Harvest Capital Credit Corporation
Q1 2017 Earnings Call Transcript

Published: 10 May 2017

[Operator:]

Good morning, my name is Samantha and I will be your conference operator today. At this time I would like to welcome everyone to the First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks' there will be a question-and-answer session. [Operator Instructions] Thank you. I'd now like to turn today's conference over to Mr. Richard Buckanavage. Please go ahead, sir.

[Richard Buckanavage:]

Thank you, operator. Good morning, everyone. And thank you for participating in this conference call to discuss our financial results for the quarter ended March 31, 2017. I'm joined today by our Chief Financial Officer, Craig Kitchin. Before we start our call, Craig, could you provide the Safe Harbor disclosure?

[Craig Kitchin:]

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.

[Richard Buckanavage:]

Thanks, Craig. Before turning the call back over to Craig later in the conference call, who will discuss our financial results in greater detail, I would like to highlight what we believe was another solid quarter of results in which we again fully covered our dividend. In the first quarter ended March 31, 2017, we generated net investment income and core net investment income of $0.35 per share which fully covers our dividend of $0.34 per share, resulting in a dividend coverage ratio of approximately 103% percent, because we fully earned the first quarter's dividend and continue to maintain approximately $0.44 per share our spill over income carryover from 2016. Portfolio performance remains solid, which enabled us to increase net asset value per share from $13.86 per share at December quarter end and incurred $13.89 at March 31. Q1, 2017 was one of the more active deployment quarters for Harvest in quite some time. As I mentioned in the prior two earnings calls, we witnessed a material uptick in the pipeline of investment opportunities in the mid to late Q3. Not only did the number of opportunities increase, but the quality of the underlying companies also improved. As a result of those two dynamics, we were able to close eight transactions in the first quarter totalling approximately $16.1 million of capital commitments. The transactions were comprised of five new investments totalling approximately $13.6 million with the remaining $2.5 million being invested in three existing portfolio companies. A breakdown of this past quarter's deployment activity is as follows. We invested $1 million of equity in four companies, $2 million of second lien term debt investments in one company, and $13.1 million of senior secured debt investment in five companies. The deployment in the quarter was comprised of approximately $7 million in fixed rate investments, and $8.1 million in floating rate investments. And six of the completed transactions involve the private equity sponsor with the remaining two being non-sponsored. We witnessed a very diverse group of transactions this past quarter, offsetting approximately $16.1 million of capital deployment activities during the quarter with the exit of two portfolio companies, a $3.8 million repayment of our sub-syndicated second lien term loan to North Atlantic trading company and a $500,000 repayment of our portfolio company WBL1, which had been partially paid down in prior periods. Both exits which represented our 26th and 27th realizations produced favourable outcomes for us. The North Atlantic second lien term produced in IRR of 12.9%, while the senior secured debt investment in WBL1 generated 15.6% IRR. 27 realizations since inception have produced an average IRR of 20.7%. Subsequent to quarter end, we closed two additional financings and the first with a $4 million junior secured debt investment with a floating rate of interest equal to LIBOR plus 11% with a 1% floor. And the second was a $3.3 million senior secured debt investment inclusive [ph] of a $300,000 unfunded revolver with a floating rate of interest equal to LIBOR + 10%. From a risk perspective the portfolio continues to exhibit solid results with a weighted average risk rating of 2.03 at 3/31/17, modest uptick from 2.01 at 12/31/16. As of 3/31, we had two debt investments and one revenue linked security on non-accrual status that represents 6.5% of total debt investments at cost in the 3.6% on fair value basis Our keen focus on capital preservation is a major factor to our achievement of growth during the quarter and an asset value per share which had $13.89 per share was $0.03 higher per share at December quarter end. We continue to remain prudent diversification across the portfolio. Due to the growth in the portfolio our top five abagore concentration increased - excuse me, decreased to 33.9% from 36.4% at prior quarter end. And the top 10 abagore concentration decreased as well from 59% at 12/31 to 57% at 3/31. Our industry diversification remains sound. Our largest sector concentration represents 14.4% of the total portfolio with only two other sectors representing above 10%, all others well below 10%. At 3/31/17, our portfolio was comprised of approximately 58.8% senior secured debt investments, that's up from 56.8% at 12/31, 36.3% junior secured debt investments and 4.4% in equity and equity like securities. As a result, approximately 96% of our total portfolio and 100% of our debt investments are secured by at least a first or second lien with no non-secured debt investments. Majority of our deployed capital investment in floating rate investments, which are approximately 68% helps to insulate Harvest Capital's future earnings from the possible negative impact of rising interest rates. In fact, we enjoy considerable upside in net interest margin as interest rate rise. For example, we estimate that NII would increase by approximately $562,000 with a next 100 basis point move in LIBOR all else being equal. This equates to approximately $0.09 per share of higher annual earnings. Turning my attention to the current state of the markets, the current state of the market in which we compete continues to be competitive, while pricing continues to be the primary basis of competition. We have recently witnessed a stabilization in rates. As evidence by our success deploying capital in Q1, our value equation too appears to be valid in both the sponsor and non-sponsor market segments. As is typical, we continue to see competitiveness gap between sponsor and non-sponsor transactions. Our current second quarter pipeline is lower than what it was in the prior quarter where probably the smaller pipeline to be as much a function of our focus on closing a transactions in Q1 rather than a true decline in the number of actionable financings. The new origination efforts since quarter end are yielding new investment opportunities each week. Despite the decrease, we will maintain a pipeline today that remains 28% higher than the average pipeline throughout 2016. Furthermore, the quality of pipeline remains solid. Continued solid pipeline of opportunities combined with good quality of the transaction volume has enabled us to secure three mandates tilling almost $14.4 million in investment commitments. All three mandates our senior secured debt investments and although these transactions are expected to close by quarter end there can be no assurances that they will close within that timeframe or that will close at all. Before turning the call back over to Craig, I'd like to announce that Harvest has commenced the process of transitioning functions historically covered under the administration agreement between us and our affiliate JMP Credit Advisors, which is based in Alpharetta, Georgia with Craig and his team. These functions include accounting, compliance and loan administration among others. The ability to access the resources of JMP Credit over these past five years has greatly benefited our shareholders by being able to manage the business in a very cost effective manner, particularly early on. However, due to the continued growth in our business and that of JMP Credit Advisors CLO business, as well at the commencement of preparation work to comply with increased SoCs [ph] requirements as we mature pasting an emerging growth company, we believe the time is right to begin transitioning these services to HCAP advisors, our investment advisor and hiring the personnel at HCAP advisors who are based out of the company's principal executive offices in New York and are dedicated to providing these services. Because our affiliation with JMP Credit Advisors, this transaction - transition will be conducted in [indiscernible] JMP Credit Advisors has offered to continue to provide these services to Harvest through March 31, 2018 if necessary, providing more than ample time to identify and hire personnel to all these roles. The flexibility to have a multi-quarter transition period is yet another example of the tangible benefits the Harvest derives from its affiliation with JMP. We believe that bringing these functions and the related personnel which included the CFO and COO to the company's offices in New York should provide some level of added operating leverage that translate into positive effects for our shareholders as the portfolio continues to grow. With that, I'll hand the call over to Craig, who will discuss our financial results in more depth.

[Craig Kitchin:]

Thanks, Rich. And good morning, everyone. Net investment income and core investment income for the quarter were $2.2 million or $0.35 per share, compared to $2.6 million or $0.41 per share for the first quarter of 2016. A couple of things to note about earnings for the quarter. Number one, there were no material investment payoffs in Q1 that helped drive earnings. However, last year in the first quarter we had the Infinite Aegis deal payoff which had a make old fee of about $600,000 or about $0.10 per share that added to net investment income. And number two, we placed CRS on full non-accrual during the quarter, it had previously been on PIK non-accrual, it is still paying cash interest by the way we're just not recognizing it. We also placed a small revenue linked security on non-accrual during the quarter. The impact of these two impacted earnings by about $0.02 per share during that period. And number three, and partially offsetting the first two is that the incentive fee was haircut due to the total return look-back feature in our management agreement without the claw back incentive fee expense would have been about $400, 000 or $0.07 per share higher. Net income for the quarter was $2.3 million or $0.37 per share, compared to a loss of $100, 000 or $0.02 per share in the first quarter of last year. The increase was driven by slightly positive realized and unrealized gain activity in the quarter versus $2.7 million in net portfolio realized and unrealized losses a year ago. At quarter end the fair value of the portfolio was $138.8 million versus amortized cost of $143.7 million, reflecting $4.9 million of net depreciation in the portfolio at the end of the quarter. At March 31st, we had total debt of $53.6 million for debt to equity ratio of 60%, down from 62% last quarter. One point to note regarding our credit facility, we did extend the revolving period which was set to expire at the end of this past April until October of 2018 and extended the final maturity date from October 2018 until April 2020. At quarter end, we had $8.2 million in cash and about $28 million of undrawn capacity on our $55 million credit facility. So with our cash and borrowing capacity we've got enough liquidity to execute the business plan in the short term. Additionally and again, I'd point out that we have about $21 million of lower yielding syndicated loans on the balance sheet that could be monetized and invested in core deals with higher yields. The syndicated loans had a weighted average effective yield of 12.1% at quarter end. The effective yield of the entire portfolio at quarter end was 14.8%. At March 31st, our NAV per share was $13. 89, up $0.03 per share from last quarter, as we had net income of $0.37 which exceeded the $0.34 in dividends paid during the period. One other thing I will mention as Rich did, is that we carried over approximately $2.8 million or $0. 44 per share and undistributed taxable earnings into 2017. This should give investors a degree of comfort as at least to the sustainability of current dividend levels. And lastly, I'll mention that during Q1 we sold 110,000 shares from our aftermarket equity program raising approximately $1.5 million in equity during the first quarter. And with that, I'll turn things back over to Rich.

[Richard Buckanavage:]

Thanks, Craig. And thank you to everyone for just being on our earnings call this morning. We understand that some of you may have some questions. So operator, could you please open up the lines for any questions our participants may have.

[Operator:]

Certainly. [Operator Instructions] And your first question comes from Ryan Lynch with KBW.

[Ryan Lynch:]

Good morning. First question, you mentioned a $14 million of mandates that you expect to close it by quarter end, you guys also closed about $7 million quarter to date through May. So that's about $21 million or so this quarter, do you guys expect to close. Last quarter in Q1 is pretty strong too of $16 million. You know, both the current quarter Q2 and the quarter you report on Q1 very strong originations versus a look at in 2016 in Q2 you did about $3 and $5 million and $4 million. So big increase in the amount of originations over the last two quarters it looks like. Can you just talk about you know what's driving that big increase, particularly with an environment as you discussed is getting more and more competitive?

[Richard Buckanavage:]

Yeah, Ryan, as you recall from few of the quarters, previous earnings calls, we throughout '16 had seen a declining pipeline of opportunities. So you know, we - and we don't control that obviously, we can originate as hard as we want, but if the market isn't there, it's not there. I think M&A was off in '16, 52%, I think we certainly felt that decline as most of our transactions are change of control events and the quality as you know, I think you heard me throughout 2016 talking about quality because we focus as much on quality as we do quantity and the quality just wasn't there. So we didn't see as many opportunities that we chased hard to potentially invest in. And that certainly translated into a - not only a not a growing portfolio, but a declining portfolio. And again back to Q3 earnings call, we did witness a material pick up, I think the uptick from the average pipeline in 2016 just at that point in time was almost 50% higher than it was through most of 2016. That continued into '14. So translate that into closings in Q1 and closings in Q2. Now the pipeline is off a little bit, it's down into the 20s relative you know, 20 I think its 28% above the average pipeline for '16. So it is off kind of the peak, but still well above the 2016 levels. What's driving that? You know, we don't have a perfect crystal ball, but we certainly think it's - overall M&A is up in '17 versus '16. I think the market while it is competitive it is not as competitive as we saw during 2016. And I just think some of the folks that were playing in the lower middle market, some of the bigger players that we would see from time to time in lower middle market and some of which are our BDC TC peers have all, not all, but some have announced that they've kind of moved up market. And I think that certainly helps our origination activities because we're consistent player in this market, this is where we want to be and we're not here just because our market isn't providing enough opportunities. And I think that's resonating with people, that we're a consistent player in the middle market. I think people have seen bigger players come down and then leave and I think folks are starting to take notice that we're a consistent player in this end of the market. So we're very fortunate in a couple of quarters. But one thing that has surprised us is the volatility in the pipeline. I'm not going to hold my breath and about next quarter, I really don't know what it I mean by that, I mean Q3, I don't know what holds Q3, but I do know we're in a pretty decent spot right now with a solid pipeline of opportunities and again quality is pretty good right now. So we were fortunate enough to win three mandates and it looks like Q2 will be a pretty good quarter in that regard.

[Ryan Lynch:]

Okay. That's very helpful commentary. If I look at your press release and I look at the portfolio activity in Q1, 2017 versus Q1, 2016, ,you guys had about $60 billion of debt investments and about $1 million of equity investments versus in the first quarter of 2016 about $18 million of debt investments and about $4 million of equity investment. So in the first quarter of 2017 you guys did a much smaller percentage of equity investments relative to overall originations. I wanted to know is that just a coincidence that that is just kind of ebbs and flows or you guys taking a concerted effort to participate less in equity co-investment given you know kind of the high valuations that we're seeing deals getting done in today's environment?

[Richard Buckanavage:]

Yes. That first quarter 2016 figure Ryan, was inflated by one large transaction which was $3 million equity investment, which was you know, just a unique situation for us. If you back that out, I think we're pretty much even to where we were in Q1. Again, not that we're looking to be even more strategically though, I think the question is are we deemphasizing equity investments and the answer is not. We will still consider making modest equity investments in transactions where we think there's an attractive equity story, that we think our shareholders to potentially participate. And so the decline really is more just a function of that one big investment, really no change to our philosophy regarding equity investments.

[Ryan Lynch:]

Okay. And then as far as a transition from administrative services from JMP to you guys internally Harvest Advisors, previously JMP had been subsidizing some of the administrative services, the cost of that, I know in 2017 I believe there's going to be a cap of $1.2 million on administrative services. So if they stop being an administrator and goes internal, what should we expect from an administrative cost standpoint from the $1.2 million, at least we're expecting for you guys to have it in 2017?

[Richard Buckanavage:]

I think it's safe to say there won't be any higher than that. We think we can do a little bit better. I think part of the decision process was cost driven. I mentioned something about leveraging, operating leverage, we were fortunate enough to have JMP subsidized in some of the earlier years those costs and obviously our shareholders benefited from that. We're now at a point in time where the dollars are large enough that you can support the team that we need to replicate the services that we obtained from JMP Credit Advisors. But we certainly don't see that number increasing going forward.

[Ryan Lynch:]

Okay. That's good to hear. And then just one quick one, maybe for Craig. So you guys amended the senior security facility in the second quarter. Are there any expected one-time costs that are going hit in Q2 from that amendment?

[Craig Kitchin:]

We won't have any thoughts. Well, we did pay a 25 basis point amendment fee for it, but there were no cost as though flush to the income statement in Q2.

[Ryan Lynch:]

So the 25 basis point amendment fee that's not going to come through, where would that come through?

[Craig Kitchin:]

Well, I just mean it will capitalize that and amortize it over the remaining life...

[Ryan Lynch:]

Okay, perfect...

[Craig Kitchin:]

That's right.

[Ryan Lynch:]

Okay, perfect. Okay. Thank you. Those were all the questions for me.

[Craig Kitchin:]

Yes.

[Operator:]

And your next question comes from the line of Brian Hogan with William Blair.

[Brian Hogan:]

Good morning. And a follow up to the last question from the kind of the cost associated with the internalization. I guess what do you expect from a cost savings perspective, and a question was previously just $1.2 million for the administrative services expenses, and you said maybe a little bit less than that in total. But is there any other expense savings or is that - is that it?

[Richard Buckanavage:]

Well, I can't tell you Brian. It's early in the process. We're commencing the process immediately to begin to identify the personnel necessary to replicate the services. So I don't have an exact figure for you. And quite frankly, we're working internally to see where certain roles might be able to be housed in some of the - you know, the personnel that we already have. So it's really very new obviously. And so we're a little early to begin putting identified cost savings. But again, I - we're were more than comfortable that with that cap that we have in place now that we will be able to replicate that and obviously the goal here is to do better than that. But we won't know until we really finalized what number of people we need, where those people will be housed likely in New York City and then obviously there's some additional location cost that go along with that. But we're pretty comfortable with that $1.2 million being no higher than that to replicate what we've got today.

[Brian Hogan:]

And do any other expense items change?

[Richard Buckanavage:]

No, I don't think so. Again, while we do have some facility costs that will likely increase, their work facility costs built into that number as well that we paid for. So it's that you know, some of the non- personnel related costs that are - were embedded in that number again, we'll have those now to fully burden, but those were embedded in that number as well. So it wasn't just personnel that was benefits and facility costs and things of that nature.

[Brian Hogan:]

Okay. And then just to be clear, it's a full internalization of the management, is that fair characterization?

[Richard Buckanavage:]

Of that part of the - so we're going to put it in the advisor, but it's - yes, we're going to take all of those services over the next couple of quarters and bring them near inner city office.

[Brian Hogan:]

Okay. On the non-accrual, the revenue in security and then CRS, you know, moving those non-accruals this past quarter, what changed?

[Richard Buckanavage:]

Craig, you want to handle the revenue linked security and how deal with CRS?

[Craig Kitchin:]

Yes. The revenue linked security, we're truly an equity investment, we account for it as a beneficial interest in securitized asset and it's a - we participate in consignment for inventory sales from one of our portfolio companies and we actually think the valuation is going to hold and the inventory at that portfolio company is still there and that the payment expectations have been delayed. You know this is a deal that we closed back in August of last year and we really expected the inventory liquidation to begin immediately and the payment stream to begin either in August or September of last year and it hasn't gotten after that quick of a start. So although we think it's still intact, we've only gotten one payment since then. So we've made decision to put it on non-accrual until that payment stream gets back on track and a little bit more consistent.

[Richard Buckanavage:]

And with CRS Brian, I hate you sound like a broken record, but the turn around that we keep waiting for has not materialized. And as with any situation the longer an event that you're waiting for goes without happening, I think the more that you discount likelihood that that is going to happen or at least discount the magnitude of the event impact on the business. And so we've got another quarter past without much movement and so we've further discounted the expectations. And when we did that it resulted in a decision tree for us to keep it on accrual or not. And I think the metrics that we generated through our assumptions regarding CRS dictated that we put it on non-accrual for the time being.

[Brian Hogan:]

Okay. You mentioned in the first quarter the diversity of the opportunities that you've seen and closed. I guess in the second quarter is that with a $21 million mandated and closed, are those similar diversity and then where are you seeing opportunities today that are the most attractive?

[Richard Buckanavage:]

So of the three mandates I think you're referring to the 14.4, those are all sponsored transactions and ironic in that we've seen that to be consistently a more competitive segment of the market versus the non-sponsored transactions. Keep in mind that these are smaller sponsors that need not the household name that many other competitors might be calling on. The all three investments are senior secured investments, so they will likely all be in that same interest rate zip code as you've seen in the Q1 and historically I would say in that kind of L10 to L11.5 range. And beyond that variety of end markets there's no concentration by end market and they are all I would say in that same kind of amounts if you will, kind of that $4 million to $6 million range. I wouldn't say it's anything different. And again, these are investments that did come to us in Q4 and didn't close in Q1 and we thought maybe make some close in May and that doesn't reflect the case, although there's probably one that has a chance to close in May. But certainly if they do close we do expect those 3 to close by end of Q2.

[Brian Hogan:]

Okay. The target leverage I mean, I appreciate your commentary about your $20 million of availability and $20 million in transitory assets. So what is your target leverage ratio. Is there any been any change to that?

[Richard Buckanavage:]

No change, 0.75 to 0.8 is where we're comfortable on the top end of that range Brian and keep in mind I think we announced this last quarter, we didn't highlight it this quarter again, but in addition to the liquidity in cash and the liquidity and the revolver and the transitory assets, we also do expect to get a sizable repayment at some point in the very near future and publicly announce Novitex and SourceHOV looking to merge. We own both of those in syndicated second lien investments. One is $7 million, one is $4 million, so collectively a $11 million that we expect to come back to us that will create some additional liquidity as well.

[Brian Hogan:]

All right. And then just lastly any update on SBIC progress in DC, last time we chatted it was pretty much stalled any change?

[Richard Buckanavage:]

No change. No we're doing nothing on that front currently. So nothing to report.

[Brian Hogan:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Your next question comes from Bill James with [indiscernible]

[Unidentified Analyst:]

If you could comment across the portfolio on just roughly the EBITDA growth if there is any thing standing out with any portfolio company or an industry that might have any type of EBITDA compression?

[Craig Kitchin:]

We look across the portfolio of the weighted average EBITDA increased just under 3% for the quarter, which is not to dissimilar from the prior quarter, but up from some cross-ends more flat results 2016. With regards to those portfolio that where we've seen some weakness, I can't say that its sector related, most of the problems that we've experienced in the portfolio has been specific to those companies and they're not end markets necessarily. So I can't say that we look at it as sector, but we are looking at different sectors, different than others as it relates to what we think the future holds over the next year or so. I can't say that we can look at the portfolio and say if there's weakness in one particular sector, most of its pretty organic [ph] to the company.

[Unidentified Analyst:]

Okay. And then with regard to CapEx, just kind generally throughout the portfolio, is a lot of this just M&A and dividend recaps and you know, family borrowings and stuff or is there - are you seeing any investment in the CapEx as a good IRR to it?

[Craig Kitchin:]

We're seeing some growth capital in our portfolio. The investment in Yucatan, which is Guatemala manufacturer, its actual growing financing to equip a new manufacturing facility. We have another borrower down in [indiscernible] that just moved into a bigger manufacturing facility called Douglas Machines and they increased their footprint due to growth. So we don't see some just pure growth financings and where the IRR supported based line - good growth in their underlying business, so which is obviously a positive sign. We think those types of situations are all indicative of a relatively healthy underlying economy.

[Unidentified Analyst:]

Great. And just last question with regard to those, that growth capital is what kind of paybacks or IRRs are you seeing with that, if you can't comment on it I understand, but I'm just curious?

[Craig Kitchin:]

Well, I mean, I am not going to comment on these banks, but I'd mentioned two names here, but I would say that the decision to spend growth dollars wasn't driven by lowering with a payback period or a return on capital threshold and these are very well worthwhile projects. And the payback I have to say is pretty attractive based on the numbers that we've seen from those - at least those two portfolio companies, but there are others that made investments in their own business over the last 12 months.

[Unidentified Analyst:]

Great. Okay, thank you.

[Operator:]

And there are no further questions at this time.

[Richard Buckanavage:]

Okay. Well, thank you everyone. I appreciate your interest in the business and listening in this morning. We'll look forward to talking to you in early August about third quarter Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect your phone lines.