Horizon Technology Finance Corp (HRZN) 2016 Q4 法說會逐字稿

Good morning and welcome to Horizon Technology Finance year-end 2016 conference call. Today's call is being recorded.

(Operator Instructions)

I would now like to turn the call over to Megan Bacon of Horizon for introductions and reading of the Safe Harbor statement. Please go ahead.

Thank you and welcome to the Horizon Technology Finance fourth-quarter 2016 conference call. Representing the Company today are Rob Pomeroy, Chairman and Chief Executive Officer; Jerry Michaud, President; and Dan Trolio, Chief Financial Officer. Before we begin, I would like to point out that the Q4 earnings press release and form 10-K are available on the Company's website at horizontechfinance.com.

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 believes, expects, anticipates, intends, or similar expressions are used to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in 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 from 10-K for the year ended December 31, 2016. 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. In 2016, we achieved a year of solid earnings for our shareholders with net investment income of $1.48 per share that exceeded our distributions of $1.38 per share. During the year, we experienced significant positive portfolio events, including liquidity events from loan prepayments, M&A, and warrant realizations, while we also experienced underperforming loans, which we worked to resolve.

These events together with our disciplined approach to sourcing quality loans contributed to the overall decline in the size of our portfolio in 2016. Over the past few months, we have taken important steps to improve our marketing and underwriting resources, which, coupled with our anticipation of a more favorable market for our loans, lead us to believe we can grow our portfolio and achieve a stable or increased NAV during 2017.

Our first step in this process was addressing the underperforming loans. At present, we have resolved three out of the four loans that were on nonaccrual as of December 31. We settled the ScoreBig loan by receiving the right to the proceeds from a long-term royalty agreement with the buyer of ScoreBig's assets, a large established ticket broker-dealer.

We also settled the New Haven Pharmaceuticals loan by receiving the right to the proceeds of a long-term royalty agreement with the buyer of New Haven's assets, a specialty pharmaceutical company that has similar products selling into the cardiovascular marketplace. Both of these royalty agreements have the potential for full recovery of our loan balances in the future and the fair value of each is in line with the September fair value of these loans.

Xterra, another portfolio company, filed for bankruptcy in the fourth quarter and a court-ordered auction in January of this year failed to produce the sale price sufficient to recover any of Xterra's obligations to us. Accordingly, the loan was written down to zero during the fourth quarter. Obviously, this was a very disappointing outcome.

Our portfolio company, Digital Signal, was on accrual as of September, but was placed on nonaccrual in the fourth quarter. The company, which had been attempting to raise capital in the third quarter, could not raise additional funds to operate. Thus its board elected to wind it down by making an assignment for the benefit of creditors which is seeking a buyer of its assets.

The ABC is in negotiation with a buyer to be sold and we anticipate the loan will be resolved during the first half of 2017. If this transaction is completed, we will have the potential for full recovery of our loan balance.

The second important step we took to improve our portfolio was adding two new talented professionals to our origination and portfolio management team. Both of these executives bring considerable life science experiences to Horizon and we expect them to provide valuable knowledge and expertise as we seek to expand our investments in this sector. Jerry will provide further details on our new team members during his comments.

With regards to market opportunities and our outlook for new business, we're seeing gradual improvement. As we have stated on the last few quarters' calls, we have continued to see steady demand for our venture lending products and a stream of opportunities, but have been very selective.

Many of these opportunities are for refinancing existing debt that already represents significant leverage at the borrower, which is inconsistent with our low loan-to-value approach of providing growth capital. We've resisted these refinancings unless the company's growth opportunities support additional leverage.

Encouragingly, during the fourth quarter, we began to see opportunities that were not overleveraged and where we could generate appropriate returns. We're cautiously optimistic that this trend will continue.

During 2016, our liquidity improved by a combination of portfolio turnover and an increase in our KeyBank revolving credit facility to $95 million, which we accomplished by adding a new lender to our banking group. With this increase borrowing capacity, we entered 2017 with considerable dry powder to expand our investment portfolio. With the additions to our advisors' origination team, we're already seeing an increase in our pipeline and backlog.

We expect that our portfolio will be flat to slightly down in Q1 and then begin to grow during the course of the year as we returned to our target leverage. We have also positioned ourselves for a rising interest rate environment. 96% of our portfolio is comprised of loans with rates that flowed up with increases in short-term interest rates. We expect to see top-line growth in interest income as well as net interest margin from any potential increases in interest rates. Dan Trolio will discuss this in more detail during his remarks.

Horizon also continues to maintain a diverse portfolio of warrants and equity positions in over 80 companies, many of which have fully repaid their original associated loans. While there has been stress from the M&A and IPO markets over the past couple of years, an improvement could lead to exits that provide additional upside to Horizon's NAV and overall profitability as our portfolio continues to mature.

Finally, we declared distributions of $0.10 per share for each of April, May, and June. These distributions bring total declared distributions of $9.32 for our shareholders since going public in 2010. We maintained a spillover of $0.15 per share at December 31, 2016.

Our goal remains to cover our distributions with net investment income over time. As we endeavored to rebuild our portfolio and our net asset value, we're focused on originating quality loans that provide appropriate risk-adjusted returns with strong onboarding yields and that generate steady net investment income. At the same time, we continue to offer our shareholders potential upside to our warrant and equity portfolio.

Before turning over the call to Jerry and Dan, I want to congratulate Dan Trolio on his recent appointment as Horizon's permanent Chief Financial Officer. Prior to being named Interim CFO, Dan served as Vice President and Corporate Controller for over 10 years. After assuming the responsibilities of Interim CFO, it swiftly became clear he was the best person to lead Horizon's finance organization.

We're very excited he has taken on the CFO permanently and look forward to his further contributions to Horizon's continued growth. We're equally pleased to congratulate Lynn Dombrowski, who has been promoted to Corporate Controller. It's a tribute to deep bench strength that we have professionals were ready and able to fill these important positions.

Jerry will now update you on our business development efforts and market environment and Dan will then detail our operating results and financial condition. Jerry?

Thanks, Rob. Good morning, everyone. During the fourth quarter, we continued to monitor what we believe is a downward sub credit cycle defined by overleveraged loan opportunities to companies with limited growth, reduced VC investment, a sluggish IPO market, and generally poor M&A activity, especially for BC-backed companies.

During the past three quarters, we have been implementing a marketing strategy more consistent with the traditional value of our loan products and aimed at the higher growth areas of our core technology and life science markets. In doing so, we have been seeking to rebuild our pipeline mostly around life science and technology companies with new and innovative technologies, but little or no leverage. We believe we made strong progress during the fourth quarter and will continue to advance our efforts in 2017.

To highlight some of the fourth quarter accomplishments, we funded two life science transactions totaling $14 million. Both of these companies, which are publicly traded, had no previous leverage. Further, they both possess strong IP product pipelines addressing critical disease indications with unmet cures. We maintained our disciplined pricing performance, achieving onboarding yields of over 12% despite overall pricing pressure across all debt markets.

We achieved a portfolio yield for the quarter of 14.2%, which continues to be one of the highest using BDC portfolios in the industry. We maintained a growing backlog of committed transactions, ending the quarter with four transactions totaling $21 million. Our pipeline of new opportunities increased from $120 million at the end of Q3 to over $150 million at December, 31, again, with an increased focus on low-leverage opportunities that are developing innovative new products addressing unmet needs.

Our pipeline has continued to build since the end of the year. Today, we have a committed backlog of more than $36 million to six companies and a pipeline of new opportunities of approximately $280 million. During the fourth quarter, we began to reweight our portfolio toward life science and healthcare technology, which resulted in an increase from 35% at the end of the third quarter to 40% of our total portfolio at the end of the year.

At the end of the fourth quarter, we held warrant and equity positions in 83 companies. In addition, we exited four loans totaling $16 million by continuing to hold warrant positions in three of the exited companies.

As Rob mentioned, our advisors strengthened its life science lending platform in Q4 by adding two seasoned investment professionals to our life science team. Sean Donaldson has joined the advisor as Managing Director. Sean brings a strong academic background in life science, with a degree from MIT, as well as significant lending and investment experience from his previous position at Fairview Capital.

Lillian Mu also recently joined our advisor as a portfolio manager on our advisors life science team. Lily brings a strong academic background to the position with advanced degrees in the sciences. In addition, Lily has substantial life science operational experience from her work at big pharma companies and investment experience from her previous position at Connecticut Innovations, where she sat on the boards of several life science portfolio companies.

Going forward, we expect our advisor will continue to strategically add marketing and portfolio capabilities in order to further build the Horizon pipeline and pursue quality opportunities in our core markets. As we continue to execute our focus strategy of providing quality debt products to companies with low leverage, continued investor support, and strong IP product platforms, I would expect or onboarding yields to be slightly lower in the coming quarters compared with historical highs we have recently achieved.

This is consistent with rebalancing our portfolio toward life science and healthcare technology transaction and our focused on incremental quality portfolio growth during 2017. At the same time, we still expect our onboarding yields will continue to remain among the highest in the BDC industry.

Before providing some perspective on the market environment, I'd like to note a development subsequent to year end. During the first quarter, one of our public life science portfolio companies, Argos Therapeutics, reported that the independent data monitoring committee for the company's ADAPT phase III trial recommended the study be discontinued for futility based on its planned interim data analysis.

Following this development, Argos repaid the outstanding principal balance of its loan to Horizon. Horizon continues to hold warrants in the company as Argos endeavors to work with the FDA on a path forward for its lead product.

Now I'll discuss the general venture capital environment. In the fourth quarter, the number of start-up companies receiving capital continued to trend down with $11.7 billion invested as reported by PWC's MoneyTree report. In terms of the number of deals and dollars, both fell to eight-quarter lows. Overall, BCs continue to remain invested in private companies longer with fewer deals and larger equity rounds.

However, 2016 was a record year for BC fundraising with nearly $42 billion raised for the year, well above the $35 billion raised in 2015, according to the National Venture Capital Association. Contributing to this increase were larger fund sizes during 2016. BC-backed exit activity continued to trend down during the fourth quarter with the lowest value since the first quarter of 2013.

Turning to our core markets, life science investment activity declined during the quarter coming off strong third-quarter highs. Despite this decline, the sector attracted 11% of the venture investment during the fourth quarter, including two of the 10 largest BC investments. BCs invested $1.9 billion into 119 life science companies with an average deal size of approximately $16 million.

With both M&A activity and IPO activity trending down in life science marketplace, we continue to expect more quality opportunities to provide debt to later-stage life science companies during 2017 as they wait for a better IPO and M&A exit markets to materialize.

Prospects in the healthcare technology market remain attractive for us as we continue to see increasing opportunities for companies that are focused on cost containment and productivity solutions in the healthcare space. Base on our multi-year industry outlook, we believe there will be compelling opportunities on both debt and equity side. The one cautionary note is the uncertainty of healthcare reform and how it will impact the overall healthcare market.

In the broad technology market, while US-based internet companies continued to receive the most funding across all sectors during Q4, investment activity for internet companies declined on a quarterly basis. The sector accounted for 39% of the US investment activity for the quarter, down from 46% in the third quarter.

Aside from the internet sectors, companies involved in artificial intelligence and robotics and other more revolutionary products and markets remained ahead of the general slowdown. Overall, we are still seeing hesitation on the part of BCs to continue to support early-stage companies who technology has been passed or are otherwise experience slow growth. We have not focused as of late on the clean tech market as venture capital investing remains scarce there.

We continue to see greater emphasis on technologies that support healthy living. However, our approach remains cautionary given the limited VC investment. Looking at the venture debt competitive landscape, technology banks continue to be active in the competition for life science transactions. This has driven opportunities for multi-partner transactions in the late-stage life science deals as evidenced by our recent venture debt financings with Strongbridge Biopharma and VTV Therapeutics. We expect to see further opportunities for joint transactions during 2017. With that update, I will now turn the call over to Dan.

Thanks, Jerry, and good morning, everyone. I will now briefly discuss our financial results for the fourth quarter and full year 2016. Of total investment income for the fourth quarter was $7 million as compared to $8.6 million for the fourth quarter of 2015. The decrease was primarily due to lower interest income and investments resulting from the smaller average size of our loan portfolio.

For the year ended 2016, total investment income increased to $33 million compared to $31 million in the prior year. Our portfolio yield for the fourth quarter was 14.2%, consistent with last year's fourth quarter. Onboarding yields in our portfolio were 12.1% and have remained stable in the 12% to 13% range since our inception. For the full year, we achieved a portfolio yield of 14.9% and onboarding yields of 12.3%.

As mentioned in the past, the primary changes period-to-period to our portfolio yields are driven by the timing of new loan originations and the timing and extent of loan prepayments and the related fee income from those prepayments, including prepayment fees and acceleration of previously unamortized end-of-term payments.

Turning to our expenses, total expenses were $3.1 million for the fourth quarter, a 30% decrease as compared to the $4.5 million in Q4 of 2015. Included in these expenses is interest expense, which decreased slightly on a year-over-year basis, mainly due to a decrease in average borrowings. Due to the fair value adjustments that Rob discussed earlier, the incentive fee expense for the fourth quarter was subject to the incentive fee cap and deferral mechanisms under our investment management agreement. This resulted in $800,000 of reduced expense and additional net investment income.

In addition, base management fee decreased year-over-year to $1.1 million compared to $1.2 million in the prior-year period, primarily due to a decrease in the average size of our investment portfolio. Total net expenses for the full-year 2016 decreased by $1.1 million to $16 million as compared to $17.1 million for the full year of 2015.

Interest expense for the full year increased slightly to $5.9 million compared to $5.8 million in the prior-year period due to an increase in the average outstanding borrowings of $14.9 million or 17%, which was partially offset by a decrease in our effective cost of debt. Base management fee expense increased [$5.3] million to $4.7 million for the full year 2016 and professional fees and general administrative expenses for the full year were unchanged at $2.3 million compared to 2015.

We earned net investment income of $0.33 per share for the fourth quarter as compared to $0.35 per share for the fourth quarter of 2015 and $0.38 per share for the third quarter of 2016. For the full year, we earned net investment income of $1.48 per share as compared to $1.25 per share in the prior-year period. After paying our deemed tax distribution of $1.36 per share and taxable earnings of $1.41 per share, the Company's undistributed spillover at year end was $0.15 per share.

As of December 31, our NAV was $12.09 per share, a $0.35 per share decrease from the prior quarter. This decrease was primarily due to the unrealized depreciation on our debt investments. New originations in the fourth quarter totaled $14 million which were offset by $14 million in scheduled principal payments and $13 million in principal fee payments.

We ended 2016 with an investment portfolio of $194 million, which consisted of secured loans to 44 companies with an aggregate fair value of $186 million and a portfolio of warrant and equity positions in 83 companies with an aggregate fair value of $8 million. New loan originations for the full year totaled $58 million to 13 portfolio companies, which were offset by $49 million in scheduled principal payments and $46 million in principal prepayments.

In terms of the balance sheet, we ended the year with a approximately $42 million in available liquidity, including cash and funds available under our credit facility. As of December 31, we had $63 million outstanding under our credit facility, which was expanded to $94 million in April of last year, and contains an accordion feature which allows for an increase in size of up to $150 million.

In addition to our credit facility, we continued to have the $33 million of publishing traded baby bonds which mature in 2019. As previously discussed, we refinanced the remaining balance of our asset-backed notes during the second quarter of 2016. We remain committed to increasing debt levels and growing our leverage ratio towards our target of 0.75 to 1. At year end, our actual leverage ratio was 0.69 to 1. Taking into consideration the current gap between our target and actual leverage ratio, we expect that we can grow our current investment portfolio by $50 million.

I now would like to provide an update on our stock repurchase plan. Since the share repurchase plan was first approved in September 2015, we have repurchased over 161,000 shares of our common stock at an average price of $11.27 on the open market at a cost of $1.8 million. As previously announced in July, our Board of Directors extended the share repurchase program until the earlier of June 30, 2017 for the repurchase of $5 million of the Company's common stock.

Before we go to questions, I'd like to briefly touch on our interest rate sensitivity, which is a topic that's received a lot of attention lately following the FOMC meeting in December when it alluded to a rising interest rate environment. Horizon, like all BDCs, could be affected by changes in interest rates. Recognizing this, for the past two years, we have been shifting our focus to floating-rate loans in anticipation of increasing interest rates.

As of year end, 96% of the outstanding principal amount of our debt investment, or interest at floating rates with coupons that are structured to increase when interest rates drive compared with 64% as of year end 2014. Based on our December 31, 2016 consolidated statement of assets and liabilities, we estimate that for 100 basis point increase in the LIBOR rate, we would increase annual net interest income by approximately $200,000 or $0.02 per share.

In summary, we believe Horizon is well-positioned to experience both increasing income and expanding net interest margin in a rising interest rate environment.

Lastly, I'd like to note that we plan to hold our next conference call to report first-quarter results during the week of May 1. This concludes our opening remarks. We will be happy to take questions you may have at this time.

Thank you.

(Operator Instructions)

Jonathan Bock, Wells Fargo Securities.

Hello, guys. Jamie Sirockman filling in for Jonathan. If you guys can, can you provide a little bit more detail on the royalty agreements for ScoreBig and New Haven? How will those look exactly? And then what are your expectations for recovery?

Yes, so both of these were negotiated during the fourth quarter and concluded in the early first quarter. They represent longer-term agreements that were entered into through an ABC. They're different, of course, because one is a service and one is a product.

The important thing on ScoreBig is that the site is back up and running. And the partner, the actual acquirer of the asset is a well-established ticket broker/dealer, and they're off and selling tickets again, which is good. And over time, we will have the potential to recover our entire balance. We fair-valued that asset based on a scenario analysis of future revenues and profit sharing royalties.

In terms of New Haven, same thing: The company's asset, primary asset, its approved drug has been acquired by another company. And we are the beneficiary of a royalty agreement from that transaction that, as the product is essentially relaunched back into the market side by side with the acquirer's other products selling into the cardiovascular market, we will start to earn royalty agreements. We expect both of these to take time to fully ramp up, but we felt strongly that negotiating these agreements was in our shareholders' best interest because it gives us the potential for full recovery over time.

Great. That helps. Switching gears a little bit as it relates to the dividend, we saw NOI was above the dividend, the new $0.30 dividend this quarter. But that was largely due to the lack of incentive fees. So, as incentive fees return, where do you expect NOI to fall? And if there is a gap between the NOI and dividend, how do you expect to bridge that gap?

So, as we've stated consistently, our goal and target is to have distributions that are covered by NII over time. The strategy in order to accomplish that is to rebuild the portfolio, which is essentially get back towards our leverage, continue to have a steady stream of liquidity events. And we believe that we can achieve that over time, hence our decision to continue at the current dividend level.

Sure. Thanks. That's all the questions for me.

Paul Johnson, KBW.

Good morning, guys. Thanks for taking my questions. I just had a question. You guys made a couple hires back in the fourth quarter, which is good. You're building out a greater ability of your platform and I know you had already talked about that a little bit in your last quarter. But this is the second straight quarter of no incentive fees and I was wondering, has that or do you expect that to put any pressure on executing on that, on your ability to retain or hire new personnel?

Hello, Paul. This is Jerry. The answer is, no, we don't. We actually have a very strong plan going forward on where our transactions are going to come from, the kind of transactions that we want, who we need on board to execute on that plan. And we plan on, as you've already seen in the fourth quarter, and you will probably see going forward, we're planning on adding the resources that we need to do that. And our strategy for 2017 is pretty much set and we're actually pretty optimistic about it.

Okay, thanks. I guess the last question is just a technical thing, but can I get an update on your total headcount, where it stands today?

I think we're at 18.

All right. Thanks, that's all for me.

Leslie Vandegrift, Raymond James.

Hello. Good morning. Thanks for taking my question.

Good morning, Leslie.

A quick follow-up to one of the earlier ones on ScoreBig and New Haven coming up this quarter -- some idea on possibly the realization there in the quarter?

In terms of realization, no, these are longer-term contracts. Both of them require some ramping up, hence our statement that we have the potential to recover the full balance over time and yet the fair value has been marked down in the 40% to 50% range of that balance. And that's because of weighting the scenarios and the timeline.

Leslie, we will continue to fair-value the scenarios over the coming quarters as more information comes in, but the royalty agreements will have a significant life to them.

Okay, so the loans themselves are still on there then. So there was no realization on the previous loans?

So, the loan for ScoreBig will be on the books for a period of time. It all has to do with the legal contract of our loan security and the lien we have on the assets at the ABC and the royalty agreement. And once certain factors change, you may see New Haven go away or ScoreBig go away over time. But as long as the loan is still outstanding, it will still be recorded as a loan.

Okay. Then on Xtera, marked at 65% approximately for value to cost last quarter. I know you said the sale came in too low for the second lien lenders there, but what kind of color did you have at that time going into the process because that's a rather large mark to go from 65% to 0%. So looking at what happened there, the difference over the quarter?

Yes, at the time that we submitted our third quarter, they had not yet filed bankruptcy. They were in the process of considering either raising additional capital; we had offered to restructure our loan. The possibility of bankruptcy was existent, but they hadn't filed until right after we had filed.

But the expectations from everyone, including the investment bank that they had hired, were that an auction would generate many strategic buyers well in excess of the combined debt. Unfortunately, that did not happen and it was very disappointing through the process that played out in bankruptcy in December and January. Leading up to the auction, we were expecting still that we had a chance for some recovery, but the auction proved to be totally unfruitful.

Okay. All right. Thank you. Then on the outlook, you said up about $15 million in the portfolio growth there for the year, I believe. So, growth at 25% on that side in this choppy market, like you said, saw a bit more opportunities in the fourth quarter, optimistic for first half. But how do we get that much growth in this coming year?

Hello, Leslie. This is Jerry Michaud. Yes, if you look at historically where our funding patents have been, we've been somewhere in the $25 million to $40 million range every quarter and generally speaking we have had prepayments in the $10 million to $15 million range. Obviously, if you look at 2016, we significantly ramped that back and I've mentioned some of the reasons for that.

We just, honestly, the opportunities we -- a combination of the opportunities we were seeing were not high quality. They were overleveraged companies. But even more importantly, we were seeing an exit market that honestly hasn't been as bad as I have ever seen, and that, if you think about 2008/2009, those were pretty bad markets. But there were still buyers around who were willing to, at the right price, pick up some of these companies. That has not been the case for the last three quarters.

It has scared the heck out of the VC community. Companies that generally would have been supported, and a couple in our portfolio, ScoreBig being one, and maybe one other one, that historically would've absolutely have been continued to be supported by their investors, with the idea of finding a soft landing a quarter or two down the road with us helping them with some restructure of the loan, and instead they just basically drop the companies. And that has not been historically how this market has worked.

So, as we were witnessing that early on in the year, we definitely pulled back. But it gave us an opportunity, I think, in the third quarter and fourth quarter to really look at where our markets were going, where the high-quality opportunities were going to be, not in 2016, but going forward, 2017, 2018, 2019. And we have reorganized our group to focus on those.

We've gone out to the market, and instead of looking at the opportunities that have been brought to us, we're going out to the market and looking for very specific opportunities where we believe there will be strong growth. And there's two reasons for that. One is, that is the, for a venture debt fund, that is where, how you rebuild NAV. You have high-quality exits. We have had them before, we know how to do that, and that's what we are -- that's our strategy for the next two years.

And so, to get to the bottom line of your question, we were very pleased in the fourth quarter and here into the first quarter having made that kind of pivot of seeing really high-quality opportunities begin to flow into our pipeline. And I expect that we can get back to that kind of $30 million or so funding on a quarterly basis with fewer exits probably, in the $10 million to $15 million range. So, if we can get back there, we will rebuild the portfolio over the course of the year, get back to our leverage of 0.75 to 1, and obviously increase NII over time.

Okay. And on that point about the -- you talked about the 2018/2019 outlook as well, I think one of the big things being talked about right now and talked about for every company, is regulation changes. But specifically for you guys, the FDA changes that are already being put out a bit there for the life sciences and pharmaceutical investments, are you guys seeing opportunities arising yet from that?

The answer is yes. Basically, the changes the FDA have been pretty positive and when I talk to pharmaceutical executives and biotechnology executives, they are much more optimistic about the FDA relative to getting drugs through that process, A, faster, so that means less cost, with hopefully better outcomes. And so we are seeing more optimism on that side of the ledger.

But I do think because of the overall healthcare hangover and question mark around that, which could impact drug prices, I do think there's still a hesitation at the top of that market, meaning IPOs and M&A, where people are still waiting to see how the fallout of that will be. It's good if you're a development-stage life science company and I think the opportunity to work with the FDA is better today than it has been really in a very long time and that's good. It might get drugs, again, through the process faster and cheaper. But there is some hesitation about, ultimately, once you do that, what will the price -- what kind of price are they going to be able to get for that product in the United States.

Okay. All right. Well, thank you for taking my questions.

Christopher Testa, National Securities.

Good morning, guys. Thanks for taking my questions. You had mentioned seeing a lot of deal flow, but a lot of the deals being way too leveraged. Just curious about which particular verticals you're seeing that are the most leveraged and how that's changed quarter to date so far here in the first quarter?

Very good question. Software -- software companies, SAAS model companies, they were overleveraged, they became overleveraged in the last 2 to 3 years based on projected revenue that didn't materialize, at least in the way that they expected. And so now they are coming back to the market being overleveraged with the same kind of pro forma growth that they haven't been able to achieve in the last three years. I think, certainly from our standpoint, those deals just aren't very interesting.

And the other part of that is that it's not just a matter of them not growing, it's a matter of their technology, or their software, not being, at the end of the day, all that innovative. In other words, there's other products in the market that have either passed them or many products competing with them, which is slowing their growth. And that's where we have seen companies that have -- SAAS model companies were very popular a couple of years ago and they were able to attract both equity and debt, and now they are, in my view, that's a very overleveraged part of our market today.

Great. Just, you had mentioned, obviously, the technology banks being very active. Just curious if you're seeing other players stepping into the VC space that were typically not in the sector prior who are making loans further down the capital stack?

Yes, not so much going downstream to the earlier stage companies that do have technology, but it's going to take a while to -- the value of those to be materialized. I think at the top of our funnel, we are seeing buy-out firms, PE firms that can't find good, true buy-out opportunities, maybe reaching down into that market and bidding on companies that otherwise would still require VC funding going forward.

But on the debt side, no, not too much. There were actually -- the competition beyond the banks really is lower than it has been in a while, again, outside of the banks. The banks are still pretty active, but the smaller funds that we used to compete with aren't nearly as active as they have been.

There is good opportunity for us. For instance, the two life science transactions we funded in the fourth quarter, high-quality deals, but we got the kind of pricing that we need, where two years ago, we couldn't -- in 2015, when that market was really hot, you were talking about single-digit interest rates on deals, and extremely low and sometimes no warrant coverage. And they were good. So, it wasn't that they weren't good companies, they were just poor investments for us relative to the kind of return profiles. We've seen that improve dramatically, so we're pretty optimistic about that.

That's good color. Thank you. And last one for me, just wondering if you could just provide us with the timing of the originations closing during the quarter?

Most of it will be at the end of the quarter.

Okay, that's all for me. Thanks for taking my questions.

(Operator Instructions)

Casey Alexander, Compass Point.

Hello, good morning, and thank you for taking my questions. First of all, on the royalty agreements, you said you ran a scenario analysis. How far out do those scenario analyses go? Five years? 10 years? There had to be a termination point for the scenario analysis.

So, both of them are in the 3- to 5-year range, Casey.

Okay. Secondly, do you anticipate accruing incentive fees at some point in time in 2017? And what quarter do you expect them to come back in?

The fee cap and deferral will impact the first quarter, and our outlook is that we could be back into incentive fees as early as the second quarter, but that requires the outlook -- that's the outlook that we would have relative to NAV.

Okay. There's a statement in the release and something that I'm just curious about. You have $37 million in cash, you have $63 million out on the credit line and there's a statement in the release that only $4.6 million in funds are available to you under the existing credit line. Why isn't there more available to you under the existing credit line?

There's more available. However, we are targeting to stay in the [0.75] to 1 leverage, and so, working within that constraint of the cash, plus probably roughly about another $8 million to $10 million of availability and to stay within that target.

Well, okay, so there is actually more liquidity available to you than what you are saying. I'm not sure why you would say it that way. At 0.69 going to 0.75, you said you could do another $15 million worth of loans. I mean, frankly, if incentive fees come back into the second quarter, given the drawdown that you've had in your total portfolio assets, from a calculation standpoint, it's not possible for you to currently cover the dividend if you pay incentive fees. Why aren't you waiving the incentive fees permanently?

We look at our NII and the dividend and distribution quarterly, and that $4 million as of December 31, that is at a point in time, and that depends on the assets that are at the SPE.

Yes, I don't think it's at all possible for you to cover the current dividend at this point in time, if you start to repay incentive fees. Secondly, the Company has lost about a third of NAV since starting as a public company. The Company currently has more than 20% of their loans in credit buckets 3 and 4. Why should we have any confidence that we are not going to see continued NAV degradation over time?

Casey, we've talked about this on the calls and in our individual calls. We work very hard to try to recover the -- resolve these underperforming loans the best we can with our shareholders over time, and we believe that there are opportunities for us to grow our portfolio. We certainly are subject to criticism based on what you've described. The buckets you described, actually, we call 1 and 2, not 3 and 4.

Excuse me.

That's all right. But they are -- we had one new loan go on nonaccrual in the fourth quarter. That's the Digital Signal deal. We expect, based on negotiations that are ongoing, that we have the potential for full recovery there. We had marked that loan down at 12/31. We had really very little movement in the 2s, new 2s that are on our watch list.

I mean, it's hard for you guys to understand because you don't see it, and it's hard for you to buy based on our track record. All we can do here is work hard to resolve the loans favorably over time. We believe we did that. It was not easy, and hard work on New Haven and ScoreBig to get, see that recovery over time and we're encouraged by the opportunities we're seeing.

And, as Jerry described, it's been a very difficult M&A market, especially for the companies that are in distress. The experience of having VC step-up to help the company find a soft landing has been very difficult these years. And what happens is that those loans end up getting -- the companies get bought at a discount to the debt, and so that's what we've experienced. Our outlook is for improvement and I understand your hesitation, but our Management Team, our new Managing Directors are committed to finding good quality loans going forward and getting as much out of the portfolio as we can.

Can I ask, then, if you have $37 million in cash and it's not listed in restricted cash, why continue to pay the interest on the credit line? Why not pay it down?

We have paid it down. It's a timing thing with our bank and the way that the key facility works. We have prepayments late in the quarter, and that cash is on the balance sheet at 12/31. We're working to make that facility, from that aspect, more efficient.

But you're right, there's no reason to borrow money and keep it in cash, pay 4% interest. We get that, and the fact is that at 12/31 we had that much cash on the balance sheet. Today, we don't.

What's the non-use fee on the credit line?

50 basis points.

Does it even make sense to have a credit line that extends out to $95 million at this point in time considering the fact that would far exceed your leverage ratio were you to go that far into the credit line?

These are the strategic decisions that we look at and make. If there was -- we worked hard to expand the facility. Something we always think about as we get together with our Board, but for right now we think it's very efficient financing, even given the non-use fee.

I understand, but I think it makes a great deal of sense to reduce your capacity, cut your fees, and clearly take a hard look at management incentive fees based upon the track record over the last five years. I think that's something that shareholders would appreciate. Thanks for taking my questions.

Thank you, Casey.

Thank you. There are no further questions. I would now like to turn the call back over to Robert Pomeroy, Chairman and CEO, for closing comments.

Thank you. Moving ahead in 2017, Horizon will use our liquidity position to grow our portfolio and our net asset value by originating new loans to promising companies. We are committed to executing on this strategy, as I just said, and to producing NII that covers our distributions.

We thank you for your interest in Horizon and we look forward to sharing our progress with you again in May. This concludes our conference call. Thank you and have a great day.