Horizon Technology Finance Corporation

portfolio companies employing the three-legged stool approach. That approach involves, first, engagement with our portfolio company management teams to ensure they are maintaining a realistic and achievable outlook, including, where appropriate, by right-sizing their staffs and expenses to preserve liquidity. We are encouraged by the responsible way our borrowers have faced this reality. Second, seeking to ensure investors are willing and able to support portfolio companies with additional new capital now and in the future. I would note that with our portfolio companies raising over $500 million in new capital in 2020, the response from investors has been overwhelmingly positive. And third, aiding companies when they are at their most challenged through various means, including deferrals, easing covenants, or making additional loans. We have done our part to support these companies in concert with management and investors. As a result of these combined efforts, over 90 percent of our portfolio companies have adequate cash resources to execute their business plans. Over 80 percent of the portfolio has cash into mid-2021, and over 50 percent have runway into late 2021 and beyond. Over 70 percent of our portfolio companies have raised capital during 2020, again showing the continued support of the investors. Entering the fourth quarter, our committed backlog and overall pipeline continue to remain active. We continue to see strong demand for venture debt within our target industries as companies simultaneously explore various paths for additional liquidity and funding. we will continue to selectively pursue new investment opportunities. With respect to distributions, we maintained our monthly distribution level at 10 cents per share through March of 2021. It is our Board's policy to make distributions in amounts that can be covered by NII over time. The distribution level reflects our outlook for the remainder of 2020 and the beginning of 2021, and our spillover income as September 30th. We have now covered our distributions with NII for the past three years. Last week, we marked our 10th anniversary as a public company. We're very proud of our team's performance and the portfolio we've collectively constructed over the years, as well as the success we have shared with our shareholders. We will remain measured and proactive with respect to our portfolio as we look to opportunistically fund new investments to further expand and diversify our portfolio and ultimately generate additional long-term value for our shareholders. With that, I will turn the call over to Barry.

Thanks, Rob. Good morning. We continue to hope you are all healthy and safe as we all traverse both the health and economic impact of the pandemic. We did begin to see some improvement in economic conditions in the third quarter, but overall, the uncertainty caused by COVID continued to be a factor. As a result, we maintained a cautious approach to our venture lending strategy, including elevating our underwriting of new investments to include a COVID-19 impact analysis. However, with knowledge-based understanding of market risk comes opportunity. Thus, we continue to selectively invest where we see significant strength. On our last call, we noted that we were beginning to see positive developments in certain technology sectors that are benefiting from the impact of COVID-19, and that trend continued into the third quarter. Utilizing our strong brand, we originated quality investments to two tech-oriented companies that provide software platforms. Both companies have strong management teams, committed investors, ample liquidity, and have demonstrated growth even through the current uncertain economic cycle. In the quarter, we made a total of $16 million in investments to the two new technology companies I just mentioned, as well as two existing life science portfolio companies. The onboarding yield for such investments was 11.9 percent. As Rob mentioned, we had strong prepayment activity in the quarter, which reflects the overall strength of our portfolio borrowers to raise additional equity or complete M&A transactions. During the quarter, we experienced four loan prepayments totaling $43 million, which significantly contributed to our NII and continued to validate our predictive pricing strategy, notwithstanding the challenging economic environment. The prepayment and accelerated income from these events helped drive a debt portfolio yield for the quarter of 15.1 percent. Our debt portfolio yield remains at the top of the BDC industry and, once again, helped us deliver income in excess of our distributions, further increasing our undistributed spillover income to 45 cents per share. During the quarter, we also received proceeds of $1.8 million from warrants in New Signature, which experienced an M&A transaction, and in OnTrack, a public company where we exercised strategically sold part of our warrant holdings. As we've noted, structuring investments with warrants and equity rights is a key aspect of our venture debt strategy and an additional value generator. Near to date in 2020, we've generated $7.9 million in proceeds from warrants, a clear indicator of our successful strategy of including warrants in the structure of our investments, as well as further proof that warrants continue to be an important value generating aspect our overall business strategy. As of September 30th, we held warrant and equity positions in 68 portfolio companies with a fair value of $13 million. In the third quarter, we closed $36 million in new loan commitments and approvals and ended the quarter with a committed and approved backlog of $96 million compared to $101 million at the end of the second quarter. Moving ahead, and as previously mentioned, We have approximately 96 million in our committed backlog, of which 60 million is committed to current life science portfolio companies as they meet key milestone value drivers in their development. In addition, we have added 77 million in new awarded and approved transactions to our backlog in October. Our pipeline of new opportunities as of today is 372 million, Thus, we believe we are well positioned to generate growth in the portfolio in the fourth quarter. Turning to our portfolio management activities, we continue to proactively manage our venture debt portfolio in a very challenging economic environment. Some of our debt portfolio companies have demonstrated solid growth and value enhancement, while some have been challenged. So, I want to take time to discuss some of the notable specific portfolio activity that took place during the quarter. In addition to the four positive portfolio exits mentioned earlier, three credits were downgraded, one of which, Encore Demertology, was materially impacted by COVID and was thus placed on non-accrual. Another, NanoSeal, was downgraded after a failed effort to complete an M&A transaction. While Encore and NanoSeal downgrades impacted NAV in the quarter, We also ended the quarter with a record level of credits with our highest credit rating of four. Turning now to the venture capital environment. According to PitchBook, approximately $38 billion was invested in VC-backed companies in the third quarter, which was relatively on par with the prior year quarter despite COVID, and the number of deals remained fairly steady with an increase in the number of late-stage companies funded. In terms of VC fundraising, $14 billion was raised in the third quarter, and a total of $57 billion raised to date in 2020 already surpasses 2019's total of $55 billion. The number of funds closed continues to be well below last year's pace, meaning that mostly large funds are able to raise funds in the current environment. In terms of VC-backed exit activity, the IPO window opened up considerably in the third quarter, with 37 venture-backed IPOs contributing to a total exit value of $104 billion, the second highest total on record. With the IPO window still open, we are seeing other firms looking at IPOs as another path to generate additional liquidity. Turning now to our core markets, we remain focused on the technology, life science, and healthcare technology markets, where we continue to selectively seek investment opportunities During the quarter, we provided funding to two new portfolio companies, a $10 million venture loan to Topia, a developer of global talent mobility software, and a $5 million venture loan to Brightcore, a developer of cloud-native software for property and casualty insurance. We also funded an additional $1 million to two of our existing portfolio companies. We entered the last quarter of 2020 with a strong balance sheet characterized by ample liquidity and lower leverage and a strong pipeline of new investment opportunities. We believe this positions us well to navigate through the current environment while selectively growing our portfolio and delivering additional long-term shareholder value. With that, I will now turn the call over to Dan.

Dan Bauschardt Thanks, Jerry, and good morning, everyone. I will provide a quick review of our third quarter 2020 results before opening up for questions. As mentioned on our last call, we successfully strengthened our balance sheet during the year, which provides us increased liquidity and lending capacity. In part, these efforts led to a strong liquidity position at the end of the quarter. On balance sheet as of September 30th, Horizon had $104 million in available liquidity, consisting of $57 million in cash and $47 million in funds available to be drawn under our existing credit facilities. As of September 30th, there was $15 million outstanding under our $125 million KeyBank credit facility and $13 million outstanding on our $100 million New York Life credit facility, leaving us with ample capacity to grow the portfolio. Additionally, during the third quarter, we issued 1.1 million shares under our ATM program, receiving $13 million in net proceeds. Our debt-to-equity ratio stood at .81 to 1 as of September 30th. which was lower than our targeted leverage of 1.2 to 1. Based on our cash position and our borrowing capacity on our revolving credit facilities, our potential capacity is $254 million at September 30th. For the third quarter, Horizon earned total investment income of $12.3 million, an 8% increase compared to $11.4 million in the prior year period. This increase was primarily due to a 21% increase in interest income on investments, given the larger average size of our loan portfolio. Our debt investment portfolio on a net cost basis stood at $319 million as of September 30, a 10% reduction from June 30, 2020. For the third quarter of 2020, we achieved onboarding yields of 11.9% compared to 11.1% achieved in the second quarter. Our loan portfolio yield was 15.1% for the third quarter versus 17.7% for last year's third quarter. Turning to our expenses, for the third quarter, total net expenses were $6.5 million compared to $5.6 million in the third quarter of 2019. Our interest expense was up $561,000 compared to the prior year period, primarily due to an increase in the average borrowings, partially offset by a reduction in our effective cost of debt. Our base management fee rose $222,000, driven by an increase in the average size of our portfolio. Net investment income for the third quarter was $0.34 per share, compared to $0.40 per share in the second quarter of 2020, and $0.42 per share for the third quarter of 2019. As Rob mentioned, we have now covered our distributions with NAI for the past three years. The company's undistributed spillover income as of September 30th was 45 cents, an increase from 42 cents as of June 30th. To summarize our portfolio activities for the third quarter, new originations totaled $16 million, which were offset by $6 million in principal payments and $43 million in principal prepayments. We ended the quarter with an investment portfolio of $312 million. The portfolio consisted of 10 investments in 34 companies with an aggregate fair value of just under $299 million, and a portfolio of warrant, equity, and other investments in 69 companies with an aggregate fair value of $13 million. Based upon our outlook for NII, our liquidity forecast, and our spillover income levels, our Board declared monthly distributions of $0.10 per share for January, February, and March 2021. We have now declared monthly distributions of 10 cents per share for 51 consecutive months. We remain committed to providing our shareholders with distributions that are covered by our net investment income over time. Our NAV as of September 30th was $11.17 per share, compared to $11.64 as of June 30, 2020, and $11.67 as of September 30, 2019. The 47-cent reduction in NAV on a quarterly basis was primarily due to our distributions and the net unrealized loss on investments exceeding our net investment income and net realized gains. As we've consistently noted, 100 percent of the outstanding principal amount of our debt investment bear interest at floating rates with coupons that are structured to increase as interest rates rise with interest rate floors. As of September 30th, 100% of our portfolio is at their specific floors. This concludes our opening remarks. We'll be happy to take questions you may have at this time.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, It may be necessary to pick up your headset before pressing the star keys. Our first question is from Mike Smith with B Riley Securities. Please proceed.

Hey, everyone. Hope you're doing well. So I guess my first question is early payoffs really outpaced originations in the quarter, and you mentioned your pipeline current sits around $372 million and expectation for growth in the fourth quarter. So I was wondering if you could just talk a little bit about your expectation for repayment, how that kind of relates to your expectations for portfolio growth in the fourth quarter.

Yeah. Hi, Mike. This is Jerry. Yeah, we were actually pleasantly surprised by the exits we had in the quarter. Actually, three out of those four, two of them, we were paid out through equity raises the companies did at significantly higher valuations, so basically cheaper equity. So that allowed them to repay our debt, and we hold warrants in one of those companies. Actually, we've held warrants in both of those companies. So those were positive. And then a new signature that they completed in a previously announced M&A transaction. So that was also a very positive event. So those were great. The equity ones were a little unexpected. We weren't really expecting to be paid off, but for those companies to lower their leverage, so that was fine. As we look forward, so we funded $16 million in the quarter. I would say that that was fine by us. We definitely have slowed our underwriting process and added to that process, so that's taking a little bit longer to get transactions through prescreens and then through underwriting, and so I think previous nine quarters, we've grown the portfolio. So we weren't too concerned about the fact that the portfolio didn't grow in the third quarter. But there were a lot of transactions in the pipeline, and that is the good news. As I mentioned, I think we have about 77 million in just new awards and approved transactions just in October. So our expectation for the fourth quarter looks very positive relative to growth. We expect to see growth in the fourth quarter. As it relates to prepayments going forward, right now I would say that we don't expect to have prepayments at the level that we had in the third quarter as I sit here today, but obviously those tend to come up later in the quarter. So we'll see what happens, but I am fairly confident that the portfolio will grow in the fourth quarter.

That helps with color. And then how are yields, covenants, kind of, et cetera, looking on some of the new investments you're looking at? Has, you know, the COVID premium spread kind of disappeared? Any call you can provide on the marketplace would be helpful.

Yeah. In terms of pricing, not really, not much change. You know, everything has been pretty consistent through the whole COVID-19 thing. And I'm not just speaking for Horizon, but, you know, we obviously – look at the competitive marketplace and, you know, we continue to be competitive and pricing has held up pretty well. I think that, you know, as we look at a transaction, we do, as I mentioned earlier, we do actually have a kind of a COVID analysis that we do now on every transaction, not only for looking at the prospect, the new prospect company, but also the markets that they serve. And so, yeah, As it relates to things like covenants, I would say our covenant position is a little stronger than it has historically had to be. Given the uncertainty, really, of COVID-19, you know, we don't feel like we're, you know, that that storm is over yet. We feel like we're still in it. We need to be cautious because of it. And so, you know, most of the transactions we are moving forward with do require a little bit higher level of covenant protection.

That's helpful. And so another question would be leverage came down a bit. Can you just talk about kind of how you think about that in the near term, scaling your expectations for origination and repayment activity?

Yeah, Mike, this is Dan. Yeah, I appreciate that. You know, as you mentioned the prepayments, exceeded our originations for this quarter. And with the ample cash, we paid down the facilities to maximize costs. And so looking forward, you know, our target leverage is still within 0.8 to 1.2 to 1. We have ample capacity and liquidity. And so we will tap the facilities when we need to fund our pipeline. So our target is still within 1.8 to 1.2. Gotcha.

That's helpful. And just one more for me, and forgive me if I missed this, but three companies were downgraded to one rating. I think you mentioned NanoSteel and Encore. I was just wondering if you could provide some more color on the third one.

Third one was Titan Pharmaceuticals.

And is there, you know, any specific color you could provide with Russia Titan?

Yeah, so actually, Titan was a deal that we had on our books. I think we owed about $1.9 million at cost. We have actually settled that account. It's right in the process, all but signed and delivered at the fair value. We carry it out at September 30th. One of our other non-accrual notes, we've also settled. We're right in the process of settling right now. So we We marked all of the marks where we have agreements to settle these on most of these, and we expect them to take place in the fourth quarter.

That's helpful. Thank you for taking my questions. Thank you.

As a reminder, there's star 1 on your telephone keypad if you would like to ask a question. Our next question is from Grace Rowe with National Securities. Please proceed.

Thank you. Good morning. Good morning. Dan, I wanted to ask you about the availability based on the borrowing base with that New York Life facility. Just saw in the queue that the availability was just $2.2 million. So kind of curious, you know, why it's kind of that low relative to a $100 million line, and what was it at the end of June, just for comparative purposes?

Yeah, so if you recall, the New York Light Facility is a new facility we put in place in the second quarter. Yeah, so it started off with close to 30 million of assets in that specific facility. Availability was, you know, north of that. So we had maybe about 10 to 15-ish available. One of the factors relating to the reason the availability came down this quarter is that a number of the prepayments that happened in the quarter were specifically in that facility. So the pool of assets in there came down, and the funding and the movement of assets going in were later in the quarter, just didn't get completed until after the quarter. And so, you know, that's the reason why the availability is down from June. But the facility is, you know, is in a good position, and as we add new originations, we'll add to the pool, and that availability will come up.

Okay, that's helpful. And then, Rob, I just wanted to clarify, I guess, the answer to the last question that was just asked about the one-rated credits and them being under contract. So there's some expectation here. in the fourth quarter that they'll get resolved and moved out, or do you expect them to come back onto accrual status with whatever resolution you've got in place?

As I said in my introductory comments, we're actually in a sale liquidation process on these accounts, and we expect them to settle for cash. and not return to accrual status. So we'll have cash to redeploy in new assets.

Okay. That's helpful. Thank you. That's all I had. Thank you.

Our next question is from Ryan Lynch with KBW. Please proceed.

Hey, good morning. Thanks for taking my questions. I just had a couple ones. Just wanted to make sure I heard this correctly. Did you say in your prepared comments that Nano Steel, that was one of the investments that was marked down but is still on accrual status? Did you say that that was placed on non-accrual status in the fourth quarter and you said that that was marked down due to the company failing to complete an M&A transaction. Is that a process you guys are still pursuing with that company, a different sort of M&A, or what's the outlook on that?

Yeah, thanks, Ryan. Yeah, that's a good point. The NanoSteel was one of the accounts that downgraded to a one, but was current through the end of the quarter, and it was information that came after the quarter that required us to downgrade it, and so It was on accrual as of September 30th, but in the fourth quarter, it is on non-accrual as we continue to work through the process of settling that account.

Okay. And another one I have on a current non-accrual, Ignition One. I know you said you guys are in the process of settling. potentially exiting some non-accruals. You know, that one's been on non-accrual for a while. That's still marked at 100% of your guys' costs. Can you just remind me of why that investment is marked so high relative to some of your other non-accruals?

Yeah, so, Ryan, this is Rob. Just to refresh your memory, Ignition One was a company that was – had some difficulties, but they ended up selling parts of the company to another private company. And in that process, the secured creditors were paid down, and we are the only remaining secured creditor against the estate of Ignition One, which holds a substantial amount of private stock in the acquiring company of Ignition One, which secures our loans. the value of that stock is multiples of our debt. Unfortunately, it's also illiquid, and so we're waiting for an opportunity to either transact that stock in a secondary sale or for that company to effect a transaction that would make that stock more liquid. We do believe that our balance is secure, so we've rated that credit, although it's on non-accrual because we're not getting paid anything, We continue to rate that as a two-rated credit.

That makes total sense. And then just finally, I had one more. Can you just talk about the ATM equity capital raise this quarter? I mean, you guys had, you know, very strong prepayments in the third quarter. you know, that well outpaced your guys' origination. So you guys had net repayments in the portfolio in the third quarter. So can you just talk about why you guys chose to raise additional equity capital via the ATM on top of that and actually further push your guys' leverage down this quarter?

It's a good question. Parts of the answer have been given already, but I'll put it all together for you. One, The ATM has been in place and operating, and so when the stock trades well, we take advantage of the opportunity to issue stock that's accretive to our existing shareholders. So we were raising that money during the quarter. We were a little bit, as Jerry said, a little bit surprised by the companies that raised the equity at very high valuations that they actually were going to repay us. we thought there was a chance that we would either roll new loans or extend terms on our existing loans. So that took us a little bit by surprise. Having said that, we have a very strong pipeline. We expect to grow the portfolio, and we're trying to take advantage when we can of raising additional equity as well to support the good debt facilities that we've obtained as well.

Okay. That's all from me. I appreciate the time this morning. Thank you.

Thank you. With no further questions, I would like to send the call back over to Robert Pomeroy, Chairman and CEO, for closing statements.

So 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 end the call.

Thank you. You may disconnect your lines at this time and thank you for your participation.