Harvest Capital Credit Corporation
Q1 2018 Earnings Call Transcript

Published: 11 May 2018

[Operator:]

Good morning. My name is Karina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Harvest Capital Credit Q1 2018 Earnings Conference Call. [Operator Instructions] Your presenters on today's call are Mr. Joseph Jolson, Chairman and Chief Executive Officer; Mr. William Alvarez, Chief Financial Officer; and Mr. Richard Buckanavage, Managing Director and Head of Business Development. Mr. Jolson, you may begin your conference.

[Joseph Jolson:]

Thank you, operator, and good morning, everyone, and thank you for joining our first quarter 2018 earnings call. Before we get started, Bill, would you please read our Safe Harbor disclosure?

[William Alvarez:]

Okay. 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 involving 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 back over to Joe.

[Joseph Jolson:]

Thanks, Bill. While we had a disappointing first quarter of 2018 with net investment income of $0.19 per share, reflecting the performance of a much smaller by 15% investment portfolio compared to last year, large payoffs in the second half of 2017 and elevated expense levels relating to the previously disclosed issues in reporting our fourth quarter results, those expenses represent about $0.04 a share and are not expected to recur. On a positive note, we did report an improvement in net asset value to $12.70 per share and our weighted average risk rating remained relatively stable during the quarter. We also successfully completed the transition of our administrative services function to personnel located in our New York City office. Looking ahead, we are focused on leveraging our capital back to roughly 0.8 times debt to equity ratio by the end of the year and returning our risk rating back to its historical good levels. Bill Alvarez, our Chief Financial Officer, will now take you through some more details on our financial performance, then Rich will discuss the current investment pipeline and competitive conditions, before I offer a few closing remarks. Bill?

[William Alvarez:]

Okay. Thank you, Joe. Net investment income for the quarter was $1.2 million or $0.19 per share compared to $2.2 million or $0.35 per share in the first quarter of 2017. Net income for the quarter was $2.1 million or $0.32 per share compared to $2.3 million or $0.37 per share in the first quarter of 2017. I would like to highlight a few notable items for this quarter. Net investment income decreased during the quarter due to a couple of factors. Investment income decreased $0.9 million as a result of a smaller investment portfolio, which decreased approximately $20.5 million from March 31, 2017. Net operating expenses increased $0.2 million, principally as a result of incurring additional professional fees related to the material weaknesses that company identified in its annual report on Form 10-K for the year ended December 31, 2017, which the company does not expect to recur in the future. These were offset by $0.1 million decrease in interest expense, directly as a result of lower bank debt outstanding at March 31, 2018, compared to March 31, 2017. The company did not record any incentive fees in the quarter ended March 31, 2018, as compared to $0.1 million in the first quarter of 2017. Net income decreased by only $2.2 million in the quarter ended March 31, 2018, compared to the quarter ended March 31, 2017. The company recorded a net increase in realized - the company recorded a net increase in realized and unrealized gains on investments of $0.8 million, which offset the majority of the decrease in net investment income I described previously. As of March 31, 2018, the fair value of our portfolio was $118.3 million, with a cost of $120.1 million, reflecting a $1.8 million of net unrealized depreciation of the portfolio at the end of the quarter. As of March 31, 2018, we had a debt balance of $38.1 million, consisting of $9.3 million of bank debt and $28.8 million of unsecured notes, for a debt to equity ratio of approximately 47%, down from approximately 56% at December 31, 2017. At quarter-end, we had $2.1 million of cash and approximately $24 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 2018. In addition, we have three syndicated loans totaling $8.4 million, which we could monetize into cash to be invested in our core lower middle market strategy as attractive opportunities arise. As of quarter-end, our net asset value was $12.70 per share, up $0.04 per share from the last quarter as we had higher net income in Q1 of 2018 compared to the fourth quarter of 2017 and also includes the effective share repurchases. Our net income of $0.32 per share exceeded our dividend of $0.30 per share we paid. At March 31, 2018, we had $1.2 million of undistributed net investment income on a GAAP basis, which represents about $0.19 per share. During the quarter ended March 31, 2018, we repurchased 64,897 shares of our common stock at an average price of $10.75 per share, with a total cost of $0.7 million. Lastly, we successfully completed the transition from the prior administrator, JMP Credit Advisors located in Alpharetta, Georgia, to HCAP Advisors in New York City. The official handoff was on April 2. We hired Brandon Campbell as our financial controller and Matt Rosencrans as our loan administrator. Brandon has substantial prior public accounting experience and has extensive experience with BDCs. Matt has deep experience with loan administration and previously worked for a big global bank. The New York administrative team has required experience to assist the company during its next phase of growth. Now, I'll turn the things over to Rich for a discussion of our operations.

[Richard Buckanavage:]

Thanks, Bill. Our first quarter's deployment was not what we had hoped for given the pipeline we carried over at year-end, and the level of quote activity we witnessed throughout the quarter. We closed three financings totaling approximately $8 million in commitments in Q1, $7.2 million of which was an investment in a new portfolio company with the remainder being invested into existing portfolio companies. As has been the case for several quarters now, portfolio exits almost entirely offset capital deployments during the quarter. Despite the portfolio churn, we continue to maintain adequate diversity with 30 portfolio companies invested across 15 separate industry sectors. The current state of the markets in this segment, in which we primary compete, remains competitive. While pricing continues to be the primary basis of competition, we have not witnessed material changes in credit spreads year-to-date. Our current pipeline is solid with 28 investment opportunities totaling approximately $185 million. It's worth noting that the quality of the pipeline remains good, and our proposal activity as a result is robust. We currently have 4 proposals issued to prospective borrowers, totaling approximately $29.5 million in capital commitments, one of which is mandated in total $5.5 million. This mandated financing as well as the other three proposals are all slated to close prior to quarter-end. Three of the three proposals include - including the mandated transaction offer unitranche financings, which is consistent with our stated preference, all else being equal, to focus on more senior-oriented debt investments. Looking ahead, we are optimistic about our deployment prospects over the next quarter or two, given the volume and quality of opportunities as I referenced earlier. Credit spreads appear to have stabilized and we are more fully utilizing our existing leverage capacity, which should be able to generate acceptable ROEs and begin to again outearn our current dividend level. To the extent we are able to utilize additional leverage capacity pursuant to the Small Business Credit Availability Act, our competitiveness in the unitranche market should increase substantially given the lower average yields in that asset class versus second lien and mezzanine investments. It's worth pointing out that approximately 30% of our pipeline during 2017 had yields below what was accretive for Harvest, given the 200% asset coverage test limitation. Through the prudent use of some additional leverage, we would expect our proposal activity to accelerate over the next year. With that, I'll hand it back over to Joe.

[Joseph Jolson:]

Thanks, Rich. I want to briefly touch on the recent board approval of an increase in our potential balance sheet leverage to essentially 2

[Operator:]

[Operator Instructions] Your first question is from the line of Brian Hogan from William Blair.

[Brian Hogan:]

First question is actually on fee income, a little lighter than I anticipated during the quarter. Is that - was it lighter than what you'd normally expect or is that may be a run rate?

[Joseph Jolson:]

Yes. Bill, you can take that.

[William Alvarez:]

Yes. Basically, Brian, it's - fee income, it kind of varies quarter-to-quarter. I mean, it's not a proxy that every quarter we get to same level as payoffs occur at different times of the year that are pretty unpredictable. So year-over-year, fee income is probably a predictable measure, but quarter-over-quarter it may change a bit.

[Joseph Jolson:]

I think that - just adding to that a little bit, Brian. It's Joe. The fee income was below normal in the quarter. And I think that we kind of have a budgeted number for the full year because it's unpredictable and primarily tied to early payoffs of loans. As a reminder, we defer all of our origination fees as a yield adjustment against the loans unlike some BDCs. And so when we do have payoffs, it accelerates those fees into the period that the payoff occurs.

[Brian Hogan:]

Right. And so from budgeted, you said like for a full year it's kind of consistent. So I mean, last year you had 2.5 of fee income. Is that at a level you would consider being normal?

[William Alvarez:]

I don't have - exactly have the budget in front of me. But again, that would be significantly - probably, significantly higher than we'd have just in this first quarter alone. Again, there - the unpredictably of payoffs that happen and when we receive these fees - on a yearly basis, there is probably going to be, kind of, a normal range that we've had in the past. At this point, I don't see anything different than that. But again, quarter-to-quarter will be lumpy.

[Joseph Jolson:]

Brian, I think that it's a smaller portfolio too versus a year ago, right? So all else being equal, will be a lower dollar number, right?

[Brian Hogan:]

Right. That's what I was kind of thinking, William. The $29.5 million of, I guess, mandates or proposals you have out there. Did I hear you right, they're supposed to close by the end of the quarter?

[William Alvarez:]

The target close for the four proposals that we have out, including the one mandated transactions, are due to close by quarter-end. But as you know, Brian, it - they never go as planned exactly. But I guess, the good news is if they don't close by quarter-end, they'll close shortly after quarter-end, giving near full interest for Q3.

[Brian Hogan:]

A little bit of timing - I mean, relative to your - pretty good tracking it into your target of $0.8 million by year-end. I guess, is that - how confident are you to be able to get to $0.8 million by year-end?

[Joseph Jolson:]

I think we're fairly confident by year-end - I would highlight that we have one mandated transaction for $5.5 million. The other three are just proposals. And I wish it was the case that we win every proposal that we issue, but that's just not the case. So of the remaining, call it, $24 million, you have to put some sort of probability on that. It's probably unlikely that we win all three remaining proposals. So - but by year-end, yes, we're pretty confident. Given, again, where the pipeline is today from a volume perspective and the quality of pipeline being pretty strong, we think by year-end that's very achievable.

[Brian Hogan:]

And the pipeline, is that more of the - is there a little bit of the shift to the senior or is that still kind of what you've been doing?

[William Alvarez:]

No. There has definitely been a concerted effort to be more senior oriented. Obviously, two factors that kind of fall from that strategy. One is that, as we've said in the prior quarters, the yields on unitranche transactions are lower than second lien and mezzanine investments. The other observation is that unitranche financings tend to be larger, right, because they encompass the entire debt being invested in the company versus just a single tranche of debt, usually second lien or mezzanine. So the average investment size is likely to be larger, which is probably why some of these numbers appear larger than normal, and of course, the yields. But again, we think that the tradeoff is well justified. And if we can use some additional leverage, as Joe said, we can get to an even higher ROE, but in a more senior-oriented portfolio than today, which is about 53% senior today.

[Brian Hogan:]

Great. Share repurchases. I've seen you repurchased a few in the second quarter in addition to the first quarter as well. Should we anticipate further share repurchases or is it more focused on asset growth at this point? Obviously, you're still trading at a pretty good discount to book value. Just kind of - how you're thinking about share repurchase?

[Joseph Jolson:]

Yes. Let me take that one. I think that we are looking at the return on capital for buying back our stock versus putting out capital in the current environment to evaluate that, Brian. And I think that we'll continue over time to look at share repurchases. The Board had approved $3 million repurchase in total. We haven't fully utilized that. So as the year goes along, we're likely to buyback more stock. But our pipeline's pretty high near term, so it may be later in the year at this point.

[Brian Hogan:]

All right. The incentive fee outlook, it's been four quarters since you've paid an incentive fee. I mean, do you expect to pay an incentive fee in the second quarter? I mean, what's - I know it's kind of just math calculation, but I guess what your...

[Joseph Jolson:]

There's two issues for an incentive fee, given our contract. Historically, the last - until recently, the lack of incentive fee was due to the clawback provision, where there's a 3-year look back on total return. And we had some credit losses over the last year. I think the other issue was covering the 8% annualized on a quarterly basis hurdle, and I think that that's come into play more recently here. So I think that we're hoping to be back getting incentive fees in the not-too-distant future. But - I mean, as we put more capital out, as you model it out, I think you will see a trend up in our ROE and that would allow for more incentive fees, assuming there aren't any more unexpected credit hits.

[Brian Hogan:]

Great. And then on your portfolio, there is - 50% of the portfolio is now fixed rate. I think a year ago it was like 30%. Is that a strategy shift? I guess, kind of, what is your - can you discuss that trend?

[Joseph Jolson:]

That's obviously not a strategy shift on our part, but perhaps, maybe, more on companies' parts. You saw a large level of payoffs for us in the second half of the year from performing credits as rates started to go up. So I think that it maybe - as the interest rates were going up on what 1- and 2-rated credits for paying us, that encouraged them to look at potentially refinancing us out. I think - I mean, we're obviously much more interested in having variable rate loans always. On the second lien side, that's tougher to do because you're limited by what the senior loan ahead of you will allow. But - so it's somewhat related to the mix, but we always would be interested in getting variable rate loans.

[Brian Hogan:]

All right. And then PIK from the controlled investments that you had some income in the 4Q. And I guess, I had thought it was going to continue, but - was that just a onetime item or I guess what we continue to think about there?

[Joseph Jolson:]

Bill, can you take that?

[William Alvarez:]

Yes. We had some - we actually have one nonaccrual investment, which is Infinite Care and WorkWell actually paid off. So that was really kind of the change there.

[Joseph Jolson:]

Yes. We put Infinite Care on nonaccrual lead in the fourth quarter, I think. But I think - I'm not sure there would've been PIK recognized before that though. We have to go and get back to you on that. I think that - but I think the current level of PIK is probably what you should go off of. I do not think that it's unusually low this quarter.

[William Alvarez:]

You just want to think, during that WorkWell, we did have PIK accrued in the first quarter, but WorkWell came off of nonaccrual - I'm sorry, in fourth quarter we had PIK income from WorkWell, and first quarter came off nonaccrual. So therefore, it was paid off, but we did not record any PIK income in the first quarter for that investment.

[Operator:]

[Operator Instructions] There are no further questions on the phone at this time. I'll now turn the call back over to the presenters.

[Joseph Jolson:]

Okay. Well, thanks everyone for your interest in Harvest Capital Credit. And as I said, we look forward to giving you an update in a few months. Thank you.

[Operator:]

This concludes today's call. You may now disconnect.