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HRZN > SEC Filings for HRZN > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for HORIZON TECHNOLOGY FINANCE CORP

Form 10-Q for HORIZON TECHNOLOGY FINANCE CORP


5-Aug-2014

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 ability of our Advisor to attract and retain highly talented professionals and to operate effectively at existing staffing levels;

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;

our ability to qualify and maintain qualification as a RIC and as a business development company;

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; 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 our annual report on Form 10-K for the year ended December 31, 2013, 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. As a RIC, we generally do not have to pay corporate-level federal income taxes on our investment company taxable income and net capital gain that we distribute to our stockholders as long as we meet certain source-of-income, distribution, asset diversification and other requirements.

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, and our day-to-day operations, 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, 2014 and
December 31, 2013:



                                     June 30, 2014                                   December 31, 2013
                                                       Percentage                                        Percentage
                         # of             Fair          of Total           # of             Fair          of Total
                      Investments        Value         Portfolio        Investments        Value         Portfolio
Term loans                   48        $  197,263             90.0 %           48        $  201,846             91.2 %
Revolving loans              1             11,934              5.4             1             11,908              5.4
Total loans                  49           209,197             95.4             49           213,754             96.6
Warrants                     75             6,347              2.9             73             6,036              2.7
Other investments            1                400              0.2             1                400              0.2
Equity                       4              3,351              1.5             3              1,094              0.5
Total                                  $  219,295            100.0 %                     $  221,284            100.0 %

Total portfolio investment activity for the three and six months ended June 30, 2014 and 2013 was as follows:

                                           For the Three Months Ended           For the Six Months Ended
                                                    June 30,                            June 30,
                                             2014               2013             2014               2013
Beginning portfolio                     $      228,560       $   247,781     $     221,284       $  228,613
New loan funding                                26,052            29,143            43,978           57,643
Less refinanced balances                             -                 -                 -                -
Net new loan funding                            26,052            29,143            43,978           57,643
Principal payments received on
investments                                     (9,860 )          (8,695 )         (21,633 )        (18,657 )
Early pay-offs and recoveries                  (25,856 )         (19,278 )         (25,856 )        (19,278 )
Accretion of loan fees                             657               753             1,063            1,301
New loan fees                                     (325 )            (368 )            (505 )           (688 )
New equity                                          12                 -                12               73
Sale of investments                               (610 )             (39 )          (1,330 )            (39 )
Net realized loss on investments                  (632 )             (45 )          (7,545 )            (62 )
Net unrealized appreciation
(depreciation) on investments                    1,297            (2,391 )           9,827           (1,972 )
Other                                                -                 -                 -              (73 )
Ending Portfolio                        $      219,295       $   246,861     $     219,295       $  246,861

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, 2014 and December 31, 2013:

                                             June 30, 2014                 December 31, 2013
                                       Loans at       Percentage       Loans at        Percentage
                                         Fair          of Total          Fair           of Total
                                        Value         Portfolio          Value         Portfolio
Life Science
Biotechnology                         $   13,445              6.4 %   $    16,376              7.7 %
Medical Device                            19,392              9.3          14,765              6.9
Technology
Communications                            19,323              9.2           9,359              4.4
Consumer-Related Technologies              1,948              0.9               -                -
Internet and Media                         4,742              2.3           6,019              2.8
Networking                                   983              0.5             963              0.5
Power Management                               -                -          13,044              6.1
Semiconductors                            45,541             21.8          37,450             17.5
Software                                  59,195             28.3          66,583             31.1
Cleantech
Alternative Energy                        10,203              4.9          11,771              5.5
Energy Efficiency                          6,308              3.0          11,403              5.3
Waste Recycling                                -                -             680              0.3
Healthcare Information and Services
Diagnostics                               14,875              7.1          12,140              5.7
Other Healthcare Related Services          6,925              3.3           6,904              3.2
Software                                   6,317              3.0           6,297              3.0
Total                                 $  209,197            100.0 %   $   213,754            100.0 %

The largest loans may vary from year to year as new loans are originated and existing loans are repaid. Our five largest loans represented 23% and 22% of total loans outstanding as of June 30, 2014 and December 31, 2013, respectively. No single loan represented more than 10% of our total loans as of June 30, 2014 and December 31, 2013.

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, 2014 and December 31, 2013:

                      June 30, 2014                 December 31, 2013
                Loans at       Percentage       Loans at       Percentage
                  Fair          of Loan           Fair          of Loan
                  Value        Portfolio         Value         Portfolio

Credit Rating
4               $  30,767             14.7 %   $   30,385             14.2 %
3                 165,386             79.1        167,231             78.3
2                  10,323              4.9          2,199              1.0
1                   2,721              1.3         13,939              6.5
Total           $ 209,197            100.0 %   $  213,754            100.0 %

As of June 30, 2014 and December 31, 2013, our loan portfolio had a weighted average credit rating of 3.1 and 3.0, respectively. As of June 30, 2014, there was one investment with an internal credit rating of 1, with a cost of $3.0 million and a fair value of $2.7 million. As of December 31, 2013, there were five investments with an internal credit rating of 1, with an aggregate cost of $23.2 million and an aggregate fair value of $13.9 million.

The reduction in the number and value of 1-rated credits during the six-months ended June 30, 2014 was primarily due to the settlement of four investments, with an aggregate cost of $22.5 million and an aggregate fair value of $14.9 million.

As of June 30, 2014, there were two investments with an internal credit rating of 2, with an aggregate cost and fair value of $10.3 million. As of December 31, 2013, there was one investment with an internal credit rating of 2, with a cost and fair value of $2.2 million.

The increase in the number and value of 2-rated credits during the six months ended June 30, 2014 was primarily due to the downgrade of two investments, with an aggregate cost and fair value of $10.3 million, from an internal credit rating of 3, partially offset by the upgrade of one investment, with a cost and fair value of $2.2 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 three months ended June 30, 2014 and 2013 were as follows:

                                                                For the Three Months Ended
                                                                         June 30,
                                                                  2014               2013
Total investment income                                      $        8,697       $     8,787
Total expenses                                                        6,821             5,106
Net investment income before excise tax                               1,876             3,681
Provision for excise tax                                                (40 )             (80 )
Net investment income                                                 1,836             3,601
Net realized loss on investments                                       (630 )             (62 )
Net unrealized appreciation (depreciation) on investments             1,229            (2,391 )
Net increase in net assets resulting from operations         $        2,435       $     1,148
Average debt investments, at fair value                      $      211,582       $   241,655
Average borrowings outstanding                               $      111,927       $   105,959

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 June 30, 2014 and 2013

Investment Income

Total investment income decreased by $0.1 million, or 1.0%, for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013. For the three months ended June 30, 2014, total investment income consisted primarily of $7.7 million in interest income from investments, which included $2.1 million in income from the accretion of origination fees and end-of-term payments, or ETPs, and $1.0 million in fee income. Total investment income decreased due to a lower average size of the loan portfolio which was partially offset by higher fee income. Fee income was primarily comprised of loan prepayment fees collected from our portfolio companies and increased primarily due to a higher number of prepayments for the three months ended June 30, 2014. 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 ETPs.

For the three months ended June 30, 2014 and 2013, our dollar-weighted average annualized yield on average loans was 16.4% and 14.5%, 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. The dollar-weighted average annualized yield represents the portfolio yield and may be higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

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 20% and 22% of investment income for the three months ended June 30, 2014 and 2013, respectively.

As of June 30, 2014 and December 31, 2013, interest receivable was $5.7 million and $4.2 million, respectively, which represents accreted ETPs and one month of accrued interest income on substantially all of our loans.

Expenses

Total expenses increased by $1.7 million, or 33.6%, to $6.8 million for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013. Total operating expenses for each period consisted principally of interest expense, base management fee, incentive and administrative fees and, to a lesser degree, professional fees and general and administrative expenses.

Interest expense for the three months ended June 30, 2014 and 2013 was $3.8 million and $1.9 million, respectively. Interest expense for the three months ended June 30, 2014, which includes the amortization of debt issuance costs, increased primarily due to the acceleration of $1.1 million of unamortized debt issuance costs and a $0.8 million prepayment fee related to the termination of the term loan facility with Fortress Credit Co LLC, or the Fortress Facility. We do not expect any ongoing obligations or expenses associated with the termination and prepayment of the Fortress Facility.

Base management fee expense for the three months ended June 30, 2014 and 2013 was $1.1 million and $1.3 million, respectively. Base management fee expense for the three months ended June 30, 2014 decreased compared to the three months ended June 30, 2013, primarily due to a decrease in average total assets and a waiver of the base management fee of $0.1 million that the Advisor would have otherwise earned during the three months ended June 30, 2014. The Advisor waived such fees associated with cash held at the time of calculation.

No performance based incentive fee was incurred for the three months ended June 30, 2014. The performance based incentive fee for the three months ended June 30, 2013 was $0.9 million, and consisted entirely of incentive fee payable on pre-incentive fee net investment income. No performance based incentive fee was incurred for the three months ended June 30, 2014 primarily due to lower pre-incentive fee net investment income as a result of the one-time costs associated with the termination of the Fortress Facility, described above.

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, 2014 increased compared to the three months ended June 30, 2013, due to increased legal fees and other costs associated with certain non-accrual investments and other assets.

Net Realized Losses 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, 2014, we realized losses totaling $0.6 million primarily due to the resolution of one debt investment that was on non-accrual status which was partially offset by realized gains on the sale of warrants in two of our portfolio companies. The debt investment was settled for a net cash payment of $1.5 million, which resulted in a realized loss of $0.7 million and unrealized appreciation of $1.4 million. During the three months ended June 30, 2013, we realized losses totaling $0.1 million primarily in connection with the disposal of a portfolio company's warrants.

During the three months ended June 30, 2014, net unrealized appreciation on investments totaled $1.2 million which was primarily due to the reversal of previously recorded unrealized depreciation on one debt investment that was settled in the period, as described above. During the three months ended June 30, 2013, net unrealized depreciation on investments totaled $2.4 million which was primarily due to the change in fair values of our investment portfolio during the period.

Consolidated results of operations for the six months ended June 30, 2014 and 2013 were as follows:

                                                                For the Six Months Ended
                                                                        June 30,
                                                                 2014               2013
Total investment income                                      $      16,232       $   16,156
Total expenses                                                      11,832            9,701
Net investment income before excise tax                              4,400            6,455
Provision for excise tax                                               (80 )            (80 )
Net investment income                                                4,320            6,375
Net realized loss on investments                                    (6,514 )           (272 )
Net unrealized appreciation (depreciation) on investments            9,759           (1,972 )
Net increase in net assets resulting from operations         $       7,565       $    4,131
Average debt investments, at fair value                      $     216,171       $  235,105
Average borrowings outstanding                               $     116,473       $   99,349

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, 2014 and 2013

Investment Income

Total investment income increased by $0.1 million, or 0.5%, for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. For the six months ended June 30, 2014, total investment income consisted primarily of $14.9 million in interest income from investments, which included $3.2 million in income from the accretion of origination fees, ETPs, and $1.3 million of fee income. Total investment income increased due to higher fee income which was partially offset by a lower average size of the loan portfolio. Fee income was primarily comprised of loan prepayment fees collected from our portfolio companies and increased primarily due to a higher number of prepayments for the six months ended June 30, 2014. 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.

For the six months ended June 30, 2014 and 2013, our dollar-weighted average annualized yield on average loans was 15.0% and 13.7%, 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. The dollar-weighted average annualized yield represents the portfolio yield and may be higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

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 18% and 23% of investment income for the six months ended June 30, 2014 and 2013, respectively.

Expenses

Total expenses increased by $2.1 million, or 22.0%, to $11.8 million for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. . . .

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