Harvest Capital Credit Corporation
Q4 2017 Earnings Call Transcript

Published: 2 Apr 2018

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Harvest Capital Credit Fourth Quarter 2018 Earnings Release. All lines have placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Joseph Jolson, CEO of JMP Securities. Please go ahead.

[Joseph Jolson:]

Okay, thanks operator. You almost got that right, Harvest Capital Credit, not JMP Securities, but Craig Kitchin our CFO will take us through our safe harbor disclaimer and then I'll follow with some remarks. 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.

[Joseph Jolson:]

Thanks Craig. I apologize for the delay in reporting our fourth quarter 2017 results. As a Cofounder and Chairman of Harvest Capital Credit I've been pleased to be a small part of the company's success during most of the past five years. Recently, I was asked to take on the additional role as CEO and to help position the company for future growth. As part of our year-end closing process, we determined that certain internal controls needed to be modified to improve the timely reporting of current portfolio developments to our Finance and Administrative Services Department. As a result of this assessment, we identified a material weakness in our internal controls over financial reporting as disclosed in our Form 10-K. In addition it had become increasingly clear that our A to Z approach for investment staff was limiting their ability to consistently focus on originating attractive risk-adjusted return opportunities. To address these issues we have restructured our operations into three functional areas; business development, portfolio management, and financial administration. Rich Buckanavage, who is routinely our largest originator will lead our business development efforts and will be supported by four investment professionals. Jim Fowler, who I worked with for most of the past 20 years has accepted the role of Chief Investment Officer of Harvest Capital Credit to oversee our portfolio management efforts. In addition we are scheduled to complete our planned transition of our financial investment administration functions to Bill Alvarez and his team in New York before the end of April. I want to publicly thank our CFO, Craig Kitchin, and our Chief Compliance Officer, Renee Lefebvre, for all their efforts during the past seven years in helping to make this business a success. Craig will take you through our financial results for the quarter before tuning it back to me for some closing remarks. Craig?

[Craig Kitchin:]

Thanks Joe, and good morning everyone. Net investment income for the quarter was $1.9 million or $0.30 per share compared to $2.4 million or $0.37 per share in the fourth quarter a year ago. NII was down in the quarter due to a couple of factors. Number one, our investment in Infinite Care was put on nonaccrual in Q4 resulting in us not booking approximately $0.05 per share of interest income. I should point out that Infinite did pay interest in Q4, we just applied it against the principal balance and number two, the portfolio was smaller. We ended 2017 with $115.6 million in investments compared to $134.1 million a year ago. Because the portfolio was smaller and less levered it didn't have the same earnings power it had a year ago. Net income was $1.5 million or $0.23 per share compared to $2.8 million or $0.44 per share in the fourth quarter last year. The decrease was driven primarily by lower NII and a small amount of depreciation this quarter compared to appreciation in the portfolio last year. As of December 31, 2017 the fair value of the portfolio was $115.6 million versus amortized cost of $119.1 million reflecting $3.5 million of net depreciation in the portfolio. At year end, we had a total debt balance of $44.5 million for a debt-to-equity ratio of 54%. However, net of cash the debt balance was $33 million and debt-to-equity was only 40%. At year-end NAV per share was $12.66 down $0.20 per share from last quarter and lastly we are caring over just over $1.1 million or $0.17 per share of undistributed spillover income into 2018. And with that, I'll turn things back to Joe.

[Joseph Jolson:]

Thanks Craig. Looking forward, I'm exciting about the opportunity to help grow Harvest Capital Credit into one of the leading providers of financing solutions to the lower middle market. We have a strong base and are well positioned for growth with excess capacity of more than $30 million to put to work by year end 2018. I believe the new operating structure will benefit the company through more consistent new investment originations and through greater scalability of the platform as we grow. We are evaluating the recently passed BDC reform legislation which could allow us to grow assets to approximately $200 million without raising new equity capital under certain conditions. In addition to focusing on increasing our new investment productivity, we are even more focused in the near-term on improving our credit quality back to our historically high standards. Since quarter end we successfully exited one of our two four related investments, WorkWell, at its year-end 2017 fair value of $3.9 million. We also took control of five rated Infinite Care through a UCC sale of its equity interest in late January. We gained functional control during the fourth quarter and acted quickly to add resources to help stabilize the business and identify operational improvements, some of which have already been successfully implemented. I want to take this moment to thank our hard-working team and our independent board members for their tireless efforts to help make Harvest Capital Credit a success, in particular, during the past few months, given the recent circumstances. I look forward to providing everyone an update on our progress when we report our first quarter results in May. Operator, with that, Rich, Craig and I would now be happy to take any questions.

[Operator:]

[Operator Instructions] Your first question comes from line of Brian Hogan with William Blair.

[Brian Hogan:]

Good morning.

[Joseph Jolson:]

Hey, Brian.

[Brian Hogan:]

The dividend reduction, is that a reflection of Infinite Care being placed on nonaccrual or is it just outlook for your business going forward, is this the current - what we should expect given the yield environment and competitiveness and just kind of what led to the dividend reduction?

[Joseph Jolson:]

Well, I'll take a crack at that. You know, we think it's important over any reasonable period of time for us to earn the dividend and redeploying capital in this environment which has been highly competitive for at least the last four years has as you've seen over time our yields have come under some pressure. And so we felt that shutting it at that level was appropriate going forward. Now we're hoping over time there is upside to that number and we'll be in a position to raise it back up again. But we don't believe in under earning the dividend for any reasonable period of time.

[Brian Hogan:]

All right and I agree with that philosophy. Can you discuss the - kind of that - I guess origination…

[Joseph Jolson:]

By the way Brian just – I don’t know if you, sorry to interrupt you, but we have also been buying stock back and so if you look at it in the context of share repurchases, perhaps the dividend, the return of capital to shareholder is not out of line with what it was before.

[Brian Hogan:]

Right. I was actually going to ask about dividend later, but that share repurchase later, but yes thanks. On the origination team is there any change in strategy with kind of a realignment, do you have enough resources dedicated there? How are you leveraging the JMP platform?

[Joseph Jolson:]

I'll let Rich take that question and then maybe I'll have a followup. Rich?

[Richard Buckanavage:]

Yes Brian, no real change in strategy with regards to originations. I think the recently announced organizational changes free up our investment staff really to focus on origination and underwriting and then hand off a little bit of the portfolio administration to Jim Fowler and his team. So I think it will be a more consistent effort in the marketplace versus how it's been handled historically where we've kind of been in the market for two months and then we kind of go out of the market during the quarterly cycle for risk rating and portfolio valuations. So I feel like we're going to be more effective in the marketplace, but as far as what we are looking for and type of company and the asset class we're looking to invest and you won't see a material change there.

[Joseph Jolson:]

Yes, I would just add to that, that Rich has been by far our most productive origination person and part of the reason for me stepping in was also to free up some of his time to fully focus on that area. It’s a highly competitive environment right now, but we have historically been able to find pockets of opportunity even in this environment. So I think Rich being able to focus maybe 80% or 90% of this time on that versus I would say may be half of his time or less should be very important going forward.

[Brian Hogan:]

Is that pretty much the reason why the leadership change there, is that the sole factor?

[Joseph Jolson:]

No, I think it was a combination of, the stuff we disclosed in the 10-K as well as the importance of really building the investment back up and to grow it going forward, so it was a combination.

[Brian Hogan:]

Sure, can you discuss the pipeline quality of that may be reference to like last previous quarters, is it better, improved, larger?

[Joseph Jolson:]

Yes, Rich why don’t you take that one too?

[Richard Buckanavage:]

Yes, Brian the pipeline right now as far as number of transactions, I would say hasn’t changed materially which actually is a good thing, so I think if you would recall, several quarters worth of discussion in the market, there were quarters where we had a very robust pipeline and then quarters where we didn’t. And I would say that for most of the first quarter we’ve seen a pretty consistent level of opportunities which is a good thing. As far as quality goes, we actually feel the quality has been pretty good as well and that’s equally as important. Just as some characterizations from looking at our pipeline that we actually discuss each Monday of 70% of the transaction are sponsored back that’s a little up on the high end for us which isn’t a bad thing, but just an observation. About 75% unitranche that’s both from I think trends in the market, borrowers or sponsors asking us for unitranche approaches and also us, I think focusing a little bit more on unitranche versus second lien and mez at this time. And with regards to pricing, I would say the pricing is clearly stabilized in Q1 and that’s also very good trend for us. I have not seen any further degradation, that we saw throughout 2017. So we're somewhat optimistic is with regards to the number of opportunities we've got. We have no current mandates, but we have several term sheets out and we’re hopeful that will win our fair share and again with a good pipeline, number of opportunities and with a good quality pipeline we're pretty comfortable that we’re going to win our fair share.

[Brian Hogan:]

All right and then Infinite Care, can you in the 10-K you’ve laid out some of the options that you are exploring and just kind of - but can you discuss Infinite Care may be on the high level like what to do and what your options are?

[Joseph Jolson:]

I’m not sure that a public forum is the right place to talk about one of our investments, where there is a lot of disclosure that we put out in the K there about the situation. I will just say this at a high level is that and Rich correct me if I’m wrong, but I think this was the first investment in seven years where we actually had to step in and take control of the company and exercise our rights and remedies and as a debt holder to do that. So I think that is a troubled situation and we got resources on the ground very quickly in the fourth quarter after we took functional control that identified some issues that we addressed and I think made some changes and it’s too early to tell now Brian, but at least for the first couple of months we have one month I guess in some flash reports I think that things have stabilized to improve. I don’t know Rich, do you have any more color to that?

[Richard Buckanavage:]

No, I think that’s proper characterization for now. I think it’s a little early for us to - mean that we've laid out what some of the options are, but I think we're still in the evaluation phase as it relates to what steps it might be.

[Brian Hogan:]

All right, and last one from me at the movement, but the BDC law change you mentioned it upfront and like I guess is there anything in your credit agreements that wouldn’t restrict how fast you can do that, some debt that matures later this year and stuff like that, but would you target the same strategy or would you go a little more senior given the increased leverage? I mean what is kind of your strategy or thought process around the law change obviously is to exploit that but…?

[Joseph Jolson:]

Well it just passed, so we have – we-re under invested right now under the old law, so I think first things first right. We want to put back to work that $30 million of cap of capacity that we have under the previous situation and as we do that I’m sure we will be updating you guys on any other changes in strategy. But, I mean, if you just look at the math, it probably gives us opportunity that we wouldn’t want to do anyway at this late stage of a business cycle to do more unitranche deals that have a little bit lower yield, but can and there we have more leverage with our lender group Brain. So - but we have a - first things first Brain, we've got to put to work the $30 million plus that is under the old rules.

[Brian Hogan:]

Understood, I appreciate your time this morning.

[Joseph Jolson:]

No, problem. Thanks for your questions.

[Operator:]

We have no further questions. Mr. Jolson, do you have any closing remarks.

[Joseph Jolson:]

No, I’m looking forward to give everyone an update in May on our progress and thanks for your interest in Harvest Capital Credit. Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.