Horizon Technology Finance Corporation

Greetings and welcome to the Horizon Technology Finance Corporation third quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce you, your host, Megan Bacon, Director, IR, and Marketing. Please go ahead.

Thank you, and welcome to Horizon Technology Finance Corporation's third quarter 2022 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 Q3 earnings press release and Form 10Q 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 believe, expect, anticipate, intend, 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.

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 conditions. We will then take some questions. It was another excellent quarter for Horizon and our advisor, Horizon Technology Finance Management, despite the challenging macroeconomic environment. Our earnings exceeded our distributions for the quarter, while we continued to responsibly grow our portfolio, improve our credit quality, and maintain our capacity to fund future growth through our strong balance sheet. For the quarter, we generated net investment income of 43 cents per share, well above our distributions of 30 cents per share. Based on our results and outlook, we are very pleased to declare a 10% increase in our monthly distributions to 11 cents per share beginning in January 2023. as well as declare a $0.05 per share special distribution payable in December. Note that this is the third consecutive year we have made a $0.05 per share special distribution. We maintained undistributed spillover income of $0.67 per share as of the end of September. We are confident in our platform's ability to generate NII that covers our distributions over time and are very pleased to distribute additional earnings to our shareholders. We grew the portfolio by $57 million, resulting in a value at quarter end of $635 million. The Horizon brand continues to resonate in the venture debt community, and our advisor continues to source and win high-quality venture debt investments. We finished the quarter with a committed and approved backlog of $252 million and a pipeline of opportunities of over $1 billion. As we look to further grow our portfolio in the current environment, we will remain selective and disciplined when making new investments. We strengthened our balance sheet through our at-the-market program by raising $19 million of equity capital at a premium to MAV. As a result, we ended the quarter with $105 million. We achieved a strong portfolio yield on our debt investments of 15.9% for the quarter, as our yield benefited from the rising rate environment and profitable liquidity. We ended the quarter with NAV of $11.66 per share, a slight reduction from June 30, 2022. And finally, our credit profile improved during the quarter, with 97% of our portfolio rated three or higher as of September 30, and with no loans on non-accrual. As always, we are consistently and actively managing our investments to maintain credit quality. Notwithstanding our strong results for the third quarter, we are cautious as we have seen the venture debt market tighten in recent months. The market is immune from the macro headwinds. The venture capital ecosystem is an exception. Capital raising by the VCs, M&A, and IPO exits, and follow-on equity rounds are all impacted by inflation, a looming recession, and higher interest rates. We are focused on these macro issues as we manage our existing portfolio and select the right new investment opportunity. For the quarter, our advisors platform funded $106 million in due debt investments across our targeted industries, including $89 million funded at HRZM. All of our new loans carry floating rates based upon prime, and the recent increases in the prime rate have resulted in higher onboarding yields, higher prime rate floors. The existing portfolio has also benefited from the higher rates, as evidenced by our strong interest income. We remain cautious as the venture debt market adjusts to higher interest rates and the prospect for further increases. The fact that both our portfolio growth and prepayment activity will be tempered by increased rates, as well as the current economic environment. While we have a record high committed backlog Many of our commitments require that our portfolio companies achieve performance or fundraising milestones. The current economic environment meeting these milestones may be more difficult. While the IPO market has drastically shrunk and M&A activity has significantly slowed, we still believe that there will be opportunities for prepayment activity from our portfolio companies being sold, raising significant new rounds of equity, or being refinanced by larger debt facilities. We have seen this in previous choppy markets and will expect some prepayments, but at a lower level than our recent historically high levels. Summary, the Horizon team has performed well in the current market. We have the right team with experience through previous periods of market dislocation to successfully execute under current conditions. Accordingly, our outlook for the balance of this year and next is guardedly optimistic. We believe that with the innovation that is partially fueled by our capital, the dynamics of the venture technology market are resilient. With that, I will now turn the call over to Jerry and Dan to give you more details and color on our performance. Jerry?

Thanks, Rob, and good morning to everyone. Despite macroeconomic headwinds in Q3, we grew our portfolio by $57 million in the quarter and finished the quarter with a portfolio of $635 million. We funded seven transactions, totaling $89 million, including $84 million in debt investments to five new portfolio companies, consisting of three new tech investments, one new life science investment, and one new healthcare tech investment, providing further diversification to our portfolio. Our onboarding yield of 12.9% during the quarter was well above last quarter's yield and reflects the value of our portfolio's floating rate interest interest rates, and a rising rate environment, as well as our continued discipline in structuring and pricing transactions to produce strong net investment income. We experienced two loan prepayments during the quarter, totaling $22 million. Prepayments were the result of two of our portfolio companies completing SPAC transactions. Prepayment fees and accelerated end-of-term payment income from those transactions further contributed to a strong debt portfolio yield of 15.9% and reflects how our predictive pricing strategy generates one of the highest portfolio yields in the BGC industry. As we have indicated over the past few quarters, given the current macro environment, we anticipate prepayments in the fourth quarter may be lighter than in prior years. As of September 30th, we held warrant and equity positions in 94 portfolio companies with a fair value of $24 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 third quarter, we closed $194 million in new loan commitments and approvals and ended the quarter with a record committed and approved backlog of $252 million compared to $221 million at the end of the second quarter. Most of our funding commitments are subject to our portfolio companies meeting certain key milestones. Meeting these milestones not only unlocks new debt investments for us and our portfolio companies, but positively impacts the credit profile of our existing debt investments, thus de-risking our investment portfolio. With the uncertainty of the macroeconomic outlook over the next few quarters, there is greater than usual uncertainty that milestones will be met and future fundings made from our committed backlog. That said, As we enter the fourth quarter with a record-committed backlog, Horizon is in a strong position to responsibly continue to grow its portfolio as we closely monitor the performance of our portfolio companies and macroeconomic conditions. Our portfolio's credit quality remains solid, as shown by the fair value of 97% of our debt portfolio consisting of three- and four-rated loans as of September 30th, an improvement from the prior quarter end. Of note, we had no one-rated credits at the end of the quarter. One of our one-rated credits at the end of Q2, Kite Hill was able to raise fresh equity to recapitalize the company and return to a three-rated credit. And our other one-rated credit at the end of Q2, Maculogix completed a sale of assets through an ABC liquidation sale. We had three portfolio companies out of a total of 57 with a 2 rating at the end of Q3. Obviously, we continue to closely follow our portfolio companies and are in continual communication with them. Turning now to the venture capital environment. As expected, VC investment activity continues to lighten as investors become more hesitant in the current environment. According to PitchBook, approximately $43 billion was invested in VC-backed companies in the third quarter of 2022. Still a healthy flow, but the lowest quarterly total since the second quarter of 2020. While the VC fundraising has already surpassed last year's record total, the $29 billion raised in the third quarter represented a quarter-over-quarter decline. Funds with established managers drove the bulk of the VC fundraising. Meanwhile, VC-backed exit activity remains muted given the current environment and the near shutting of the IPO window. Total exit value for the quarter was $14 billion, just above last quarter's total. And it's likely that the exit value for the year will fall below $100 billion for the first time since 2016. While the economic environment and investor sentiment remains challenging, VC firms continue to maintain record levels of dry investment powder, nearly $300 billion, which may provide liquidity for new investment opportunities and to support existing portfolio companies. Demand for venture debt has tightened recently, but we continue to see opportunities to invest in growth-stage companies. We are also watching closely to see if the tech-oriented banks begin to pull away from the venture debt market. Should this occur, it may create additional opportunity for our advisor to source and originate high-quality venture debt loans for us. Given our advisor's strong and active lending platform and the solid investment capacity of Horizon, We believe Horizon is well situated to compete for and win opportunistic investments in the current environment. Subsequent to the end of the third quarter, we funded two new transactions totaling $10 million. Our committed, approved, and awarded backlog as of today stands at $282 million. Our advisors pipeline of new opportunities today remains over $1 billion, a near historic high. Looking ahead, We expect the challenging environment to carry into 2023, but believe there are still attractive, quality companies that are looking for venture debt solutions. This provides an opportunity to continue to selectively grow our portfolio, our committed backlog, and our advisor's pipeline. We will also continue to squarely focus on credit quality to ensure optimal outcomes. 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. Thanks, Jerry, and good morning, everyone. We continue to enhance our capital resources during the quarter and maintain a strong balance sheet. Through our ATM program, we successfully and incredibly sold over 1.5 million shares of stock, opportunistically raising an additional 19 million and providing us with further capacity to continue to grow the portfolio. July 2021. we received additional proceeds of $7.3 million from the exercise of the over-allotment of our 2027 notes. Subsequent to quarter end on October 26th, we priced a new $100 million securitization, which when closed, will lock in a 7.56% coupon rate, free up our key bank credit facility, and increase our capacity to make new debt investments. As of September 30th, we had $105 million in available liquidity. existing of $32 million in cash, $73 million in funds available to be drawn under our existing credit facilities. In addition, there were $68 million outstanding under our $125 million key bank credit facility and $137 million outstanding on our $200 million New York Life credit facility, leaving us with ample capacity to grow the portfolio. Our debt-to-equity ratio stood at 1.18 to 1 as of September 30th, slightly below our target leverage of 1.2 to 1. Netting out cash on the balance sheet, our net debt-to-equity was 1.07 to 1. Based on our cash position and our borrowing capacity on our credit facilities, our potential new investment capacity at September 30th was $152 million. For the third quarter, we earned total investment income of $23.3 million, an increase of 42% 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 and an increase in the base rate on our variable rate debt investment. Our debt investment portfolio on a net cost basis stood at $612 million as of September 30th, a 9% increase from June 30th, 2022. For the third quarter of 2022, we achieved onboarding yields of 12.9% compared to 11.6% achieved in the second quarter. Our loan portfolio yield was 15.9% for the third quarter compared to 16.2% for last year's third quarter. Total expenses for the quarter were $12 million compared to $8.3 million in the third quarter of 2021. Our performance-based incentive fee increased to $2.8 million from $2 million for last year's third quarter. Our interest expense increased to $5.3 million from $3.1 million in last year's third quarter due to an increase in average borrowing and higher interest on our borrowing. Our base management fee was $2.8 million, up from $2 million in last year's third quarter due to an increase in the average size of our portfolio. That investment income for the third quarter of 2022 was $0.43 per share, compared to $0.35 per share in the second quarter of 2022 and $0.40 per share for the third quarter of 2021. The company's under-distributed spillover income as of September 30th was $0.67 per share. We anticipate that our larger portfolio, along with our predictive pricing strategy, will enable us over time to generate NII that covers our increased distributions. To summarize our portfolio activities for the third quarter, Net new originations totaled $89 million, which were partially offset by $5 million in scheduled principal payments and $22 million in principal prepayments. We ended the quarter with a total investment portfolio of $635 million. Given the macro environment, we would expect to have limited portfolio growth in the fourth quarter. On September 30th, the portfolio consisted of debt investments in 57 companies with an aggregate fair value of $609 million. and a portfolio of warrant, equity, and other investments to 96 companies with an average fair value of $26 million. Based on our results to date and our outlook for 2023, our board declared a 10% increase in our monthly distribution to $0.11 per share for January, February, and March 2023, as well as a $0.05 per share special distribution available in December 2022. We're very pleased to be able to raise our distribution as a reflective strength of our performance and the confidence we have in our future prospects. 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 $11.66 per share compared to $11.69 as of June 30, 2022 and $11.63 as of September 30th, 2021. The three-cent reduction in NAV on a quarterly basis was primarily due to paid distributions and adjustments to fair value, partially offset by net investment income. 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 to the interest rate floor. As of September 30th, 98% of our debt portfolio will benefit from additional increases in their applicable base rates. This concludes our opening remarks.

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

Ladies and gentlemen, we will be conducting a question and answer session. 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. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Paul Johnson from KBW. Please go ahead.

Yeah, good morning, guys. Thanks for taking my questions. I was wondering if you could speak to just kind of, I guess, any sort of statistics or colors you provide on your portfolio companies in terms of, like, cash runway or liquidity or, you know, what you may kind of, you know, judge the support potential of any of the portfolio companies. that you guys work with, any sort of commentary there in terms of just cash support and support from sponsors for these companies in this kind of environment?

Yeah, hi, Paul. This is Jerry. So at the very beginning of this year, there were many articles written, and certainly what we were hearing in the market is venture capital firms were telling their portfolio companies to focus on cutting costs, reducing burn, and getting to profitability versus the alternative of growth. And so we saw a lot of that in the first half of 2022. The other part of that was they also asked the companies to look for ways to extend runway. And that's why in the first half of 2022, I think venture debt became such an attractive product because it allowed companies to add capital to their balance sheets that was basically non-dilutive in an environment where valuations were relatively low. We saw that in the first half of this year. What we're noticing, or what we did notice from that, in our own portfolio, is companies have, in fact, reduced their burn fairly considerably. and they have added cash from venture debt or other less dilutive ways of funding the company. But what that really means is that in our own portfolio, for example, runways have been extended without adding a lot of liquidity by cost cutting. And so as what we're seeing in our portfolio is that there is less cash on the balance sheet of our portfolio companies, but they are, interestingly enough, their fundraising plans are coming to fruition. They don't have as much cash, but as they plan out the cash that they will need going forward, they are adding cash through both equity rounds and other sources of capital. When I look at our portfolio today compared to, say, a year ago when it was more of a growth type of environment, the liquidity on the company's balance sheets are still strong. Their runways are a little bit longer. But most importantly in this environment, what you want to see is if they have less cash, you want to see that their plans, their strategic plans for raising equity are actually coming to fruition. And we have been seeing that with all of our portfolio companies. As they need to raise capital, they have been raising capital in the form of equity and debt. So overall, going into 2023, we're actually feeling pretty good about where all of our portfolio companies stand relative to liquidity.

I appreciate that, Jerry. And I guess I'd ask you as well on that, you know, how do you feel about, you know, buyers and sellers, you know, in the VC market today in terms of, you know, the distance that we are apart, you know, on price? I think, you know, beginning of the year, there was a lot of, you know, distance between the two there as the market was still kind of, you know, more or less in a reset mode. Do you still find that today? I mean, do you find that the capital that, you know, we're talking about here, you know, extending the runway that they are able to raise, is this being raised more or less for, you know, anticipation of the VC market coming back? Or is this, you know, still, I guess, a reset sort of taking place within the VC market? Yeah.

Yeah, it's interesting. We've been through other cycles before, difficult cycles, choppy cycles, whatever you want to term that. But this one is a little bit different. We haven't been in an interest rate increase environment in a very long time like we're in today. But what we are seeing is a lot of patience so far. And, of course, it helps if VCs have a lot of dry powder. But we're seeing a lot of patience on the part of venture capital firms in finding ways to fund their companies. Maybe it's a smaller equity round. Maybe it's a flat valuation done by insiders, as well as raising non-dilutive financing. But we're seeing some patience with an understanding that 2023, you know, could be a pretty difficult period to navigate. The other thing I would say, though, is there are certain sub-sectors that are still being very well funded, not just existing companies, but adding new portfolio companies to their portfolios in certain sub-sectors. We're well aware of that. We're aware of where the VC money is going versus where it was. Go to where the puck is going, not where it is. We're quite cognizant of that. As we look at transactions in various markets, we know which one of those subsectors are certainly in favor in the VC community. Having that experience helps us a lot as we evaluate new transactions.

Appreciate the answers there. Very helpful. My last few questions, smaller questions. One, I know you mentioned on the call, I just didn't grab all the details. You mentioned there were, I think, I thought I heard it right, two prepayments in the quarter that sort of drove the end-of-term payment incomes. the income this quarter. Just wanted to know if I heard that correctly, if the higher, obviously you guys had lower prepayments this quarter. So whatever drove that higher this quarter is the only thing I wanted to confirm. And my last question, I'll go ahead and ask it, was just on the securitization. I was wondering if you guys had provided, if there was a maturity on the recent securitization that you guys had just completed. And those are my last two questions. Thanks.

Yeah, sure. This is Dan. On the prepayments, you're correct. We had two prepayments at $22 million this quarter. And as you know, that is a bit on the lower side. But each prepayment has different features to it. And so on average, it usually generates around 4% to 5% of additional income between fee income and acceleration of interest expense and accelerated costs. This quarter, there was one of the deals that prepaid had a very opportunistic feature in it for us that increased that 6% to a higher, roughly around 10%. So that did drive a larger interest income line item because it flowed through towards that line item versus fee income. On the securitization, we have not published the maturity, but the seven-year securitization has a two-year revolving period. There is a buyout feature that is in this structure that we can take advantage of if interest rates do go down in the next couple of years.

thank you ladies and gentlemen if you wish to ask a question please press star one

Our next question comes from the line of Vilas Abraham from UBS. Please go ahead.

Hey, everyone. Thanks for taking the question. I just wanted to ask on documentation in terms and what you guys are seeing now for the incremental investments that you're making and how that's evolving at all.

So in terms of the documents, are we talking about covenants and pricing? Is that your question?

Yeah, yeah, yeah, covenants and pricing, exactly.

Yeah, so I think as markets tighten, the opportunity does exist to be a little bit more aggressive on our part for covenants and access to the capital from our commitments, but not a quantum leap from where we were before, a competitive market. We're looking to provide, as Jerry described, growth capital and runway and to do it in a way that matches the company's ability to stretch its own runway through cost-cutting and capital commitments and execution on their business plans. So we're using those covenant tools where we can, but not a dramatic shift from where we were a year ago.

Okay, and then just real quick on, you know, on spreads, you know, as base rates continue to go up fairly quickly, what's your outlook on spreads? And is it going to be biased to compress here as hikes keep coming through?

So we price our loans on a floating rate basis off of prime. I think as prime has moved up pretty significantly this year and there's anticipations that it will go up again with further Fed actions, we are seeing some compression in the initial spread over prime, but that's offset by also increasing the prime floors. Venture debt has traditionally traded in an ultimate cost range that We will continue to maintain, but we're seeing rates, as we said, onboarding yields in this quarter were 12.9%, and we would expect that to be higher, but not on a point-for-point basis with the increase in prime.

Okay, thank you. That's all I had. Thank you.

Ladies and gentlemen, we have reached the end of the question and answer session. I would now like to turn the conference over to Mr. 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, and we look forward to speaking with you again in the new year. This will end the call. Thank you.

Thank you. The Conference of Horizon Technology Finance Corporation has now concluded. Thank you for your participation. You may now disconnect your lines.