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HRZN > SEC Filings for HRZN > Form 10-Q on 5-Nov-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


5-Nov-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 September 30, 2013
and December 31, 2012:



                                             September 30, 2013                                 December 31, 2012
                                                               Percentage of                                      Percentage of
                                   # of            Fair            Total              # of            Fair            Total
                                Investments        Value         Portfolio         Investments        Value         Portfolio
Term loans                                48     $ 216,569               89.7 %              41     $ 200,685               87.8 %
Revolving loans                            2        15,092                6.3 %               4        19,612                8.6 %
Total loans                               50       231,661               96.0 %              45       220,297               96.4 %
Warrants                                  71         6,611                2.7 %              62         5,468                2.4 %
Other investments                          1         2,000                0.8 %               1         2,100                0.9 %
Equity                                     4         1,047                0.5 %               2           748                0.3 %
Total                                            $ 241,319              100.0 %                     $ 228,613              100.0 %

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

                                             For the Three Months Ended          For the Nine Months Ended
                                                    September 30,                      September 30,
                                                2013               2012            2013               2012
Beginning portfolio                        $      246,861       $  195,600     $     228,613       $  178,013
New loan funding                                   11,500           48,464            69,143          117,459
Less refinanced balances and
participation                                           -          (12,000 )               -          (30,739 )
Net new loan funding                               11,500           36,464            69,143           86,720
Principal payments received on
investments                                       (10,536 )        (10,607 )         (29,193 )        (28,522 )
Early pay-offs                                     (7,483 )         (1,459 )         (26,761 )        (15,664 )
Accretion of loan fees                                694              606             1,995            1,698
New loan fees                                        (118 )           (372 )            (806 )         (1,120 )
New equity                                              -                -                73                -
Proceeds from sale of investments                       -                -               (39 )            (38 )
Net realized loss on investments                   (5,566 )              -            (5,629 )            (61 )
Net appreciation (depreciation) on
investments                                         5,967              677             3,996             (117 )
Other                                                   -                -               (73 )              -
Ending Portfolio                           $      241,319       $  220,909     $     241,319       $  220,909

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 September 30, 2013 and December 31, 2012:

                                                    September 30, 2013               December 31, 2012
                                                Loans at        Percentage       Loans at       Percentage
                                                  Fair           of Total          Fair          of Total
                                                  Value         Portfolio         Value         Portfolio
Life Science
Biotechnology                                  $    22,618              9.8 %   $   38,018             17.3 %
Medical Device                                      19,423              8.4 %       23,446             10.6 %
Technology
Software                                            71,953             31.0 %       54,358             24.7 %
Internet and Media                                   6,579              2.8 %        9,763              4.4 %
Communication                                        6,296              2.7 %            -                -
Semiconductors                                      36,106             15.6 %       25,795             11.7 %
Power Management                                    14,289              6.2 %       15,792              7.2 %
Cleantech
Energy Efficiency                                   14,153              6.1 %       12,950              5.9 %
Waste Recycling                                      1,629              0.7 %        2,197              1.0 %
Alternative Energy                                  12,841              5.5 %        8,586              3.9 %
Healthcare Information and Services
Diagnostics                                         14,809              6.4 %       21,340              9.7 %
Other Healthcare Related Services                    6,894              3.0 %        2,655              1.2 %
Software                                             4,071              1.8 %        5,397              2.4 %
Total                                          $   231,661            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 21% and 23% of total loans outstanding as of September 30, 2013 and December 31, 2012, respectively. No single loan represented more than 10% of our total loans as of September 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 September 30, 2013 and December 31, 2012:

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

Credit Rating
4               $    38,909             16.8 %   $   30,818             14.0 %
3                   170,768             73.7 %      181,019             82.2 %
2                    14,880              6.4 %        3,560              1.6 %
1                     7,104              3.1 %        4,900              2.2 %
Total           $   231,661            100.0 %   $  220,297            100.0 %

As of September 30, 2013 and December 31, 2012, our loan portfolio had a weighted average credit rating of 3.1 and 3.2, respectively. As of September 30, 2013, there were three 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 September 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 September 30, 2013 and 2012 are as follows:

                                                              For the Three Months Ended
                                                                     September 30,
                                                                2013                2012
Total investment income                                    $        8,712       $      6,619
Total expenses                                                      5,145              3,650
Net investment income before excise tax                             3,567              2,969
Provision for excise tax                                              (80 )                -
Net investment income                                               3,487              2,969
Net realized loss on investments                                   (5,566 )                -
Net unrealized appreciation on investments                          5,967                677
Net increase in net assets resulting from operations       $        3,888       $      3,646
Average investments, at fair value                         $      238,167       $    195,147
Average debt outstanding                                   $      133,000       $     59,112

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 three months ended September 30, 2013 and 2012

Investment Income

Investment income increased by $2.1 million, or 31.6%, for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012. For the three months ended September 30, 2013, total investment income consisted primarily of $8.2 million in interest income from investments, which included $1.6 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, for the three months ended September 31, 2013, of $0.5 million was primarily earned from prepayment fees collected from our portfolio companies, as we experienced early payoffs of $7.5 million. For the three months ended September 30, 2012, total investment income consisted primarily of $6.4 million in interest income from investments, which included $1.1 million in income from the accretion of origination fees and ETPs.

For the three months ended September 30, 2013 and 2012, our dollar-weighted average annualized yield on average debt investments was 14.6% and 13.6%, 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 21% and 23% of investment income for the three months ended September 30, 2013 and 2012, respectively.

As of September 30, 2013 and December 31, 2012, interest receivables were $4.1 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 $1.5 million, or 41.0%, to $5.1 million for the three months ended September 30, 2013 as compared to the three months ended September 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 September 30, 2013 and 2012 was $2.2 million and $1.1 million, respectively. Interest expense for the three months ended September 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 September 30, 2013 and 2012 was $1.3 million and $1.1 million, respectively. Management fee expense increased compared to the three months ended September 30, 2012 as a result of an increase in average gross assets partially offset by a waiver of the base management fee earned on cash during the period. The Advisor waived $0.1 million of the base management fees it would have otherwise earned during the three months ended September 30, 2013. The Advisor waived such fees because we held more cash during the three month period than is typical for us to hold during a three month period. We held such cash due to the sale of the Asset-Backed Notes on June 28, 2013. Our Advisor is not obligated to waive the base management fee on cash in future periods.

Performance based incentive fee for the three months ended September 30, 2013 increased compared to the three months ended September 30, 2012 due to higher pre-incentive fee net investment income in the three months ended September 30, 2013. The incentive fees for the three months ended September 30, 2013 and 2012 were $0.9 million and $0.7 million, respectively, and consisted entirely of incentive fees payable on pre-incentive fee net investment income. Administrative fee expense for the three months ended September 30, 2013 and 2012 was $0.3 million and $0.4 million, 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 three months ended September 30, 2013, we recognized realized losses totaling $5.6 million primarily due to the determination that our non-accrual debt investment and warrant investments in one portfolio company were not recoverable, which resulted in a realized loss totaling $5.3 million. During the three months ended September 30, 2012, we did not have any recognized realized gains or losses.

During the three months ended September 30, 2013, net unrealized appreciation on investments totaled $6.0 million which was primarily due to the reversal of previously recorded unrealized depreciation on our non-accrual debt investment and warrant investments in one portfolio company totaling $5.3 million and the remainder related to the change in fair values of our investment portfolio during the period. During the three months ended September 30, 2012, net unrealized appreciation on investments totaled $0.7 million which was primarily due to the change in fair values of our investment portfolio during the period.

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

                                                               For the Nine Months Ended
                                                                     September 30,
                                                                2013                2012
Total investment income                                     $      24,868       $     18,726
Total expenses                                                     14,846             10,146
Net investment income before excise tax                            10,022              8,580
Provision for excise tax                                             (160 )                -
Net investment income                                               9,862              8,580
Net realized loss on investments                                   (5,839 )              (61 )
Net unrealized appreciation (depreciation) on investments           3,996               (117 )
Net increase in net assets resulting from operations        $       8,019       $      8,402
Average investments, at fair value                          $     235,745       $    179,417
Average debt outstanding                                    $     110,692       $     59,886

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 nine months ended September 30, 2013 and 2012

Investment Income

Investment income increased by $6.1 million, or 32.8%, for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012. For the nine months ended September 30, 2013, total investment income consisted primarily of $24.0 million in interest income from investments, which included $4.6 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. Fee income for the nine months ended September 31, 2013 of $0.9 million was primarily earned from prepayment fees collected from our portfolio companies as we experienced early payoffs of $26.8 million. For the nine months ended September 30, 2012, total investment income consisted primarily of $17.8 million in interest income from investments, which included $3.1 million in income from the accretion of origination fees and ETPs.

For the nine months ended September 30, 2013 and 2012, our dollar-weighted average annualized yield on average debt investments was 14.1% and 13.9%, 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 22% and 23% of investment income for the nine months ended September 30, 2013 and 2012, respectively.

Expenses

Total expenses increased by $4.7 million, or 46.3%, to $14.8 million for the nine months ended September 30, 2013 as compared to the nine months ended September 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 nine months ended September 30, 2013 and 2012 was $5.9 million and $2.8 million, respectively. Interest expense for the nine months ended September 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 and our 2019 Notes.

Management fee expense for the nine months ended September 30, 2013 and 2012 was $3.8 million and $3.0 million, respectively. Management fee expense increased compared to the nine months ended September 30, 2012 as a result of an increase in average gross assets.

Performance based incentive fees for the nine months ended September 30, 2013 increased compared to the nine months ended September 30, 2012 due to higher pre-incentive fee net investment income in the nine months ended September 30, 2013. The incentive fees for the nine months ended September 30, 2013 and 2012 were $2.5 million and $2.0 million, respectively, and consisted entirely of incentive fees payable on pre-incentive fee net investment income.
Administrative fee expense for both the nine months ended September 30, 2013 and 2012 was $0.9 million.

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 . . .

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