Horizon Technology Finance Corp quarterly report, Q3 FY2023

Horizon Technology Finance Corporation — 2023 Q3 Form 10-Q Summary

Business context and reporting period

Horizon Technology Finance Corporation is an externally managed, non-diversified business development company and regulated investment company that primarily provides secured venture loans to development-stage companies in technology, life sciences, healthcare information and services, and sustainability. The filing covers the three and nine months ended September 30, 2023, compared with the same periods in 2022.

Key financial metrics

Metric	Q3 2023	Q3 2022	Nine months 2023	Nine months 2022
Total investment income	$29.1 million	$23.3 million	$85.3 million	$56.0 million
Net investment income	$17.4 million	$11.1 million	$46.4 million	$25.4 million
Net realized gain/(loss)	$(11.8) million	$(8.6) million	$(28.5) million	$(9.5) million
Net unrealized appreciation/(depreciation)	$(17.5) million	$3.4 million	$(24.4) million	$1.2 million
Net increase/(decrease) in net assets from operations	$(12.0) million	$6.0 million	$(6.5) million	$17.1 million
Net investment income per share	$0.53	$0.43	$1.54	$1.06
Distributions declared per share	$0.33	$0.30	$0.99	$0.90

Net investment income margin was approximately 59.6% in Q3 2023 versus 47.9% in Q3 2022, and approximately 54.4% for the first nine months versus 45.4% in the prior-year period.
Investment income benefited from a larger portfolio, higher prime rates, and increased payment-in-kind interest. Q3 PIK interest was $3.9 million; nine-month PIK interest was $6.1 million.
Investment fair value was $729.1 million at September 30, 2023, versus $720.0 million at December 31, 2022. Debt investments represented $679.8 million of fair value.
Total assets were $797.2 million and net assets were $346.6 million at September 30, 2023, compared with $766.8 million and $318.4 million, respectively, at December 31, 2022.
NAV per share declined to $10.41 from $11.47 at year-end 2022, primarily reflecting realized and unrealized investment losses and distributions.
Cash, money market funds, and restricted money market funds totaled $50.1 million at September 30, 2023. Unrestricted cash and money market funds totaled approximately $47.3 million.
Operating activities used $16.5 million of cash in the first nine months of 2023, while financing activities provided $36.1 million. Ending cash, cash equivalents, and restricted cash increased to $50.1 million from $33.2 million at September 30, 2022.
Borrowings outstanding were $439.7 million before debt issuance costs, or $435.5 million net, versus $439.3 million before costs and $434.1 million net at December 31, 2022. Asset coverage for borrowed amounts was 179%.
Available borrowing capacity, subject to facility terms and advance rates, was approximately $38.3 million under the Key Facility and $5.1 million under the NYL Facility.

Material changes versus the prior comparable period

Q3 investment income increased 25.3%, and nine-month investment income increased 52.2%, driven by portfolio growth and higher floating interest rates.
Q3 net investment income increased 55.9%; nine-month net investment income increased 82.5%. Interest expense increased 33.1% in Q3 and 64.8% for the first nine months because of higher average borrowings and higher funding costs.
Performance-based incentive fee expense was zero in Q3 2023 versus $2.8 million in Q3 2022. The incentive fee cap and deferral mechanism reduced expense by $3.5 million in Q3 and $6.8 million for the first nine months. The contingent amount subject to potential future recoupment was $7.8 million at September 30, 2023.
Investment losses materially worsened. Nine-month realized losses increased to $28.5 million from $9.5 million, while unrealized results shifted from $1.2 million of appreciation to $24.4 million of depreciation.
The portfolio’s composition shifted toward software and healthcare-information investments, while biotechnology exposure declined. Senior Term Loans represented 87.4% of debt investments at fair value.
The company issued 3.25 million common shares in a June 2023 follow-on offering for net proceeds of $38.9 million and sold 2.24 million shares through ATM programs during the first nine months for approximately $26.1 million of net proceeds.
In September 2023, the company replaced its prior ATM agreement with a new agreement authorizing up to $150 million of common-stock sales; approximately $146.8 million remained available at quarter-end.
The Key Facility commitment increased to $150 million, with an accordion feature potentially increasing total commitments to $300 million. The NYL Facility commitment increased to $250 million and its maturity was extended to 2029.

Guidance, outlook, commentary, risks, and unusual items

Management stated that current cash, operating cash generation, and available credit facilities should be sufficient to meet working capital and capital commitments for at least the next 12 months. No earnings or portfolio-growth guidance was provided.
Three investments were on non-accrual status at September 30, 2023, with aggregate cost of $43.6 million and fair value of $17.2 million. Two debt investments had the lowest internal credit rating, with aggregate cost of $41.5 million and fair value of $15.5 million.
The company recorded significant losses because several portfolio companies ceased operations after being unable to raise additional capital. Management also identified continued exposure to portfolio-company credit risk, valuation uncertainty, and dependence on additional financing by borrowers.
Approximately 95% of outstanding debt-investment principal carried floating rates. Management estimates that a 100-basis-point increase in rates would increase annual net assets from operations by approximately $6.0 million before incentive-fee effects; a 100-basis-point decrease would reduce them by approximately $5.1 million.
Unfunded commitments totaled $181.8 million at quarter-end, including $134.3 million due within one year. Commitments are generally subject to milestones and may expire without being drawn.
On September 13, 2023, New Aerofarms assumed Horizon’s Aerofarms debt investments in connection with a bankruptcy-related asset purchase. In September, Horizon and a co-lender also acquired substantially all of IMV’s assets through HIMV LLC; Horizon owns 70% of that entity.
After quarter-end, Evelo Biosciences repaid $11.0 million of loan principal. The fair value of Horizon’s Evelo equity investment declined to $1.1 million as of October 30, 2023, from $8.5 million at September 30.
Other principal risks include inflation and supply-chain disruption, geopolitical uncertainty, changes in interest rates, funding-market access, financial-institution liquidity events, regulatory and tax-status requirements, valuation of predominantly Level 3 investments, and the ability to maintain RIC and BDC status.
The company reported no material legal proceedings, no defaults upon senior securities, effective disclosure controls, and no material changes in internal control over financial reporting.

Important facts for investors to verify

Reconcile the $24.4 million nine-month unrealized depreciation and $28.5 million realized loss with the detailed portfolio valuation and non-accrual disclosures.
Assess whether the $7.8 million contingent incentive-fee liability could become payable and how future investment performance affects the fee cap.
Review near-term liquidity against $181.8 million of unfunded commitments and scheduled debt obligations, particularly the Key Facility revolving period ending June 2024.
Evaluate credit quality of the two rating-1 loans and the three non-accrual investments, including collateral values and expected recoveries.
Monitor NAV per share, distribution coverage, spillover income of $1.23 per share, and whether distributions remain supported by taxable investment income and cash receipts rather than PIK or other non-cash income.
Review the effect of the Advisor’s acquisition by an affiliate of Monroe Capital, related-party fees, earnout arrangements, and potential co-investment conflicts.
Verify subsequent developments affecting Evelo, New Aerofarms, IMV, and other distressed or highly valued Level 3 portfolio investments.