WhiteHorse Finance Inc (WHF) 2017 Q4 法說會逐字稿

Good morning. My name is Lori, 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 hosts 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 replay beginning at 1:00 p.m. Eastern. The replay dial-in number is (404) 537-3406 and the PIN number is 9589848. (Operator Instructions)

It is now my pleasure to turn the floor over to Sean Silva of Prosek Partners.

Thank you, Lori, 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 the 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 and 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 $0.331 per share, slightly below our dividend of $0.355 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 $0.355 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 3 new originations during the fourth quarter totaling $22.7 million as well as a refinancing that added to an existing position. 3 of these 4 transactions were nonsponsor 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, SecurAmerica, was in $11 million first-lien loan. And additionally, we refinanced our position in multicultural 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 in 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 $111 million at an average effective yield of 11.3%, and recorded $106.3 million of repayments in sales, including $88 million relating to full exits from 8 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 than the deals being syndicated in the broad marketplace. And our average leverage on closed deals is consistent with our historical track record of about 3.5x.

I'll now provide more detail on this by reviewing our portfolio activity.

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 indexed to LIBOR. The portfolio had an average investment size of $10.2 million based on fair value, with the largest investment being $25.7 million. Within the portfolio, we have -- we held 43 positions across 32 companies.

As of the end of the fourth quarter, our deployment resulted in net leverage of 51%. As of today, when accounting for 4 new originations that we 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 and prepayments 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, had been first-lien transactions, resulting in a higher concentration of first-lien positions in our portfolio, while still generating 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 prerestructuring cost basis of $20.7 million. As it regards 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 earn interest income, which helps create coverage for the dividend of the BDC.

In general, for every incremental $2 million of cash, we're 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 H.I.G. sourcing model continues to drive strong results and remains key differentiator for us in the lower mid-market, specifically our 3-tiered sourcing architecture takes advantage of over 300 investment professionals at H.I.G -- over 350 investment professionals at H.I.G., and these professionals include approximately 25 global business development resources, who help to source deals for a proprietary list of over 21,000 lawyers, accountants, wealth managers, boutique bankers and off-the-run sponsors. In addition, WhiteHorse has deployed 16 dedicated originators across 10 cities in the United States, who're directly originating in the nonsponsor and off-the-run sponsor markets. Collectively, we are optimistic about our business model and how it 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 continuing to make inroads into the middle market, and spread compression is a reality across the market. However, we feel that our business model of direct originations in the lower mid-market provides us some insulation from both of these headwinds. We continue to pursue sponsor deals because sponsors bring professional management, professional systems and the ability to support a company to recycle. And we also remain very focused on nonsponsor deals because they have much lower loan leverage, much lower loan to value and much higher debt service coverage than sponsor 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 2 as our pipeline now is more robust than it's ever been. Regarding other macro factors, we have not seen an impact from 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, this 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 $0.331 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 in 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 remain 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 statute's requirement of 200%.

Our effective debt-to-equity ratio after adjusting for cash on hand was 0.51x.

Last, I'd like to highlight our quarterly distributions. On December 6, we declared a distribution for the quarter ended December 31, 2017, of $0.355 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 $0.355 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?

(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 multiples? Or is there something fundamental occurring at the company that we should know about?

Mickey, thanks for the question. 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 marked that asset down to what you've seen it marked 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 that were reported in The Wall Street Journal. So we mark 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.

Stuart, that's helpful. And if I could just follow-up. In your prepared remarks, I think you 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 others not? Or is that a general statement about the 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 were 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 than 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, I saw this little additional position now of RCS credit or trust. I'm wondering, is that a recurring kind of additional unit that you get from holding the position? Or is that just a cleanup 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 -- it's some litigation.

Okay. And refresh our memory, what -- who has the controlling position in -- or -- yes, actually -- what is your position in Aretec? And how -- what kind of influence do 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 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 stretch of the 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 are -- 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 Wedel of JPMorgan.

Melissa on for Rick today. Wanted to follow up on the comment you made in prepared remarks about new investments made so far in 1Q '18. I might have missed it. I know that you said, you closed, I believe, 4 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 a few minutes and see if Ed has it and if he can pull that up to share it with you. I will add then in addition to the 4 transactions that have already closed, which obviously, in and itself would be a very solid quarter. There are 4 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're still in the midst of 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 4 deals are closed. We would hope and anticipate that more will close, but there can be no assurance on that. And Ed, were you able to come up with the dollar amount of the investments that we've done on the 4 that closed?

It's a -- I can say, it's over $50 million for the 4 deals, but specific number, I don't have.

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

So my general thesis is that the starting point for conservatism is booking assets that have low risk of loss. We are focused on doing that. The fact that all 8 of the transactions that closed in Q4, and so far in Q1, are 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 those 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 3.5x are not yielding double-digit levels for people who are buying off the syndicated desks. So direct origination model is doing exactly what it's supposed to do in finding these low leverage, low loan-to-value loans that have high return. I'd also add to that, that all 4 of the deals that are mandated, again, some of which or none of which may close this quarter, are also first-lien transactions so that trend will continue. In the face of having a, what we believe, is conservative and strong performing portfolio, we feel comfortable having leverage of between 70% to 80% on the assets in the BDC. We've been under that 70% level since we raised equity as 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. One final follow-up. Do you have visibility into any meaningful repayments or exits this quarter?

There is 1 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 1 can you share with me? I only can think of 1 at the moment.

(Operator Instructions)

Sorry, Stuart, to follow up to your note, I was on mute there for a minute. It's 3 known or likely. And it's just under $20 million.

Okay. Thank you, Ed.

At this time, there are no further questions. Thank you for participating in the WhiteHorse Finance Fourth Quarter and Full Year 2017 Earnings Conference Call. You may now disconnect.

Thank you.