Horizon Technology Finance: Summary of IQ 2018 Results
- Press Release 10-Q Filing Conference Call
The BDC Reporter previewed the IQ 2018 results of Horizon Technology Finance (HRZN) on April 13, 2018 following a periodic “portfolio update from the BDC. As is typical in these situations, we were right about a number of items, wrong about others and left plenty out. After a full review of the actual results, reading the 10-Q and reading the Conference Call transcript, here is our review of HRZN’s performance, and how the results compare to our projections for 2018. Earlier in the year – following the IVQ 2017 results, we projected 2018 Net Investment Income Per Share would drop to $0.87, from $1.07 in 2017 and $1.48 in 2016.
Origination activity was very tepid the first quarter of 2018, with just $11mn funded in the period to 3 companies. (Last year at this time the figure was $73mn ! ). After $18mn of investment sales and repayments, the size of the portfolio dropped, both in total and in debt terms. Three companies left the portfolio as well, but no equity or warrants gains were booked, but ETPs (End Of Term Payments) were, as we’ll discuss below. One of the loans repaid (Lantos Technologies) was in the form of a refinancing, a development always worth noting just in case the BDC is keeping the borrower “alive” with by rolling over debt. Debt investment outstandings have dropped marginally as we expected. We projected $190mn, the balance came in at $193mn and below $204mn in prior quarter.
Investment Income was up from the prior quarter at $7.2mn. However, that was boosted by the way HRZN accounts for revenue. There were $500,000 in fees accelerated (success fees & ETPs) in the period. That was higher than usual and speaks to the very uneven earnings that the BDC achieves. If there had been no prepayment related fees both revenues and net earnings would have been very different. The average portfolio yield over the past yield has been on the decline, as pointed out by an analyst on the Conference Call. Some of that is attributable to how income is booked, as discussed above. However, part of the reason – according to comments made by management – is an attempt to book “safer” loans of late. That’s what HRZN President Michaud said:
“I think we’ve talked about this really for the last year, we have become far more strategically focused on what parts of the venture technology and life science spaces that we’re interested in investing in, and we are looking for higher quality opportunities with better strategic alliance with the investors, and so that does–those deals are in fact going to be a little bit more competitive and a little bit more price sensitive.”
Expenses were $4.0mn in the period. Costs were kept down by the impact of Incentive Fees being partly reduced by the look-back feature in the compensation arrangement. That saved the BDC $0.2mn in the period. (Nonetheless Incentive Fees were still $0.545mn in the quarter). The interest rate on the BDC’s Revolver increased by 0.31% in the quarter thanks to the rise in LIBOR, adding to the cost of debt. Other expenses were in line with prior periods.
Net Investment Income was $3.2mn, or $0.28 on a per share basis. That’s substantially higher than the prior quarter ($0.21) which had been impacted by the cost of refinancing HRZN’s Unsecured Notes, which added ($0.06) per share in “extraordinary” costs. That’s higher than we anticipated. We guessed HRZN would be pressed to reach $0.27.
Net Debt to Equity was much unchanged at 0.71X and close to traditional self imposed limits. Debt outstanding was divided between the secured Revolver and the Unsecured Notes.
Distributions continue to outstrip the $0.30 quarterly distribution and Undistributed Taxable Income is minimal: equal to $0.07 a share.
Overall, there are 32 loans on the books, down from 33 in the prior quarter.There are 80 warrants and other non-income producing investments.
Credit-wise, the BDC claims to have no loans on non-accrual. However, the 10-Q shows two $173,000 loans to Mederi Therapeutics as being on non-accrual. Both are valued at par. On the Conference Call, management said the footnote indicating a non-accrual status was a mistake.
The BDC’s own Debt Investment Quality Table shows a material downward change in the quarter. Loan investments rated 2 increased from 3 to 5 and the dollar value at FMV jumped from $5.6mn to $21.4mn or 11.1% of all debt investments. Nothing was rated in the lowest category, an improvement from the prior quarter when there was 1 investment at a value of $2.9mn.
Here are the Watch List credits we’ve identified, and which may – or may not – match up with HRZN’s own under-performing company list:
Signix,Inc., which has a cost of $2,025,000 is valued at $1,640,000, down from $1,930,000 the prior quarter. This is a long standing borrower (2014) and the senior debt was extended to 2020 in IIIQ 2017 and was lat valued close to par in 2016. The current discount to par is (19%), the highest yet recorded in quarterly valuations. We have added the Company to our Watch List.
Next, vTv Therapeutics – according to the Conference Call – was the main company which was moved to a 2 rating on HRZN’s scale in the first quarter. Total exposure at cost is $10.0mn in debt and equity. The latter was valued at a premium to cost just a quarter ago and has now been written down by (73%). However, most of the exposure in in debt which has been only modestly written down. We have added vTv to our Watch List.
Decisyon, Inc., which HRZN has $3.7mn of exposure to, also saw its equity tranche written down and has been added to our Watch List.
Stereo Vsion.Inc. was also invested in and written down modestly within the quarter, closing at a FMV of $3.483mn.
Besides these individual names, we remain concerned about portfolio concentration risk, which affects both book value and income. At March 31, 2018 the 5 largest investments accounted for 32% of of total debt investments.
Earnings started out 2018 ahead of our projections, albeit still below the level of the quarterly distribution. Again. However, lower pre-payment activities in the rest of the year; continuing pressure on loan yields and higher borrowing costs may cause earnings in future periods to be lower. Also, looking at the BDC’s Risk Profile, the credit trend is negative, but it is too early to tell if the Watch List credits on the books will result in actual Realized Losses or a reduction in income. The upside potential is an unexpected series of investment pay-offs which would boost investment income because of greater-than-usual fee and end of term accelerations. We’ll leave aside for the moment the potential impact on earnings from 2019 if the BDC leverages up under the new BDC rules. The Investment Advisor seems keen to proceed and the high yields on venture debt might cause those new assets purchased to be accretive. However, the risk in the portfolio would increase proportionately. If HRZN seeks out “safer loans” in venture lending, just how the economics might work are unclear.
The market does not appear to have been enthusiastic about HRZN’s results. The stock price has dropped to $10.06 at the close on May 2, 2018, down from $10.36 before the earnings release. However, HRZN was already headed downward since early 2018 when the price peaked at $11.81 (intra-day). The stock is down (15%) from that 2018 high. The stock pays a 11.9% dividend. This suggests investors have largely expected a dividend reduction for some time and have not been convinced otherwise by the latest quarterly results.
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