Horizon Technology Finance (HRZN) Q2 2022 Earnings Call Transcript

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Horizon Technology Finance (HRZN -1.34%)
Q2 2022 Earnings Call
Aug 03, 2022, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Horizon Technology Finance Corporation second quarter 2022 earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Megan Bacon, director of IR and marketing. Please proceed.

Megan Bacon — Director of Investor Relations and Marketing

Thank you, and welcome to Horizon Technology Finance Corporation second quarter 2022 conference call. Representing the company today are Rob Pomeroy, chairman and chief executive officer, Jerry Michaud, president, and Dan Trolio, chief financial officer. I would like to point out that the Q2 earnings press release and Form 10-Q are available on the company’s website at horizontechfinance.com. Before we begin our formal remarks, I need to remind everyone that during this conference call, the company will make certain forward-looking statements, including statements with regard to the future performance of the company.

Words such as believes, expects, anticipates, intends or similar expressions are used to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements. And some of these factors are detailed in the risk factor discussion in the company’s filings with the Securities and Exchange Commission, including the company’s Form 10-K for the year ended December 31, 2021.

The company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. At this time, I would like to turn the call over to Rob Pomeroy.

Rob Pomeroy — Chairman and Chief Executive Officer

Welcome, everyone, and thank you for your interest in Horizon. As we always do on our quarterly calls, I will update you on our performance and our current overall operating environment. Jerry will then discuss our business development efforts, our portfolio events and our markets. And Dan will detail our operating performance and financial condition.

We will then take some questions. Today, we are reporting the results of our strong performance in the second quarter despite a challenging macroeconomic environment. We hit on all cylinders in the second quarter, validating the power of the lending platform of our advisor, Horizon Technology Finance Management. Our earnings exceeded our distributions for the quarter and first half of 2022, while we significantly grew our portfolio, maintained our credit quality and further strengthened our balance sheet in order to provide ample capacity to fund our growth.

We are keeping a watchful eye on the impacts of inflation, rising interest rates and volatile markets on our portfolio, but we are proud of our execution and results in these challenging times. For the quarter, we generated net investment income of $0.35 per share, above our distributions of $0.30 per share. Based on our results and outlook, we declared monthly distributions of $0.10 per share through the end of the year, which will mark six straight years of monthly distributions at this level. We maintained undistributed spillover income of $0.53 per share as of June.

We grew the portfolio by $62 million, another quarterly record for HRZN, which resulted in a portfolio value at quarter end of $577 million. The Horizon brand has gained significant traction in the venture debt community and our advisor continues to be successful in sourcing and winning high-quality venture debt investments. We finished the quarter with a record committed and approved backlog of $221 million and a pipeline of opportunities of over $1 billion. This momentum in the market provides us with the capability to be selective and disciplined as we look to further grow our portfolio.

We strengthened our balance sheet by issuing over $57 million of 2027 notes at 6 1/4%, further increasing our investment capacity and reflecting our ability to raise capital in a challenging environment. In addition, during the quarter, we raised approximately $10 million of equity capital at a premium to NAV through our at-the-market program. As a result, we ended the quarter with over $120 million of liquidity. We achieved a portfolio yield on our debt investments of 14.2% for the quarter.

We ended the quarter with NAV of $11.69 per share, up $0.01 from March 31, 2022, and up $0.49 from the end of Q2 2021. And finally, we maintained a stable credit profile with 96% of our portfolio rated three or higher as of June 30. As always, we are consistently and actively managing our portfolio of investments to maintain its credit quality. Looking forward, there continues to be very strong demand for venture debt within our targeted industries as evidenced by our committed backlog and pipeline.

We are keenly aware of the current environment and are prudent with respect to structuring and originating new high-quality investments. For the quarter, the advisor’s platform funded a record $192 million in new venture debt investments spread throughout our targeted industries, including a record $137 million funded by the public company. We believe our advisor continues to build us a portfolio with the opportunity for enhanced yields, utilizing our advisor’s predictive pricing strategy. This strategy predicts our borrowers’ early exits from refinancings and liquidity events and the additional income and accelerated income that we received from such events.

We are proud of the team efforts of our advisor, not just over the first half of the year, but for all it has accomplished over the past few years to successfully grow and manage its platform and our portfolio. Team is stronger than ever, prepared to address the changing macro environment, and we believe, well positioned to navigate through this environment and continue generating sustainable growth and profitability. With that, I will now turn the call over to Jerry and Dan to give you more details and color on our performance. Jerry?

Jerry Michaud — President

Thanks, Rob, and good morning to everyone. It was another historically strong quarter of growth for Horizon even in the face of increasingly challenging macro environment. We grew our portfolio by $62 million in the quarter, a second consecutive quarterly record, and finished the quarter with a portfolio of $577 million. We funded 15 transactions totaling a record $137 million, including $63 million in debt investments to seven new portfolio companies consisting of four new life science investments, two new technology investments and one new healthcare tech investment, providing further diversification to our portfolio.

We also funded $74 million to eight of our existing portfolio companies. Our onboarding yield of 11.6% during the quarter reflected the continued discipline in pricing transactions that we expect to produce strong net investment income. We experienced three loan prepayments during the quarter totaling $57 million, which included a portfolio loan that we refinanced. The repayment fees and accelerated income from such prepayments contributed to a strong debt portfolio yield of 14.2%, once again among the top of the BDC industry.

Given the current macro environment, we anticipate prepayments for the remainder of the year may be lighter than we’ve typically seen in the second half of prior years. As of June 30, we held warrant and equity positions in 90 portfolio companies with a fair value of $26 million. As we’ve consistently noted, structuring investments with warrants and equity rights is a key aspect of our venture debt strategy and an additional value generator. In the second quarter, we closed $203 million in new loan commitments and approvals and ended the quarter with a record committed and approved backlog of $221 million compared to $151 million at the end of the first quarter.

While there is no guarantee we will fund all these transactions and our committed or awarded backlogs, we are clearly well positioned to further grow our investment portfolio in the second half of the year. Our portfolio’s credit quality remained solid as the fair value of 96% of our debt portfolio consisted of three and four-rated loans as of June 30, consistent with our prior quarter end. During the quarter, one investment was downgraded to a two rating and one investment was downgraded to a one rating. At the end of the quarter, we had a total of five credits with a one or two rating with the remaining 50 portfolio credits rated three or better.

Since the quarter end, one of our one rated credits, MacuLogix, sold its assets and we received an initial cash payment and equity in the acquiring company, as well as potential future value from the collection of AR and royalty payments on future sales. Turning now to the venture capital environment. As expected, we saw a reduction in VC investment activity compared to the record-setting entire prior year. According to PitchBook, approximately $62 billion was invested in VC-backed companies in the second quarter of 2022, less than the first quarter but still a healthy flow.

VC fundraising momentum continued in the second quarter as $48 billion was raised, making it likely that last year’s full year fundraising record will be surpassed in the third quarter. Larger VC funds continued to drive the bulk of the fundraising. Meanwhile, VC-backed exit activity was markedly lower given the current environment and the near shutting of the IPO window. Total exit value for the quarter was $13 billion, the lowest quarter total since 2016.

While the economic environment and investor sentiment have clearly shifted in the first half of 2022, we again note that VC firms continue to maintain record levels of dry powder that may provide liquidity for new investment opportunities and support for existing portfolio of companies. As is evident in our recent performance, the severe tightening of the IPO market and significant reduction in SPAC exits is in part driving increased demand for venture debt, a key source of additional liquidity for growth stage companies. While we expect demand for venture debt to remain strong in the second half of 2022, we also anticipate that VC firms will participate alongside most new debt investments with follow-on equity fundings in order to provide additional liquidity and runway to reach better equity and M&A markets. The VC community and venture debt community will need to work collaboratively to provide the necessary and appropriate funding to their portfolio companies in order to successfully navigate through the current environment.

Based on Horizon’s knowledge and experience and its long-standing and favorable position in the venture capital ecosystem, we expect to work closely with the VC community to support our portfolio companies, as well as fund new portfolio companies. With our advisor’s strong and active lending platform and the solid investment capacity of Horizon, we believe we are well situated to continue competing and winning in the current environment. Subsequent to the end of the second quarter, we continued our growth momentum funding four transactions totaling $38.5 million in July. Our committed, approved and awarded backlog as of today stands at $364 million, which includes new awards during July.

Our advisor’s pipeline of new opportunities today is still approximately $1 billion, among historically high levels of opportunities to further grow our venture portfolio over the coming quarters. Looking ahead, with an abundance of demand from attractive quality companies for venture debt solutions for which to grow our committed backlog and our advisor’s pipeline, we remain very mindful of the current environment and are pleased to be in a position where we can afford to be selective in making new investments. We also continue to hold an active and regular dialogue with each of our portfolio companies and their investors in order to manage our credit quality and identify changes in the VC ecosystem. Accordingly, because of such efforts, we believe we remain well positioned to continue to deliver additional long-term shareholder value.

With that, I will now turn the call over to Dan.

Dan Trolio — Chief Financial Officer

Thanks, Jerry, and good morning, everyone. During the second quarter, we built on our efforts from the beginning of the year and further enhanced our capital resources. First, we increased our lending capacity through the issuance of $57.5 million of 2027 notes at 6 1/4%, which includes $7.5 million issued in early July from the exercise of the over-allotment. Second, through our ATM program, we successfully and accretively sold 868,000 shares of stock, opportunistically raising over $10 million.

These actions provide us with further capacity to grow the portfolio. Turning to our operating results. As of June 30, we had $123 million in available liquidity, consisting of $76 million in cash and $47 million in funds available to be drawn under our existing credit facilities. As of June 30, there was $75 million outstanding under our $125 million KeyBank credit facility and $137 million outstanding on our $200 million New York Life credit facility, leaving us with ample capacity to grow the portfolio.

Debt-to-equity ratio stood at 1.27 to 1 as of June 30, which was slightly higher than our target leverage of 1.2 to 1. But netting out our leverage with cash on the balance sheet, our net debt-to-equity ratio was one to one. Based on our cash position and our borrowing capacity on our credit facilities, our potential new investment capacity at June 30 was $190 million. For the second quarter, we earned total investment income of $18.6 million, an increase of 38% compared to the prior year period.

Interest income on investments increased primarily as a result of a higher average earning debt investment portfolio for the quarter. Our debt investment portfolio on a net cost basis stood at $563 million as of June 30, a 13% increase from March 31, 2022. For the second quarter of 2022, we achieved onboarding yields of 11.6% compared to 11.4% achieved in the first quarter. Our loan portfolio yield was 14.2% for the second quarter compared to 14.7% for last year’s second quarter.

Total expenses for the quarter were $9.9 million compared to $7.3 million in the second quarter of 2021. Our performance-based incentive fee increased to $2.1 million from $1.5 million for last year’s second quarter. Our interest expense increased to $4.2 million from $3 million in last year’s second quarter due to an increase in average borrowings. Our base management fee was $2.5 million, up from $1.8 million in last year’s second quarter due to an increase in the average size of our portfolio.

Net investment income for the second quarter of 2022 was $0.35 per share compared to $0.26 per share in the first quarter of 2022 and $0.31 per share for the second quarter of 2021. The company’s undistributed spillover income as of June 30 was $0.53 per share. We anticipate that our larger portfolio with our predictive pricing strategy will enable us over time to generate NII that covers distributions. As we have said in the past, we will experience prepayments throughout the year, but the timing is difficult to predict.

To summarize our portfolio activities for the second quarter, net new originations totaled $137 million, which were partially offset by $5 million in scheduled principal payments and $65 million in principal prepayments and principal paydowns. We ended the quarter with a total investment portfolio of $577 million. Given the macro environment, we would expect portfolio growth to normalize from the first half of 2022 levels. The portfolio consisted of debt investments in 55 companies with an aggregate fair value of $552 million and a portfolio of warrant and equity and other investments in 91 companies with an aggregate fair value of $26 million.

Based upon our outlook for 2022, our board declared monthly distributions of $0.10 per share for October, November, and December 2022. We have now declared monthly distributions of $0.10 per share for six consecutive years. We remain committed to providing our shareholders with distributions that are covered by our net investment income over time. Our NAV as of June 30 was $11.69 per share compared to $11.68 as of March 31, 2022, and $11.20 as of June 30, 2021.

The $0.01 increase in NAV on a quarterly basis was primarily due to our net investment income, partially offset by paid distributions and adjustments to fair value. As we’ve consistently noted, 100% of the outstanding principal amount of our debt investments bear interest at floating rates with coupons that are structured to increase as interest rates rise with interest rate floors. As of June 30, over 90% of our portfolio will benefit from additional increases in the prime rate. This concludes our opening remarks.

We’ll be happy to take questions you may have at this time.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Paul Johnson with KBW. Please proceed.

Paul Johnson — KBW — Analyst

Yeah. Good morning, guys. Thanks for taking my questions. I have several for you this morning.

The first is just basically around growth expectations kind of looking out over the next year or so. I know you said first half likely not to be as robust maybe as the first half of this year. But I mean, on a net basis, are we talking about roughly kind of flat to no growth for the BDC is what we could expect? Or do you think there’s a little bit of ability to continue to grow the portfolio through the end of the year?

Jerry Michaud — President

Paul, this is Jerry. Yes, I still think there is room for growth. If you look at our numbers on our committed backlog and what’s been awarded just recently, we certainly think that the demand is there to continue to grow the business. But of course, what we — what’s a little bit more difficult to predict is prepayments over the second half.

We do think that they will slow. I think we’ve been pretty much indicating that now for a couple of quarters, given the slowdown in the equity markets and the choppiness of the environment in general. So I do think there could be room for growth, maybe not as robust as it was in the first half. We do have some potential prepayments here in the second half.

We have a couple of companies that are well along in the SPAC process, which if those transactions happen, we’d probably get prepayments. And then, there’s a couple of others that were also — there seems to be some indication that we might be prepaid over the second half. So there will be some prepayments. I do think even with that, though, given our strong backlog, given strong demand from what we’re hearing in the marketplace, we do think there will be some level — some opportunity to continue to grow the portfolio, but probably not at the level we did in the first half.

Paul Johnson — KBW — Analyst

Got it. And as far as like the activity that you’re seeing, the demand for venture capital, how much of it would you say here recently in the second quarter and today in general quarter to date? I mean is that driven by companies essentially looking to kind of avoid down rounds or lower valuation equity raises, that are good companies just essentially kind of seeking a longer runway versus kind of higher tax burn, potentially earlier-stage companies that are just, quite frankly, just in need of capital and already financing those types of companies today.

Jerry Michaud — President

Yes. So that’s the right question, I think. Most of what we’re seeing today are — and I had mentioned this and I wanted to get some of this into my comments because I think it is really important based on some articles that I have just seen recently, too. Venture debt in this kind of environment doesn’t replace equity.

That’s not the idea. Now, to your point, and it’s a good one, if it’s a high-quality company with really strong investors and they’ve demonstrated continued support, that’s certainly something we’re interested in looking at and funding. A significant amount of what we’re seeing today is we’re providing debt along with equity. So yes, valuations are down.

VCs don’t want to have to put more money than they need to into some of their portfolio companies to get to a better M&A market. But they’re still very good companies, and the VCs are going to continue to support them. And in fact, they have the ability to do that because of the fundraising that the VC community has experienced over the last couple of years actually. So most of what we’re seeing is really quality companies coming to the market for both debt and equity.

And those are the kinds of transactions that we are — we obviously have a high level of interest in, and that is most of what we are seeing. To your — to the second part of that, companies that need to raise capital, there’s been definitely — VCs have definitely put pressure on their portfolio companies to reduce costs, reduce burn and we are seeing a lot of that. For the most part, those are not transactions that we probably are prepared to step up to put debt in, in replace of what should be some additional equity. We’re not really seeing that many of them either though, in fairness.

So most of it is a pretty strong market. It’s opportunistic, but the demand is so high. As we had mentioned, we actually can be fairly selective and still meet what we hope to be our growth numbers for the remainder of the year. But it is a choppy market and we are paying very close attention to what the VC community in general is doing.

We’re paying very close attention to specifically what venture capitalists are doing relative to our portfolio companies and that is guiding us relative to looking at new opportunities. And the last thing I would just add is one — another area we’re probably staying away from is we’re not really interested in refinancing debt that companies already have because they probably — at the time they got the leverage, it was probably OK. But given valuations have come down, we think some of those companies are probably over-leveraged at this point.

Paul Johnson — KBW — Analyst

Right. Yes. Makes sense and appreciate all the color on that. My next question is really for having Jerry or Dan, either way, just has to kind of do with just the marks on book this quarter.

Curious as to a quarter where we kind of expect to have NAV headwinds of mid-single digits, probably not at higher end for VCs with more public equity exposure. I understand your equity investments aren’t quite as large as some of the other venture BDCs out there. But can you just kind of walk us through kind of how you guys look at the mark for this quarter for the assets. And I’m also interested just as far as the equity investments go, looks like they were marked higher this quarter.

Was there anything particular in there that drove that?

Dan Trolio — Chief Financial Officer

Yes, Paul, this is Dan. What we said every quarter is for a venture debt portfolio, we look at the fair value of each investment every quarter. There really is no one specific index that would allow us to take a fair value adjustment across the board for our asset class that really wouldn’t be fair value. And so, we go through each investment on a quarterly basis and based on the information we have at the time that we — up until the day we file, we adjust and make our fair value changes.

And that is reflected in the Q. There were our normal migration between two and one-rated and three and four-rated credits. So on the debt side, that has been reflected in the fair value. And then, yes, on the warrant piece, we don’t hold a significant portion of warrants in public equity.

But you’re right, the warrants portion of our fair value did increase and that is specific to handful of our deals. Our portfolio companies were able to raise equity in this environment at a pretty significant up round and that drove the increase in the fair value that you’re looking at.

Paul Johnson — KBW — Analyst

Got it. Appreciate it. That answers my question. I guess last question I had, I apologize for so many questions.

I’ll get back in the queue after this. But it’s just around the unfunded commitments, I mean we touched on this earlier the quarter. But how much visibility do you guys have around the unfunded commitments that’s building over the last few quarters. I imagine with all the new investment activity that you’ve had, yes, just curious about how much visibility that you have around any of that getting drawn down from quarter to quarter.

Jerry Michaud — President

Yes. So we actually have some visibility because a great portion of our committed backlog is based on companies meeting certain milestones. And we know based on projections they have given us when they expect to meet those milestones. So we do have good visibility in terms of when there would be an opportunity for the company to draw it down.

Now, whether they meet those milestones in this market, of course, is certainly something that is not as probably clear as it would be in a better environment. So that will really be the question is our company is able to meet their milestone requirements in order to actually draw the capital. Now, we had a pretty active second quarter in terms if you look at the portfolio — existing portfolio companies that we funded. Some of those were a result of companies meeting milestones.

One company, we actually refinanced the debt package. They raised a very significant equity round and we refinanced their debt package, which extended the runway for the company, along with the significant equity they’ve raised, and we were also able to get our final payment pulled forward. So it was actually an income event from that transaction as well. So it is a little bit more difficult to determine if milestones will be met, but we certainly have pretty good visibility when the expectation is that they’ll meet those milestones.

That’s not necessarily a whole lot different than — even in a better market, but in a better market, we probably have a little bit more confidence that milestones would be met.

Paul Johnson — KBW — Analyst

Thank you for that. And thanks for taking my questions.

Operator

[Operator instructions] There are no further questions in queue at this time. I would like to turn the floor back over to Mr. Rob Pomeroy for closing comments.

Rob Pomeroy — Chairman and Chief Executive Officer

Thank you all for joining us this morning. We appreciate your continued interest and support in Horizon. We hope you and your families continue to remain safe and healthy, and we look forward to speaking with you again soon. This will conclude our conference call this morning.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Megan Bacon — Director of Investor Relations and Marketing

Rob Pomeroy — Chairman and Chief Executive Officer

Jerry Michaud — President

Dan Trolio — Chief Financial Officer

Paul Johnson — KBW — Analyst

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