Horizon Technology Finance Corp (HRZN) 2012 Q2 法說會逐字稿

Good morning and welcome to the Horizon Technology Finance's second-quarter 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. 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.

Thank you and welcome to the Horizon Technology Finance second-quarter 2012 conference call. Representing the Company today are Rob Pomeroy, Chairman and Chief Executive Officer, Gerry Michaud, President, and Chris Mathieu, Chief Financial Officer.

Before we begin, I would like to point out that the Q2 press release and 10-Q is available on the Company's website at www.HorizonTechnologyFinanceCorp.com.

Now I will 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 believes, expects, anticipates, intends, 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. Certain factors could cause actual results to differ on a 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, 2011. The Company undertakes no obligation 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.

Good morning and thank you all for joining us.

During today's call, I will discuss our second-quarter and year-to-date highlights. Gerry will then provide a market overview. After that, Chris will review our financial results as well as our investment portfolio. Chris, Gerry and I will then be happy to take your questions.

Today, I would like to talk about the significant drivers for Horizon's performance and published results, and how the impact of the drivers is reflected in quarterly reporting. Our constant focus on these important components of our business allows us over the long term to consistently meet our investment objective, which is to generate current income from the loans we make and capital appreciation from the warrants we receive when making such loans.

The first driver for Horizon is direct loan originations. During the second quarter, we continued to take advantage of the robust demand for our venture debt products and achieve record commitments of $60 million. This record performance led to strong sequential growth of 17% in the size of our secured loan portfolio, and our fourth consecutive quarter of increased loan fundings and a substantially larger committed backlog.

The larger loan portfolio strengthens our Company's position going forward not only with the increased earning potential of the larger portfolio, but our larger committed backlog provides a foundation for new loan fundings in coming quarters. The impact of the loan origination driver on earnings is affected by the timing of funding of new loans in the quarter. In the second quarter, many of the new loans funded near the end of the quarter. Thus the positive impact on net investment income from a larger portfolio was not seen in the second quarter, but will be seen in subsequent quarters.

The next major driver is the return that we generate on the investments that we make. This return results from the transaction yield on specific investments generated by coupon interest, commitment fees, final payments and other transaction fees.

Horizon has consistently earned unlevered yields on its loan investments in the range of 11% to 15%. In the second quarter, we maintained our pricing discipline on new investments as we increased our new loan activity.

A third driver of our business as the timing and frequency of early loan prepayments. This driver has a strong impact on our reported results on a quarterly basis. During the first quarter of this year, we experienced higher than normal levels of prepayments, and resulting prepayment fee income. This has the positive effect of increasing net investment income to $0.44 per share for the quarter, but also reduced the size of our portfolio as we entered the second quarter.

During the second quarter we had no loans prepay, and thus no prepayment fees, which impacted our reported net investment income of $0.30 per share. But the lack of prepayments contributed to our higher portfolio balance at the end of the quarter. Looking at the first two quarters of 2012 on a combined basis produces more normalized results with net investment income of $0.74 per share and an ending investment portfolio of $196 million, up 10% from the portfolio balance at year-end.

The fourth driver that impacts our long-term performance is credit quality. During the second quarter, we maintained our strong credit quality with a weighted average credit rating for our loan portfolio of 3.3, where 3 is the standard credit on a four-point scale. In addition, we had no loans on non-accrual as of June 30, and have not had any realized loan losses since our inception in 2008.

The next major driver for our long-term performance is the availability of and our access to debt and equity capital. The effective use of debt leverage increases the return on shareholder equity and enhances our ability to pay dividends.

In the second quarter, we issued and sold an additional $3 million of senior unsecured notes, which added to the $30 million of senior notes we issued and sold in the first quarter. In July, we received gross proceeds of $31 million from the issuance and sale of shares of our common stock. This equity offering was minimally dilutive to per-share book value and we expect it will be accretive to net investment income. We believe that each new equity dollar raised will be accretive to net investment income per share, because the transaction yields on our investments exceed both our cost of debt and our dividend yield. We will use the proceeds of our debt and equity offerings to further grow our investment portfolio high-quality, high-yielding investments. As we continue to grow our portfolio and our equity base, we will look to increase our debt capacity to appropriately meet our leverage target.

Our debt and equity capital raises demonstrate Horizon's ability to access the capital markets and give us the confidence to compete effectively in our market for new loan opportunities. Gerry will speak to the venture loan market dynamics and demand for our loan products, and Chris will address our liquidity and capital resources in more detail.

The final driver for long-term performance is the warrants we receive in connection with nearly all of our loans. Warrants provide us with the opportunity to participate in the increased value of our portfolio companies. Currently, Horizon is in the unique position amongst BDCs of having earned net realized gains from its warrants. Horizon has earned over $0.91 per share in realized gains since going public in 2010, and experienced no realize loan losses on its investment portfolio. To date, we have used a portion of these gains to augment our current quarterly net investment income in order to support our quarterly dividends.

By focusing on all of these important drivers, Horizon has been able to reward our shareholders with consistent high-yielding dividends. As we announced yesterday, our Board of Directors declared a dividend for the second quarter of $0.45 per share, a fourth consecutive dividend in this amount. Including this dividend, Horizon has now declared a cash dividend in each of its seven quarters as a public company for a cumulative dividend of $2.75 per share.

Following the payment of our second-quarter dividend on August 31 to shareholders of record on August 17, there will be approximately $0.55 per share remaining in undistributed income that we expect to distribute through future dividends. Our second-quarter dividend represents an annualized yield of 10.8% based on our net asset value of $16.73 per share as of June 30, 2012.

In summary, we are pleased with our second-quarter and first-half results. In the second quarter, we executed on our important drivers of long-term success, robust loan originations, high yields on new investments, continued potential for loan prepayment income, strong credit quality, access to debt and equity capital and potential for net realized gains. Our portfolio and market momentum have positioned us well for the future as we look to deploy our new capital into high-quality opportunities.

Now I'll turn the call over to Gerry.

Good morning everyone. As we looked back at our second-quarter marketing activity it showed that market demand for our venture loan product was very strong and in some segments of our targeted markets appear to be demonstrating significant growth relative to the broader global markets.

In the second quarter, Horizon was able to take advantage of the strong demand and growth as demonstrated by the following highlights. We funded 12 transactions during the quarter totaling $37 million. This represents our fourth consecutive quarter of increased gross fundings. We added seven new companies our portfolio which expanded our warrant portfolio to 55 companies. We increased our investment and warrant positions in five of our existing portfolio companies which had strong operating performances. We committed to 11 new transactions in a record high amount of $60 million in the second quarter which compared to commitments to three companies in the amount of $25 million in the first quarter.

Overall, we significantly grew our loan portfolio by 17% in the second quarter from $168 million at the end of the first quarter to $196 million at the end of the second quarter.

Importantly, our committed backlog of $39.3 million to 13 companies at the end of the second quarter is more than double the committed backlog of $16 million to six companies at the end of the first quarter. While there can be no assurance that all of these transactions on our committed backlog will fund, a strong and growing committed backlog should help grow our portfolio for the balance of 2012.

As further evidence of increasing demand for our venture debt products, we are evaluating an additional $100 million of new opportunities in our pipeline though there can be no assurance these transactions will result in commitments. I would also add as a further update our July 10 press release that, in July, we approved two new transactions totaling $12 million and funded one transaction of $1 million from our committed backlog, increasing our committed backlog from $39 million at the end of June to $50 million at the end of July.

So overall, we took advantage of a very active venture lending market in the second quarter. And we believe, based on the current pipeline activity, our significantly stronger liquidity position compared to the same period in 2011, we are well positioned to take advantage of the anticipated strong demand for our venture loan products for the balance of 2012.

In our core targeted markets, we are seeing some shifting in venture capital investment. Investment in traditional technology related growth companies remained very strong in the second quarter and we expect that to continue for the balance of 2012. However, there was a drop of VC investment in biotech, clean-tech and healthcare information and services. We believe drop in VC investment in clean-tech in part is an over reaction to the Solyndra effect on the clean-tech market and we have seen some evidence in our own pipeline that clean-tech focused venture capital firms are already returning to that market. Accordingly, we believe the clean-tech market will remain fairly robust for the balance of 2012 and into 2013.

The biotech market is a slightly different story. Venture capital firms have been struggling over the past two years to find an investment model for biotech companies that reduces the amount of capital they need to invest and reduces the time period for their expect expected return to the capital. This has called a pullback in investment activity but there is still a strong stated desire to invest in this important market sector.

There's also strong demand for development stage life science projects by Big Pharma and medical device companies who need to rebuild product portfolios as their products come off patent. As a result, a new finance model for development stage life science is beginning to emerge based on Big Pharma and med-tech companies making early strategic investments in development stage life science companies and venture capital coming in after the strategic investment. This model potentially reduces the amount of capital a life science venture capital firm needs to commit to a life science company, shortens the time period of the VC's investment, and reduces the VC's technology risk based on the strategic investor's validation of the technology. We've seen more of these types of financing strategies in the life science venture capital marketplace and we are developing a lending strategy to adjust to the new model so we can take advantage of what we believe will be increased growth in biotech investment beginning in the fourth quarter of 2012.

Additional support for our expectation of increased growth arises from the fact that the value of the excess for biotech companies compared to tech companies has been strong in 2012, which is increasing VC's interest in becoming more active in the life science market. According to the National Venture Capital Association, there were seven life science M&A transactions completed in the second quarter with a total disclosed value of $1.7 billion, or an average of approximately $250 million per M&A compared to 18 technology M&A transactions with a total value of $2.5 billion or an average of approximately $143 million.

With respect to healthcare information and services market, we've previously indicated that investment in this sector will continue to be measured until the healthcare regulatory environment becomes clearer, presumably post-election. Nonetheless, there are significant current market opportunities in this sector related to improving patient outcomes and reducing healthcare costs, which we believe will lead to an increase in venture capital investment in 2013.

In the second-quarter, the number of M&A transactions involving venture capital backed companies increased by about 7% to 110 companies totaling $13.6 billion compared to 98 companies completing M&A transactions totaling $12.7 billion in the first quarter. We expect to see significant M&A activity through 2012 as mature technology companies with strong balance sheets look to enhance their product platforms and embrace leading-edge technology solutions.

The number of IPOs in the second quarter dropped significantly from 20 companies in the first quarter compared to 11 companies in the second quarter. In terms of IPO dollars raised, the second quarter was completely skewed by the Facebook IPO with $7.7 billion raised in the second quarter compared to $1.4 billion in the first quarter. However, after deducting for the Facebook IPO, overall the amount of IPO dollars raised in Q2 was lower than the first quarter. We believe the Facebook IPO may have negatively impacted the IPO market related to technology IPO demand.

We expect the IPO market to be soft in Q3, mostly related to seasonal issues, but we anticipate seeing stronger IPO demand in Q4 of 2012 for growth-oriented technology companies with strong technology platforms and growing revenues. This demand will be aided by venture capital backed companies beginning to take advantage of changes to the IPO regulatory environment as a result of Congressional passage of the Jobs Act.

Finally, we saw little change in the competitive landscape for venture lending during the second quarter of 2012. Market demand for venture debt was strong and we continue to see a very rational competitive marketplace.

Let me now turn the call over to Chris Mathieu, our Chief Financial Officer.

Thanks Gerry. I'd like now to turn your attention to Horizon's financial performance. Our consolidated financial results for the three and six months ended June 30, 2012 have been presented in our earnings release distributed after the market closed yesterday. We also filed our 10-Q with the SEC last night.

Our total investment income for the second quarter of 2012 was $5.5 million compared to $6 million for the second quarter of 2011. This decrease is primarily due to a lower average portfolio balance in the quarter. The lower balance was due to the majority of new loans funding late in the quarter and higher than normal prepayments in the first quarter. Substantially all of the $5.5 million in investment income for the quarter was earned from interest income from our loan portfolio.

For the six months ended June 30, total investment income increased 5.9% to $12.1 million compared to $11.4 million in the prior-year period. The six-month increase was primarily due to the increased average size of the loan portfolio.

Total investment income for the first six months of 2012 of $12.1 million consisted of $11.4 million in interest income from investments. Fee income of $700,000 was primarily from prepayment fees from portfolio companies during the first quarter. We continue to believe loan prepayments are a natural and healthy part of our portfolio lifecycle. Excluding warrant gains, our weighted average portfolio yield was 12.9% for the second quarter and 14.1% for the same period in 2011. This lower yield was largely due to a reduced level of average earning assets as the majority of our new loans funded late in the second quarter. In addition, there were no loan prepayments in the second quarter compared to one prepayment in the second quarter of 2011. The Company's weighted average annualized portfolio yield for the six months ended period June 30 was 14.1% and 14.6% for the first half of 2011.

The Company's total expenses decreased $800,000 to $3.2 million for the quarter as compared to $4 million for the quarter ended June 2011. Total expenses for each period consisted of interest expense, management fees, incentive and administrative fees, and to a lesser extent professional fees and G&A expenses.

Management fee expense for the three months ended June 30 decreased compared to the prior year as a result of a decrease in the average gross assets as we delevered the portfolio through the ongoing amortization of our investments held within our WestLB credit facility.

Performance-based incentive fees decreased by $1.2 million in the quarter compared to 2011 primarily due to an accrual for the incentive fee related to realize gains that we earned in the second quarter of 2011 with no such accrual recorded in the second quarter of 2012. The decrease in total expenses for the second quarter of 2012 was partially offset by higher interest expense due to increased usage of the Company's Wells Fargo credit facility and the issuance of senior unsecured notes, offset by our continued pay down of the Company's WestLB facility.

For the six months ended June 30, total expenses decreased $700,000 to $6.5 million as compared to $7.2 million in the prior year.

The Company earned net investment income of $2.3 million or $0.30 per share for the quarter ended June 2012 as compared to $2 million or $0.26 per share in the prior year. For the six months ended June 2012, net investment income was $5.6 million or $0.74 per share as compared to $4.2 million or $0.55 per share in the prior-year period. Although we did not realize any warrant gains in the second quarter, we believe our expanding investment portfolio, which now includes more positions in 55 companies at the end of the second quarter, provides potential to realize significant gains in the future. Since going public, we have reported aggregate realize gains of approximately $6.8 million or $0.91 per share.

During the second quarter, there were no material change in the net fair value of our investments. This compares to net unrealized depreciation on investments of $3.5 million for the three months ended June 2011, which is primarily due to the reversal of previously recorded unrealized appreciation on warrant investments that we realized in the period. For the six months ended June 2012, the net unrealized depreciation on investments totaled $800,000 which was primarily due to $1.2 million of net unrealized depreciation on three investments partially offset by unrealized appreciation on our warrant investments.

Overall asset quality on the portfolio has remained strong. Our three and four rated credits now represent over 94% of our total fair value on our loan portfolio compared to 90% at the end of the first quarter and 87% at the end of 2011. Our two rated credits were reduced to 5.6% at June 30 from 8.5% at March 2012, and 13.5% at December 31. As of June 30, our net asset value was $16.73 per share or $127.9 million. For the three months ended June 30, we increased net assets from operations by $2.2 million or $0.29 per share and for the six months ended June 30 we increased net assets from operations by $4.8 million or $0.62 per share.

We began the second quarter with an investment portfolio of $167 million. Net new loan investments totaled $37 million with no refinance balances in the quarter. We also recorded $9 million in normal contractual loan prepayments -- repayments and had no prepayments leading to an ending investment portfolio balance of $196 million as of June 30. Our investment portfolio as of June 30 included 41 secured loans with an aggregate fair value of $188 million, and 55 warrant positions with an aggregate fair value of $5 million.

As of June 30, we had cash and cash equivalents up $7.5 million. We continue to manage our cash balances to keep non-earning assets low. This is achieved by applying our free cash to our revolving credit facility and re-borrowing as needed. We continue to benefit from our two existing credit facilities which provide attractive leveraged to enhance the Company's earnings.

As of June 30, our Wells Fargo credit facility has a current commitment of $75 million and had a total of $33 million outstanding. Our WestLB credit facility had $14 million outstanding. Based on eligible debt investments held by Horizon at June 30, we had an additional $17.8 million of borrowing capacity available under our Wells facility.

In July, we completed a public offering of 1.9 million shares of common stock for gross proceeds of about $31 million. This share offering followed our public offering in March and April of $33 million in senior unsecured notes due 2019. We do appreciate the strong support we've received in connection with these offerings, both of which were oversubscribed, demonstrating the confidence the capital markets have in Horizon's strategy and future growth prospects. We have used the net proceeds from the recent equity raise to repay outstanding debt borrowings under our credit facility with Wells Fargo, and then through re-borrowing under the facility, we expect to invest the net proceeds of the offering in portfolio companies consistent with our investment strategy and objectives.

As of June 30, we had leverage of 0.63-to-1, sufficiently below our current target ratio of approximately 0.8-to-1. With the impact of our July equity offering, we reduced our overall leverage to 0.34-to-1. With net proceeds from the recent equity offering and the availability under the Wells facility, we estimate that we have liquidity to fund investments exceeding $75 million. We expect to further enhance liquidity with additional commitments for leverage in the future which could increase liquidity by as much as $15 million based on our current equity capital of approximately $157 million.

In June, a bill was introduced in the House of Representatives that could help Horizon grow its business as well as provide more capital to the venture capital backed companies we serve. The bill is currently in the House Committee on Financial Services and has not yet been presented for formal House vote. The bill is targeted directly at BDCs to increase the capital availability and the goal of the bill would include, among other things, to increase the maximum leverage of debt-to-equity of 2-to-1 from the current 1-to-1 maximum leverage. It would also allow preferred stock to count as equity instead of debt for regulatory purposes, and finally streamline the registration of reporting requirements for raising new capital. We believe the passing of the bill into law could have a positive impact on Horizon by allowing higher levels of leverage to increased return on equity, earnings and dividends, and although we are optimistic on the ultimate outcome given the upcoming national election, we don't expect any proposed bill to receive significant attention until 2013.

Now I'd like to turn it back to Rob.

Thank you Chris. We are pleased by our performance during the first half of 2012 and remain excited by our future prospects. Based on our record deal originations in the second quarter combined with our increased liquidity, Horizon is in a strong position to further expand its portfolio of venture loans yielding between 11% and 15% while maintaining the opportunity to enhance total returns via warrants. We remain focused on executing our investment strategy as we have consistently done in the past, which we believe will enable the Company to expand future earnings and continue to provide attractive dividends for the benefit of our shareholders.

Before we open the floor for questions I would like to note that we plan to hold our next quarterly conference call during the week of November 5, 2012. At that time, we also expect to announce our dividend for the third quarter. We'll be happy to take questions you may have at this time.

(Operator Instructions). Greg Mason, Stifel Nicolaus.

Good morning gentlemen. First, I want to talk about the yield on new investments. Just as we look at the coupons on those new investments, they look to be call it 1% below what's general in your portfolio. Could you talk about if you're seeing any spread compression on the new investments?

And then as a follow-up to that, I know you said the average yield was -- calculated yield was low this quarter because a lot of the loans funded at the end of the quarter. Should we expect to see that portfolio yield move back up into that 14% range next quarter? Maybe what was the yield on a run rate at the end of the quarter? Thanks.

So the gap yield is combined current coupon, which you see in the Q. It also includes commitment fees that we receive upfront and increase them over time. Generally those are anywhere from 0.5% to 1.5% of the regional funding amount. And then we also have final payments which accrete into income over time. So it's a combination of those three that come into income. So when we talk about overall spreads, we are using all three of those as the measure. And those have remained in the 12% range consistently at least the past six quarters or so.

Great. And then maybe to help us to be able to calculate for our modeling purposes, kind of could you give us the average portfolio balance for Q1 and Q2 so we can have a better feel for the impact of these loans funding late in the quarter?

I don't have the exact numbers, but the real issue is being sure that you use a time weighted average for the portfolio rather than a simple average. So the best way I would say to think about our earning potential in any quarter is to take where we are at the end of the quarter or the beginning of the quarter for that quarter, and pretty much ignore the portfolio changes during the quarter.

Today we announced, Gerry announced that we've had $1 million of fundings and no prepayments through early August and yet we still expect it to be a good strong funding quarter.

For us, the issue is that this is all paper push to get these loans funded by the end of the quarter. And so in this third quarter, that paper push doesn't really start in earnest until after Labor Day. So as a result, we expect fundings in the third quarter to be back-end loaded again as well.

Okay. Great. Then as we think about you said your leverage target is 0.8 debt-to-equity, call it $155 million of equity after the capital raise. That would imply you want about $125 million of debt on your balance sheet. That would mean you need to expand some of your current leverage capacity. What ways are you thinking about expanding that leverage, and are you in discussions to do that?

There is really three ways to think about that. We can look at additional additional baby bonds that we issued back in March and April. Those are performing very well. We have availability under the accordion feature of the Wells Fargo facility. Currently, there is $75 million commitment. We can expand that to $50 million. And we always have the option to do additional credit facilities above and beyond those that we currently have in place. So, we are looking at a number of options as we continue long-term to have the strategy to grow the business and to leverage smartly, and at the right leverage level and pricing.

Great. One last question. You talked about the spillover dividend of $0.55, and that's kind of supportive the gap between NOI and the dividend. But long-term, at least our view is that is a little more risky from a dividend perspective. Do you think you can uncover the dividend from operating income, or is your strategy going to be continually to hopefully generate gains to support the dividend over the long-term?

Over the long term, this model has consistently earned net realized gains from warrants that exceed net realized losses. And so we think this is a permanent part of our model. We understand you guys need to see that over time, but that's what we expect to happen. We also expect that we will have the ability to grow NII as a percentage of that dividend over time as we deploy the assets that are accretive from an NII perspective. But we expect that the long-term realized gains will be a part of our strategy, dividend strategy, going forward.

Okay, great. Thanks guys.

Robert Dodd, Raymond James.

Hi guys. Could you give us an update on the nonaccrual, which you don't have any more, obviously. The end of last quarter you had [Vet Corp.] or [Veti] Corp. on nonaccrual. We had a discussion last quarter about how that was going to be revolved. Obviously, it's gone to portfolio now, so could you give us an update how that finally played out, and what the recovery was there?

So we -- at March 31, the loan was still with Vet corp., which was our borrower, and on nonaccrual. In April the assets of Vet Corp. were acquired via another third party. And as part of that transaction, we entered into a new agreement with a new buyer that will pay us basically a royalty agreement over an extended period of time. Plus, we share in some proceeds from the sale of some real estate if that happens. That arrangement is just starting. We had the first-quarter report and we fair-valued that new agreement at about $2 million in our portfolio, consistent with the carrying value I believe at the end of the first quarter.

Got it. Then just getting back to kind of capital, you paid down quite a lot on the WestLB in the second quarter, even though it's got an amortization phase that goes through to 2015, and it still has, from what we talk about, $50 million pledged to it. Can you let us know what the decision was there? It's pretty cheap debt. It doesn't look like you had to pay it down, and it looks like you've got, again, significant assets still pledged to it. So what was the decision? What was the basis for deciding to pay that down rather than keep that on the books as another source of capital?

Just to clarify, if I misspoke, it was actually paid down on the Wells Fargo facility, which is currently still in its revolving period. So WestLB we have not accelerated the repayment. So the WestLB facility still has about $14 million or so on it, and we are letting it continue to amortize as the loans repay, the ultimate end-users repay to us. The equity was used to pay down the short-term WestLB -- I'm sorry, Wells Fargo facility. So we'll --

Right, but just to clarify, if I remember right, the WestLB had $35 million outstanding at the end of Q1, and only $15 million at the end of Q2. So I'm talking about in the second quarter, not with the acquisition.

So that's not -- we did not -- we stayed within formula, and so it was nothing to do with accelerated repayments because -- optional repayment. So there's buckets, concentrations and whatnot. So as the portfolio get smaller, the concentrations within the design of the structure kick in. And so those were just built into the structure.

Got it. Then on the bill in the House, in terms of potentially increasing BDC leverage ratios to 2-to-1 instead of 1-to-1 in terms of caps, how -- have you had any preliminary discussions with your banks or bankers for that matter in terms of the advance rate on the Wells facility is 50%, so that pretty much captured 1-to-1. Obviously that's secured, if you could go unsecured to take the rest of the debt. But do you think you'd get similar pricing for example on additional baby bonds if you were to be taking a much larger debt position? I mean there's an unsecured borrower there, you'd be -- have potentially more risk if your leverage ratio went to well north of 1-to-1. Have you got any feedback there?

Yes, we actually have. If you remember, the WestLB facility actually started out as a 3-to-1 leverage vehicle for us. So we have a track record of being able to get facilities that have more than 1-to-1 leverage and that certainly was a very attractive pricing, probably something that the venture lending space won't see again. But we do think we can gain access to additional baby bonds should the markets be right when we look for it. We also have some pretty optimistic views on obtaining other nonpublic transactions where we can get more than 1-to-1, more in the 2-to-1 leverage type of structure. Pricing still to be determined.

Thank you. Casey Alexander, Gilford Securities.

Good morning. I'm kind of curious as to your view of how the deal flow is coming in, and are you seeing more deal flow and companies staying either intentionally or unintentionally private longer because of the lack of robustness of the IPO market?

Yes, it's a very good question. There's always -- for over 20 years, there's always been a bandwidth relative to the strength of the IPO market and M&A market and -- on one end. And then on the other end, VC investment in very early-stage companies. So that band is always expanding and closing depending on how those two ends of the market are performing.

What we're seeing today is I would say kind of on the higher end of the bandwidth companies are in fact staying private longer. There is a number of reasons for that. Some are in fact out of their control; that is the IPO market is not as robust as I think a lot of people would like to see.

There is very good M&A activity going on, but it's very discreet. Certain companies are getting very large premiums, doing very well in their exits, but there are other areas where there just isn't the demand for the product right now. And so those companies have to kind of continue to execute as a private company.

As a venture debt lender, we have opportunities to provide financing in either of those scenarios, generally speaking. If the IPO market and M&A market isn't as robust as they would like, then obviously that means companies are going to be private longer. They're going to need more capital from various sources and venture debt fits very well into that bucket.

On the other hand, when later-stage companies start to see the opportunity to an exit, the last thing they want to do is raise that last private round of equity before they feel they can either get acquired or go public. And so they use venture debt kind of as the last financing for a company. So we see opportunities there as well.

The other thing is on the other that that spectrum is that when IPO and M&A activity gets strong, then VCs become much more focused on investing in early-stage companies again because they are starting to get some of their capital back and they need to redeploy it, and so we are seeing early -- we see a lot more earlier-stage opportunities for debt as well. So that's kind of how the market contracts and expands relative to the IPO and M&A activity.

And today it's -- I would say we're seeing more expansion money, meaning companies think they're going to be in it for a little bit longer haul which is fine by us. These are really strong companies that in a better IPO market or M&A market would probably have been acquired or gone public by now. So, we are actually taking less risk as it relates to that, because the overall profiles of the companies are stronger right now.

You guys have been investing in this model for quite a while now. Is it common as your portfolio develops to see kind of like a build up of warrant stubs from leftover deals, and then if the IPO market picks up at some point in time a year, two years in the future that stub portfolio starts to get cleaned out?

I think that's a good point. Without a doubt there is a correlation between exits relative to the warrants that we are holding, and we have 55 positions today. There is definitely a direct correlation between a stronger IPO and M&A market, generally speaking, when that draft upticks, it takes a lot of companies. It sucks up a lot of companies into it as it becomes significant competition all of a sudden to buy up these companies and gain the technology that some of these stronger companies that need to be competitive in the marketplace. So yes, there is definitely a correlation I think relative to that. But even in the worst of markets, we've had companies get acquired with premiums on a one-off basis. So with 55 portfolio companies, we believe that history has proven that, over time, on a quarterly basis, you're going to see some of those. And we would expect to as well.

Is that 55 portfolio companies in terms of warrant positions versus the 41 secured loans that you are showing on the books?

Correct.

Correct.

Okay, great. Thank you for taking my questions.

(Operator Instructions). Jonathan Bock, Wells Fargo.

Thank you for taking my questions. Gerry, real quick on the industry, you did, as Greg mentioned, see the central decline in coupon. I want to know what are you seeing in terms of warrant coverage on some of these deals? Are you more than willing to maybe lower the coupon in exchange for either higher warrant coverage or potentially higher quality transactions?

It's a good question. The reality is that we evaluate every single transaction on that basis, and so through that evaluation, if we believe that a company has really strong upside with relatively lower downside risk on a comparative basis to our overall portfolio, we might be willing to look at a stronger warrant position.

But getting back to coupons and things like that as it relates to today's market, the reality is that when we look at pricing from the top down, that means from the competitive marketplace versus from the bottom-up, which is prepayments when transactions actually go on to the portfolio. In this quarter they went on -- in last quarter they went on later, so that had an impact. But on a top-down from a pricing standpoint, what we are seeing in the market is value borrowers. They want value for the loan that we are making. And what I mean by that is they are looking to use our capital to stretch as far as it can to create as much value for their companies as possible. To the extent we are doing that, pricing becomes significantly less of an issue. And that has always been kind of how we've looked at the market and how we've competed in the marketplace. So, we don't compete on dollar-to-dollar for pricing, and as I look quarter-to-quarter at our pricing from the top down, our pricing has been as good this quarter as it has been -- I think Chris mentioned over the last five or six quarters. So we are really not seeing any -- a lot of compression there. But you do have to be providing value, and that's something that, given the experience of are managing directors and our ability to underwrite these deals, we do pretty well effectively, which results in less real risk and -- but yet we get value for it for taking what appears to be risk. So that's how we're seeing pricing today.

Back to the warrant part of that, we haven't seen a lot of compression on warrant coverage in the last two or three quarters. It's been fairly consistent. Your point is a good one, though. We do like when the opportunity presents itself, what we feel is a high-quality with significant upside potential, to make sure that we are paying attention to that warrant on that transaction to make sure that we can hopefully get the benefit of it.

Let me make one other clarification so that everybody is clear. When we list the investments in the 10-Q, we list the coupon, the stated coupon, not the yield. And so the trends -- Jonathan -- when you mentioned that the coupon average -- or Greg did this -- is off 1%, the trade-off isn't for warrant coverage as much as it might be for final payment or other fees that aren't included in what's listed in the investment list.

I understand that point, and thanks for the color. And Rob, the next question really relates to the topic of dividend coverage. I completely get your point that gains is an important part of the VC model, but when I think back to the list of BDC that is found capital gains as a part of their dividend policy, really a few names came to mine. American Capital, Allied, Prospect. I'm not really sure that is is very good list for Horizon to be on. So maybe a more poignant question, why not just pay out a dividend in line with net interest income or through cash flow, for that matter, and then use the gains to either pay out a special or build a spillover dividend?

I'll make a couple of distinctions of us versus the names you mentioned. First of all, we are only actually using this to the extent that we are in a net realized gain position, not on the promise of future net realized gain.

Second, it's a small augment to what we expect to be growing NII over time. And we feel it's appropriate to reward our existing shareholders with the gains that have been earned on their watch. And so we didn't come up with this strategy, Jonathan, on a prospective basis but on an absolutely when should we reward the shareholders who have been owners of our shares. And so that's the way we look at it. We understand there are prejudice that exists from predecessors. We hope we don't get painted too much with that brush. But we would like everybody to understand that this is a concerted effort, and we -- on a normalized NII basis, we believe the amount of augmentation that's being done is appropriate and it gives us the confidence to sit here today and look at what's left in that bank, if you will, and what we expect to be normalized NII over the foreseeable several quarters to support that dividend strategy.

Okay. I get that that you're going to bridge the gap, and obviously that gap gets smaller and smaller. I guess maybe the initial question is that I had a need for some clarity on is is it your intention to fully cover the dividend from net investment income on a steady-state basis over time?

That would be a goal, but I think what we would do then is look -- because we expect to continue to have realized gains is that we would then look at what coverage we had from NII and how much we had in this undistributed income and adjust our dividend accordingly. And by that, to be clear, but we would have adjust it upwards so that we have that same sort of ratio going forward.

Okay, great. Thanks for the color, appreciate it.

At this time, I am not showing any further questions. I'd like to turn the call back to Mr. Pomeroy for closing remarks.

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

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