Horizon Technology Finance Corporation

Greetings and welcome to Horizon Technology Finance Corporation's second quarter 2021 earnings conference call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star one, star zero, excuse me, that is star zero on your telephone keypad. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Megan Fox. Thank you. You may begin.

Thank you, and welcome to the Horizon Technology Finance second quarter 2021 conference call. Representing the company today are Rob Pomeroy, Chairman and Chief Executive Officer, Jerry Michaud, President, and Dan Trollio, 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, Horizon Technology Finance 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, 2020. 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.

Good morning. Thank you for joining us and for your continued interest in Horizon. Today, I will update you on Horizon's performance and its overall current operating environment. Jerry will then discuss our business development efforts and our markets. Dan will detail our operating performance and financial condition, and then we will take some questions. We had another strong performance in the second quarter of 2021 and made significant headway during the first half of the year in growing our portfolio. During the quarter, we grew our portfolio over the $400 million mark, a 6% increase from the end of the first quarter and up 15% from the end of 2020. We finished the quarter with a record committed backlog of $144 million. We generated net investment income of 31 cents per share in excess of our distribution level for the quarter. Based on our outlook and our undistributed spillover income of 34 cents per share as of June 30th, we declared monthly distributions through December, which marks 60 consecutive months at 10 cents per share. We achieved another industry-leading portfolio yield on our debt investments of 14.7 percent. We kept our portfolio credit profile stable and ended the quarter once again with no one-rated loans and no loans on non-accrual. We are consistently and actively managing our portfolio investments to maintain the credit quality of our portfolio. We ended the quarter with NAV of $11.20 per share, a 13 cent per share increase from March 31st. And we maintained a strong balance sheet with ample capacity to fund the ongoing growth of our portfolio. Earlier in the year, our advisor, Horizon Technology Finance Management, expanded its origination platform with a $100 million venture debt fund, which may co-invest with Horizon. We are already seeing the clear benefits of the new fund in terms of Horizon's recent portfolio growth. For the quarter, the advisors platform funded a record $100 million in business. The platform expansion is enabling Horizon to access and control additional opportunities in its core markets while further reducing its concentration risk. The new venture debt fund has the potential to expand to $300 million and to further broaden Horizon's investment opportunities. As part of our expansion, we continue to grow and develop our team. With the recent appointment of Dan Dvoracic to Chief Operating Officer and other promotions within our team, we continue to strengthen our bench as we prepare for the future. Entering the second half of the year, we believe we remain well positioned to continue growing our portfolio and generating strong NII due to the following. Demand for venture debt within our targeted industries continues to be at or near record levels. Our committed backlog and pipeline for investments are historically strong. Our advisor's new investment vehicle is enabling us to better compete for new loan opportunities. And we continue to maintain ample capacity on our balance sheet to execute on our backlog of commitments and pipeline of new opportunities. We generated another quarter of solid growth and are successfully competing for quality venture debt opportunities. With our strong brand in the venture debt market, robust balance sheet, disciplined underwriting, and enhanced platform, we remain in a prime position to further expand and diversify our portfolio and generate net investment income. I appreciate our entire team's continuing efforts which resulted in another strong quarter for Horizon and our shareholders. And with that, I will now turn the call over to Jerry.

Thanks, Rob, and good morning to everyone. We continue to generate strong growth in the second quarter, resulting in our portfolio topping $400 million at the end of Q2. With the robust demand for venture debt, we fund nine transactions, totaling $67 million during the quarter. Meanwhile, our onboarding yield of 12.2% during the quarter once again reflects our discipline's focus on pricing transactions that we believe will provide strong NII enhanced by our predictive pricing strategy. We experienced full loan prepayments during the quarter, totaling $38 million, and the prepayment fees and accelerated income from the prepayments increased our debt portfolio yield for the quarter to 14.2%. again among the top of the BDC industry. In addition, we received proceeds of $2.8 million from the redemption of warrants and the sale of equity. As of June 30th, we held warrant and equity positions in 71 portfolio companies with a fair value of $17 million. Since the beginning of 2020, Horizon has received over $12 million in warrant and equity proceeds from nine companies in its portfolio. 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 $97 million in new loan commitments and approvals. We ended the quarter with a record committed and approved backlog of $144 million compared to $94 million at the end of the first quarter. Demand for venture debt has remained at record levels throughout this year. and we ended the quarter with a pipeline of new opportunities totaling $843 million. Subsequent to 2Q, we funded $7.9 million of venture debt loans and received a $10 million loan repayment. Our committed and approved backlog stood at $141 million, and our pipeline of new opportunities is nearly $1 billion, providing us with a solid base of opportunities to further grow our venture debt portfolio. Along with the growth of our portfolio, we maintain strong credit quality in our portfolio, with another quarter of no loans on non-accrual or one-rated, and 94% of our debt portfolio's fair value consisting of three and four-rated credits. During the quarter, two of our portfolio investments migrated down to the two-rated bucket. As we always do, we are aggressively managing them in order to provide stability and ultimately achieving a positive outcome. Turning now to the venture capital environment, the sector continues to be dynamic. According to PitchBook, approximately $75 billion was invested in VC-backed companies in the second quarter, tracking with last quarter and putting the industry well on pace to smash last year's record level of investment by the middle of the third quarter. In terms of VC fundraising, $41 billion was raised in the second quarter, pretty much ensuring that 2021 will break last year's record and make it conceivable that VC fundraising will clear the $100 billion milestone before the end of the year. Larger funds continue to mostly drive the increased fundraising. Regarding VC-backed exit activity, the IPO and SPAC window remained wide open in the second quarter with venture-backed IPOs and SPACs helping to drive a total exit value in the quarter of over $240 billion. Overall, there are a multitude of options for venture-backed companies to generate additional liquidity, including from venture capital, IPOs, venture debt, and M&A activity. Suffice it to say, all of these funding options available to development technology and life science companies have created both opportunity as well as competition for Horizons. Based on our results for the first half of 2021, we believe we are well positioned to compete and win in this environment. Turning now to our core markets, we continue to see a wealth of investment opportunities as reflected by our committed backlog and robust pipeline. During the quarter, we made $52 million in debt investments to six new portfolio companies consisting of two new life science investments, two sustainability investments, and two technology investments. providing further diversification to our portfolio. We also funded $15 million to three of our existing portfolio companies. Overall, the current environment has produced a record amount of venture debt investment opportunities. Demand for new products and services in industries such as ag tech, fintech, space, mobility, medtech, healthcare tech, and drug development are being met with innovative technology and product companies that are fueled by capital from VCs, venture lenders, SPACs, and the public markets. As Horizon remains disciplined in adding quality investments to its portfolio, its advisor's recent platform expansion, including additional marketing and capital resources, gives Horizon a considerable edge, enables it to better access investment opportunities, and to more rapidly grow its portfolio. As we enter the second half of the year, we are in prime position with ample capacity, a deep pipeline, and our predictive pricing strategy to further profitably expand our portfolio and deliver additional long-term shareholder value. With that, I will now turn the call over to Dan.

Thanks, Jerry, and good morning, everyone. As Rob and Jerry mentioned, Q2 was another strong quarter for Horizon as we continue to grow our portfolio and maintain a strong overall balance sheet. As a reminder, during the quarter, we successfully reduced our cost of capital through the redemption of our six and a quarter notes. Additionally, through our ATM program, we successfully and incredibly sold 361,000 shares, opportunistically raising nearly $6 million. As of June 30th, Horizon had $83 million in available liquidity, consisting of $40 million in cash and $43 million in funds available to be drawn under our existing credit facilities. As of June 30th, there was $15 million outstanding under our $125 million KeyBank credit facility and $51 million outstanding on our $100 million New York Life credit facility, leaving us with ample capacity to grow the portfolio. On June 22nd, we amended the credit facility with KeyBank, which, among other things, extends the draw period to June 2024 and the maturity date to June 2026. The amendment strengthens our ability to capitalize on compelling opportunities that will allow us to maintain our high portfolio yield and to grow net investment income. We appreciate our long-standing relationship with Key and our syndicate partners and look forward to continuing this relationship. Our debt-to-equity ratio stood at 1 to 1 as of June 30, which was lower than our target leverage of 1.2 to 1. Based on our cash position and our borrowing capacity and our revolving credit facilities, our potential new investment capacity at June 30th was $199 million. As we go towards our target leverage of 1.2 times, we would expect that our NII will also increase. For the second quarter, Horizon earned total investment income of $13.5 million, comparable with the prior year period. Interest income on investments increased primarily as a result of higher average earning debt investment portfolio for the quarter, and fee income decreased as lower fees were earned on prepayments. Our debt investment portfolio on a net cost basis stood at $387 million as of June 30th, a 7% increase from March 31st, 2021. For the second quarter of 2021, we achieved onboarding yields of 12.2% compared to 11.7% achieved in the first quarter. Our loan portfolio yield was 14.7% for the second quarter versus 16.9% for last year's second quarter. Turning to our expenses, for the second quarter, total expenses were $7.3 million compared to $6.8 million in the second quarter of 2020. Our performance-based incentive fee was $1.5 million, a reduction from $1.7 million for last year's second quarter based on LIDAR NII generated in the second quarter of 2021. Our interest expense increased to $3 million from $2.6 million in last year's second quarter due to an increase in average borrowings. Our base management fee was $1.8 million up from $1.7 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 was $0.31 per share compared to $0.31 per share in the first quarter of 2021 and $0.40 per share for the second quarter of 2020. The company's undistributed spillover income as of June 30th was $0.34 per share. To summarize our portfolio activities for the second quarter, new originations totaled $67 million, which were partially offset by $3 million in scheduled principal payments and $38 million in principal prepayments. We ended the quarter with a total investment portfolio of $404 million. The portfolio consisted of debt investments in 39 companies with an aggregate fair value of $386 million, and a portfolio of warrant, equity, and other investments in 73 companies with an aggregate fair value of $18 million. Based upon our outlook for NII for 2021, our liquidity forecast, and our spillover income levels, our board declared monthly distributions of $0.10 per share for October, November, and December 2021. We have now declared monthly distributions of $0.10 per share for 60 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 June 30th was $11.20 per share compared to $11.07 as of March 31st, 2021 and $11.64 as of June 30, 2020. 13 cent increase in NAV on a quarterly basis was primarily due to our net investment income exceeding paid distributions, the appreciation of our portfolio, and accretion from the sale of our shares through our ATM program. 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 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.

At this time, we'll be conducting a question and answer session. If you'd 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'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Sarkis Sherbetchen with B. Reilly Securities. Please proceed with your question.

Hey, good morning, everyone, and thank you for taking my question here. Morning. Morning. Yeah, I just wanted to kind of get a sense for... The new capacity for investments, Dan, I think you mentioned was close to $200 million. And with your debt to equity at about one time, just want to understand kind of the cadence that you'd like to grow into that new investment capacity figure. Any kind of help or color you can give on that thought process given the strong venture debt environment would be helpful. Thank you.

Yeah, thanks for the question. Yeah, you're correct. The capacity today is close to $200 million. And being at 1 to 1, we're focused on getting to the 1.2 to 1. And so we analyze the leverage in our portfolio at the beginning of the quarter, determine how to fund that through the leverage or through equity. And so as we continue to build the portfolio, we'll determine how we get to the 1.2 between the leverage and drawing equity on the ATM.

Got it. And just to kind of come back on the prepayment cycle, anything unusual that you're seeing currently? Have prepayments started to kind of get to more normalized patterns, if you will? Or do you think that here in the near term, you know, the prepayment activity is still going to be kind of elevated? Just want to kind of get your sense real time what's happening on that front.

Yeah, this is Jerry. Very good question. As I mentioned in the script, it's a pretty dynamic market right now. So we're seeing a number of our portfolio companies that have signed SPAC agreements. Last quarter, we had two companies that went public, one of which paid us off, Keypath. We have at least one company that has already filed confidentially. to go public this quarter, and we know we have a couple of companies that are in very late-stage M&A discussions. So we expect for the second half of this year for prepayments to be somewhat elevated from certainly the previous two quarters. That said, Given, if you look at our historically high level of backlog, committed backlog, approved backlog, and new opportunities, we still think there'll be plenty of room to grow the portfolio during the second half of the year.

Got it. So just to kind of recap that thought process, right? Prepayment's still elevated. You think it's going to look more so for your specific portfolio? outlook here in the second half, but you have more than enough room to net-net grow the portfolio. Is that the right summary? I think that's correct. Okay, good. And then just kind of want to touch a little bit more on the underwritten yields. It sounded like in your prepared remarks they were up quarter on quarter. Was that right? And then, you know, what's kind of driving that? What's the biggest driver of the onboarding yields going up?

Yeah, so really, you know, on a quarter-to-quarter basis, it's not really – we don't really look at significant changes in onboarding yields because it could be one transaction that kind of skews that number. What I can tell you is that even though there is a significant amount of competition in the market, I think from the overall venture debt perspective – Yields have actually held up very, very well, and we're pretty pleased about that. Part of that is always because we're not just being compared to other debt deals, we're being compared to the cost of equity for raising funds through equity funding, through VCs and the like, and so that's kind of a part of the comparison that companies are doing when they're figuring out how to get additional liquidity in the company. You know, I think overall, I think our response to that would be yields have held up pretty well, and we kind of expect to see that to continue again during the second half of the year.

Okay, great. So nothing like systemically changing here. It's more so maybe one or two transactions that skew it, but generally you think that from a macro perspective, things are business as usual.

That's where we are today. That's exactly how we look at it today, yes.

Okay, fantastic. I'm going to hop on the queue. Thank you so much for answering the questions.

Thank you. Thanks, Circus.

As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. One moment, please, while we poll for questions. Our next question comes from Ryan Lynch with KBW. Please proceed with your question.

Hey, good morning, guys. Good morning. First question I had was you mentioned in your prepared comments two loans were downgraded in the quarter to the level two credit rating. I would just love if you could give any more color on that. companies will be downgraded as they start to run closer to a fundraising cycle or capital raise cycle that's taking longer. Is that what's going on at these companies or is there something fundamentally deteriorating at those two to cause those downgrades?

Yeah, Ryan, this is Rob. So your former description is where these companies are. They are in Fundraising or trying to transact a company, that process is becoming a bit protracted. So we, for a sense of caution, have downgraded these into that bucket. Both of them are working with potential sources of new capital that we hope will come to fruition in the second half. But because of our experience, we felt it was appropriate to put them in the two bucket.

Okay. understood that's helpful um you know your platform has grown pretty meaningfully over the last uh year or so with with both you know the on balance sheet growth as well as the the additional fund raised you know outside of of the bdc um you know now that you guys are deploying capital and that fund you know is contributing to that that capital deployment and and investing alongside the bdc Have you guys shifted the way you guys are approaching or the kind of companies you guys are targeting or industries you guys are going into with the additional dry power, you know, kind of across the platform?

This is Jerry. So, you know, about two years ago, we identified, went out to the market, did a significant due diligence and research effort to identify the markets where we believed that Venture capital would be putting their money in the future. And we came up with a kind of a subsectors within our basic markets that we decided to go ahead to follow very closely. And we've been doing that and sticking to that strategy. It has been extremely successful for us. We have developed new relationships within those sectors, including new investors and large funds that are investing in those sectors, and they are relying on Horizon for providing debt to these companies. So it has been an effort that we feel like really has worked out quite well for us. So that has allowed us to access more transactions. I think we're a little bit ahead of where some of the other debt lenders were in the market relative to some of these subsectors that were not as well-known two years ago as they are today. And so that's where that growth and opportunity is, combined with the fact that we have expanded our marketing team, again, a little bit ahead of the curve. Started in 2019 through 2020, we've added significant depth on the origination side. So that's where the growth is coming from. So we think we're in a pretty stable position now relative to our ability to grow relative to both. Obviously, our capital is Dan has talked about position, but also in terms of our bench strength within the advisor. So that's that's where that growth is coming from. That's where we'll continue to come from.

OK, makes sense. And then, you know, as far as, you know, your guys' specific market as well as the broader VC market and even just the general U.S. economy. Things seem to be going pretty well. The U.S. economy is recovering nicely. The VC market ecosystem has been really resistant during COVID and showing a lot of strength, as you mentioned, some of the fundraising numbers today. And he also talked about the demand for venture debt is really high today. So things seem to be going very well in your business and more broadly. So what are you guys worried about today? What are the risks that you guys are looking at today as you guys look to deploy capital in this market? What kind of worries you and keeps you guys looking around the corner for?

Okay, so none of it keeps me up at night. I want to be clear on that point. But there are three things that I think that we, you know, we are quite focused on and continue to look at and follow. Obviously, the new Delta variant of COVID is becoming a concern and getting people vaccinated and the potential impact if that doesn't happen by the fall and winter, which is when you probably could see potentially significant increases in COVID again. So we're clearly following that. Inflation is something that we are also looking at. We don't see it as being kind of something we have to be overly concerned with today. But I can tell you just in talking to companies within our own market and talking to VCs, You know, there are some supply problems, which is the number three thing that we're a little bit concerned with, which is driving up costs in terms of being able to get parts and chips and things like that. So those are the issues that we are kind of tracking. I don't think we see any more concern in that than the broader market does. But we anecdotally, obviously, hear from our customers on these things. And so we are, as part of our due diligence, whenever we're looking at new opportunities right now, those are things that we are also taking into consideration.

Okay, understood. Those are all my questions. I appreciate the time this morning.

Thanks, Ryan.

There are no further questions. I would now like to turn the call back to Rob Pomeroy, Chairman and CEO, for closing comments.

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. Have a great summer, and we look forward to speaking with you again soon. This concludes the call.

This concludes today's conference. You may disconnect your lines at this time.