Harvest Capital Credit Corporation
Q4 2019 Earnings Call Transcript

Published: 13 Mar 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Harvest Capital Credit Corporation Q4 2019 Earnings Conference Call. At this time, all participants 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 now like to hand the conference over to your host, Mr. William Alvarez, Chief Financial Officer. Thank you. Please go ahead.

[William Alvarez:]

Okay. Thank you, operator. Good morning, everyone, and thank you for participating in this conference call to discuss our financial results for the fiscal year and quarter ended December 31, 2019.I'm joined today by our Chairman and Chief Executive Officer, Joseph Jolson; and by Richard Buckanavage, our President.Before we start, I'll provide a disclaimer regarding any forward-looking statements that we make during this presentation. This presentation contains forward-looking statements, which relate to future events or Harvest Capital Credit's 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 of 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 continue to make progress towards achieving our 2020 goals of leveraging our existing capital to grow to roughly $150 million investment portfolio, as well as returning $10.2 million of non-accrual loans to interest earning status. We currently have nearly $15 million of mandates that we expect could close in the next few months. We also continue to work hard on resolving these problem assets and they have shown underlying improvements in the past few quarters.I have Bill go through some of the financial results from the quarter and fiscal year, and then Rich give some color on the current lending environment before I'd make some concluding remarks. Bill?

[William Alvarez:]

Hey. Thanks, Joe.Net investment income for the quarter was $1.2 million, or $0.19 per share, compared to $1.6 million or $0.25 per share in the fourth quarter of 2018. Net investment income decreased by $0.4 million in 2019 as compared to 2018, as a result of a decrease in investment income of $0.7 million as a result of a lower income between periods, offset by a decrease of $0.3 million in expenses in the 2019 period, as compared to 2018. Net loss for the quarter was $0.3 million or $0.05 per share compared to net income of $1.5 million or $0.24 per share in the fourth quarter of 2018.The decrease in net income principally resulted from the Company recording lower investment income as a result of the lower weighted average effective yield, lower prepayment and other nonrecurring fees, the addition of CP Holdings Company, Inc. to nonaccrual status during 2019, and an increase in realized losses, offset by an increase in unrealized appreciation and lower operating expenses.Reflecting on the year ended December 31, 2019. Net investment income was $3.8 million or $0.63 per share, compared to $6 million, or $0.93 per share for the year ended December 31, 2018. The $2.2 million decrease in the 2019 fiscal year as compared to 2018, primarily related to the Company recording $3.5 million of lower investment income as a result of a lower income earning portfolio throughout the year compared to 2018 and lower effective yield offset by lower operating expenses of $1.4 million for the year ended December 31, 2019.Net loss for the year ended December 31, 2019 was $1.2 million or $0.20 per share, compared to net income of $5.1 million or $0.79 per share in the year ended December 31, 2018. The $6.3 million decrease was primarily attributable to a $3.5 million decrease in investment income, a $1.9 million increase in realized losses and a $2.3 million increase in a change in unrealized depreciation, partially offset by a decrease in expenses net of reimbursements of $1.4 million.We recognized fee amortization income of $148,000 in three months ended December 31, 2019, compared to $305,000 in the comparable 2018 quarter. The higher fee amortization in 2018 resulted from the Company exiting $18.6 million of debt investments in the fourth quarter of 2018.Our fees are deferred until they are, either earned, amortized into income over the life of the investment using the effective yield method or fully recognized when an investment payoff occurs. As a result, our fees and other income will fluctuate quarter-to-quarter depending on portfolio activity. As of December 31, 2019, the fair value of our portfolio was $116.8 million, with a cost basis of $123.4 million, reflecting $6.6 million of net unrealized depreciation in the portfolio at the end of the year.As of December 31, 2019, we had a debt balance of $72.5 million, consisting of $43.7 million of bank debt, and $28.8 million in 2022 notes or debt to equity ratio approximately 108%, compared to approximately 58% at December 31, 2018.At year end, we had $21.8 million of cash and approximately $1.2 million of undrawn capacity on our $55 million credit facility. As of year-end, our net asset value was $11.23 per share, down $1.07 per share from December 31, 2018, principally as a result of paying $0.98 per share in distributions for the year ended December 31, 2019, realizing a $0.20 decrease in net assets from our 2019 operations, offset by $0.11 of accretion due to shares repurchase during 2019.Now, I want to turn the call over to Rich for some further discussion on the investment environment.

[Richard Buckanavage:]

Thanks, Bill.The current state of the market in which we compete, continues to be competitive, although this is not the sole factor in our lower than anticipated deployment in Q4 or year-to-date 2020. Deal flow remains robust, and the quality of the opportunities we are currently evaluating is high. Much of the factors contributing to the slower than expected deployment activity relate to unusually high number of delays and transaction closing timetables, and in few cases deals being terminated in diligence, all of which are outside our control or prudent responses to diligence issues.As was the case in most recent quarters, our ability to utilize a higher level of leverage has put Harvest in a position to pursue a broader array of transactions, most notably our ability to be competitive on unitranche financings, which continue to represent a greater percentage of our current mandates and the pipeline in general.The upside to pursuing unitranche financings, in addition to the collateral priority benefits we enjoy from unitranche financings is that the average hold size tends to be larger as compared to standalone mezzanine investments, enabling us to achieve our overall deployment objectives with a fewer number of closed transactions.We continue to be encouraged by our ability to identify attractive new investment opportunities, although our deployment activity in Q4 was largely portfolio related. In the aggregate, we closed approximately $4.5 billion in debt commitments across five portfolio companies, bringing our portfolio to 25 investments. Subsequent to quarter-end, we increased our senior term loan to Slappey Communications by approximately $1.1 million in order to finance an add-on acquisition for this portfolio company, as well as make a small equity investment totaling $200,000, representing our pro rata share of an equity raise associated with an add-on acquisition for King Engineering.As we look forward to the remainder of Q1 2020 and early Q2, we remain optimistic regarding our current pipeline. We currently have three mandated transactions totaling approximately $14.8 million and investment commitments, approximately $14.1 million in fundings that closed. All of these transactions represent new investments, which will bring our total portfolio to 28. And all three are unitranche investments with yields similar to yields for previously closed unitranche investments. Many of these financings are expected to close by quarter -end, but because of the late date in the quarter, these mandates are not likely to contribute meaningfully to this quarter's income but will provides solid earnings momentum for Q2 and beyond.With that, I'd like to turn the call back over to Joe for some final thoughts.

[Joseph Jolson:]

Thanks, Rich. We continue to believe that if we execute on our current plan to increase our investment portfolio to roughly a 1.3 to 1 leverage ratio, that investment income will cover our current dividend level with potential upside from the redeployment of $22 million of non-interest earning assets, which includes $12 million of equity investments at fair value back into interest earning investments over time. We also believe that our stock has a compelling value at current price levels, and we would anticipate a favorable reaction if we are successful in the next few quarters in achieving our plan. Our advisor and its employees are well-aligned with shareholders, given its ownership of roughly one-third of the shares outstanding.In closing, I wanted to also congratulate Rich Buckanavage who is elected President of the Company recently and has led our investment efforts since inception. I also want to thank our employees and Board members for the continued efforts to make Harvest Capital Credit a success, and our shareholders for their continued support.With that operator, we’d take any questions if anyone has any. Thank you.

[Operator:]

[Operator Instructions] Your first question comes from the line of Ryan Lynch with KBW. You may ask your question.

[Ryan Lynch:]

Hey. Good morning. Thanks for taking my questions. First, just a quick one, housekeeping one on the income statement. During the last -- during 2019, you guys had professional fees or expenses of about $1.1 million. But, over the last couple of quarters, the third quarter and the fourth quarter, they're like $200,000, and in the fourth quarter, they were around $100,000. I'm just curious, do you have any guidance on what do we should expect from a full year 2020 from a professional fees standpoint?

[William Alvarez:]

Yes, Ryan. Thanks for the question. We basically have reduced our professional fees substantially over 2019. We changed our orders, aligned ourselves with firm that's little more sensitive to our needs and best aligned to our business. So, going forward, the level of fees in 2020 should kind of match that what we've incurred in 2019.

[Ryan Lynch:]

Okay.

[Joseph Jolson:]

Hey, Ryan. The other thing, just to remember, is there is some seasonality to those fees, based on the annual audit and all that. We can accrue that evenly through the year. So, the first quarter every year, there's a lot higher fees than maybe by the time you get to the second half of the year. Just to remind you.

[Ryan Lynch:]

Got you. Okay. And then, as you were talking about in your prepared comments, and I think in the press release you talked about wanting to get to around $150 million investment portfolio. In 2020, can you just speak about that that sort of goal of growing the portfolio pretty substantially? How does that play out in an economic environment where economic activity seems to be grinding to a halt? Do you think it is still prudent to be meaningfully deploying capital and growing your portfolio in this uncertain environment?

[Joseph Jolson:]

I'm sure Rich has some comments on that. But, that's why we do it typically two or three months of due diligence on all these investments, and a lot of them haven't come through, based on due diligences. But, yes, we think that if you just go back to the environment, I don't know in knowledge, it's I guess 8, 10 years ago, in hindsight, the best time to put capital out in our part of the market was when fear and uncertainty caused a lot of these overly aggressive providers of interest paying investments to fleet. And so, I would expect that over the -- if the market’s discounting a recession or a downturn or slowdown whatever it is that we will have opportunities to potentially put out our capital at higher levels in terms of returns than we've had in recent history. But Rich, why don't you maybe add some color there.

[Richard Buckanavage:]

Sure. No. That’s good question. And prior to all of what we're experiencing currently, we've already begun to more scrutinize potential new investments. And I think as I alluded to in my prepared remarks, we have blocked away from several transactions in Q4 and early 2020 where issues came up in diligence. So, we're not jeopardizing underwriting standards to grow the balance sheet. In fact, if anything, we're probably going to grow less quickly than we otherwise would have, given the current environment. But we've already been adjusting our internal models with regards to economic growth, a couple of quarters ago. And so, we've already been -- and we’ll continue to factor this current situation into our underwriting process as well. And that might mean that we walk away from other transactions, but we're keenly focused on investments that do not exhibit a strong correlation to the overall economy or are counter cyclical. Those are the types of investments that we are pursuing today in this environment and likely for the foreseeable future.

[Ryan Lynch:]

I mean, as we kind of are working through this in real time of -- with talking about deal flow and potential deals that are getting done today, I mean, how are you guys -- as you guys evaluate new deals, how are you guys ensuring that the deals that you guys are putting on today or a week from now or months from now are going to be well-positioned, if we do go into some sort of economic downturn or recession? Are you guys changing the businesses that you guys focus on, the sectors that you focus on, or are you guys not changing that but also ensuring that the leverage is much lower on these businesses, the covenants are better, yields are higher? How are you guys evaluating new deal opportunities in today's environment, versus how you were six months ago, given the environment has dramatically changed? And also, as you run your internal models and do your due diligence, what sort of base case are you using for the economic environment? Are you guys assuming that the U.S. economy goes into recession over the next year? Is that sort of the base case you guys you're using or something more favorable?

[Richard Buckanavage:]

Yes, Ryan, I mean, all of the above. Clearly, we are not investing in sectors today that we might have invested in prior periods. The automotive would be a perfect example. And we've been shying away from that that sector for quite some time, knowing that likely was at the peak. And of course, we already know that unit volumes are down in the automotive sector. So, we adjust our underwriting criteria based on the factors in the marketplace. And so, yes, we're altering industries that we will invest in versus sectors that we won't invest in, looking at, as you said lower leverage, and of course, adjusting our internal models. I mean, at this point, we had not factored in a recession. But of course, all of this is quite new and likely that we do -- our internal models do reflect some sort of recession, which I think is pretty widely expected at this point -- is short term as it might be.So, our underwriting criteria is always evolving, based on the current environment that we're facing. And certainly, we're going to be working on further adjustments. And I would add and also that we may delay some closings by several weeks, just to get a further look into what some of the -- some of these companies. And so, we're doing everything we can to ensure that we're making prudent investments, given some of the uncertainty in the marketplace.

[Ryan Lynch:]

Okay. And then, one last one for me. When I look at your guys' stock price today, you guys are trading less than $0.50 on the dollar, 50% -- less 50% of book value today? You guys, at the end of the year had a 14% portfolio yield. So, when you guys are evaluating the -- you guys are allocators of capital. So, when you guys are looking to allocate capital to different investment decisions, whether that is new companies or there's the other decision to repurchase shares. When you guys are trading at less than 50% of book value and have a portfolio yield of 14% that you can get for less than 50% of book value, how can you find any deals in the market with close to 50% expected IRR, which was what you can basically buy your portfolio at today by repurchasing your shares?

[Joseph Jolson:]

Well, yes, we agree with you. Our stock is undervalued and unlike -- I don’t you follow a broad sector. We've actually been active repurchasers of our stock in the open market over time. I think, last -- in last year, we probably bought back close to 10% of the shares. So, we don't disagree with you that the stock is a compelling value here. We have certain blackout periods and timing for other things. But, to the extent that this is a new reality, where these kind of stocks, including ours are going to be trading at, you can be assured, we'll be taking a hard look at that, and not just announcing a buyback like some companies but actually doing a buyback.

[Ryan Lynch:]

Do you worry, just on that point -- and this will be my last question. Just on that point, do you weigh at all with the share repurchases, the very compelling opportunity to buy your current portfolio for less than 50% of its value today via the share repurchase versus your market cap of being $20 million, $30 million today, your equity base of $67 million today, do you ever worry that the share repurchases, just further pressing your kind of the relevance of your BDC across the broader space and not being able to really operate a sufficiently sized BDCs? So, how do you weigh that, the compelling opportunity for share repurchase but also just shrinking your balance sheet and your equity base and your market cap for what's already an incredibly small BDC?

[Joseph Jolson:]

Those are all factors. But, I mean, I think ultimately, we're well aligned with shareholders. And I think, we'll continue to hopefully do the right thing that's in the best interest of our shareholders. But yes, we went public and we had a market cap of under $100 million, if you recall. So, we've never been a large company. So, it's not as if we've ever, according to some people's expectations of what kind of asset size you had to be. We've never been close or above that threshold that seems to get applied. But, I think that the -- I mean, our issue when continuing to buy back stock, has more to do with deleveraging on our current fixed costs for the public company than anything else, I think. So, it's a little bit more complicated kind of analysis than what you just said buying the portfolio at a big discount just because we -- on the marginal, shrinking the ability to grow assets, squeezes the existing earnings a lot more, given the fixed costs of being public.

[Operator:]

[Operator Instructions]

[Joseph Jolson:]

Operator, it doesn't seem like there are any other questions. So, why don't we conclude the call? And Bill, Rich and I are obviously available, if you want to call us directly with other questions. Otherwise, we look forward to updating everyone on our progress after the first quarter, in early May. Thank you.

[Operator:]

Thank you. And that concludes today's conference. Thank you all for joining. You may now disconnect.