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Houston Ventures III Annual Report December 31, 2016
To Our Limited Partners: Houston Ventures III, L.P. and Houston Ventures III (Institutional), L.P., collectively (the “Fund” or “HV III”), invests growth-stage equity in technology companies addressing operational challenges in the Energy industry. Specifically, we target market-validated technology solutions that enable process improvements for industry participants. By identifying industry pain points where the effective application of technology can drive the largest returns to end users, Houston Ventures strives to build companies with sustainable revenue streams and healthy margins. The portfolio contains four direct investments in companies offering technology-enabled products and services to the upstream oil and gas sector. We have worked with each management team to establish performance measures for guiding strategic thinking and execution of their business models to achieve maximum shareholder value upon exit.
Company Security
Date of Initial
Investment Invested
Estimated Fair
Value % of Portfolio Fund Ownership
NuPhysicia Preferred Stock Mar-12 $1,367,201 $581,963 2.4% 7.0%
LiquidFrameworks Preferred Stock Sep-12 $5,000,001 $14,860,877 60.4% 31.2%
Geoforce Preferred Stock Aug-13 $4,436,350 $4,792,593 19.5% 10.4%
Oseberg Preferred Stock Dec-15 $4,000,000 $4,040,000 16.4% 21.1%
Other Carried Interest 1 $314,649 1.3%
$14,803,552 $24,590,082 100.0%
1 Carried Interest in Houston Ventures III Co-Invest, L.P.
As always, we look forward to your feedback and appreciate your support.
Best regards,
Chip Davis Jim Newell Fred Lummis
Houston Ventures III 1 2016 Annual Report
Since inception, we have called approximately $20.3 million of capital or 75% of total Fund
commitments. Investors have made five cash contributions and, on a weighted basis, have been
invested for three years. As of December 31, 2016, called capital has been utilized as follows:
$14.8 million (72.9%) for portfolio company investments, $4.6 (22.7%) for Fund start-up and
operating expenses, and $0.9 million (4.4%) cash on hand. No distributions have been made to
date.
The Fund’s portfolio positions are at various
stages of investment maturity and are
collectively valued at $24.6 million or 1.21x net
cash contributions.
Venture capital funds typically exhibit substantial
negative net internal rates of return early in
their lives. These negative returns
mathematically decline as capital is deployed
and management fees comprise an increasingly
smaller percentage of capital called. Accounting
policies regarding the carrying values of
investments can also handicap early year
returns. The industry has a term for this
pattern of returns, the “J-curve”. Annual returns
plotted in a time-series will start at zero, turn
negative in the early years, then grow positively
as investments appreciate in the latter years of
a fund’s life. 2016 marked the fifth “full year” of
Fund operations. To the right is a plot of the
Houston Ventures J-curve from inception
through December 31, 2016.
At December 31, 2016, a Fund limited partner
with capital commitments of $100 thousand
would have made capital contributions of $75 thousand, resulting in an equity value of $89.7
thousand as depicted in the graph below. We forecast HV III’s performance to continue to
improve during 2017 as the recent downturn in upstream oil and gas moves further behind us.
The carrying value of the Fund’s portfolio investments rose $4.7 million (23.6%) in total during
2016.
Houston Ventures III 2 2016 Annual Report
The Fund invests in technologies that improve processes in the Energy industry. Our strategy is
to assume a limited number of investment positions, and then to assist entrepreneurs in
developing sales, product development, and other operational tactics we believe will best
position them to achieve revenue growth and operating efficiencies with a scalable economic
model.
The relatively high cyclicality of the
oil and gas industry creates
significant challenges for operators
and service companies, who
struggle to efficiently scale their
operations to meet current
demand. In this context, we
search for technologies that
address processes with the
following characteristics (see blue
circles in the image):
The oil and gas industry very
closely fits the attributes above
where many mission critical
workflows include different
business functions passing around
spreadsheets (“loosely structured”) under volatile market conditions (“business rules change
frequently”) that are frequently changing what people have to do next (“highly variable”).
Despite the generally high level of technical sophistication in the oil and gas sector, this pattern
of ineffective collaboration persists across corporate processes, field processes, and between
supply chain partners.
Advances in cloud architecture and related software design techniques have substantially reduced
the cost and time required to create technologies to solve complex business problems. The
reduction in capital requirements to build these technologies, combined with advances in software
architecture, have also made technologies less burdensome to sell and buy, all adding up to
decreased friction for all parties involved in the adoption of new enterprise software.
Houston Ventures III 3 2016 Annual Report
Prior to 2010, we invested in horizontal market technology plays. Product development historically required significant investment prior to commercial readiness, and committing to a single industry vertical meant voluntarily limiting a company’s market opportunity relative to its go-to market cost (something that venture funds do not like). The evolution of “cloud” economics altered the risk profile of industry specialization for funds such as ours, and caused a shift in our views on market optionality. Buyers generally want to believe enterprise solutions understand their business in the same way that a job candidate has relevant employment experience. It is the relevant experience of current solutions that make them attractive to potential buyers, thus accelerating adoption. The chart above tracks the historical price to sales ratios of vertically focused software companies against those of horizontal “high-growth” (>20%) software companies. It reveals that for the first time, vertically focused public software companies are trading at a premium to horizontal “high growth” software companies despite lower short-term growth estimates.
Houston Ventures III 4 2016 Annual Report
The Fund’s portfolio companies provide the Energy industry with technologies that are meant to make operations more scalable and mitigate the effects of cyclicality. Since 2000, the rate of fluctuation in oil and gas drilling exceeded that of automobile manufacturing (a common reference point of “cyclicality”) by more than 300 percent (based on trailing two-year averages). Furthermore, instances of oil & gas drilling fluctuations exceeding those of automobile manufacture occurred at a rate of 13 to 4. During the period late 2014 through 2016, the oil and gas supply chain experienced a severe contraction which had a mixed influence on portfolio company operating results. By categorizing each portfolio company according to its fundamental service offering, we can see how different categories correlate to changes in industry conditions and how the industry prioritizes itself around those conditions (see chart below). Using our portfolio results as a proxy for measuring those priorities, “Income Statement Optimization” (by means of “Revenue Management” and “Market Intelligence”) is the highest priority, “Balance Sheet Optimization” (by means of “Asset Management”) is second, and “Crew Welfare Enhancement” is a distant third. Using Q3-2014 as a baseline, the average spot price for West Texas Intermediate crude declined by fifty-one percent through Q4-2016. To the positive, LiquidFrameworks and Oseberg (stub period since initial investment) experienced revenue increases of 46% and 7%, respectively. To the negative, Geoforce and NuPhysicia experienced revenue declines of 22% and 46%, respectively. Geoforce’s revenue decline was attributable, in part, to product defect issues (as previously reported) which makes correlation to industry cycles less discernable. NuPhysicia’s target market was offshore drilling which was the hardest hit (comparing US land to offshore drilling) and has yet to reveal any meaningful recovery. In the cases of revenue decline, the senior position of our preferred stock securities played a positive role in mitigating the negative effects of operating declines on respective investment values. Despite the varying operating results across the portfolio, the Fund increased in value during 2016 by 23.6%. In other words, HV III’s portfolio concentration in “Income Statement Optimization” rendered the aggregate portfolio a “net winner” during a period of severe industry contraction. As stated above, we expect HV III’s performance to continue to improve during 2017 as the downturn in oil and gas moves further behind us.
Houston Ventures III 5 2016 Annual Report
The Fund’s investment period ends November 4, 2017. As of December 31, 2016, HV III has
uncalled cash of $6.74 million for follow-on investments in existing portfolio companies,
potential investment in one new portfolio company, and operating expenses.
Houston Ventures III 6 2016 Annual Report
NuPhysicia, based in Houston, Texas, provides advanced medical
services. Founded in 2007 as a spinout of the hallmark telemedicine
programs of the University of Texas Medical Branch.
The Company’s patented solution uses technology to distribute physician services to multiple remote locations
and markets. The method combines physicians, paramedics, electronic medical records, pharmacy
management, wellness, and proprietary telemedicine systems into an integrated, turnkey solution. Current
customers include offshore energy companies, corporate employers, regional clinic networks, and the U.S.
military. Select summary data follows.
Company Security
Date of
Initial
Investment
Price
Per
Share Total
Fair Value
Per Share Total
Fully
Diluted
Ownership
NuPhysicia Series C-1 Mar-12 $2.68 $1,367,201 $1.14 $581,963 7.70%
Positives Negatives
Workplace Clinic Marketing – Sales and marketing processes are maturing for the Medicine at Work product generating qualified opportunities for the 2017 sales pipeline.
No New Subscription Bookings - Closed no new deals aside from one-time equipment sales.
Houston Ventures III 7 2016 Annual Report
Subscription Revenue
As the Fund’s portfolio companies mature, recurring revenue growth becomes the most important performance
metric positively correlated with equity value and a potential liquidity event. The chart below summarizes two
components of historical revenue performance for NuPhysicia: Annualized Recurring Revenue (“ARR”) tracked
on the left axis and Annualized Subscription Value (“ASV”) of new quarterly subscription bookings tracked on
the right axis.
Based on the Company’s revenue model and achievable profit margins, we calculate an ARR target for
NuPhysicia based on a hypothetical 3x ARR exit multiple, a five-year investment hold period, and a targeted
minimum gross IRR of 25%. The Company has achieved 18.6% of its exit ARR goal at roughly the end of the
Fund’s assumed investment hold period.
Commentary & Outlook
NuPhysicia is now focused solely on growing its Employee Health Care business line of workplace clinics. The
Company has sharpened its marketing message based on results from experimentation during the year. Clinics
are now offered at “no startup cost” for worksites with 200+ employees. The simplified employer pricing
model is per employee, per month, with no co-pays or insurance claims to consider. Lead generation for this
product is now focused on industry referrals from healthcare brokers who consult with self-employed
employers. At year-end, NuPhysicia had six clinics under contract, including one that opened in early January
2017. The 2017 plan calls for opening four new clinics to bring the total to ten by year-end, which would
elevate the Company to a more sustainable cash flow positive position.
Conclusion
Based on the established investment benchmarks, NuPhysicia is currently not on track to meet the Fund’s
minimum investment objectives.
Houston Ventures III 8 2016 Annual Report
LiquidFrameworks, based in Houston, Texas, provides field force
automation software to companies in the energy and industrial
service industries. Customers using the LiquidFrameworks product
suite report numerous benefits including increased cash flow, labor
reduction, improved invoice accuracy, and greater revenue capture. The Company’s flagship product, FieldFX,
allows users to manage contracts, quotes, equipment, jobs and field tickets along with customer-specific
electronic forms such as safety incidents, inspections, and other operational data reports. Select summary data
follows.
Company Security
Date of
Initial
Investment
Price
Per
Share Total
Fair Value
Per Share Total
Fully
Diluted
Ownership
LiquidFrameworks Series A Sep-12 $0.47 $5,000,001 $1.41 $14,860,877 31.1%
Positives Negatives
Sales – Record setting fourth quarter with over $1.9 million of closed subscription bookings. Exceeded sales plan for the year by more than 90%.
Upsells – Major upsells with several significant house accounts expanding their annual subscriptions by more than $300 thousand each.
Customer Attrition – Eight customer losses during the fourth quarter bringing the total for the year to eighteen.
Houston Ventures III 9 2016 Annual Report
Subscription Revenue
As the Fund’s portfolio companies mature, recurring revenue growth becomes the most important performance
metric positively correlated with equity value and a potential liquidity event. The chart below summarizes two
components of historical revenue performance for LiquidFrameworks: Annualized Recurring Revenue (“ARR”)
tracked on the left axis and Annualized Subscription Value (“ASV”) of new quarterly subscription bookings
tracked on the right axis.
Based on the Company’s revenue model and achievable profit margins, we calculate an ARR target for
LiquidFrameworks based on a hypothetical 5x ARR exit multiple, a five-year investment hold period, and a
targeted minimum gross IRR of 25%. The Company has achieved 113% of its exit ARR goal with
approximately nine months remaining in the assumed investment hold period.
Commentary & Outlook
LiquidFrameworks posted its best sales quarter in its history with $1.9 million of annualized subscription
bookings. That includes major upsells in three existing accounts plus a small new account with Chevron, the
Company’s first oil and gas operator customer. New subscription bookings for 2016 totaled $3.5 million, and
the product mix consisted of 75% field ticketing revenue and 25% derived from the other six FieldFX modules.
The Company is gaining significant traction outside of oilfield services in the areas of industrial and
environmental services. The Company reports a current winning percentage on competitive deals in excess of
90%.
The erosion of smaller accounts was a steady theme throughout 2016, as the extended oil and gas downturn
hit small service companies particularly hard. On the positive side, the Company’s focus on moving up market
resulted in significantly larger average account sizes. The average account size grew 35% year over year to
$138 thousand.
During 2017, the Company will look to scale the organization to capture additional market share in its core
oilfield, industrial, and environmental services markets. LiquidFrameworks has $4.4 million cash on hand,
which is sufficient to finance the 2017 growth plan. We believe the Company will be in a position to explore
exit opportunities during the second half of the year.
Conclusion
Based on the established investment benchmarks, LiquidFrameworks is currently on track to exceed the Fund’s
minimum investment objectives.
Houston Ventures III 10 2016 Annual Report
Geoforce, based in Coppell, Texas, develops and markets systems for automating management of oilfield service equipment. The Company uses a combination of proprietary and third party GPS (satellite and cellular) reporting devices combined with a web-based software platform to enable
customers to best utilize their oilfield equipment and maximize rental revenues. The Fund’s Series A investment in Geoforce financed the Company’s international expansion and several hires in key functional corporate roles. The Fund’s Series B investment financed the replacement of defective GPS devices and ongoing operations. Select summary data follows.
Company Security
Date of
Initial
Investment
Price
Per
Share Total
Fair Value
Per Share Total
Fully
Diluted
Ownership
Geoforce Series A, Warrants Aug-13 $21.50 $3,049,990 $22.93 $3,344,542 7.4%
Series B, Warrants Nov-15 $24.00 $1,386,360 $24.50 $1,448,052 3.0%
Positives Negatives
HAL & PXD Wins – Closed new deals with major North
American land accounts, Halliburton and Pioneer Natural
Resources.
Product - The Company’s reengineered proprietary tracking
units seem to be performing well and likely creating a
material competitive advantage.
Negative Active Device Growth – Total active devices
declined for the second straight quarter. Account churn
remains a major challenge hampering the Company’s
performance.
Cash – Negative operational performance created a liquidity
squeeze and a significant projected cash shortfall in the
2017 plan.
Houston Ventures III 11 2016 Annual Report
Subscription Revenue
As the Fund’s portfolio companies mature, recurring revenue growth becomes the most important performance
metric positively correlated with equity value and a potential liquidity event. The chart below summarizes two
components of historical revenue performance for Geoforce: Annualized Recurring Revenue (“ARR”) tracked
on the left axis and Annualized Subscription Value (“ASV”) of new quarterly subscription bookings tracked on
the right axis.
Based on the Company’s revenue model and achievable profit margins, we calculate an ARR target for
Geoforce based on a hypothetical 5x ARR exit multiple, a five-year investment hold period, and a targeted
minimum gross IRR of 25%. The Company has achieved 60% of its exit ARR goal with approximately
eighteen months remaining in the assumed investment hold period.
Commentary & Outlook
Geoforce reported another poor quarter with negative net device growth, as a result of 6,282 device
cancellations for a gross quarterly churn rate of 8.3%. Total gross device churn for the 2016 year was 28.8%.
117 total accounts canceled during 2016, which represents a 22% customer churn for the year.
The Company booked $916 thousand of new subscriptions during the fourth quarter, its highest quarterly
bookings since 3Q2015. That includes key account wins with Halliburton (US Land) and Pioneer Natural
Resources (1,000+ vehicles). Demand from the US services market is rebounding, but the Company must
improve its service delivery to reduce churn and generate net business growth in 2017.
Subsequent to year-end, the Company secured $2 million of warrant financing to cover a projected 2017 cash
shortfall. The Fund did participate in the financing and full details will be included in the 2017 first quarter
report to the limited partners.
During 2017, new sales efforts will focus on growth opportunities within the Company’s “Big 3” accounts –
Swire, Schlumberger, and Petrobras. Geoforce is currently considering a significant new growth capital raise,
potentially in excess of $10 million, to capitalize on the strong current market appetite for deals in the
“Internet of Things” space.
Conclusion
Based on the established investment benchmarks, Geoforce is currently behind the requirements to meet the
Fund’s minimum investment objectives.
Houston Ventures III 12 2016 Annual Report
Oseberg, based in Oklahoma City, Oklahoma, provides customers in
the oil and gas industry with leading analytics software, rich datasets,
and industry expertise to inform decision-making. The Company
focuses primarily on extracting and presenting information contained
within a variety of regulatory filings that historically have only been
available in unstructured formats. The Company’s products include Atla, a SaaS product that provides access
to an ever-expanding database of actionable information and geospatial analytics, and Sol, a lighter weight
SaaS product that provides quick and up-to-date access to essential industry data points. Select summary
data follows.
Company Security
Date of
Initial
Investment
Price
Per
Share Total
Fair Value
Per Share Total
Fully Diluted
Ownership
Oseberg Series A Dec-15 $1.00 $4,000,000 $1.01 $4,040,000 21.0%
Positives Negatives
TX Sales – Closed three accounts for the new TX data set,
and one multi-state (OK & TX) deal during the quarter.
TX Product Development – New TX historical lease data set
is currently 81% complete and TX lease acquisition costs to
date have come in under budget.
Account Churn – Successfully renewed 15 out of 16
accounts, however net quarterly revenue churn was 8.8% in
the quarter, comprised of the one cancellation and three
subscription downgrades.
Houston Ventures III 13 2016 Annual Report
Subscription Revenue
Recurring revenue growth is the single most important performance metric positively correlated with building portfolio company equity value in the Fund. The chart below summarizes two components of historical revenue performance: Annualized Recurring Revenue (“ARR”) tracked on the left axis and Annualized Subscription Value (“ASV”) of new quarterly subscription bookings tracked on the right axis.
Based on the Company’s revenue model and achievable profit margins, we calculate an ARR target for Oseberg based on a hypothetical 5x ARR exit multiple, a five-year investment hold period, and a targeted minimum gross IRR of 25%. The Company has achieved 25% of its exit ARR goal with over four years remaining in the assumed investment hold period.
Commentary & Outlook
Oseberg historically sells one-year subscriptions. The fourth quarter carries the heaviest renewal burden for the Company’s customer success team. All but one customer account successfully renewed during the quarter, however net quarterly revenue churn still hit 8.8 percent. For 2017, we would like to see net churn held under five percent quarterly. The Company’s small legacy accounts in Oklahoma are at a high risk of churning in any given year. However, the addition of new state data sets to the Oseberg product suite will give the Company’s sales team ammunition to upsell larger multi-state customers to offset those smaller account losses. Total ARR at year-end was $2.6 million, which represents seventeen percent year over year growth. The Oseberg sales team closed eight small new accounts with an average annual subscription value of $11 thousand. Three of these new accounts are Texas only subscriptions. Although the new data set is not yet 100% complete, the Company is aggressively pushing into the Texas product and already enjoying some success. In 2016, Oseberg invested a significant amount of capital towards extending the product set to include Texas. Many of the Company’s customers operate in both Oklahoma and Texas, which we believe will bode well for sales of the new Texas data set. Oseberg has begun to earnestly market in Texas. As exploration activity continues to rebound, especially in the Permian Basin, fundamentals look supportive of meaningful revenue growth in 2017. On the product side, Oseberg will continue development of its new Texas and New Mexico products. The company has a new vendor relationship in place with a specialized technology provider delivering data extraction services for lease files. As the partnership matures, more efficient processing of historical lease data should accelerate development timeline for new data sets.
Houston Ventures III 14 2016 Annual Report
Conclusion
It is too early to draw any conclusions about the performance of the Oseberg investment.
Houston Ventures III 15 2016 Annual Report
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Financial Statements
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