Runway Growth Finance Corp. Q1 FY2022 Earnings Call

Thank you, operator. Good afternoon, everyone, and welcome to the Runway Growth Finance Conference Call for the first quarter ended March 31, 2022. With us on the call today from Runway Growth Finance are David Spreng, Chairman, Chief Executive Officer, Chief Investment Officer and Founder; and Tom Raterman, Chief Financial Officer and Chief Operating Officer. Runway Growth Finance's first quarter 2022 financial results were released just after today's market close and can be accessed from Runway Growth Finance's Investor Relations website at investors.runwaygrowth.com. We have arranged for a replay of the call at the Runway Growth Finance webpage or by using the telephone number and passcode provided in today's earnings release. During this call, I want to remind you that we may make forward-looking statements based on current expectations. The statements on this call that are not purely historical are forward-looking statements. These forward-looking statements are not a guarantee of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements including, and without limitation, the uncertainty surrounding the COVID-19 pandemic and other factors we identify from time to time in our filings with the SEC. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of the assumptions can prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained on this call are made as of the date hereof, and Runway Growth Finance assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of SEC-related filings, please visit our website. With that, I will turn the call over to David.

Thank you, Mary, and thank you all for joining us today. I'm pleased to provide an update on our first quarter results and our outlook for the rest of the year. Runway Growth had a tremendous start to 2022, making significant progress towards our business objectives in the first quarter against a backdrop of volatility in the equity capital markets. We continue to originate high-quality loans in a competitive growth lending environment, increase our investment portfolios with already market-leading credit quality and thoughtfully utilize leverage to drive portfolio growth and expand ROE for our shareholders. The value of the Runway Growth brand is gaining even more traction in the marketplace as more companies fully understand our differentiated and durable model. We believe we have a unique opportunity to further position our venture lending products as an attractive and optimal capital solution for rapidly growing companies given the slowdown in equity capital markets activities in the first quarter and concerns surrounding inflation, increasing interest rates and geopolitical uncertainty. During the first quarter, we completed seven investments in new and existing portfolio companies, representing $135 million in new commitments, including $83.5 million in funded loans. We funded all investments in the first quarter with proceeds from our revolving credit facility as part of our ongoing strategy to fund prudent portfolio growth with leverage. Notably, we doubled our core leverage ratio quarter-over-quarter to 26.1%. We recorded record total and net investment income of $19.3 million and $12.5 million at the end of the first quarter, up 17% and 8.5%, respectively, from the prior year period. Net assets were $597.5 million at the end of the first quarter, up 26% from $473.5 million at the end of the first quarter 2021. Runway Growth is a credit-first organization with what we believe to be the latest stage, lowest risk portfolio among the public venture debt BDCs, with a weighted average loan-to-value at origination of 16.3%. In addition, at the end of 2021, approximately 90% of our underlying investments were well-protected, first lien senior secured loans, which compares to an average of 72% first lien loans for the other public venture debt BDCs. Runway Growth is building a prudent platform with best-in-class underwriting rigor, and we believe our portfolio composition underscores that. Our credit quality continues to be very strong. And in the first quarter, our weighted average risk rating for the portfolio improved again, down to 1.98 from 2.04 in the fourth quarter. Our risk rating system is based on a scale of 1 to 5, where 1 represents the most favorable credit rating. This is a testament to our investment strategy, focusing on recession-resistant, late-stage companies, as well as our team's disciplined diligence in the underwriting process and active monitoring of our investments to prevent losses and keep strong companies in the portfolio. Runway is as committed as ever to our overall investment strategy and focus on the fast-growing sectors of the economy we know best, including life sciences, technology, and select consumer service and product industries. We were particularly pleased to originate two new loans in the life sciences sector in the first quarter to Mustang Bio and Revelle Aesthetics. Life sciences has been an integral part of our strategy from the beginning. Personally, I have a long history in life science investing. I was Chairman of a publicly traded biotech company and helped found a medical device incubator with Medtronic. Runway made its first life sciences investments in 2018 when we financed CareCloud, Mingle Health and Mobius Imaging, one of which is a healthcare IT company, one is a healthcare services company and one is a medical device company. We continue to capitalize on strong originations activity in the life sciences space due to our deep bench, industry knowledge, extensive network and unparalleled reputation. Runway Growth has strategically grown our originations team to enhance prudent portfolio growth, and our strategy remains the same going forward. A reminder that we source our investments across three distinct lending verticals. First, late and growth-stage VC-sponsored companies, seeking an alternative or complement to equity to minimize dilution; second, non-sponsored companies, which give more time to source, but generally provide more favorable terms and conditions for the lender; and third, PE-backed companies with great potential, but insufficient cash flow or assets to support loans from their traditional lending sources. We introduced the latter on our last call. And while we do not originate new loans to PE-backed companies in the first quarter, we remain excited about this new vertical. PE-backed companies are increasingly looking to flexible loan options to fund capital-efficient growth, and Runway can help structure the right loans to provide growth capital to get to the next level of operational success. In terms of what we're seeing in the market overall, the contraction of multiples in the public equity markets is impacting liquidity in terms for late-stage venture rounds, while having little material impact for us on loan-to-value and portfolio valuation. In the first quarter, as our dollar weighted average portfolio enterprise value declined by 5.8%, our strong dollar weighted loan-to-value was up only 3.9%. Remember that our valuation is based on our methods, not the value assigned by VCs in the last round. From a spread perspective, we continue to see a stable environment attributed to our focus on late and growth stage companies with sound fundamentals. Runway has proven risk mitigation methods that have provided consistent and attractive returns for shareholders during the previous times of stress, most recently during the COVID-related market volatility of 2020. And we are confident in our ability to execute against macroeconomic headwinds. I'd like to spend a moment on our outlook for 2022 before passing it to Tom to review our financial results. We believe the current market environment is set to benefit Runway Growth. According to Pittsburgh, U.S. venture-backed companies attracted $71 billion in financing in the first quarter, indicating a slight downturn from the record levels seen in 2021, yet still well above 2020 activity. With funding starting to pull back, we're also seeing more conservative views when it comes to VC equity valuations. Every day, we hear feedback from late-stage companies that they are being compared to public market valuations, making equity financing options much less attractive. Runway is strategically positioned to benefit from the decline in VC equity valuations as more late-stage companies turn to the private markets for the crucial capital needed to fund their next phase of growth. We want to reiterate our view that in the rising rate environment, debt remains cheaper than equity, and we believe that the cost differential between debt and equity capital will be further magnified going forward. Runway Growth is prepared to capitalize on these tailwinds and we'll continue to focus on driving value for our shareholders.

Thanks, David, and good afternoon, everyone. Runway Growth completed seven investments in new and existing portfolio companies in the first quarter, which is traditionally a slower quarter, representing $135 million in new commitments, which resulted in $83.5 million in funded loans. As David mentioned earlier, each investment was funded with proceeds from our revolving credit facility as part of our ongoing strategy to fund prudent portfolio growth with leverage. Runway's weighted average portfolio rating further improved for a second consecutive quarter to 1.98 in the first quarter as compared to 2.04 in the fourth quarter of 2021 from 2.20 in the third quarter of 2021. As of March 31, 2022, we had one portfolio company on nonaccrual status. At the end of the first quarter, our total investment portfolio, excluding U.S. treasury bills, had a fair value of approximately $754.3 million compared to $684.5 million at the end of 2021 and $590.1 million at the end of the first quarter 2021, representing increases of approximately 10% and 28%, respectively. As of March 31, 2022, Runway Growth had net assets of $597.5 million, decreasing slightly from $606.2 million at the end of the fourth quarter. NAV per share was $14.45 at the end of the first quarter compared to $14.65 at the end of the fourth quarter 2021. The majority of the decline in NAV per share was the result of the decline in valuations of our public equity portfolio. In the first quarter, we received $8.4 million in prepayments, inclusive of interest, fees and proceeds from the exercise and sale of warrants, which compares to $94.1 million in the fourth quarter of 2021. This slower pace of prepayments resulted from increasing credit spreads in the bank market, volatility in both public and private equity markets, which slowed potential refinancings and slowed M&A markets. We do have a number of portfolio companies that are evaluating an M&A process and could see a number of deals completed in coming quarters. In the first quarter, we generated total investment income of $19.3 million and net investment income of $12.5 million compared to $16.4 million and $11.5 million in the first quarter of 2021, driven by an increase in the size of our portfolio of $164.1 million or approximately 28%. Our debt portfolio generated a dollar weighted average annualized yield of 12.2% for the first quarter of 2022 as compared to 13.5% for the first quarter 2021. Moving to our expenses. For the first quarter, total operating expenses were $6.8 million, increasing from $4.9 million for the first quarter 2021, driven by an increase in debt financing fees due to our increased leverage and fees incurred pertaining to amendments of our credit facility that have resulted in more favorable terms. Our performance-based incentive fee was $1.3 million for the first quarter compared to $1.0 million for the first quarter of 2021. Our base management fee was $2.6 million, up from $2.1 million in the first quarter of 2021 due to the increase in the average size of our portfolio. Runway had a realized loss of $0.4 million for the first quarter, which compares to a realized loss of $0.2 million for the first quarter of 2021. We recorded net unrealized depreciation of $9.2 million in the first quarter, which was the result of the decline in the value of our equity portfolio, driven primarily by two public holdings. Turning to our liquidity. Our total available liquidity as of March 31, 2022 was $132.5 million, including unrestricted cash and cash equivalents and a borrowing capacity of $129 million under our credit facility, subject to existing terms and conditions. This compares to $158.7 million and $154 million, respectively, at December 31, 2021. Weighted average interest expense was 3.9% at the end of the first quarter, increasing from 3.8% for the fourth quarter 2021. End-of-period leverage was 26.1% and asset coverage was 483% as compared to 13.4% and 582% at the end of fourth quarter 2021, respectively. As mentioned earlier, all investments in the first quarter were funded with proceeds from our revolving credit facility as part of our ongoing strategy to fund prudent portfolio growth with leverage. Subsequent to the quarter end, we amended our credit facility with KeyBank to extend the maturity and increase the current size of the credit facility to $225 million and the accordion provision to $500 million. We anticipate reaching our core leverage target for the portfolio, which is between 0.8 and 1.1x by the fourth quarter of this year or the first quarter of 2023. Before considering prepayments, we have the ability to grow our portfolio by approximately $500 million without exceeding our core leverage targets and returning to the equity markets. A quick note on interest rate sensitivity. Our loan portfolio is comprised of nearly 100% floating rate assets and will benefit from increasing interest rates as levels continue to move beyond our contractual interest rate floors. Slide 20 of our investor deck provides a look at our earnings as rates increase. As mentioned on our fourth quarter call in early March, our Board of Directors approved a stock repurchase program in late February to acquire up to $25 million of Runway Growth common stock. The program expires on February 23, 2023. Management and the Board wanted to have a program in place to strategically buy back shares as the company sees fit based on the market dynamics underpinning our overarching goal of creating long-term shareholder value. Finally, on April 28, 2022, our Board declared a dividend distribution for the second quarter of 2022 of $0.30 per share, an 11% increase from our first quarter dividend of $0.27 per share and a second consecutive quarterly increase in our dividend as a public company. We expect that with continued portfolio growth driven by increased leverage, we will be able to continue to expand the dividend in coming quarters. This concludes our prepared remarks. We'll now open the line for questions.

First question on the credit profile. I think the name came off nonaccrual, correct me if I'm wrong. You still had some portfolio NAV headwinds, however. So seeing if you could break down how much idiosyncratic this was versus market or base rate or multiple market based.

Yes, absolutely. So this is David. I'll make a first comment on the specific company and then turn it over to Tom. So the company that went off accrual as of 1/1/22 is Mojix, and for us, it's a really positive story. We're super fortunate that we've had very, very few credit situations because of our focus on very late stage, less risky companies and our underwriting discipline and our portfolio monitoring. But Mojix is a company that went on nonaccrual, stayed there for a while. We worked very closely and, I would say, patiently and productively with the equity sponsors to find a solution. And very happy to say today, like hours ago, we received a wire for a full return of principal and interest. So went off of nonaccrual in January and was repaid in full today. So it's a great example of our skills in working with the rare event of a troubled credit. Let me turn it over to Tom to talk about financial stuff.

Yes. Fin, the change in NAV from $14.65 to $14.45 was really driven—about $0.17 of that was driven by a change in the public equity holdings, primarily the value of our holding in Brilliant Earth and in CareCloud.

Okay. That's helpful. And just a follow-up. David, you gave some high-level color on how the market is behaving given the events that have been more intense post quarter. But a question, sorry if I missed it, is how does this impact your outlook or ambitions for reaching target leverage? When do you think that milestone would be reached now versus where you thought it would last quarter?

Yes. So it's a great question. I think we have a more pessimistic view on what's happening in the venture equity markets than a lot of people. And we're in the trenches seeing late-stage, venture-backed companies struggling to achieve the valuations that they hope for. As a result, the equity is more expensive than it has been and makes our value proposition even better. And so our funnel has never been better. So we're very optimistic about our ability to continue to originate very strong loans to an even higher quality of company and continue our focus on really late-stage, lower-risk companies in the industry sectors that we know well. And then continue to underwrite and monitor and manage those in a way to continue our success as having the lowest credit losses in the industry. So in terms of timing, we see nothing really has changed. But we are, I think, less optimistic than a lot of people in terms of their view on the venture equity side of things.

Hopefully, you can hear me. I'm on the road traveling. How would you say this dislocation compares to 2000? How does this rate so far on the Richter scale?

It's not nearly as severe as it was in 2000. Back then, we saw 95% of the public market value lost in certain sectors, especially in Internet and telecom companies, which isn’t happening now. In the current environment, private companies are much more established. In the late '90s and 2000, many funded concepts were unproven and unstable, requiring massive amounts of capital to follow through on their plans. When liquidity became scarce, those ventures failed. Today, we aren't witnessing that level of collapse. Therefore, I don't believe this correction or reset is as serious as it was then. However, it is prompting venture capitalists to reassess their investment strategies. We are already noticing them advising their companies to extend their financial runway and explore options for bolstering their capital, whether through equity or debt. In almost any market, the strongest companies will still manage to secure funding, but in the upcoming year, it’s increasingly difficult. This aligns with trends seen throughout the investment community, from limited partners to institutional investors facing challenges. There are around 2,900 venture firms, but only about 100 can raise funds at any time, leaving 2,800 firms looking for their next fundraising opportunities. This has made the investment process more cautious overall. To summarize, it's nothing like the situation in 2000 and 2001 yet.

Got it. Okay. And just as a follow-up, you mentioned the tick-up in LTV. It's not surprising. Do you have any sense of the variability of that or the obviously, the upside that we can see in that metric over time? How should we think about that?

Yes. So the change in LTV we reported was a 3.9% increase in LTV against a decline of 5.8% in total enterprise value. And that means that the median public peer group for the comps is down. And so there'll be some volatility in that. The reason that the LTV change is less than the decline in the enterprise value is because these companies are still continuing to grow. So there's a mitigating factor there. While on one hand, the multiple is going down, on the other hand, the companies are still performing very well. And we would expect that to continue just because of the quality of the companies that we lend to.

I have one question. Considering the current forward LIBOR and the steep curves, nominal rates on debt liabilities for portfolio companies could increase significantly in the near term. I would like to understand how much of that increase you believe private lenders like Runway will retain compared to any spread compression that might occur to assist borrowers during these volatile times.

Yes, I would say that we have worked diligently to establish a resilient portfolio that can withstand economic downturns. We continuously assess our portfolio's capacity to handle challenges such as rising interest rates and wage inflation, and we evaluate fixed versus variable costs to see how companies can manage their expenses in different economic conditions. Currently, we have not observed spread compression. If interest rates rise significantly, borrowers may request it, but a couple of years ago, rates were predicted to increase. We believe we can adjust accordingly. You might see instances where borrowers negotiate slightly tighter spreads but in exchange for higher back-end fees or larger warrants, and we are open to those discussions. However, our top priority remains credit quality. If we can offer a slightly better rate while securing a back-end fee that compensates for it, maintaining our overall return and lowering risk, we are amenable to that approach. Thus far, we haven't encountered this situation.

I'm curious to hear you talk about the health portfolio companies in terms of their ability to sort of weather the impact of higher inflation. And what are you seeing in terms of cash burn rates and other sort of KPIs that you think are relevant to your portfolio?

Melissa, it's a great question. And as I said, it's something that we spend a lot of time thinking about both for the existing portfolio and for new investments. We're fortunate that most of our companies don't have big cost of goods sold. But certainly, we, just like pretty much the rest of the economy, see wage inflation. It's certainly not new to Silicon Valley. That's been a fact of life for a long time. We've done some work, which I think Tom can talk about in terms of the impact that that is having on our portfolio and how it may play out, but we feel really good about where we are positioned today with a strategy that starts with recession-proof industries and then ends up with a weatherproof portfolio. And maybe, Tom, if you want to comment.

The key is starting with a very low loan to value, meaning the debt portion of these borrowers' capital structure is quite small. We're at around 16% at the time of origination. When we examine the percentage of interest relative to the total cash burn, our weighted average was about 10% to 11%. Therefore, interest constitutes a small part of the overall expenses. Additionally, the cash burn as a multiple of revenue is under 1x, and interest expense is typically less than one-third of the cash balance. Consequently, these borrowers are in a solid position going into this. From an inflation standpoint, we assess them not only from an expense angle but also from a revenue perspective. This evaluation is conducted upfront during the underwriting process, breaking down revenue and products to ensure they are truly mission-critical and capable of enduring potential price increases. This applies to our life sciences portfolio and our tech portfolio, where often these are essential enterprise-level software companies that can't be deprioritized during renewals, despite rising expenses.

That makes sense. A separate question, the exits and repayments were quite low this quarter. I'm just wondering if you are expecting any sort of catch-up period on that over the next few quarters to normalize after what was a very low level in the first quarter.

Yes, absolutely. And it's a great question. And as we always say, and as you alluded to and you know well, it's very difficult to predict prepayments. But I think we see certainly more than we had in Q1 coming over the subsequent quarters. It's difficult to predict exactly. But we have a number of extremely strong companies in our portfolio that could refinance us or could be acquired. And that's the kind of thing that's hard to predict. But I do think that you're right in assuming that it will probably go up from here.

Okay. And one last question, if I could. With the issuance of the unsecured, can you remind us how you think about sort of ideal funding split between a revolver or a similar facility and secure?

Yes. Well, the $70 million unsecured note offering was our inaugural, unsecured note offering, and we used the 482 market, and we were pleased. We went out for 50, and we were able to accept offers for $70 million of notes. We wish it would have been $170 million in retrospect, but that's not where the market was. So we will go out for more unsecured paper at some point during this year, one, to extend our maturities; two, to increase that fixed rate component; and three, because at least as it stands today, we do have a limit of 80% secured financing. So we'll use a combination of fixed and floating rate, and we'll be very opportunistic about when we do it. We have now an effective end to the generic BDC shelf. So we can really access any market for unsecured. We could do registered, unregistered, we could do a $25 par, $1,000 par. So we're going to be opportunistic about it. But today, with the amendments to the revolver, it's the cheapest source of funding. But I would think over time, we would want to get to a mix of about 50% unsecured and 50% secured.

And I'm showing no further questions at this time. I will now turn the call back over to our CEO, Mr. David Spreng, for closing remarks.

Thank you, operator, and thank you all for joining us today and for your support of Runway Growth. We hope everyone stays safe and healthy and look forward to updating you on our second quarter results in August.

And this concludes today's conference call. Thank you for participating. You may now disconnect.