Q1 2024 Horizon Technology Finance Corp Earnings Call

Participants

Megan Bacon; Director of Marketing and Investor Relations; Horizon Technology Finance Management LLC

Robert Pomeroy; Chairman of the Board, Chief Executive Officer; Horizon Technology Finance Corp

Daniel Trolio; Chief Financial Officer, Executive Vice President, Treasurer; Horizon Technology Finance Corp

Gerald Michaud; President, Director; Horizon Technology Finance Corp

Daniel Devorsetz; Chief Operating Officer, Executive Vice President, Chief Investment Officer; Horizon Technology Finance Corp

Bryce Rowe; Analyst; B. Riley Securities

Paul Johnson; Analyst; KBW

Christopher Nolan; Analyst; Ladenburg Thalmann

Presentation

Operator

Greetings and welcome to the Horizon Technology Finance Corporation first quarter 2024 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Megan Bacon, Director of Investor Relations and Marketing. Thank you, you may begin.

Megan Bacon

Thank you, and welcome to Horizon Technology Finance Corporation's First Quarter 2024 conference call, representing the Company today are Rob Pomeroy, Chairman and Chief Executive Officer; Jerry Michaud, President; Dan Devorsetz, Chief Operating Officer and Chief Investment Officer; and Dan Trolio, our Chief Financial Officer.
I would like to point out that the Q1 earnings press release and Form 10-Q are available on the Company's website at HorizonTechnologyFinance.com.
Before we begin our formal remarks, I need to remind everyone that during this conference call, the Company will make certain forward-looking statements, including statements with 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. Due 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, 2023. 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.

Robert Pomeroy

Welcome everyone, and thank you for your interest in Horizon. Today, we will update you on our performance and our current overall operating environment and the Board seats will take us through recent business and portfolio developments. Gerry will then discuss the current status, the venture lending market, and Antonio will detail our operating performance and financial condition. We will then take some questions before we get to our specific results for the first quarter.
I would like to speak to the nature and current status of the venture lending business. Venture lending is an exciting and rewarding endeavor, which is driven by the support of venture investors and the advancement of technology. The Horizon platform has one of the most experienced teams of venture lenders, and we are passionate about our industry and its prospects.
We seek investment opportunities in development stage companies that drive technological innovation and are backed by committed investor support, including significant capital investments. These companies rely on additional capital to advance their technologies and growth venture debt is an essential part of this capital ecosystem. When we underwrite a venture loan, we base our investment thesis on an enterprise's strength of technology or market position, its ability to further develop its market and technology, its ability to grow or achieve revenue, so ability to attract additional institutional capital or strategic interest and eventually to advance to an exit or more traditional bank lending business.
Plans for these younger companies are subject to many kinds of detours and their agility to adapt and react is necessary to navigate ever-changing waters as seasoned venture lenders. We know that plans and the environment are always changing. Sometimes there are jolts to the ecosystem like we experienced last year with the tech bank crisis, global unrest, higher interest rates and pandemics. Just to name a few.
Recent shocks can upset plants and require management investors and venture lenders to thoughtfully react and adapt. While we have experienced all of the impact of these shocks over the past several quarters, we are starting to see the beginnings of a recovery in the venture ecosystem. We recognize the signs of recovery because we have previously seen and experienced cycles of shocks and recovery. Our senior lending team has an average tenure in the venture lending business of over 20 years.
This tenure has provided us with the experience to know how to smartly support our portfolio companies through difficult times while seeking to preserve shareholders' capital and maximize net asset value. The results for the first quarter reflect our expertise and our efforts to grow our portfolio and maximize NAV in a difficult environment. Our debt portfolio yield remains strong and our earnings continue to cover our distributions as they have for more than six years. This is the essence of the venture lending model.
I will turn the call over to Jerry and Dan to give you the details of our first quarter results and progress. We appreciate your continued interest and support in Horizon Technology Finance platform. Dan?

Daniel Trolio

Thanks, Rob, and good morning to everyone. Our portfolio size grew slightly in the first quarter to $711 million as new originations in the quarter were mostly offset by prepayments and normal portfolio amortization as well as fair value adjustments. In the first quarter, we funded five debt investments totaling $33 million, all to existing portfolio companies opportunities within the portfolio, both in terms of funding committed backlog to existing borrowers that achieve important operational and financial milestones as well as providing new financing commitments to strong performing borrowers remains an important aspect of our quarterly funding strategy.
While we continue to see a steady stream of opportunities to provide financing to new borrowers, transactions that meet our underwriting standards or taking longer to develop in this challenging environment, we will remain disciplined in our approach to originating loans to new companies and expect slow and steady progress in new originations in the second quarter and the back half of the year as conditions improve.
During the quarter, we experienced one loan prepayment, one refinance loan and one partial paydowns totaling 20 million in prepaid principal. We expect modest prepayments in the second quarter of 2020 for prepayments are often driven by IPOs and M&A activity. And while there are signs of activity in the IPO and M&A markets remain below normal, our onboarding yield of 13.4% during the first quarter remained high compared to our historic levels, once again, reflecting the ability of our team to structure quality, high-yielding venture loans with strong follow-on investment opportunities.
Even in this challenging environment, we expect our capabilities in structuring and pricing transactions to continue to produce strong net investment income. Our debt portfolio yield of 15.6% for the quarter was again one of the highest yielding debt portfolios in the BDC industry. We have consistently generated industry high debt portfolio yields for many years, which is a further testament to our profitability of our venture lending strategy and our execution of that strategy across various market cycles and interest rate environments.
As of March 31, we held warrant and equity positions in 99 portfolio companies with a fair value of $31 million. Structuring investments with warrants and equity rights is a key component of our venture debt strategy and is a potential generator of shareholder value. In the first quarter, we closed $37 million in new loan commitments and approvals and ended the quarter with a committed and approved backlog of $168 million compared to $218 million at the end of the fourth quarter.
As I referenced earlier, for our committed backlog with most of our funding commitments, subject to company's achieving certain key milestones provides a solid base to prudently grow our portfolio. As of quarter end, 90% of the fair value of our debt portfolio consisted of three and four rated debt investments, consistent with where it stood at December 31. 10% of the fair value of our portfolio was rated two or one also consistent with December 31. So the one rated portion of the portfolio increased during the quarter.
We continue to diligently work on our stress investments in order to maximize additional recoveries. And as we do for all of our portfolio companies, we continue to work closely and collaboratively with management teams, investors and stakeholders to help navigate the challenging environment. Meanwhile, we will continue to look towards sourcing and originating new venture loans to high-quality companies, while our portfolio continues to benefit from the current interest rate environment.
With that, I'll turn it over to Jerry for a look at that overall venture industry and current environment.

Gerald Michaud

Thank you very much, Dan. Turning now to the venture capital environment. According to PitchBook, approximately $37 billion was invested in VC-backed companies in the first quarter, maintaining the relative pace that we saw for much of last year. Notably, VC investment in later-stage companies declined 36% from the same period in 2023, reflecting continued concerns by venture capital investors related to overvalued later-stage companies.
In addition, while exit markets did show some improvement in the quarter, venture capital firms are looking to see higher levels of exits within their own portfolios before they will be willing to invest in later-stage companies. As a result, insider lead rounds, convertible debt transactions and bridge financing continue to be the primary financing support for VC-backed companies in today's environment.
That said, there is an abundance of venture capital sitting on the sidelines, especially in funds raised in 2021 and 2022. Theses need to invest their committed capital before the investment period of their funds preclude further investment and the opportunity for any meaningful returns is made nearly impossible. That pressure, combined with lower interest rates and the already improving IPO market may lead to a stronger VC ecosystem during the second half of 2024.
VC interest and investment in certain market segments such as AI solutions and life science are seeing significant increases in terms of VC fundraising, only $9 billion was raised in the first quarter of 2024 the lowest first quarter in a decade. VCs committed capital from their LPs continue to remain at record highs as a result of amounts raised during 2021 and 2022 and much smaller investment activity over the last two years.
VCs have high hurdles for raising new funds based on their recent returns, quality of portfolios, size and investment strategy. Although VC-backed exit activity remained low at $18 billion in the first quarter. There was some optimistic signs, most notably the successful IPOs of credit and a stereo labs show that if the macro environment could further stabilize, there should be plenty of opportunities for companies to exit via IPOs in the subsequent quarters.
Meanwhile, M&A market for venture-backed companies remain at mute as acquirers continue to stay on the sidelines. We continue to believe that M&A buyers in industries such as biotech, energy, technology and healthcare have best position to resume M&A activity given their recent positive earnings results, rising public stock prices and elevated levels of cash and liquidity on their balance sheets.
In terms of market conditions for new venture loan investments, we expect to remain selective in the second quarter. In terms of originations, while we have seen the top of our pipeline fully replenished at $1.8 billion as of today, which is a testament to our reputation and brand. We are resolute in ensuring that we only fund high-quality venture debt investments, thus we expect portfolio growth will be weighted toward the second half of the year.
To sum up, we continue to navigate through the uncertain and changing VC environment. We remain focused on credit quality and providing all of our portfolio companies with support to ensure optimal outcomes. While we continue sourcing high-quality opportunities for potential venture debt originations, we believe we remain well positioned to continue generating solid NII for our shareholders and building additional long-term shareholder value.
With that, I will now turn the call over to Dan Devorsetz.

Daniel Devorsetz

Thanks, Jerry, and good morning, everyone. It was a solid first quarter from an NII standpoint, as we once again generated NII more than covered our distributions. We also made additional progress in boosting our balance sheet through our ATM program successfully and accretively selling over 1 million shares in the quarter, raising $12 million, further demonstrating our continued ability to opportunistically access the equity markets in addition, we continue to diligently work with all of our companies in order to optimize outcomes for our portfolio and further enhance our credit quality. We believe we remain well positioned to add quality investments to our portfolio and create additional value for shareholders moving forward.
As of March 31, we had $91 million in available liquidity, consisting of $71 million in cash and $20 million in funds available to be drawn under our existing credit facilities. We currently have $60 million outstanding under our $150 million KeyBanc credit facility and $181 million outstanding on our $250 million New York Life credit facility, leaving us with ample capacity to grow the portfolio.
Our debt to equity ratio stood at 1.37 to 1 as of March 31, and netting out cash on our balance sheet, our net leverage was 1.16 to 1, which was within our target leverage. Based on our cash position and our borrowing capacity on our credit facilities. Our potential new investment capacity at March 31, was $230 million.
For the first quarter, we earned investment income of $26 million compared to $28 million in the prior period, primarily due to lower interest income on our debt investment portfolio. Our debt investment portfolio on a net cost basis stood at $720 million as of March 31, a modest reduction from December 31, 2023.
For the first quarter of '24, we achieved onboarding yields of 13.4% compared to 13.8% achieved in the fourth quarter, our loan portfolio yield was 15.6% for the first quarter compared to 16.3% for last year's first quarter. Total expenses for the quarter were $13.1 million compared to $14.8 million in the first quarter of '23.
Our interest expense increased to $8.2 million from $7.1 million in last year's first quarter due to higher interest rates on our borrowings. Our base management fee was $3.2 million comparable with the prior year period. An incentive fee of $300,000 in the first quarter compared to an incentive fee of $3 million for last year's first quarter. This was due to the deferral of incentive fees otherwise earned by our adviser in the quarter under our incentive fee cap and deferral mechanism. The deferrals driven by unrealized and realized losses on our portfolio.
As 2024 progresses, we expect deferrals to end net investment income for the first quarter of '24 was $0.38 per share compared to $0.45 per share in the fourth quarter of '23 and $0.46 per share for the first quarter of '23. Companies undistributed spillover income as of March 31 was $1.30 per share. We anticipate that the size of our portfolio, along with the portfolio's elevated interest rates and our predictive pricing strategy, will enable us to continue generating NII that covers our distribution over time. Given the current macro environment, we continue to expect prepayment activity will remain light in the near future.
To summarize our portfolio activities for the first quarter. New originations totaled $33 million, which were offset by $11 million in scheduled principal payments and $20 million in principal prepayments and partial paydowns. We ended the quarter with a total investment portfolio of $711 million. Given the macro environment, we expect to remain selective in the near term with respect to originations.
On March 31, the portfolio consisted of debt investments in 54 companies with an aggregate fair value of $671 million and a portfolio of line equity and other investments and 103 companies with an aggregate fair value of $40 million. Based upon our outlook, our Board declared monthly distributions of $0.11 per share for July, August and September 2024.
We remain committed to providing our shareholders with distributions that are covered by our net investment income over time. Our NAV as of March 31 was $9.64 per share compared to $9.71 as of December 31, 2023, and $11.34 as of March 31, 2023. The $0.07 reduction in NAV on a quarterly basis was primarily due to our paid distributions, including the $0.05 per share special distribution and adjustments to fair value, partially offset by net investment income.
As we've consistently noted, nearly 100% of the outstanding principal amount of our debt investments bear interest at floating rates with coupons that are structured to increase if interest rates rise with interest rate floors.
This concludes our opening remarks. We'll be happy to take questions you may have at this time.

Question and Answer Session

Operator

(Operator Instructions)
Bryce Rowe, B. Riley Securities.

Bryce Rowe

Great, thanks and good morning. I'm going to maybe start with the the net unrealized losses here for the quarter. You know a lot of moving parts with now with several of the portfolio companies. Maybe maybe you guys could could speak to the write up of the Evelo on investment and looks like a pretty meaningful right out and quarter over quarter.

Gerald Michaud

Yeah, hi, this is Jerry. So when we market at the end of the last quarter, it was coming off of the failed clinical trial for [29 39] and we were just kind of trying to get our arms around on what the potential value of the assets were. It was a pretty depressed biotech market in general in 2023. So and yeah, we I think we market at around $1 million. However, since then, we've been working very closely with the Company and our investors and there is some there are some significant opportunities for the potential value was up some some of their assets.
And so we're working diligently to and trying to obviously maximize that value. So while I don't have anything to report specific today and the Company has not reported anything specific today, we are we are working very closely with them and believe over the next quarter or two, we should see them be able to hopefully maximize some of the value. So we put it out, we put the value what we believe right now, there appears to be some interest in some of the value of their technology.

Bryce Rowe

Okay. That's helpful, Jerry. And maybe another one, just on some marketing. You had on an additional additional nonaccrual added on looks like that at fair value fair value mark relative to cost wasn't too terribly much different versus last quarter. And then next year you saw kind of a write down. There's been there's been some talk of that over the last couple of conference calls. Maybe an update on those two nonaccruals next car next, if you wouldn't mind.

Daniel Devorsetz

Good question. How you doing? The answer to that is quite similar to what Jerry was describing with Valero in that there is for both of them on there is there's different degrees of technology going concern, value, asset value of that we are looking to maximize and working on with the Company both companies on management teams, investors and third parties. There are parties interested in both of those companies' assets and businesses. Similar to what Jerry said, we're working through that is going to be probably another quarter or two, maybe a little more to get to the other side of that, we mark the values this quarter based upon on all of that, the technology, the going concern value and the interest that we're seeing in the market for Nexi in particular, there was a small recovery, small sale of one of the one of the subsidiaries of Nexi that was that was reported in the Canadian courts at Reed. Our resulted in a small recovery. There is a lot of activity around the broader business, including the company's technology and on customer base still going on.

Bryce Rowe

Okay. Right. Appreciate that. And then maybe just a question around some potential origination and repayment activity from the backlog that you noted, can you give us a sense of kind of the mix there between existing companies and potentially new platform companies? And then from a repayment perspective, I heard a couple of different adjectives. I heard modest and I heard right. So just trying to kind of handicap what what that what that actually kind of means or could mean if we want to just talk about a range of potential repayment activity over the next couple of quarters. It would be helpful. Thanks.

Daniel Devorsetz

Dan again, I think somewhere between modest and light is the way to model it enough. So we. Yeah, exactly. The first question of the backlog numbers that was mentioned, I think that that is entirely committed backlog to existing borrowers in the portfolio, primarily milestone-based. So that's the number that was referenced in the prepared remarks.
In terms of new originations, we are seeing and activity at the top of the funnel for quality companies looking for venture loans, it is taking a long time to develop, as I mentioned. So we are we are not rushing anything looking for companies that meet our underwriting hurdles and structuring transactions that are win-win for everybody. So those are taking longer given this environment. So again, later this quarter and back half of the year, we think that volume is going to pick up. But right now it is really the top of the funnel activity at the moment.

Bryce Rowe

Okay. I'll jump back in queue. I appreciate it.

Operator

(Operator Instructions)
Paul Johnson, KBW.

Paul Johnson

Yes, good morning, guys. Just on the lower interest income this quarter, I mean, was that primarily it was kind of lower excuse me, lower activity in the quarter? Or are you guys seeing any kind of compression on spreads.

Daniel Trolio

It's a combination of a couple of things on the portfolio size and the prepayment activity was lower this quarter. And the amount of income and acceleration of fees that were related to those repayments were down and so as you can recall, the first quarter normally is a lower quarter for us and we are in regards to prepayment and that type of activity. So we're not seeing spread compression.

Paul Johnson

Got it. Thanks. And then just around know, kind of the current environment, sounds like it's still a fairly cautious environment for venture capital and in terms of like the convertible of transactions or preferred capital kind of creative ways that so sponsors or partners have kind of come in that kind of as we bridge the gap as the market remains. Obviously cautious. I mean, are those sorts of solutions? Has that been in any way in competition with the venture debt markets? Or is this capital that's coming in oh two to replace debt in any way? Or is this just should just kind of been seen more or less, you know, a bridge to the next financing round?

Gerald Michaud

Yes. I guess as I think about our own portfolio. I would say that it's not in competition with the debt. We are often asked on in combination with some sort of equity transaction with whether it be convertible debt or and some sort of bridge to potentially help them with modified terms. It's going to extend the runway of our portfolio company and get them to a yes, some sort of inflection point. So it's definitely not in competition with us on at all relative to our own portfolio as we're seeing new transactions come into the market. And this is when we talked about the top of the funnel really being quite robust right now.
We are seeing some, I think, a reality check from the equity markets. I think from during 2023. They went out to the debt market on many occasions and unfortunately find out that there wasn't enough support from the equity holders to get venture debt. The venture debt market excited about a lot of companies that we're actually doing pretty well, but just didn't have the liquidity that they gave us gave us meaning us the market, the debt market comfort.
So I think we're starting to see some of that now with they're coming back to the market and with somebody a portfolio companies where they're making a realistic attempt to provide significantly liquidity and asking the venture debt market to provide some additional debt financing. And so we're starting to see those opportunities. It's a bit of a green shoot. We haven't we didn't see much of that '23 at all. So we're feeling side to build better.
I hope that's come across and about the top of our funnel. But as Dan mentioned because of everything that's taken place with a lot of these companies over the last year. Just trying to understand how to underwrite them at this point if market conditions for the Company and whatever their strategy is still is consistent with what we saw before, and that's taking a little bit longer. So in terms of funding activities, that could be to take take a little bit longer, be a little bit slower, but we are definitely seeing improvement in both more and more equity capital coming in for new companies. And if they realistically want to want to access the Internet.

Paul Johnson

Got it. Appreciate. That's a very helpful detail. That's all for me. Thanks.

Operator

Christopher Nolan, Ladenburg Thalmann.

Christopher Nolan

I want to follow up a Tuesday. I joined the conference late on to follow up on Paul's line of questioning. Are you seeing more deal flow from tech companies, which are looking to switch out debt financing from another BDC.

Daniel Devorsetz

So this is the end, of course, it's Chris. That's a common use of proceeds for venture debt is a refinances and different markets are used for different reasons. It Bucks primarily when we're looking at potentially replacing another lender, we want to make sure that we're not refinancing a problem account to it. Just replacing debt for debt is not is not of good use of our funds, but if it's and natural progression from a smaller lender to a larger lender where you're both three, three placing debt from providing growth capital as well, oftentimes with additional equity, that's that's the types of opportunities we do look at there are there are deals coming to market where it is a straight swap and that is usually a bad sign that the existing lender doesn't want to reopen. And those are situations where we would avoid.

Christopher Nolan

And also, I guess as a follow-up question on the venture debt market, at least as it pertains to BDC, seem to be really bifurcated, you get some of the larger players who seem to have real pricing power and lower cost of capital there, just getting no better deal flow ein general, how you guys compare competing with that? I mean to offer lower rates? Do you offer real easy terms and conditions for me? Because it seems like there's a real separation between some of the higher larger players and then a lot of the others, but

Gerald Michaud

You know, essentially and there's really only one larger player. But I think basically the market is relative to BDCs is pretty much a set market I think we can compete. We certainly can compete with and any venture lender relative to price. Some size becomes an issue. Obviously, we don't want to be doing transactions that are just, you know them to larger percentage of our own portfolio. We actually pay very close attention to our top 10 investments in the portfolio at all times to see where we are our ability to raise to raise capital is Dan Proglio mentioned earlier, has actually been pretty good in a really difficult market.
We did a follow-on equity rounds last year in a difficult market and we've been using our ATM to continually raise capital. So I think we have liquidity to fund transactions and can be competitive. And I know I don't think we are actually being competitive. We're competing for deals every day. So we have a sense of what's out there in the marketplace and so we can. So I think size is probably one that did yes. In fact, it does impact our ability.
I think the other thing that has changed in our market is the tech banks, you know everything that's happened since the SVV. situation last year, they are still trying to settle in on where they want to be in the market. And we have seen more collaboration and relative to working with tech banks than we had seen prior to SVVM. So there's opportunity here for us and there's a situation where we can be very price competitive because we can use some sort of combined on price between the bank and Horizon to be to provide very attractive financing for Venture capital-backed companies.

Christopher Nolan

Yes. Okay.

Operator

Thank you. There are no further questions. I would now like to turn the call back over to Robert Pomeroy's, Chairman and CEO, for closing comments.

Robert Pomeroy

Thank you all for joining us this morning. We appreciate your continued interest and support in Aurizon, and we look forward to speaking with you again soon. This will conclude our call.

Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation and you may disconnect your lines at this time.