WhiteHorse Finance, Inc. 7.875% Notes due 2028 (WHFCL) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Maria 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 2014 Earnings Teleconference. Our hosts for today’s call are Jay Carvell, Chief Executive Officer, Bill Markert Chief Operating Officer and Gerhard Lombard, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 1 pm Eastern Time. The replay dial-in number is 404-537-3406 and the pin number is 75705168. 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 Emily Liehen of Prosek Partners.

Thank you, Maria, and thank you everyone for joining us today to discuss WhiteHorse Finance’s fourth quarter and full year 2014 earnings results. Before we begin, I would like to remind everyone that certain statements made during this call, which are not based on historical facts 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 begin, WhiteHorse Finance's CEO, Jay Carvell. Jay, you may begin.

Thanks, Emily. Good morning. Thank you for joining us today. As you know, our press release was issued this morning before market and I hope you have had a chance to review our results. We are very pleased to report a strong fourth quarter in terms of both, portfolio activity and NII. Gerhard and I will go over some of the details during the call today, but the results for the quarter and the year continue to flow out of our disciplined investment approach in the smaller end of the capital markets. We achieved a strong quarter in originations and exceeded our full year origination goals for 2014. During the fourth quarter, we $91 million across nine portfolio companies, bringing our investment activity to $261 million for the year. We previously discussed targeting a $50 million per quarter investment pace and are glad to have surpassed that over the last year. Gross proceeds from sales and repayments for the quarter totaled $56 million, which was in line with our expectations. For the year, gross proceeds from sales and repayments were $135 million or $35 million lower than total repayments for 2013. While we expect some natural turn in the portfolio from early repayments and refinancings that activity slowed somewhat from our historical pace during Q4. A portion of the repayment activity in the quarter was tied to portfolio optimization. I would like to highlight a few items regarding our investment portfolio. As of December 31st, fair value of the portfolio was $404 million, an increase of $131 million from the fourth quarter of 2013 and approximately $34 million higher than what we reported last quarter. Our investment portfolio of 37 total positions is primarily composed of senior secured loans to 31 different borrowers. The portfolio was well diversified across a number of industries with an average investment size of $10.9 million and a weighted yield of 11.3%. None of our investments are currently in or have been in non-accrual status. One topic that seems to be at the forefront of everyone's mind is the energy sector. The drop in oil prices at the back-end of last year caused a big down drought in trading levels of names related in any way to energy and particularly to exploration and production companies. Our overall portfolio exposure to energy names is about 6%. We are comfortable with our position and believe there will be attractive risk return opportunities in the space over the longer term. More than 96% of the loans in our portfolio carry a variable rate, which should continue to position the portfolio for potential rising interest rate environment. The $91 million we invested in the fourth quarter was spread across nine companies and nine different industry segments, including healthcare facilities, food, retail and trucking. The $56 million of proceeds we received from sales and repayments was attributable to the prepayment of two loans and ongoing portfolio optimization, whereby we improved overall risk return of the portfolio by opportunistically divesting away from lower yielding positions. Looking at the broader capital markets, we saw a great deal of volatility in the fourth quarter of 2014. As I mentioned earlier, the drop in oil prices drove the energy sector lower, which led the way for the larger market. We expect this general market turn [ph] to persist, but in the sector and as a whole for the near-to-mid term. While volatility persisted to smaller end of credit markets, we are somewhat shielded from this phenomenon. As you can see by our origination activity during the quarter, WhiteHorse took advantage of this environment by putting money to work at attractive rates of returns. Over the longer horizon, we expect to see solid opportunities to put capital in this space. We believe that our overall portfolio was well positioned to withstand any further movements in the market. We believe that BDC space in general should see favorable tailwinds as fewer banks were able to meet the borrowing needs of small businesses. Also, as you are aware, the seller [ph] market is facing hurdles of its own due to regulatory changes further benefitting us. Heading into 2015, our outlook remains positive and we are seeing excellent opportunities within the small cap space. Our close relationship with HIG Capital continues to serve as a strong asset to us as we selectively identify opportunities to add to the portfolio. With that, I will now turn the call over to Gerhard. Gerhard?

Thanks, Jay. Let us begin with our results for the quarter December 31, 2014. Net investment income was $5 million compared with $4 million reported last quarter. This 23% increase in NII over the prior quarter is the result of the continued deployment of capital into higher-yielding directly originated loans. Assuming no other changes in the portfolio, we would expect to see a further increase in NII during Q1 2015 from the full quarter revenue impact of investments made during Q4 2014. Our investment income continues to consist primarily of recurring cash interest. Fourth quarter fee income was $197,000 compared to third quarter fee income of $346,000. Net realized and unrealized losses on investments were $1.4 million compared with net realized and unrealized gains on investments of $520,000 during the third quarter of 2014. As a result, we reported an increase in net assets from operations of $3.6 million or $0.24 per share for the fourth quarter of 2014 compared with $4.6 million or $0.31 per share in the third quarter. The variance between the two quarters relates primarily to unrealized losses on our energy investments recorded during the fourth quarter, but we cannot state with certainty at which levels we will exit any of our positions we feel comfortable with where our portfolio assets and energy investments in particular are marked. Expenses for the quarter totaled $6 million and primarily consisted of interest expense on our credit facilities of $1.7 million and base management fees and performance-based incentive fees of $3.4 million. This compared with $5.2 million in expenses for the prior quarter. The primary driver of the increase in expense is from Q3 to Q4 was portfolio growth, which caused variable expenses like interest and management fees increased in line with the underlying portfolio assets. As of December 31, 2014, net asset value was $225.4 million or $15.04 per share compared with $227.1 million or $15.16 per share as of September 30, 2014. Now, let me turn my attention to our results for the full year ended December 31, 2014. For 2014, we reported net investment income of $17 million or $1.13 per share, which compares with $19.3 million or $1.29 per share in 2013. 2014 net investment income includes fee income of $1.6 million while fee income was $3.5 million during 2013 and included significant non-recurring fees related to the prepayment of a number of large investments. Net realized and unrealized gains on investments were $2.5 million for 2014 compared with net realized and unrealized losses on investments of $280,000 in 2013. The company reported an increase in net assets from operations of $19.5 million in 2014, up from $19 million in 2013. Switching over to portfolio and investment activity, as of ended December 31 the share value of WhiteHorse Finance's investment portfolio was $403.5 million, invested 37 positions across 31 companies and consistent with the previous quarter. The portfolio was primarily comprised of senior secured debt. The weighted average current yield on the portfolio at the end of the quarter was 11.3% increasing over the prior quarter as a result of direct proprietary origination. For the majority of investments in the portfolio, risk ratings remained unchanged. Last, there were no non-accrual loans as of December 31, 2014. Turning to our balance sheet, WhiteHorse Finance had cash resources including restricted cash of approximately $16.1 million as of December 31, 2014. This compares with $26.5 million as of September 30, 2014 and $96 million as of December 31, 2013. As of December 31, 2014, the company had indebtedness in the former senior notes and two credit facilities that on a combined basis withdrawn by approximately $105.5 million. We remain comfortable that our cash position and credit lines will continue to provide us the ability to source loans and meet the origination goals and the ability to optimize the portfolio as Jay mentioned earlier whereby we replaced lower yielding loans with investments that have more attractive risk return profiles. The company's asset coverage ratio for borrowed announces as defined by 1940 Act was 218% at December 31, 2014, well above the statute's requirements 200%. Our net effective debt to equity ratio after adjusting for unsettled trades in cash on hand was 0.77. We closely monitor our asset coverage ratio and feel very comfortable with our leverage as of December 31, 2014. We do not manage to a specific target, but continue to take into account a variety of factors, including portfolio liquidity and market conditions. As we continue to make direct proprietary investments that are less liquid, we may decrease our leverage. Finally, I would like to highlight our quarterly distribution. On November 25, we declared a distribution for the quarter ended December 31 of $0.355 per share for total distribution $5.3 million the distribution was paid to stockholders on January 2, 2015. This marks the company's ninth distributions since our IPO in December 2012, for total distributions at the rate of $0.355 per share per quarter. We expect to be in a position to continue our regular distributions. This concludes my formal remarks. I will now turn the call back to the operator for your questions. Operator?

Thank you. The floor is now opened for questions. [Operator Instructions] Our first question comes from Troy Ward of KBW.

Great. Thank you. Good morning, Jay. Good morning, Gerhard. Could you just provide a little bit of - you talked about spreads, we have heard a lot about spread widening in the last half of the year. Can you talk about how that maybe came into the first quarter of 2015 here and entire year quarter to-date activity?

Sure. Thanks for dialing in, Troy. I appreciate it. You are right that the volatility in the markets and in credit markets in general is a somewhat of a good sign for companies like ours and we are seeing more opportunities and the opportunity to put money to work at attractive levels. We generally do not comment on your specifically on the pipeline as you know. I will tell you that we are seeing a lot of what we consider attractive opportunities and think will be able to put that money to work in Q1 and into the year. What that will mean for as I think is some of that portfolio optimization activity I talked about earlier, where we are able to cycle out of some of things that are yielding less than the things that we are looking at now.

Okay. Can you talk about kind of on the number side, what do have for portfolio optimization? What's left in that portfolio and how that has been impacted by wider spreads?

I think you saw some of that in Q4. You can kind of compare the portfolios quarter-over-quarter and see where we were able to cycle out of some names that were yielding less than 10 and to things that are even more than 10% for example. We don't like to talk about trading very much in terms of kind of future activity. We try to hold that a little bit close to us [ph], but it is not that bigger mystery probably to look through and see things that you think are yielding at a level that you would say that is not as attractive something you are probably seeing in the new market. In terms of how much that is, that will be a little bit market-driven, it will be able to driven both, on the origination side and a little bit on the optimization side. I am comfortable that we can cycle out a demand, so we want to, as we find opportunities that are more attractive.

Okay. Then one final one, on your investment in the New Mountain senior loan program, that is now where you added I think about $7 million to that, you have put a $20 million investment which is still one of your own larger investments in the portfolio. Can you just provide us some color on your thought process there to invest in obviously onto another BDC and why shareholders quite honestly would be giving you capital to invest with another BDC?

We know there are new and I think we talked about this at the outside of this, this is what we feel like was good yield for us. The commitment there is $20 million, so you won't see that grow. Frankly traffic and things that we do not, and it's a good diversification for our portfolio as well, so we are comfortable with them as a manager in those names and feel like it is good use of capital for us in the portfolio given where the names that they invest in verses kind of what we do.

What is the current yield on that?

Roughly 12%.

Okay. All right. That is all my questions. Thanks.

Thanks, Troy.

[Operator Instructions] Our next question comes from Rick Shane of JPMorgan. Rick, your line is open. Make sure you are not on mute.

Guys, can you hear me now?

Yes.

Sorry about that. It has been a little bit of a crazy morning. I would love to talk about two things. You talk a lot about the demand for capital. Given where your balance sheet is, you guys are to some extent capital constrained in your ability to take advantage of that. Can you talk about ways that you can potentially increase your capital base? Obviously trading label local a book that has a little bit harder, could you get capital from your sponsor and in light of that, would you talk a little bit about your dividend policy at this point still not covering the dividend that erodes further book value uses capital. Can you think about what that might look like going forward as well?

Yes. Thanks, Rick. You are right. We feel like we are pretty efficient with our balance sheet right now in terms of our leverage and where we are with the of portfolio, so I think in the near-term there is still some opportunities for us to optimize some of those names like we were talk about with Troy in terms of cycling out some of the lower yielding into some higher-yielding deals that falls in with your question about the dividend. We are right on top of it at this point. I think that given the longer runway with having deals in the portfolio during the quarter and having an earnings that interest over the longer timeframe, we feel comfortable with where we are in terms of our distribution and our NII. You rightly point out that given where we are trading, we are probably not likely go out and seek a secondary, but we also feel like as we are earning that dividend and as you see that that we will get closer and closer to that level at NAV level and that will give us more opportunities to raise capital. Away from that, you are right that it is possible to talk to the sponsor here. It is possible on a couple of other fronts in terms of raising capital to put to work in the BDC itself for exploring those. We have not felt too constrained yet just given where we are in the portfolio and the kind of things I have talked about today, so we have not really felt like we needed to panic and find some other way to bring capital in, but it is certainly something we are exploring looking out over longer-term horizon and we seeing the opportunities. We want to be able to put that capital to work and use our network and not miss opportunities, so it is certainly something we are looking at.

Look. It certainly makes sense being front of that and avoids that sort of panic scenario. We never know two or three quarters down the road what the world is going to look like.

Yes. That is our thinking.

Got it. Thank you guys.

[Operator Instructions] I am showing no further questions at this time.

Thanks for joining today. We look forward to speaking to you all next quarter. Operator; back to you.