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Horizon Technology Finance Corporation (NASDAQ:HRZN)

Q4 2012 Earnings Conference Call

March 13, 2013 9:00 am ET


Robert D. Pomeroy Jr. - Chairman and CEO

Gerald A. Michaud - President

Christopher M. Mathieu - SVP, Chief Financial Officer and Treasurer

Nick Rust - IR, IGB Group


Jonathan Bock - Wells Fargo Securities

Boris Pialloux - National Securities

Robert Dodd - Raymond James

Greg Mason - KBW


Good morning, and welcome to Horizon Technology Finance's Fourth Quarter and Full Year 2012 Conference Call. Today's call is being recorded. All lines have been placed on mute. We will conduct a question-and-answer session after the opening remarks and instructions will follow at that time.

I would now like to turn the call over to Nick Rust of The IGB Group for introductions and the reading of the Safe Harbor statement. Please go ahead, sir.

Nick Rust

Thank you, and welcome to the Horizon Technology Finance fourth quarter and full year 2012 conference call. Representing the Company today are Rob Pomeroy, Chairman and Chief Executive Officer; Jerry Michaud, President; and Chris Mathieu, Chief Financial Officer. Before we begin, I would like to point out that Q4 press release is available on the Company's website at

Now, I'll read the following Safe Harbor statement. During this conference call, Horizon Technology Finance will make certain forward-looking statements including statements with regard to the future performance of the Company. Words such as believe, expect, anticipate, intend, or similar expressions are used to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties and predicting future results and conditions. Current factors could cause actual results to differ on material basis from those projected in these forward-looking statements, and some of these factors are detailed in the 'Risk Factor' discussion in the Company's filings with the Securities and Exchange Commission, including the Company's Form 10-K for the year ended December 31, 2012. The company undertakes no obligations to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

At this time, I would like to turn the call over to Rob Pomeroy.

Robert D. Pomeroy Jr.

Good morning, and thank you all for joining us. For today's call, I will discuss our fourth quarter and full year 2012 highlights. Jerry will then provide a market overview. After that, Chris will review our financial results as well as our investment portfolio. Chris, Jerry, and I will then be happy to take your questions.

We are pleased by our performance for the fourth quarter and full year 2012 as management continues to expand Horizon's earning assets while maintaining a high credit quality of our overall portfolio. During the fourth quarter, we utilized our strong market origination capabilities to increase both new loan commitments and gross fundings to record levels. We also achieved strong fee income from prepayments and realized a modest gain from the sale of warrants in support of our financial results.

For the fourth quarter, we earned net investment income of $0.36 per share, covering our monthly dividends to clear for the first quarter of 2013 totaling $0.345 per share. We will discuss our new monthly dividend policy in more detail a little later on the call. In further highlighting our performance, we ended 2012 with an investment portfolio of $228.6 million, an increase of over 28% compared to the end of 2011, despite a high level of prepayment activity in both the fourth quarter and full-year 2012.

As we stated in the past, prepayments are unpredictable and can have a material impact on net investment income. While prepayments serve as a fundamental aspect of the venture lending model, they are best measured over a 12 month period to more accurately assess their impact on NII. To date in the first quarter, we have had no material prepayments. However, as with the timing of new loan fundings, prepayments often occur near the end of the quarter. We are aware of the potential for the prepayment of one or two loans before the end of March. These may or may not happen or may slip into the second quarter.

Net investment income was $3.4 million or $0.36 per share for the fourth quarter and $12 million or $1.41 per share for the full year. In the fourth quarter, many of the new loans are funded near the end of the quarter, which is typical in our industry. Therefore, the positive impact on net investment income from a larger portfolio will be more fully realized in subsequent periods.

Our portfolio yield was 14.7% for the fourth quarter and 14.2% for the full year, and at December 31, our net asset value per share was $15.15 which reflects in part the one-time event of declaring both the third and fourth quarter 2012 dividends during the calendar quarter, calendar fourth quarter. As previously announced, we declared and paid a third quarter dividend in November of 2012. Later that same month, we declared monthly dividends of $0.115 per share for each of January, February, and March 2013. Because these monthly dividends, totaling $0.345, were declared and accrued during the fourth quarter, they reduced our NAV at year-end.

Our dividend strategy is designed to pay monthly dividends that are covered by net investment income over time. With most of our past warrant gains now distributed through regular dividends, we will retain the remaining realized gains as well as future gains as undistributed income or spill-over income for future payout consideration.

On March 8, we declared monthly dividends of $0.115 per share for each of April, May, and June 2013, totaling $0.345 per share, representing an annualized deal of approximately 9.1% based on our current net asset value. We have declared cumulative dividends of $3.89 per share since going public in October of 2010.

During the fourth quarter, we addressed credit issues on three portfolio accounts including the bankruptcy proceedings for one of these companies. We placed all three accounts on non-accrual during the quarter and took fair value impairments on each. Satcon Technology, one of these accounts, filed for bankruptcy in October 2012. As the bankruptcy process progresses, we now believe that the proceeds from the liquidation of the company's assets will be insufficient to fully repay the company's creditors and retire any of Horizon's debt. Accordingly, we took a fair value impairment and the remaining fair value on this investment at year end is zero.

Summarizing our expedience on the Satcon loan, we made a $10 million loan in June 2010. We received normal interest and principal payments totaling $7.3 million. Our principal balance at the time of the bankruptcy was $5.2 million, so that we recognize that balance as unrealized depreciation during the fourth quarter. Our book loss therefore will be $5.2 million when the bankruptcy is discharged and our actual investment loss will be $2.7 million.

The other two portfolio accounts with credit losses have been 2-rated credits for some time as they struggled to raise capital or sell their businesses. We have placed these two loans on non-accrual and taken impairments to fair value in order to reflect our belief in the likely outcome for each of these two portfolio companies. All three of these trust accounts are now 1-rated credits. Looking at the balance of our portfolio, we have only one portfolio company with a 2-rating. This account has been rated 2 for some time but continues to make clinical progress and has stabilized its operations.

Over 96% of our portfolio is performing at or better than expected at the time of underwriting with a weighted credit rating of 3.2 at year and. While the three impairments reduced our NAV, the performance of our portfolio since inception has been excellent. Since our inception as a private company, in March 2008, total loans made exceed $477 million with no realized loan losses, and total loan impairments of $10.6 million, offset by $7.2 million in net realized warrant gains. The $10.6 million includes the $3 million fair value adjustment we took on [Vet Corp] (ph) when it was acquired in early 2012. The replacement royalty agreement has been performing as expected for three quarters and supports the current fair value for this investment. Taken as a whole, our cumulative loan impairments are 2.2% of the loans made over five years or 0.4% per year. Our net loan impairments, when offset by realized gains, are only $3.4 million or 0.7% of loans made over five years or 0.15% per year.

I would now like to turn our attention to our liquidity. During the fourth quarter, we continued to benefit from our two $75 million credit facilities with Wells Fargo and Fortress. During the fourth quarter, we paid off the small remaining balance of our original WestLB facility. Our two credit facilities, along with the $33 million in senior notes issued in March 2012, provide more than adequate leverage opportunity for our current level of equity. While each of these facilities is potentially expandable over time, we have no immediate plans to augment or add to these facilities. As opportunities present themselves, we will selectively endeavor to improve the terms and extend our existing facilities, find other lower-cost of debt capital, and improve the return to our stockholders.

In addition to our credit facilities, the cash generated by portfolio amortization and early termination provide capital for reinvestment. As capital is returned through amortization or prepayment, we may be able to redeploy a portion of the proceeds into higher yielding assets as we continue to expand our portfolio. At December 31, 2012, we had cash resources, credit availability, and cash flow from our existing portfolio to selectively find new opportunities that meet our strict underwriting and return criteria over the coming quarters. Our focus remains on deploying capital efficiency efficiently and profitably while maintaining an opportunistic approach to increasing our financial flexibility. Our outlook remains cautious due to the ongoing challenges in the clean-tech industry, increased competition, and an uncertain macroeconomic environment. We believe however that our extensive experience in various economic cycles and strong track record in generating attractive risk-adjusted returns from both high-yielding loans and warrant gains positions Horizon well in 2013 and beyond.

I will now turn the call over to Jerry.

Gerald A. Michaud

Thank you, Rob, and good morning everyone. Throughout the year, we steadily increased our investment activity as new loan commitments and gross fundings totaled $203.2 million and $184 million respectively. This is since we have achieved deploying capital into high-yielding assets and using our credit facilities to leverage returns while generating income from loan prepayments and other fees, is reflective of the successful execution of our venture lending business model.

Also reflective of our successful execution in 2012 is the expansion of our warrant portfolio by more than 30% with warrants now held in 62 companies. As a reminder, Horizon is a direct origination shop and we underwrite all of our loans in-house with a focus on capital preservation. Although we are not equity investors, we still share in a portfolio of companies' future success through the warrants we receive as part of each transaction. We will continue to monitor our opportunities to monetize our growing inventory of warrant positions and augment total returns.

Let me now turn to the fourth quarter. We maintained our strong market momentum as investment levels increased for the sixth consecutive quarter. We continue to experience strong demand for our value-added loan products and are pleased to have ended the year on a particularly strong note. During the fourth quarter, we funded 11 companies totaling $66.5 million, a record high for our Company. We added seven new companies to our portfolio, which increased the total number of companies in which we hold warrants to 62. We opportunistically increased the amount of our investment and warrant positions in four of our existing portfolio companies. In the fourth quarter, we made 11 new loan commitments in the amount of $77.4 million. It grew our portfolio by 3.5% in the fourth quarter from $220.9 million at the end of the third quarter to $228.6 million at the end of the fourth quarter. A high level of prepayment activity in Q4 while enhancing our NII lowered the impact of growth in our loan portfolio.

As of December 31, 2012, our approvals and committed backlogs stood at $28.6 million to 10 companies. Although there can be no assurance that transaction's early evaluation will result in commitments, our pipeline remains robust with approximately $200 million of new opportunities being evaluated. Subsequent to our investment portfolio update press release issued on January 3, we have been awarded three new transactions totaling $10 million, we have approved four new transactions totaling $20 million, and funded four transactions totaling $15 million, from our committed backlog. After considering this activity to date in the first quarter, today our approvals and committed backlog totals $24.2 million to 10 companies.

Before prepayments, we expect the net portfolio growth for the first quarter may be in the range of $10 million to $15 million. However, if the two prepayments Rob mentioned earlier occur, there would be little net portfolio growth. Based on current liquidity and past experience, we expect the net portfolio growth will be approximately $10 million per quarter for the rest of 2013. There is no guarantee that all of the new transactions will eventually fund, as many are subject to credit approval and maybe structure transactions subject to borrowers meeting specific milestones.

We continue to focus on portfolio diversification, a key driver in our ability to effectively mitigate risk. At the end of the year, we had approximately 48% of our portfolio in technology companies, 28% in life science, 13% in healthcare information and services, and 11% in clean tech.

Turning to our core market sectors, we have continued to see good lending opportunities to well-sponsored technology companies, especially in the submarkets of media and ad technology platforms, product computing, and mobile device. We are also seeing good opportunities in the medical device sector. We have some concerns related to the significant increase in the size of debt financing being completed in the drug development sector as life science companies look to increase their debt and lower shrinking DCF rate capital, but we have been and we'll continue to be active in the drug discovery market, we do not think that debt can completely fill the void of alternative financing needed for drug development companies to move drug candidates through the costly regulated drug development process. In that regard, we are also concerned how sequestration may impact the FDA's ability to move drugs through what is already a slow and expensive regulatory environment.

As mentioned at the end of the third quarter, we have taken a cautious approach to clean tech investment and we expect that to continue, that policy to continue in the first half of 2013, as we evaluate progress being made on our existing investments as well as new investments being made in the clean tech sector by venture capitalists. With the election behind us, we are beginning to see more activity and equity going into the healthcare information and services sector, and we expect that this should be a growth market for venture debt in 2013 and 2014. We are already seeing an increase in venture debt opportunities as healthcare information and service companies begin to take advantage of significant market opportunities and healthcare cost reduction strategies and improved patient outcomes.

Overall, venture capital investment for 2012 totaled $30 billion as compared to $35 billion in 2011. This decline of 14%, while significant, still represents an increase compared to investment levels of $29 billion in 2010 and $24 billion in 2009, which we consider to have been here with rational levels of investment. U.S. VCs raised approximately $20 billion in 2012, which was consistent with the amount raised in 2011. As a result, we expect to see continued VC investment in the tech sector where fewer dollars can potentially create incrementally more value than the life science sector. We also expect to see significant investment in medical device phase as healthcare market looks for new technologies that improve patient outcomes and reduce overall healthcare costs. We expect VCs to be more selective in making investments in drug development companies and clean tech companies until they see signs of a more robust M&A and IPO market.

So while challenges remain, we are confident that VC investment will be relatively strong in 2013, as global economic indicators continue to improve and the M&A market begins to return capital and more attractive returns to the VC investors. The total value of M&A transactions in the fourth quarter of 2012 was approximately $9 billion as compared to $10 billion in the third quarter. For the year 2012, there were 433 M&A transactions of venture capital backed companies receiving total proceeds of $40 billion compared to 548 M&A transactions of venture capital backed companies receiving total proceeds of $49 billion in 2011. We believe that M&A activity will increase in 2013 as mature public companies with strong balance sheets look to expand their existing product platforms. Experience suggests that demand on the buy side combined with the supply of VC-backed technology companies with significant revenue traction and medical device companies with completed clinical trials and CE Mark or FDA approval may result in a robust M&A environment in 2013.

On the IPO front, of the 94 IPOs completed in 2012, 48 were venture capital backed companies, which was consistent with 2011 IPO market which had 81 IPOs of which 43 were venture capital backed companies. An important factor to the venture debt market is that the average time to an IPO for venture capital backed company increased from approximately 7 years in 1990s to 12 years by 2012. This increased length of time is a significant reason for the growth and demand for venture debt as growth oriented venture capital backed companies need alternative private debt and equity financing to fund operations and continue their growth for an extended period of time prior to exit. We anticipate strong demand for IPOs in 2013 from growth oriented companies with strong technology platforms and increasing revenues, especially if the overall stock market continues to climb and investors look for growth stocks with great appreciation potential.

Turning to competition, we are definitely seeing increased competition for late-stage life science transactions which has resulted in significant pricing pressure as well as extended terms, not only of venture lenders competing against each other, but a relatively new royalty lending market has evolved which creates significant competition for late-stage clinical development companies. We are also seeing the technology banks becoming more aggressive for venture debt transactions which have historically been beyond their risk appetite.

While we competed very effectively in the fourth quarter against our competition by focusing on second-lien transactions in the tech sector and first-lien transactions in the medical device sector, we have continued to see pricing pressure in the fourth quarter in all market sectors. As a result, we will need to continue to use our significant experience and strong market relationships to attract financing opportunities where we can provide a value-added product and maintain the same pricing discipline we used in the fourth quarter that led to erected volumes without compromising our overall yield.

With that update, I will now turn the call over to Chris.

Christopher M. Mathieu

Thanks Jerry. I'd like you to turn your attention now to Horizon's financial performance. Our consolidated financial results for the three months and year ended December 31, 2012 have been presented in our earnings release distributed after the market closed yesterday. We also filed our 10-K last night after the market.

Our total investment income for the fourth quarter of 2012 was $7.9 million compared to $6.2 million for the fourth quarter of 2011. This increase of approximately 28% was primarily due to the increased average size of our loan portfolio. Total investment income for the quarter included $7.5 million from interest income. Total investment income also included approximately $450,000 of fee income associated with prepayment fees from six of our portfolio companies and other loan amendment fees.

While we experienced stronger than usual prepayment activity in the fourth quarter, these prepayments have served to further enhance Horizon's overall returns to stockholders. For the year ended December 31, total investment income increased 10.9% to $26.7 million as compared to $24.1 million in the prior year period. Total investment income in 2012 of $26.7 million consisted of $25.3 million in interest income from investments. Fee income of approximately $1.4 million was primarily from prepayment fees from a total of 13 portfolio companies during 2012.

Our weighted-average portfolio yield was 14.7% for the fourth quarter compared to 13.6% for the third quarter and 14.3% for the fourth quarter last year. Our weighted-average portfolio yield for the full year ended December 31, 2012 and 2011 were 14.2% and 14.6% respectively.

The Company's total expenses were $4.3 million for the fourth quarter as compared to $2.7 million for the quarter ended December 31, 2011. For the year ended December 31, 2012, total expenses were $14.4 million as compared to $13.3 million in the prior year period. Total expenses for each period consisted of interest expense, management fees, incentives, and administrative fees, and to a lesser extent professional fees and G&A expenses.

Interest expense increased quarter-over-quarter due to our higher aggregate effective interest rate of approximately 6.4% under a combination of our credit facilities with Wells Fargo and Fortress Credit as well as our publicly traded senior unsecured notes due in 2019. Although actual usage will vary, we project that credit facilities that we currently have maybe used equally over the remaining terms. In addition to the interest rate on our borrowings, we have the effects of debt issue costs that continue to be amortized over the term of each credit facility.

Performance-based incentive fees for the year ended December 31, 2012 remained flat compared to 2011, primarily due to the part one incentive fee increasing as pre-incentive fee net investment income increased year-over-year, offset by no part two incentive fee in 2012. Incentive fees for the fourth quarter of 2012 increased compared to the fourth quarter of 2011, primarily due to the reversal of a part two incentive fee accrual, but part one incentive fee was flat quarter-over-quarter.

The Company earned net investment income of $3.4 million or $0.36 per share for the quarter ended December 31, 2012, as compared to $3.3 million or $0.44 per share in the year earlier period. Remember that in July 2012, we completed a public offering of 1.9 million shares of our common stock which raised gross proceeds of approximately $31 million and increased our average number of shares outstanding. For the year ended December 31, 2012, net investment income was $12.1 million or $1.41 per share as compared to $10.5 million or $1.38 per share in the prior year period.

During the fourth quarter, we reported a realized net gain of approximately $169,000 or $0.02 per share after exercising warrants in connection with the acquisition of one of our portfolio companies. This compares to a net realized gain of approximately $800,000 or $0.10 per share for the fourth quarter of 2011.

For the year ended December 31, 2012, we recorded net gains on investments of $100,000 or $0.01 a share as compared to $6.3 million or $0.83 per share for the year ended December 31, 2011. We believe our expanding investment portfolio, which includes warrant positions in 62 portfolio companies at the end of the fourth quarter, provides the opportunity to realize significant more gains in the future.

For the three months ended December 31, 2012, the net unrealized depreciation on investments was $8 million or $0.84 per share, primarily due to $7.3 million of unrealized depreciation on three debt investments that are now on non-accrual status. For the three months ended December 31, 2011, the net unrealized depreciation on investments was $3.2 million or $0.42 per share and was due to the reversal of previously recorded unrealized depreciation on warrant investments that were realized in the period as well as unrealized depreciation on four debt investments. For the years ended December 31, 2012 and 2011, the net unrealized depreciation on investments was $8.1 million or $0.96 per share and $5.7 million or $0.75 per share respectively.

Overall, our portfolio quality remained strong. Our 3 and 4-rated credits represent 96% of the total fair value of the loan portfolio at year-end. As of December 31, 2012 and 2011, the Company's loan portfolio had a weighted-average credit rating of 3.2 and 3.1 respectively, with 4 being the highest credit rating and 3 being the standard level of risk rating. A rating of 2 or 1 represents a deteriorating credit quality and increased risk.

As of December 31, 2012, there was one investment with a credit rating of 2. As of December 2011, there were six investments with a credit rating of 2. As of December 31, 2012, there were three investments with a credit rating of 1 and a non-accrual status with approximate cost of $12.9 million and a fair value of approximately $4.9 million. There were no loans with a credit rating of 1 or a nonaccrual status as of December 31, 2011.

As of December 31, 2012, our NAV was $15.15 per share, or $145 million, which reflects the fair value adjustments on three non-accrual loans as well as the one-time event related to the accounting treatment of the declaration of dividends for Q3 2012 paid in November and the declaration of Q4 dividends paid in the month of January, February, and March 2013 as Rob discussed earlier.

For the three months ended December 31, the net decrease in net assets from operations was $4.4 million or $0.46 per share. This compares to a net increase in net assets resulting from operations of $800,000 or $0.10 per share for the three months ended December 31, 2011. For the year ended December 31 of '12 and '11, we increased net assets from operations by $4 million or $0.47 per share and $11 million or $1.44 per share respectively.

Turning now to our investment activity, we began the fourth quarter with an investment portfolio of $220 million. Our fourth quarter new loan fundings totaled $66.7 million with $14 million of this amount coming from refinanced balances with existing portfolio of companies. We also recorded $10.6 million in normal contractual loan payments and $26.6 million in loan prepayments, leading to an ending investment portfolio balance of $228 million at the end of the year.

Traditionally, we provide you with our investment portfolio update after the end of each quarter. Beginning next month, we'll be expanding that update to include not only the gross new portfolio investments but also provide color around prepayments, refinancing activity, and flows from normal loan principal payments.

Our investment portfolio at December 31 included 45 secured loans with an aggregate fair value of $220 million and 62 warrant positions with an aggregate value of $5.5 million. Horizon ended the fourth quarter with approximately $54 million in available liquidity including cash and short-term investments totaling $3.6 million as well as $50 million in funds available under existing credit facility commitments. As of December 31, our Wells facility with a current commitment of $75 million had a total of $46 million outstanding as we continue to utilize this facility to provide leverage for both new and existing investments. Our delayed draw term loan facility of $75 million with Fortress Credit had a $10 million outstanding balance as of December 31. This facility which provides for a 2 to 1 advance rate on eligible loans increases our ability to conduct more second-lien transactions and further diversify our portfolio. As opportunities present themselves, we will selectively endeavor to improve the terms and extend our existing facilities, find other cost of debt capital and improve returns to our stockholders.

We also repaid all of our outstanding obligations under our credit facility with WestLB and this facility was closed during the fourth quarter of 2012. We continue to enjoy the leverage provided by our senior unsecured notes totaling $33 million. As we approach our first year with these bonds outstanding, we realize they have been a great source of flexible liquidity and have provided real value to Horizon. The bonds trade on the New York Stock Exchange under the symbol HTF.

As of December 31, our leverage was 0.65 to 1, modestly higher than our September level and substantially below our current target ratio of 0.8 to 1 for further portfolio growth. We're comfortable with our current level of debt and we will use our leverage commitments to further enhance our earnings potential. As of December 31, 2012, we reported an excise tax totaling approximately $237,000. This tax relates to 2012 income that we expect to distribute to stockholders in 2013.

Now, I'd like to turn the call back to Rob.

Robert D. Pomeroy Jr.

Thank you, Chris. We are pleased with our performance throughout 2012, which demonstrates the strength of Horizon's unique business model. We remain committed to generating a stable stream of interest income through a high-quality portfolio of venture loans, while maintaining the opportunity to enhance total returns via warrants. By executing our investment strategy as we have consistently done in the past, we intend to further strengthen Horizon's leading industry brand and drive shareholder value over the long term.

So we hope that you take away from this call the following key points for HRZN; portfolio growth of over 28% for 2012; portfolio yield of over 14%; NII of $0.36 per share covering our monthly dividend of $0.115 per month per share for April, May, and June; and the credit issues addressed with still strong overall credit performance.

Before we open the floor for questions, I would like to note that we plan to hold our next conference call to report first quarter results during the week of May 6, 2013. We'll be happy to take questions you may have at this time.

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line of Jonathan Bock from Wells Fargo Securities. Your line is open, please go ahead.

Jonathan Bock - Wells Fargo Securities

Thank you for taking my questions. Just a few housekeeping questions first. I wanted to ensure, when you put the loans on non-accrual in the fourth quarter, there was no interest income from those loans that flowed into income at all during the quarter, it was an adjust, they were placed on non-accrual maybe in the quarter, but had both interest income into fourth quarter earnings, (indiscernible), correct?

Christopher M. Mathieu

It's a hybrid of that. So, two of the accounts we had no income in the quarter, so we put it on non-accrual effective October 1 and then one of the transactions we had a small amount in the fourth quarter's income and then it went on non-accrual for the rest of the quarter. Kind of put it in perspective, it's about $375,000 was taken off the P&L by putting a non-accrual and it will be about $420,000 in the first quarter, about $0.04 a share impact.

Jonathan Bock - Wells Fargo Securities

Great, thank you. And Rob, I wanted to make sure I understood this correctly, so you did mention that on Satcon, the creditors do expect a return, correct, as this entity works its way through bankruptcy, is that correct?

Robert D. Pomeroy Jr.

Yes, the process continues, it is in Chapter 7 liquidation, moved from Chapter 11. There will be some proceeds from the sales of assets, but as we've said today, not enough to clear even the most senior debt.

Jonathan Bock - Wells Fargo Securities

Okay, and that brings up the question of second-lien in venture debt, and if I'm not mistaken, Satcon was a second-lien investment?

Robert D. Pomeroy Jr.

That's correct.

Jonathan Bock - Wells Fargo Securities

So, is it possible – are both Cereplast and ACT Biotech also second-lien?

Robert D. Pomeroy Jr.

No, they are both first-lien deals.

Jonathan Bock - Wells Fargo Securities

Okay. So, maybe then Rob, and of course Jerry, the benefits of second-lien, can you walk us through what that provides in light of the fact that at least for the Satcon example, being a second lien creditor, it was a difficult position to be in? I'm just trying to see how you would contract the risk and reward between first lien senior secured and a second lien venture debt investment?

Gerald A. Michaud

Sure, this is Jerry. So, first of all, over a very long period of time, over a universe of life science technology transactions, we have found no correlation between the first and second lien. In other words, in our history, we have had losses from senior lien life science transactions, where there was absolutely no other debt in the company whatsoever but there was some sort of failure of the technology, or whatever the case may be. Obviously in the case of Satcon, very different situation, public company, tech sector.

So, that's not really the correlation when we're looking at a transaction. We're kind of underwriting to some very basic fundamentals on our underwritings tool, and to the extent that those exist, whether it's a first-lien or second-lien deal at the end of the day, is only a definition of the transaction. You know, total debt compared to the equity that has been raised, total debt to the enterprise value, all those things that we traditionally look at, are consistent with every transaction we underwrite, they were consistent with Satcon clearly when we underwrote the deal and in fact there was actually at one point significant improvement in Satcon during early 2011 compared to when we had underwrote it.

So, we obviously look at every transaction when they get distressed like this to see if there was any things we could have looked at and takeaways, but the reality is that over very, very long track record, numerous portfolios, it's not about first-lien, second-lien, there were other events relative to specific transaction that have generally driven the company to move from a very favorable position to a more distressed position.

Jonathan Bock - Wells Fargo Securities

I appreciate the color. One question, Chris. I know you mentioned that there's $46 million outstanding on the Wells line and an additional $10 million with Fortress, can you give us a sense of current liquidity or current available borrowing capacity subject to borrowing base limitations?

Christopher M. Mathieu

Sure. We have availability under both facilities where we could draw approximately $50 million today as of the end of the year. So, we had liquidity at the end of the year of $50 million.

Jonathan Bock - Wells Fargo Securities

So in light of that, and also in light of just the near-term credit situations and obviously working itself through, can you maybe give us a sense of how you're looking at the potential growth in the equity balance over the course of the year and whether or not that is anything kind of on top of mind at this point?

Christopher M. Mathieu

Based on the current liquidity of $50 million and our expectation of having just natural portfolio prepayments and prepayments that we've experienced over some period of time, I think Jerry mentioned that we think about the portfolio growing at a kind of a $10 million per quarter clip on a net growth basis. So, between the current liquidity from the leverage we have, the leverage commitments we have, plus the normal principal coming back, we can be in the market to grow the portfolio in that kind of $10 million range per quarter.


Thank you. Our next question comes from the line of Boris Pialloux from National Securities. Your line is open, please go ahead.

Boris Pialloux - National Securities

Thanks for taking my questions. Just had a quick question regarding competition. You mentioned that you saw a lot of competition in the late-stage sector. Is that on the biotech or do you see all type of sectors where you have competition or competitive pressures?

Robert D. Pomeroy Jr.

No, it's been primarily very kind of late stage clinical late Phase 2, Phase 3 type companies where the transactions have gotten in our view are extremely large in the kind of running – it used to be a $25 million venture debt deal on a life science phase for late stage technology company, was a large deal, they got done, there was usually a substantial amount of both liquidity in the company as well as enterprise value related to the technology platforms that they had in clinical trials. And what we're seeing today is kind of a breakthrough of that kind of financing where we're talking $30 million, $40 million, $50 million type deals where competition isn't just between venture lenders, it's between venture lenders and royalty companies who have raised substantial amounts of liquidity over the last couple of years and are putting into these. We'd see those transactions being more like a venture capital platform where you're taking a few risks and probably only maybe one or five are going to actually work and cover the risk. That's not the venture debt model. The venture debt model is, we've got to get a return of our capital and get a reasonable economics on the transaction.

So when venture debt starts competing for those types of transactions, I think you got to be really careful. So, we've seen both by the economics of those deals come down over the last certainly six months and we've seen the deals get – and what we believe our view is, a little bit too large for where debt should be playing such a significant role in the outcome of still clinical development technologies.

Boris Pialloux - National Securities

Okay, and the second question is regarding your – I mean it's related to the previous question before, do you have any debt to equity target where you feel comfortable with?

Gerald A. Michaud

So we're at 0.65 right now and I think we're comfortable going to kind of 0.8 to 1.


Thank you. Our next question comes from the line of Robert Dodd from Raymond James. Your line is open, please go ahead.

Robert Dodd - Raymond James

Kind of a general for your allocation, it looks like six of the more recently deals were in software. Obviously you've talked about there being issues and competition in life sciences and maybe risk with sequestration. I mean can you give us an idea about what you're primarily looking for sector vice, if you've got a target about where you'd like to focus through the course of this year?

Gerald A. Michaud

Yes, we're certainly feeling more comfortable. First of all, software, that's a very broad market, so it can be in a lot of different areas, and so you have some diversification even within those transactions. But we definitely like companies that are demonstrating growth in terms of revenue traction and customer traction, software-as-a-service where the revenues are more sticky, we like to see that where companies are moving towards profitability so there's not as much pressure on the investors to continue to have to invest capital and the money is truly being used for growth. Those are areas where we're seeing some really interesting opportunities, where companies are doing a lot of really creative things and there's significant demand for product as a result of that.

So, we definitely like that sector, we definitely like the medical device sector, we've seen a number of companies that have completed now their clinical trials and are beginning to move into the product commercialization stage. They have still got pretty attractive valuations relative to the warrants we get, so we certainly continue to like that market.

I want to be careful. We still like the life science drug development market. A lot has been a cornerstone of what we've done, but we're just being more cautious and looking at the models, the actual models for each transaction and making sure that they are using the appropriate amount of strategic financing. There's certainly nothing wrong with using some leverage as well as who their equity sponsors are and how well-financed those investors are in their commitment to the companies.

Robert Dodd - Raymond James

Thank you. On kind of going back to the competition question, I mean it looks in the new origination in the fourth quarter, it looks like you held the coupon pretty steady, maybe even up a tiny bit versus the blended. I mean are you giving up anything else in terms of terms? I mean obviously adjusting a little bit towards second-lien to get it, but I mean end-of-term payments, origination fees, are any of those terms shifting (indiscernible)?

Gerald A. Michaud

Yes, not too much, and that's why I was careful to point out that we were pretty selective relative to the market segments we went after. We kind of saw that starting to happen really kind of over the year progress, and so we were very focused going into the second half of the year and especially into the fourth quarter about what kinds of transactions we were going to be looking for. And I think that helped us a lot because that's what was in our pipeline. We had already started that process and so we were able to actually in the fourth quarter improve our cash on cash yield, so that would be – let me define that for you, that would be the interest rate, the commitment fees, and end-of-term payments. We're actually able to increase our yield from the third quarter and actually we increased our yield every quarter, from the first to the fourth quarter, and there was a combination of making sure we were focused on the right market segments first of all, and then we did in fact do more second lien transactions in the fourth quarter, as I had mentioned, at the end of the third quarter, given that we had the Fortress line in place and of course that helped us from a yield perspective as well.

Robert Dodd - Raymond James

Right, and then one last one kind of on the capital position. Obviously we've had some discussions (indiscernible) there's a note in the K saying you have no intention to – indicating that no intention to pursue that in the near term. Can you give us any color on why not, given one of the issues that presented in the past seems to be dealt with?

Robert D. Pomeroy Jr.

Yes, I mean the issues that existed when we went through the application back in 2011 continue and we really right now are not in a position to move ahead and we just don't like giving out an impression that we're doing that.


Thank you. (Operator Instructions) Our next question comes from the line of Greg Mason from KBW. Your line is open, please go ahead.

Greg Mason - KBW

One housekeeping question. I believe you said it, but I think I missed it, I want to make sure I get the right number, the prepayment fee income that happened in the fourth quarter, do you have that number?

Christopher M. Mathieu


Greg Mason - KBW

Great, thank you. And then, Rob, you talked about that you finished paying out all of the capital gains that you had in the past and the special dividend, and going forward, any future gains you expect to be spilled over. Is that a change in kind of your dividend policy of what you want to do with capital gains and kind of your thought process behind that?

Robert D. Pomeroy Jr.

Yes, I think we announced this, we talked about this certainly back in November and when we changed our dividend policy, we really are focused on trying to cover our dividend with NII over time and that we will look at the realized gains or the spill-over income and make decisions based on what to do with them over time as they present themselves. So, that is the switch from where we were from sort of August of 2011 when we decided, made the decision to augment the NII with realized gains.

Greg Mason - KBW

Okay, great. And then, you talked about, it sounds like you expect to be able to meet all of your investment capacity this year based on funds coming back in and the available borrowing at your current facilities, are you planning on asking for shareholder approval to issue stock below book again, or how are you viewing kind of below book issuances in light of kind of your guidance for capital deployment expectations?

Robert D. Pomeroy Jr.

We will ask for the below NAV vote. Our view always is that we will only raise additional equity capital when it's beneficial to our shareholders to do so, based on market conditions and opportunities we're looking at, leverage availability of that capital when it's raised and our ability to deploy it, but we have no immediate plans to do so.


Thank you, and I'm showing no further questions in queue, and would like to turn the conference back over to Mr. Rob Pomeroy for any closing remarks.

Robert D. Pomeroy Jr.

I'd like to thank everyone again for joining us on today's call and for following Horizon story. We look forward to sharing our progress with you again in the future.


This concludes Horizon Technology Finance Corporation's conference call. Thank you and have a great day.

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