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HRZN > SEC Filings for HRZN > Form 10-K on 11-Mar-2014All Recent SEC Filings

Show all filings for HORIZON TECHNOLOGY FINANCE CORP

Form 10-K for HORIZON TECHNOLOGY FINANCE CORP


11-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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. 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 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 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 our Venture Loans to companies backed by established venture capital and private equity firms in our Target Industries. 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. In addition, for U.S. federal income tax purposes, we have elected to be treated as a RIC under Subchapter M of 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. As a RIC, we generally will not have to pay corporate-level federal income taxes on any investment company taxable income that we distribute to our stockholders if we meet certain source-of-income, distribution, asset diversification and other requirements.

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, and our day-to-day operations, are managed by the Advisor and supervised by our Board, of which a majority of the members are independent of us. Under 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 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 December 31, 2013
and 2012:



                                  December 31, 2013                                December 31, 2012
                                                         % of                                             % of
                         # of             Fair           Total            # of             Fair           Total
                      Investments        Value         Portfolio       Investments        Value         Portfolio
Term loans                      48     $  201,846            91.2 %              41     $  200,685            87.8 %
Revolving loans                  1         11,908             5.4 %               4         19,612             8.6 %
Total loans                     49        213,754            96.6 %              45        220,297            96.4 %
Warrants                        73          6,036             2.7 %              62          5,468             2.4 %
Other investments                1            400             0.2 %               1          2,100             0.9 %
Equity                           3          1,094             0.5 %               2            748             0.3 %
Total                                  $  221,284           100.0 %                     $  228,613           100.0 %

Total portfolio investment activity as of and for the years ended December 31, 2013 and 2012 was as follows:

                                                  December 31,
                                               2013          2012
Beginning portfolio                          $ 228,613     $ 178,013
New loan funding                                88,362       184,202
Less refinanced balances and participation           -       (45,295 )
Net new loan funding                            88,362       138,907
Principal received on investments              (41,166 )     (39,092 )
Early pay-offs                                 (46,331 )     (42,291 )
Accretion of loan fees                           2,635         2,531
New loan fees                                   (1,076 )      (1,676 )
New equity                                          73             -
Sales of investments                              (200 )        (306 )
Net realized (loss) gain on investments         (7,299 )         108
Net depreciation on investments                 (2,254 )      (8,113 )
Other                                              (73 )         532
Ending Portfolio                             $ 221,284     $ 228,613

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, 2013 and 2012:

                                             December 31, 2013                December 31, 2012
                                         Loans at        Percentage       Loans at        Percentage
                                           Fair           of Total          Fair           of Total
                                           Value         Portfolio          Value         Portfolio
Life Science
Biotechnology                           $    16,376              7.7 %   $    38,018             17.3 %
Medical Device                               14,765              6.9 %        23,446             10.6 %
Technology
Networking                                      963              0.5 %             -                -
Software                                     66,583             31.1 %        54,358             24.7 %
Internet and Media                            6,019              2.8 %         9,763              4.4 %
Communications                                9,359              4.4 %             -                -
Semiconductors                               37,450             17.5 %        25,795             11.7 %
Power Management                             13,044              6.1 %        15,792              7.2 %
Cleantech
Energy Efficiency                            11,403              5.3 %        12,950              5.9 %
Waste Recycling                                 680              0.3 %         2,197              1.0 %
Alternative Energy                           11,771              5.5 %         8,586              3.9 %
Healthcare Information and Services
Diagnostics                                  12,140              5.7 %        21,340              9.7 %
Other Healthcare Related Services             6,904              3.2 %         2,655              1.2 %
Software                                      6,297              3.0 %         5,397              2.4 %
Total                                   $   213,754            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 22% and 23% of total loans outstanding as of December 31, 2013 and 2012, respectively. No single loan represented more than 10% of our total loans as of December 31, 2013 or 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. See "Item 1 - Business" for a more detailed description of the internal credit rating system. The following table shows the classification of our loan portfolio by credit rating as of December 31, 2013 and December 31, 2012:

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

Credit Rating
4               $   30,385             14.2 %   $   30,818             14.0 %
3                  167,231             78.3 %      181,019             82.2 %
2                    2,199              1.0 %        3,560              1.6 %
1                   13,939              6.5 %        4,900              2.2 %
Total           $  213,754            100.0 %   $  220,297            100.0 %

As of December 31, 2013 and 2012, our loan portfolio had a weighted average credit rating of 3.0 and 3.2, respectively. As of December 31, 2013, there were five investments with an internal credit rating of 1, and with a cost of $23.2 million and a fair value of $13.9 million. As of December 31, 2012, there were three investments with an internal credit rating of 1, with a cost of $12.9 million and a fair value of $4.9 million.

Consolidated Results of Operations

As a BDC and a RIC, we are subject to certain constraints on our operations, including limitations imposed by the 1940 Act and the Code. The consolidated results of operations described below may not be indicative of the results we report in future periods.

Consolidated results of operations for the years ended December 31, 2013, 2012 and 2011 were as follows:

                                            2013          2012          2011
Total investment income                   $  33,643     $  26,664     $  24,054
Total expenses                               20,132        14,437        13,332
Net investment income before excise tax      13,511        12,227        10,722
Provision for excise tax                       (240 )        (231 )        (211 )
Net investment income                        13,271        11,996        10,511
Net realized (loss) gains                    (7,509 )         108         6,316
Provision for excise tax                          -             -          (129 )
Net unrealized depreciation                  (2,254 )      (8,113 )      (5,702 )
Net income                                $   3,508     $   3,991     $  10,996
Average investments, at fair value        $ 233,045     $ 187,760     $ 164,437
Average debt outstanding                  $ 115,562     $  62,973     $  78,106

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 $7.0 million, or 26.2%, for the year ended December 31, 2013 as compared to the year ended December 31, 2012. For the year ended December 31, 2013, total investment income consisted primarily of $31.9 million in interest income from investments, which included $6.4 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 and a one-time success fee received upon the completion of an acquisition of one of our portfolio companies.

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.

For the years ended December 31, 2013, 2012 and 2011, our dollar-weighted average annualized yield on average loans was 14.4%, 14.2% and 14.6%, 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 23%, 22% and 21% of investment income for the years ended December 31, 2013, 2012 and 2011, respectively.

As of December 31, 2013 and 2012, interest receivable was $4.2 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 $5.7 million, or 39.4%, to $20.1 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012. 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 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 years ended December 31, 2013 and 2012 was $8.1 million and $4.3 million, respectively. Interest expense for the year ended December 31, 2013 increased compared to the year ended December 31, 2012 primarily due to an increase in average borrowings. Interest expense for the year ended December 31, 2012 increased compared to the year ended December 31, 2011 primarily due to an increase in borrowings under the Wells Facility and Fortress Facility, and the issuance of our 2019 Notes, offset by repayment of the WestLB Facility.

Management fee expense for the years ended December 31, 2013 and 2012 was $5.2 million and $4.2 million, respectively. Management fee expense for the year ended December 31, 2013 increased compared to the year ended December 31, 2012 primarily due to an increase in average gross assets. 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.

Performance based incentive fees for the year ended December 31, 2013 increased compared to the year ended December 31, 2012 primarily due to part one of the incentive fee increasing as Pre-Incentive Fee Net Investment Income increased year over year. Performance based incentive fees for the year ended December 31, 2012 remained relatively 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. The incentive fees for the year ended December 31, 2013 consisted of $3.3 million of part one of the incentive fee. The incentive fees for the year ended December 31, 2012 consisted of $2.8 million of part one of the incentive fee.

In 2013 and 2012 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 both December 31, 2013 and 2012, we recorded an excise tax payable of $0.2 million and $0.2 million on $6.1 million and $5.9 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, 2013, we realized losses totaling $7.5 million primarily due to two debt investments that were on non-accrual. One was settled for $2.1 million, along with future contingent success payments, which generated a $1.8 million realized loss. We determined that the other investment was not recoverable, which resulted in a realized loss totaling $5.3 million. During the year ended December 31, 2012, we realized realized gains totaling $0.1 million primarily due to the sale of warrants of one portfolio company. During the year ended December 31, 2011, we realized realized gains totaling $6.3 million primarily due to the sale of warrants of three portfolio companies.

During the year ended December 31, 2013, net unrealized depreciation on investments totaled $2.3 million which was primarily due to the unrealized depreciation on the five debt investments on non-accrual status offset by the reversal of previously recorded unrealized depreciation on two debt investments that were settled in the period, as described above. During the year ended December 31, 2012, net unrealized depreciation on investments totaled $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 $5.7 million which was primarily due to $4.0 million in reversal of previously recorded unrealized appreciation on the sale of warrants and $2.7 million of previously recorded unrealized depreciation on six debt investments partially offset by unrealized appreciation on investments.

Liquidity and Capital Resources

As of December 31, 2013 and 2012, we had cash and investments in money market funds of $26.5 million and $3.6 million, respectively. These amounts are available to fund new investments, reduce borrowings, pay operating expenses and pay dividends. In addition, as of December 31, 2013 we had $6.0 million of restricted investments in money market funds, which may be used to make monthly interest and principal payments on the Asset-Backed Notes. Our primary sources of capital have been from our private and public common stock offerings, use of the Wells Facility and Fortress Facility and issuance of our 2019 Notes and our Asset-Backed Notes.

As of December 31, 2013, there were no outstanding amounts due under the Key Facility. As of December 31, 2013, we had available borrowing capacity of $50.0 million under our Key Facility, subject to existing terms and advance rates.

As of December 31, 2013, the outstanding principal balance under the Fortress Facility was $10.0 million. As of December 31, 2013, we had available borrowing capacity of $65.0 million under our Fortress Facility, subject to existing terms and advance rates. As of December 31, 2012, the outstanding principal balance under the Wells Facility and Fortress Facility was $46.0 million and $10.0, respectively. All obligations under the WestLB Facility were paid, and the WestLB Facility was terminated, during the fourth quarter of 2012.

Our operating activities provided cash of $6.5 million for the year ended December 31, 2013, and our financing activities provided cash of $17.8 million for the same period. Our operating activities provided cash primarily from regular principal payments and early pay-offs received, offset by investments made in portfolio companies. Our financing activities provided cash primarily from the issuance of our Asset-Backed Notes. This increase from investing activities was partially offset by repayments of $56.7 million of borrowings and $12.6 million of dividends paid.

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 2019 Notes for net proceeds of $31.7 million, and the completion of a follow-on public offering of 1.9 million shares of common stock for net proceeds of $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 of 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 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 (to the extent available). 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, 2013 and 2012 is as follows:

                                    December 31, 2013
                        Total            Balance           Unused
                      Commitment       Outstanding       Commitment
Asset-Backed Notes   $     90,000     $      79,343     $          -
Fortress Facility          75,000            10,000           65,000
Key Facility               50,000                 -           50,000
2019 Notes                 33,000            33,000                -
Total                $    248,000     $     122,343     $    115,000




                                   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
2019 Notes                33,000            33,000                -
Total               $    183,000     $      89,020     $     93,980

We, through our wholly owned subsidiary, Credit II, entered into the Wells Facility on July 14, 2011 and on November 4, 2013 we renewed and amended the Wells Facility, which among other things, assigned all rights and obligations of Wells to Key. The interest rate on the Key Facility is based upon the one-month London Interbank Offered Rate, or LIBOR, plus a spread of 3.25%, with a LIBOR . . .

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