Horizon Technology Finance Corp (HRZN) 2011 Q4 法說會逐字稿

Good morning and welcome to Horizon Technology Finance's fourth-quarter 2011 conference call. Today's call is being recorded. All lines have been placed on mute. We will conduct a question-and-answer session after the opening remarks. Instructions will follow at that time. I would now like to turn the call over to Nick Rust of the IGB Group for introductions and the reading of the Safe Harbor statement. Please go ahead, sir.

Thank you and welcome to the Horizon Technology Finance fourth-quarter 2011 conference call. Representing the Company today are Rob Pomeroy, Chairman and Chief Executive Officer; Gerry Michaud, President; and Chris Mathieu, Chief Financial Officer.

Before we begin, I would like to point out that the Q4 press release is available on the Company's website at www.horizontechnologyfinancecorp.com.

Now I will read the following Safe Harbor statement. 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, 2010. 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 and thank you all for joining us. During today's call, I will discuss our fourth-quarter and full-year 2011 performance highlights. Gerry will then provide a market overview. After that, Chris will review our financial results, as well as our investment portfolio. Chris, Gerry and I will then be happy to take your questions.

We are very pleased to report our results for the fourth quarter and our first full year as a public company. We achieved significant success in the execution of our investment strategy. By maintaining a disciplined approach and deploying a total of more than $106 million in high-yielding assets within our core markets, preserving the strong credit quality of our portfolio and realizing substantial warrant gains, Horizon has further strengthened its leading franchise in the venture lending industry and posted solid financial results.

Highlighting our performance for the fourth quarter and full year, we ended 2011 with an investment portfolio of $178 million, an increase of over 30% compared to the end of 2010. Net investment income was $3.3 million, or $0.44 per share for the fourth quarter and $10.5 million, or $1.38 per share for the full year. We recorded net realized gains on investments of $800,000, or $0.10 per share in the fourth quarter bringing our total for the full year to $6.3 million, or $0.83 per share. At December 31, our net asset value per share was $17.01 and our portfolio yield was 14.3% for the fourth quarter and 14.6% for the full year.

These strong results were achieved by executing on all of the main drivers in our business. During the fourth quarter, we maintained our discipline on strong current pay interest rates while deploying new loans of $20 million, maintained our industry-leading credit quality with no loans on non-accrual, earned additional fee income from the prepayment of one loan and realized warrant gain income from the sale of one of our portfolio companies.

Yesterday, we announced our fifth consecutive quarterly dividend since going public. For the second quarter in a row, we will pay a dividend of $0.45 per share, bringing our cumulative dividend to $1.85 per share. Our dividend is substantially covered by our net investment income. Horizon is in a unique position of having net realized gains since going public. Our Board of Directors has elected to use a portion of the cumulative realized gains to augment our NII in the quarterly dividend. With the payment of this upcoming dividend on March 30, there remains $0.64 in undistributed realized gains. Our fourth-quarter dividend represents an annualized yield of 11% as of yesterday's closing stock price of $16.40 per share and an annualized yield of approximately 10.6% based on our year-end net asset value of $17.01 per share.

I would now like to turn your attention to our liquidity. During the fourth quarter, we continued to utilize our Wells Fargo credit facility, which currently provides a commitment of $75 million of leverage for loan investments. In addition, we continue to benefit from the remaining balance under the WestLB facility as it amortizes. During the fourth quarter, our debt to equity ratio decreased from 0.6 to 1 to 0.5 to 1 as the WestLB balance declined. Horizon has room under the BDC asset coverage ratio for additional leverage and we will look to utilize both existing and future leverage to increase its earnings portfolio.

At December 31, 2011, we had cash resources, credit availability and cash flow from the existing portfolio to fund new opportunities. Gerry will speak in a moment about the market, but we are encouraged by the quantity and quality of the opportunities available to us. Our challenge is to increase our capacity to match those opportunities.

We continue to explore a wide range of initiatives aimed at increasing our liquidity in a manner that best serves the Company and its shareholders. Consistent with this important objective, we filed a shelf registration statement on Form N-2, which was declared effective by the SEC on February 6, 2012. This filing positions Horizon to issue debt and equity securities in one or more public offerings from time to time, providing optimal flexibility in accessing the capital markets in order to take advantage of financing opportunities when and if market conditions are favorable.

As we maintain our focus on deploying our existing capital efficiently and profitably, our overall portfolio quality remains strong. During the fourth quarter, the weighted average credit rating for our loan portfolio was 3.1 where 3 is the standard credit on a four-point scale. Our portfolio has a mix of 4, 3 and 2-rated credits. The current portfolio has a slight increase in 2-rated credits, but is still well within the normal operating range. We have no 1-rated credits and no loans on non-accrual as of December 31. We believe management's strong track record over the past 20 years in generating compelling risk-adjusted returns from high-yielding loans and warrant gains bodes well for Horizon in 2012 and beyond.

Going forward, we remain committed to taking advantage of select investment opportunities that meet our strict underwriting and return criteria, capitalizing on our leadership position in the venture lending market, growing our franchise and expanding our future earnings. I will now turn the call over to Gerry to provide an overview of the markets we serve.

Thank you, Rob and good morning, everyone. Before I discuss our fourth-quarter marketing activity, I would like to make a couple of comments about 2011. First, as we look back at our gross fundings of $106 million for the year, I believe we were extremely efficient at converting the cash from our IPO proceeds into high-quality earning assets and using our Wells Fargo credit facility prudently to augment our portfolio of growth of over 30% for the year.

Second, we were extremely pleased with the number of positive portfolio warrant gains we had during the year. We had five portfolio companies contribute over $6 million in realized gains during 2011. In addition, we presently have three of our portfolio companies in registration -- Supernus, a drug discovery company in our life science portfolio;, Impinj, an RFID tracking device company in our technology portfolio; and Enphase Energy, a solar panel micro inverter technology company in our cleantech portfolio.

We believe when you combine the 30% growth in our loan portfolio with the significant realized gains from our portfolio of warrants that 2011 represented an affirmation of our long-term investment strategy of providing value added loan products to our core technology markets in return for high current yields and real upside potential from warrants. We expect to build on this success during 2012 as our liquidity position improves and we are able to more fully utilize our experienced loan origination group.

Turning to our fourth-quarter marketing activity, we funded seven transactions totaling $7 million in the fourth quarter compared to three transactions totaling $7 million in the third quarter. We finished the fourth quarter with approximately $22 million in committed backlog compared to $19 million at the end of the third quarter.

The significant increase in fundings and committed backlog in the fourth quarter is really just a function of having our credit facility in place with Wells Fargo and allowing our experienced origination group to begin to ramp up marketing activity during the quarter.

Looking at our target markets, we were pretty much spot on regarding our prediction early in 2011 that market activity across all of our market sectors would grow during 2011. Venture capital investment of $33 billion in 2011 represented a 10% increase over the $30 billion invested in 2010.

More importantly, we have seen a significant increase in investment in early to mid-stage companies, which has provided a significant uptick of new financing opportunities for Horizon. Historically, early to mid-stage companies have been our investment sweet spot for the last 10 years and we are beginning to see a lot more pipeline activity in this area, which should bode well for Horizon in 2012.

We were also able to maintain our portfolio of yields in the fourth quarter despite an increase in competitive pressure during the quarter. We expect competition to continue to put pressure on pricing in 2012. We will be monitoring our pipeline activity closely over the coming quarters to ensure we maintain a high quality and well-priced venture debt portfolio. With that, let me now turn the call over to Chris Mathieu, our Chief Financial Officer.

Thanks, Gerry. I would like to turn your attention now to our financial results. Our consolidated financial results for the three months and year ended December 31, 2011 have been presented in our earnings release distributed after the market closed yesterday. We expect to file our Annual Report on Form 10-K with the SEC later today. Horizon posted another strong quarter as our total investment income for the fourth quarter of 2011 increased 24% to $6.2 million compared to $5 million for the quarter ended December 2010. This increase is primarily due to higher interest income on our portfolio from the increased average size of our total loan portfolio. Substantially all investment income for the quarter ended December 2011 was earned from interest income from our loans.

Included in this quarterly investment income amount is approximately $200,000 of fees earned in connection with the loan prepayment of one of our portfolio companies. We continue to believe that loan prepayments are a natural and healthy part of our portfolio lifecycle that further enhances Horizon's liquidity and overall returns to our shareholders.

For the year ended December 31, 2011, total investment income was $24.1 million as compared to $18.2 million in the prior year, an increase of 32%. Excluding warrant gains, our average portfolio yield was 14.3% for the fourth quarter and 14.6% for the full year ended December 2011. This compares to 14.6% for the prior year.

The Company's total expenses were $2.7 million for the quarter ended December 2011 compared to $2.5 million for the quarter ended December 2010. Total expenses for the year ended December 2011 were $13.3 million compared to $7.8 million for the prior year. Total expenses consisted of interest expense, management, administrative and incentive fees, and other third-party costs such as professional fees and G&A expenses. Incentive fees in this period were reduced by the reversal of previously accrued part two incentive fees totaling approximately $380,000, or $0.05 per share, due to the increase in unrealized depreciation on investments.

Third-party costs increased quarter-over-quarter and quarter-over-quarter due to the costs associated with operating as a public company since October of 2010. The fourth-quarter expenses for administrative fees, professional fees, and G&A expenses are now more representative of our normalized costs as a public company. The Company earned net investment income of $0.44 per share, or $3.3 million for the quarter ended December 2011, as compared to $2.5 million for the quarter ended 2010. Net investment income was $10.5 million for the year ended December 2011 and $10.4 million for the prior year.

During the fourth quarter, we recognized a net realized gain from the sale of Concentric Medical, one of our portfolio companies. In connection with the sale of Concentric in October, we realized approximately $0.10 per share in gains, or $800,000 and an additional $200,000 in prepayment fees as our $7 million loan was repaid in connection with the Company's sale. Concentric increases our total to five portfolio company warrant positions that have resulted in realized gains for Horizon in 2011. As a result of these gains, we recorded net gains on investments of $6.3 million, or $0.83 per share during 2011. Heading into 2012, we hold warrant positions in an additional 47 portfolio companies.

For the three months ended December 31, 2011, the net unrealized depreciation on investments was $3.2 million and $5.7 million for the full year 2011. In 2010, we reported net unrealized appreciation on investments of $1.4 million in the fourth quarter and $2.9 million for the full year. For the full year of 2011, the net unrealized depreciation on investments was primarily due to the reversal of $4 million in unrealized depreciation following the sale of warrants in five portfolio companies and $2.7 million of unrealized depreciation on six debt investments, each partially offset by unrealized appreciation on investments the Company still holds.

As of December 31, 2011, our net asset value was $17.01 per share, or $130 million. For the three months ended December 31, 2011, the net increase in net assets from operations was $800,000, or $0.10 a share and $11 million, or $1.44 per share for the full year 2011.

We began 2011 with an investment portfolio of $137 million. Net new loan investments during the year totaled $98 million while we recorded $35 million in normal contractual loan payments, $17 million in loan prepayments and $5 million of other ordinary adjustments to activities within the portfolio all leading to an ending investment portfolio of $178 million as of December 31.

Our investment portfolio at year-end was comprised of 38 secured loans with an aggregate fair value of $173 million and 47 warrant and equity positions with an aggregate fair value of about $5 million. As of December 31, we had cash and investments in money market funds totaling $14.8 million.

Our two existing credit facilities provide the Company with cost-effective leverage and have provided a meaningful positive impact on earnings. As of year-end, our Wells Fargo credit facility had a total of $18 million outstanding and a total of $47 million was outstanding on our WestLB credit facility. Our current level of leverage is approximately 0.5 to 1 or said another way, our asset coverage is approximately 300%, well within the limits established by the BDC market. We are comfortable with our current level of debt and will continue to leverage to further improve earnings for the Company and our shareholders. Now I would like to turn your attention back to Rob.

Thank you, Chris. We are pleased with our performance throughout 2011 and remain excited about our future prospects. The application of our unique business model has produced consistently strong returns and enabled Horizon to build a leading industry brand with a mature high-quality portfolio of venture loans yielding between 11% and 14%. Combined with the opportunity to benefit from further upside via warrants, we are well-positioned to continue to provide attractive dividends and drive long-term shareholder value.

Before we open the floor for questions, I would like to note that we planned to hold our next quarterly conference call during the week of May 7. At that time, we also expect to announce our dividend for the first quarter. I would like to thank everyone again for joining us on today's call and for following the Horizon story. We would be happy to take questions you may have at this time.

(Operator Instructions). Greg Mason, Stifel Nicolaus.

Great, good morning, gentlemen. Can you talk a little bit about your target leverage as it has been declining a little bit over the past few quarters from call it 0.7 to today 0.5? What is your target leverage and do you anticipate that going back up?

Sure, you are right. We have deleveraged the balance sheet a little bit. That is primarily a function of the WestLB facility where we had more than 1 to 1 leverage built into the facility. So probably a more modeled number would be more like 0.7, 0.75 would be the kind of area where we would try to target to.

Okay, great. And then as we continue to think about that WestLB wind-down, it looks like it has kind of been winding down between $10 million to $20 million per quarter. Should we expect that pace to continue or was some low hanging fruit kind of refied quickly out of that? What should we think about that pace of that wind-down going forward?

At the IPO, we had mentioned that we expected about 18 months before that came to a point of a low enough balance that we would just clean up the facility. It is pretty much on that track right now. That facility has a structure where, when a company pays its normal contractual payments or prepays, we just do a borrowing base and get back in formula. So a lot of the pace of repayment is dictated by the pace of prepayments and we did experience a number of those over the past year and so we do expect that to continue. It looks like it has been maybe one or two prepayments on a quarterly basis.

Great. And then my last question, can you talk a little bit about what looks to be some portfolio decline this quarter of about $2.5 million? I know in your prepared comments, you said you had a slight uptick in 2-rated credits. Could you just talk to us about, if you can, some specific names or what you are seeing in the 2-rated credits in your portfolio?

This is Rob, Greg. Yes, we have actually -- we have quite a mix of 2s, 3s and 4s. I think we enjoyed an unusually low percentage of 2s sort of during 2011 where about 13%, 14% of the portfolio is 2-rated. This is very normal operating range for us. So although it has increased from its low point at the end of 2010 where I think we were down to about 5%, this is not at all an uncomfortable position for us to be in. Normal course.

And can you talk about -- you have no 1-rated credits. What is kind of the typical, if you call it, normal run rate for having 1-rated credits and do you have any fears that some of those 2s will move into the 1 category?

Well, again, some loan losses or restructures or difficulties are part of the venture lending model. We have enjoyed extraordinary success in this portfolio since March of 2008 with no loans going on non-accrual or 1-rated credits. Fair warning to everybody, it is going to happen eventually. We don't see anything in the near-term future, but the possibility exists that this could happen. Remember, 2-rated credit is along where we believe we are going to get all of our principal back, although the Company is performing at the high end or below plan and is experiencing some stress in their operations.

Okay, great. Thank you, guys.

(Operator Instructions). Robert Dodd, Morgan, Keegan.

Thank you. Good morning, guys. If I could just go back to one of your comments, I think Gerry said during the prepared comments in terms of competition increasing and should continue to increase. Can you give us any color on what's the source of that right now? I mean is it banks getting in, hedge funds? I mean I wouldn't think so. Or is it just cash from the private equity guys that are more aggressive on what pricing they are asking for?

Yes, good question. A couple of things. First of all, in the fourth quarter, I think that some of our competitors really wanted to get some of their cash deployed before the end of the year. That is not abnormal at all and it was the normal competitors. There were no new additions relative to competition that came in and had any real impact on pricing. But just from normal competition end of the quarter, end of the year, especially on the life science side, we saw some compression in rates relative to some of the transactions that got done.

We do expect that, first of all, 2012 is going to be a good year from a venture lending standpoint. In other words, activity looks fairly strong right now, certainly here in the first quarter and in talking to the venture capital community, they are very much outward looking and there is a lot of good things going on in the technology sectors.

Our existing competitors, the people that we compete with, have been competing with are pretty well-funded right now, so we expect to see continued competition from them. There has been a couple -- there's at least one new entrant into the venture lending business, hasn't had an impact yet, but a company called NXT acquired a group and so we will see what kind of impact that has. We have not run into them yet in the marketplace. But I just think it is going to be more in just the normal course with well-funded competitors competing in the market.

I would say on the life science side, there is kind of a new product in the market, synthetic royalty transactions. They are really not a direct competitor to what we do. They are actually kind of the next step after kind of the venture lending facility for a life science company, but there is a lot of capital that has been raised in that sector and if they do decide to come down market a little bit, it will probably put a little more competition in the marketplace relative to life science deals. That is about it.

Okay, thank you. Very helpful. And then Christopher, you mentioned that you are at a run rate of expenses now -- I mean if we look at the last couple of quarters, I mean particularly professional fees have been very volatile. I mean should we expect expenses from Q4 levels to grow more in line with assets now or can you give us any color on that?

Yes, I think what we were trying to describe is that now that we have kind of gone through a full year, each quarter, we seem to have something unique whether it was in the professional fees or G&A. I think we are now -- now that we have kind of completed a full year, I think the fourth-quarter numbers are representative of our numbers for our size of business. And even as we grow a bit, those are really -- those numbers are scalable. Meaning there is room for growth without increasing those numbers.

Great, thank you.

Robert Brock, West Family Investments.

Good morning, guys. Just a question with regard to the equity warrants. I think you had them valued as $4.1 million at the end of the year. Could you just talk about what the composition of the warrants are, how you basically value them, what kind of unrealized value there might be and are any of the stocks in registration, that they are going to be monetized in the near future?

Sure. We use a Black-Scholes model to value all of our warrants. We do that at the inception of the loan and the warrant that we receive at the time of the loan origination and then we mark those warrants each quarter in connection with our public information. So you are right. It is about $4 million, $4.1 million and it is a broad group among all of our portfolio companies.

In addition, it includes a handful of about a dozen transactions where we don't have any credit risk anymore and we just hold onto the warrant for potential upside. There are three transactions that are currently in registration and without regard to what the kind of noise is on the market for those transactions, we continue to use Black-Scholes modeling for those valuations.

Might there be embedded value in those warrants at this point if the deals get done or you basically mark them only on Black-Scholes you said then?

Yes, so the answer is it could be. We don't know. We stick with our fundamental valuation policy. We would mark to market in a subsequent period if the company did go public and instead of using the embedded enterprise value of the private company, we would use the public stock price of the company if they did go public. So you could see movement in the valuations on those companies going forward.

Great, thank you.

Casey Alexander, Gilford Securities.

Hi, good morning. To follow up on Robert's question, can you give us a little color on the warrant position that was harvested during the quarter and sort of what the discipline was that led you to go ahead and harvest that warrant gain?

There is really two ways that we harvest warrants. One is through M&A and we don't really have an option. We just take the liquidity event and that is what happened with Concentric. The Company was acquired, we computed the value of the warrant, exercised it at the closing and took the cash.

The other is in the case of a transaction that is either public when we do the deal or becomes a public company after and then there will be opportunities along the valuation curve to harvest the warrant and realize gains from that underlying security. And we use -- basically from the initial underwriting the transaction, our portfolio managers monitor the progress of the companies and their valuation in line with how we originally underwrite it and subsequently value the company and make a decision at that point from time to time whether we should sell or hold.

Okay, great. Thank you.

Jonathan Bock, Wells Fargo.

Yes, thank you. Gerry, just a quick -- a few more follow-ups on the venture marketplace. First, could you tell us what the yields were on the new investments transacted in the quarter versus what was coming off? And then the second point is we have heard that there is the potential for 100 bps to perhaps 200 basis points of spread compression on venture assets as you mentioned competition increases. And I want to know, does that line up with your expectation?

Relative to the first question, we were actually able to maintain our yields in the fourth quarter relative -- very closely to what was coming off and what was going on. So we really didn't see a whole lot of price compression, but we were aware of a number of transactions that did get done in the marketplace that would have been below where we have normally seen deals get done. So that is relative to what happened in the fourth quarter.

The answer to the second part of your question is no, we actually don't expect to see that 100 to 200 basis point compression in yields. It might have a lot to do though with where we kind of play in the market versus some of our competitors. We are, as I had mentioned actually I think early in my statement -- our kind of sweet spot is really early to mid-stage companies and we have -- it is a little bit more of a diverse approach across technology, cleantech, life science, healthcare and information services and also first and second lien deals.

And when you use that kind of a model, generally speaking, you can maintain across on a portfolio basis. You can still maintain pretty good yields by -- I think the really good thing in our market today, which was true in 2011, is customers are still looking for value. If you were providing a value product, they are certainly willing to pay for that. And 50 to 100 basis points isn't going to make a big difference to them on a comparative basis to the value you are providing relative to providing additional liquidity to their companies.

And so that is where we really focus our attention on trying to provide that additional value and get compensated for it. And I think that we will continue to be able to do that in 2012. I would say that we could see some compression, but not in the 100 to 200 basis points range.

Okay, all right. Thanks, Gerry. And now, Rob, on the equity or debt capital raise front, I know you mentioned you filed a shelf. Can you give us a little bit more granularity in perhaps some of the options that might work for you in this current environment to raise capital?

So as we said, as I said in my prepared comments, we are looking at all of the options in the market. We have seen a couple of the senior note offerings that -- or the unsecured note offerings that have been gone, so we are interested in that market on the leverage side. We are always in dialogue with other banks and lenders for increasing the capacity of our credit facilities. Although we think they are pretty well-scaled right now for our current pace.

We do not have the below NAV vote as you are all aware, so we will be looking for hopefully the markets to reward our performance with a stock price relative to our NAV that would allow us to access in the right size equity markets if the markets allow us to. So those are the kinds of things that we are looking at doing today.

Okay, great. And I know you mentioned earlier kind of all-in liquidity and you talked about Wells and $75 million. I understand that that is your stated capacity. I just want to know, under your borrowing base constraints, are you still able to access that entire amount of $75 million on the Wells facility?

To the extent that we have qualified assets that fit into the facility?

Yes.

We can, yes.

Okay. And then the last question, Chris, this is just a small one. I apologize if I missed it, but the prepayment fee I believe that came in this quarter, what was that as a dollar amount impact on a per-share basis?

It was $200,000.

Okay. Okay, guys. Thank you so much.

John Hecht, JMP Securities.

Thanks, very much for taking my questions. A little bit of follow-up to Jonathan's questions before. Has there been any pricing pressure on either capital structuring fees or prepayment fees as a result of some of the competition you have referred to?

Not really. I mean I think we have pretty sophisticated borrowers in our marketplace and they look at the totality of the offering that you are giving them relative to the financing that they need. And I will say that every company is a little bit different at how they look at various price points in the overall offering. But essentially what they are -- again, to go back to what I said before, what essentially they are looking for is how much value are you providing them because they can create a substantial amount of value off the capital that we are providing on a comparative basis to equity they raise and so they are looking for how much value can they create off the financing you are giving them compared to the cost that they are going to pay for that.

And the cost is really incremental to the value that they can create. If you are providing them with a high-quality product that really is going to extend their liquidity, give them the longer runways and things like that, those are the value added things that they are looking at. They will -- of course, they'll use the competitive marketplace to try to get the best deal, but, at the end of the day, it is really taking kind of the whole look at a term sheet and figuring out if the value is really there for your price point.

Great, thank you guys very much.

At this time, there are no more questions. This concludes Horizon Technology Finance Corporation's conference call. Thank you and have a nice day.