want to thank our team, including our independent directors for their continued hard work for HCAP shareholders to achieve a favorable outcome. As of the completion of our most recent share purchase our advisor, management team and our board collectively own 31% of the shares outstanding compared to 19% at the time of the IPO, all made through open market purchases.With that Nora, we'd be open for any questions. Thank you.

[Operator:]

[Operator Instructions] You have a question from the line of Paul Johnson of KBW. Your line is open.

[Paul Johnson:]

Good morning, guys.

[Joseph Jolson:]

Hey, Paul.

[Paul Johnson:]

Thank you for taking my – good morning. Thanks for taking my questions. My first question was on the new non-accrual this quarter Deluxe Entertainment, I was just hoping you could provide maybe a brief description of - sort of detailing what exactly that company is. And then also with that an investment that drove the depreciation this quarter?

[Joseph Jolson:]

You know, I can start and then maybe Bill can talk about the depreciation. But yeah that was a chunk of the unrealized depreciation this quarter. Deluxe Entertainment it was a broadly syndicated credit that we purchased over the last seven or eight years opportunistically from time to time. We become aware of some situations where we think there's a opportunity over 12 to 18 month period perhaps to - to put some capital to work at a pretty good risk adjusted return. Up until this situation, we had a perfect record in these kinds of things. This is our first situation where we've had a loss, you know or at least a unrealized loss.So Deluxe Entertainment is one of the - perhaps the largest player in the - within the entertainment industry in terms of back end production. And maybe Rich can give further color on that. But it was owned by a large private equity firm that had been supporting the investment and the loan was maturing in a year and the company hit a little rough spot in terms of Hollywood releases being down materially and needed to restructure the credit or refinance it.And unfortunately they couldn't come to an agreement with the credit committee and decided instead to take it into a pre-pack bankruptcy where essentially as first lean lender we own 65% of the equity now and as the primer we participated fully in the primer facility, we got 35% of the equity and that you know, I think that the - so a lot of our recovery here we think we have conservatively booked it at the end of the quarter and a lot of our potential recovery here over the next year is the company hitting their projections and selling the business in the next 12 plus months.Anyway with that color Rich I don't know if you have anything to add or Bill.

[Richard Buckanavage:]

This is Rich, I don't have anything to add. Joe, I think you characterized the situation accurately.

[Paul Johnson:]

Okay. Thanks for that. There's very good detail. And can you just remind me approximately if you have that information, of how much of your portfolio are in those DSL or syndicated type deals that you purchased opportunistically?

[Richard Buckanavage:]

Yeah. Bill would have that. I mean, let me be - there's been a few investments we made in the syndicated business that we've held as a long-term investment as opposed to a opportunistic, something we thought there would be an event in the next year or so. I believe the only one we own right now that would be in that category is GNC. Correct me if I'm wrong Bill?

[William Alvarez:]

Yeah…

[Richard Buckanavage:]

Well we own a few others but those have been long-term holes – holds.

[William Alvarez:]

Right. It's approximately $12.5 million in total.

[Richard Buckanavage:]

And the GNC will have a large bill?

[William Alvarez:]

Yeah. GNC is $4.2 million.

[Richard Buckanavage:]

Of that total?

[William Alvarez:]

Of the total. Yes.

[Paul Johnson:]

Okay, great.

[Richard Buckanavage:]

The GNC is actually performing as expected or better than expected. And you know the other credits that are on that list Bill are - what you just list the other two because [indiscernible].

[William Alvarez:]

Yeah. It's its flavors. Okay. Deluxe flavors, GNC and GK Holdings Global Knowledge.

[Paul Johnson:]

Okay, great. I appreciate that. And then next. I was hoping you could touch on maybe what sort of your average or target investment size is for new investments in the portfolio?

[Richard Buckanavage:]

I mean, we'd like to originate new investments between let's say 5 million and 10 million. I think the issue is the diversity test under the BBC rules, so our investment portfolio grows 5% investment you know increases and we have some capacity to right now to be above 5% on some investments.I think that with our current team perhaps you know, adding you know, one more person we think that - that over the next couple of years we can migrate the average size up to that level maybe in the $6.5 million to $7 seven million range and drive portfolio growth.

[Paul Johnson:]

Okay. And I am just curious so how do you guys manage your whole size or your investment size just given that most investments probably around that area will probably be close to 5% maybe or more of the portfolio for new originations.I am just curious does Harvest have any sort of co-investment capabilities to share in the investments or any other way to potentially manage just the size of new investments?

[Joseph Jolson:]

Well, you know, obviously has to be managed, but that's kind of the lower middle market size anyway that $5 million to $10 million, Paul. So that's not inconsistent with where we would see the bulk of our investment opportunities at the kind of risk adjusted yields that we are looking for.But that being said, you notice at the end of the quarter, early quarter to quarter were carrying or rather large cash balance. And that's essentially a one day or two day borrowing to increase the denominator. So that's one way to manage it.And now obviously monitoring the new deal sizes. But you know, if you kind of see our pipeline almost all the kind of sourced investment opportunities that are in our wheelhouse for the kind of yields we're looking for would at least initially be in that kind of size.

[Paul Johnson:]

Okay.

[Richard Buckanavage:]

Hey Paul I would also add you know we do have a private credit fund the JMP affiliate that we do co-invest with which also has a message you know our whole sizes. So for example if we're looking at something that's $12 million and as Joe said we want to be more in the 5 to 10 range you know for those transactions that are appropriate for that fund's mandate.We do have the ability to also you know for example take down a $12 million deal hold, 8, 9, 10 of that and then put the remainder into the private credit fund that also allows us to be very effective in that market where we're slightly above our hold size, but not so much so that we don't want to pursue that.So that's another net debt - that's been probably something we've had in place for about two years has allowed us to you know consider investments that are slightly above our average hold size you know where we want to be.

[Paul Johnson:]

Great. Thanks that's very helpful. And then last question maybe more of a modeling question, but you guys were able to pretty significantly reduce your professional fees over the last few quarters.I am just curious is the current level that you're sort of running at this quarter about a 198,000 do you view that is sustainable or do you expect that should tick higher over the coming quarters?

[Joseph Jolson:]

Bill, you want to take that.

[William Alvarez:]

Yeah, sure. No we've been able to reduce our professional fees. I mean we you know - you know based on the size that we actually - you know earlier this year we actually changed auditors. You know we have [indiscernible] who is probably better suited to serve our market better at a more cost effective rate.So you know, we're watching all those things. You know our fees will fluctuate a little bit quarter to quarter as far as you know. some of the one off things that may come in or the timing of when you know an audit bill come in or a tax bill or what have you. But I would say generally speaking that our run rate now that you're looking at is more representative going forward in the future rather than what it was historically.

[Paul Johnson:]

Okay great. Thank you very much. Those were my questions.

[Joseph Jolson:]

Great. Thank you.

[Operator:]

[Operator Instructions] There are no further questions at this time. You may proceed presenters.

[Joseph Jolson:]

Okay, great. Well we appreciate the interest and we'll be hopefully excited to get back on a call in three months and talk about our progress in the fourth quarter. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.