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HRZN > SEC Filings for HRZN > Form 10-Q on 7-May-2013All Recent SEC Filings

Show all filings for HORIZON TECHNOLOGY FINANCE CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for HORIZON TECHNOLOGY FINANCE CORP


7-May-2013

Quarterly Report


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

In this quarterly report on Form 10-Q, 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. Amounts are stated in thousands, except shares and per share data and where otherwise noted.

Forward-Looking Statements

This quarterly report on Form 10-Q, including the 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 quarterly report on Form 10-Q 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 investment advisor, Horizon Technology Management LLC, or the 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 set forth as "Risk Factors" in our annual report on Form 10-K, or Form 10-K, and elsewhere in this quarterly report on Form 10-Q.

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 quarterly report on Form 10-Q, 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 U.S. Securities and Exchange Commission, or the SEC, including, reports on Form 10-Q and current reports on Form 8-K and Form 10-K.

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 business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, for U.S. federal income tax purposes, we have elected to be treated as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. 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 Funding Company LLC, or 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 investment activities are managed by the Advisor and supervised by our board of directors, or the Board, of which a majority of the members are independent of us. Under an investment management agreement, or the Investment Management Agreement, we have agreed to pay the Advisor a base management fee and an incentive fee for its advisory services to us. We have also entered into an administration agreement, or the Administration Agreement, with the Advisor under which we have agreed to reimburse the Advisor for our allocable portion of overhead and other expenses incurred by the Advisor in performing its obligations under the Administration Agreement.

Portfolio Composition and Investment Activity



The following table shows our portfolio by asset class as of March 31, 2013 and
December 31, 2012:



                                           March 31, 2013                                 December 31, 2012
                                                             Percentage                                       Percentage
                                # of            Fair          of Total           # of            Fair          of Total
                             Investments        Value        Portfolio        Investments        Value        Portfolio
Term loans                             46     $ 221,262             89.3 %              41     $ 200,685             87.8 %
Revolving loans                         3        17,487              7.1 %               4        19,612              8.6 %
Total loans                            49       238,749             96.4 %              45       220,297             96.4 %
Warrants                               66         6,048              2.4 %              62         5,468              2.4 %
Other investments                       1         2,100              0.8 %               1         2,100              0.9 %
Equity                                  3           884              0.4 %               2           748              0.3 %
Total                                         $ 247,781            100.0 %                     $ 228,613            100.0 %

Total portfolio investment activity as of and for the three months ended March 31, 2013 and 2012 was as follows:

                                                      For the three months Ended
                                                               March 31,
                                                         2013               2012
   Beginning portfolio                              $      228,613       $  178,013
   New loan funding                                         28,500           31,700
   Less refinanced balances and participation                    -          (18,739 )
   Net new loan funding                                     28,500           12,961
   Principal payments received on investments               (9,962 )         (9,120 )
   Early pay-offs                                                -          (14,205 )
   Accretion of loan fees                                      548              642
   New loan fees                                              (320 )           (182 )
   New equity                                                   73                -
   Net realized loss on investments                            (18 )              -
   Net appreciation (depreciation) on investments              420             (813 )
   Other                                                       (73 )              -
   Ending Portfolio                                 $      247,781       $  167,296

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 March 31, 2013 and December 31, 2012:

                                              March 31, 2013                 December 31, 2012
                                         Loans at       Percentage       Loans at        Percentage
                                           Fair          of Total          Fair           of Total
                                          Value         Portfolio          Value         Portfolio
Life Science
Biotechnology                           $   35,319             14.8 %   $    38,018             17.3 %
Medical Device                              24,606             10.3 %        23,446             10.6 %
Technology
Software                                    67,860             28.4 %        54,358             24.7 %
Internet and Media                           9,796              4.1 %         9,763              4.4 %
Semiconductors                              24,563             10.3 %        25,795             11.7 %
Power Management                            15,329              6.4 %        15,792              7.2 %
Cleantech
Energy Efficiency                           11,812              5.0 %        12,950              5.9 %
Waste Recycling                              2,469              1.0 %         2,197              1.0 %
Alternative Energy                          13,604              5.7 %         8,586              3.9 %
Healthcare Information and Services
Diagnostics                                 19,955              8.4 %        21,340              9.7 %
Other Healthcare Related Services            9,030              3.8 %         2,655              1.2 %
Software                                     4,406              1.8 %         5,397              2.4 %
Total                                   $  238,749            100.0 %   $   220,297            100.0 %

The largest loans may vary from year to year as new loans are recorded and repaid. Our five largest loans represented approximately 21% and 23% of total loans outstanding as of March 31, 2013 and December 31, 2012, respectively. No single loan represented more than 10% of our total loans as of March 31, 2013 and December 31, 2012.

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 represents an increased level of risk and while no loss is currently anticipated for a 2 rated loan, there is potential for future loss of principal. A rating of 1 represents a deteriorating credit quality and increased risk. The following table shows the classification of our loan portfolio by credit rating as of March 31, 2013 and December 31, 2012:

                      March 31, 2013                December 31, 2012
                Loans at       Percentage       Loans at       Percentage
                  Fair          of Loan           Fair          of Loan
                  Value        Portfolio         Value         Portfolio

Credit Rating
4               $  33,696             14.1 %   $   30,818             14.0 %
3                 180,859             75.8 %      181,019             82.2 %
2                  18,914              7.9 %        3,560              1.6 %
1                   5,280              2.2 %        4,900              2.2 %
Total           $ 238,749            100.0 %   $  220,297            100.0 %

As of March 31, 2013 and December 31, 2012, our loan portfolio had a weighted average credit rating of 3.1 and 3.2, respectively. As of March 31, 2013, there were four investments with a credit rating of 2. As of December 31, 2012, there was one investment with a credit rating of 2. As of both March 31, 2013 and December 31, 2012, there were three investments with a credit rating of 1, all of which were on non-accrual status.

Consolidated Results of Operations

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 March 31, 2013 and 2012 are as follows:

                                                                For the three Months Ended
                                                                         March 31,
                                                                 2013                 2012
Total investment income                                     $        7,368       $        6,625
Total expenses                                                       4,595                3,273
Net investment income                                                2,773                3,352
Net realized loss on investments                                      (210 )                  -
Net unrealized appreciation (depreciation) on investments              420                 (813 )
Net increase in net assets resulting from operations        $        2,983       $        2,539
Average investments, at fair value                          $      230,291       $      171,592
Average debt outstanding                                    $       92,665       $       65,469

Net increase in net asset resulting from operations 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, quarterly comparisons of net income may not be meaningful.

Investment Income

Investment income increased by $0.7 million, or 11.2%, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. For the three months ended March 31, 2013, total investment income consisted primarily of $7.3 million in interest income from investments, which included $1.2 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 offset by lower fee income, as we had no prepayments in the quarter.

For the three months ended March 31, 2012, total investment income consisted primarily of $5.9 million in interest income from investments, which included $1.1 million in income from the accretion of origination fees and ETPs. Fee income of $0.7 million was primarily earned from prepayment fees collected from our portfolio companies as we experienced early payoffs and refinances of approximately $27.6 million.

For the three months ended March 31, 2013 and 2012, our dollar-weighted average annualized yield on average debt investments was approximately 12.8% and 15.4%, respectively. We calculate the yield on dollar-weighted average debt investments for any period measured as (1) total investment income during the period divided by (2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period.

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 23% and 29% of investment income for the three months ended March 31, 2013, and 2012, respectively.

As of March 31, 2013 and December 31, 2012, interest receivable was $3.5 million and $2.8 million, respectively, which represents accreted ETPs and one month of accrued interest income on substantially all of our loans.

Expenses

Total expenses increased by $1.3 million, or 40.4%, to $4.6 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. 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 the for three months ended March 31, 2013, which includes the amortization of debt issuance costs, increased primarily due to an increase in our average debt outstanding, as well as an increase borrowing cost associated with our Fortress Facility and our Senior Notes.

Management fee expense for the three months ended March 31, 2013 increased compared to the three months ended March 31, 2012 as a result of an increase in average gross assets.

Performance based incentive fees for the three months ended March 31, 2013 decreased compared to the three months ended March 31, 2012 due to lower pre-incentive fee net investment income in the three months ended March 31, 2013. The incentive fees for the three months ended March 31, 2013 and 2012 were approximately $0.7 million and $0.8 million, respectively, and consisted entirely of incentive fees payable on pre-incentive fee net investment income.

Administrative fee expense for the three months ended March 31, 2013 remained flat compared to the three months ended March 31, 2012.

Professional fees and general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses for the three months ended March 31, 2013 remained flat compared to the three months ended March 31, 2012.

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 three months ended March 31, 2013, we recognized realized losses totaling approximately $0.2 million primarily in connection with the disposal of a portfolio company's warrants. During the three months ended March 31, 2012, no realized gains were recognized.

During the three months ended March 31, 2013, net unrealized appreciation on investments totaled approximately $0.4 million which was primarily due to the change in fair values of our investment portfolio during the period. During the three months ended March 31, 2012, net unrealized depreciation on investments totaled approximately $0.8 million which was primarily due to $1.2 million of net unrealized depreciation on six debt investments partially offset by unrealized appreciation on our warrant and equity investments.

Liquidity and Capital Resources

As of March 31, 2013 and December 31, 2012, we had cash and investments in money market funds of $4.6 million and $3.6 million, respectively. These amounts are available to fund new investments, reduce borrowings under a revolving credit facility with Wells Fargo Capital Finance, LLC, or the Wells Facility, and a term loan credit facility with Fortress Credit Co LLC, or the Fortress Facility, pay operating expenses and pay dividends. In this quarterly report on Form 10-Q, we refer to the Wells Facility and the Fortress Facility, collectively, as the "Credit Facilities." Our primary sources of capital have been from our private and public common stock offerings, use of our Credit Facilities and issuance of our 7.375% senior unsecured notes due in 2019, or the Senior Notes.

As of March 31, 2013, the outstanding principal balance under the Wells Facility was $67.0 million. As of March 31, 2013, we had available borrowing capacity of approximately $8.0 million under our Wells Facility, subject to existing terms and advance rates.

As of March 31, 2013, the outstanding principal balance under the Fortress Facility was $10.0 million. As of March 31, 2013, 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 $18.4 million for the three months ended March 31, 2013, and our financing activities provided cash of $17.8 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 advances on our Wells Facility offset by our dividends paid in the first quarter.

Our operating activities provided cash of $3.2 million for the three months ended March 31, 2012 and our financing activities provided cash of $1.2 million for the same period. Our operating activities provided cash primarily from normal amortization and prepayments of our debt investments. Our financing activity provided cash primarily from our issuance of our Senior Notes offset by payments made on our Credit Facilities and our dividends paid in the first quarter.

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 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 March 31, 2013 and December 31, 2012 is as
follows:



                                    March 31, 2013
                       Total            Balance           Unused
                     Commitment       Outstanding       Commitment
Wells Facility      $     75,000     $      67,037     $      7,963
Fortress Facility         75,000            10,000           65,000
Senior Notes              33,000            33,000                -
Total               $    183,000     $     110,037     $     72,963




                                   December 31, 2012
                       Total            Balance           Unused
                     Commitment       Outstanding       Commitment
Wells Facility      $     75,000     $      46,020     $     28,980
Fortress Facility         75,000            10,000           65,000
Senior Notes              33,000            33,000                -
Total               $    183,000     $      89,020     $     93,980

We, through our wholly owned subsidiary, Horizon Credit II LLC, or Credit II, entered into the Wells Facility on July 14, 2011. The interest rate is based upon the one-month LIBOR plus a spread of 4.00%, with a LIBOR floor of 1.00%. The interest rate was 5.00% as of March 31, 2013 and December 31, 2012.

We may request advances under the Wells Facility through July 14, 2014, or the Revolving Period. After the Revolving Period, we may not request new advances, and we must repay the outstanding advances under the Wells Facility as of such date, at such times and in such amounts as are necessary to maintain compliance with the terms and conditions of the Wells Facility, particularly the condition that the principal balance of the Wells Facility does not exceed fifty percent (50%) of the aggregate principal balance of our eligible loans to our portfolio companies. All outstanding advances under the Wells Facility are due and payable on July 14, 2017.

The Wells Facility is collateralized by loans held by Credit II and permits an advance rate of up to 50% of eligible loans held by Credit II. The Wells Facility contains covenants that, among other things, require us to maintain a minimum net worth, to restrict the loans securing the Wells Facility to certain criteria for qualified loans and to comply with portfolio company concentration limits as defined in the related loan agreement.

On March 23, 2012, we issued and sold $30 million aggregate principal amount of Senior Notes, and on April 18, 2012, pursuant to the underwriters' 30 day option to purchase additional notes, we sold an additional $3 million of such notes. The Senior Notes will mature on March 15, 2019 and may be redeemed in whole or in part at our option at any time or from time to time on or after March 15, 2015 at a redemption price of $25 per security plus accrued and unpaid interest. The Senior Notes bear interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The Senior Notes are our direct, unsecured obligations and rank (1) equally in right of payment with our future senior unsecured indebtedness; (2) senior in right of payment to any of our future indebtedness that expressly provides it is subordinated to the Senior Notes; (3) effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness and (4) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries. As of March 31, 2013, we were in material compliance with the terms of the Senior Notes. The Senior Notes are listed on the New York Stock Exchange under the symbol "HTF". . . .

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