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Edited Transcript of HCAP earnings conference call or presentation 8-Nov-19 4:00pm GMT

Q3 2019 Harvest Capital Credit Corp Earnings Call

NEW YORK Nov 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Harvest Capital Credit Corp earnings conference call or presentation Friday, November 8, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joseph Andrew Jolson

Harvest Capital Credit Corporation - Chairman of the Board & CEO

* Richard P. Buckanavage

Harvest Capital Credit Corporation - MD, Head of Business Development & Director

* William E. Alvarez

Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary

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Conference Call Participants

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* Paul Conrad Johnson

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Harvest Capital Credit Corporation Third Quarter 2019 Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, speaker William Alvarez, Chief Financial Officer of Harvest Capital Credit Corporation. Thank you. Please, go ahead sir.

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [2]

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Okay. Thank you, Nora. Good morning, everyone, and thank you for participating in this conference call to discuss our financial results for the third quarter ended September 30, 2019.

I'm joined today by our Chairman and Chief Executive Officer, joseph Jolson; and by Richard Buckanavage, our Managing Director and Head of Business Development.

Before we start, I'll provide a disclaimer regarding any forward-looking statements that we make during this presentation. 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. Now, I'll turn the call over to Joe.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [3]

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Thanks, Bill. We showed some improvements in the third quarter results as our investment portfolio has now grown for the third consecutive quarter and by -- it's up almost 22% from December year-end of last year.

Our progress on resolving our 4 and 5 rated credits, however, has been frustratingly slow.

We do remain optimistic that the roughly $12 million in currently noninterest earning assets will be contributing to our net investment income sometime during the next year.

We also completed the most recent 250,000 shares stock repurchase authorization recently and in total have bought nearly 8% of the shares outstanding during 2019 and more than 9% of the shares outstanding since inception. And as everyone knows, these purchases at the price levels are immediately accretive to net asset value and net investment income per share.

I'll have Bill go through some of the financial results from the quarter, and then Rich will discuss the current investment environment, and then I'll make some closing remarks. Bill?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [4]

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Great. Thanks, Joe. Net investment income for the quarter was $1.1 million or $0.18 per share compared to $1.6 million or $0.25 per share in the third quarter of 2018.

Net investment income decreased by $0.5 million in 2019 as compared to 2018, as a result of a decrease in investment income of $1 million, as a result of a lower income earning portfolio and lower effective yield at September 30, 2019, compared to September 30, 2018, offset by a decrease of $0.5 million in expenses in the 2019 period as compared to 2018.

Net loss for the quarter was $1 million or $0.17 per share compared to net income of $0.6 million or $0.10 per share in the third quarter of 2018.

The decrease in net income principally resulted from the company recording lower investment income as a result of a lower income earning portfolio and lower effective yield, and an increase in unrealized depreciation offset by lower operating expenses, as previously mentioned.

Reflecting on the 9 months ended September 30, 2019, net investment income was $2.7 million or $0.43 per share compared to $4.5 million or $0.69 per share in the 9 months ended September 30, 2018.

The $1.8 million decrease in the 9 months of 2019 primarily resulted to the company recording $2.8 million of lower investment income as a result of a lower income earning portfolio and lower effective yield, offset by lower expenses of $1.1 million for the 9 months ended September 30, 2019.

Net loss for the 9 months ended September 30, 2019 was $0.9 million or $0.15 per share compared to net income of $3.5 million or $0.55 per share in the 9 months ended September 30, 2018.

The $4.4 million decrease was primarily attributable to a $2.8 million decrease in investment income, $3.2 million increase in the change in unrealized depreciation, offset by a $0.6 million positive change in net realized gains, and a decrease in expenses of $1.1 million.

We recognized fee amortization income of $182,000 and $666,000 in the 3 and 9 months ended September 30, 2019, compared to $308,000 and $974,000 in the comparable 2018 3 and 9-month periods.

The higher fee amortization in 2018 resulted from several balloon payment exits, where greater fees were earned in 2018 compared to 2019.

Our fees are deferred until they are either earned, amortizing the income over the life of the investment using the effective yield method or fully recognized when an investment payoff occurs.

In addition, we also recognized other income of $46,000 and $288,000 in 3 and 9 months ended September 30, 2019, compared to $241,000 and $318,000 in the comparable 2018 3- and 9-month periods.

As a result, our fees and other income will fluctuate quarter-to-quarter depending on portfolio activity.

As of September 30, 2019, the fair value of our portfolio was $115.6 million with a cost basis of $123.1 million, reflecting $7.5 million of net unrealized depreciation in the portfolio at the end of the quarter.

As of September 30, 2019, we had a debt balance of $65.1 million, consisting of $36.3 million of bank debt and $28.8 million of 2022 notes for a debt-to-equity ratio approximately 95% compared to approximately 58% at December 31, 2018.

At quarter end, we had $17.8 million of cash and approximately $3.8 million of undrawn capacity on our $55 million credit facility.

Our cash and borrowing capacity provides us with sufficient liquidity in order for us to execute our business plans for 2020.

As of quarter end, our net asset value was $11.52 per share, down $0.78 per share from December 31, 2018, principally as a result of paying $0.74 per share in distributions for the 9 months ended September 30, 2019, compared to $0.15 decrease in net assets from our 9 months of 2019 operations and enhanced by $0.11 of accretion due to shares repurchased during 2019.

On May 3, 2019, the Board of Directors authorized an open market stock repurchase program to repurchase up to 250,000 shares in the aggregate of the company's common stock in the open market.

At September 30, 2019, the company purchased 210,533 shares under the May 2019 repurchase program, and subsequent to September 30, the remaining 39,467 shares were acquired completing the repurchase plan.

Now, I want to turn the call over to Rich for some further discussion on the investment environment.

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Richard P. Buckanavage, Harvest Capital Credit Corporation - MD, Head of Business Development & Director [5]

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Thank you, Bill. The current state of the market, in which we compete, continues to be competitive, although credit spreads, leverage levels and covenant structures have been very stable since the start of the year.

The access to additional leverage, which went into effect in May, continues to provide us with an enhanced competitive position in order to compete for a larger percentage of unitranche financings that we decide to pursue.

While we continue to pursue both senior and junior secured debt investments, pursuing a larger percentage of unitranche investments better positions us to achieve one of our more important strategic objectives, which is to increase our average transaction size, given that unitranche financings tend to be substantially larger than stand-alone mezzanine investments.

We continue to be encouraged by our ability to identify attractive investment opportunities. During the third quarter, our investment activities include both new investments as well as additional capital deployment in existing portfolio companies.

In the aggregate, we closed approximately $14.6 million in debt commitments and $600,000 of equity investments across 2 new and 3 portfolio companies, bringing our portfolio to 26 investments.

Subsequent to quarter end, we increased our senior term loan to Northeast Metal by approximately $1.6 million in order to refinance the company's existing line of credit that was maturing in early 2020.

As we look forward to the remainder of 2019, we remain optimistic regarding our current pipeline.

We currently have 5 mandated transactions totaling approximately $27.6 million. Many of these financings are expected to close by year-end, however, given the expected timing of these closings, which is weighted towards the back end of the fourth quarter, these mandates are not likely to contribute meaningfully to this quarter's income, but will provide us solid earnings momentum for Q1 2020.

With that, I'd like to turn the call back over to Joe.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [6]

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Thanks, Rich. As Rich just mentioned, we've a strong pipeline of mandated deals that are progressing towards closing in the next 3 months.

2019 new investment levels have recovered back to a run rate of about $60 million compared to doing only $19 million for all of 2018.

At the current level, we should be fully invested sometime in the third quarter of 2020 depending on the timing of selected payoffs of noninterest earning investments, which are $24 million, which equates to 21% of total investments, have been a major drag on our net investment income in the last year or so.

In particular, the redeployment of any and all of the current fair value dollars invested in our 4 and 5 rated credits that total little less than $12 million, and we have about $8 million invested in 2 very successful investments in the equity that there could be a liquidity event sometime next year. Those different investments are not contributing to net investment income. So there's quite a bit of upside, we think, once we get fully invested in terms of further net investment income growth into 2021 by redeploying that capital.

Our current risk rating continues to creep a little higher in the third quarter to 2.51 from 2.44 in the June quarter. The benefit from the renewed growth impacting this metric is somewhat lagged by our valuation policy of holding our new investments at cost and at a 2 rating or, if warranted, at a lower rating for the first 6 months after closing. At the end of September, roughly $26 million or 22% of our total investments were in this category and would have otherwise penciled to a 1 risk rating at that time.

As a result of this dynamic, as well as the resolution prospects for our 4 and 5 rated credits, we do remain optimistic that the 2.51 risk rating could improve materially in the next 6 to 12 months.

Once the redeployment of our asset capacity has -- I'm sorry, while the redeployment of our asset capacity has been taking longer than we would have hoped a year ago, we have made good progress in the last 3 quarters of growth. And if you take it from the low point at the end of January, our portfolio is up almost 30% since then through the end of September.

Growth could have been faster, if we're willing to increase our credit risk exposure or reduce our targeted IRRs below 10% on average, both of which we have not been willing to do.

By maintaining that discipline, and assuming we continue to make steady progress with our key initiatives, we believe we can cover our current dividend by the middle of next year, hopefully, in the second quarter, with further upside potential ahead from additional growth in the redeployment, as I mentioned, of the noninterest earning investments detailed earlier.

In closing, I want to thank our team, including our independent directors for their continued hard work for HCAP shareholders to achieve favorable outcome.

As of the completion of our most recent share repurchase, our advisor, management team and our Board collectively own 31% of the shares outstanding compared to 19% at the time of the IPO, all made through open market purchases.

With that, Nora, we'd be open for any questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from the line of Paul Johnson of KBW.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [2]

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My first question was on the new nonaccrual this quarter, Deluxe Entertainment. I was just hoping if you could provide maybe a brief description of -- or a, sort of, detail of what exactly that company is? And then also was that an investment that drove the depreciation this quarter?

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [3]

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I can start and then maybe Bill can talk about the depreciation, but yes, that was a chunk of the unrealized depreciation this quarter.

Deluxe Entertainment was a broadly syndicated credit that we purchased. Over the last 7 or 8 years, opportunistically, from time to time, we become aware of some situations where we think there is an opportunity over a 12- to 18-month period, perhaps, to put some capital to work at a pretty good risk-adjusted return. Up until this situation, we had a perfect record in these kind of things. This is our first situation where we've had a loss or at least an unrealized loss.

So Deluxe Entertainment is one of the -- perhaps, the largest player in the -- within the entertainment industry in terms of back-end production. Maybe Rich can give further color on that, but there -- it was owned by a large private equity firm that had been supporting the investment and the loan was maturing in a year and the company hit a little rough spot in terms of Hollywood releases being down materially and needed to restructure the credit or refinance it. And unfortunately, they couldn't come to an agreement with the credit committee and decided instead to take it into a prepack bankruptcy, where essentially as first lien lender we own 65% of the equity now. And as the primer, we participated fully in the primer facility. We got 35% of the equity and I think that the -- so a lot of our recovery here, we think, we have conservatively booked it at the end of the quarter and a lot of our potential recovery here over the next year as the company hitting their projections and selling the business in the next 12-plus months.

Anyway, with that color, Rich, I don't know if you've anything to add, or Bill?

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Richard P. Buckanavage, Harvest Capital Credit Corporation - MD, Head of Business Development & Director [4]

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Yes, this is Rich. I don't have anything to add. Joe, I think, you characterized the situation accurately.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [5]

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Okay. That's very good detail. And can you just remind me approximately, if you have that information, how much of your portfolio are in those DSL or syndicated type deals that you purchased opportunistically?

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [6]

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Yes, I guess, Bill would have that. I mean let me be -- there's been a few investments we've made in syndicated business that we've held as a long-term investment as opposed to an opportunistic something we thought there would be an event in the next year or so. I believe the only one we own right now that would be in that category as GNC. Correct me if I'm wrong, Bill?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [7]

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The GK thing -- Yes, the GK...

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [8]

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While we own a few others but those have been long-term holds, right?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [9]

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It's approximately $12.5 million in total.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [10]

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And the GNC is how large, Bill?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [11]

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Yes, GNC is about $4.2 million.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [12]

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Of that total?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [13]

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Of the total, yes.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [14]

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The GNC is actually performing as expected or better than expected. And the other credits that are on that list, Bill, are -- why don't you just list the other 2 because they're on our SOI.

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [15]

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Yes, it's flavors, okay. Deluxe flavor is GNC and GK Holdings Global Knowledge.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [16]

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Okay. Great. I appreciate that. And then next, I was hoping if you could touch on maybe what sort of your average or target investment size is for new investments in the portfolio?

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [17]

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Yes. I mean we'd like to originate new investments between, let's say, $5 million and $10 million. And I think, the issue is the diversity test under the BDC rules shows our investment portfolio grows our 5% investment increases, and we have some capacity right now to be above 5% on some investments.

The -- I think that with our current team perhaps adding one more person we think that over the next couple of years we can migrate the average size up to that level maybe in the $6.5 million to $7 million range and drive portfolio growth.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [18]

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Okay. And I'm just curious, so how do you guys manage your hold size or your investment size, just given that most investments probably around that area will probably be close to 5% maybe or more of the portfolio for new originations. I'm just curious, does Harvest have any, sort of, coinvestment capabilities to share any investments or any other way to potentially manage just the size of new investments?

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [19]

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Well it, obviously, has to be managed. But that's kind of the lower-middle market size anyway that $5 million to $10, Paul. So that's not inconsistent with where we would see the bulk of our investment opportunities at the kind of risk-adjusted yields that we are looking for.

But that being said, you noticed, at the end of the quarter or at least quarter-to-quarter, we're carrying rather a large cash balance. And that's essentially a 1-day or 2-day borrowing to increase the denominator, so that's one way to manage it. And obviously, monitoring the new deal sizes, but if you kind of see our pipeline, almost all the kind of sourced investment opportunities that are in our wheelhouse for the kind of yields we're looking for would at least initially be in that kind of size.

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Richard P. Buckanavage, Harvest Capital Credit Corporation - MD, Head of Business Development & Director [20]

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Paul, I would also add, that we do have a private credit fund, JMP affiliate, that we do coinvest with, which also allows us to manage our hold sizes. So for example, if we're looking at something that's $12 million, and as Joe said, we want to be more in the $5 million to $10 million range, for those transactions that are appropriate for that fund's mandate, we do have the ability to also for example, take down the $12 million deal, hold $8 million, $9 million, $10 million of that and then put the remainder in the private credit fund. That also allows us to be very effective in that market where we're slightly above our hold size, but not so much so that we don't want to pursue that. So that's another -- and that's been probably something we've had in place for around 2 years has allowed us to consider investments that are slightly above our average hold size where want to be.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [21]

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Okay. Great. That's very helpful. And then last question, maybe more of modeling question, but you guys were able to pretty significantly reduce your professional fees over the last few quarters. I'm just curious, is the current level that you're, sort of, running at this quarter about $198,000, do you view that as sustainable? Or do you expect that should tick higher over the couple of quarters?

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [22]

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Bill, you want to take that?

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William E. Alvarez, Harvest Capital Credit Corporation - CFO, Chief Compliance Officer & Secretary [23]

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Yes, yes, sure. Yes -- no, we've been able to reduce our professional fees. I mean, we -- based on our size, we actually -- earlier this year, we actually changed orders.

We have RSM McGladrey, who is probably better suited to serve our market better at a more cost-effective rate.

So we're watching all those things. Our fees will fluctuate a little bit quarter-to-quarter as far as some of the one-off things that may come in or the timing of when an audit bill come in or a tax bill or what have you. But I would say, generally speaking that our run rate now that you're looking at is more representative going forward in the future rather than what it was historically.

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Operator [24]

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(Operator Instructions) There are no further questions at this time. You may proceed, presenters.

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Joseph Andrew Jolson, Harvest Capital Credit Corporation - Chairman of the Board & CEO [25]

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Okay, great. Well, we appreciate the interest, and we'll be hopefully excited to get back on the call in 3 months and talk about our progress in the fourth quarter. Thank you very much.

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Operator [26]

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Okay. Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.