WhiteHorse Finance Inc (WHF) 2018 Q2 法說會逐字稿

Good morning. My name is Crystal, and I'll be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Second Quarter 2018 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 Standard Time. The replay dial-in number is (404) 537-3406 and the PIN number is 2791007.

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

Thank you, Crystal, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's Second Quarter 2018 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.

Thank you, 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 second quarter operating performance and then Ed will review our financial results, after which we'll take your questions.

During the second quarter, we continued our positive momentum and delivered another strong set of results under the backdrop of a very competitive credit environment. We recorded net asset value per share of $14.87, a $0.57 increase from the first quarter of 2018 and an increase of $1.04 from the second quarter of 2017. Additionally, our weighted average effective yield held constant at 12.0%.

Core net interest income was $0.331 per share. This excludes a $2.2 million accrual for a capital gains incentive fee resulting from our markup during the quarter on Aretec. Ed will provide further detail on core versus GAAP net interest income shortly, prior to which, I'll detail our top achievements during the quarter.

First, our value and our position in Aretec grew to $37.4 million, which was later confirmed with Aretec's announced sale to Genstar. In marking that asset, we took an appropriate discount for the possibility that the transaction will not close. However, if the transaction closes as contemplated, there will be further value accretion as that discount is turned into cash.

In general, as I've shared before, for every $2 million of cash we receive and invest at a 10% yield at our historical target leverage, we typically increase net interest income by approximately $0.01 per share on an annual basis.

Second, we recently held our Annual Shareholders Meeting, where shareholders approved the proposal for increasing our leverage on the terms and conditions of the Small Business Credit Availability Act. For the near term, we intend to manage the BDC's leverage between 1 and 1.25x. Based on net asset value as of June 30, 2018, the impact of these new leverage levels could increase investable assets between $61 million to $137 million.

Further, if we invest this capital at a 10% yield, the company's annual net interest income per share would increase between $0.07 and $0.16 per share. I do also want to caution the deployment of this amount of capital will be managed with due care and we expect it to occur over the coming 9 to 12 months.

In terms of good things this quarter, third, we issued $30 million in new senior notes that mature in 2023 and pay a fixed rate of interest of 6%. We will use the proceeds to redeem our current senior notes that have a 6.5% interest rate, thereby, saving approximately $0.01 per share on an annual basis.

Further, we believe this is a positive development for the company as we maintain the proportion of fixed debt in our capital structure, while at the same time extending its duration in anticipation of higher future interest rates and expanded our debt capacity to be able to access the additional leverage that shareholders provided us.

Going forward, we expect to increase our borrowing capacity when needed in connection with the increased leverage limits. This may include a mix of additional fixed and/or floating rate debt.

Fourth on the list of good things is we have 5 new originations, 3 sponsor deals and 2 nonsponsor deals and all of these deals were first lien in the capital structure. Total amount of these deals is $71.2 million. Since Q4 of last year, all 15 of our originations, including refinancings, have been first lien.

Our percentage of first lien assets in the debt portfolio has increased from approximately 57% to 68% over that same period and our goal is to reach a first lien allocation of approximately 75% in the BDC. The leverage multiple on these new deals was under 4x and the effective yield was 10.5%, showing our ability to source high-yielding, high-quality deals.

All 5 origination whole positions range between $10 million to $15 million, which is consistent with our target range of $4 million to $20 million. Repayments and sales totaled $42.5 million compared to $33 million during the first quarter, primarily driven by a full pay down on prepaid legal services of $19 million and a full down -- full pay down on Pay-O-Matic Corp. of $11.8 million.

Turning now to our investment portfolio. As of June 30, 2018, the fair value of the portfolio increased to $511.4 million compared to $467.7 million reported at the end of the first quarter and consists 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 $9.8 million based on fair value. While we did have 4 issuers in the portfolio above our target range -- hold range of $4 million to $20 million, we are actively working on reducing 3 of those exposures on those positions and we hope to have those 3 positions reduced below $20 million by year-end.

While average leverage during the quarter was 65%, leverage at the end of the quarter was 71%, which falls at the lower end of our historical range of 70% to 80%. Further, our portfolio continues to perform very well with only one loan on nonaccrual and that loan is valued at $1 million of original face value.

Turning now to our pipeline. During the third quarter, we've already closed one second-lien sponsor transaction and we have another 2 transactions under mandate and pending. As always, the mandates in our pipeline are subject to due diligence and we do not know how many of these will actually close.

Our sourcing and origination efforts remain as active as ever. We currently have 34 investment professionals directly supporting the WhiteHorse Finance strategy. Those 34 people are located in 10 cities across the U.S. Our pipeline is very strong, but markets remain competitive and we're turning down more deals than ever in staying true to our conservative credit standards. This again speaks to the effectiveness of our 3-tiered H.I.G. sourcing architecture, which facilitates disciplined, prudent sourcing and origination across a wide range of opportunities.

With that, I'll now turn the call over to Ed.

Thanks, Stuart. I'll first address our Q2 results and conclude by discussing the July refinancing of our senior notes. We recorded net investment income of $4.6 million or $0.224 per share. This accounts for GAAP reporting requirements that the recognition of capital gains based incentive fee be accrued if realized gains and unrealized appreciation of investments exceed realized losses and unrealized depreciation of investments.

As such, during the quarter, we recognized an accrued expense of $2.2 million stemming from an unrealized gain, driven by the continued markups of our position in Aretec. Core NII, which excludes the accrual of capital gains incentive fee, was $6.8 million for the quarter or $0.331 per share. This compares to $8.6 million or $0.418 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 $19.1 million or $0.93 per share for the second quarter, which includes $12.2 million markup of Aretec. As of June 30, 2018, net asset value was $305.3 million or $14.87 per share, up from $293.5 million or $14.3 per share as reported for Q1.

As it pertains to our portfolio and investment activity, the risk ratings of our portfolio saw modest improvements with 3 of our portfolio companies being upgraded to a 1 rating and another being upgraded from a 3 to a 2 rating.

Turning to our balance sheet. We had cash resources of approximately $18.6 million as of June 30, including $4.1 million of restricted cash and approximately $12.2 million of undrawn capacity under our revolving credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of June 30, 2018.

The company's asset coverage ratio for borrowed amounts as defined by the 1940 Act was 240.2% at the end of the second quarter, well above our recently reduced requirement under the statute of 150%. Our net effective debt-to-equity ratio after adjusting for cash on hand was 0.65x at the end of the quarter.

Next, I'd like to highlight our quarterly distribution. On June 5, we declared a distribution for the quarter ended June 30, 2018, of $0.355 per share for a total distribution of $7.3 million to stockholders of record as of June 18, 2018. The distribution was paid to stockholders on July 3. This marks the company's 23rd distribution since our IPO in December 12 -- 2012. With all distributions at a rate of $0.355 per share per quarter, we expect to be in a position to continue our regular distributions.

And finally, as Stuart referenced, in July, we announced an agreement to sell in a private offering $30 million aggregate principal amount of 6% senior notes due 2023. These were offered only to qualified institutional buyers. These notes were delivered and paid for on August 7.

We'll use the net proceeds from this offering to redeem our 6.5% senior notes maturing 2020, which will then be delisted from the NASDAQ Global Select Market. We'll redeem 100% or $30 million of the aggregate principal amount of the issued and outstanding notes and expect this redemption to complete -- be completed on August 9, 2018.

I'll now turn the call over to the operator for your questions. Operator?

(Operator Instructions) Our first question comes from the line of Mickey Schleien with Ladenburg.

I have a couple more follow-up questions on Aretec. I understand, obviously, that it's a private transaction, Stuart, but it is a large position in the portfolio and you mentioned that it's still carried at a discount to the exit price. Could you give us a sense at least whether the discount is a single-digit discount or are we talking a double-digit discount?

I've got to be careful on that because the transaction while announced is still confidential vis-à-vis the actual pricing. I guess, the best way to answer would be to say that at the end of the quarter, the transaction had not been announced yet.

And so, if anything, the level of certainty of the transaction has increased with public announcements both of the transaction and of the financing for the transaction. But as of the end of the quarter, we still felt there was significant uncertainty and the discount to the final valuation is well into the double digits.

Okay. That's helpful, Stuart. And I think from the press releases, it said that's going to close next month, which will provide you with a pretty meaningful amount of liquidity. I think in your prepared remarks, you mentioned the pipeline, but do you think it's large enough to absorb this level of liquidity? Or is it more likely that leverage will decline at least for a while?

So, Mickey, when we are working on building a pipeline for the BDC, we are very cautious about getting involved in committing to things before we have the capital in. That said, the increased leverage is now approved and so we have flexibility on capital funding through increased leverage. So we are just now starting to work on ramping up the pipeline to be able to deploy that money.

But as I shared in the remarks, both the increased leverage, which provides the $61 million to $137 million of additional investing capacity and then the conversion of the RCS equity into cash will create a very significant amount of investing capacity. And if we maintain our investment positions of no more than $20 million per transaction, then it is best estimated that it will take us between 9 to 12 months to get to full deployment on all that asset. It will not occur in a quarter or 2.

Okay. That's helpful. And just -- I don't want to beat a dead horse, but a couple more questions, more sort of housekeeping on Aretec. Will there be any dividend or fee income associated with that transaction? And do you expect to distribute the realized gains to shareholders or retain the capital?

The expectation is that the gain on Aretec will be used to enhance the investing activities of the BDC and to make our ability to earn our dividend even more reliable than it is now. So we do not anticipate distributing those proceeds.

And will there be any sort of fee or dividend income associated with it?

At the moment, that has not been decided.

Okay. And just a couple of more, if I may. The SLF, I understand, operates as an LLC. That terminates next year, although I understand there is a 1-year extension possible. Do you expect the extension to be exercised? And if you don't, do you expect to roll that into another SLF investment out there or just on to the balance sheet itself?

I don't have any data to share with you on that, Mickey. I'm sorry.

Okay. And just on -- maybe for Ed. On the refinancing of the notes, can you quantify how much the write-off for the deferred financing cost will be? And will that be reported as an operating expense or realized loss?

I don't think I have that here at my fingertips, Mickey. But...

I will follow up with you later then.

Yes, yes. It would be -- from the existing notes it would be written off through the expenses in this quarter.

Okay. Fine. I'll follow up with you with the figure later today.

Yes, yes.

Our next question comes from the line of Chris Kotowski with Oppenheimer.

(inaudible) my questions. But let me just ask on redeploying the gain. Let's just for argument, say, it's $20 million the gain from Aretec. If you don't distribute that, but retain it, is that like you have to pay a 4% annual excise tax on it, so it's like 4% debt financing almost? Is that the way it would work on a go-forward basis?

That's right.

I'm sorry?

Ed speaking. Yes, that's right, on the gain component.

Okay. And it's 4% a year forever, but 4% money is pretty good, right?

Well, it's a onetime 4%.

It's a onetime 4%. Okay.

Yes, yes.

All right. Well, that's really good.

And, Mickey, to circle back, it's $300,000 of deferred finance on the baby bonds that will be written off in Q3.

Our next question comes from the line of Rick Shane with JPMorgan.

Melissa on for Rick today. Wanting to check in with you about the fee structure on -- under the new increased leverage framework. Are you reducing fees on assets above a certain amount of leverage or will it remain flat?

We have certainly noted the announcements that have been made by a number of other BDCs in regard to lower fees on assets that are invested at leverage at over 1x and that will be an active discussion point among the management of the company, but no decisions on that have been reached at this time.

Okay. And a similar question regarding dividend level and the potential to boost NII through this increased leverage. Any discussion at this point of a potential dividend increase?

So discussion of a dividend increase would need to occur after the money is invested and we have clarity, and the market has clarity on what the net interest income being generated on a quarterly basis is.

First and foremost, we see the increase in leverage providing us with an opportunity to rebalance the BDC between first lien and second lien and to create a safer portfolio of assets.

We think we've been putting good second lien assets on the BDC. We've suffered only $1 million of nonaccrual on any of those second lien assets, but there is no argument that first lien assets are safer than second lien assets. And so the first focus is in making the existing earnings of the BDC and the existing dividend more safe and more secure.

If after we get the Aretec proceeds and invest the increased leverage in the BDC, there is sufficient ongoing income to justify a dividend increase. The management of the company and the board would consider that at that time.

But, again, I do indicate that it is likely to take 9 to 12 months to invest that capital. So while there is certainly the possibility of an increase in the future, it would not be anything that would be determined in the near term.

Okay. One follow-up question on Aretec, I'm sorry if I missed it. Did you guys provide any guidance or context around potential timing of close. I understood it's not certainty of close at this point, but if that transaction were to close, would that be a 3Q or a 4Q event?

The public-stated intention of the buyer is that it would be a Q3 event. But as we all know, things happen and so we don't know whether it would be most likely to occur in Q3 or Q4. Our assumption based on publicly-available data is late Q3 or early Q4.

Our next question comes from the line of Mickey Schleien with Ladenburg.

Mickey?

Ed, can you hear me?

Yes, we can hear you.

Yes, Just a follow-up...

Oh, we lost you again, Mickey, I think...

His line is still connected. Mickey?

I'm here.

Oh, we couldn't hear your question, Mickey.

Can you hear me now?

We can now, yes.

Okay. I'll try once more. I just want to confirm on the excise tax question. I want to confirm what I think I heard, that you'll accrue, for example, on a $20 million gain, an $800,000 excise tax at the time that the transaction closes. Is that correct? Or -- but you won't pay it until you finish your tax return. Is that right?

That's right. I mean, we'll accrue it at the time the transaction happens and we determine not to make that distribution of the proceeds. So yes, it would be paid subsequently when the tax return is filed.

Okay. And on the write-off of the deferred financing, you said it was $300,000. Again, is that going to be an operating expense or a realized loss?

Operating expense come through the interest expense.

Our next question comes from the line of Troy Ward with Ares Management.

Stuart, can you hear me?

Yes, we can hear you.

Great. Can you give us an update on Grupo HIMA. I know, it's a singular (technical Difficulties]

Oh, did we lose the line?

Yes, one moment.

Okay.

(Operator Instructions)

And did we lose Troy or is Troy still on?

There's no response from his line at the moment.

All right. Well, I heard at least the start of the question, so I'll seek to answer it. Grupo HIMA continues to be in a long and complex restructuring. The mission-critical nature of the services provided by the hospitals of Grupo HIMA are supportive of the fact that there is long-term value in that asset.

We do believe that the overall capital structure through the second lien was overleveraged and, therefore, the second lien is both on nonaccrual and has been written down to $0.10. But the first lien leverage is at a very reasonable level, especially with the second lien on a noncash pay basis and the company is making all scheduled payments as appropriate.

I don't have an estimated timing for the resolution of the restructuring of that debt, but I do feel comfortable saying that the leverage level on the senior debt is not excessive and that through restructuring, it is my hope that we will have enhanced value on the senior debt in the future. But given the current uncertainty and the slow pace of the restructuring discussions, we are holding that at what we believe is an appropriately conservative value in the mid-70s. Are there any other questions, operator?

Not at this time.

Okay. Well, I appreciate everybody's attention. And if anyone wants to have conversation separately, management always remains open to providing whatever data we can to our investors.

This concludes today's conference call. You may now disconnect.