Horizon Technology Finance Corporation (HRZN) Q1 2021 Earnings Report, Transcript and Summary

Greetings, and welcome to Horizon Technology Finance Corporation First Quarter 2021 Earnings Call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow the presentation [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Megan Bacon. Thank you. Please go ahead.

Thank you, and welcome to the Horizon Technology Finance first quarter 2021 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 Q1 earnings press release and Form 10-Q are available on the company's Web site, 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 provide an overall perspective on Horizon’s performance and its 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 an excellent and very active start to 2021 in all facets of our operations. We grew our portfolio to $380 million, an 8% increase from the end of 2020. We generated net investment income of $0.31 per share in excess of our distribution model. Based on our outlook, we are maintaining our monthly distribution through September, marking 57 consecutive months at $0.10 per share. We achieved an industry leading portfolio yield on our debt investments of 15.2%. We further improved our portfolio credit profile and ended the quarter with no one rated loans or loans on nonaccrual. When one considers where the venture industry and overall economy stood a year ago we are particularly proud of our accomplishments and our team's ability to successfully navigate through the pandemic. We ended the quarter with NAV of $11.07 per share, a $0.05 increase from the end of 2020. And at the end of the quarter, we successfully lowered our cost of capital and further strengthened our balance sheet, completing an offering of 4.75 notes due 2026 and used the proceeds to fully redeem our 6.25 notes due 2022. In addition to our strong results for the quarter, I also want to highlight our advisors Horizon Technology Finance management's recent platform expansion, which provides the capacity to originate and manage $100 million venture debt portfolio for Waterfall Asset Management. The platform has the potential to expand to $300 million over time. With the addition of this new investment vehicle, which will invest side by side with Horizon, Horizon now has the ability to access larger and more investment opportunities, while at the same time further improving its portfolio diversity and reducing concentration risk. The new vehicle has invested $21 million of venture debt today and we expect that it will be an important factor in Horizon's future portfolio and net investment income growth. Looking ahead, 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 high; our committed backlog and pipeline for investments are at record levels; our advisors’ new investment vehicle will help us better compete for new loan opportunities; and we maintain ample capacity on our balance sheet to execute on our backlog of commitments and pipeline of new opportunities, as well as new opportunities we originate. Our strategic balance sheet management, strong marketing, disciplined underwriting and proactive management of our portfolio, has enabled us to successfully navigate through the pandemic and placed us in a prime position to further expand and diversify our portfolio and ultimately, generate net investment income and additional long term value for our shareholders. I want to thank our entire team for all their hard work and strong -- for another strong quarter. And with that, I will now turn the call over to Jerry.

Thanks, Rob. Good morning to everyone. The momentum we generated toward the end of 2020 continued throughout the first quarter as we took advantage of strong market demand for venture debt and originated eight transactions, totaling $51 million during the quarter. Our onboarding yield of 11.7% during the quarter reflected our continued disciplined focus on pricing transactions that will provide strong NII that can then be enhanced by our predictive pricing strategy. We also experienced two loan prepayments during the quarter, totaling 19 million and the prepayment fees and accelerated income from the prepayments increased our debt portfolio yield for the quarter to 15.2%, which was once again among the top of the BDC industry. During the quarter, we also received proceeds of $800,000 from the exercise and sale of warrants. As we have consistently noted, structuring investments with warrants and equity rights is a key aspect of our venture debt strategy and an additional value generator. As of March 31st, we held warrant and equity positions in 67 portfolio companies with a fair value of $17 million. In the first quarter, we closed $54 million in new loan commitments and approvals and we ended the quarter with a committed and approved backlog of $94 million compared to $107 million at the end of 2020. Demand for venture debt remains elevated and we ended the quarter with a pipeline of new opportunities totaling $839 million. Subsequent to Q1, we funded an additional loan of $2.5 million and increased our committed and approved backlog to a record $125.5 million. Our pipeline of new opportunities now stands at almost $1 billion, including $105 million of recently awarded transactions, which provides us with a solid base to further grow our venture debt portfolio. Also subsequent to Q1, we exited our investment in Kate Farms receiving $15 million in principal repayment along with the accrued interest, a prepayment fee and accelerated final payment. Horizon continues to hold warrants in Kate Farms. Along with the growth of our portfolio, we are particularly pleased with the improvement in the credit quality of our portfolio as we ended the quarter with a strong credit profile, including having over 98% of our [debt] and portfolio’s fair value consisting of three and four rated loans and having no loans or non-accrual or one rated. In the quarter, we exited our debt investment in NanoSteel with our recovery consistent with the investments fair value at December 31st. And we exited our investment in IgnitionOne, achieving strong recoveries from that process. As a result, our venture debt portfolio was strong and well positioned to generate NII while it continues to grow throughout 2021 and beyond. Turning now to the venture capital environment. Sector continues to remain on a very continues to remain at a very strong footing. According to PitchBook, approximately $69 billion was invested in VC backed companies in the first quarter, well above last year's first quarter. In terms VC fundraising, $33 billion was raised in the first quarter, putting 2021 on a pace to shatter 2020’s record performance of $80 billion. Larger funds continue to mostly drive the increased fundraising. Regarding VC backed exit activity, the IPO and SPAC window, remained wide open in the first quarter. 50 venture backed IPOs or SPACs helping to drive a total exit value of $118 billion. SPACs raised $83 billion in newly registered vehicles in the first quarter alone. While there is growing regulatory and market uncertainty around the SPAC markets, there still remains multiple paths for venture backed companies to generate additional liquidity, including from venture capital, IPOs, venture debt and M&A activity. Turning now to our core markets, we continue to see a multitude of investment opportunities as reflected by our committed backlog and robust pipeline. During the quarter, we made $39 million in debt investments to six new portfolio companies, consisting of one new life science investment and five new technology investments, which provided further diversification to our portfolio. We also funded $12 million to two of our existing portfolio companies. Overall, there remain substantial demand for venture debt investment as debt and equity remains widely available to companies in our target markets of life science, technology, healthcare tech and sustainability. As Rob mentioned, we expect our advisors’ recent platform expansion provide us with a considerable advantage in this dynamic environment and access to larger potential investment opportunities. As part of that expansion, our advisors added experienced venture debt marketing and portfolio management professionals in New England, California and Austin, Texas. We entered the second quarter in an excellent position to continue utilizing our liquidity, our robust 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 noted in his remarks, we had a strong first quarter with respect to our portfolio and continuing to strengthen our overall balance sheet. In terms of our balance sheet, we successfully reduced our cost of capital and extended our maturity with the issuance of $57.5 million of our 4.78 notes, which trade under the ticker, HTFB. Last week, with the proceeds from the offering, we redeemed all of our 6.25 notes. As a result, we’ll incur additional interest expense of $400,000 in the second quarter of 2021 related to the acceleration of unamortized debt issuance costs. Additionally, through our ATM, we successfully and accretively sold 366,000 shares, opportunistically raising nearly $5 million. As of March 31st, Horizon had just under $149 million in available liquidity, consisting of $81 million in cash and $68 million in funds available to be drawn under our existing credit facilities. As of March 31st, there was no outstanding balance 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. Our debt to equity ratio stood at 1.13:1 as of March 31st, which was lower than our target leverage of 1.2:1. Based on our cash position and our borrowing capacity on our revolving credit facility, our potential new investment capacity at March 31st was $255 million. We know that with the redemption of our ‘22 notes last week, our debt to equity ratio has materially lowered to 0.96:1. As we grow towards our target leverage of 1.2 times, we would expect that our NII will increase commensurately. For the first quarter, Horizon earned total investment income of $13.2 million, a 31% increase compared to $10.1 million in the prior year period. Growth is mainly due to increased interest income on investments, which is primarily a result of a higher average earning debt investment portfolio for the quarter. Our debt investment portfolio on a net cost basis stood at $362 million as of March 31st, 6.5% increase from December 31, 2020. For the first quarter of 2021, we achieved onboarding yield of 11.7% compared to 12.2% achieved in the fourth quarter. Our loan portfolio yield was 15.2% for the first quarter versus 13.2% for last year's first quarter. Turning to our expenses for the first quarter, total expenses were $7.2 million compared to $5.8 million in the first quarter of 2020. Our performance based incentive fee rose to $1.5 million compared to $1.1 million based on greater NII generated in the first quarter of 2021. Our interest initial expense increased to $2.7 million from $2.2 million in the prior first quarter due to an increase in average borrowing. Our base management fee was $1.8 million, up from $1.6 million in the prior first quarter due to an increase in the average size of our portfolio. Net investment income for the first quarter was $0.31 per share compared to $0.21 per share in the fourth quarter of 2020 and $0.26 per share for the first quarter of 2020. As mentioned in the past, changes period to period to quarterly NII per share are primarily driven by the timing of new loan originations and the timing and extent of loan prepayments and the related fee income from those prepayments, including prepayment fees and acceleration of previously unamortized end of term payments. Looking ahead, we would continue to expect to generate a solid base of NII driven by our larger debt investment portfolio with additional upside dependent on the timing of prepayment activity. The company's undistributed spillover income as of March 31st was $0.33 per share. Summarize our portfolio activities for the first quarter, new originations total $51 million, which were partially offset by $5 million scheduled principal payments and $19 million in principal prepayments. We ended the quarter with a total investment portfolio of $380 million. The portfolio consisted of debt investments in 37 companies with an aggregate fair value of $362 million and a portfolio of warrants, equity and other investments in 69 companies with an average 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 July, August and September 2021. We've now declared monthly distributions of $0.10 per share for 57 consecutive months. We remain committed to providing our shareholders with distributions that are covered by our net investment income overtime. Our NAV as of March 31st was $11.07 per share compared to $11.02 as of year end 2020 and $11.48 as of March 31, 2020. The $0.05 increase in NAV on a quarterly basis was primarily due to our NII and accretion from our ATM program exceeding a distribution. As we consistently noted, 100% 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 March 31st, 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. The floor is now open for questions [Operator Instructions]. Our first question is coming from Sarkis Sherbetchyan of B. Riley FBR.

Just wanted to get a sense, if you can provide some insight on prepayment activity for the balance of fiscal '21 and maybe if you can compare that to the originations that you're expecting to deploy given your balance sheet as we move through the year?

So for Q1, we have line of sight of about $20 million. If you look at last year's prepayments, I think they're about $120 million for the year. Our portfolio, obviously, has been growing. So we could potentially expect it to be a little bit higher than that this year. But as you know, in the cautionary note here, prepayments are not as predictable as other aspects of our business. So on a quarter to quarter basis that can vary pretty significantly Q1 and I think it was $19 million, we expected to be a little bit more elevated than that under the non-circumstances. So that's kind of the prepayment activity that we're expecting for the rest of the year.

And as far as the cadence for originations, do you think you'll start to get a little bit more aggressive kind of given the level of leverage that you can achieve to get to your target, or would you say it’d be at a more moderate pace?

Yes, that's a really good question, because, today, we're looking at pipelines and the $800 million to $1 billion of transactions we're looking at. You don't have to go that far back where that pipeline might have looked at -- like more like $200 million to $300 million. So the activity in the marketplace is significantly elevated for a whole bunch of reasons, so lot of equity going into the marketplace, a lot of new technology development in certain areas. So we really don't have to get more aggressive. There's far more selection in the marketplace for us than it has been historically. So we believe that we can grow the portfolio very nicely without having to lower interest rates or move out only credit spectrum at all. So it's really a pretty strong, solid market for us to be operating in. But we do believe we will grow the portfolio during the course of the year.

One more for me and I'll hop back in the queue. I find the announcement on the platform expansion fairly interesting. Can you maybe give some more detail on how you expect the Horizon BDC to benefit from the platform expansion with Waterfall Asset Management?

One of the features many BDCs in the market have are multiple platforms. And having that is beneficial to the public BDCs where as we mentioned in our prepared remarks, where it gives you access to larger deals but also provide further diversification at the public BDC. And so that was a strategic initiative of ours to expand our platform and to allow us to look at larger deals and hold those deals ourselves, and create the diversification at the horizon platform.

[Operator Instructions] Our next question is coming from Ryan Lynch of KBW.

Congrats on the additional fund close outside of the BDC. One question I did have on that. That's obviously a pretty sizable fund relative to the BDC, which will definitely have, I think, an impact on guided your investment strategy going forward. I was just wondering, are there any other funds outside of the BDC, outside of the one you just closed or is that the only -- is this new fund the only other capital you're managing outside the BDC?

Currently, that is the only other fund outside of BDC.

And then, you guys mentioned in your prepared remarks the amount of capital being raised in the VC market today, that, in combination with the kind of elevation of valuations in that space. Does that create more competition and does that result in venture debt potentially being a less compelling product when entrepreneurs or venture capital are looking to take on additional capital?

So the short answer to that would be yes, we definitely are seeing, in this environment, competition from equity, whether it's public equity, or SPACs, or even private VC funds. It's hard to ignore the correlation between very, very large VC funds, raising lots of money and then the size of investments in particular sectors that we cover moving up considerably. So they are putting a lot more money to work. That said, in terms of how we're competing in the marketplace, we're still seeing greater elevated opportunities as well. For venture debt, there's still the value proposition that venture debt provides to the entrepreneurs and even to the existing investors and companies where venture debt can provide incremental capital at a significantly reduced cost compared to what the equity would be. So yes, it is a more competitive environment relative to that but there's also a lot more demand in the marketplace for both equity and debt and we're finding the market very strong for both.

Has that resulted in you guys having to change your terms or structures materially on the deals you're doing versus where you were maybe in 2019, and where does the landscape look like from look like from a competitive standpoint?

Not from a pricing standpoint, I think pricing has held up and you can see that in our first quarter results. Pricing has held up very strong. There’s always this perception of risk relative to the markets that we serve. And so that's always used to kind of keep pricing relatively stable as always potential someone with new will come into the market on the debt side and do something that isn’t that consistent with market. But we haven't seen that. As it relates to the debt markets, again, it is fairly competitive. I think -- to this day, I still think that there are certain venture lenders who have been in this market for a very, very long time that have really strong relationships and reputation. And I think we always have that advantage in the marketplace, it doesn't mean that Horizon is going to win every transaction even though we want to win every transaction, but it does give us a competitive advantage. And we are seeing that. We are seeing when we're competing head up against other lenders in the marketplace, we do quite well. So yes, it is going to continue to be a very competitive marketplace. There's no question about that. There's a lot of tailwind behind the market right now. But we're maintaining kind of a balanced position relative to credit quality, pricing, things like that. And with the significantly expanded pipeline, we're still holding our own quite nicely and do expect to expand the portfolio over the course of the remaining 24 months.

Thank you. There are no further questions. I'd like to turn the call back over to Robert 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 soon. This will end our call.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and have a wonderful day.