Horizon Technology Finance Corp (HRZN) 2018 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Horizon Technology Finance Corporation Fourth Quarter 2018 Financial Results Conference Call.

(Operator Instructions)

As a reminder, this call will be recorded.

I would now like to introduce your host for today's conference, Ms. Megan Bacon. You may begin.

Thank you, and welcome to the Horizon Technology Finance Fourth Quarter 2018 Conference Call. Representing the company today are Rob Pomeroy, Chairman and Chief Executive Officer; Gerry Michaud, President; and Dan Trolio, Chief Financial Officer.

I would like to point out that the Q4 earnings press release and Form 10-K are available on the company's website at horizontechfinance.com.

Before we begin our formal remarks, I need to remind everyone that during this conference call, 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, 2018. 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. The fourth quarter capped off a very successful year at Horizon on many fronts.

We grew our portfolio for the third consecutive quarter and ended the year with a total portfolio of $248 million, including $216 million in venture debt investments. We recorded net investment income per share in the fourth quarter of $0.34 and, importantly, fully covered our $1.20-per-share distributions for 2018. We finished the year with no new nonaccruals, the sixth consecutive quarter we have accomplished this, and a testament to our focus on credit quality.

We had a weighted average debt investment yield for the fourth quarter of 16.7% and our average weighted debt investment yield for 2018 was 15.3%, which takes into account regularly scheduled interest and fee income, as well as income from liquidity events. We continue to maintain a quality, premium-yield, floating-rate portfolio that mirrors our strategic objective of obtaining premium pricing on each investment we make through our predictive pricing strategy.

Our NAV at the end of the year was $11.64, down slightly from the prior quarter, impacted by the end-of-year volatility in the stock market. The fair value of our investments in public stock and warrants has already recovered from the mark-to-market loss we incurred in Q4. And significantly, we upsized our credit facility with KeyBank and built our joint venture to allow us to begin accessing the JV's $100-million senior secured debt facility, providing us with ample capacity from which to continue growing Horizon.

All in, we exited 2018 in a strong position, and we are poised to build upon that strength in 2019 and beyond.

We have been able to significantly enhance results over the past couple of years by utilizing our predictive pricing strategy to produce event-driven income on a quarterly basis, and I want to discuss that strategy in a bit more detail. As some of our longer-term investors know, the way we structure a loan is integral to all of our debt investments. We use our deep expertise to structure our loans to allow us to obtain a strong initial yield that can be enhanced in the event of prepayment through the acceleration of end-of-term payments and prepayment fees. That is, the structure of our loans includes a probability analysis of the likelihood of the timing of prepayment based on the investment profile of our borrower and our proprietary database of over 200 historical investments, from which we can draw on similar profiles and their historic repayment patterns. Using this strategic method of determining probable prepayment outcomes, we structure each investment to maximize returns at the most likely time of repayment.

By aligning our portfolio investments to probable prepayment outcomes, we are positioned to generate consistent, event-driven income each quarter. Indeed, we expect it. The customer pays off its loan and grows into its next stage of development, while we receive increased return on our investments via accelerated income and can redeploy the capital more quickly into additional investments. We also typically retain equity and warrant rights, which gives us an additional benefit should the portfolio company be sold or exit via an IPO. It's a model that works for everyone.

Turning to our investment activity, in the fourth quarter, we funded 6 new loans totaling $47 million and increased our portfolio on a net basis by $9 million from the end of the third quarter. We also closed on $54 million in new approvals and commitments and maintained a backlog of $42 million at the end of the year. We are pleased with our pipeline and the demand we're seeing, as well as our unique ability to originate quality investments. As we enter 2019, we expect to grow both the size of the Horizon portfolio as well as our joint venture.

With respect to the joint venture, there were 3 new investments made by the JV in Q4. These investments were each initially funded at Horizon in order to provide our portfolio companies with the highest quality of service and timely closing. During Q4, a portion of each loan was transferred to the JV, and it's important to note that both JV partners must approve all transactions funded by the JV. We believe that as we grow the JV portfolio and access the leverage facility, the JV will be a value generator for Horizon shareholders over the long term.

We maintain solid asset quality with no new nonaccruals for 6 straight quarters, and we continue to have no 1-rated loans. During the quarter, we experienced a normal level of migration with our 2-rated credits, with 1 loan being upgraded to a 3 rating while another loan was newly rated at 2. The Horizon venture debt strategy includes aggressively managing portfolio accounts that are underperforming or needing to raise capital. Our senior management is consistently involved with these accounts.

Looking at the balance of 2019, we are well positioned to continue driving portfolio growth and sustainable NII. We maintain a robust pipeline and backlog from which to invest and overall demand for tech and life science investment remains strong. Our asset coverage requirements for senior securities is now limited to 150%, equivalent to a 2-to-1 debt-to-equity ratio. With a debt-to-equity ratio of 0.95-to-1 as of December 31, we have ample room within our coverage requirements to grow and diversify our portfolio, although we note that we expect to prudently remain within a targeted leverage range of 0.8-to-1 to 1.2-to-1.

We began 2019 with $147 million of total capacity at Horizon and our joint venture from which to make new investments. Our advisor previously reduced the base management fee percentage to 1.6% on the amount by which gross assets, less cash and cash equivalents, exceeds $250 million, further aligning our advisor with shareholders' interests. And the advisor has also agreed to waive the recoupment of previously deferred incentive fees during all of 2019.

To conclude, the fourth quarter and 2018 in total were successful for Horizon and have set the stage for an even more successful 2019.

I will now turn the call over to Gerry, who will update you on our business development efforts and market environment, and then to Dan, who will detail our operating performance and financial condition.

Thanks, Rob. Good morning, everyone. Our fourth quarter closed out a strong year for Horizon as we added 6 new floating-rate transactions to our portfolio totaling $47 million and have now grown the size of our portfolio by 28% since the end of 2016.

We continue to focus on disciplined underwriting before entering into all of our investments. Our onboarding yields have remained strong, evidenced by the 12.1% onboarding yields in the fourth quarter of 2018. We had 3 loan portfolio exits during the quarter totaling $24.5 million. The prepayment and accelerated income from these events resulted in a loan portfolio yield for the quarter of 16.7%.

In addition, as Rob mentioned, we transferred portions of 3 portfolio investments totaling $16.8 million into our joint venture. We continue to maintain a premium-yielding debt portfolio, as reflected by our leading yield position in the BDC industry, which generates a predictable income stream while we continue to add new investments with higher ETPs and prepayment opportunities.

We closed $53.5 million in new loan commitments and approvals and ended the fourth quarter with a committed backlog of $41.5 million, compared to a backlog of $47 million at the end of the third quarter. Our committed, approved and awarded backlog as of December 31 was $59 million to 8 companies and a pipeline of new opportunities of over $400 million. With a continued solid committed backlog and a robust pipeline, we are optimistic for another solid year of performance.

Our ultimate strategy remains unchanged. Grow our portfolio and predictable income stream while enhancing NII with prepayment and accelerated income. At year-end, we held warrant and equity positions in 76 portfolio companies with a fair value of $11.2 million. In Q4, one of our warrant portfolio companies, Ekahau, closed an M&A transaction, and we received warrant proceeds of approximately $900,000 in connection with the termination of our warrants. Subsequent to the end of Q4, we have funded 2 new investments totaling $11 million and funded an additional $3 million into our joint venture through accessing our New York Life leverage facility. In addition, we have been awarded transactions totaling $20 million to date in Q1.

We exited 2 portfolio companies in Q1 and received proceeds of $13.8 million. One of those portfolio companies, Luxtera, was acquired by Cisco. As a result, we received approximately $780,000 in warrant proceeds, resulting in a realized warrant gain of approximately $540,000 in the first quarter. We also exited our equity investment in Insmed. We received proceeds of $985,000, resulting in a realized gain of approximately $770,000 in Q1.

Turning now to the venture capital environment. $130 billion was invested in VC-backed companies in 2018, according to PitchBook. This was the highest level of VC funding since the year 2000 and is an indicator of future positive venture debt markets.

In terms of VC fund-raising, a record $55.5 billion was raised in 2018 and was the fifth consecutive year that at least $34 billion has been raised. VC-backed exit activity in 2018 also showed great strength, with the fourth quarter being the largest exit value quarter since 2014.

The recovery in the public markets thus far in 2019 resulted in the IPO window being opened again, providing VCs with the opportunity to generate returns and reinvest their capital. In the fourth quarter, we saw 18 venture-backed IPOs, 72% of which were in the healthcare and life science sector, which bodes well for Horizon. We now have 2 portfolio companies that have recently filed to go public under the JOBS Act.

Turning now to our core markets. In the fourth quarter, demand for financing in the life science and healthcare technology markets remained robust. During the fourth quarter, we funded 2 $4-million venture loans to existing portfolio companies in healthcare technology - HealthEdge Software, a provider of next-gen tech products for the healthcare insurance market, and MacuLogix, a pioneer in the detection of age-related macular degeneration. The broader technology sector continues to be very active with funding new and growth-oriented companies, particularly in AI, FinTech and the internet. With the recovery of the public market in early 2019, we remain optimistic that the tech IPO window will remain open in 2019 with a number of high-profile tech companies expected to go public.

The strong demand for venture debt generally and our products specifically was much of the same in the fourth quarter as in recent prior quarters. With larger equity rounds being completed, larger debt transaction requests follow. As such, we continue to take a more strategic market posture, looking for opportunities that have not just raised a lot of equity, but also represent segments of our market that we believe are poised for significant technological advancements over the next 3 years. Our brand, experience and reputation strongly position us to provide growth capital to innovative companies in our core markets with a strong bent toward maintaining our credit quality. We expect there will continue to be investment and exit opportunities throughout 2019. This, along with our robust pipeline, our ability to identify and win attractive investment opportunities and our adequate liquidity position us to continue delivering long-term disciplined portfolio growth.

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

Thanks, Gerry, and good morning, everyone. Let's turn to our financial results for the fourth quarter and full year 2018.

Horizon earned total investment income of $8.8 million for the fourth quarter of '18, a 43% increase compared to $6.2 million in the prior year period, which was primarily due to higher interest income on investments given the larger average size of our loan portfolio.

At the end of 2018, our debt investment portfolio had grown to $216 million, a 6% increase from the prior year-end. We have a strong base of debt investments and are well positioned to succeed in 2019.

For the year ended 2018, total investment income grew 21% to $31 million, compared to $26 million in the prior year. This increase was driven by the larger size of our investment portfolio and the increase in LIBOR over the course of the year.

For the fourth quarter, we achieved onboarding yields of 12.1%, compared to 13.3% in the third quarter of '18. Our loan portfolio yield was 16.7% for the fourth quarter of '18, compared to 14.8% in the third quarter and 14.1% for last year's fourth quarter.

For full year 2018, we achieved a loan portfolio yield of 15.3% and an onboarding yield of 12.4%, an improvement compared to a loan portfolio yield of 15.1% and onboarding yield of 11.8% for 2017. As we previously mentioned, the primary changes period to period to our portfolio yields are driven by the timing of new loan originations and the timing and exit of loan prepayments and the related fee income from those prepayments, including prepayment fees and acceleration of previously unamortized end-of-term payments.

Turning to our expenses. Total net expenses for the fourth quarter were $4.8 million, compared to $3.8 million in the fourth quarter of '17. Our net incentive fee increased $450,000, our base management fee rose $200,000 and interest expense grew $100,000 compared to the prior year period.

Total net expenses for 2018 were $17.2 million, a $3.7-million increase compared to $13.5 million for 2017. Interest expense for the full year of '18 was $6.4 million, compared to $5.2 million in '17. This change is primarily due to an increase in the average outstanding borrowings of $24 million. Base management fee for 2018 was $4.6 million, compared to $3.8 million in '17, which was driven by the larger average size of our investment portfolio. Net incentive fee expense for 2018 was $3.2 million, compared to $1.6 million in the prior year. This change was driven by increased preincentive fee net investment income and a lower deferred incentive fee amount.

As a reminder, back in 2014, we implemented changes to the investment management agreement between Horizon and our advisor. One of the changes was the inclusion of an incentive fee cap and deferral mechanism for the incentive fee calculation. Since that time, $3 million of incentive fees have been deferred and could be recouped based on positive financial performance. Of that amount, $1.2 million has been waived by the advisor in 2018. As Rob mentioned, the advisor also declared that it will irrevocably waive the receipt of incentive fees related to the amount previously deferred that it may be entitled to receive under the investment management agreement for all of 2019.

Net investment income for the fourth quarter was $0.34 per share, an increase compared to $0.30 per share in the third quarter of '18 and $0.21 per share for the fourth quarter of '17. For the full year, we recorded net investment income per share of $1.20 versus $1.07 per share in 2017.

After covering our distributions with net investment income for the fourth quarter, the company's undistributed spillover income as of December 31 was $0.11, compared with $0.09 at the end of 2017.

Based upon the growth in our NII and our outlook, our board declared monthly distributions of $0.10 per share for April, May and June 2019. We have now declared distributions at this $0.30-per-share level for 10 consecutive quarters. We remain committed to providing our shareholders with distributions that are covered by our net investment income over time and maintain an undistributed spillover of $0.11 per share in support of future distributions.

Our NAV as of December 31, 2018, was $11.64 per share, compared to $11.66 as of September 30 and $11.72 at the end of '17. The $0.02 decline in NAV on a quarterly basis was due to the volatility in the stock market at the end of the year, causing $0.05 per share of net unrealized depreciation during the fourth quarter. Many of our positions have recovered thus far in 2019, and for the first 2 months of 2019, we have seen net appreciation of approximately $0.05 per share in these positions.

To summarize our portfolio activity for the fourth quarter, new originations totaled $47 million, which were offset by $5 million in scheduled principal payments and $25 million in principal prepayments. We ended the fourth quarter of 2018 with an investment portfolio of $248 million, which consists of debt investments in 34 companies with an aggregate fair value of $216 million, a portfolio of warrant and equity positions in 76 companies with an aggregate fair value of $11 million, other investments in 4 companies with an aggregate fair value of $8 million and an equity interest in our JV with an aggregate fair value of $13 million.

New loan originations for the full year totaled $112 million for 23 portfolio companies, which were partially offset by $24 million in scheduled principal payments and $71 million in principal prepayments.

As we've highlighted in the past, nearly 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. As such, we believe Horizon remains well positioned to benefit from a rising rate environment and experience both increasing income and expanding net interest margin.

On the balance sheet, Horizon ended the year with $13.5 million in available liquidity, consisting of $12.6 million in cash and $900,000 in funds available under our existing credit facility. As of today, our liquidity position is $28 million, after taking into account prepayments and principal collections since year-end.

On December 28, we amended our revolving credit facility with KeyBank and increased our aggregate commitments under the facility by $25 million to $125 million, while maintaining the accordion feature that, if utilized, allows us to borrow up to an aggregate of $150 million. As of December 31, there was $90.5 million outstanding under the facility.

With respect to our joint venture, we funded it with 3 additional investments during the quarter, which allows the JV portfolio to meet the $25-million threshold, enabling the JV to access its $100-million senior secured debt facility. We have ample capacity at both the company and the JV to grow our portfolio in 2019.

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

(Operator Instructions)

And our first question comes from Robert Dodd with Raymond James.

First, a question on the JV disclosure. Obviously you've given us really helpful disclosure here in the quarter on the on-balance-sheet new investments, repayments, et cetera, et cetera. Will you be giving us any kind of detail at that level, or at the same time, to track the JV? Because obviously that moves dynamics depending where the assets reside if you transfer assets into the JV. So just, what's the plan on disclosing that, for visibility for shareholders?

Yes, Robert, this is Dan. We did talk about that, and since the majority of the activity this quarter were new additional fundings, I think you're referring to kind of the portfolio roll-forward that we do -- yes. Yes, we will -- we're planning to add that as more investments are populated in the JV and there is principal repayment and more activity.

Okay, got it. Thank you. And then the other one's kind of a bigger period. You talked about the probability pricing model. As we know, right, it's really hard to predict the timing of prepayments, et cetera. So what's the balance you strike there in terms of -- I mean, obviously it makes sense. You might be willing to trade off a little bit of coupon for a higher probability weighting of getting prepaid early, for example. But that, to a degree, requires you to call the prepayment cycle, the IPO cycle, the M&A cycle, 2 years from now, which is very difficult to project. So can you give us a little bit more color on how you balance those dynamics and how much weight you give to prepayments versus cash coupon today?

Yes, Robert. Hi, this is Gerry. So we actually do do a probability analysis. There are -- you're right, there are variables that we have to take into account, and you're correct, market timing at the time of an exit is probably the one that is -- we have the most volatility to it. But on the other hand, if we were to take a medical device company that was just FDA-approved and they're launching their product into the market, I can probably pull 5 or 6 portfolio companies out of our stored portfolio and look at what those transactions did. We obviously spend a lot of time talking to the management teams and the investors in these companies, and so we will have a sense from their projections of this. And so if you think of it as kind of a bell-shaped curve, you're right, we may end up on either side of the curve. In other words, we may think it's going to pay -- and we don't, like, try to pick a month. We'll say somewhere between month 28 and month 34, this would be kind of a normal place for this company to exit. And it may happen sooner and end up on the left side of the curve. It may end up going full term and end up on the right side of the bell-shaped curve. But the probability of it falling within that range, as we have looked at our -- all of the information we have in our portfolio, and all the data, actually it's a reasonable model to follow.

Yes. I presume as your portfolio gets bigger, the stats would get more meaningful as well, right? So that's it for my questions. Thank you, guys, and good quarter.

Thanks, Robert.

And our next question comes from Leslie Vandegrift with Raymond James.

Hi, guys. Thank you. Sorry, Robert and I are in different locations today, so I've got a few questions to add on to his. On the investment -- on your income statement, you had an increase in G&A and professional fees in the quarter, a bit higher than expected. Was that due to the JV? And if so, what's kind of the run rate there?

No, the JV gets reported as a net income through the dividend income line on the top line, so it has its own P&L and expenses run through there. The G&A we did look at pretty closely. Quarter-over-quarter it's slightly higher. One of the additional expenses we did incur this year were some shareholder expenses basically related to the below [NAV vote].

Okay. And then on the JV ramp there, you had a quarter for moving investments into that and getting it to that threshold. What does that portfolio size and pace of ramp look like over the next 12 to 18 months?

So the -- we ended the year with -- the JV has $25 million. We added 1 additional investment in the fourth -- first quarter, excuse me. We expect that to grow, probably, double or more during 2019.

Okay. And then my last question's on the investment schedule and the portfolio marks. You mentioned in your prepared remarks the unrealized depreciation in the quarter, $0.05 per share, but when you look at the investments, there's only 3 portfolio companies that have debt investments marked below cost. And so some of them are actually marked up a little bit from where they were last quarter, still below cost. So where are those marks, and why is it that only 3 on the portfolio are not right at cost?

So a 2-part question. The biggest variant in NAV fair value was markdowns of public warrants. In specific, the largest was Insmed. That stock -- that value of that warrant actually increased fairly rapidly as the stock market rebounded and in fact we have, as we mentioned in the script, we've sold that -- those shares and realized that gain as of the end of February. The other question you asked, which is -- we use a discounted cash flow method to fair value our loans, and we do not increase the value of the loans above par, above cost. And so it's the 2-rated loans that are reviewed and assigned discount rates relative to the relative level of risk. And then -- yes, the other -- yes, I'm sorry, the other aspect is that during the quarter, some of the 2-rated loans, we actually are receiving both principal and interest payments. So that'll change the value.

And our next question comes from Christopher Testa with National Securities.

You guys had mentioned transferring several loans with roughly $17 million into the JV. Should we expect this to be the strategy for the JV going forward, whereupon you're making the loans and then transferring them, and we effectively have 100% overlap, or they're going to inevitably be things that are going to be in the JV that don't make sense on balance sheet?

Actually, just the opposite. We will continue to, most likely, fund the loans at Horizon and then transfer them at some point during the quarter. But it's more likely that there are loans that are on Horizon's balance sheets that are not in the JV, rather than the other way. It's not contemplated that there'll be loans in the JV that are not also on the balance sheet of Horizon.

Okay, that's helpful, Rob. And the -- just curious, too, what your debt-to-equity target is for the JV, especially given the ramp that you had just mentioned to an earlier question? And also, just wondering, too, just as a quick follow-up to that, how you're looking at the -- your debt-to-equity target on balance sheet and the total economic leverage with the fully ramped JV?

So that's a really good question about the JV. I think our targets there will be similar to the targets for Horizon in general. We'll, of course, work with our JV partner on that, and we do have the 2-to-1 leverage facility inside the JV from New York Life, so we might end up with a little bit higher leverage overall there, but not at 2-to-1. Certainly, something considerably below that. We want to operate inside on the balance sheet at Horizon, including our equity investment in the JV, in total, at a target ratio of leverage of 0.8- to 1.2-to-1, and that's our stated goal.

Okay, that's fair. And I know you guys have mentioned the total yield of 16.7% and the 12.1% onboarding yield. I guess, is the delta between those simply just the ETP and other fees?

That would be correct.

Yes, by and large.

Got it. And I know you had taken down some of the equity valuations with the volatility in the market. Does any of the volatility in the cash flow lending market have any impact on how you mark the venture loans and spreads on the venture loans?

No, as Rob mentioned, we have a valuation policy here. We do look at kind of the macroeconomics in the economy, but by and large, we -- they're very specific to the underlying companies, their performance and the risk rating related to that and the cash flows.

And our next question comes from Casey Alexander with Compass Point.

Your extension of not recapturing the previous income fee waiver. Is it your estimation that in 2019, by not recapturing that amount, you would completely wipe out the balance of previously waived fees, or does that number just push out to the future?

You can't -- it's not -- they're not further deferred. They're waived. And so to the extent -- yes. To the extent that there is income enough to recoup, then we in fact will waive those fees.

And do you think that 2019 will wipe out the remaining balance of those fees that you've previously deferred?

Well, without giving guidance, but at the -- if we continue on the path we've been, that is a possibility.

Okay. Secondly, can you -- I think if I remember from the previous schedule, there are 5. Can you review the names of the 2-rated credits in the portfolio, please?

We don't do that. We haven't done that. They're listed as -- I mean, you can determine the ones that are valued below par, our 2-rated on.

Okay, all right. The economics of your JV. Are they -- I mean most of these special-purpose JVs are 87.5% and 12.5% with a JV partner, but if I recall, is yours 50/50?

The economics are 50/50 and the voting rights, just like every other JV, is 50/50.

Right, okay, that's helpful. Thank you. Next, you're certainly trading kind of at the best valuation that you've been at a while, and so are we at levels where the company might consider raising equity? I realize that you've authorized the increased leverage ratio, but then again, the market doesn't always offer that opportunity to raise equity. Is raising additional equity something that you have in your quiver with the stock at levels that it hasn't been at for a while?

Yes, so as we noted in our remarks, we have capacity to grow our portfolio within our target leverage with the benefit of our increase at the KeyBank facility. We also are constantly monitoring the capital markets, reviewing the overall capital structure with our board, looking at leverage opportunities as well as the possibility of raising equity. But we'll only do that -- we're looking for the best possible price on leverage, and we would only raise additional capital if the equity was appropriately accretive to the company (inaudible).

Thank you. There are no further questions in the queue. I'd like to turn the call back to Mr. Robert Pomeroy, Chairman and CEO, for closing comments.

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

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.