Horizon Technology Finance Corp (HRZN) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Horizon Technology Finance's Second Quarter 2017 Conference Call. Today's call is being recorded. (Operator Instructions)

I would now like to turn the call over to Ms. Megan Bacon of Horizon for introductions and the reading of the safe harbor statement. Please go ahead, ma'am.

Thank you, and welcome to the Horizon Technology Finance Second Quarter 2017 Conference Call. Representing the company today are Rob Pomeroy, Chairman and Chief Executive Officer; Jerry Michaud, President; and Dan Trolio, Chief Financial Officer.

Before we begin, 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.

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, 2016.

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. In the second quarter, we continued to see strong investment activity as we are now seeing the benefits from our efforts over the previous 3 quarters to expand and improve Horizon's lending platform. These efforts were made with very specific goals: to grow our portfolio with quality transactions; maintain our profitability; and to stabilize and improve the overall credit quality of our portfolio. Since last December, we have substantially enhanced our capabilities, including the hiring of several professionals. Most recently, we added Todd McDonald as Managing Director for the Mid-Atlantic and Southeast technology markets. Further, we have added additional talent in key areas such as portfolio management, business development, accounting and finance.

In the second quarter, we funded new loans at a level that maintained our portfolio size, while we experienced profitable prepayments and normal amortization. Importantly, we also increased our backlog, finishing the quarter with a committed backlog of $45 million. Jerry will provide details of our origination efforts later in this call.

During the second quarter, we also continued to see the advantage of our seasoned portfolio with liquidity events from 4 portfolio companies, including $12.3 million in loan prepayments and realized gains from the exercise and sale of warrants. Our goal, as always, is to achieve long-term, sustainable portfolio growth without sacrificing quality. This approach has enabled us to consistently achieve strong portfolio yields, including 14.7% for the second quarter, which remains among the highest in the BDC industry. We have ample liquidity to deploy into attractive investments. Currently, we have over $61 million in liquidity, including unrestricted cash and availability under our $95 million revolving credit facility.

As we continue to drive increased investment activity, our focus remains on originating loans to companies in the life science, technology and healthcare technology sectors. We are encouraged by the recent trends in our investment activity. We continue to see increased pipeline activity and improvement in the quality of potential transactions. These factors, coupled with the expanded capabilities of our investment platform and strong liquidity position, give us confidence in our ability to grow our portfolio over the next few quarters.

While the top priority has been to grow originations, we also continue to work on recovering underperforming loans. During the first half of 2017, we have seen a reduction in the level of underperforming and nonaccrual loans from the levels at year-end. At December 31, there were 4 loans on nonaccrual. Since that time, 2 of these loans were settled and 2 remain pending resolution. One new loan, Interleukin, was recently placed on nonaccrual in the second quarter, which I will provide more detail on shortly.

Of the 6 loans rated 2 at year-end, 3 have been repaid in full, including Skyword, which just repaid the outstanding balance of their loan in the third quarter. While we expect a certain degree of fluctuation in our portfolio given the inherent nature of venture lending, this lower level of underperforming loans demonstrates our progress towards stabilizing our overall credit quality. In the quarter, we recorded unrealized appreciation of $2.1 million, which contributed to an NAV of $11.87 per share at quarter-end. The decline in NAV was mostly related to our ScoreBig investment. As we previously discussed, in the fourth quarter of 2016, we obtained the right to receive profit-sharing payments from a long-term license agreement of ScoreBig's intellectual property. Accordingly, we fair valued the investment based upon the initial projections of such payments that would be paid under the long-term license agreement. These initial projections were made shortly after the relaunch of the ScoreBig service. During the most recent quarter, the licensee provided an updated forecast based on actual results. Based upon performance and revised projections, which show profit-sharing payments being paid out over a longer time period than initially projected, we have fair valued the investment at $2.6 million as of June 30.

Notwithstanding, we continue to believe that the license agreement has the long-term potential for full recovery of our investment.

An additional impact to NAV in the quarter resulted from Interleukin, which is pursuing an orderly liquidation of its assets. Early in the quarter, we had been working with the company's equity sponsors to provide financial support as Interleukin pursued a financial -- a clinical services agreement related to its proprietary technology. As time progressed, it became apparent the company would be unable to obtain a clinical services agreement in a suitable time frame. We continue to work with Interleukin's management during the liquidation process to achieve an outcome that generates the greatest value for our shareholders.

For the quarter, our NII was $0.24 per share. Horizon recently declared monthly distributions for October, November and December 2017 totaling $0.30 per share. Since our IPO in 2010, we have declared distributions of $9.92 per share. Our goal remains to provide our shareholders with distributions that are covered by our net investment income over time. We maintain an undistributed spillover of $0.08 per share in support of future distributions.

In summary, we have shown progress with increased originations and growing our investment pipeline, which reflects the steps we have taken to strengthen Horizon's lending platform. We continue to benefit from liquidity events with our portfolio companies. And we have ample liquidity to deploy into attractive investments and remain committed to growing our portfolio with quality investments and providing our shareholders with stable distributions.

Jerry will now update you on our business development efforts and market environment. Dan will then detail our operating results and financial conditions. Jerry?

Thanks, Rob. Good morning, everyone. Greater demand for our venture loan product in our technology, life science and healthcare technology markets, combined with the enhancements in our advisers' origination platform over the last 3 quarters, have contributed to a more robust lending environment for Horizon and improved committed backlog, the largest in the last 21 quarters. In the second quarter, we originated 5 new loans totaling $22 million and closed $44 million in new loan commitments. As a result, we finished the quarter with committed backlog of $45 million as we entered the second half of 2017. From a pricing perspective, we remained disciplined in the second quarter, achieving strong onboarding yields of over 11.6%. We also generated a portfolio yield of 14.7% for the quarter compared to 15.5% in the first quarter. Horizon continues to have one of the highest yielding portfolios in the BDC industry. This is due to our ability to consistently maintain strong onboarding yields since our inception, combined with strategically pricing and structuring transactions with ETPs and prepayment fees to maximize returns received from companies exiting our portfolio. As a result, Horizon has maintained a portfolio yield on our debt investments of over 14% for 8 straight quarters. As Rob mentioned, we continue to see increased pipeline activity and considerable improvement in the quality of the companies we're looking at for potential transactions. This is due to focusing our efforts on originating loans to companies in our target markets, which have low leverage, continued support from their equity sponsors and a plan to use our capital to achieve revenue growth while meet development milestones. In addition to our committed backlog of $45 million at quarter-end, we're presently evaluating over $320 million in new opportunities.

At the end of the second quarter, we held warrant and equity positions in 77 portfolio companies with a fair value of $8.3 million. Complementing our favorable origination activity in the quarter, we experienced positive liquidity events from 4 portfolio companies, which included prepayments of $12.3 million compared to $27 million in the first quarter. We continue to hold warrant positions in 3 of the exited companies. Of note, one of the liquidity events was the result of the successful merger of our portfolio company, ControlScan, with Echosat, a leading provider of payment security, managed firewall and managed network solutions. In connection with this transaction, ControlScan prepaid the outstanding principal balance of its $4.5 million venture loan plus interest, ETP and prepayment fee. Horizon also realized a warrant gain of approximately $300,000.

Subsequent to the end of the second quarter, Horizon has funded 4 new loans totaling $15 million, and we have received 2 prepayments totaling $11 million. One of the portfolio companies that prepaid in the quarter was Strongbridge Biopharma, a transaction we closed in Q4 of 2016. As a result of the early termination, Horizon received prepayment fees, ETPs and earned an IRR of 31%. Horizon continues to hold warrants in Strongbridge.

Now I'll provide some perspective of the general venture capital environment. In the second quarter, U.S. VC investing increased from the second -- increased for the second consecutive quarter, with $18.4 billion in total financing across 1,152 companies, according to MoneyTree. While total venture capital invested was up by 27% quarter-over-quarter, the number of companies receiving capital actually shrank due to strong mega-round activity, which we would define as an equity investment of over $100 million. Overall, VC fundraising was off slightly from 2016 levels, yet it remains healthy, nonetheless. 58 funds closed in the second quarter, adding $11.4 billion of dry powder to the market. With fewer funds raising capital, it is challenging for early-stage companies to raise small VC-led rounds, as VCs need to make larger investments to efficiently deploy larger funds. As a result, early-stage companies are attracting other sources of capital, such as angel funding and strategic funding. VC-backed exit activity continued to decline in the second quarter, with $10.5 billion of value for 156 transactions compared to -- with $17.2 billion of exit value on 211 transactions in the first quarter. The growing pipeline of companies in the registration process suggests a stronger second half of the year for venture-backed IPO activity. Having said that, performance during the second quarter was mixed, notably Cloudera's IPO value being lower than its last private funding round and companies like Blue Apron and Tintri cutting their expected pricing range prior to going public. While we remain optimistic for the long term, we're still seeing VCs having to support portfolio companies longer while M&A valuations remain unattractive. A note of optimism is the exit value per transaction has been steadily increasing since the fourth quarter of 2014, rising from $120 million to $161 million in the second quarter of 2017, according to PitchBook.

Turning to our core markets. In the life science market, we continue to see better and higher quality deal flow in the second quarter. We have begun to see the benefits of our enhanced life science capabilities and expanded team of senior professionals and are optimistic about our prospects in this market. On the healthcare technology side, the second quarter marked perhaps the largest single quarter for digital health funding. Several mega-rounds boosted U.S. digital health funding to over $2 billion, led by companies such as Outcome Health, Guardant Health and Peloton, with the number of deals rising 38% to 113 in the quarter. These figures represent 8-quarter highs. This activity level clearly underscores the importance VC investors are placing on these healthcare technologies, despite any short-term uncertainty around national health care reform. Of note, Horizon closed a $20 million commitment to HealthEdge in Q2, a leading provider of healthcare insurance software and services to the healthcare insurance industry. In the broader technology market, U.S.-based Internet companies continue to see the most funding across all sectors, with $8.7 billion invested across 505 deals. Aside from the Internet, cybersecurity was a strong growth area for venture capital in the second quarter, with funding for start-ups crossing the $1 billion mark for the first time. This was driven by 5 mega-rounds for relatively well-established start-ups. We're still seeing fewer technology companies looking to go public as liquidity continues to come from private equity firms. However, the quality opportunities we're seeing continues to improve. We believe we are well placed in this market as shown by recent fundings we've completed for technology companies like PebblePost and IgnitionOne. We continue to have no immediate plans in the cleantech market. While we still see long-term potential in this area due to continued demand for sustainable and energy-efficient technologies, venture capital investment in this sector remains limited.

Looking at the venture debt competitive landscape, we continue to see competition from technology banks in our targeted markets. We're seeing some pricing pressure from this, but there are still opportunities for attractive onboarding yields, including the potential for multipartner transactions, most notably for later-stage companies in the life science area. With a less robust IPO market for life science companies, we still expect many companies coming back to the debt market over the next 24 months to supplement their liquidity as they continue their product development. This should continue to create financing opportunities for our venture debt product in this market.

Our outlook for the balance of 2017 is positive as we continue to see increased pipeline activity and improvement in the quality of potential transactions. Taking this into account and our higher level of committed backlog going into the second half of 2017, we believe Horizon is positioned to grow its investment portfolio over the coming quarters.

With that update, I will now turn the call over to Dan.

Thanks, Jerry, and good morning, everyone. I will now briefly discus our financial results for the second quarter of 2017. Our total investment income for the second quarter was $5.9 million as compared to $9.1 million in the second quarter of '16. The decrease is primarily due to the lower interest income on investments resulting from the smaller average size of our loan portfolio. Onboarding yields in our portfolio were 11.6% for the current period. Our portfolio yield for the second quarter was 14.7% as compared to 15.5% for the last year's second quarter.

Turning to our expenses. Total expenses were $3.1 million for the second quarter, a 33% decrease as compared to $4.7 million in the second quarter of '16. Included in these expenses is interest expense, which decreased 28% on a year-over-year basis, mainly due to a decrease in average borrowings. Our base management fee decreased 29% year-over-year to $0.9 million compared to $1.2 million in the prior year period. This change is primarily due to a decrease in the average size of our investment portfolio.

In addition, incentive fee expense for the second quarter was subject to the incentive fee cap and deferral mechanism under our Investment Management Agreement. This resulted in $200,000 of reduced incentive fee expense and additional net investment income. Professional fees and general and administrative expenses, which consist primarily of legal and audit fees, remained flat for the second quarter as compared to the second quarter of '16. We earned net investment income of $0.24 per share for the second quarter as compared to $0.39 per share for the second quarter of '16 and $29 million -- $0.29 per share for the first quarter of this year.

After paying distributions of $0.30 per share and earning $0.24 per share for the quarter, the company's undistributed spillover income as of June 30 was $0.08 per share. Our NAV as of June 30 was $11.87 per share as compared to $12.11 in the prior quarter. This decrease is primarily due to the unrealized depreciation that Rob discussed earlier. The originations in the second quarter totaled $22 million, which were offset by $8.4 million in scheduled principal payments and $12.3 million in principal prepayments. On a cost basis, we were able to slightly increase our debt investment in the second quarter. We ended the second quarter of 2017 with an investment portfolio of $179 million, which included earning debt investments in 34 companies with an aggregate fair value of $157 million, a portfolio of warrant and equity positions in 77 companies with an aggregate fair value of $8.3 million, and other investments in 3 companies with an aggregate fair value of $6 million.

In terms of liquidity, we ended the quarter with approximately $50 million in available liquidity, which included cash and funds available under our credit facility. As of June 30, we had $23 million outstanding under our $95 million credit facility, which has an accordion feature that allows for an increase in size of up to $150 million.

In addition to our credit facility, we continued to have $33 million in publicly traded baby bonds which mature in 2019. Our goal remains to grow our portfolio size and increase our leverage ratio towards our overall target of 0.75:1. At June 30, our leverage ratio was 0.4:1. Taking into consideration our cash position and the current gap between our target and actual leverage ratio, we expect that when we reach our target leverage, our investment portfolio will have grown by approximately $60 million.

As previously announced, on April 27, our Board of Directors extended the share repurchase program until the earlier of June 30, 2018, with a repurchase of $5 million of the company's common stock. Since the plan was first approved, we've repurchased over 161,000 shares of our common stock at a total cost of $1.8 million. During the second quarter, we did not repurchase any additional shares.

Lastly, before we go to our Q&A, I'll briefly touch on our interest rate sensitivity. As we've said previously, expecting that interest rates would eventually rise, for nearly 3 years, Horizon has shifted its portfolio to floating-rate loans. As of June 30, 99% of the outstanding principal amount of our debt investments were interest at floating rates and are structured to increase when interest rates rise. Based on our June 30, 2017, consolidated statements of assets and liabilities, we've determined that for a 100 basis point increase in the LIBOR rate, we would increase annual net interest income by approximately $1.3 million or $0.12 per share. Considering this, we believe Horizon is well positioned to realize both increasing income, expanding net interest margin in a rising interest rate environment.

Before we go to questions, I'd like to note that we plan to hold our next conference call to report third quarter results in the week of November 6.

This concludes our opening remarks. We'll be happy to take questions you may have at this time.

(Operator Instructions) Our first question comes from Leslie Vandegrift from Raymond James.

We just had a first question on the new nonaccrual, Interleukin Genetics. So last quarter, it was marked at -- almost lost 98.4% there. But it looks like the payments for April, May and June had already been deferred until that FDA test or, excuse me, the next approval process was going through. And since that didn't happen, obviously, we have the mark down this quarter. But how early was it determined to push those payments back? Was that before May or after?

Yes, the timing here intraquarter is sort of interesting. We did make the additional advance in April alongside the equity investors. And we're working towards an outcome that would have given the company a second life. Became -- we really determined that, that process was not going to be fruitful in June. And so the reversal to nonaccrual happened late in the quarter.

Okay. And then on that, I know that it was announced that they're liquidating instead because of that. So how far long are we in that process? And how much of that is taken into account at the end of quarter mark, down to 75%?

Yes, so the -- they've engaged consultants and are working towards an orderly liquidation process, which is kicking off sort of now. We expect it will be concluded over the next -- in the third and fourth quarter. Our mark reflects our expectations from that process.

Okay. And then, I know you talked about the increase in portfolio size to get to target leverage of about $60 million. But what's the short term, next quarter, next 2 quarters target versus the long term, which, I believe, in the past is down about 75% debt to equity there?

So you build a portfolio one new loan at a time, less one prepay or normal amortization at a time. So it's too early for us in the quarter to say where we'll exactly end up. But as we said in our prepared comments, we're encouraged by both the level of our committed backlog and the quantity and quality of the transactions we're looking at.

Okay. And then just a final quick question. I know that you said on the second quarter, there wasn't any more share repurchases. Are you seeing opportunities to do more of that in the third quarter so far?

We always make the determination based on whether we think that investment is the right one for the company and our shareholders. And, of course, that's dependent on the price and other opportunities we have, and it has to happen within the window in which we can do it.

Our next question comes from Jonathan Bock from Wells Fargo.

Fin O'Shea in for Jonathan this morning. I just had a quick follow-up to Leslie's question on Interleukin. Given the situation you described, why was the follow-on investment only 8% PIK versus your outstanding in a much richer investment? And why invest alongside equity at that rate?

So these are the decisions as venture lenders we make. We co-lended with the equity investors to try to get to a better outcome. And we thought that, that was in our best interest long term.

Okay, very well. And then, I guess, sort of a similar one on Decisyon. That was one of the improvements this quarter where you also had a follow-on, but at a much -- that one was also all PIK, which generally isn't indicative of improvement in the company unless you're sort of shoring it up. So any sort of commentary on how that one came to improvement? Did that have to do with your investment ?

Yes, it's pretty much the same answer. We were in a position where we could help the company progress, and we're investing alongside both existing and new investors. And so a portion of our new loan is at PIK interest, but we're in a secured position.

Our next question comes from Ryan Lynch from KBW.

If I look at you guys' historical committed backlog in fundings at 12/31, you guys had about $21 million backlog; you closed $26 million in Q1. As 3/31, you had about $11 million backlog, closed $22 million in the second quarter. If I look today, about a $45 million backlog. It's one of the biggest that I've seen for you all. I mean, if I look at backlog relative to fundings, I mean, you guys have funded in the next -- the following quarter about as many -- the level of funding to have equaled or a bit greater than the amount of backlog. So I mean, is it reasonable to expect that in Q3, you could have $40 million plus of fundings in the quarter?

Well, I -- Ryan, this is Jerry Michaud. The answer to that is that one of the things that we've obviously been focused on is improving not just the quantity of our backlog, but the quality of our backlog. And we have -- a couple of the transactions that we have entered into are significantly larger to later-stage companies that actually we're co-investing. And those transactions also have milestones, so they've tranched. And the timing in which those milestones get met could just happen within the next 2 quarters, but they also may fall into next year as well. So let me just -- the answer is, your assumptions are actually pretty good. It could fall within the $40 million range, but some of that could slip too, and I just want to be -- make you aware of that.

Okay. Understood. And then one on the dividend sustainability. I mean, you guys recently reduced the dividend a few quarters ago. So far in Q1 and then in Q2, earnings have been below the dividend. Can you just talk us -- talk about or walk through how do we get from the most recent quarter earnings of $0.24 per share, which included only a partial incentive fee payment, which helped out by about $0.02, so with a full incentive fee, it would actually be lower than that. And how do we get from this $0.24 per share up to the $0.30 quarterly dividend? Or is it even -- is that number -- or is the quarterly dividend of $0.30 even sustainable?

So when we -- our board sets the dividend based on our goal and of being -- have been setting distributions we can cover over time by NII. The -- I think the drivers to get to dividend coverage are to work back towards our target leverage and maintain a normal pace of prepayments and the income that comes from those. And so when we set the dividends, we do it consistent with our goal of being able to cover our dividend with NII over time.

Our next question comes from Christopher Testa from National Securities.

Just in relation to ScoreBig, obviously, that took a decent hit this quarter. I'm just curious, how often do the projections for the payments you'll receive, how often are you [recalibrating those] assumptions? And is there a potential for this to go down further? And also is this a similar process evaluating digital signal as well?

Well, Chris, this is Dan. In relation to ScoreBig, we have monthly contact with the company, and we get monthly performance, as we're always in close contact with our portfolio companies. So we will review that on a monthly and on a quarterly basis. And throughout that process, the company will work with us and provide us annual forecasting as the document requires on an annual basis. So it is within our normal fair value policy, and it will be looked at quarterly.

Okay. And just with the tech banks and your commentary on you guys still seeing competition from them. I'm just curious if you could provide some additional color on whether these are the usual suspects or whether there's any new ones? And just how aggressive they're being in terms of the leverage they're extending relative to last year?

Yes. Good question. It is the same players. There aren't any new ones, at least on the banking side, that are -- we're seeing materially impact the market. And so really, it's more about them competing with each other, which is driving up leverage a little bit, but really it's more about pricing. And so that has both a positive and negative impact relative to what we do. We are finding that they are far more interested today than, say, a year ago of actually participating with us and -- in much of what we do because that allows them to be aggressive relative to pricing and win part -- portions of transactions without having to drive up their own leverage. So that has a very positive effect. Where it has a negative effect is when they're competing head-to-head and on transactions which are relatively, generally speaking, not large transactions, so they're in the $10 million or below range. Then those transactions become very competitive from a venture lender standpoint compared to what the banks are willing to do.

Got it. And just curious, I know you've provided the quarter-to-date kind of summary information on originations and prepayments. But are you seeing from now on potentially prepayments slowing down? Is there sort of a burnout of refi, in your opinion, in the portfolio? Or do you expect this kind of staying in line with historically?

Yes, I mean, it's difficult to say. It's very dynamic companies. They're built to be acquired or go public. And the timing of those events are -- generally come up pretty quickly in any quarter. So I mean, I think if you look historically at our prepayment activity, in the $15 million range would be kind of a normal quarter. And so sometimes, as I think in the first quarter, we had significantly higher prepayments than that. Second quarter was pretty much as we would have expected. And I kind of see normalization relative to that going forward.

Okay. And just on the repurchases, I know you guys extended the $5 million program past couple of quarters. Just with originations being light and leveraged so low, how should we think about the appetite for doing repurchases? Does the multiple has to get extremely attractive for you to do this? Or if investment activity remains slow, is this something that you would do maybe at 90% of book or 85%? Just any color there is appreciated.

So we -- we don't have a target price at which we would buy, but it's a combination of the return profile and attractiveness of investments, is the alternate use of the corporate liquidity versus where we think the stock price is -- would be a really good price for us to buy. So that's the decision we make, again, within the window when we have that opportunity.

Our next question comes from Casey Alexander from Compass Point.

Two quarters ago, you said the scenario analysis around ScoreBig anticipated a payback period of 3 to 5 years. What is the payback period now?

It's probably still in the 3 to 5, maybe but -- a little bit longer.

I'm sorry. The payback period, the scenario analysis is the same, but the value of the mark got marked down substantially?

It's more on the timing of when the payments are occurring. So now with the forecast and a slower ramp from when it was initially projected by the company that has taken over the ScoreBig name and the ticket website. So the timing in -- of when we will be collecting those payments has slowed in the earlier part of their projections and that's why...

What were you paid this quarter?

They are still -- we have not been paid anything. They're still working through ramping up the website and all the features to it.

I'm showing no further questions at this time. I would like to hand the conference back over to Mr. Robert Pomeroy, Chairman and CEO, for closing remarks.

Thank you all for joining us this morning. We appreciate your continued interest and support in Horizon. And we look forward to speaking with you again in November. This will end our call. Thanks.