Good morning and welcome to Horizon Technology Finance’s first quarter 2017 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 Megan Bacon of Horizon for introductions and the reading of the Safe Harbor statement. Please go ahead.

Thank you, and welcome to the Horizon Technology Finance first quarter 2018 conference call. Representing the company today are Rob Pomeroy, Chairman and Chief Executive Officer; Gerry Michaud, President, and Dan Trolio, Chief Financial Officer. Before we begin, I would like to point out that the Q1 earnings press release and Form 10-Q are available on the company’s website at horizontechfinance.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 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 Form 10-K for the year ended December 31, 2017. 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 on this beautiful morning in New England. Coming off the strongest origination quarter in our history, we entered 2018 with a larger, younger and stronger portfolio than Horizon has had in some time. Our goals looking forward, as always, are to maintain our strong portfolio, continually build our pipeline, aggressively manage any underperforming loans, and continue to earn high yields. Today we will discuss our progress on these important goals. For the quarter, we earned net investment income of $3.2 million or $0.28 per share. This is an improvement from our fourth quarter earnings driven largely by our increased portfolio which funded late in the fourth quarter. Our debt portfolio yield for the quarter of 14.4% was consistent with our historical yields, which are among the highest for BDCs. During the quarter in addition to our normal portfolio interest, we earned income from accelerated income events and from a portfolio company’s payment to Horizon of a success fee upon its sale. Notably, we received the success fee long after the company had repaid its loan in 2013. The high yield of our debt portfolio, our receipt of accelerated income and receipt of success fee highlight the earnings power of our portfolio. For the quarter, we funded $11 million in loans to three companies. This resulted in a decrease in our portfolio of about $10 million due to prepayments, refinances, and normal amortization totaling $20 million. As we mentioned on our March conference call, the pace of prepayments slowed in the first quarter. We expect prepayments in 2018 to be at more historic levels compared to 2017’s higher levels. The more normalized levels will continue to present opportunities for accelerated income from liquidity events while supporting a portfolio with a more stable…

Thanks Rob. Good morning everyone. During the first quarter, we originated three new floating rate loans totaling $11 million and closed $8.2 million in new loan commitments. We continued to achieve strong on-boarding loan yields of 13.1% and generated a loan portfolio yield of 14.4% for the quarter as we remain disciplined with respect to pricing. Since inception, Horizon has consistently had one of the highest yielding debt portfolios in the BDC industry with an average portfolio yield of 14.6%. This reflects our ability to consistently maintain strong on-boarding yields and strategically priced and structured transactions with prepayment fees and ETPs in order to maximize returns when our portfolio companies exit our loan portfolio. Consistent with what we said on last quarter’s call, all of the transactions we funded in Q4 2017 and Q1 2018 added investments with the potential for higher prepayment fees and with new ETPs as we replaced aging investments that had lower prepayment fees and significantly accretive ETPs. As a result, we now have a large portfolio with enhanced prepayment fee and ETP potential as well as a more predictable interest income stream from newly originated transactions in their interest-only periods. Included in our new loans was an upsized investment in Health Edge Software, a healthcare technology company that is providing next generation technology products to the health insurance market. It is one of our high performing portfolio companies, and we were pleased to have made an additional investment in it. At the end of the quarter, we held warrant and equity positions in 76 portfolio companies with a fair value of $11.2 million. We experienced liquidity events during the quarter from two portfolio companies, Le Tote and Digital Signal, totaling $9.5 million, and we had one of our portfolio companies, Titan Pharmaceuticals pay down their…

Thanks Gerry, and good morning everyone. I will now briefly discuss our financial results for the first quarter. Rise in earned total investment income of $7.2 million for the first quarter of ’18 as compared to $7 million for the first quarter of ’17. The increase was due to higher interest income on investments given the larger average size of our loan portfolio. For the first quarter, we achieved on-boarding yields of 13.1% compared to 11.6% in the fourth quarter and consistent with our historical performance. Our debt portfolio yield was 14.4% for the first quarter of ’18 compared to 15.5% for last year’s first quarter. Turning to our expenses, total expenses for the first quarter were $4 million compared to $3.6 million in the first quarter of ’17. Interest expense increased year-over-year to $1.5 million compared with $1.3 million in the prior year period. This change was primarily due to an increase in average borrowings. Base management fee increased year over year to $1.1 million compared with $1 million in the prior year period. This change was primarily due to an increase in the average size of our investment portfolio. In addition, incentive fee expense for the first quarter was subject to the incentive fee cap and deferral mechanism under our investment management agreement. This resulted in $200,000 of reduced expense and additional net investment income. Net investment income was $0.28 per share for the first quarter compared with $0.29 per share in the first quarter of ’17 and $0.21 per share for the fourth quarter of last year. After paying distributions of $0.30 per share and earning $0.28 per share for the quarter, the company’s undistributed spillover income as of March 31 was $0.07 per share Our NAV as of March 31 was $11.65 per share as compared…

[Operator instructions] Our first question comes from Leslie Vandegrift of Raymond James. Your line is open.

Hi, good morning. Thank you for taking my questions. Just a quick question on Digital Signal. What was the numbers on the exit there? I missed that in the beginning.

Hang on one sec. The loan was repaid by purchasing the assets by StereoVision. The amount of the loan at the time of the acquisition was about $2.8 million.

Okay, and then on the new non-accrual, mediri, I know it’s small, but just a little bit of color there would be great.

Leslie, mediri was not on non-accrual.

Oh, okay.

We ended the quarter with no new non-accruals and no loans on non-accrual.

Okay, all right. I know you mentioned earlier in the call that the board is reviewing the leverage opportunities with the new rules, but the credit facility that you just re-did in early April, does that have any changes to covenants or any covenants at all limiting leverage in it?

No, it does not. The amendment, we started talking with Keybanc back in December, and it was basically to extend the revolving period and the maturity period.

Okay. On the yield for the quarter, so 14.4%, I know on-boarding was up a little bit this quarter, but you have 110 basis point of yield decline over the last year, but LIBOR itself has gone up a little over 100 basis points in that same period. I know competition has been heavier in the venture space, but you talked about where you were seeing the money in life sciences versus healthcare, etc. Where is a lot of that compression coming from? Is it concentrated somewhere, and are there other major drivers than competition doing that?

Yes, so actually on a quarter to quarter basis, much of our--or a portion of our yield is obviously highly dependent upon prepayment activity in the venture debt portfolio, because you do get--as you well know, you do get a lot of churn in the portfolio through exits and refinances and things like that. I think on-boarding yields actually haven’t been as impacted as much. That said, I think we’ve talked about this really for the last year, we have become far more strategically focused on what parts of the venture technology and life science spaces that we’re interested in investing in, and we are looking for higher quality opportunities with better strategic alliance with the investors, and so that does--those deals are in fact going to be a little bit more competitive and a little bit more price sensitive. But I think overall, we can still get a very nice bell curve blended on-boarding yield, and I think we have been doing that, and I would just remind you that everything we do is floating rate, so as rates go up on our existing portfolio, the rates on those transactions obviously float up with them.

Okay. On that, so $11 million originations in the first quarter and you talked about the drivers there, and the press release discussed since the portfolio is rather newer vintages, at least, that you think that the income is more predictable. Does that mean you think the originations are going to be more predictable, more steady, or just the prepayment flow?

Certainly prepayments will. In terms of originations, a lot has to do with timing. Many of our commitments and even term sheets that have been awarded are oftentimes subject to equity raises happening, and so we’re relying on something that’s not as much in our control to get those equity financings done before we put in our debt, so those are timing issues which can impact. What I will say is that in looking at our pipeline, the number of opportunities are quite favorable. We’re seeing plenty of incoming opportunities to refinance. Rob did mention and I would second that, that we actually kicked a lot of opportunities in the first quarter we saw to the curb because they didn’t fit into our strategic goal of--or narrower strategic goal, I guess, in terms of the kinds of companies we’re looking to finance and the markets that they're in, so there will be some of that. We’re going to be patient on that. Our leverage is at 0.7 to 1, I think it was about the same last quarter, so we have liquidity, we are in a pretty good position to be able to invest, but we’re going to continue to be very focused on finding the right kind of transactions for the portfolio.

Would those parameters change materially if you did end up getting that extra turn of leverage?

No, actually I think that that would just allow us to do higher quality deals and be a little bit more competitive on pricing.

Okay, and then sorry, just last note, I did just flip through the Q - mediri is marked as non-accrual in the first quarter. That was the source of my question on that. Again, it’s two small term loans, but it is marked as that. Is that an error, then?

Yes, that must be an error.

Okay, all right. Thank you for answering my questions this morning.

Our next question comes from Jonathan Bock of Wells Fargo Securities. Your line is open.

Hi, good morning, and thank you for taking my questions. Gentlemen, greatly appreciate the analysis that you’re putting into the approach to 2 to 1, and also happy to see the amendments as well. This just brings up a current question. Rob, Gerry, Dan, if you were--let’s say forget the constraint of one-to-one leverage and let’s just imagine it doesn’t exist. How much current capacity up to your borrowing base do you have to grow the portfolio without any consideration of additional equity issuance? Just a ballpark.

Yes, we could grow the portfolio about $20 million to $30 million net.

Okay, so then Rob, as you mentioned how the board is reviewing 2 to 1, do you feel that an additional--number one, we’ll separate it. Getting the statutory or getting the approval for 2 to 1 leverage is much different than actually using it, right? I know there’s a bunch of questions that relate with the ratings agencies, etc., and it can absolve a few risks that relate to bonds that have covenants tied to it. Is it your intention, Rob, if you were to have an additional turn of leverage, does the investment strategy change? Do you choose to focus on any different types of assets to further diversify, or stay in the same niches as what you do and what you’ll continue to do on a go-forward basis?

Yes, so the answer is only slightly on the margin. I think Gerry said it in his answer to the previous question, is that we would be looking to do more of the higher quality, better transactions. As a reminder, we entered this world with a credit facility that was 3 to 1 leverage as a public company in 2010, so the strategy--there is no intention to go somewhere where we’re not currently competing. We’re not going to go to a very low rate buying participations in middle market leads.

Sure, that makes sense. The question is, so--and Gerry, just because I know you see everything, you see it all, could the extent that you were going to focus on lower risk, perhaps more senior in the stack style venture loans within your wheelhouse, what would be the on-boarding yield that you would be able to kind of put on in today’s environment?

Yes, that’s a really good question, Jonathan, and honestly it’s exactly the kind of things that we are looking at right now and discussing with our board, so we can articulate kind of a--not just a strategy related to whether we go to the 2 to 1 leverage, but to your point, where in our market can we take advantage of having the 2 to 1 leverage. Obviously I think in the life science space, there is a significant amount of opportunity relative to transactions that we look at that if you have greater leverage, you can provide to those types of companies really quality financings that, a, help the company, but they are also willing to pay you for it in terms of warrants and things like that. So yes, you may give up some yield which you can recover somewhat from the higher leverage, but you also get higher--the potential for greater warrant coverage. Let me give you one example. When we--

And this is all conceptual, Gerry, so I appreciate it. No one is pushing you down this road, just trying to get an understanding of what may--

Jonathan, it’s a really good question and of course it’s very timely. So we did a deal with PharmaSet back in 2009 before we went public. It was a $30 million commitment. Now, I’m not going put a $30 million commitment on Horizon’s balance sheet today, okay, given the leverage we have; but that ended up being a great transaction. The interest rate on the transaction may have been a little bit lower than what else we were getting in the marketplace on tech deals and things like that, but the company ended up being sold for $11 billion and our warrant turned out to be extremely valuable. So those kinds of transactions are things that we have done in the past that we know that we are capable of doing, we know where to find them, we know the investors will invest in them, and that would give us an opportunity to look at those.

So then maybe just another hypothetical. Gerry, would that mean that what we would be looking at would be L5 and 6 instead of L7 and 8?

No, no.

No, so a little higher, or--?

Yes, I mean, look - this is venture lending still. There is both the perception and the reality of risk. I don’t think--in my 30 years, I’ve never seen the market, no matter how competitive it has got, Jonathan, relative to competition coming in, go to that kind of pricing over any kind of sustained period of time, and I wouldn’t expect that. The additional leverage is great, but it wouldn’t impact pricing to that extent, at least not that we’d be doing.

Not on our book.

Yes.

Got it. So here’s the genesis. Rob and Gerry, if you have and grow the ability to leverage your current equity base, the question is, if you invest in, quote-unquote, lower yielding, more senior transactions, is there an available, or can you point to a tangible increase in NIM and/or shareholder ROE as a result of moving down in that stack? In the middle market world, spreads are so tight and the fees on assets are at a point to where there’s no incremental spread that flows through to the bottom line to investors, so what you’re--what it sounds like you’re telling me, and you can say yes or no, is that Jon, yes, if we utilize incremental leverage, there is definitely something left over from a--that will fall to the shareholders after our fee is paid, and/or we’ll consider perhaps adjusting the fee to ensure that some level of flow-through occurs so that not all of the incremental spread is gobbled up by fee and interest costs.

Absolutely that is exactly what is our board is considering, as Gerry says. We’re looking at the market opportunity, the pricing structure, the return. We will do this if we feel it’s advantageous for our shareholders.

I’d just add real quickly to that, Jonathan, because--you know, I saw your model on that, and you just asked a very interesting question a minute ago, which is would we have to change our strategy or anything like that. That’s exactly--I mean, one of the reasons we feel we’re in a very strong position is because we are not one of those companies. We are not a middle market lender fighting for every half an interest rate point on yield and fees and things like that. We’re in a different market that requires a different strategy and a different knowledge base and a different understanding, and I think that when we use the same kind of dynamics you used in your model, we came out with obviously a different result because actually the kind of yields that we have historically been able to get very consistently--you know, we will capture some of that. We might be willing to give a little bit of it away for higher quality, but we will still capture a fair amount of that, and I think that it makes a very big difference in your model, which is [indiscernible].

And at the end of the day, this is what shareholders, I would argue a certain group, that Leslie and everybody else on this phone speaks to, is that if there is some element of shared incremental upside, please - diversified portfolios matter, Gerry and Rob. We would love for you to be in safer loans, and a PharmaSet repeat would also be amazing, but also keeping in context what is left over for shareholders, because if there’s no incremental spread and leverage is increasing, there stands to be some set of public disappointment because they would believe that all incremental returns go in favor of the external manager, which in this case given how you yield, wouldn’t be the case, but you understand the problem for the industry writ large. You have to demonstrate how it actually helps them. So credit to you for thinking about it. There is no right answer, and you are clearly in a different market, but sounds like everybody is on the right track and we greatly appreciate the context you gave us today.

Thanks.

Thanks Jonathan.

Our next question comes from Christopher Testa of National Securities. Your line is open.

Hey, good morning guys. Thanks for taking my questions. You guys had previously done a securitization, and with risk retention just about dead, just curious if this is something that you guys would consider again for a source of financing going forward.

Yes Chris, we’re always looking at different avenues and ways to leverage our balance sheet, and I have talked to numerous people relating to that, but we will leave right now the Keybanc facility that we have and the availability that we have that makes sense with our balance sheet as it currently stands.

Okay. Just touching a bit on the credit facility, and I know you guys just gave an exhaustive amount of detail on the potential for a leverage increase, but as you guys have explored the process of potentially reducing the asset coverage, I’m just curious what your discussions have been with the banks on your facility, whether they are seemingly more receptive to look at this on a case-by-case basis or whether they’re painting everything with a broad brush, like S&P had done.

When we spoke to Key and our syndicate, they are looking at it as a case-by-case basis, and like everyone else, they’re waiting and seeing how the market turns and won’t be leaders in that. But they like our facility, we like our relationship with them, and time will tell.

Got it, so would you say, Dan, that that made them very receptive to the potential for you guys or the sector in general increasing, and that you wouldn’t expect a major change in terms or rates?

Yes, they’ve been very receptive, and as we mentioned, we just amended it, went through a review with them and going through their due diligence, and they appreciate our relationship and we appreciate the relationship also, so everything has been very positive.

Got it. How have the discussions been with the shareholders? I’m sure you’ve spoken to many of them, whether you call them or they call you to discuss your plans for that potential. I’m just curious what you’ve taken away and what the highlights have been with the discussions from people holding your stock.

Remember, most of our stock--we’re largely retail, Chris, so not a lot of feedback.

Okay, that’s fair. I know you guys have mentioned that you had a few of the open commitments were terminated during the quarter, the milestones were not met. Just wondering, was this concentrated to a particular sector or was this just idiosyncratic on a case-by-case basis with these?

Absolutely on a case-by-case basis. Nothing abnormal relative to anything that we historically see in our portfolio.

Got it, okay. The loans that you guys have rated two increased pretty significantly - about $15 million or so quarter over quarter. How many companies and which companies in particular were ranked two during the quarter?

The primary--one loan, vTv Therapeutics that we mentioned, we downgraded to a two, based on their clinical news that Gerry mentioned in his part of the script, so that was the major dollar amount movement.

Got it.

The others were normal course, in the process of raising funds, some stress in that process, so when that happens we will downgrade those from threes to twos and watch them closely, as we watch all of our accounts.

Okay, all right. That’s all for me. Thanks for taking my questions.

Thanks Chris.

Our next question comes from Chris Kotowski of Oppenheimer. Your line is open.

Good morning. Most of mine were asked, but you mentioned at the outset that in the quarter, you recognized accelerated income and success fees. Did you tell us how much those were this quarter, and is there a typical run rate?

No, we did not mention how much they were, but they were in the ballpark of around $500,000 between the ETPs and the success fee. There isn’t a normal run rate that you can typically model. It’s very dependent on the prepayments that happen in the quarter.

Could you ballpark how much, say, within the last three years on average per year?

I would say ballparking it, it’s about 2.5 to 3% related to the prepayment activity that happens in the quarter, and on a normal quarterly prepayment run rate, it would be about $10 million to $15 million of prepayments a quarter.

Okay. All right, that’s it for me. Thank you.

Our next question comes from Casey Alexander of Compass Point. Your line is open.

Yes, good morning. I’m not sure I understood - did you say that there was a success fee that was earned during the quarter that was a delayed success fee, that came from a loan that was paid off in 2013?

That’s correct.

How much was that?

Ballpark, $200,000.

Two hundred thousand - okay. As it relates to the portfolio, 100% of the portfolio is senior secured, isn’t that right?

That’s correct.

How much of that would you consider to be first lien?

Included in that 100% senior secured are some loans that are secured behind a revolving credit facility, and it’s around 45% of the portfolio.

Okay, because to Jon’s question, it seems as though what you said was that there are higher quality deals that you’re currently turning down, that you would not turn down in the event that you were able to access the second turn of leverage. What type of higher quality deals are you turning down?

We’re not turning them down, Casey, we’re not winning them or we’re not able to control the pricing because of the competition. We’re not turning them down.

Okay, thanks for taking my questions.

Our next question comes from Ryan Lynch of KBW. Your line is open.

Hey, good morning guys. I just have one question. When I kind of look at the outlook in 2018 as far as prepayment and end of term fees, as I think about the comments you guys said, you guys now have a younger portfolio which means you have higher prepayment and end of term fees in the portfolio, you also said that the portfolio or the markets are conducive of potential IPOs and M&A, which means to me there could be some higher prepayments, actual loans prepaid in the quarter or throughout 2018. If you had those higher end of term fees and prepayments due to a younger portfolio, should we expect fee income to increase from an annualized basis in 2018 versus 2017, considering the younger portfolio?

It’s sort of a balanced position, Ryan. Because the portfolio is younger, the loans are in interest only, most of them, so it takes a liquidity event or an exit event, like the ones you’ve described, to happen, but when they do happen, they will produce superior income because the prepayment fees are higher and the end of term payments have not been accreted. So the incidence might be lower, but the profit from each event will be higher.

Okay, that makes sense. That’s my only question, thanks.

Thank you. There are no further questions. I’d like to turn the call back to Robert Pomeroy, Chairman and CEO for closing remarks.

Thank you all for joining us this morning. We appreciate your continued interest and support at Horizon, and we look forward to speaking with you again in August. This will end our call, thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.