Horizon Technology Finance Corp annual report, FY2022

Horizon Technology Finance Corporation — 2022 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended December 31, 2022, and was filed February 28, 2023. Horizon is an externally managed, non-diversified business development company and regulated investment company that provides secured venture loans to development-stage companies in technology, life science, healthcare information and services, and sustainability industries.

At December 31, 2022, the portfolio included 60 debt investments with a fair value of $686.5 million; 90.2% consisted of senior term loans.
Total portfolio investments, including warrants, equity and other investments, had a fair value of $720.0 million versus $458.1 million in 2021.
The Company also held warrants in 90 portfolio companies, equity interests in eight companies and success-fee or royalty arrangements.
The Company had 27,753,373 common shares outstanding and NAV per share of $11.47 at year-end.

Financial performance and key metrics

Metric	2022	2021	Change
Total investment income	$79.2 million	$60.0 million	+32.0%
Total expenses	$42.3 million	$31.4 million	+34.7%
Net investment income	$36.2 million	$28.2 million	+28.2%
Net realized loss	$(9.5) million	$(3.6) million	Higher loss
Net unrealized depreciation	$(5.6) million	$3.2 million appreciation	Negative swing
Net increase in net assets from operations	$21.2 million	$27.8 million	Lower by 23.9%
Net investment income per share	$1.46	$1.41	+3.5%
Distributions declared per share	$1.28	$1.25	+2.4%
Total return based on market value	(19.3)%	29.7%	Significant decline

Debt investment yield on average investments was 14.4%, compared with 15.7% in 2021; overall portfolio yield was 13.8%, compared with 15.0%.
Interest income increased to $77.4 million, primarily because average debt investments increased by $168.9 million, or 44.3%.
Fee income fell to $1.8 million from $5.6 million, principally because of lower prepayments.
Interest expense increased to $19.2 million from $12.0 million as average borrowings rose 50.0% and borrowing costs increased.
Net assets increased to $318.4 million from $245.3 million, largely reflecting equity issuance and operating results, while NAV per share declined from $11.56 to $11.47.

Cash flow, debt and liquidity

Operating activities used $246.3 million of cash, primarily to fund portfolio investments.
Financing activities provided $229.5 million, including debt issuance, credit-facility advances and equity offerings, partially offset by debt repayments and distributions.
Cash, unrestricted money market funds and restricted money market funds totaled $30.5 million at year-end, compared with $47.3 million in 2021. Unrestricted cash and money market funds were $27.7 million.
Borrowings totaled $439.3 million before debt issuance costs, versus $260.3 million in 2021. Net borrowings were $434.1 million.
Year-end debt included $176.8 million under the NYL Facility, $5.0 million under the Key Facility, $42.6 million of 2019 Asset-Backed Notes, $100.0 million of 2022 Asset-Backed Notes, $57.5 million of 2026 Notes and $57.5 million of 2027 Notes.
Asset coverage for borrowed amounts was 172%, above the 150% BDC requirement.
Unused commitments under the Key and NYL facilities totaled $143.3 million, subject to facility terms and advance rates.
Unfunded portfolio-company commitments were $190.0 million, compared with $114.5 million in 2021. Management stated that available resources were adequate to satisfy these commitments and expected liquidity to cover at least the next 12 months.

Material changes versus the prior comparable period

The portfolio expanded substantially: total investments increased 57.2%, and debt investments at fair value increased from $437.3 million to $686.5 million.
New debt investments totaled $452.6 million, while principal payments, early payoffs and sales reduced investments by approximately $145.8 million before other adjustments.
The Company completed a $157.8 million loan securitization in November 2022 and issued $100.0 million of 2022 Asset-Backed Notes bearing a fixed 7.56% rate.
The Company issued $57.5 million of 6.25% 2027 Notes and raised $84.6 million of net equity proceeds, including $50.3 million through the ATM program and $34.3 million from a follow-on offering.
Credit quality weakened modestly: the weighted-average internal credit rating declined from 3.2 to 3.1. Three investments were rated 1 at year-end, with aggregate cost of $20.9 million and fair value of $8.3 million, compared with one such investment in 2021.
All 2022 debt investments were classified as floating rate. The Company reported that 100% of debt-investment principal was floating rate at year-end.
The Advisor became the valuation designee in July 2022, subject to Board oversight, under amended SEC Rule 2a-5.

Guidance, outlook, management commentary, risks and unusual items

The Company intends to continue monthly distributions, but the Board controls their timing and amount. The filing provides no earnings or distribution guidance beyond declared distributions of $0.11 per share for March, April and May 2023.
Management cited inflation, supply-chain disruption, rising interest rates, geopolitical uncertainty, the Russia-Ukraine conflict, recession risk and capital-market disruption as material risks to portfolio-company performance and financing access.
Higher rates may increase income on floating-rate investments, but may also increase borrower defaults, accelerate prepayments and raise the cost of the Company’s floating-rate debt.
Three debt investments were on non-accrual status at year-end, with cost of $20.9 million and fair value of $8.3 million. No interest income was recognized from non-accrual investments in 2022.
Approximately $6.3 million of investment income was non-cash, and 11.2% of interest and fee income resulted from non-cash original-issue-discount-related income. Such income can create distribution and liquidity pressure.
Level 3 investments totaled $716.3 million, representing the substantial majority of portfolio fair value. Valuation depends on significant unobservable assumptions, including market yields, cash-flow probabilities, company performance and warrant volatility.
The Company has substantial leverage, secured facilities, securitizations and unsecured notes. Defaults or covenant breaches could result in acceleration, cross-defaults, forced asset sales or restrictions on distributions.
Unfunded commitments may require cash at times when portfolio companies have limited access to capital. Securitization documents also contain repurchase obligations for breaches of representations and warranties and rapid-amortization triggers.
In February 2023, the Board approved a new advisory agreement subject to stockholder approval and the closing of the proposed sale of the Advisor to an affiliate of Monroe Capital LLC. Management did not expect the transaction to materially adversely affect the Company and expected the venture-lending strategy and investment personnel to remain in place.
Subsequent events included $6.6 million of January 2023 equity proceeds, loan prepayments by Canary Medical, Unagi and Embody, and new February 2023 debt investments of $5.0 million to BriteCore and $20.0 million to Noodle Partners.

Most important facts for an investor to verify

Whether the 2022 portfolio growth and higher net investment income are sustainable after considering increased leverage, lower portfolio yield and higher interest expense.
The current status, valuation and recovery prospects of the three non-accrual investments and the two investments with significant fair-value reductions noted in the investment schedule.
Liquidity available to fund the $190.0 million of unfunded commitments and upcoming debt obligations, including the Key Facility investment-period expiration in June 2024 and the 2026 Notes maturity in March 2026.
Compliance with the 150% asset-coverage requirement and all covenants governing the Key Facility, NYL Facility and securitizations.
The sensitivity of net investment income and NAV to interest-rate changes, borrower defaults, prepayments and valuation changes in Level 3 assets.
Whether distributions are fully supported by taxable income and cash receipts, given $18.8 million of undistributed taxable income, non-cash income and potential return-of-capital considerations.
Stockholder approval, closing conditions and final terms of the proposed advisory agreement and Advisor transaction.