Harvest Capital Credit Corporation
Q4 2014 Earnings Call Transcript

Published: 12 Mar 2015

[Operator:]

Good morning, my name is Naine and I will be your conference operator today. At this time I would like to welcome everyone to the Harvest Capital Credit Cooperation Q4, 2014 Earnings Call. [Operator Instructions]. Thank you. I would now like to turn the call over to Mr. Richard Buckanavage. Please go ahead, sir.

[Richard Buckanavage:]

Thank you. Good morning, everyone and thank you for joining us for this conference call to discuss our financial results for the fourth quarter and full year-end December 31, 2014. I'm joined today by our Chief Financial Officer, Craig Kitchin. Before we start the call, Craig could you please 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. As is typical for our earnings call I will discuss a few high level topics that I believe are particular interest to our shareholders including our deployment activities forte quarter, portfolio takeaways at quarter and fiscal year-end, the current state of the markets and our current pipeline of potential investment opportunities as we look forward to the end of the first quarter in a few weeks. I will then turn the call over to Craig who will discuss our financial results in more depth, after which we will provide time to field any questions our participants have. Before I begin though I would like to briefly comment about our financial results for fiscal year 2014 which I'm very proud. Harvest Capital generated core net investment income of $8.5 million or $1.38 per share earning our annual dividend of $1.35 by $0.03 per share. This was a 55.2% increase from core NII in fiscal year 2013. Net asset value per share increased to $14.60 per share from $14.45 per share at fiscal year-end 2013 and $14.51 per share last quarter. Furthermore our taxable income for fiscal year 2014 was $1.52 per share which includes $0.12 of long term capital gains which enables us to carry over $0.17 of taxable earnings into 2015 providing us with financial flexibility and shareholders with confidence and our ability to maintain our current distribution level. These accomplishments are worth mentioning because they contrast with many of our peers that are experiencing declining NAV and finding it difficult to earn their dividend resulting in several recently announced dividend reductions. Now on to the fourth quarter's activities, during the fourth quarter we converted a robust investment environment into eight closed transactions totaling $24.5 million in investment commitments. Six of these investments were made to entirely new companies with the remaining two financings in existing portfolio companies. The weighted average yield on these investments were 13.1% including two small placeholder investments and 13.5% excluding the placeholder investments. These are pure yield numbers excluding the impact of upfront fees and various other fees that we may charge. This investment activity allowed us to increase our total number of portfolio companies at December 31 to 29 from 20 at the end of the same period last year. Due to the maturation of our portfolio, investment exists are becoming a routine event and the fourth quarter was no exception. We experienced two full exists and one partial exit during the quarter totaling $6.9 million resulting in net portfolio growth of approximately $17.6 million. These three exists produced a weighted average IRR of over 25% and excluding the partial exit of NATC one of our placeholder investments the weighted average IRR was over 28%. These exits further our track record of favorable outcomes for our shareholders and demonstrate the benefits of our disciplined value oriented investment strategy that continues to produce equity like returns to investments through investments and largely debt securities. As of December 31 our portfolio was comprised of investments in 29 companies because the deployment activity this quarter was weighted toward entirely new companies to total portfolio increased from prior periods. Growth in the portfolio helps to create greater diversity across a variety of metrics by [indiscernible], by industry, by asset class among others resulting in tangible benefits to shareholders. For example the Top 5 investments in our portfolio represented 34.4% at December 31, 2014 compared to 35.7% at the end of the third quarter and 38.3% at the end of fiscal year 2013. The Top 10 investments also saw a meaningful reduction to 58.4% at December 31, 2014 compared to 63% at September 30, and 70% at fiscal year-end 2013. While our disciplined investment strategy does at times limit our growth trajectory it is the same discipline strategy that has created very attractive portfolio diversification by end market. With our largest industry category representing only 9% of the total portfolio and our portfolio comprise of 29 investments is invested in 27 distinct end markets. Our diversified investment strategy that includes an array of different asset classes continues to deliver benefits to shareholders in terms of risk mitigation. At December 31, 2014 our portfolio was comprised of 50% senior secured debt investments. 45.8% junior secured debt investments and 4.2% of equity and equity like securities. As a result over 95% of our total portfolio and 100% of our debt portfolio is secured by at least a first or second lien. The benefits to shareholders include Harvest Capital having a front row seat at the table and any restructuring discuss enabling us to have meaningful input into resolution conversations and maximizing our recovery of principle. Because senior secured debt investments typically have a floating rate pricing structure. For the fourth consecutive quarter we’re able to increase the percentage of floating rate investments relative to our total portfolio to 62.4% as compared to 57.1% last quarter and 45.2% at fiscal year-end 2013. Where our current capitalization stands today our future earnings have very low exposure to rising interest rates. From a credit perspective the portfolio continues to perform acceptably with a weighted average risk rating at December 31, 2014 of 1.97, an improvement from 1.99 last quarter and remains approximately equal to the two risk rating assigned to each investment at the time the investment is made. At December 31, we have 5 investments rated one, 18 rated two, 2 rated three, 1 rated four and 1 rated five. We currently have two loans on non-accrual status. Lastly the weighted average annualized yield of the debt portfolio at December 31 was 15.1% compared to 15.4% at September 30. The decline in portfolio yield is partially attributable to the continued focus on senior secured debt investments that tend to have lower yields than standalone mezzanine investments. As well as lower returns on standalone mezzanine securities due to competitive market forces and to a lesser extent temporary placeholder investments which tend to have significantly lower yields that are highly rated and highly liquid securities that are easily monetized and reinvestment into our core strategy. After a robust fourth quarter the lower middle market appear to be taking a breather as we enter 2015 as our average pipeline and investment opportunities fell and then the number of quality opportunities fell even further. As a result quarter to-date 2015 we have closed only two transactions totaling $7.5 million in investment commitments. One was an increased to an existing portfolio company totaling $4.5 million with the other financing in an entirely new portfolio company. During the remaining few weeks of Q1 we do not anticipate to have [indiscernible] payments and as such we expect our net deployment for Q1 to be no less than $7.5 million. Looking ahead to Q2 and the remainder of the year, we expect the lending environment to remain extremely competitive and we expect this environment to persist for at least the next few quarters. While the number of debt providers currently participating in our market remains elevated it may be that in the second half of 2015 we finally witness a slowdown in the aggressive lending practices of some firms as they come to terms with the inability to raise additional capital due to low stock prices relative to NAV and fully levered balance sheets. Because leverage levels in the low middle market have been relatively stable for several quarters we see the primarily benefit being yield expansion should these events transpire. As I mentioned during prior earnings call our response to this competitive environment continues to be finding new previously untapped channels of origination where we can augment our traditional deal flow and differentiate ourselves from our peer group. We continue to seek to leverage certain areas of expertise, housing our corporate partner JMP, as well as tap into silos of knowledge within our Board of Directors. With that I would like to turn the call over to Craig Kitchin.

[Craig Kitchin:]

Thanks, Rich. Good morning, everyone. Core net investment income for the quarter was $2.3 million or $0.36 per share compared to $2 million or $0.32 per share in the fourth quarter of 2013. Core net investment income for the year was $8.5 million or a $1.38 per share, compared to $5.5 million or a $1.24 per share last year. I will remind everyone again though that the per share comparisons to the full year 2013, are not quite apples to apples as we were a private company for the first four months of that year. We completed our IPO in May of '13 increase the share count and taking on public company expenses that we did not have before. Core NII exceeded the dividend for the quarter by $0.02 and that’s after taking into account two investments on non-accrual which reduced NII by $4.05 for the period. This is the second quarter in a row since the IPO that the company has out-earned the dividend. We also did it for the full year by $0.03. In addition, to out-earning the dividend with core earnings we also had $0.11 in realized capital gains in 2014. It is worth noting that earnings for the quarter and the year were still largely unlevered although we had 26 million drawn on the credit facility at the end of the year, the average debt outstanding during the fourth quarter and the 12 months was 18.2 million and $5.7 million respectively. This puts our average debt to equity ratio at 20% for the quarter and 6% for the year both of which were well under our target leverage level of 75%. PIK income represented 7% of total interest income in Q4 and 10% of interest income for all of 2014, the percentage of our income that PIK has been on the decline recently as a larger percentage of our investments have been senior or unitranche transactions which tend to have a less of a PIK component than more junior deals. Additionally we have been collecting a lot of previously piked income when investments are realized. In 2014 we accrued 1.4 million in income PIK. I point this out because PIK sometimes gets discounted more heavily than other income since it doesn’t turn into cash right away but it's the portfolio gets more seasoned and realizations continue the collections do catch up with the accruals. Net income was $2.7 million or $0.44 per share for the quarter compared to $521,000 or $0.09 per share in Q4 of 2013. For the year net income was $9.4 million or a $1.52 per share compared to 4.1 million or $0.93 per share in 2013. As of year-end 2014 the fair value of the portfolio was a 115.8 million versus amortized cost of a 115.1 million reflecting $700,000 of net appreciation in the portfolio at the end of the year. The fair value of the portfolio has been above cost since inception even after the relatively large realized gain in Q4. I mentioned the two non-accrual investments earlier, CRS was placed on non-accrual in Q3 and Solex in November of Q4, together they represent 5.8% of the portfolio at fair value and 7% at cost. The NII impact in Q4 was $0.045 on a full quarter run-rate basis the impact is $0.05 per share. As of quarter end we had 2.2 million in cash and only 26 million drawn on our $55 million credit facility. Additionally we completed a baby bond offering in Q1 of 2015 raising $27.5 million and using the proceeds to pay down the credit facility balance to zero. So with our cash and borrowing capacity we have enough dry powder to fund new investments for 2015 but with the $55 million credit facility plus the $27.5 million of bonds that brings our total debt availability to 82.5 million which essentially maxes out our borrowing capacity until additional equity is raised. I would point out that we also have $11.3 million of lower yielding broadly syndicated loans that could be monetized and invested in core deals with higher yields. These investments had a weighted average yield of 10.5% at year-end. As of quarter end as Rich mentioned our NAV is $14.60 per share, was up $0.09 from a quarter ago and net income of $0.44 in the quarter was offset by $0.34 and dividends paid. Our taxable income for 2014 is $1.52 per share, $1.40 of that is ordinary income and $0.12 is long term capital gains. The realized gain of $0.11 mentioned earlier is a GAAP gain. There are few other book tax differences as well. One of the bigger ones relates to our CLO equity investment in which the cash distributions and the estimated taxable income are considerably higher about 321,000 higher than the GAAP income that we booked from that investment in 2014. This was offset by $464,000 of unrealized depreciation for GAAP that is not taxable until it's realized. That concludes my comments and I will turn the call back over to Rich.

[Richard Buckanavage:]

Thanks, Craig. We’re very proud of the accomplishments in 2014, it's been a very exciting year for us as we continue to grow the platform, the portfolio, produced the kind of results that we had hoped to produce. The metrics that we target throughout the year, we’re earning the dividend and maintaining our NAV and we have accomplished both of those objectives. With the $0.17 per share spill over taxable earnings we’re at sound footing going into 2015. The portfolio continues to perform well and its composition continues to become more granular affording many benefits to our shareholders. With that I would like to thank everyone for listening in this morning and ask the operator now to open up the lines for any questions you may have.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Troy Ward with KBW.

[Troy Ward:]

Rich and Craig, just a couple of quick questions on the portfolio and particularly on the credit quality. The two non-accruals CRS and Solex, I know the 10K isn't -- or maybe it just hit but can you provide us what are the fair value marks on those -- at the December year-end?

[Richard Buckanavage:]

Sure, we have CRS marked at 81 and we have Solex marked at 76.

[Troy Ward:]

Okay and then on your internal credit ratings, last quarter we had two at a four, now we have one in a four and one at five. I assume one of those is the one that slip down to five is that correct?

[Richard Buckanavage:]

That is correct.

[Troy Ward:]

And can you tell us which one?

[Richard Buckanavage:]

It's Solex.

[Troy Ward:]

And then Rich, you talked about -- when you’re talking about the competitive landscape and clearly as we think about the competitive landscape a lot of it does have to do with public companies and BDCs access to capital and that’s definite new capital headed after loans in the marketplace but when you think of the landscape what percentage do you think of the competitors that you see on deals are public versus private and where do you see the most pressure coming from on pricing and structure from public guys or private guys?

[Richard Buckanavage:]

It's always difficult to tell exactly Troy, we don’t have perfect clarity on every transaction but I would say that if I had to ball park it it's probably pretty evenly mixed between private and I guess for us private probably means SBICs clearly seeing strong competition from the SBICs, tremendous amount of money is being raised in that sector and they are obviously looking to deploy that capital. With regards to the publics I guess the BDCs, we have no problem competing against the traditional lower middle-market players because they don’t understand the space. The players that we’re most concerned about some of the larger BDCs that have slipped down into our market to find yield and tend to underprice transactions and in some cases over lever but it's really the main basis of competition for us and the main issue for us today is really more yield than it is leverage. Leverage has pretty stabilized for several quarters so it's really a yield issue for us and some of the bigger BDCs that come into our market and price credits that we feel are 100 to 200 basis points higher under where we think it's logical to invest. So those are the players that concern us the most and we hope those are the players migrate back to their core market at some point in the future.

[Troy Ward:]

Okay and then one final one and then we will hop back in the queue. You had the debt issuance in the quarter and the proceeds from that. Rich, how do you view the use of proceeds we have seen where you will take placeholder investments, I think I saw the Chrysler and Dell both in there. How do you kind of think about using placeholder investments versus just being under levered for a period of time. I know the proceeds by and large are going to be used to pay down debt with only $7.5 million quarter to-date, do you anticipate any additional placeholder investments?

[Richard Buckanavage:]

No we don’t and to your point those are fairly modest as you can see 500,000 in each and they were done in the fourth quarter prior to the baby bond offering. The baby bond offering actually does some -- has some tangible benefits for us and so what we were looking to do at quarter end is to create some additional cushion both in our risk diversification task and our diversification task that’s within our revolving credit facility to give us a little bit more cushion so we can sleep at night. So we really after the baby bond issue we really at that cushion has actually increased even more and so the need to have additional placeholder investments is eliminated and in fact my guess is you won't see those credits on our balance sheet for very long but they served a purpose for temporary period of time.

[Troy Ward:]

So the purpose was diversification and not income?

[Richard Buckanavage:]

Correct.

[Operator:]

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

[Brian Hogan:]

My first question is on Rich I think you mentioned in your script new channels of originations, can you elaborate a little bit on that and I think it's maybe partially with the I mean did a large deal with FOX Rent A Car but you syndicated half of it out. Is that kind of what you’re talking about or just kind of elaborate on that please?

[Richard Buckanavage:]

Sure. Actually the FOX Rent A Car transaction and what I referenced in my script were really two different things but it's worth bringing up. What we were trying to do is find opportunities where we can where we can differentiate ourselves and use some of the expertise that we have here at Harvest. One of those areas of expertise is our knowledge of the marketplace and relationships with other lending groups. FOX is a perfect example of that, stepping up to a $20 million transaction and then syndicating out down to a target hold level for us which was 10 million to 12.5 million, we ended up 10 and syndicated the other 10 to two institutions because of our backgrounds we do have some syndication capital markets background here. We’re able to utilize that versus maybe historical periods where said 20 million transaction was just too large for us and pass on that opportunity. We want to be able to use some of that expertise to maybe step up slightly larger hold positions and then syndicate down to a lower target level. Contrast that against what I referenced in my opening remarks. What we’re trying to do is we’re trying to find areas of expertise within Harvest Capital Credit within as I mentioned our corporate sponsor JMP or even on our board and there is a couple of areas that we continue to look into. If you look at JMP being their four core verticals being healthcare, tech, real estate and financial services, we’re looking at some interesting opportunities within those silos and take advantage of some knowledge there to again differentiate ourselves generate some differentiated proprietary deal flow where we’re not just looking back to the same historical origination channels but we’re trying to expand those channels so that’s an example. Nothing to talk about concretely today but we have made some progress and I think certainly in 2015 we hope that we will find an area where we can unlock some deal flow that we previously have found interesting but have largely untapped.

[Brian Hogan:]

All right. And then on the syndicated, FOX Rent A Car, I assume you’re earning fees on that. Does that show up in the other income line because it's been higher than we have looked at or expected for the past four quarter?

[Craig Kitchin:]

Yes, the syndication fee is another income in Q4.

[Brian Hogan:]

How much was it?

[Craig Kitchin:]

250,000.

[Brian Hogan:]

You mentioned the competition from the SBICs, what are your thoughts on obtaining SBIC license. I think you would provide additional accretive growth opportunities for you down the road?

[Richard Buckanavage:]

Well our corporate policy is not to comment on strategic initiatives such as an SBIC license, I guess will make the following observations, clearly it's an attractive area to explore for BDC, it unlocks attractive -- access to attractive debt financing and if you look at the core business for Harvest Capital take away some of the syndicated deals that we participated in but look at our core business. Most if not all of that core activity would fit the criteria of the small business criteria of the SBA. So it's all I can say right now, but certainly something that we have looked into and have explored and certainly think that it would be something that would be an attractive adjunct to our current capitalization.

[Brian Hogan:]

All right. And then one last question, the spill over income, $0.17 a share. What are your thoughts on special dividend or just carrying that forward?

[Richard Buckanavage:]

I think our thought is we’re going to see how rest of 2015 plays out but the options are I think for us we can announce a special dividend or we can use part of that to support the existing distribution level. I think we want to get further into 2015 before we make that determination but obviously it's a nice thing to have and certainly provides us with the flexibility in '15 and certainly should provide shareholders with confidence in our at least our current distribution level.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Troy Ward with KBW.

[Unidentified Analyst:]

This is Greg, actually I wanted to follow-up on Troy's question on the two non-accruals CRS and Solex. Obviously $0.05 a quarter is a huge -- could be a huge boast to your income. Can you just talk about what roles you’re playing in both of those and do you’ve any expectations of -- you know any abilities to return those and get a nice boast to income when those come back on accrual status?

[Richard Buckanavage:]

Well let me take I guess each one separately because it's obviously two very different situations, CRS I guess the facts that I can't state are that it has taken longer for this situation to resolve itself. I think the guidance that we gave was maybe by year-end or maybe into January, obviously we’re here in mid-March without resolution. What I can tell you in that particular instance is that all parties are working collaboratively which is always a most likely for good outcome. The stakeholders continue to support the business with liquidity that enables the company to continue to operate during this period of uncertainty. Right now it is very difficult, this is a foreign jurisdiction so it's very difficult for us to pinpoint a resolution date but I do believe based on some of the more recent events that we will have more concrete statements to make at our next earnings call. But that may not transpire but I do believe progress has been made and as I said the parties at the table which include the company and all of its lenders and its private equity groups I think all are working collaborative and being supportive of the company during this time. With regards to Solex, that’s a relatively new non-accrual and that is one that we continue to work on. There is another lender in the credit and so it always makes it a more challenging negotiation when there is more parties but again right now the parties are working collaboratively towards a solution. We I think feel like there is a solution that could return some portion of that investment back to accrual. It's little too early to tell, that’s one a little further behind as it kind of really we went back to November but we recently just put on non-accrual post year-end. So still working with the company on that one, I wish had more to report that’s just not a whole lot to report on that particular one but again I think on that one as well. I think there will be some statements we will be able to make during our Q1 call.

[Operator:]

Your next question comes from the line of [indiscernible].

[Unidentified Analyst:]

Just a follow-up on both Solex and CRS, can you provide some color of where you’re on the waterfall and what the collateral is?

[Richard Buckanavage:]

So CRS is a little complicated but and I think a lot of people on this phone are probably aware that there is two other BDCs in that credit, although at different levels. I guess simplistically Mitchell, we’re behind THL and ahead of Triangle in the capital structure as far as the waterfall goes. Assets are significant assets -- this is a global company, AR -- probably less of inventory a lot of M&E but that’s quite frankly that’s not how we’re looking at. I think we’re a long way away from thinking about CRS in the context of asset value. I still think that we believe this is one customer, although albeit a large customer. It is one customer and many of the company's other business lines continued to perform well. So it's unfortunate and there is large customer but it is not to the point where we’re thinking about asset values. With regards to Solex, asset values there would be inventory and AR, largely no M&E associated with that business. We’re second in-line, we have a -- we hold a last out portion of a senior secured loan in that particular company.

[Operator:]

And there are no further questions. I would now like to turn the call back over to Mr. Buckanavage. Please go ahead.

[Richard Buckanavage:]

Thank you, everyone for listening in this morning. We look forward to talking again in another couple of months about our first quarter 2015 results. Thank you.

[Operator:]

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