Horizon Technology Finance Corporation (HRZN) Q4 2021 Earnings Report, Transcript and Summary

Greetings and welcome to the Horizon Technology Finance Corporation Fourth Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Ms. Megan Bacon, Director, Investor Relations and Marketing for Horizon Technology Finance Corporation. Thank you. You may begin.

Thank you and welcome to the Horizon Technology Finance Corporation fourth 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 Q4 earnings press release and Form 10-K 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 regards to the future performance of the company. Words such as belief, 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 that 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.

Good morning. Thank you for joining us and for your continued interest in Horizon. Today, 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. Dan will detail our operating performance and financial condition and then we will take some questions. 2021 was a fantastic year for HRZN and the lending platform of our advisor Horizon Technology Finance Management. We began the year in a strong position after successfully navigating the most challenging aspects of the pandemic and into the year having significantly grown our portfolio and strengthened our brand and our balance sheet. We are proud of our advisors deep and professional team, their dedication and their contributions to our excellent performance in 2021. Our performance validated our predictive pricing strategy and disciplined investment approach. Like you, we are keeping a close eye on events around the world, including the turmoil unfolding in Eastern Europe and on domestic issues including inflation and what this may all mean for us and the broader economy in the months ahead. Turning to our accomplishments in 2021. Our portfolio at year end stood at $458 million, an increase of 30% from the end of 2020. Consider that we achieved 30% growth despite a record year of nearly $175 million in pre-payments. Our growth was a testament to both our advisors' ability to source and win larger, high quality venture debt investments and the increasing power of the horizon brand and the venture debt community. To that end, our advisor expanded this platform during 2021 through an agreement with a private investment vehicle to originate and manage a venture debt portfolio to invest alongside Horizon. We are pleased that this relationship has had a positive impact on Horizon's ability to access additional and larger investment opportunities. We finished the year with a committed and approved backlog of $127 million, our largest yearend total, which provides us with a significant base to further expand our portfolio in 2022. We generated net investment income of $1.41 per share well in excess of our distribution level for the year, thanks in part to the continued success of our predictive pricing strategy. Based on our outlook and our undistributed spillover income of $0.51 per share as of yearend we declared monthly distributions at $0.10 per share through June of 2022, which will mark 5.5 years of monthly distributions at this level. We achieved a portfolio yield on our debt investments of 16.2% for the second consecutive quarter and a full year portfolio yield of 15.7%. at or near the top of the BDC industry. We maintained a stable credit profile with nearly 98% of our portfolio rated three or higher at the end of the year. We are consistently and actively managing our portfolio of investments to maintain its credit quality. We ended the year with NAV of $11.56 per share slight reduction from the prior quarter, but up 5% from the end of 2020. Finally, we strengthened our balance sheet in several respects. We raised approximately $30 million of equity in 2021 from our aftermarket program, all at a premium to NAV. We reduced our cost of capital by refinancing our publicly traded [six in the (“Notes”)] with [indiscernible]. We ended the year with available liquidity and capacity to fund additional growth in our portfolio as well as move closer to our target leverage of 1.2 to 1. Just this week, we announced an increase in the size of our credit facility with New York Live to $200 million, further increasing our capacity and positioning us for growth. We entered 2022 with excellent momentum across the board and believe we remain well-positioned to continue growing our portfolio of investments and producing strong net investment income. Our advisor continues to strengthen their Horizon platform with new hires and by promoting members of our team into key management positions. This will ensure horizon continues on its path to further growth and continued profitability. Demand for venture debt within our target industries is still burgeoning and we are winning our share of transactions including new awards thus far in the first quarter. Our committed backlog and pipeline of investments remains robust. Our advisors expanded lending platform and the power of the horizon brand continues to enable us to access a larger number of investment opportunities and we continue to maintain capacity to execute on our backlog of commitments as well as our advisors pipeline of new opportunities. 2021 was a banner year for Horizon, and we believe the best is yet to come. 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, everyone. We funded a record number of 17 transactions totaling $80 million in the fourth quarter, another quarter of substantial activity. Our onboarding yield of 11.3% during the quarter reflected the power of our advisors' predictive pricing strategy, and its continued discipline and pricing transactions that it expects to produce strong NII. We experienced five loan pre-payments during the quarter, totaling $66 million, with the prepayment fees and accelerated income from such pre-payments contributing to a debt portfolio yield of 16.2% for the second consecutive quarter, once again among the top and the BDC industry. In addition, to receive proceeds of $400,000 from the sale of warrants and equity, a further testament to our method of structuring investments to generate additional yield from our growing warrant and equity portfolio. As of December 31, we have warrant and equity positions and 76 portfolio companies with a fair value of $21 million. Since the beginning of 2020 we have received approximately $14 million in proceeds from warrant equity investments. 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 fourth quarter, we closed $115 million in new loan commitments and approvals and ended the quarter with a committed and approved backlog of 4127 million compared to $101 million at the end of the third quarter. While there is no guarantee we will fund all of the transactions and are committed to award backlog, the total supports a positive funding outlook for 2022. Subsequent to the end of the year, we funded 32 million in new venture debt loans and received $12 million in loan pre-payments. Our committed and approved backlog as of today has grown to $179 million, which includes new awards in 2022. In addition, our advisors' pipeline of new opportunities today is approximately $876 million, providing us with a solid base of opportunities to further grow our venture debt portfolio over the coming quarters. Our portfolio's credit quality remains robust as the fair value of nearly 98% of our debt portfolio consisted of three and four rated loans as of yearend. During the quarter one investment was downgraded to a one rating, and at the end of the quarter, we had a total of two credits with a one or two rating. As always, we are aggressively managing the one and two rated credits in order to achieve the best possible outcome. In Q4 we exited MVI a one rated credit in Q3 and fully recovered our principle. Turning now to the venture capital environment. It was a record shattering year in 2021. According to PitchBook approximately $330 billion was invested in VC-backed companies in 2021, essentially doubling 2020's prior record of $166 billion. In terms of VC fundraising $32 billion was raised in the fourth quarter and for the year, VC fundraising eclipsed the $100 billion mark for the first time ever as $128 billion was raised. Larger VC funds continue to drive the bulk of increased fundraising. Regarding VC-backed exit activity. The IPO and SPAC window remained open during the quarter, helping to drive a total exit value for the year of nearly $775 billion. However, we have seen recent underperformance by some SPAC transactions and a decline in the public biotech market in the second half of 2021 where it will be challenging for VCs to match 2021 to record performance in the venture capital market, particularly with respect to exit value. VC firms will start 2022 with record levels of dry powder that will provide liquidity for new investment opportunities and support for existing portfolio companies. Numerous other options remain, for venture backed companies to generate additional liquidity including venture debt, which has become an important tool for growth stage companies to finance their development plans. To that end, we expect 2022 to provide opportunity as well as competition for technology, life science, sustainability, and healthcare technology investments. With our advisor strong and active lending platform, we believe we are well-positioned to compete and win in the current environment. Turning now to our lending markets. They continue to offer many quality investment opportunities to further fill and enhance our committed backlog and our advisors pipeline. During the quarter, we made $46 million in debt investments to seven new portfolio companies, consisting of two new life science investments, and five new technology investments, providing further diversification to our portfolio. We also funded $34 million to 10 of our existing portfolio companies. We continue to keep a close eye on the macro environment and our underwriting new investments with those concerns in mind. We also continue to have active and regular dialogue with all of our portfolio companies in order to maintain the credit quality of our portfolio. As we progress in 2022, venture debt opportunities remain attractive and the technology and sustainability markets like science, public equity markets have significantly tightened, which is impacting valuations and access to capital for some biotechs. However, life science venture capital firms have plenty of dry powder and find lower valuations to be an opportunity to selectively invest in both private and public biotech companies with strong clinical pipelines. Historically, when the public markets for biotech companies tighten, the market looks for alternative funding sources, such as Big Pharma collaborations and M&A as well as venture debt. We are seeing opportunities come to the venture debt market that fit that description. Our advisor will remain disciplined in its marketing and underwriting and continue to seek quality investments that will rationally grow our portfolio. We believe we remain well-positioned to continue to deliver additional long term shareholder value in 2022 and beyond. With that, I will now turn the call over to Dan.

Thanks, Jerry. And good morning, everyone. As Rob and Jerry mentioned, the fourth quarter capped off an excellent year for Horizon as we significantly grew our portfolio and generate strong NII and more than covered our distributions while maintaining a strong overall balance sheet and stable credit quality. We believe we entered 2022 position to expand our portfolio and generate additional long term value for our shareholders. Recap 2021, we grew our portfolio by 30% to $458 million. Our advisor expanded its platform to originating and managing a venture debt portfolio for a private investment vehicle, which expands our ability to win transactions and grow our portfolio in 2022. We reduced our cost to capital during the year by redeeming our [indiscernible]. And to our ATM program we successfully and accreatively sold 1.9 million shares and raised 30 million in 2021 which included receiving net proceeds of approximately 13 million from the program in the fourth quarter, demonstrating our ability to opportunistically access the equity markets. 2021 was a landmark year for Horizon and we believe it puts us firmly on the path for additional growth and shareholder value creation in 2022. As of December 31, we had $71 million in available liquidity consisting of $46 million in cash and $25 million in funds available to be drawn under our existing credit facilities. As of December 31, there was $54 million outstanding under our KeyBanc credit facility, and $79 million outstanding on our New York Life credit facility. debt-to-equity ratio stood at 1.1 to 1 as of December 31, which was lower than our target leverage of 1.2 to 1. Based on our cash position and our borrowing capacity and our credit facilities. Our potential new invest incapacity at December 31, was $139 million. With our increased capacity on our New York credit facility, today we have $239 million in new investment capacity. As we grow towards our target leverage, we would expect that our NII will also increase. For the fourth quarter, the company earned total investment income of $16.9 an increase of 68% 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 higher fee income due to a larger amount of prepayments. Our debt investment portfolio on a net cost basis stood at $442 million as of December 31, a 3% increase from September 30, 2021. For the fourth quarter of 2021 we achieved onboarding yields of 11.3% compared to 11.5% achieved in the third quarter. Our loan portfolio yield was 16.2% for the fourth quarter, up 320 basis points from 13%, the last year's fourth quarter. Turning to our expenses, for the fourth quarter total expenses were $8.7 million, compared to $5.9 million in the fourth quarter of 2020. Our performance based incentive fee was $2 million, an increase of a million from last year's fourth quarter based on higher NII generated in the fourth quarter of 2021. Our interest expense increased to $3.3 million from $2.3 million in last year's fourth quarter due to an increase in average borrowings. Our base management fee was $2 million up from $1.6 million in last year's fourth quarter, due to an increase in the average size of our portfolio. Net investment income for the fourth quarter was $0.39 per share, compared to $0.40 per share in the third quarter of 2021 and $0.21 per share for the fourth quarter of 2020. For the full year 2021 we generated NII of $1.41 per share more than covering our total distributions during 2021 of $1.25 per share. The company's undistributed spillover income as of December 31, was $0.51 per share. As a reminder, first quarter is typically the lightest in terms of prepayment activity and we expect the first quarter of 2022 to be in line with that historical norm. However, our significantly larger portfolio along with our predictive pricing strategy should enable us over time to generate solid NII that covers our distribution. To summarize our portfolio activities for the fourth quarter new originations totaled 80 million, which were partially offset by 2 million and scheduled principal payments and 66 million in principal prepayments. We ended 2021 with a total investment portfolio of $458 million. Portfolio consisted of debt investments in 45 companies with an average fair value of $437 million, and a portfolio of warrants, equity, and other investments in 78 companies with an average fair value of $21 million. Based upon our outlook for 2022, our board declared monthly distributions of $0.10 per share for April, May and June 2022. We have now declared monthly distributions of $0.10 per share for 5.5 years. We remain committed to providing our shareholders with distributions that are covered by our net investment income over time. Our NAV as of December 31 was $11.56 per share compared to $11.63 as of September 30, 2021 and $11.02 as of December 31, 2020. A $0.07 reduction in NAV on a quarterly basis was primarily due to pay distributions, including the 510 special distribution and unrealized and realized losses offsetting strong net investment income and accretion from the sale of our shares to our ATM program. As we've consistently noted a 100% of the outstanding principle amount of our debt investments, their interest at floating rates with coupons that are structured to increase as interest rates rise with interest rate floors. As of December 31, 80% of our portfolio was at the prime rate floor. And that's what benefit from an increase in the prime rate. In fact, the prime rate would have to increase 75 basis points before our cost of debt begins to rise potentially providing us with a positive spread for at least a couple of quarters should the prime rate rise. This concludes our opening remarks. We'll be happy to take questions you may have at this time.

Thank you. At this time, we'll be conducting a question and answer session. [Operator Instructions] Our first question comes from the line of Sarkis Sherbetchyan with B.Riley Securities. Please proceed with your question.

Hi, good morning, and thank you for taking my question here. You guys talked about the environment here and also how some of the lower valuations are providing an opportunity to selectively invest in some of the stronger companies. Are you seeing VC debt becoming more relevant in the conversations today as opposed to perhaps the equity stack? And then in light of that, as well you talked about kind of the $239 million in new capacity. Maybe you can talk about how you anticipate on deploying that capital for growth.

Yes. Hi, this is Jerry. So yes, I am specifically talking about the life science market. It's not an unusual phenomenon when that market tightens, which can be uncorrelated to the global markets, based on things that are happening in the biotech market. Oftentimes, when that does happen, biotech companies will try to extend their cash runway, using other sources of capital, non-dilutive capital, like doing a deal with Big Pharma or doing a venture debt transaction. Just as an example, we recently had a public biotech company come to us and ask us for some financing that would extend their runway about two quarters, but it's two quarters out in 2024, the last quarter of 2024, and the first quarter 2025. So they're looking forward, the public markets have tightened this company, had an ATM in place most biotech public biotechs do. They didn't want to draw on that right now, because their price was obviously being impacted by tightened market. So we do expect to see opportunity in that marketplace relative to a tightening equity market.

Sarkis, this is Dan Trolio. On your second part of the question related to the capacity. We'll continue to look at deploying our debt to grow into our target leverage of 1.2 times and do that in the combination of cash and a balance sheet, the capacity and availability we have on our facilities and continually opportunistically raising equity through the quarter.

Right, that makes sense. And also a follow up, if I may. Looking at kind of the onboarding yields it's fairly consistent quarter-on-quarter. And then when we factor in some of the incremental yield on the prepays or the fees, or the accelerated income, I think you guys are topping out at 16%. Is that the correct level to expect into fiscal ‘22 considering kind of the interest rate, backdrop and talks of obviously rates increasing, etc.?

I think if you look historically at prepayments for Horizon, generally speaking, they've always been lower in the first quarter and then they grow over time and especially in the fourth quarter, and we had a lot of prepayments in the fourth quarter this year too. So I really think you have to kind of least we do pay attention to that kind of activity. As we've always said, it's a little bit more difficult to predict prepayments. But if you look historically at how that has worked for us, the first quarter has generally been at a relatively, comparatively lower prepayment activity in the first quarter as companies are still figuring out their financing plans, still getting board approval on getting financings done or M&A transactions closed or IPOs or whatever. So it's generally speaking, not an even thing, but over the course of the year yes, we will expect our portfolio to yield somewhere between 14% and 16%. I think that's been a pretty again, if you go back and historically look at the portfolio, especially if you do it on a quarter-on-quarter basis is that just an annual basis you'll see that we've been pretty consistent in that in that regard that has to do with how we priced transactions not just on the onboarding yield, but our expectation of exits, based on the specific footings of a company that we're financing and we have a lot of data on that. So that allows us to try to maximize the pricing when we can anticipate there will be an exit from a transaction.

Thank you. That's very helpful. I'm going to hop back in the queue.

Thank you. [Operator Instructions] Our next question comes from the line of Ryan Lynch with KBW. Please proceed with your question.

Hey, good morning. Thanks for taking my questions. I kind of worry about the follow up on the discussion regarding just the pullback and valuations and kind of the high growth areas of the market, which is where you guys participate in. It sounds like given the pullback, maybe there are some new opportunities that you guys are seeing as venture debt becomes maybe a more attractive source or more available source of capital for some of these businesses. But I'm just wondering, on balance that sounds like that's maybe a positive aspect of it. I was wondering on balance you have the other side of it, and the companies needing to raise additional capital, that you guys currently have a good portfolio and so does it making it more difficult for them to go out and fundraise at appropriate valuations as well as you guys don't have equity in warrant book pressure on valuation probably doesn't go well for that. So just love to hear kind of your -- kind of full circle discussion on how you guys are viewing kind of a pullback in valuations impacting your business, both on the pros and cons side?

Ryan, it's Jerry. So I think you got it right. Your comment on balance is probably correct. It definitely creates more opportunity, as companies look for other ways to provide liquidity for their growth, outside of raising equity. So that is something that is a very positive aspect of our business. However, we can't ignore the fact that that one of the reasons they're coming to us is they don't want to or can't, more importantly, in some instances, raise equity. And so you do have to balance how you're looking, how we are looking at the market going forward relative to equity. And I think one of the positive things coming into 2022 valuations are down. There is no question about it. But VC funds are actually up. The amount of liquidity that VC funds have to support their existing portfolio companies and invest in new opportunities is higher than has historically ever been. So there is liquidity available to these companies. They are going to have to be realistic about valuation. It is going to create some opportunity for us. We also what inevitably happens is there is some valuations tighten especially when markets tighten, public markets tighten VC firms start looking at their portfolio companies and kind of start ranking them. It's inevitable just to kind of a human thing that they do. And so we want to make sure that all of the portfolio -- all of our portfolio companies, that the -- investors are still strongly supportive of those companies and obviously, every time we're looking at a new transaction in this kind of market, we do a pretty deep dive not that we don't otherwise but do a much deeper dive on who the investors are, how much capital they have, and how much they have reserved for the transaction that we're looking at. And so it's on balance a positive thing. It will create certainly more opportunity for us. But our experience tells us that there has to be a level of caution and moving forward as well.

Okay, that's helpful, kind of open discussion on that. One-one quick question I had was you can talk about Q1 being kind of a seasonally slow quarter for prepayments. Is that going to even be kind of magnified just given the discussion that we just had with some companies at valuations of pullback probably looking to hold on capital for longer until maybe hopefully evaluations recover? So even though there is seasonal slowness and the Q1 prepayment use that that can be magnified even more given the market dynamics?

Yes. Ryan it's always hard [to project some] prepayments, but what we do we feel currently today is that prepayments will probably come back to our historical norm, 2020 and 2021 were high level prepayments in comparison to the balance sheet. As Jerry mentioned the first quarter, we have $12 million today. And if you go back and look at specifically 2020, and also '19 and '18, where we had very similar prepayments in the first quarter what NII was produced during those periods, but overall throughout the year, we're very positive NII income producing years. And so as we say venture debt portfolio prepayments always part of the picture, it's just the timing of it, it's hard to predict.

Ryan, this is Rob. I'd add as it relates to magnifying the normal seasonality that Dan and Jerry just spoke to that when you have all the markets like we have right now M&A and other methods that produce the exits and prepays are tempered until the markets stabilized. So that's our outlook for Q1 but we remain the fundamental underlying predictive pricing strategy should produce results over time, just not on a quarter by quarter basis.

Yes. Understood. I appreciate the time today.

Thank you.

Thanks Ryan.

Thank you. Ladies and gentlemen, our next question is a follow up from the line of Sarkis Sherbetchyan with B.Riley Securities. Please proceed with your question.

Hi, thank you for taking the follow up here. Just two more for me. If you can please provide us an update or some sort of a refreshed outlook for credit quality and loan to value ratios here in fiscal ‘22. And I have one more as a follow up.

So the fundamental underwriting strategy continues. Sarkis this is Rob. We continue to underwrite to low loan to values going in and we try to make sure that we are managing our portfolio companies to maintain that. What's the second part of your question was? No fundamental difference in the way we look at these although, as Jerry and Dan have noted, we are being cautious about the macro environment, the impact of inflation, the impact of supply chain, all of those things on the capacity of our companies to service the debt.

Yes. Got you. I guess what I was trying to also tease out was if there were anything that Horizon is especially mindful of in underwriting credit in today's environment versus kind of your historical norm. That's what I was trying to tease out. Thank you.

Okay. Yes. So those are the things we're looking at. Impact on supply chain inflation global, we do not have any direct exposure to Eastern Europe kind of investments or anything that would be directly impacting our portfolio.

Great, thank you. That's all for me.

Thank you. Ladies and gentlemen, this concludes our question and answer session. I'll turn the floor back to Mr. Pomeroyfor any final comments.

We want to 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 concludes our call.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.