WhiteHorse Finance, Inc. 7.875% Notes due 2028 (WHFCL) Q3 2016 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 Third Quarter 2016 Earnings Conference Call. Our hosts for today's call are Stuart Aronson, Chief Executive Officer, and Edward Giordano, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 1:00 PM Eastern. The replay dial-in number is 404-537-3406, and the pin number is 3321749. At this time, all participants have been placed in 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, operator, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's third quarter 2016 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. During this call, we will discuss GAAP and non-GAAP financial measures, for which a reconciliation can be found in our press release, which is available on our website, www.whitehorsefinance.com. With that, allow me to introduce WhiteHorse Finance's CEO, Stuart Aronson. Stuart, you may begin.

Thank you, Sean. Good morning and thank you for joining us today. As you are aware, we issued our press release this morning prior to market open, and I hope you have had a chance to review our results, which are also available on our website. I am going to take you through our third quarter operating performance and then Ed will review our financial results, after which we will take our questions. As our results indicate, we had a strong quarter across all key operational and financial metrics, the result of our prudent and patient approach to the business and adherence to a disciplined philosophy regarding origination activity. We reported net investment income of $0.397, our second highest quarterly net investment income since 2013, and well above our quarterly stockholder distribution of $0.355, allowing us to comfortably us to cover our dividend. Our average effective yield increased to 12.1%, up from 11.9% last quarter, and our NAV per share was $13.48, an increase of $0.11 from the NAV of $13.37 last quarter. We continue to pursue low leverage, high yielding opportunities that advance our goal of maximizing shareholder value. On the origination side we had two new loans totaling $33 million. The first was a $13.4 million origination to AG Kings Holdings, a high end grocery chain located in New England at 10.95%. This is consistent with a low leverage, high return goals that define our business strategy. And the second origination was $19.6 million, refinancing of an existing asset-based loan at Oasis Legal Finance. The new loan issued at 11.75% is consistent with the underlying credit guidelines that were in place when the original loan was made. On the repayment side, we saw total activity during the quarter of $33.2 million, down from $39.3 million last quarter. For the nine months ended on September 30, 2016, we invested $69.6 million in new and existing portfolio companies, offset by repayments in sales of $87 million. This compares to $104 invested in new and existing portfolio companies, and repayments in sales of $128.6 million in the first nine months of 2015. Another positive development that I would like to highlight is Fox Rent A Car, which we placed on non-accrual status, is once again performing. All amounts currently due including default interest have been paid. As part of the amendment process for the technical breach that occurred, we were able to strengthen our position within the capital structure and are comfortable with our loan from a cash flow coverage standpoint. Turning now to our investment portfolio. As of September 30, 2016, the fair value of the portfolio was $402.9 million, slightly above the $400.9 million reported at the end of the second quarter. As of that date, the majority of our portfolio was comprised of senior secured loans to lower mid-cap borrowers and over 99% of those loans were variable rate investments primarily indexed to LIBOR. The portfolio had an average investment size of $11.9 million based on fair value and the largest investment being $34.2 million with a weighted average effective yield of 12.1%. We now hold 34 positions across 28 companies, and I will provide an update on a few of our positions within the portfolio. We have lowered our mark in our position in Future Payment Technologies, a merchant payments company based in Dallas. We have lowered it by $2.7 million due to a decrease in performance that led us to adjust the fair value of the asset. We are actively engaged with the company to help evaluate the situation and enhance performance going forward. Also, though our exposure to energy remains very low at 4%, improving prices in the sector have driven a corresponding increase in the marks on those positions. Throughout most of the quarter the portfolio was close to fully invested. Our leverage levels decreased from 0.79 times to 0.7 times due to repayment to the credit line during the third quarter with proceeds from a large loan repayment at the end of the second quarter. As we have mentioned on prior calls, our long-term target leverage level is between 80% and 90%. Looking ahead, we are encouraged by our pipeline as we continue to source direct investment opportunities. We have several mandates for potential closings during the fourth quarter. We will remain highly selective in our sourcing as we continue working on these new opportunities. Looking ahead to 2017, all of our underwriting activity takes into account the potential for underlying economic volatility over the next one to three years. For each underwritten transaction we examine a severe downside case with a goal of ensuring that any loan we make will return principal through such a cycle. One of the specific benefits of concentrating in non-sponsor lending is that the covenants of our loans are set more tightly than in sponsored lending, which means that if there is an economic disruption, we will generally be at the table early in these situations and able to take both credit actions and economic actions. That includes having owners inject new money into the companies or selling a piece of the company to pay down debt. Economic actions include waiver fees, amendment fees, adjustments to rate or, where appropriate, taking warrants to adjust to the economic risk. We remain committed to our goal of making strategic investments that allow us to earn our dividend and at the same time protect NAV. We are encouraged by how that played out during the third quarter. As rising interest rate environment continues to be prolonged by global uncertainty, we are optimistic about the yields we are able to offer via our portfolios thanks to our focus on diversified, low leverage, high yielding loans. We look forward to continuing to update you on our progress. And with that I'll turn the call over to Ed.

Thanks, Stuart. Starting with the Q3 2016 results, NII was $7.3 million for the quarter or $0.397 per share, an increase from $6.4 million, or $0.351 in the prior quarter. Our investment income continues to consist primarily of recurring cash interest. We reported a net increase in net assets from operations of $8.6 million, or $0.47 per share for the third quarter. We also reported our small realized gain of $0.7 million driven primarily from realized gains on the sale of our Orion Healthcare warrants. As of September 30, 2016, net asset value was $246.8 million, or $13.48 per share, up from $244.7 million, or $13.37 per share, as reported for Q2. Switching over to portfolio and investment activity. As of September 30, the fair value of WhiteHorse Finance's investment portfolio was $402.9 million, an increase over the prior quarter. The risk rating on our portfolio remained mostly unchanged. We continue to maintain a three rating on our energy holdings to reflect the current macroeconomic conditions. As a reminder, we continue to have lower exposure to the energy sector overall with approximately 4% of our portfolio representing energy or energy-related investments. We also had a credit, Fox Rent A Car, move from nonaccrual to accrual status. All amounts due, including default interest, have been paid. As part of the amendment for the technical breach that occurred, the loan has been converted to a first lien cash flow loan with a cash flow multiple consistent with our low leverage guidelines. Turning to our balance sheet. WhiteHorse Finance had cash resources of approximately $23.7 million as of September 30, 2016, and approximately $20 million of undrawn capacity under its revolving credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of September 30, 2016. The Company's asset coverage ratio for borrowed amounts as defined by the 1940 Act was 242.5% at the end of the third quarter, well above the statute's requirement of 200%. Our net effective debt-to-equity ratio after adjusting for cash on hand was 0.61 times. Last, I'd like to highlight our quarterly distribution. On September 8, we declared the distribution for the quarter ended September 30, 2016 at $0.355 per share for a total distribution of $6.5 million to stockholders of record as of September 19, 2016. The distribution was paid to stockholders on October 3. This marked the 16 distribution since our IPO in December 2012, with all distributions at the rate of $0.355 per share per quarter. We expect to be in a position to continue our regular distributions. I now turn the call to the operator for your questions. Operator?

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Merrill Ross with Wunderlich.

Hi. Good morning. I had noticed that Caelus in Alaska had made a significant discovery and I wondered why that wasn't reflected in the valuation, maybe that discovery wasn't included in the asset base for the loan.

Our borrower owns a portion of the value for that discovery. Developing that discovery will cost a lot of money, and it is not clear. There is clearly some value that accretes directly to our borrower from that discovery, but it's not clear how much. As a result, the trading level on that loan, while it has strengthened, is consistent with where we have that loan marked, so we think the relative valuation we're showing on that asset is appropriate. And as with all of our assets, our goal is to recover par value over time.

Thank you. I just was curious. Appreciate it.

Our next question comes from the line of Dan Nichols of Baird.

Good morning. This is actually Bryce Rowe with Baird. I wanted to ask about the Fox Rent A Car moving from non-accrual back to accrual status. Could you guys quantify the revenue impact, I guess, of the catch up nature of the interest that was paid in the quarter? Thanks.

Sure, I'll take that. For the catch up portion of it, it was a little over $300,000 up through the beginning of the third quarter, and approximately another $300,000 for the interest earned during the quarter.

Great. Thank you.

[Operator Instructions] There are no further questions. I would like to turn the call back over to Stuart Aronson for any closing remarks.

I would just like to say thank you for tuning in. We will continue to focus on consistently earning our dividend over the course of any given year and protecting NAV, and we will maintain our conservative investing philosophy in directly originated loans to accomplish that. Thanks, everybody.

Thank you. That does conclude today's conference call. Thank you for your participation. All participants may disconnect at this time.