Horizon Technology Finance (HRZN) Q2 2021 Earnings Call Transcript

Horizon Technology Finance (HRZN 1.65%)
Q2 2021 Earnings Call
Jul 28, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to Horizon Technology Finance Corporation's second-quarter 2021 earnings conference call. [Operator instructions] 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.

Megan Bacon -- Director of Investor Relations and Marketing

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 Trolio, 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.

Rob Pomeroy -- Chairman and Chief Executive Officer

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 year with a record committed backlog of $144 million.

We generated net investment income of $0.31 per share in excess of our distribution level for the quarter. Based on our outlook and our undistributed spillover income of $0.34 per share as of June 30, we declared monthly distributions through December, which marks 60 consecutive months at $0.10 per share. We achieved another industry-leading portfolio yield on our debt investments of 14.7%. We kept our portfolio credit profile stable and into the quarter once again with no one-rated loans and no loans on nonaccrual.

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 $0.13 per share increase from March 31. 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 advisor's 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 Devorsetz 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.

Jerry Michaud -- President

Thanks, Rob, and good morning to everyone. We continued 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 disciplined focus on pricing transactions that we believe will provide strong NII enhanced by our predictive pricing strategy.

We experienced four 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 30, 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 Q2 , 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 maintained strong credit quality in our portfolio with another quarter of no loans on nonaccrual 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. This 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 Horizon. 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 the industries such as ag tech, fintech, space, mobility, med tech, healthcare tech and drug development now 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 advisors 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.

Dan Trolio -- Chief Financial Officer

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 6.25% notes. Additionally, through our ATM program, we successfully and accretively sold 361,000 shares, opportunistically raising nearly $6 million.

As of June 30, Horizon had $83 million in available liquidity consisting of $40 million in cash and $43 million of funds available to be drawn under our existing credit facilities. As of June 30, 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 22, 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 1-1 as of June 30, which was lower than our target leverage of 1.2-1. Based on our cash position and our borrowing capacity and our revolving credit facilities, our potential new investment capacity on June 30 was $199 million. As we go toward our target leverage of 1.2x, we would expect that our NII will also increase.

In 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 30, a 7% increase from March 31, 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 lighter 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 30 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 to $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 in 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 30 was $11.20 per share, compared to $11.07 as of March 31, 2021, and $11.64 as of June 30, 2020. The $0.13 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 30, 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.

Questions & Answers:

Operator

[Operator instructions]Our first question comes from Sarkis Sherbetchyan with B. Riley Securities. Please proceed with your question.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Good morning everyone, and thank you for taking my question here. 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 1x, I 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.

Dan Trolio -- Chief Financial Officer

Yeah. Thanks for the question. Yeah, you're correct. The capacity today is close to $200 million.

And being at 1-1, we're focused on getting to the 1.2-1. 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 will determine how we get to the 1.2 between leverage and drawing equity on the ATM.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

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

Jerry Michaud -- President

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. We've had -- 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 discussion. 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, improved backlog and new opportunities, we still think there'll be plenty of room to grow the portfolio during the second half of the year.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Got it. So just to recap that thought process, right? Prepayments still elevated, do you think it's going to look more so for your specific outlook here in the second half, but you have more than enough room to net-net grow the portfolio. Is that the right summary?

Jerry Michaud -- President

I think that's correct.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

OK. Good. And then just want to touch a little bit more on the underwritten yields. It sounded like in your prepared remarks, they were up quarter on quarter.

Is -- was that right? And then, what's driving that? What's the biggest driver of the on-boarding yields going up?

Jerry Michaud -- President

Yeah. So really, it -- on a quarter-to-quarter basis, it's not really -- we don't really look at significant changes in on-boarding yields because it could be one transaction that kind of skews that number. What I can tell you is that as even though there was 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 were 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 the companies are doing when they're figuring out how to get additional liquidity into the company. So I think overall, I think our response to that would be yields have held up pretty well, and we expect to see that to continue again during the second half of the year.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

OK. 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.

Jerry Michaud -- President

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

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

OK. Fantastic. I'm going to hop on the queue. Thank you so much for answering the questions.

Operator

[Operator instructions]Our next question comes from Ryan Lynch with KBW. Please proceed with your question.

Ryan Lynch -- KBW -- Analyst

Good morning, guys. 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 you to give any more color on that. I know sometimes companies will be downgraded as they start to run closer to a fundraising cycle or a capital raise cycle that's taking longer.

Is that what's going on at these companies? Or is there something fundamentally deteriorating at those to cause those downgrades?

Rob Pomeroy -- Chairman and Chief Executive Officer

Yeah. Ryan, this is Rob. So the -- your former description is where these companies are. They are in fundraising or trying to transact the 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 progression in the second half. But because of our experience, we felt it was appropriate to put them in the two bucket.

Ryan Lynch -- KBW -- Analyst

OK. Understood. That's helpful. Your platform has grown pretty meaningfully over the last year or so with both the on-balance sheet growth, as well as the additional fund raised outside of the BDC.

Now that you guys are deploying capital and that fund is contributing to that capital deployment 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 powder kind of across the platform?

Jerry Michaud -- President

This is Jerry. So about two years ago, we identified -- went out to the market did a significant due diligence on research effort, to identify the markets where we believe 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 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 that and large funds that are investing in those sectors, and they're relying on Horizon for providing debt to these companies. So it has been a very -- 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, as Dan has talked about position, but also in terms of our bench strength within the advisors. So that's where that growth is coming from. That's where it will continue to come from.

Ryan Lynch -- KBW -- Analyst

OK. Makes sense. And then as far as 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 is -- has been really resistant during COVID and showing a lot of strength, as you mentioned, some of the fundraising numbers today. And you also talked about the venture, 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 risk that you guys are looking at today as you guys look to deploy capital in this market, what kind of worries you've? And it keeps you guys looking around the quarter for?

Jerry Michaud -- President

OK. 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 are quite focused on and continue to look at and follow.

Obviously, the new delta variants 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'd probably see -- 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 over in our own market and talking to VCs, there are some supply problems, which is the No. 3 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, on -- we're looking at new opportunities right now. Those are things that we are also taking into consideration.

Ryan Lynch -- KBW -- Analyst

OK. Understood. Those were all my questions. I appreciate the time this morning. 

Jerry Michaud -- President

Thanks, Ryan.

Operator

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

Rob Pomeroy -- Chairman and Chief Executive Officer

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.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Megan Bacon -- Director of Investor Relations and Marketing

Rob Pomeroy -- Chairman and Chief Executive Officer

Jerry Michaud -- President

Dan Trolio -- Chief Financial Officer

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Ryan Lynch -- KBW -- Analyst

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