Runway Growth Finance Corp. (NASDAQ:RWAY) Q3 2023 Earnings Call Transcript November 11, 2023
Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Runway Growth Finance Third Quarter 2023 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Taylor Donahue, [ph] Investor Relations. Please go ahead.
Unidentified Company Representative: Thank you, operator. Good evening, everyone, and welcome to the Runway Growth Finance Conference Call for the third quarter ended September 30, 2023. Joining us on the call today from Runway Growth Finance are Greg Greifeld, Acting Chief Executive Officer of Runway Growth Finance and Deputy Chief Investment Officer and Head of Credit of Runway Growth Capital; as well as Tom Raterman, Acting President and Chief Financial Officer and Chief Operating Officer. Runway Growth Finance’s third quarter 2023 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 web page.
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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, market conditions caused by uncertainties surrounding rising interest rates, the impact of the COVID-19 pandemic, changing economic conditions and other factors we identified in our filings with the SEC. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those 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 Greg.
Greg Greifeld: Thanks, Taylor, [ph] and thanks, everyone, for joining us to discuss our third quarter results. Before starting my prepared remarks, we want to provide an update on David Spreng, Runway Growth’s Chairman, Founder and Chief Executive Officer, who is on a medical leave of absence. We are pleased to share that David is doing well and has resumed select responsibilities at our external adviser, Runway Growth Capital. We look forward to and are hopeful for David’s return in the first half of 2024 and appreciate the ongoing support the investment community has provided during his recovery process. Today, I’ll provide third quarter 2023 highlights speak to the market environment and lastly, discuss our outlook heading into 2024.
Our third quarter results demonstrate the resilience of our credit-first investment approach that has been a guiding principle for Runway Growth since inception. While the U.S. economy has performed better than expected in 2023, market uncertainty remains elevated as the effects of a higher interest rate environment and tighter financial conditions play out. Our focus on underwriting low loan-to-value loans to high-quality companies has allowed us to build a portfolio that can continue to succeed and not just survive. We have always favored opportunities that have limited downstream financing risk, which has proven crucial for portfolio companies with unknown timing for exits or that require additional capital raises. Our patience in deploying capital during 2023 has been strategic and the current environment is more lender-friendly than earlier this year.
We expect this lender-friendly environment to continue into 2024 and we are beginning to see an increase in favorable investment opportunities. We believe Runway has maintained its position as a preferred venture debt lender with a steady hand enforced by our ability to deliver industry-leading credit performance with a late-stage portfolio focused on recession-resistant industries. We continue to believe Runway Growth represents a compelling opportunity for investors that are looking for stable risk-adjusted returns from partnering with the highest-quality growth companies in the market. Turning to third quarter operating results. Runway completed six investments in new and existing portfolio companies in the third quarter, representing $40.8 million in funded loans.
Originations and deployment activity during the quarter reflect our high bar for evaluating new investments to preserve credit quality while mitigating risk. Runway has built a strong track record of mitigating credit losses, which we attribute to our disciplined approach to loan structuring and rigorous underwriting process. Runway delivered total investment income of $43.8 million and net investment income of $22 million in the third quarter, representing an increase of approximately 62% and 52% from the prior year period. Net assets were $570.5 million at the end of the third quarter, down 1% from $573.9 million last quarter. Tom will provide a deeper look at our credit quality, but our weighted average portfolio risk rating increased slightly in the third quarter to 2.24 from 2.21 in the second quarter.
Runway’s loan portfolio is comprised of nearly 100% senior secured first lien investments and weighted average loan-to-value at origination is 18% across the entire portfolio. We continue to uphold our credit standards as we evaluate opportunities to expand the Runway Growth portfolio. Let’s turn now to the market outlook. According to recent PitchBook Data, U.S. late-stage venture equity deal value, which we view as a proxy for the venture debt market opportunity, was approximately $57 billion Q3 year-to-date. While deal value is down from record levels in 2021 and 2022, it remains above the comparable period in 2020 and preceding years. U.S. late-stage venture equity deal value represented 46% of total deal value for 2023 year-to-date and nearly one third of total deal count.
This is a continuation of the dynamic we’ve observed in recent quarters, more late-stage deals but at smaller values. This snapshot shows that the late-stage VC ecosystem is active. However, our team expects deal volume to accelerate into the middle of next year as companies that raised substantial equity in 2021 and 2022 spend the remainder of those proceeds. As liquidity runs dry, companies will need to raise additional capital to fund growth. We believe the high-quality late-stage companies that Runway targets will explore minimally dilutive growth capital in the form of venture debt to supplement previous raises. Runway’s outlook remains consistent with previous quarters. For many companies, new business opportunities and growth potential remains high.
Capital availability has become a major concern as management navigate tightening market conditions. The market outlook gives us additional confidence in our ability to execute for the foreseeable future. Our strong reputation and depth of relationships has kept our pipeline robust and we continue to evaluate a steady stream of deal opportunities. That said, Runway will continue to focus on high-quality companies with proven business models and a clear path to success. This goes back to our credit-first philosophy and careful monitoring, which are essential to achieving premium results. As we evaluate deals we are seeing in the market today, we are making sure to only engage with those that meet our high bar. With a deleveraged balance sheet and ample capital to deploy from our revolving credit facility, Runway is well positioned to drive nondilutive portfolio growth without sacrificing on quality, terms, protections or size.
We believe we have positioned ourselves to capitalize on the evolving market conditions in Q4 2023 and 2024. I’ll now turn it over to Tom.
Tom Raterman: Thanks, Greg, and good evening, everyone. Runway completed six investments in the third quarter, representing $40.8 million in funded loans. Runway’s weighted average portfolio risk rating increased slightly to 2.24 in the third quarter from 2.21 in the second quarter of 2023. Our rating system is based on a scale of 1 to 5, where 1 represents the most favorable credit rating. At quarter end, we continued to have only one portfolio company rated five in our nonaccrual status, which is Pivot3. As we’ve said on earlier earnings calls, we are in the late phases of our Pivot3 resolution and expect next steps to be completed prior to year-end. Looking across markets more broadly, we expect ongoing uncertainty to weigh on the United States economic trajectory as we approach 2024.
While forecasts indicate that the probability of a soft landing has increased, we anticipate a challenging environment as the market grapples with the impact of higher for longer interest rates. We believe Runway’s track record of effectively managing risk is a differentiator. Our team’s priority is to deliver superior credit performance while preserving capital to maximize risk-adjusted returns for our shareholders. A key variable in that equation is our proactive approach to portfolio monitoring. Runway connects with each of its portfolio company management teams, at least quarterly and often every six weeks. Our team takes a proactive approach to address problems and has difficult conversations early when optionality remains the highest.
In line with previous quarters, we calculated the loan to value for loans that were in our portfolio at the end of the second quarter and current quarter. We found that our dollar weighted loan-to-value ratio slightly increased from 24.2% in Q2 to 24.8% in Q3. Our total investment portfolio had a fair value of approximately $1 billion, decreasing 8% from $1.1 billion in the second quarter of 2023 and increasing 11% from $910.2 million for the comparable prior year period. As of September 30, 2023, Runway had net assets of $570.5 million, decreasing slightly from $573.9 million at the end of the second quarter of 2023. NAV per share was $14.08 at the end of the third quarter compared to $14.17 at the end of the second quarter of 2023. As a reminder, our loan portfolio is comprised of 100% floating rate assets.
All loans are currently earning interest at or above agreed-upon interest rate floors, which generally reflect the base rate plus the credit spread set at the time of closing or signing the term sheet. In the third quarter, we received $125.3 million in principal repayments, an increase from $88.7 million in the second quarter of 2023. This increase is driven primarily by Runway Growth’s credit-first approach to investing that prioritizes the highest quality late-stage companies, which are ideal candidates for refinancing our acquisition in most market environments. Elevated prepayments are an indicator of the strength and Runway’s approach to underwriting and health of the overall portfolio. Further prepayment activity provides Runway with liquidity to deploy in a manner that’s fully accretive, which we view as a differentiator in 2024.
Runway generated total investment income of $43.8 million and net investment income of $22 million in the third quarter of 2023 compared to $41.9 million and $19.7 million in the second quarter of 2023. Our debt portfolio generated a dollar weighted average annualized yield of 18.3% for the third quarter of 2023 as compared to 16.7% for the second quarter of 2023 and 14.4% for the comparable period last year. Moving to our expenses. For the third quarter, total operating expenses were $21.7 million, down 2% from $22.2 million for the second quarter of 2023. Runway recorded a net unrealized loss on investments of $7.2 million in the third quarter compared to a net unrealized gain of $2.6 million in the second quarter of 2023. In the third quarter of 2023, our leverage ratio and asset recoveries were 0.79 and 2.27x, respectively, compared to 0.97 and 2.03x at the end of the second quarter of 2023.
All investments in the third quarter were funded with leverage as part of our strategy to generate nondilutive portfolio growth. Turning to our liquidity. At September 30, 2023, our total available liquidity was $311.9 million, including unrestricted cash and cash equivalents, and we had borrowing capacity of $297 million as compared to $227.7 million and $190 million, respectively, on June 30, 2023. We had unfunded loan commitments to portfolio companies of $203.5 million, the majority of which were subject to specific performance milestones. $75.1 million of these commitments are currently eligible to be funded. During the quarter, we experienced five prepayments totaling $125.3 million and scheduled amortization of $0.3 million. The prepayments included full principal repayments of our senior secured term loans to Allurion Technologies for $55 million, Dtex Systems for $10 million, Epic IO Technologies for $40 million and Fidelis Cybersecurity for $14.9 million as well as the partial principal repayment of our senior secured term loan to Marley Spoon for $5.4 million.
Subsequent to quarter end, Runway’s funded investments of $8 million to Betterment Holdings and $1.4 million to Snagajob as well as funded $3.1 million to Gynesonics as part of a larger equity raised by the company. In addition, late last week, we funded a $30 million senior secured term loan under a $37.5 million commitment to Linxup, a provider of software for real-time vehicle GPS monitoring and tracking. Runway also received a partial prepayment of $24.5 million from Brivo, Inc. Finally, on November 2, our Board declared a regular distribution for the fourth quarter of $0.40 per share as well as a supplemental dividend of $0.06 per share payable with the regular dividend. The Board also approved the $25 million share repurchase program effective through November 1, 2024.
This concludes our prepared remarks. We’ll now open the line for questions. Operator?
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Q&A Session
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Operator: [Operator Instructions] Our first question comes from the line of Mickey Schleien with Ladenburg. Your line is open.
Mickey Schleien: Yes. Good afternoon, Greg and Tom, I wanted to start with a high-level question. As you mentioned, venture debt funding is down this year. And I think that’s mostly the impact of SVB and lenders raised the underwriting bar. Looking out into next year, I appreciate your comments on the need for liquidity that may drive demand. But to what extent do you think a potential recession next year could continue to depress deal volume as lenders in your space keep the bar high?
Greg Greifeld: Yeah. So I think that without a doubt, a combination of macroeconomics as well as SVB and other industry-specific shocks have had impact on deal volume this year. However, as we’ve seen in that PitchBook Data, volume for late-stage equity deals is down as well. And we believe that that’s driven by companies having raised substantial amounts of capital in 2020 and 2021 who realized that the market has changed, they needed to make that capital last for longer and as such, have made substantial cuts to their P&L in order to have the capital last for longer. And we do think that in the middle or second half of next year, these companies are going to reenter the market, needing additional capital for growth, and we do expect that to be a substantial tick-up in volume.
Mickey Schleien: Okay. I appreciate the clarification. Could you give us some insight into what drove this quarter’s unrealized depreciation?
Tom Raterman: Yes, Mickey, it’s Tom. There were some broad changes in the debt marks and then really changes in the public equity marks. There was one in particular for CareCloud that had a fairly sizable movement. But there was no wholesale change in terms of credit quality or methodology that was driving that.
Mickey Schleien: Okay. Tom, were there any outsized contributors to the fee income, which, despite the level of exits, still seems pretty significant?
Tom Raterman: Well, there was a significant amount of end-of-term payments, so there was a fair amount of acceleration of the OID there, and then prepayment fees were really the big driver on that.
Mickey Schleien: Okay. My last question, it looks like those exits and repayments were weighted towards the end of the quarter. Is that right? Or am I misinterpreting the numbers?
Tom Raterman: Deal volume, either in or out, tends to be weighted toward the end of the quarter. We did have one prepayment at the beginning of the fourth quarter, a partial prepayment on Brivo. That’s kind of the exception to the rule. But most of those come at the end of the quarter.
Mickey Schleien: Okay. Those are all my questions this afternoon. I appreciate your time. Thank you.
Operator: Our next question comes from the line of Melissa Wedel with JPMorgan. Your line is open.
Melissa Wedel: Good afternoon. Thanks for taking my questions today. I appreciate the transparency you provided in the investment activity so far in 4Q. It actually sounds like a pretty busy quarter so far, and we’re only about five weeks into it. Given that a lot of activity tends to be skewed towards the back end of this quarter, just wondering if you have any additional commentary on sort of activity yet to come this quarter versus what you’ve already seen and then any color on sort of repayment activity that might pull inside with that?
Greg Greifeld: Yes. So we definitely do echo the sentiment that it has been a busy start to the quarter. We do have line of sight that there should be some additional activity for the rest of the quarter as folks, with the beginning of that trend, are starting to look towards their budgets for the next year, realizing that there is growth opportunity with the need to actually fund it and we expect that trend to continue.
Tom Raterman: And then as to repayments, Melissa, there isn’t anything in particular outside of the normal pace. I think it’s going to be substantially less. We would expect it to be substantially less than Q3.
Melissa Wedel: Okay. That’s helpful. Thank you. If I could follow up on two particular near-term maturities, if we’re looking at this right, it looks like you might have a couple coming due in the fourth quarter around Circadence and Mingle, both of which are marked at a bit of a discount to cost. I’m just wondering if there’s anything that we should read into that in terms of repayment or refinancing?
Greg Greifeld: Yes. I think both of those names are actively looking to refinance, as you might expect, with the maturities coming up. We are also determining if there is a structure that makes sense for them to stay on our books. Since they are credits that we have known for a period of time, we have seen them weather through a variety of cycles and just know the names intimately.
Operator: [Operator Instructions] Our next question comes from the line of Bryce Rowe with B. Riley. Your line is open.
Bryce Rowe: Thanks. Good evening. I wanted to maybe just ask about the buyback you just talked about. And I guess, paired up with the lower balance sheet leverage that you’re working with right now, Greg and Tom, can you kind of talk about the prospects for some active buyback activity relative to the pipeline and what origination volume might look like? It sounds like you’ve got some good opportunities as we go into 2024, and so just kind of curious where you’d kind of prefer to spend the money or put the money? Thanks.