WhiteHorse Finance, Inc. (WHF) Q4 2017 Earnings Report, Transcript and Summary

Good morning. My name is Laurie and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Fourth Quarter and Full Year 2017 Earnings Conference Call. Our host for today's call are Stuart Aronson, Chief Executive Officer; and Ed Giordano, Interim Chief Financial Officer. Today's call is being recorded and will be available for a replay beginning at 1 p.m. Eastern. The replay dial-in number is 404-537-3406 and the PIN number is 9589848. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Silva of Prosek Partners.

Thank you, Laurie, and thank you everyone for joining us today to discuss WhiteHorse Finance's fourth quarter and fiscal year 2017 earnings results. Before we begin, I would like to remind everyone that certain statements, which are not based on historical facts, made during this call, including any statements relating to financial guidance, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, these are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. WhiteHorse Finance assumes no obligation or responsibility to update any forward-looking statements. With that, allow me to introduce WhiteHorse Finance's CEO, Stuart Aronson. Stuart, you may begin.

Thanks, Sean. Good morning and thank you for joining us today. As you're aware, we issued our press release this morning prior to market open, and I hope you've had a chance to review our results which are also available on our website. I'm going to take you through our fourth quarter fiscal year operating performance, and then Ed will review our financial results after which we're happy to take your questions. During the fourth quarter, we recorded net interest income of $33.1 per share slightly below our dividend of $0.35 and a share. We had advised during our last call that this was likely due to the delay in deploying capital from our follow-on equity offering at the end of Q2. That said, we expect to once again generate the net interest income that covers the $35.5 dividend once we’re fully redeployed and I’m pleased to share that we’ve made meaningful progress during the fourth quarter and so far in the first quarter towards reaching that goal, more on that later. We recorded fourth quarter NAV per share of 13.98, a $0.06 increase from the third quarter of 2017 and a $0.35 increase from the fourth quarter of 2016. Additionally and for the third consecutive quarter, our weighted average effective yield held constant at 11.9%. We had three new originations during the fourth quarter totaling 22.7 million as well as the refinancing that added to an existing position. Three of these four transactions were non-sponsored loans. The first deal Planet Fitness was a sponsored transaction and was a $4.7 million first lien loan. The second transaction was the Rural Media Group in the form of a $7 million first lien loan. The third transaction Secured America was in $11 million first lien loan and additionally we’ve refinanced our position in multi-cultural radio broadcasting from a second lien loan into a first lien loan at lower leverage while adding 5.8 million to the prior existing position. All of these originations fell within our target range of $4 million to $20 million hold positions. We recorded total repayments and sales for the quarter of 26.2 million compared to 14.8 million recorded during Q3. This increase was primarily driven by full pay downs of 15.2 million on Intersection acquisition and $4 million on Climate Pros. For the full year 2017, we originated loans to 10 new portfolio companies totaling a $111 million at an average effective yield of 11.3% and recorded a 106.3 million of repayments and sales including 88 million of relating to full exits from eight portfolio companies. In addition to the refinancing I mentioned earlier, we also added approximately 6 million of follow-on investments to existing positions during the year. The transactions we closed in 2017 and expect to close in 2018 are in our opinion materially better on average for the deals being syndicated in the broad market place, and our average leverage on close deals is consistent with our historical track record of about 3.5 times. I’ll now provide more detail on this by reviewing our portfolio exhibiting. As of December 31, 2017, the fair value of the portfolio was 440.7 million compared to 435.3 million reported at the end of the third quarter. As of that same date, our loan portfolio consisted primarily of senior secured loans to lower mid-market borrowers that are variable rate investments primarily index to LIBOR. The portfolio had an average investments size of 10.2 million based on fair value with the largest investment being 25.7 million. Within the portfolio, we held 43 positions across 32 companies. As of the end of the fourth quarter, our deployment resulted in net leverage in 51% as of today when accounting for four new originations that we’ve closed thus far in Q1. Leverage increased to 68% which is near our target leverage range of 70 to 80%. The BDC could potentially be fully deployed at the end of the first quarter based on mandated deals on the pipeline. However, as always there is no assurance that any of these deals will close and in addition any unexpected spikes in prepayment could also prevent full deployment in Q1. The WhiteHorse team remains focused on originating deals that have low leverage, low loan to value, and meaningful financial covenants in addition all the deals closed in Q4 and so far in Q1 have been first lien transactions resulting in a higher concentration or first lien positions in our portfolio while still generating mostly attractive, mostly double digit returns. I’ll now briefly address our position in Aretec, which based on strong company performance was marked up from $0.60 last quarter to over $0.80 this quarter as a percentage of our pre-restructuring cost basis of $20.7 million. As regards to our BDC’s ability to earn the annual dividend, I’d like to highlight that when WhiteHorse is able to convert equity positions into cash, we can redeploy that cash into investments which earned interest income which helps create coverage for the dividend of the BDC. In general, for every incremental $2 million of cash we were able to invest approximately $3.5 million including leverage capital and if the investment is in assets with a 10% yield, WhiteHorse increases net interest income by approximately $0.01 per share for each incremental $2 million of cash. More broadly, our HIG sourcing model continues to drive strong results and remains key differentiator for us in the lower mid-market. Specifically, our three tiered sourcing architecture takes advantage of over 300 investment professionals at HIG, over 350 investment professionals at HIG and these professionals include approximately 25 global business development resources who helped to source deals from a proprietary list of over 21,000 lawyers, accountants, wealth managers, bouquet bankers and off-the-run sponsors. In addition, WhiteHorse has deployed 16 dedicated originators across 10 cities in the United States who are directly originating in the non-sponsor and off-the-run sponsor markets. Collectively, we are optimistic about our business model and how we can continue to drive strong results. I’ll turn now quickly to a macro outlook, general market conditions do remain very aggressive, covenant like deals continue to make inroads into the middle market, and spread compression is reality across the market. However, we feel that our business model of direct originations in the lower mid-market provides us some installation from both of these headwinds. We continue to pursue sponsor deals because sponsors bring professional management, professional systems and the ability to support the Company through a recycle and we also remained very focused on non-sponsored deals because they have much lower loan leverage, much lower loan devalue and much higher debt service coverage in sponsored deals. Our platform provides us access to both types of deals, which we view as a differentiator and we’re optimistic about our ability to optimize between the two as our pipeline now is more robust than it’s ever been. Regarding other macro factors, we have not seen an impact in the recent tax reform on the desire of mid-market companies to take leverage to grow or make acquisitions. Further, we do not expect any meaningful impact from the recent volatility in the equity markets in fact if anything that seems to create opportunity for us. With that, I will now turn the call over to Ed.

Thanks, Stuart. Starting with our fourth quarter results from operations, NII was $6.8 million for the quarter or $33.1 per share. This compares to $5.9 million or $0.29 per share in the prior quarter. Our investment income continues to consist primarily of recurring cash interest. We reported a net increase and net assets resulting from operations of approximately $8.5 million or $0.41 per share for the fourth quarter. As of December 31, 2017, net asset value was $287 million or $13.98 per share, up from $285.5 million or $13.92 per share, as reported for Q3. As it pertains to our portfolio and investment activity, the risk ratings on our portfolio remained mostly unchanged. Turning to our balance sheet, we had cash resources of approximately $38.9 million as of December 31, 2017, including $3.7 million of restricted cash and approximately $45 million of undrawn capacity under our revolving credit facility. We also have the ability to increase this capacity by an additional $35 million by exercising our accordion option under the credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of December 31, 2017. The Company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act was 255.1 million at the end of the fourth quarter, well above the statutory requirement of 200%. Our effective debt to equity ratio after adjusting for cash on hand was 0.51 times. Last, I'd like to highlight our quarterly distribution. On December 6, we declared a distribution, for the quarter ended December 31, 2017, of $35.5 per share for a total distribution of $7.3 million to stockholders of record as of December 18, 2017. The distribution was paid to stockholders on January 2. This marks the Company's 21st distribution since our IPO in December 2012, and with all distributions at the rate of $35.5 per share per quarter. We expect to be in a position to continue our regular distributions. I'll now turn the call to the operator for your questions. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Mickey Schleien of Ladenburg.

Just one quick question, I saw that Outcome Health was marked down pretty meaningfully. Was that due to changes in multiple? Or is there something fundamental occurring to the Company that we should know about?

Outcome Health received a lot of publicity in a series of Wall Street Journal articles for issues that went on in the Company. We were very actively involved in dealing with the resolution of those issues. As a part of doing that, there are many things that are confidential, but after we mark that asset down to what you see in mark down to in this first quarter 23% of that asset has been repaid at par so that is good news and the Company has been significantly capitalized by its equity holders who again I won’t say, but I believe you could find that in the public data in the Wall Street Journal to help the Company get through the issues there were reported in the Wall Street Journal. So, we’ve marked that to a level that we believe is appropriate and conservative, and again 23% of that position has been repaid at par since the end of the fourth quarter.

And if I could just follow up in your prepaid remarks, I think you've mentioned that you don’t expect the changes in the tax rates that occurred recently to have an impact on your borrowers desire to borrow or to conduct M&A activity. Is that comment sort of generalized across the portfolio with certain borrowers being impacted and other not? Or is that a general statement about key market in general?

The best way I can answer that for you Mickey is to talk about our inflow pipeline. A year ago in any given week, we had between 30 to 40 deals that we're in our inflow pipeline. At this point, last week we had 80 deals in our inflow pipeline. So in terms of the need and desire of lower mid-market companies to have growth capital or acquisition capital, what we’re seeing broadly across the market is that appetite is very high. I will add to that that we are turning down a greater percentage of deals that we’ve ever turned down. The market conditions are aggressive and we are working very hard to make sure that every deal that we book is a strong credit that can withstand a downturn in the economy, if a downturn does occur. So, we’re sticking to our credit philosophies, but we have ramped up our origination efforts and it's that larger pipeline and deals that will allow us to continue to increase diversity in the BDC as we go on through 2018.

Your next question comes from the line of Chris Kotowski of Oppenheimer.

I was just curious under the Aretec position, you saw this little additional position now of RCS Creditor Trust. I’m wondering is that a recurring kind of additional unit that you get from holding the position or is that just clean up adjustment from the restructuring?

Ed, can you speak to that please?

Sure, that’s related to a claim, the residual claim from the estate and the primary asset within there is some litigation.

And refresh our memory of -- who has the controlling position in our actually -- what is your position in Aretec and what kind of influence you have on the disposition of it?

So, in the bankruptcy and restructuring of RCS with the resulting company being Aretec, the lenders in aggregate, first lien lenders and second lien lenders, are ended up with 80% ownership in the Company. We had a position in the second lien loan, which has given us the shares that you see. We are a significant holder but not a majority holder by any structuring imagination and we do not have any direct control at all on the decision regarding disposition of the Company or the sale of the Company. So we are tracking performance, we believe appropriately reflecting value quarter-to-quarter, and at some point which we can’t predict we expect the Company will be sold and when the Company is sold then obviously our position will convert into cash and as I was stating earlier that cash will be able to be reinvested, which will help with dividend coverage for us going forward.

[Operator Instructions] Your next question comes from the line of Melissa Ladal of JP Morgan.

Melissa on for Rick today. I wanted to follow up on the comment you've made in prepared remarks about new investments made so far in 1Q '18. I might have missed that I know that you said closed I believe four investments. Did you specify a dollar amount of originations related to that?

I didn’t and I don’t have it in front of me and I'll talk for few minutes to see, if Ed has it and if he can pull that up to share with you. I will add then in addition to the four transactions that have already closed which obviously in and itself will be a very solid quarter. There are four other transactions that we have mandates on. We don’t know whether all or any will close in the quarter, but there are several that are scheduled to close in the quarter. We still in the midst for doing due diligence on those transactions, and as the market is seeing if our due diligence does not come out appropriately, we will not close on deals. So, four deals are closed. We would hope and anticipate that more will close, but there can be no assurance on that. And Ed, will you able to come up with the dollar amount of the investments that we done on the four of the close?

I can say it’s over 50 million for the four deals that specific number now.

Okay. That’s helpful. A quick follow-on here, you also said that it’s possible you could be fully deployed by the end -- potentially full deployed by the end of Q1. Just as a reminder, can you guys talk about how you view your targeted leverage range? And where you’re comfortable particularly at the stage of the cycle and in this environment?

So, my general thesis is that the starting point for conservatives is booking assets that have low risk of loss. We are focused on doing that the fact that all eight of the transactions that closed in Q4 and so far in Q1 or first lien is I think a testimony to that. And it’s worth noting that even though they are first lien deals, we are for the most part still achieving double digit yields on these transactions, which speaks to the power of our origination model. All of you who cover the broader markets you know that first lien loans at a leverage level of about 3.5 times are not yielding double digit levels or people who are buying of a syndicated desk. So direct origination model is doing exactly what it's supposed to do and finding these low levers, loan onto value that have high return. I’d also add to that, that all forward deals that are mandated again some of which are not originally close this quarter are also first lien transactions so that trend will continue. In the phase of having a, what we believe is conservative and strong performing portfolio, we feel comfortable of having leverage of between 70 to 80% on the assets in the BBC. We’ve been under that 70% levels since we raised equity ad deployment was slower than planned but we would intend if these transactions close this quarter to finish the quarter with leverage in the planned range which will obviously be accretive to our ability to earn our dividend quarter-to-quarter.

Got it. Thanks for that clarification and one I have a follow-up. Do you have visibility in to any meaningful or e-payments that exit this quarter?

There is one repayment that we are expecting between now and quarter end that I’m aware of. I’m thinking now and Ed if you know of any others that we’re expecting if that number is more than one, can you share with me. I only can think of one at the moment.

[Operator Instructions]

Sorry, Stuart to follow up to your note. I was on mute there for a minute. It's three known are likely and it's just under 20 million.

Okay. Thank you, Ed.