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HRZN > SEC Filings for HRZN > Form 10-Q on 10-Aug-2011All Recent SEC Filings

Show all filings for HORIZON TECHNOLOGY FINANCE CORP

Form 10-Q for HORIZON TECHNOLOGY FINANCE CORP


10-Aug-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In this section, except where the context suggests otherwise, the terms "we," "us," "our" and "Horizon Technology Finance" refer to Horizon Technology Finance Corporation and its consolidated subsidiaries. The information contained in this section should be read in conjunction with our consolidated financial statements and related notes thereto appearing elsewhere in this quarterly report on Form 10-Q . For periods prior to October 28, 2010, the consolidated financial statements and related footnotes reflect the performance of our predecessor, Compass Horizon Funding Company LLC, and its wholly owned subsidiary, Horizon Credit I LLC, both of which were formed in January 2008 and commenced operations in March 2008. Amounts are stated in thousands, except shares and per share data and where otherwise noted.

Overview

We are a specialty finance company that lends to and invests in development-stage companies in the technology, life science, healthcare information and services, and cleantech industries, which we refer to as our "Target Industries." Our investment objective is to generate current income from the loans we make and capital appreciation from the warrants we receive when making such loans. We make secured loans, which we refer to as "Technology Loans," to companies backed by established venture capital and private equity firms in our Target Industries, which we refer to as "Technology Lending." We also selectively lend to publicly traded companies in our Target Industries.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the Investment Company Act of 1940, or the 1940 Act. As a BDC, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our investments through borrowings. However, as a BDC, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing.

Compass Horizon Funding Company LLC, which we refer to as "Compass Horizon," our predecessor company, commenced operations in March 2008. We were formed in March 2010 for the purpose of acquiring Compass Horizon and continuing its business as a public entity. Our shares are listed on The NASDAQ Global Market under the symbol "HRZN."

Portfolio Composition and Investment Activity

As of June 30, 2011 and December 31, 2010, our loan portfolio consisted of 37 and 32 loans, respectively, which had an aggregate fair value of $180.1 million and $130.2 million, respectively. Our warrant portfolio had an aggregate fair value of $4.9 million and $6.2 million at June 30, 2011 and December 31, 2010, respectively.

The following table shows our portfolio by asset class as of June 30, 2011 and December 31, 2010.

                                        June 30, 2011                                   December 31, 2010
                                                             % of                                              % of
                              # of            Fair           Total             # of             Fair           Total
                          Investments         Value        Portfolio        Investments         Value        Portfolio
                                                                ($ in thousands)
Secured term loans                   36     $ 178,482            96.0 %                31     $ 127,949            93.5 %
Equipment loans                       1         1,628             0.8 %                 1         2,285             1.6 %
Total loans                          37       180,110            96.8 %                32       130,234            95.1 %

Warrants                             48         4,853             2.6 %                43         6,225             4.6 %
Equity                                3         1,066             0.6 %                 2           351             0.3 %
Total                                       $ 186,029           100.0 %                       $ 136,810           100.0 %


Total portfolio investment activity for the periods ended June 30, 2011 and 2010 was as follows:

                                                For the three months ended                For the six months ended
                                           June 30, 2011         June 30, 2010      June 30, 2011         June 30, 2010
                                                                         ($ in thousands)
Beginning portfolio                        $      153,216       $       117,921     $      136,810       $       113,878
New loan funding                                   51,000                47,417             79,833                60,517
Less refinanced balances                           (5,907 )              (9,833 )           (8,677 )             (10,908 )
Net new loan funding                               45,093                37,584             71,156                49,609
Principal and stock payments received on
investments                                        (6,348 )              (8,537 )          (14,107 )             (16,826 )
Early pay-offs                                     (2,247 )              (3,454 )           (5,593 )              (3,454 )
Accretion of loan fees                                434                   282                829                   483
New loan fees                                        (415 )                (422 )             (927 )                (517 )
New equity investments                                  -                     -                577                     -
Net depreciation on investments                    (3,704 )                (366 )           (2,716 )                (165 )
Ending portfolio                           $      186,029       $       143,008     $      186,029       $       143,008

We receive payments in our loan portfolio based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our loans prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period.

The following table shows our debt investments by industry sector as of June 30, 2011 and December 31, 2010:

                                                 June 30, 2011                 December 31, 2010
                                           Loans at       Percentage       Loans at       Percentage
                                             Fair          of Total          Fair          of Total
                                             Value        Portfolio         Value         Portfolio
                                                                ($ in thousands)
Life Science
Biotechnology                              $  33,330             18.5 %   $   30,470             23.4 %
Medical Device                                27,481             15.3 %       19,572             15.0 %
Technology
Consumer-related Technologies                  3,153              1.8 %        4,460              3.4 %
Networking                                     1,628              0.9 %        2,285              1.8 %
Semiconductors                                 9,713              5.4 %            -              0.0 %
Software                                      22,100             12.3 %        8,745              6.7 %
Data Storage                                   6,926              3.8 %        7,912              6.1 %
Communications                                 6,136              3.4 %        7,591              5.9 %
Cleantech
Energy Efficiency                             22,026             12.2 %       16,570             12.7 %
Waste Recycling                                4,870              2.7 %        2,363              1.8 %
Healthcare Information and Services
Diagnostics                                   23,500             13.0 %       20,472             14.5 %
Other Healthcare Related Services and
Technologies                                  19,247             10.7 %        9,794              7.5 %
Total                                      $ 180,110            100.0 %   $  130,234            100.0 %

The largest loans may vary from year to year as new loans are recorded and repaid. Our five largest loans represented approximately 26% and 31% of total loans outstanding as of June 30, 2011 and December 31, 2010, respectively. No single loan represented more than 10% of our total loans as of June 30, 2011 and December 31, 2010.

As of June 30, 2011 and December 31, 2010, interest receivable was $2.7 million and $1.9 million, respectively, which represents one month of accrued interest income on loans. The increase in the first half of 2011 was due to a larger loan portfolio relative to 2010.


Loan Portfolio Asset Quality

We use a credit rating system which rates each loan on a scale of 4 to 1, with 4
being the highest credit quality rating and 3 being the rating for a standard
level of risk. A rating of 2 or 1 represents a deteriorating credit quality and
increased risk. The following table shows the classification of our loan
portfolio by credit rating as of June 30, 2011 and December 31, 2010:

                      June 30, 2011                 December 31, 2010
                Loans at       Percentage       Loans at       Percentage
                  Fair          of Loan           Fair          of Loan
                  Value        Portfolio         Value         Portfolio
Credit Rating                        ($ in thousands)
4               $  20,751             11.5 %   $   29,054             22.3 %
3                 147,237             81.8 %   $   94,200             72.3 %
2                  12,122              6.7 %   $    6,980              5.4 %
1                       -                -              -                -
Total           $ 180,110            100.0 %   $  130,234            100.0 %

As of June 30, 2011 and December 31, 2010, our loan portfolio had a weighted average credit rating of 3.1 and 3.2, respectively. As of June 30, 2011 and December 31, 2010, no investments were on non-accrual status.

Consolidated Results of Operations for the three months ended June 30, 2011 and 2010

The consolidated results of operations set forth below include historical financial information of our predecessor, Compass Horizon, prior to our election to become a BDC and our election to be treated as a RIC. As a BDC and a RIC for U.S. federal income tax purposes, we are also subject to certain constraints on our operations, including limitations imposed by the 1940 Act and the Code. Also, the management fee that we pay to our Advisor under the Investment Management Agreement is determined by reference to a formula that differs materially from the management fee paid by Compass Horizon in prior periods. For these and other reasons, the results of operations described below may not be indicative of the results we report in future periods.

Consolidated operating results for the three months ended June 30, 2011 and 2010 are as follows:

                                                                  For the three months ended June 30,
                                                                     2011                    2010
                                                                           ($ in thousands)
Total investment income                                        $           5,970       $           4,270
Total expenses                                                             3,990                   1,761

Net investment income                                                      1,980                   2,509
Net realized gain (loss) on investments                                    5,355                      (2 )
Net unrealized depreciation on investments                                (3,512 )                  (364 )
Credit for loan losses                                                         -                     116
Net income                                                     $           3,283       $           2,259
Average debt investments, at fair value                        $         168,189       $         123,576
Average borrowings outstanding                                 $          82,233       $          78,539

Net investment income for the three months ended June 30, 2011 was $2.0 million or $0.26 per share. Excluding the impact of the capital gains incentive fee expense of $0.9 million, net investment income totaled $2.9 million or $0.38 per share.


Investment Income

Investment income increased by $1.7 million, or 39.8%, for the three months ended June 30, 2011 as compared to the three months ended June 30, 2010. For the three months ended June 30, 2011, total investment income consisted primarily of $5.9 million in interest income from investments, which included $0.4 million in income from the amortization of discounts and origination fees on investments. Interest income on investments and other investment income increased primarily due to the increased average size of the loan portfolio. Fee income on investments was primarily comprised of prepayment fees from one of our portfolio companies. For the three months ended June 30, 2010, total investment income consisted primarily of $4.2 million in interest income from investments, which included $0.3 million in income from the amortization of discounts and origination fees on investments. For the three months ended June 30, 2011 and 2010, our dollar-weighted average annualized yield on average loans was approximately 14.1% and 13.8%, respectively.

Investment income, consisting of interest income and fees on loans, can fluctuate significantly upon repayment of large loans. Interest income from the five largest loans accounted for approximately 26% and 20% of investment income for the three months ended June 30, 2011 and 2010, respectively.

Expenses

Total expenses increased by $2.2 million, or 126.6%, to $4.0 million for the three months ended June 30, 2011 as compared to the three months ended June 30, 2010. Total operating expenses for each period consisted principally of management fees, incentive and administrative fees and interest expense and, to a lesser degree, professional fees and general and administrative expenses. Interest expense, which includes the amortization of debt issuance costs, decreased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to the end of our Credit Facility's revolving term and the scheduled amortization of the remaining balance.

Effective with the completion of our initial public offering in October 2010, we pay management and incentive fees under the Investment Management Agreement, which provides a higher management fee base as compared to amounts previously paid by Compass Horizon. Management fee expense for the three months ended June 30, 2011 increased by approximately $0.5 million compared to the three months ended June 30, 2010 primarily due to the higher management fee base. Incentive fees for the three months ended June 30, 2011 totaled approximately $1.6 million compared to no incentive fees for the three months ended June 30, 2010. The incentive fees for the three months ended June 30, 2011 consisted of approximately $0.7 million and $0.9 million for part one and part two of the incentive fee, respectively. In connection with the Administration Agreement, we incurred $0.2 million of administrative expenses for the three months ended June 30, 2011. We did not pay an administrative servicing fee for the three months ended June 30, 2010.

Professional fees and general and administrative expenses include legal and audit fees, insurance premiums, and miscellaneous other expenses. These expenses for the three months ended June 30, 2011 increased by approximately $0.5 million compared to the three months ended June 30, 2010 primarily due to the increased cost of being a public company.

Net Realized Gain (Loss) and Net Unrealized Appreciation (Depreciation)

During the three months ended June 30, 2011, and 2010 we recognized $5.4 million in net realized gain on investments and $0.02 million in net realized loss on investments, respectively. During the same periods, we had $3.5 million and $0.4 million in unrealized depreciation on investments, respectively. Net realized gain on investments resulted from the sale of stock through the exercise of warrants in portfolio companies. For both periods, the net increase in unrealized depreciation on investments was primarily from our warrant and equity investments. Net unrealized depreciation on warrants and equity investments is the difference between the net changes in fair values of warrant and equity investments fair values from the prior determination date and the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. The increase in net unrealized depreciation on investments for the three months ended June 30, 2011 is primarily due to the reversal of previously recorded unrealized appreciation on our warrant investments that were realized in the second quarter.


Consolidated operating results for the six months ended June 30, 2011 and 2010

                                                For the six months ended June 30,
                                                   2011                   2010
                                                        ($ in thousands)
Total investment income                      $         11,430       $          8,063
Total expenses                                          7,222                  3,442
Net investment income                                   4,208                  4,621
Net realized gain (loss) on investments                 5,561                     (2 )
Net unrealized depreciation on investments             (2,318 )                 (162 )
Credit for loan losses                                      -                    419
Net income                                   $          7,451       $          4,876
Average debt investments, at fair value      $        155,182       $        117,631
Average borrowings outstanding               $         82,360       $         72,379

Net investment income for the six months ended June 30, 2011 was $4.2 million or $0.55 per share. Excluding the impact of the capital gains incentive fee expense of $0.9 million, net investment income totaled $5.1 million or $0.67 per share.

Investment Income

Investment income increased by $3.4 million, or 41.8%, for the six months ended June 30, 2011 as compared to the six months ended June 30, 2010. For the six months ended June 30, 2011, total investment income consisted primarily of $10.8 million in interest income from investments, which included $0.8 million in income from the amortization of discounts and origination fees on investments. Interest income on investments and other investment income increased primarily due to the increased average size of the loan portfolio. Fee income on investments was primarily comprised of a one-time success fee received upon the completion of an acquisition of one of our portfolio companies. For the six months ended June 30, 2010, total investment income consisted primarily of $7.9 million in interest income from investments, which included $0.5 million in income from the amortization of discounts and origination fees on investments. For the six months ended June 30, 2011 and 2010, our dollar-weighted average annualized yield on average loans was approximately 14.6% and 13.7%, respectively.

Investment income, consisting of interest income and fees on loans, can fluctuate significantly upon repayment of large loans. Interest income from the five largest loans accounted for approximately 24% and 18% of investment income for the six months ended June 30, 2011 and 2010, respectively.

Expenses

Total expenses increased by $3.8 million, or 109.8%, to $7.2 million for the six months ended June 30, 2011 as compared to the six months ended June 30, 2010. Total operating expenses for each period consisted principally of management fees, incentive and administrative fees and interest expense and, to a lesser degree, professional fees and general and administrative expenses. Interest expense, which includes the amortization of debt issuance costs, decreased for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to the termination of our Credit Facility's revolving term and the amortization of the remaining balance.

Effective with the completion of our initial public offering in October 2010, we pay management and incentive fees under the Investment Management Agreement, which provides a higher management fee base as compared to amounts previously paid by Compass Horizon. Management fee expense for the six months ended June 30, 2011 increased by approximately $1.0 million compared to the six months ended June 30, 2010 primarily due to the higher management fee base. Incentive fees for the six months ended June 30, 2011 totaled approximately $2.1 million compared to no incentives fees for the six months ended June 30, 2010. The incentive fees for the six months ended June 30, 2011 consisted of approximately $1.2 million and $0.9 million for part one and part two of the incentive fee, respectively. In connection with the Administration Agreement, we incurred $0.5 million of administrative expenses for the six months ended June 30, 2011. We did not pay an administrative servicing fee for the six months ended June 30, 2010.

Professional fees and general and administrative expenses include legal and audit fees, insurance premiums, and miscellaneous other expenses. These expenses for the six months ended June 30, 2011 increased by approximately $0.9 million compared to the six months ended June 30, 2010 primarily due to the increased cost of being a public company.


Net Realized Gain (Loss) and Net Unrealized Appreciation (Depreciation)

During the six months ended June 30, 2011 and 2010, we had $5.6 million in net realized gain on investments and $0.02 million in realized loss on investments, respectively. During the same periods, we had $2.3 million and $0.2 million in unrealized depreciation on investments, respectively. Net realized gain on investments resulted from the sale of stock through the exercise of warrants in portfolio companies. For both periods, the net increase in unrealized depreciation on investments was primarily from our warrant and equity investments. Net unrealized depreciation on warrants and equity investments is the difference between the net changes in warrant and equity investments fair values from the prior determination date and the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. The increase in net unrealized depreciation on investments for the six months ended June 30, 2011 is primarily due to the reversal of previously recorded unrealized appreciation on our warrant investments that were realized in the period offset by a net increase in the fair value of our investments.

Credit for Loan Losses

For the three and six months ended June 30, 2010, the credit for loan losses was $116 and $419 respectively. The loan portfolio had a weighted average credit rating of 3.1 as of June 30, 2010. See "Loan Portfolio Asset Quality." As of the date of our election to be treated as a BDC on October 28, 2010, we no longer record a credit or provision for loan losses. We record each individual loan and investment on a quarterly basis at fair value. Changes in fair value are recorded through our statement of operations.

Liquidity and Capital Resources

As of June 30, 2011 and December 31, 2010, we had cash and cash equivalents of $19.3 million and $76.8 million, respectively. Cash and cash equivalents are available to fund new investments, reduce borrowings under the Credit Facility, pay operating expenses and pay dividends. To date, our primary sources of capital have been from our IPO, use of our Credit Facility and from the private placement for $50 million of equity capital completed on March 4, 2008.

The Credit Facility had a three year initial revolving term and on March 3, 2011 the revolving term ended. The balance as of June 30, 2011 of $73,947 will be amortized based on loan investment payments received through March 3, 2015.

Our operating activities used cash of $41.8 million for the six months ended June 30, 2011 and our financing activities provided net cash proceeds of $15.7 million for the same period. Our operating activities used cash primarily for investing in portfolio companies. Such cash was provided primarily from proceeds from our initial public offering and draws under the Credit Facility.

Our operating activities used cash of $24.6 million for the six months ended June 30, 2010 and our financing activities provided net cash proceeds of $27.1 million for the same period. Our operating activities used cash primarily for investing in portfolio companies that was provided primarily from our availability on our Credit Facility.

Our primary use of available funds will be investments in portfolio companies and cash distributions to holders of our common stock. After we have used our current capital resources, including the net proceeds from our initial public offering, we expect to opportunistically raise additional capital as needed, and subject to market conditions, to support our future growth through future equity offerings, issuances of senior securities and/or future borrowings, to the extent permitted by the 1940 Act.

In order to satisfy the Code requirements applicable to a RIC, we intend to distribute to our stockholders all or substantially all of our income except for certain net capital gains. In addition, as a BDC, we generally will be required to meet a coverage ratio of 200%. This requirement will limit the amount that we may borrow.

Current Borrowings

We, through our wholly owned subsidiary, Credit I, entered into the Credit Facility. Per this agreement, base rate borrowings bear interest at one-month LIBOR plus 2.50%. The rates were 2.69% and 2.76% as of June 30, 2011 and December 31, 2010, respectively.

We were able to request advances under the Credit Facility through March 4, 2011. We may not request new advances and we must repay the outstanding advances under the Credit Facility as of such date and at such times and in such amounts as are necessary to maintain compliance with the terms and conditions of the Credit Facility, particularly the condition that the principal balance of the Credit Facility does not exceed seventy-five percent (75%) of the aggregate principal balance of our eligible loans to our portfolio companies. All outstanding advances under the Credit Facility are due and payable on March 4, 2015.


The Credit Facility is collateralized by loans held by Credit I and permitted an advance rate of up to 75% of eligible loans. The Credit Facility contains certain customary affirmative and negative covenants, including covenants that restrict certain of our subsidiaries' ability to make loans to, or investments in, third parties, pay dividends and distributions, incur additional . . .

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