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HRZN > SEC Filings for HRZN > Form 10-K on 12-Mar-2013All Recent SEC Filings

Show all filings for HORIZON TECHNOLOGY FINANCE CORP

Form 10-K for HORIZON TECHNOLOGY FINANCE CORP


12-Mar-2013

Annual Report


Item 7. 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 annual report on Form 10-K. For periods prior to October 28, 2010, the consolidated financial statements and related footnotes reflect the performance of our predecessor, Compass Horizon, 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.

Forward-Looking Statements

This annual report on Form 10-K, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements that constitute forward-looking statements, which relate to future events or our future performance or financial condition. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our industry, our beliefs and our assumptions. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties, including statements as to:

our future operating results, including the performance of our existing loans and warrants;

the introduction, withdrawal, success and timing of business initiatives and strategies;

changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of our assets;

the relative and absolute investment performance and operations of our Advisor;

the impact of increased competition;

the impact of investments we intend to make and future acquisitions and divestitures;

the unfavorable resolution of legal proceedings;

our business prospects and the prospects of our portfolio companies;

the impact, extent and timing of technological changes and the adequacy of intellectual property protection;

our regulatory structure and tax status;

the adequacy of our cash resources and working capital;

the timing of cash flows, if any, from the operations of our portfolio companies;

the impact of interest rate volatility on our results, particularly if we use leverage as part of our investment strategy;

the ability of our portfolio companies to achieve their objective;

our ability to cause a subsidiary to become a licensed Small Business Investment Company ("SBIC");

the impact of legislative and regulatory actions and reforms and regulatory supervisory or enforcement actions of government agencies relating to us or our Advisor;

our contractual arrangements and relationships with third parties;

our ability to access capital and any future financings by us;

the ability of our Advisor to attract and retain highly talented professionals; and

the impact of changes to tax legislation and, generally, our tax position.

We use words such as "anticipates," "believes," "expects," "intends," "seeks" and similar expressions to identify forward-looking statements. Undue influence should not be placed on the forward looking statements as our actual results could differ materially from those projected in the forward-looking statements for any reason, including the factors in "Risk Factors" and elsewhere in this annual report on Form 10-K.

We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements in this annual report on Form 10-K, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including, reports on Form 10-Q and current reports on Form 8-K.

You should understand that under Sections 27A(b)(2)(B) and (D) of the Securities Act and Sections 21E(b)(2)(B) and (D) of the Exchange Act, the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 do not apply to statements made in connection with this annual report on Form 10-K or any periodic reports we file under the Exchange Act.

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 "Venture Loans," to companies backed by established venture capital and private equity firms in our Target Industries, which we refer to as "Venture 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 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. The amount of leverage that we employ depends on our assessment of market conditions and other factors at the time of any proposed borrowing.

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.

Portfolio Composition and Investment Activity



The following table shows our portfolio by asset class as of December 31, 2012
and 2011:



                                                 December 31, 2012                               December 31, 2011
                                                                       % of                                            % of
                                        # of            Fair           Total            # of            Fair           Total
                                     Investments        Value        Portfolio       Investments        Value        Portfolio
Term loans                                     41     $ 200,685            87.8 %              37     $ 172,363            96.8 %
Revolving loans                                 4        19,612             8.6 %               -             -               -
Equipment loans                                 -             -               -                 1           923             0.5 %
Total loans                                    45       220,297            96.4 %              38       173,286            97.3 %
Warrants                                       62         5,468             2.4 %              47         4,098             2.3 %
Other investments                               1         2,100             0.9 %               -             -               -
Equity                                          2           748             0.3 %               3           629             0.4 %
Total                                                 $ 228,613           100.0 %                     $ 178,013           100.0 %

Total portfolio investment activity as of and for the years ended December 31, 2012 and 2011 was as follows:

                                                            December 31,
                                                         2012          2011
Beginning portfolio                                    $ 178,013     $ 136,810
New loan funding                                         184,202       106,350
Less refinanced balances and participation               (45,295 )      (8,677 )
Net new loan funding                                     138,907        97,673
Principal and stock payments received on investments     (39,092 )     (34,793 )
Early pay-offs                                           (42,291 )     (16,649 )
Accretion of loan fees                                     2,531         1,895
New loan fees                                             (1,676 )      (1,049 )
New equity                                                     -           579
Sales of investments                                        (306 )      (6,985 )
Net realized gain on investments                             108         6,599
Net depreciation on investments                           (8,113 )      (5,974 )
Other                                                        532           (93 )
Ending Portfolio                                       $ 228,613     $ 178,013

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 loan portfolio by industry sector as of December 31, 2012 and 2011:

                                                        December 31, 2012               December 31, 2011
                                                    Loans at       Percentage       Loans at       Percentage
                                                      Fair          of Total          Fair          of Total
                                                     Value         Portfolio         Value         Portfolio
Life Science
Biotechnology                                      $   38,018             17.3 %   $   39,854             23.0 %
Medical Device                                         23,446             10.6 %       19,281             11.1 %
Technology
Consumer-Related Technologies                               -                -          1,762              1.0 %
Networking                                                  -                -            923              0.5 %
Software                                               54,358             24.7 %       21,427             12.4 %
Data Storage                                                -                -          3,437              2.0 %
Internet and Media                                      9,763              4.4 %            -                -
Communications                                              -                -          5,134              3.0 %
Semiconductors                                         25,795             11.7 %       11,765              6.8 %
Power Management                                       15,792              7.2 %            -                -
Cleantech
Energy Efficiency                                      12,950              5.9 %       23,790             13.7 %
Waste Recycling                                         2,197              1.0 %        4,455              2.6 %
Alternative Energy                                      8,586              3.9 %            -                -
Healthcare Information and Services
Diagnostics                                            21,340              9.7 %       21,347             12.3 %
Other Healthcare Related Services                       2,655              1.2 %       18,184             10.5 %
Software                                                5,397              2.4 %        1,927              1.1 %
Total                                              $  220,297            100.0 %   $  173,286            100.0 %

The largest loans may vary from year to year as new loans are recorded and repaid. Our five largest loans represented approximately 23% and 28% of total loans outstanding as of December 31, 2012 and 2011, respectively. No single loan represented more than 10% of our total loans as of December 31, 2012 or 2011.

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. See "Item 1 - Business" for more detailed descriptions. The following table shows the classification of our loan portfolio by credit rating as of December 31, 2012 and 2011:

                     December 31, 2012               December 31, 2011
                 Loans at       Percentage       Loans at       Percentage
                   Fair          of Loan           Fair          of Loan
                  Value         Portfolio         Value         Portfolio

Credit Rating
4               $   30,818             14.0 %   $   30,108             17.4 %
3                  181,019             82.2 %      119,753             69.1 %
2                    3,560              1.6 %       23,425             13.5 %
1                    4,900              2.2 %            -                -
Total           $  220,297            100.0 %   $  173,286            100.0 %

As of December 31, 2012 and 2011 our loan portfolio had a weighted average credit rating of 3.2 and 3.1, respectively. As of December 31, 2012, there were three investments on non-accrual status with an approximate cost of $12.9 million and fair value of approximately $4.9 million. There were no loans on non-accrual status as of December 31, 2011.

Consolidated Results of Operations

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 years ended December 31, 2012, 2011 and 2010:

                                               2012          2011          2010
Total investment income                      $  26,664     $  24,054     $  18,207
Total expenses                                  14,437        13,332         7,823
Net investment income before excise tax         12,227        10,722        10,384
Provision for excise tax                          (231 )        (211 )           -
Net investment income                           11,996        10,511        10,384
Net realized gains                                 108         6,316           680
Provision for excise tax                             -          (129 )           -
Net unrealized (depreciation) appreciation      (8,113 )      (5,702 )       2,930
Credit for loan losses                               -             -           739
Net income                                   $   3,991     $  10,996     $  14,733
Average investments, at fair value           $ 187,760     $ 164,437     $ 124,027
Average debt outstanding                     $  62,973     $  78,106     $  77,174

Net income can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation. As a result, annual comparisons of net income may not be meaningful.

Investment Income

Investment income increased by $2.6 million, or 10.9%, for the year ended December 31, 2012 as compared to the year ended December 31, 2011. For the year ended December 31, 2012, total investment income consisted primarily of $25.3 million in interest income from investments, which included $5.0 million in income from the accretion of origination fees and ETPs. 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 collected from our portfolio companies.

Investment income increased by $5.8 million, or 32.1%, for the year ended December 31, 2011 as compared to the year ended December 31, 2010. For the year ended December 31, 2011, total investment income consisted primarily of $22.9 million in interest income from investments, which included $3.6 million in income from the accretion of origination fees and ETPs. 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 and from prepayment fees collected from our portfolio companies.

For the years ended December 31, 2012, 2011 and 2010, our dollar-weighted average annualized yield on average loans was approximately 14.2%, 14.6% and 14.6%, 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 22%, 21% and 22% of investment income for the years ended December 31, 2012, 2011 and 2010, respectively.

As of December 31, 2012 and 2011, interest receivable was $2.8 million and $3.0 million, respectively, which represents one month of accrued interest income on substantially all our loans and accreted ETPs.

Expenses

Total expenses increased by $1.1 million, or 8.3%, to $14.4 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011. Total expenses increased by $5.5 million, or 70.4%, to $13.3 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010. Total operating expenses for each period consisted principally of management fees, incentive and administrative fees, interest expense and, to a lesser degree, professional fees and general and administrative expenses.

Interest expense, which includes the amortization of debt issuance costs, increased in 2012 from 2011 primary due to an increase in borrowings under the Wells Facility and Fortress Facility, and the issuance of our Senior Notes, offset by repayment of the WestLB Facility. Interest expense decreased in 2011 from 2010 primarily due to a lower effective interest rate in 2011.

Management fee expense for the year ended December 31, 2012 remained flat compared to the year ended December 31, 2011 primarily due to our average assets remaining relatively consistent. Management fee expense for the year ended December 31, 2011 increased by approximately $1.5 million compared to the year ended December 31, 2010 primarily due to the higher management fee base.

Performance based incentive fees for the year ended December 31, 2012 remained flat compared to the year ended December 31, 2011 primarily due to part one of the incentive fee increasing as pre-incentive fee net investment income increased year over year, offset by a decrease in part two of the incentive fee in 2012. Incentive fees for the year ended December 31, 2011 increased compared to the year ended December 31, 2010 due to a full twelve months of expense in 2011 compared to only two months in 2010. The incentive fees for the year ended December 31, 2012 consisted of approximately $2.8 million for the incentive fee on income. The incentive fees for the year ended December 31, 2011 consisted of approximately $2.7 million and $0.3 million for the incentive fee on income and capital gains, respectively. There were no incentive fees prior to the IPO.

Administrative fee expense for the year ended December 31, 2012 remained flat compared to the year ended December 31, 2011. The administrative fee increased for the year ended December 31, 2011 compared to the year ended December 31, 2010 due to a full twelve months of expense in 2011 compared to only two months in 2010.

Professional fees and general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses for the year ended December 31, 2012 remained flat compared to the year ended December 31, 2011. These expenses for the year ended December 31, 2011 increased by approximately $1.7 million compared to the year ended December 31, 2010 primarily due to the increased cost of being a public company.

In 2012 and 2011 we elected to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4% excise tax on such income. At December 31, 2012 and 2011, we recorded an excise tax payable of approximately $0.2 million and $0.3 million on approximately $5.9 million and $8.5 million of undistributed earnings from operations and capital gains, respectively.

Net Realized Gains and Net Unrealized Appreciation and Depreciation

Realized gains or losses on investments are measured by the difference between the net proceeds from the repayment or sale and the cost basis of our investments without regard to unrealized appreciation or depreciation previously recognized and includes investments charged off during the period, net of recoveries. The net change in unrealized appreciation or depreciation on investments primarily reflects the change in portfolio investment fair values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

During the year ended December 31, 2012, we recognized realized gains totaling approximately $0.1 million primarily due to the sale of warrants of one portfolio company. During the year ended December 31, 2011, we recognized realized gains totaling approximately $6.3 million primarily due to the sale of warrants of three portfolio companies. We recognized realized gains of approximately $0.7 million during the year ended December 31, 2010 primarily due to the sale of warrants of two portfolio companies.

During the year ended December 31, 2012, net unrealized depreciation on investments totaled approximately $8.1 million which was primarily due to the unrealized depreciation on the three debt investments on non-accrual status. During the year ended December 31, 2011, net unrealized depreciation on investments totaled approximately $5.7 million which was primarily due to $4.0 million in reversal of unrealized appreciation on the sale of warrants and $2.7 million of unrealized depreciation on six debt investments partially offset by unrealized appreciation on investments. During the year ended December 31, 2010, net unrealized appreciation on investments totaled approximately $2.9 million which was primarily due to fair value appreciation on some of our warrants.

Credit or Provision for Loan Losses

For the period from January 1, 2010 through October 28, 2010, the credit for loan losses was $0.7 million. The credit was primarily due to improved portfolio asset quality during 2010 across all credit ratings within the loan portfolio. The loan portfolio had a weighted average credit rating of 3.1 as of October 28, 2010. Since October 28, 2010, the date of our election to be treated as a BDC, we do not 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 December 31, 2012 and 2011, we had cash and investments in money market funds of $3.6 million and $14.8 million, respectively. These amounts are available to fund new investments, reduce borrowings under the Wells Facility and the Fortress Facility (collectively, the "Credit Facilities"), pay operating expenses and pay dividends. We had a revolving credit facility (the "WestLB Facility") with WestLB, AG, New York Branch ("WestLB") which all obligations under the WestLB Facility were paid and the WestLB Facility was terminated. Our primary sources of capital have been from our private and public common stock offerings, use of our Credit Facilities and issuance of our Senior Notes.

As of December 31, 2012, the outstanding principal balance under the Wells Facility was $46.0 million. As of December 31, 2012, we had available borrowing capacity of approximately $29.0 million under our Wells Facility, subject to existing terms and advance rates.

As of December 31, 2012, the outstanding principal balance under the Fortress Facility was $10.0 million. As of December 31, 2012, we had available borrowing capacity of approximately $65.0 million under our Fortress Facility, subject to existing terms and advance rates.

Our operating activities used cash of $36.1 million for the year ended December 31, 2012, and our financing activities provided cash of $35.8 million for the same period. Our operating activities used cash primarily for investing in portfolio companies, net of principal payments received. Our financing activities provided cash primarily from the issuance of our Senior Notes for net proceeds of approximately $31.7 million, and the completion of a follow-on public offering of 1.9 million shares of common stock for net proceeds of approximately $29.5 million. These increases from investing activities were partially offset by repayments of $8.6 million of debt under the Credit Facilities and $15.1 million dividends paid.

Our operating activities used cash of $4.0 million for the year ended December 31, 2011 and our financing activities used cash of $32.4 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 IPO and draws under the WestLB Facility and Wells Facility.

Our operating activities used cash of $38.1 million for the year ended December 31, 2010 and our financing activities provided net cash proceeds of $75.0 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 IPO and draws under the WestLB Facility.

Our primary use of available funds is to make investments in portfolio companies and for general corporate purposes. We expect to raise additional equity and debt capital opportunistically 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 are required to meet a coverage ratio of 200%. This requirement limits the amount that we may borrow.

We believe that our current cash and investments in money market funds, cash generated from operations, and funds available from our Credit Facilities will be sufficient to meet our working capital and capital expenditure commitments for at least the next 12 months.

Current Borrowings



A summary of our borrowings as of December 31, 2012 and 2011 is as follows:



                                              December 31, 2012
                         Total            Balance           Unused           Average
                       Commitment       Outstanding       Commitment       Outstanding
Wells Facility        $     75,000     $      46,020     $     28,980     $      15,137
. . .
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