Runway Growth Finance Corp. (NASDAQ:RWAY) Q4 2022 Earnings Call Transcript

Runway Growth Finance Corp. (NASDAQ:RWAY) Q4 2022 Earnings Call Transcript March 2, 2023

Operator: Ladies and gentlemen, thank you for standing by. And welcome to the Runway Growth Finance Fourth Quarter 2022 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the call over to Mary Friel, Assistant Vice President, Business Development and Investor Relations. Please go ahead.

Mary Friel: Thank you, Operator. Good evening, everyone. And welcome to the Runway Growth Finance conference call for the fourth quarter and fiscal year ended December 31, 2022. Joining 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 fourth quarter and fiscal year 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. 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 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 uncertainty surrounding the rising interest rates, the impact of the COVID-19 pandemic, changing economic conditions and other factors we identify in our SEC filings. 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 the SEC related filings, please visit our website. With that, I will turn the call over to David.

David Spreng: Thank you, Mary, and thank you all for joining us this evening to discuss our fourth quarter results. I’d like to start by providing fourth quarter 2022 highlights, then I will discuss broader market dynamics and the outlook for 2023. 2022 was a pivotal year for Runway. It was our first full calendar year as a public company. We believe our investment thesis was validated and we demonstrated the value in pursuing a portfolio that focuses on the latest stage companies in the venture market. Despite a volatile backdrop, Runway continued to prudently deploy leverage to fuel non-diluted growth for its portfolio companies, while delivering five consecutive quarters of dividend increases to our shareholders. Since inception, we have built a track record of lending to what we believe to be the highest quality, late and growth stage companies.

I want to take a moment to summarize our very successful year. Runway delivered record originations of $878 million. We expanded leverage more than seven-fold to 0.97 times. We grew ROE 165 basis points to 10.3%. Increased our base dividend per share to $0.40, marking an 11% increase from our prior quarter and 60% increase since our initial public offering. Additionally, we declared a supplemental dividend of $0.05 per share payable with the first quarter dividend, along with our intention to pay a similar dividend in each quarter of 2023. We recorded zero realized credit losses. We expanded our investment in finance teams by over 40% and we grew our strategic footprint with new offices in Boston and Dallas. Now let’s turn to our fourth quarter results.

Runway closed 2022 with record fourth quarter portfolio growth. We completed 12 investments in new and existing portfolio companies. This represents $327 million in new commitments, including $233 million in funded loans. Runway is committed as ever to focusing on quality, high growth potential companies in the sectors we know best, including life sciences, technology and select consumer service and product industries. Notably, our team deployed two loans to PE-sponsored companies during the fourth quarter, highlighting our strategy to migrate towards larger, less risky opportunities. We view growth-focused PE-backed companies as an integral segment of the platform that offers compelling risk-adjusted returns. We also increased our core leverage ratio from 0.6 times to 0.97 times in the fourth quarter, reaching our target range and on an accelerated schedule.

This is an important achievement for Runway as we unlock the full potential of our balance sheet’s earnings power and expand our return on equity. Runway delivered total investment income of $37 million and net investment income of $18 million in the quarter. This represents an increase of approximately 109% and 68%, respectively, from the prior year period. Net assets were $576 million at the end of the fourth quarter, down 5% from $606 million in the prior year period, yet up from $574 million at the end of Q3 2022. Tom will dive deeper into our continued credit quality, but our weighted average portfolio rating improved to 2.1%, compared to 2.2% in Q3. We are pleased with the strength and resilience of our portfolio. While we anticipate continued macro turbulence in 2023, we believe our durable portfolio is built for all economic environments.

Our top priority is the quality of our portfolio and due to persistent Fed rate increases and inflationary pressure, our team has been even more selective in evaluating additions to the Runway portfolio. We demonstrated our ability to grow and execute, however, during kinds of uncertainty, we redouble our diligence efforts and become even more patient. Our next area of focus is our structuring and underwriting. We focus on mutually beneficial terms that position Runway at the top of the cap table. Relative to other listed venture debt BDCs, we believe Runway is exposed to the least amount of risk. This is demonstrated by our concentration in first-lien senior secured loans, as well as our weighted average active loan-to-value at origination of 17.4% across the entire portfolio.

As we have done in the past, we also calculated the loan-to-value for loans that were in our portfolio at the end of Q3 and Q4. In comparing this consistent grouping of loans, our dollar weighted loan-to-value ratio was consistent at 22% in Q3 and 23% in Q4. This reflects the extremely conservative approach to valuation our credit team takes during the underwriting process to insulate our portfolio from exaggerated valuations. For our existing positions, we pride ourselves on our monitoring process. From term sheet to final payment, we are in regular communication with our portfolio companies, to proactively assess their ability to identify and navigate potential challenges. Our communication cadence with portfolio companies is built into our terms on each loan.

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We do not take a one-size-fits-all approach. Portfolio monitoring is built on a core set of requirements for all portfolio companies and is customized from that base to ensure an ongoing program that meets our needs as a lender, while allowing the borrower to operate as efficiently as possible. Additionally, each position in our portfolio undergoes a comprehensive valuation process internally on a quarterly basis and periodically by a third-party. For perspective, every material investment in our portfolio was reviewed by a third-party valuation specialist at least twice throughout 2022. This gives us confidence in our marks, even amid challenging operating environments for our portfolio companies. Looking at the broader market outlook, three themes are clear, valuations are declining, we see deployments are down and exit activity is slowing to recent year lows.

We view these trends as a natural part of the venture cycle. There are also demand drivers for non-dilutive growth loans as an alternative to expensive equity. Our credit bar is high and we see increasing demand for Runways creative financing solutions. Our team continues to originate high quality deals, while focusing on companies with sound fundamentals and proven business models. The latest venture capital data reinforces these things. According to recent PitchBook Data, late-stage venture capital activity continued to decline through 2022 as the market faced ongoing volatility. However, it’s important to note, 2022 late-stage deal values remain historically high, outpacing 2020 and 2019 by 34% and 62%, respectively. Compared to record levels in 2021, deal count only declined by 5%.

In other words, based on this data, late-stage companies are continuing to raise equity capital but in smaller increments. The venture capital ecosystem is nearing the end of a 10-year expansion cycle. According to PitchBook Data, even though U.S. venture capital raised in 2022, was a record $163 billion. Venture capital fundraising slowed significantly in the fourth quarter as the full impact of the denominator effect became apparent in investor commitments. We expect this trend to continue for the foreseeable future, suggesting that VCs will be very judicious in deploying available dry powder. On the venture debt side, according to PitchBook, 2022 was the fourth consecutive year surpassing $30 billion in new loan fundings. This demonstrates the resilience of venture-backed companies embracing debt as non-dilutive growth capital, which bodes well for Runway.

Before I turn the call over to Tom, I want to highlight a performance metric we take prior in. Our consistent dividends to shareholders and sustained shareholder return. Since becoming a public company, we have increased our dividend five consecutive quarters, representing 60% total growth. We achieved this while building what we believe to be the most stable portfolio in the venture debt landscape. While the macro environment likely will continue to impact our portfolio companies, we have confidence that we can continue to execute our disciplined strategy to drive long-term shareholder value. Turning to 2023, we continue to prioritize financing recession-resistant companies with proven business models and minimal downstream financing risk.

The cost differential between debt and equity capital continues to be a tailwind for the Runway platform. As a reminder, the first quarter tends to be seasonally the slowest period in terms of originations activity, which is consistent with what we have experienced year-to-date. This market dynamic is not expected to impact the supplemental dividend program we discussed earlier on this call, of course, subject to Board approval. The team continues to see a robust pipeline of opportunities in the marketplace and we will continue to evaluate these deals with discipline and rigor that we have employed to-date. I will now turn it over to Tom.

Tom Raterman: Thanks, David, and good evening, everyone. Runway completed 12 investments in new and existing portfolio companies in the fourth quarter, representing $327 million in new commitments, which included $233 million in funded loans. Runway’s weighted average portfolio rating improved to 2.1% from 2.2% in the third quarter. As a reminder, our risk rating system is based on a scale of 1 to 5, where 1 represents the most favorable credit rating. At quarter end, we continue to have only one portfolio company rated 5 and on non-accrual status. At the end of the fourth quarter, our total investment portfolio, excluding U.S. treasury bills, had a fair value of approximately $1.1 billion, compared to $910.2 million at the end of the third quarter and $684.5 million for the comparable prior year period.

This represents a sequential increase of approximately 24% and a year-over-year increase of 65%. As of December 31, 2022, Runway had net assets of $576.1 million, increasing from $573.7 million at the end of the third quarter. NAV per share was $14.22 at the end of the fourth quarter, compared to $14.12 at the end of the third quarter. We are pleased with our stable NAV, which we feel reflects industry leading levels of scrutiny. With respect to interest rates, our loan portfolio is comprised of 100% floating rate assets, which will continue to benefit from higher rates. All loans are currently earning interest at or above agreed upon interest rate floors, which generally reflects the base rate plus the credit spread set at the time of closing or signing of the term sheet.

In the fourth quarter, we received $16 million in principal repayments, a decrease from $55 million in the third quarter of 2022. We expect prepayment activity to remain relatively low, given equity valuations and a pullback in the refinancing markets. However, a number of our late-stage companies remain attractive acquisition targets in any environment, which makes it difficult to predict future prepayments. In the fourth quarter, we generated total investment income of $36.8 million and net investment income of $18.4 million, compared to $17.6 million and $10.9 million in the fourth quarter of 2021, driven by our growing portfolio and rising interest rates. Our debt portfolio generated a dollar weighted average annualized yield of 15.5% for the fourth quarter 2022, as compared to 14.0% for the fourth quarter 2021.

Moving to our expenses. For the fourth quarter, total operating expenses were $18.4 million, increasing from $6.7 million for the fourth quarter of 2021, driven by an increase in interest expense and management and incentive fees. Our performance-based incentive fee was $4.6 million for the fourth quarter, compared to $2.7 million for the fourth quarter of 2021. Our base management fee was $3.4 million, up from $2.3 million in the fourth quarter of 2021 due to the increase in the average size of our portfolio during the year. Beginning in Q1 2023, our management fee declined from 1.6% per annum to 1.5% per annum with our total assets now exceed in dollars. Runway had a net realized loss of $2 million in the fourth quarter, compared to a net realized gain of $8.2 million for the fourth quarter of 2021.

We recorded net unrealized depreciation of $2.1 million in the fourth quarter, primarily driven by adjustments to the equity portfolio. Weighted average interest expense was 6.5% at the end of the fourth quarter, increasing from 5.5% during the third quarter 2022. End-of-period leverage was 97% and asset coverage was 203% as compared to 60% and 266%, respectively, at the end of the third quarter 2022. All investments in the fourth quarter were funded with leverage as part of our strategy to generate non-dilutive portfolio growth. Turning to our liquidity. At December 31, 2022, our total available liquidity was $93.8 million, including unrestricted cash and cash equivalents, and borrowing capacity of $88 million under our revolving credit facility all subject to existing terms and conditions.

This compares to $255.8 million and $250 million, respectively, on September 30, 2022. Subsequent to quarter end, we further enhanced our liquidity by increasing our credit facility by $50 million to a total of $475 million subject to the terms and conditions as reflected in the amended credit facility agreement. Runway continues to be disciplined in deploying capital at favorable terms while maintaining market-leading credit quality. Our credit quality reflects our rigor across the entire life cycle of a loan, including sourcing, negotiating, underwriting and monitoring, while focusing on industries with long-term growth potential. We continue to have dry powder and available leverage capacity for growth. Runway is opportunistically positioned to grow earnings while driving shareholder value.

As leverage builds to the upper end of our target range, we believe it will unlock the full potential of our earnings power. On that note, we achieved our core leverage target for the portfolio, which is between 0.8 times and 1.1 times, marking tremendous progress. As we have said in previous calls, we believe we can safely increase our leverage ratio to 1.3 times, which is more in line with our publicly traded BDC peers. In 2022, our Board of Directors approved a stock repurchase program to acquire up to $25 million of Runway’s common stock. The program expired on February 23, 2023 and the Board has not renewed the program at this time. In aggregate, during 2022, Runway purchased 871,000 shares at a price of $10.8 million. Finally, on February 23, 2023, our Board declared a base dividend distribution for the first quarter of $0.40 per share, an 11% increase from our fourth quarter dividend of $0.36 per share and our fifth consecutive quarterly dividend increase.

In addition, our Board approved a supplemental dividend of $0.05 per share payable with the base dividend and our intention to pay a similar dividend in each quarter of 2023. This concludes our prepared remarks. We will now open the line for questions. Operator?

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Q&A Session

Operator: Thank you. And our first question comes from the line of Mickey Schleien with Ladenburg.

Mickey Schleien: Yes. Good evening, everyone. David, I wanted to ask you about the Internet and Direct Marketing Retail segment. I realize it’s not particularly large, but obviously, we are all aware of the headwinds that the consumer is facing and I am curious whether this segment, I am curious how this segment is performing in light of those headwinds?

David Spreng: Yeah. Thanks for the question, Mickey. So of the different sectors that we focus on and just as a quick reminder, it’s within tech, we really like mission-critical enterprise technology, we like life sciences and healthcare broadly, and the third bucket that would be the one we are kind of being most cautious on is the consumer and we have always focused on recession-resistant businesses. And so for something in the consumer space for us to do it today, it’s going to have to be recession-resistant and have very impressive momentum and economics and the new deal that was done in the last quarter meets those standards and that’s Madison Reed, and you are right, it was not a very big loan, but the company is really very well run, has really good economic metrics and is quite recession resistant.

They built a fantastic business direct-to-consumer and then through COVID actually raised quite a bit of equity to roll out an omnichannel approach where they have these color bars in big cities with a very small footprint a great economic model. And most importantly, the revenue model is mostly on a subscription basis where a woman primarily could pay a fixed monthly charge and come into the color bar as much as they want or on a a regular basis. So it’s the smallest part of our portfolio. It’s the highest bar to get into the portfolio today, but we do think that selectively there is room for continued investment in that space.

Mickey Schleien: That’s good to hear, David, and I appreciate that transparency. You mentioned in your prepared remarks a focus on more sponsored deal flow and I don’t recall off the top of my head what proportion of the portfolio is sponsored today, but to the extent there’s headwinds developing in your portfolio. Anything anecdotal you can tell us about how sponsors are behaving in the portfolio in terms of supporting your portfolio companies?

David Spreng: Yeah. Of course. The comment that I made in the prepared remarks was referring to PE-backed companies. So a different category of sponsor than the traditional VC and we did two deals in Q4 with PE sponsors, one that was sponsored by Mainsale and one that was sponsored by BlackRock and we really like their backing. They are obviously very sophisticated and are very committed to their companies and our great counterparty for us. So we plan to continue to look for more PE-sponsored companies. The broader question you asked is about within the portfolio, how are sponsors behaving? And I would say that in venture land you are seeing a lot of VCs doing triage on their portfolios and deciding that the limited amount of capital that they have access to even though there is a lot of dry powder in the system right now.