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HRZN > SEC Filings for HRZN > Form 10-Q on 6-Aug-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


6-Aug-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;

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 for the year ended December 31, 2012, 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, periodic reports on Form 10-Q and Form 10-K and current reports on Form 8-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 June 30, 2013 and
December 31, 2012:

                                     June 30, 2013                                   December 31, 2012
                                                       Percentage                                        Percentage
                         # of             Fair          of Total           # of             Fair          of Total
                      Investments        Value         Portfolio        Investments        Value         Portfolio
Term loans                      50     $  222,525             90.1 %              41     $  200,685             87.8 %
Revolving loans                  2         15,346              6.2 %               4         19,612              8.6 %
Total loans                     52        237,871             96.3 %              45        220,297             96.4 %
Warrants                        72          5,964              2.4 %              62          5,468              2.4 %
Other investments                1          2,100              0.9 %               1          2,100              0.9 %
Equity                           4            926              0.4 %               2            748              0.3 %
Total                                  $  246,861            100.0 %                     $  228,613            100.0 %

Total portfolio investment activity as of and for the periods ended June 30, 2013 and 2012 was as follows:

                                         For the three months ended
                                                  June 30,                   For the six months ended June 30,
                                           2013              2012               2013                   2012
Beginning portfolio                     $   247,781       $   167,296     $        228,613       $        178,013
New loan funding                             29,143            37,295               57,643                 68,995
Less refinanced balances and
participation                                     -                 -                    -                (18,739 )
Net new loan funding                         29,143            37,295               57,643                 50,256
Principal payments received on
investments                                  (8,695 )          (8,795 )            (18,657 )              (17,915 )
Early pay-offs                              (19,278 )               -              (19,278 )              (14,205 )
Accretion of loan fees                          753               450                1,301                  1,092
New loan fees                                  (368 )            (566 )               (688 )                 (748 )
New equity                                        -                 -                   73                      -
Proceeds from sale on investments               (39 )             (38 )                (39 )                  (38 )
Net realized loss on investments                (45 )             (60 )                (62 )                  (61 )
Net appreciation (depreciation) on
investments                                  (2,391 )              18               (1,972 )                 (794 )
Other                                             -                 -                  (73 )                    -
Ending Portfolio                        $   246,861       $   195,600     $        246,861       $        195,600

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 June 30, 2013 and December 31, 2012:

                                               June 30, 2013                 December 31, 2012
                                         Loans at       Percentage       Loans at        Percentage
                                           Fair          of Total          Fair           of Total
                                          Value         Portfolio          Value         Portfolio
Life Science
Biotechnology                           $   22,277              9.4 %   $    38,018             17.3 %
Medical Device                              20,870              8.8 %        23,446             10.6 %
Technology
Software                                    69,784             29.3 %        54,358             24.7 %
Internet and Media                           9,193              3.8 %         9,763              4.4 %
Communication                                4,848              2.0 %             -                -
Semiconductors                              33,207             14.0 %        25,795             11.7 %
Power Management                            15,288              6.4 %        15,792              7.2 %
Cleantech
Energy Efficiency                           14,409              6.1 %        12,950              5.9 %
Waste Recycling                              2,151              0.9 %         2,197              1.0 %
Alternative Energy                          13,492              5.7 %         8,586              3.9 %
Healthcare Information and Services
Diagnostics                                 19,560              8.2 %        21,340              9.7 %
Other Healthcare Related Services            8,524              3.6 %         2,655              1.2 %
Software                                     4,268              1.8 %         5,397              2.4 %
Total                                   $  237,871            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 June 30, 2013 and December 31, 2012, respectively. No single loan represented more than 10% of our total loans as of June 30, 2013 and December 31, 2012.

Loan Portfolio Asset Quality

We use an internal 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. Our internal credit rating system is not a national credit rating system. The following table shows the classification of our loan portfolio by credit rating as of June 30, 2013 and December 31, 2012:

                      June 30, 2013                 December 31, 2012
                Loans at       Percentage       Loans at       Percentage
                  Fair          of Loan           Fair          of Loan
                  Value        Portfolio         Value         Portfolio

Credit Rating
4               $  25,169             10.6 %   $   30,818             14.0 %
3                 190,794             80.2 %      181,019             82.2 %
2                  19,257              8.1 %        3,560              1.6 %
1                   2,651              1.1 %        4,900              2.2 %
Total           $ 237,871            100.0 %   $  220,297            100.0 %

As of June 30, 2013 and December 31, 2012, our loan portfolio had a weighted average credit rating of 3.1 and 3.2, respectively. As of June 30, 2013, there were five 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 June 30, 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 subject to certain constraints on our operations, including limitations imposed by the 1940 Act and the Code. 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, 2013 and 2012 are as follows:

                                                                For the three Months Ended
                                                                         June 30,
                                                                  2013               2012
Total investment income                                      $        8,787       $     5,482
Total expenses                                                        5,106             3,224
Net investment income before excise tax                               3,681             2,258
Provision for excise tax                                                (80 )               -
Net investment income                                                 3,601             2,258
Net realized loss on investments                                        (62 )             (60 )
Net unrealized (deprecation) appreciation on investments             (2,391 )              18
Net increase in net assets resulting from operations         $        1,148       $     2,216
Average investments, at fair value                           $      241,655       $   170,605
Average debt outstanding                                     $      105,959       $    57,065

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.

Comparison of the three months ended June 30, 2013 and 2012

Investment Income

Investment income increased by $3.3 million, or 60.3%, for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012. For the three months ended June 30, 2013, total investment income consisted primarily of $8.4 million in interest income from investments, which included $1.8 million in income from the accretion of origination fees and end-of-term payments, or ETPs. Interest income on investments and other investment income increased primarily due to the increased average size of the loan portfolio and higher fee income. Fee income of $0.4 million was primarily earned from prepayment fees collected from our portfolio companies, as we experienced early payoffs of approximately $19.3 million. For the three months ended June 30, 2012, total investment income consisted primarily of $5.5 million in interest income from investments, which included $0.8 million in income from the accretion of origination fees and ETPs.

For the three months ended June 30, 2013 and 2012, our dollar-weighted average annualized yield on average debt investments was approximately 14.5% and 12.9%, 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 22% and 32% of investment income for the three months ended June 30, 2013 and 2012, respectively.

As of June 30, 2013 and December 31, 2012, interest receivables were $3.9 million and $2.8 million, respectively, which represent accreted ETPs and one month of accrued interest income on substantially all of our loans.

Expenses

Total expenses increased by $1.9 million, or 58.4%, to $5.1 million for the three months ended June 30, 2013 as compared to the three months ended June 30, 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 for the three months ended June 30, 2013 and 2012 was $1.9 million and $1.0 million, respectively. Interest expense for the three months ended June 30, 2013 increased primarily due to an increase in our average debt outstanding, as well as an increase in borrowing cost associated with our term loan credit facility.

Management fee expense for the three months ended June 30, 2013 and 2012 was $1.3 million and $1.0 million, respectively. Management fee expense increased compared to the three months ended June 30, 2012 as a result of an increase in average gross assets.

Performance based incentive fee for the three months ended June 30, 2013 increased compared to the three months ended June 30, 2012 due to higher pre-incentive fee net investment income in the three months ended June 30, 2013. The incentive fees for the three months ended June 30, 2013 and 2012 were approximately $0.9 million and $0.4 million, respectively, and consisted entirely of incentive fees payable on pre-incentive fee net investment income.

Administrative fee expense for the three months ended June 30, 2013 and 2012 was $0.3 million and $0.2 million, respectively. Administrative fee expense increased compared to the three months ended June 30, 2012 due to an increase in costs associated with servicing a growing investment portfolio.

Professional fees and general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses for the three months ended June 30, 2013 remained flat compared to the three months ended June 30, 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 June 30, 2013, we recognized realized losses totaling approximately $0.1 million primarily in connection with the disposal of a portfolio company's warrants. During the three months ended June 30, 2012, we recognized realized losses of approximately $0.1 million primarily due to the charge off of warrants in one portfolio company.

During the three months ended June 30, 2013, net unrealized depreciation on investments totaled approximately $2.4 million which was primarily due to the change in fair values of our investment portfolio during the period. During the three months ended June 30, 2012, net unrealized appreciation on investments totaled approximately $0.02 million which was primarily due to the change in fair values of our investment portfolio during the period.

Consolidated operating results for the six months ended June 30, 2013 and 2012 are as follows:

                                                         For the six Months Ended
                                                                 June 30,
                                                           2013              2012
Total investment income                                $      16,156       $  12,107
Total expenses                                                 9,701           6,496
Net investment income before excise tax                        6,455           5,611
Provision for excise tax                                         (80 )             -
Net investment income                                          6,375           5,611
Net realized loss on investments                                (272 )           (61 )
Net unrealized depreciation on investments                    (1,972 )          (794 )
Net increase in net assets resulting from operations   $       4,131       $   4,756
Average investments, at fair value                     $     235,105       $ 172,061
Average debt outstanding                               $      99,349       $  60,262

Net increase in net assets 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.

Comparison of the six months ended June 30, 2013 and 2012

Investment Income

Investment income increased by $4.0 million, or 33.4%, for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. For the six months ended June 30, 2013, total investment income consisted primarily of $15.8 million in interest income from investments, which included $3.0 million in income from the accretion of origination fees and ETPs. Interest income on investments increased primarily due to the increased average size of the loan portfolio.

For the six months ended June 30, 2012, total investment income consisted primarily of $11.4 million in interest income from investments, which included $2.0 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 six months ended June 30, 2013 and 2012, our dollar-weighted average annualized yield on average debt investments was approximately 13.7% and 14.1%, 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 31% of investment income for the six months ended June 30, 2013 and 2012, respectively.

Expenses

Total expenses increased by $3.2 million, or 49.3%, to $9.7 million for the six months ended June 30, 2013 as compared to the six months ended June 30, 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 for the six months ended June 30, 2013 and 2012 was $3.7 million and $1.7 million, respectively. Interest expense for the six months ended June 30, 2013 increased primarily due to an increase in our average debt outstanding, as well as an increase in borrowing cost associated with our Fortress Facility and our 2019 Notes.

Management fee expense for the six months ended June 30, 2013 and 2012 was $2.6 million and $2.0 million, respectively. Management fee expense increased compared to the six months ended June 30, 2012 as a result of an increase in average gross assets.

Performance based incentive fees for the six months ended June 30, 2013 increased compared to the six months ended June 30, 2012 due to higher pre-incentive fee net investment income in the six months ended June 30, 2013. The incentive fees for the six months ended June 30, 2013 and 2012 were approximately $1.6 million and $1.3 million, respectively, and consisted entirely of incentive fees payable on pre-incentive fee net investment income.

Administrative fee expense for the six months ended June 30, 2013 and 2012 was $0.6 million and $0.5 million, respectively. Administrative fee expense increased compared to the six months ended June 30, 2012 due to an increase in costs associated with servicing a growing investment portfolio.

Professional fees and general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses for the six months ended June 30, 2013 remained flat compared to the six months ended June 30, 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 six months ended June 30, 2013, we recognized realized losses . . .

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