Harvest Capital Credit Corporation
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good morning. My name is Tabitha and I will be your conference operator today. At this time I would like to welcome everyone to the Q3 Harvest Capital Credit Corporation Earnings Conference Call. (Operator Instructions). Thank you. I'll now turn the call over to Mr. Rich Buckanavage, Company's CEO. Please go ahead.

[Richard Buckanavage:]

Thank you. Good morning everyone and thank you for joining us for this conference call to discuss our financial results for the third quarter ended September 30, 2014. I'm joined today by our Chief Financial Officer, Craig Kitchin. Before we start the call, I would like to ask Craig to 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:]

Thank you, Craig. The topics I'd like to cover this morning, prior to turning the call over to Craig who'll discuss our financial results in more debt, include our deployment activities for the. The performance and characteristics of the portfolio at quarter end the current state of the market and then provide insight into our current quarter to-date investment activities. I'm pleased to report that we closed six financings in the third quarter totaling approximately $21.2 million. Five of these investments were attributable to increases and existing portfolio companies with the remaining one being an entirely new investment. Due to the maturation of our portfolio, investment exits are becoming more commonplace than in prior periods. Evidence of this began earlier in the year and again this quarter in which we exited four investments totaling $11.9 million. One of the four exits was the sale of one of our last placeholder investments and therefore generated an immaterial and internal rate of return. For the three other exits, we realized internal rates of return between 15% and 27%. These exits were attractive outcomes for our shareholders and demonstrative of our disciplined value oriented investment strategy. As of September 30, our portfolio was comprised of investments in 25 companies. Because much of the investment deployment activity this quarter was in existing portfolio companies, total investments declined from 27 the prior quarter. Despite the modest contraction in a number of investments, we continue to make progress in further diversifying the portfolio. The top five investments represented 34.8% of the total portfolio at September 30, compared to 38.3% at fiscal yearend 2013, and 47.3% at the end of the prior year comparable period. Top 10 investments also saw a meaningful decline to 61.5% versus 70% at fiscal year-end and 83% at the end of the prior year comparable period. The continued diversification is a positive for our shareholders. With our capital deployment in the third quarter being fairly diversified 34% senior secured first lane, 23% senior secured last out, and 43% second lane mezzanine. The portfolio composition by asset class didn’t not change materially. Approximately 48% of the total portfolio were in senior secured investments. Approximately 47% second lane and mezzanine investments with remaining 5% in equity and equity like securities. Because senior secured investments typically have floating rate pricing structures, we were able to again this quarter increase the percentage of floating rate investments relative to our total portfolio 57.1%. As compared to 55.4% last quarter and 45.2% at fiscal year-end 2013. From a credit perspective, the portfolio is performing acceptably with a weighted average risk rating of 1.99, which compared to 1.95 last quarter and remains approximately equal to the two risk rating assigned to each investment at the time the investment is made. At September 30, we had six investments rated one and 14 investments rated 2, resulting in 20 of our 24 debt investments rated in our highest two risk categories. Our watch list is limited to four investments, two 3 rated investments and two 4 rated investments. We only have one non-accrual loan, our investment in CRS reprocessing. We placed CRS on non-accrual on July 1, so the negative impact replacing this loan on non-accrual was felt the entire quarter. CRS represents $0.03 per share on accrual basis after incentive management fees. Despite the absence of any income attributable to CRS, we are pleased to have earned the net investment income in excess of our $0.1125 monthly distribution. The first time we've achieved this objective after removing the incentive fee waiver support this year. To address our sole non-accrual loan, particularly in light of the fact that two other BDCs are debt providers to the company and have already hosted earnings call prior to this call. The underperformance at CRS is attributable to ongoing restructuring process added one of its largest customers. During this period, our revenue from these companies had seized and the collectability of AR associated with past sales to this customer is questionable. As CRS' customer works through the restructuring process, the key stakeholders have taken decisive action and have infused CRS with appropriate level of liquidity and secured consensus among the various parties necessary to enable the company to ride out the storm. While the ultimate outcome of the restructuring process is difficult to predict, we are encouraged by the steps taken by the stakeholders, and meaningful level of dialogue that CRS is having with this customer, we believe indicates a genuine attempt to produce a mutually acceptable resolution for all parties. It is worth noting that these events have not impacted their other customers nor the end markets that CRS services and as a result, the company continues to generate positive cash flow. In the event that the most draconian scenario comes to fruition, that no future revenue is recognized from this customer, we believe that adequate enterprise value exists to provide support for HCAP's investment. Lastly, in order to clarify and put perspective around our position in the debt capitalization of CRS, our investment is junior to that of the debt investment of THL credit, but senior to the debt investment of Triangle Capital who have previously reported. The last aspect of the portfolio characteristics, I would like address is investment yields. The weighted average annualized yield of the portfolio at September 30 was 15.4%. This excludes the impact of placeholder investments and the CRS debt financing. This was changed from last quarter, but below the 16.6% portfolio yield at fiscal year-end 2013. The decline in portfolio yield is particularly -- is partially attributable to placeholder investments made during the prior two quarters, a large percentage of (indiscernible) loans that tend to have lower yields and standalone mezzanine investments as well as competitive market forces. Now I'd like to provide a brief preview into the fourth quarter. Quarter-to-date we closed five transactions totaling approximately $19 million. one was an increase to an existing portfolio of company while the remaining four were entirely new investments. Net deployment quarter-to-date is approximately $12.1 million after realizing two exits during the fourth quarter and the sale of one of our placeholder investments. The two exits produced attractive outcomes for our shareholders. Our exit of the Rostra of tool investment generated an IRR of approximately 25%. The exit of our investment in SISD or Garden State produced an IRR of almost 43%. These two additional exits continued to build on HCAP's track record of generating equity like returns through investments and instruments with deft characteristics. Now looking ahead for the remainder of the year. We expect the debt investment environment to remain very competitive and we expect this situation to persist for the foreseeable future. While both leverage and pricing appear to have stabilized, the number of debt providers participating in our market continues to be elevated. Despite the competitive landscape, our origination efforts are benefiting from the addition of two new investment professionals hired mid-year. In addition to more feet on the street, our originations efforts benefit from our creativity and resourcefulness as we search out new avenues to generate incremental differentiated deal flow. As mentioned during last quarter's call, one of the way we had hope to generate previously untapped deal flow was through utilizing our balance sheet that is to say underwrite larger transactions and syndicate a portion of the financing to arrive a prudent hold position. Evidences of successfully implementing this strategy exists this quarter in which we underwrote a $20 million debt financing for FOX Rent A Car. HCAP syndicated this financing in order to achieve our target hold of $10 million. Our willingness and ability to underwrite higher amounts enabled Harvest to win the financing mandate. Bright Media was another such example of this strategy last quarter. In many cases, this strategy also allows Harvest to earn syndication fees and/or fees income. With that, I would like to hand the call over to Craig Kitchin, who'll discuss the financials results in more detail.

[Craig Kitchin:]

Thanks Rich and good morning everyone. Core net investment income for the quarter was $2.2 million or $0.36 per share compared to $1.4 million or $0.23 per share in the third quarter last year. Core net investment income for the year-to-date was $6.3 million or $1.1 compared to $3.5 million or $0.91 per share last year. I will point out again though that the per share comparisons for the year-to-date period are still not completely relevant as we were a private company for the first four months of last year. We completed our IPO in May of 2013 increasing the share count and changing our cost structures, we took on public company expenses that we did not have before. For the quarter, as Rich mentioned, we out earned the dividend by $0.02 and that's after taking into account the one credit placed on accrual which reduced NII by $0.03 per share for the period. This is the first quarter since the IPO that the company has earned the dividend without the waiver of incentive fees and due to out earning the dividend in Q3, the company has now also earned the dividend for the year-to-date period. I would also point out that earnings for the quarter and the year-to-date are largely unlevered. Although we had $14 million drawn on the credit facility at the end of the quarter. The average debt outstanding during the period was $2.4 million and for the year-to-date period, was $1.5 million. So as the company takes more full advantage of its available leverage, earnings should expand. Net income was $2 million or $0.33 per share for the quarter compared to $1.1 million or $0.18 per share in Q3 of last year. Net income for the year-to-date was $6.7 million or $1.8 compared to $3.6 million or $0.93 per share a year ago. We had unrealized depreciation in the quarter of $243,000 or $0.04 per share compared to depreciation of $360,000 or $0.06 per share in Q3 of last year, the depreciation for the quarter was primarily attributable to our one non-accrual account and the reversal of unrealized depreciation related to the pay-offs of ARC loan [ph] and (indiscernible) during the quarter. These were partially offset by strong unrealized gains on Rostra and LNB. The Rostra investment paid off in October generating additional net investment income and a large realized gain on the equity investment in that deal. As of September 30, fair value of the portfolio was $98.5 million versus amortized cost of $97.8 million reflecting $800,000 of net unrealized depreciation in the portfolio at the end of the period. As of September 30, we had $7.8 million in cash and only $14 million drawn on our $55 million facility. So with our cash and borrowing capacity we have enough dry powder to fund new investments for the next quarter or two, but since the pipeline is full, we are planning for our next capital raise and pleased to announce that our shelf registration statement was declared effective by the SEC last week allowing us to more efficiently raise equity, high yield debt and convertible debt or preferred equity. We have no imminent plans to raise money off the shelf at this point but we are glad it's available and given the current stock price we'd point out that an equity offering is not in the near term horizon. We'll most likely explore raising additional debt funds either through the exercising of the accordion feature on our credit facility or a baby bond or convertible debt offering off the shelf. As of quarter, NAV per share was $14.51 down $0.01 from a quarter ago. Our net investment income of $0.37 per share was offset by $0.34 in dividends and $0.04 of depreciation in the quarter. And with that I will turn things back over to Rich.

[Richard Buckanavage:]

Thank you Craig. Operator, would you please open up the lines so that we can address any questions our audience has. (Operator Instructions). Your first question comes from the line of Brain Hogan, William Blair.

[Brain Hogan:]

First question on the non-accrual and thanks for the detailed discussion around that. How much interest was related to that?

[Craig Kitchin:]

It was net $0.03 for the quarter, $0.04 growth and $0.03 after the incentive fee.

[Brain Hogan:]

Okay that's -- but how much interest did you non-accrue?

[Craig Kitchin:]

It was approximately $250,000.

[Brain Hogan:]

Okay. Thank you. And then the fee income and the other income were actually well above our expectations and above prior quarters (indiscernible) realized those are probably both lumpy lines. I'm just trying to get a better sense of what is maybe a normal run rate, what's -- how lumpy was the lumpiness?

[Craig Kitchin:]

Well there was $0.08 gross, $0.06 net related to the payoffs of (indiscernible) in the quarter and so it was higher than it had been. I guess we'd also point out that our policy on capitalizing and deferring fees is very conservative and so as Rich mentioned, with the portfolio maturing, it's less of a one-time thing and probably more of a recurring type of amount of income. It's hard to predict, but there is approximately $0.38 in deferred fees on the balance sheet. So as these credits certainly in the portfolio turnover, we'll have more of that sort of one-time fee income.

[Brain Hogan:]

Okay. You mentioned competition. Is it stable pricing and relatively stable leverage too? And is it increased competition? Who is banks coming downstream as other kind of niche players?

[Richard Buckanavage:]

Yes, definitely a pretty wide array of competitors that we were confronted with today. There is a few BDCs that have dropped down into our market. Certainly SBIC funds when we're talking about mezzanine investments, non BDC financial entities and then as you said banks, commercial banks are squarely in our market. They are not competing that aggressively on leverage but they are competing very aggressively on price. So we're kind of seeing a pretty broad base of competition, some of which we think they are consistent players, consistent competitors in this end of the market. Some we believe actually are temporary competitors and we think that will migrate back up to the larger deal market once that market generates enough opportunities to satisfy the dollars that have been raised to focus on that market.

[Brain Hogan:]

And then with where your share price is at, I know you put a self-offering out there, but two things around that as one would you repurchase shares at this level and two, would you raise capital below book value?

[Richard Buckanavage:]

Yes, with regards to the first one, we haven't really talked about that that much. We're really looking at deploying capital and we think right now we're still finding opportunities to deploy capital and generate returns as you heard from my prepared remarks. Those returns are well in excess of what we think we would achieve at least currently by buying back our stock. With regards to issuing equity below book, absolutely not.

[Operator:]

Your next question comes from the line of (indiscernible) with KBW.

[Unidentified Analyst:]

Rich again, I reiterate that there was great color on the CRS. Just a couple questions following up on that. First of all, does the senior debt have blocking lights on either your instrument or anything below you?

[Richard Buckanavage:]

They do.

[Unidentified Analyst:]

Okay. Is that kind of -- is that why you are non-accrual but still have to hire even though you believe the enterprise value is high, with still a pretty high mark on it is that's the reason to be on non-accruals because the senior is blocking?

[Richard Buckanavage:]

Yes, that's a safe assumption.

[Unidentified Analyst:]

Okay. And then Craig you talked about leverage and potential baby bond and buyback. Can you remind us what your target leverage is for the portfolio?

[Richard Buckanavage:]

Yes, we've been targeting I think pretty much from the beginning kind of 0.7, 0.75, which obviously as Craig said, fairly unlevered today. But that where we hope to get to over time.

[Unidentified Analyst:]

Okay. And then one last one. Kind of the new deals that you're seeing, obviously we've heard that there is over the last couple of years obviously the energy sector has taken off in so many different direction that the availability of investments in the energy sector has really increased. Can you talk about the any exposure you have there today and kind of in the pipeline there are you looking at any additional energy investments?

[Richard Buckanavage:]

We really don't have a lot of exposure to energy in the portfolio. We're always concerned that when things look so attractive and have such a big run up that they can fall just as fast, and of course we've seen that in the energy sector, but I don't really -- I can't think of a portfolio company that has a significant exposure to energy or declining oil prices. So and I think certainly we would -- we don't just look at the companies and kind of what the market stays. We -- sometimes you have to look through their customers and looking at where their demand is and I'm not aware of any exposure to energy.

[Operator:]

(Operator Instructions). And your next question will come from the line of William James, Major Investment [ph].

[Unidentified Analyst:]

Going forward, is it possible in your release to put your last dollar in to EBITDA by asset class?

[Richard Buckanavage:]

Yes, certainly we can talk about that. It's not something that we've clearly done historically. We will consider the request and determine whether that makes sense for us to going forward, but it's -- I know some other folks have done that in their released information.

[Operator:]

At this time there are no further questions.

[Richard Buckanavage:]

Okay. Well thank you everyone. We appreciate you spending the time us with this morning and we look forward to talking to you in a couple of months to discuss our year-end results.

[Operator:]

Thank you ladies and gentlemen. That does conclude the call for today. You may now disconnect.