Harvest Capital Credit Corporation
Q4 2015 Earnings Call Transcript

Published: 15 Mar 2016

[Operator:]

Good morning, my name is Holly and I will be your conference operator today. At this time I'd like to welcome everyone to the Harvest Capital Credit Fourth Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn today's conference over to Richard Buckanavage, President and CEO. Sir, please go ahead.

[Richard Buckanavage:]

Thank you, operator. Good morning everyone, and thank you for participating in this conference call to discuss our financial results for the fourth quarter and full year ended December 31, 2015. I'm joined today by our Chief Financial Officer, Craig Kitchin. Before we get started, Craig can 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. I'm going to address a few topics today in my prepared remarks before turning the call back over to Craig who will discuss our financial results in depth. And then we'll open up lines to all of you to answer any questions you may have. The topics I'd like to highlight today include the quarter's deployment activity, our continued success in exiting investments that generate attractive returns for shareholders, a brief update on our activity's subsequent to quarter-end, a discussion of some portfolio metrics to provide listeners with a better sense for the underlying performance of the companies and our portfolio, our shareholder-centric approach to managing the business, and lastly, some brief comments on the state of the credit markets. Without being duplicative with Craig's comments, I do want to take a moment to state that we are very pleased to have again out-earned the dividend by generating $0.54 per share of core NII in Q4 versus our dividend of approximately $0.34 per share. The strength of this past quarter's financial performance when combined with the solid results earlier in the year resulted in the Harvest Capital out-earning our dividend for all of 2015. On a taxable basis, we estimate that this will enable us to spill over $0.18 per share into 2016. We are also able to maintain a stable net asset value per share this past quarter which at $14.26 was almost level with last quarter's NAV per share of $14.27. Out-earning our dividend for the year and maintaining our NAV flat to prior quarter, we believe distinguishes Harvest Capital in the BDC sector. Q4 was a solid quarter of capital deployment for the business. We converted a healthy pipeline into three investments totaling approximately $13 million. Our deployment activity for the quarter was broken down between one new investment and two following investments in existing portfolio companies. The composition of the deployment activity was $12.8 million of debt investments and $300,000 of minority equity capital. The weighted average yield on the debt capital deployed during the fourth quarter was approximately 13.6% excluding fees and other forms of potential yield we may receive, as compared to the yield on debt investments made last quarter of 11.5%. During the fourth quarter we also experience a meaningful level of exit activity, experiencing two full repayments and one partial exit totaling $11.8 million in the aggregate. We're refinanced out of two portfolio positions; Americana Holdings and Optimal Blue, and we sold down a portion of our investment in Bradford Soap. The exit of Americana produced a full repayment of our $3.6 million junior secured term loan at par along with an early repayment fee of approximately $100,000, and we received $1.5 million payout of our revenue-link security. The combination of these proceeds produced an internal rate of return of 35.7%. The exit of Optimal Blue sold a full repayment of our $5.2 million junior secured term loan investment at par plus an early repayment fee of approximately $100,000 producing an internal rate of return of 17.2%. While we exited our entire debt position, we opted to maintain our equity investment in Optimal Blue with the goal of realizing a capital gain for shareholders at some point in the future. At December 31, 2015 we fair valued our equity investment in Optimal Blue at approximately $526,000 compared to our cost basis of $100,000. As part of our portfolio optimization efforts, we decided to sell $3 million of our junior secured term loan investment in Bradford Soap, reducing our hold position to $4.5 million. The $3 million tranche was sold at slightly above our cost basis. While the performance of the underlying company has been strong, having raised our internal hurdle rate and with the expectation of widening spreads going forward, we believe monetizing a portion of that investment given its yield and reinvesting the proceeds in a higher yielding security was appropriate. While exits present challenges to us to find suitable replacement investments, we welcome portfolio exits because they represent the most definitive and objective method for shareholders to evaluate our stated investment strategy. Q4's results continue to build further upon this track record. These two realizations in Q4 represent our 18th and 19th exit since inception. To-date, the average internal rate return for these 19 exits has been 22% and 25.1% excluding low yielding syndicated placeholder investments. Subsequent to quarter-end, we exit two additional portfolio investments totaling $10 million in the aggregate. In early February, we exited our investment in Solex Fine Foods, accepting approximately $926,000 in full satisfaction of our $1.8 million debt investment. As of September 30, 2015, we're holding the Solex investment at $1 million at fair value. This realization equated to approximately 93% of the fair value of the debt investment from the prior quarter and most importantly, eliminates from our portfolio the single non-accrual loan that we had at December 31. Also in February, we exited our investment in Infinite Aegis Group. As part of the exit, we received a $9.1 million repayment at par of our debt investment. In addition, we received previously accrued but unpaid interest and certain other exit fees totaling $1.4 million as part of this transaction. Harvest Capital decided to participate in the buyout transaction alongside a private equity group that acquired majority of the company's assets. Our involvement in this new transaction included providing a $6 million senior secured term loan and a $1 million unfunded revolver commitment. In addition to our debt investment, Harvest Capital also invested $3 million of equity and obtained a non-controlled ownership in the newly formed entity. We continue to maintain prudent diversification across the portfolio. Our top five obligor concentration declined to 33% at the end of Q4 from 34. 4% at the end of the comparable prior year period, and top ten obligor concentration decreased to 54.7% at December 31, 2015 from 58.4% at December 31, 2014. We continue to remain diligent regarding industry diversification as well. Due to the heightened focus on the oil and gas industry we believe it makes sense to coin up our exposure for you. We have no direct exposure to the oil and gas sector however, the underlying portfolio in our loan investment and CLO equity does have approximately 2% of its portfolio invested in oil and gas. Because this $1.6 million only represents 1.1% of our portfolio, we have negligible downside exposure to that space. At December 31 our portfolio was comprised of 57% in senior secured debt investments, 41% junior secured debt investments and 2% in equity and equity like securities. As a result 98% of our total portfolio and 100% of our debt investments are secured by at least a first or second lien with no unsecured debt investments. The migration to senior secured unit branch assets has resulted in a continued uptake in the percentage of floating rate investments relative to the total portfolio. As of December 31, 2015 approximately 71% were at floating rates. As such our future earnings have no exposure to rising interest rates; in fact we will enjoy meaningful upsides as interest rates rise. These benefits while modest currently, are already being realized. From a credit perspective, the portfolio continues to perform well with the weighted average risk rating at December 31 of 1.98. This marks the 11th consecutive quarter since our IPO in which the weighted average risk rating of the total portfolio was equal to or lower than the two risk rating assigned to each investment at the time the investment is made. We had one loan on non-accrual status on December 31, 2015 however, as I stated earlier subsequent to quarter end we exited that investment and now are able to reinvest those proceeds in to yield bearing assets. From the perspective of the performance of the underlying portfolio companies we continue to see growth, although at lower levels than Q3 than earlier quarters in 2015. In discussion with our portfolio companies we were not surprised by the government's fourth quarter GDP announcement indicating slower growth. While we expected growth to slow based on these conversations, our expectations was for continued growth in revenue and cash flow and our direct lower market portfolio taken as a whole. The actual results support this conclusion. The portfolio average LTM EBITDA grew by 2.7% during Q4 based on solid operating fundamentals experienced by the companies that comprise our portfolio. Average total net debt through Harvest Capital's last dollar was approximately 3.7X at December 31, 2015. Based on early financial results and further discussions with our portfolio companies subsequent to quarter end, we expect to see continued modest portfolio EBITDA growth for Q1. The majority of the below budget performance in our portfolio appears to result idiosyncratic factors versus macroeconomic pressures. As reported in our earnings release, the board of directors also authorized a $3 million stock repurchase program, with the stock price trading well below NEV we felt it was prudent to implement a program that will enable us to repurchase shares should we be unable to identify suitable investments capable of generating the agreed returns to the shareholders. In terms of managing the company for the benefits of the stakeholders, we believe actions speak louder than words. We maintain a management agreement that encompasses many best in class features. Our administration agreement with our affiliate JMP Credit Advisors is a cost based arm's length contract and since inception shortfalls to actual cost incurred have been subsidized by the BDC's advisors or one of its affiliates. Lastly, the management team and our corporate sponsor JMP have been consistent buyers of our shares an today own over 20% of the company which we believe aligns our interest with that of our shareholder base. The stock repurchase program is yet another concrete example of our shareholder centric philosophy. Lastly, consistent with much of the 2015 in which we witnessed robust investment activity in one quarter followed by decidedly slower levels the next; we are experiencing the same trends in early stages of 2016. January and February can be characterized as slow months. Volume was well off our normalized pipeline levels and the quality of the opportunities was below average. Just recently we have begun to see a gradual build in our investment pipeline and quality has improved. There has been quite a bit of press on the widening of spreads in the broadly syndicated loan market, but unfortunately thus far in 2016 changes in the spreads in the lower middle market have been muted. At most we have experienced spreads in our segment of the market take up by approximately a 100 basis points. Proposed leverage levels in the current pipeline of opportunities are reasonable and current structures continue to be prudent. Although this has mostly been consistent in the lower middle market as the basis of competition over the prior two years was primarily on pricing. In terms of competition we have witnessed what we believe is a modest decline in the number of active lower middle market participants. We remain far removed from the lender family confines of 2012 and 2013 however, the general trend appears favorable. Anecdotal data points such as the declining number of the newly issued SPIC licenses continued regulatory scrutiny of the commercial banking sector and widening spreads in the broadly syndicated mark which could attract some of the hot money to that segment might prove beneficial to us going forward. That concludes my formal remarks this morning so I would like to turn the call back over to Craig.

[Craig Kitchin:]

Thanks Rich and good morning everyone. Coordinated net income for the quarter was $3.4 million or $0.54 per share compared to $2.3 million or $0.36 per share in the fourth quarter of 2014. The increase in co-earnings is attributable primarily to the path of our investment in Americana which accelerated about $1.2 million of deferred fees into interest income. Net of incentive fees the Americana added about $0.15 to the NII for the quarter. This was our best quarter since the IPO in terms of co-earnings and I would point out that even without the extra NII from pay-offs, our run rate earnings are enough to cover the current dividend. This has been achieved even as asset yields have tightened considerably over the past year as a result of deploying more leverage and reducing our borrowing cost in 2015 with the amendment of our credit facility. For the year, core NII was $1.52 versus $1.38 for 2014. Net income per share for the quarter was $0.33 compared to $0.44 in the fourth quarter of last year. The decrease was driven by $1.3 million in realized and unrealized depreciation in the quarter compared to $631,000 in realized and unrealized gains in the portfolio last year. I would point out that leverage for the quarter and the year were still below our target level of 80%. We had on average during the fourth quarter a total debt balance of $64 million for debt-to-equity ratio during the quarter of 72%. For the year, the average debt balance was $46 million for a debt-to-equity ratio of 52%. At year-end, our debt-to-equity ratio was 64%, so we still have room to grow earnings by reaching our internal limit of approximately 80% debt-to-equity. PIK income represented 3.2% of total interest income in Q4 compared to 7% of interest income in Q4 2014. For the year, it was 5.4% compared to 10.1% for 2014. Additionally, the portfolio is seasoned enough that we collect almost as much PIK as we accrue now. In 2015, we accrued $1.1 million of PIK income and collected $900,000 of PIK income that had been previously accrued. Overall, the percentage of our income as PIK has been on the decline as the larger percentage of investments have been senior unit tranche which tend to have less of or no PIK component compared to more junior deals. As of December 31, 2015, the fair value of the portfolio was $142.8 million versus amortized cost of $144.2 million, reflecting $1.5 million of net unrealized depreciation in the portfolio at the end of the year. As of year-end, we had $3 million in cash and $25 million available on our $55 million credit facility. So with cash and borrowing capacity we have enough dry powder to fund new investments up to our target leverage level. Additionally, I would note that we have about $29 million of lower yielding syndicated loans that could be monetized and invested in core deals with higher yields. The syndicated loans had a weighted average effective yield of 11.4% at year-end. As of year-end, our NAV was $14.26, down $0.01 from last quarter as net income of $0.33 per share was outpaced by the $0.34 in dividends paid during the quarter. With that I will turn things back to Rich.

[Richard Buckanavage:]

Thanks for that financial summary, Craig. We know that many of you may have questions, so operator, could you please open up the lines for any questions our participants may have?

[Operator:]

[Operator Instructions] Our first question comes from the line of Ryan Lynch with KBW.

[Ryan Lynch:]

Good morning guys and thank you for taking my questions. First one -- just had a couple of questions on the revenue side of the business. Of the $1.1 million of amortization fees, discount and premiums, how much of these was accelerated fees of OID, or fees from early pay-offs in the quarter?

[Craig Kitchin:]

Ryan, this is Craig. Most of the deferred fees that get accelerated when the loan pays off goes up to the interest income line, so not much of the amortization was a result of that. So most of that is just normal regular amortization.

[Ryan Lynch:]

So -- I mean the $1.1 million that jumped up a lot, first at the prior quarter, is that a decent run rate to expect going forward or is there something else in there that's more one-time that's hidden in this fourth quarter?

[Craig Kitchin:]

Yes, we had the payment income in the quarter that made it a little bit higher. It's probably a little higher than it's going to be on a go-forward basis.

[Ryan Lynch:]

Okay. I know you guys don't have any direct exposure to energy, excluding maybe some drilling down in the CLOs in your portfolio. But however, some of your portfolio companies, have you guys looked at or any of those companies, maybe not directly tied to the oil and gas industry, but maybe have customers in the oil and gas industry sector? Maybe have operations that are heavily in energy-concentrated areas, maybe in Texas or other places that focus at a lot of energy operations? Have you guys looked at any kind of companies in your portfolio that maybe have some ancillary exposure to oil and gas customers or geographies?

[Richard Buckanavage:]

Ryan, this is Rich. We have and we do. We have one company in our portfolio that has a customer base that includes companies in the oil and gas industry. About 15% of their total revenue goes into the oil and gas sector. Right now it has been soft but not overly soft because of the nature of what they do for these companies, which is compliance. So there has been a little softness there. It represents less than 4% of our total portfolio so again, it's not a big downside for us there, but that's really the only company that we have no regional, rural companies in the areas that would be particularly influenced by the decline in oil and gas and as far as customer base, that's about it in the portfolio.

[Ryan Lynch:]

Okay, great. You guys implemented a buyback in Q1. Obviously there are a lot of factors to consider before buying back shares. Liquidity is one, deals in your pipeline; you guys have a smaller market cap right now. All those factors in consideration, how are you guys viewing buying back shares as we sit here today at your current stock price with your current liquidity on your balance sheet?

[Richard Buckanavage:]

I think all of those factors, Ryan. I think that for several quarters when we were trading at 15% discount to NAV, I think other factors were we felt more important at that time liquidity, pipeline, ability to generate a creed of deals despite where we were trading relative to NAV, I think that when we started to decline, when we approached to 20% and then 25% to 30% discount NAV, we felt like it was time to relook at whether implementing a stock repurchase program was the right decision. We have got liquidity, with the pipeline as I mentioned earlier is okay, it's nothing to write home about and was very soft in January or February, and we continue to trade at roughly 25% discount to NAV. So we felt like it was appropriate to bring that onto the table as another consideration factor as to what we do with our capital and I think time will dictate how much we use of that relative to making new investments but we certainly know that the bar has been raised internally from a whole rate perspective. Some of the transactions that might have made sense for us 9 or 12 months ago may no longer make sense for us today. Obviously, we are weighing that against the backdrop of a smaller flow. Obviously, that's something that we would like to grow so this is counter to that but again, if you relook at all the factors that we took into consideration right now more factors point towards implementing the stock repurchase program than not.

[Craig Kitchin:]

Ryan, this is Craig. I was just going to follow up on your first question about the geography of the interest income. On the Americana payoff we had a little over half a million dollars related to deferred fees on the term loan. They got accelerated into the interest income line. There was also about a half a million dollar gain on the revenue linked securities in the pre amortization line. So, the components to the million to gain are about half the interest income, half in the amortization and then there is $100,000 pre-payment fee in other income.

[Ryan Lynch:]

Okay, thanks for that clarification. Just one last one on Infinite Aegis paid off in Q1 2016. You guys mentioned about $1.4 million you guys received in accrued and unpaid interest and fees, was any of those $1.4 million fees received, was any of that accelerated or one time fees due to the other early repayment of that investment?

[Craig Kitchin:]

Yes there was over half a million dollars of accrued and unpaid interest incomes and then there was over $600,000, and we call make old fee on the transaction.

[Ryan Lynch:]

Okay. Perfect, that's all the questions from me. It looks like a good quarter, so congrats guys.

[Richard Buckanavage:]

Thanks.

[Craig Kitchin:]

Thanks, Ryan.

[Operator:]

[Operator Instructions] Our next question will come from the line of Edward Brown with Merrill Lynch.

[Edward Brown:]

Hey guys, just a perception for the BDC space. When do you think we are going to start seeing the whole group to trade better?

[Richard Buckanavage:]

Wish we had that answer for you and we are hopeful that at least for us anyway, a quarter like this is going to be helpful in that regard. I think if you look at the industry, there were pretty dire prognostications last quarter and as earnings came out really largely disproved that expectations. And I think this quarter, I think there has been some book value decline but I don't think that was not expected across the BDC's phase. I think a lot of that was mark to market book value decline. And as far as the dividend coverage, so far it's been mixed but I think more positive than negative. But I think it just needs to be other couple of quarters where the sector continues to spell the illusion that this is the sector that is right for a significant downturn or uptick in non-accruals, I don't think we have seen that significant in any way. I think more people are covering the dividend than not of course, there are some that aren't. I think what we are hopeful for is that investors begin to differentiate between the folks that are running the dividends, the balance sheets that are stable and not growing NA versus those that are not and of course, we think we are in the category of producing stable and improving NAV and certainly covering our dividend for 2015 and we have got some wind in our back for 2016 which is in the form of the $0.18 per share of spillover. So we feel we are in good shape. We think the sector just needs to continue to do the right thing and continue to demonstrate to shareholders that we have got their interests at heart and improve the financial results as a sector as a whole and maybe for another couple of quarters. That may not be, we are already two quarters into where we think we are disproving as an industry the expectation for falling off a cliff scenario.

[Edward Brown:]

I am happy that you buying back a little stock just as a statement. Thanks again, guys.

[Richard Buckanavage:]

You're welcome.

[Operator:]

And currently we have no further questions. I will turn the call back over to you for closing remarks.

[Richard Buckanavage:]

Thank you everyone for participating in our earnings call this morning. We look forward to speaking with you in early May to discuss Q1 2016 results.

[Operator:]

Once again, we would like to thank you for your participation on today's conference call. You may now disconnect.