UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

þQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012 OR

OR

 

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                      TO     

 

COMMISSION FILE NUMBER: 814-00802

 

HORIZON TECHNOLOGY FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE   27-2114934
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
312 Farmington Avenue    
Farmington, CT   06032
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code (860) 676-8654
Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of Each Exchange on Which Registered
Common Stock, par value $0.001 per share   The NASDAQ Global Select Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o .

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller Reporting Company o
        (Do not check if a smaller reporting company)    

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ .

 

As of May 7, 2012, the Registrant had 7,640,049 shares of common stock, $0.001 par value, outstanding. 

 

 
 

 

HORIZON TECHNOLOGY FINANCE CORPORATION

 

FORM 10-Q
TABLE OF CONTENTS

 

      Page
  PART I    
       
Item 1. Financial Statements    
       
  Consolidated Statements of Assets and Liabilities as of March 31, 2012 and December 31, 2011 (unaudited)   4
  Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (unaudited)   5
  Consolidated Statements of Changes in Net Assets for the three months ended March 31, 2012 and 2011 (unaudited)   6
  Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (unaudited)   7
  Consolidated Schedules of Investments as of March 31, 2012 and December 31, 2011 (unaudited)   8
  Notes to the Consolidated Financial Statements (unaudited)   14
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   26
Item 3. Quantitative And Qualitative Disclosures About Market Risk   33
Item 4. Controls and Procedures   33
       
  PART II    
       
Item 1. Legal Proceedings   33
Item 1A. Risk Factors   34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   34
Item 3. Defaults Upon Senior Securities   34
Item 4. Mine Safety Disclosures   34
Item 5. Other Information   34
Item 6. Exhibits   34
  Signatures   35
EX-31.1
EX-31.2
EX-32.1
EX-32.2

 

2
 

 

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 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 in “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2011 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 SEC, including, future reports on Form 10-Q, current reports on Form 8-K and annual reports on Form 10-K.

 

3
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Assets and Liabilities (Unaudited)
(In thousands, except share data)

 

   March 31,
2012
   December 31,
2011
 
Assets          
Non-affiliate investments at fair value (cost of $170,745 and $180,651, respectively) (Note 4)  $167,296   $178,013 
Investment in money market funds   22,944    13,518 
Cash   5,697    1,298 
Interest receivable   2,502    2,985 
Other assets (Note 2)   2,958    1,997 
Total assets  $201,397   $197,811 
           
Liabilities          
Borrowings (Note 6)  $70,236   $64,571 
Base management fee payable (Note 3)   595    330 
Incentive fee payable (Note 3)   838    1,766 
Other accrued expenses   683    1,260 
Total liabilities   72,352    67,927 
           
Net assets          
Preferred stock, par value $0.001 per share, 1,000,000 shares authorized, zero shares issued and outstanding as of March 31, 2012 and December 31, 2011        
Common stock, par value $0.001 per share, 100,000,000 shares authorized, 7,640,049 and 7,636,532 shares outstanding as of March 31, 2012 and December 31, 2011, respectively   8    8 
Paid-in capital in excess of par   124,570    124,512 
Accumulated undistributed net investment income   4,881    4,965 
Net unrealized depreciation on investments   (3,472)   (2,659)
Net realized gains on investments   3,058    3,058 
Total net assets   129,045    129,884 
Total liabilities and net assets  $201,397   $197,811 
Net asset value per common share  $16.89   $17.01 

 

See Notes to Consolidated Financial Statements

 

4
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Operations (Unaudited)
(In thousands, except share data)

 

   Three Months
Ended
   Three Months
Ended
 
   March 31, 2012   March 31, 2011 
Investment income          
Interest income on non-affiliate investments  $5,910   $4,893 
Interest income on money market funds       65 
Fee income on non-affiliate investments   715    502 
Total investment income   6,625    5,460 
Expenses          
Interest expense   675    810 
Base management fee (Note 3)   994    1,075 
Performance based incentive fee (Note 3)   838    529 
Administrative fee (Note 3)   256    295 
Professional fees   307    318 
General and administrative   203    205 
Total expenses   3,273    3,232 
Net investment income   3,352    2,228 
           
Net realized and unrealized (loss) gain on investments          
Net realized gain on investments       206 
Net unrealized (depreciation) appreciation on investments   (813)   1,194 
Net realized and unrealized (loss) gain on investments   (813)   1,400 
           
Net increase in net assets resulting from operations  $2,539   $3,628 
Net investment income per common share  $0.44   $0.29 
Change in net assets per common share  $0.33   $0.48 
Weighted average shares outstanding   7,636,609    7,593,421 

 

See Notes to Consolidated Financial Statements

 

5
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Changes in Net Assets (Unaudited)
(In thousands, except share data)

 

               Accumulated             
               Undistributed             
               (Distributions   Net Unrealized         
           Paid-In   in  Excess of)   Appreciation   Net     
           Capital in   Net   (Depreciation)   Realized     
   Common Stock   Excess of   Investment   on   Gains on   Total 
   Shares   Amount   Par   Income   Investments   Investments   Net Assets 
Balance at December 31, 2010   7,593,421   $8   $123,836   $(143)  $3,043   $451   $127,195 
Net increase in net assets resulting from operations               2,228    1,194    206    3,628 
Balance at March 31, 2011   7,593,421   $8   $123,836   $2,085   $4,237   $657   $130,823 
Balance at December 31, 2011   7,636,532   $8   $124,512   $4,965   $(2,659)  $3,058   $129,884 
Net increase in net assets resulting from operations               3,352    (813)       2,539 
Issuance of common stock as stock dividend   3,517        58                58 
Dividends declared                (3,436)           (3,436)
Balance at March 31, 2012   7,640,049   $8   $124,570   $4,881   $(3,472)  $3,058   $129,045 

 

See Notes to Consolidated Financial Statements

 

6
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

 

 

   Three Months
Ended
   Three Months
Ended
 
   March 31,
2012
   March 31,
2011
 
Cash flows from operating activities:          
Net increase in net assets resulting from operations  $2,539   $3,628 
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities:          
Amortization of debt issuance costs   51    194 
Net realized gain on investments       (206)
Net unrealized depreciation (appreciation) on investments   813    (1,194)
Purchase of investments   (12,961)   (26,063)
Principal payments received on investments   23,325    11,106 
Proceeds from sale of investments       321 
Stock received in settlement of fee income       (482)
Changes in assets and liabilities:          
Net increase in investment in money market funds   (9,426)   (1,686)
Decrease (increase) in interest receivable   483    (343)
(Decrease) increase in unearned loan income   (460)   34 
Decrease in other assets   40    26 
(Decrease) increase in other accrued expenses   (577)   271 
Increase in base management fee payable   265    16 
(Decrease) increase in incentive fee payable   (928)   115 
Net cash provided by (used in) operating activities   3,164    (14,263)
           
Cash flows from financing activities:          
Proceeds from issuance of senior notes   30,000     
Net (decrease) increase in revolving borrowings   (24,335)   5,287 
Dividends paid   (3,378)    
Debt issuance costs   (1,052)    
Net cash provided by financing activities   1,235    5,287 
Net increase (decrease) in cash   4,399    (8,976)
           
Cash:          
Beginning of period   1,298    37,689 
End of period  $5,697   $28,713 
Cash paid for interest  $581   $532 
Supplemental non-cash investing and financing activities:          
Warrant investments received & recorded as unearned loan income  $185   $395 
Decrease in interest rate swap liability  $   $(78)

 

See Notes to Consolidated Financial Statements

 

7
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments

March 31, 2012

(In thousands)

 

        Type of   Interest           Principal   Cost of   Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)       Maturity   Amount   Investments (6)   Value  
Debt Investments                                        
Debt Investments — Life Science — 46.0%                                        
ACT Biotech Corporation   Biotechnology   Term Loan (1)   13.10 %     12/1/2013   $ 913   $ 898   $ 797  
        Term Loan (1)   13.01 %     12/1/2013     913     907     807  
        Term Loan (1)   13.01 %     12/1/2013     1,410     1,384     1,229  
Ambit Biosciences Corporation   Biotechnology   Term Loan (1)   12.25 %     10/1/2013     4,009     3,976     3,976  
Anacor Pharmaceuticals, Inc. (5)   Biotechnology   Term Loan (2)   9.41 %     4/1/2015     3,333     3,247     3,247  
        Term Loan (2)   9.67 %     4/1/2015     2,667     2,616     2,616  
GenturaDx, Inc.   Biotechnology   Term Loan (2)   11.25 %     4/1/2014     1,643     1,624     1,624  
N30 Pharmaceuticals, LLC   Biotechnology   Term Loan (1)   11.25 %     9/1/2014     2,303     2,259     2,259  
        Term Loan (2)   11.25 %     7/1/2015     2,500     2,422     2,422  
Revance Therapeutics, Inc.   Biotechnology   Convertible Note (1)   8.00 %     2/10/2013     62     68     68  
Sunesis Pharmaceuticals, Inc.   Biotechnology   Term Loan (2)   8.95 %     10/1/2015     2,000     1,946     1,946  
Supernus Pharmaceuticals, Inc.   Biotechnology   Term Loan (2)   11.00 %     8/1/2014     2,913     2,890     2,890  
        Term Loan (2)   11.00 %     7/1/2015     7,000     6,915     6,915  
Tranzyme, Inc. (5)   Biotechnology   Term Loan (2)   10.00 %     7/1/2015     7,700     7,642     7,642  
Xcovery Holding Company, LLC   Biotechnology   Term Loan (2)   12.00 %     10/1/2013     1,216     1,213     1,144  
        Term Loan (2)   12.00 %     7/1/2014     1,500     1,483     1,397  
OraMetrix, Inc.   Medical Device   Term Loan (1)   11.50 %     4/1/2014     3,928     3,882     3,882  
PixelOptics, Inc.   Medical Device   Term Loan (2)   10.75 %     11/1/2014     10,000     9,933     9,933  
Tengion, Inc. (5)   Medical Device   Term Loan (2)   11.75 %     1/1/2014     4,627     4,594     4,359  
ViOptix, Inc.   Medical Device   Term Loan (1)   13.55 %     5/1/2012     170     170     170  
Total Debt Investments — Life Science                               60,069     59,323  
Debt Investments — Technology — 30.6%                                        
Tagged, Inc.   Consumer-related Technologies   Term Loan (1)   12.78 %     5/1/2012     87     87     87  
        Term Loan (1)   11.46 %     8/1/2012     113     103     103  
Xtera Communications, Inc.   Semiconductors   Term Loan   11.50 %     12/1/2014     10,000     9,841     9,841  
        Term Loan   11.50 %     7/1/2015     2,000     1,956     1,956  
Vette Corp. (8)   Data Storage   Term Loan (1)   11.75 %     7/1/2014     4,951     4,888     1,937  
Optaros, Inc.   Internet and Media   Term Loan (2)   11.95 %     10/1/2015     2,000     1,962     1,962  
IntelePeer, Inc.   Networking   Term Loan (1)   12.43 %     4/1/2012     35     35     35  
        Term Loan (1)   12.33 %     6/1/2012     109     109     109  
        Term Loan (1)   12.33 %     10/1/2012     407     406     406  
Construction Software Technologies, Inc.   Software   Term Loan (2)   11.75 %     12/1/2014     4,000     3,955     3,955  
        Term Loan   11.75 %     6/1/2014     2,000     1,975     1,975  
Courion Corporation   Software   Term Loan   11.45 %     10/1/2015     3,500     3,472     3,472  
        Term Loan   11.45 %     10/1/2015     3,500     3,472     3,472  
Recondo Technology, Inc.   Software   Term Loan (2)   11.50 %     4/1/2015     2,000     1,930     1,930  
Seapass Solutions, Inc.   Software   Term Loan (2)   11.75 %     11/1/2014     5,000     4,943     4,943  
StreamBase Systems, Inc.   Software   Term Loan (1)   12.51 %     11/1/2013     2,468     2,446     2,446  
        Term Loan (1)   12.50 %     6/1/2014     815     805     805  
Total Debt Investments — Technology                               42,385     39,434  
Debt Investments — Cleantech — 22.7%                                        
Cereplast, Inc. (5)   Waste Recycling   Term Loan (1)   12.00 %     4/1/2014     2,133     2,099     1,977  
    Waste Recycling   Term Loan (1)   12.00 %     6/1/2014     2,282     2,242     2,112  
Aurora Algae, Inc.   Energy Efficiency   Term Loan (2)   10.50 %     5/1/2015     2,500     2,479     2,479  
Enphase Energy, Inc. (5)   Energy Efficiency   Term Loan (1)   12.60 %     10/1/2013     4,684     4,642     4,642  
        Term Loan   10.75 %     4/1/2015     2,000     1,976     1,976  
        Term Loan   10.75 %     4/1/2015     3,000     2,951     2,951  
Satcon Technology Corporation (5)   Energy Efficiency   Term Loan (1)   12.58 %     1/1/2014     7,041     6,931     6,931  
Tigo Energy, Inc.   Energy Efficiency   Term Loan (1)   11.00 %     8/1/2014     3,295     3,240     3,240  
        Revolver (2)   10.75 %     1/1/2014     3,000     2,943     2,943  
            (Prime + 7.50 %)                          
Total Debt Investments — Cleantech                               29,503     29,251  

 

See Notes to Consolidated Financial Statements

 

8
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments

March 31, 2012 — (Continued)

(In thousands)

 

        Type of   Interest         Principal   Cost of   Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)     Maturity   Amount   Investments (6)   Value  
Debt Investments — Healthcare information and services — 26.3%                    
BioScale, Inc.   Diagnostics   Term Loan (1)   12.00 %   8/1/2012   558   557   557  
        Term Loan (1)   11.51 %   1/1/2014   4,436   4,399   4,399  
Radisphere National Radiology Group, Inc.   Diagnostics   Term Loan (2)   11.00 %   10/1/2015   10,000   9,829   9,829  
        Term Loan   11.00 %   10/1/2015   2,000   1,971   1,971  
Aperio Technologies, Inc.   Other Healthcare   Term Loan   9.64 %   5/1/2015   5,000   4,945   4,945  
Patientkeeper, Inc.   Other Healthcare   Term Loan   10.50 %   12/1/2014   5,500   5,291   5,291  
Singulex, Inc.   Other Healthcare   Term Loan (1)   11.00 %   3/1/2014   2,372   2,351   2,351  
        Term Loan (1)   11.00 %   3/1/2014   1,581   1,566   1,566  
Talyst, Inc.   Other Healthcare   Term Loan (1)   12.10 %   12/1/2013   1,567   1,547   1,547  
        Term Loan (1)   12.05 %   12/1/2013   1,566   1,545   1,545  
Total Debt Investments — Healthcare information and services           34,001   34,001  
Total Debt Investments                         165,958   162,009  
Warrant Investments                                
Warrants — Life Science — 1.0%                                
ACT Biotech Corporation   Biotechnology   Preferred Stock Warrants (1)           71   30  
Ambit Biosciences, Inc.   Biotechnology   Preferred Stock Warrants (1)           143   134  
Anacor Pharmaceuticals, Inc. (5)   Biotechnology   Common Stock Warrants (2)           67   27  
Anesiva, Inc. (5)   Biotechnology   Common Stock Warrants (1)           18    
GenturaDx, Inc.   Biotechnology   Preferred Stock Warrants (2)           63   28  
N30 Pharmaceuticals, LLC   Biotechnology   Preferred Stock Warrants (1)(2)           122   257  
Novalar Pharmaceuticals, Inc.   Biotechnology   Preferred Stock Warrants (1)           69    
Revance Therapeutics, Inc.   Biotechnology   Preferred Stock Warrants (1)           223   496  
Sunesis Pharmaceuticals, Inc.   Biotechnology   Common Stock Warrants (2)           9   122  
Supernus Pharmaceuticals, Inc.   Biotechnology   Preferred Stock Warrants (2)           93   167  
Tranzyme, Inc. (5)   Biotechnology   Common Stock Warrants (1)(2)           6   5  
EnteroMedics, Inc. (5)   Medical Device   Common Stock Warrants (1)           347    
OraMetrix, Inc.   Medical Device   Preferred Stock Warrants (1)           78   1  
PixelOptics, Inc.   Medical Device   Preferred Stock Warrants (2)           96   34  
Tengion, Inc. (5)   Medical Device   Common Stock Warrants (2)           62    
ViOptix, Inc.   Medical Device   Preferred Stock Warrants (1)           13    
Total Warrants — Life Science                         1,480   1,301  
Warrants — Technology — 1.6%                                
OpenPeak, Inc.   Communications   Preferred Stock Warrants (1)           89    
Everyday Health, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)           69   104  
SnagAJob.com, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)           23   269  
Tagged, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)           27   86  
Xtera Communications, Inc.   Semiconductors   Preferred Stock Warrants           206   204  
Vette Corp.   Data Storage   Preferred Stock Warrants (1)           75    
XIOtech, Inc.   Data Storage   Preferred Stock Warrants (1)           22   73  
Cartera Commerce, Inc.   Internet and media   Preferred Stock Warrants (1)           16   24  
Optaros, Inc.   Internet and media   Preferred Stock Warrants (2)                 18   18  
Grab Networks, Inc.   Networking   Preferred Stock Warrants (1)           74    
IntelePeer, Inc.   Networking   Preferred Stock Warrants (1)           39   522  
Motion Computing, Inc.   Networking   Preferred Stock Warrants (1)           7   306  
Impinj, Inc.   Semi-conductor   Preferred Stock Warrants (1)           7    
Clarabridge, Inc.   Software   Preferred Stock Warrants (1)           28   20  
Construction Software Technologies, Inc.   Software   Preferred Stock Warrants (2)           45   36  
Courion Corporation   Software   Preferred Stock Warrants (1)           107   78  
DriveCam, Inc.   Software   Preferred Stock Warrants (1)           20   120  
Netuitive, Inc.   Software   Preferred Stock Warrants (1)           27   16  
Recondo Technology, Inc.   Software   Preferred Stock Warrants (2)           47   135  
Seapass Solutions, Inc.   Software   Preferred Stock Warrants (2)           43   35  
StreamBase Systems, Inc.   Software   Preferred Stock Warrants (1)           67   68  
Total Warrants — Technology                         1,056   2,114  

 

See Notes to Consolidated Financial Statements

 

9
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments

March 31, 2012 — (Continued)

(In thousands)

 

        Type of   Interest           Principal     Cost of     Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)     Maturity     Amount     Investments (6)     Value  
Warrants — Cleantech — 0.3%                                        
Cereplast, Inc. (5)   Waste Recycling   Common Stock Warrants (1)                       112        
Enphase Energy, Inc. (5)   Energy Efficiency   Common Stock Warrants (1)                       175       265  
Satcon Technology Corporation (5)   Energy Efficiency   Common Stock Warrants (1)                       285        
Tigo Energy, Inc.   Energy Efficiency   Preferred Stock Warrants (1)(2)                       101       80  
Total Warrants — Cleantech                                     673       345  
Warrants — Healthcare information and services — 0.7%                                        
BioScale, Inc.   Diagnostics   Preferred Stock Warrants (1)                       54       52  
Precision Therapeutics, Inc.   Diagnostics   Preferred Stock Warrants                       73       159  
Radisphere National Radiology Group, Inc.   Diagnostics   Preferred Stock Warrants (1)(2)                       298       459  
Aperio Technologies, Inc.   Other Healthcare   Preferred Stock Warrants                       34       27  
Patientkeeper, Inc.   Other Healthcare   Preferred Stock Warrants                       269       45  
Singulex, Inc.   Other Healthcare   Preferred Stock Warrants (1)                       39       69  
Talyst, Inc.   Other Healthcare   Preferred Stock Warrants (1)                       100       67  
Total Warrants — Healthcare information and services                             867       878  
Total Warrants                                     4,076       4,638  
Equity — 0.5%                                                
Insmed Incorporated (5)   Biotechnology   Common Stock (1)                       227       121  
Overture Networks Inc.   Communications   Preferred Stock (1)                       482       526  
Active Networks (5)   Consumer-related Technologies   Common Stock (1)                       2       2  
Total Equity                                     711       649  
Total Portfolio Investment Assets — 129.6%                           $ 170,745     $ 167,296  
Short Term Investments — Money Market Funds — 17.8%                                        
Blackrock Liquid Fed Funds Institutional (Fund #30)                         $ 3,721     $ 3,721  
First American Prime Obligations Fund (Class D)                           18,532       18,532  
Fidelity Prime Money Market (Class I Fund #690)                           691       691  
Total Short Term Investments — Money Market Funds                           $ 22,944     $ 22,944  

 

 

(1)Has been pledged as collateral under the WestLB Facility.

 

(2)Has been pledged as collateral under the Wells Facility.

 

(3)All investments are less than 5% ownership of the class and ownership of the portfolio company.

 

(4)All interest is payable in cash due monthly in arrears, unless otherwise indicated and applies only to the Company’s debt investments. Amount is the annual interest rate on the debt investment and does not include any additional fees related to the investment, such as deferred interest, commitment fees or prepayment fees. All debt investments are at fixed rates for the term of the loan, unless otherwise indicated. For each debt investment, we have provided the current interest rate in effect as of March 31, 2012.

 

(5)Portfolio company is a public company.

 

(6)For debt investments, represents principal balance less unearned income.

 

(7)Preferred and common stock warrants and equity interests are non-income producing.

 

(8)Investment was on non-accrual status as of March 31, 2012 and is therefore considered non-income producing.

 

See Notes to Consolidated Financial Statements

 

10
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments
December 31, 2011
(In thousands)

 

        Type of   Interest           Principal     Cost of     Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)     Maturity     Amount     Investments (6)     Value  
Debt Investments                                                
Debt Investments — Life Science — 45.5%                                        
ACT Biotech Corporation   Biotechnology   Term Loan (1)     13.10 %     12/1/2013     $ 913     $ 894     $ 734  
        Term Loan (1)     13.01 %     12/1/2013       913       906       906  
        Term Loan (1)     13.01 %     12/1/2013       1,410       1,378       1,378  
Ambit Biosciences Corporation   Biotechnology   Term Loan (1)     12.25 %     10/1/2013       4,574       4,530       4,530  
Anacor Pharmaceuticals, Inc. (5)   Biotechnology   Term Loan (2)     9.41 %     4/1/2015       3,333       3,240       3,240  
        Term Loan (2)     9.67 %     4/1/2015       2,667       2,608       2,608  
GenturaDx, Inc.   Biotechnology   Term Loan (2)     11.25 %     4/1/2014       1,824       1,800       1,800  
N30 Pharmaceuticals, LLC   Biotechnology   Term Loan (1)     11.25 %     9/1/2014       2,500       2,447       2,447  
        Term Loan (2)     11.25 %     7/1/2015       2,500       2,413       2,413  
Pharmasset, Inc. (5)   Biotechnology   Term Loan (1)     12.50 %     10/1/2012       1,111       1,107       1,107  
Revance Therapeutics, Inc.   Biotechnology   Convertible Note (1)     8.00 %     2/10/2013       62       66       66  
Sunesis Pharmaceuticals, Inc.   Biotechnology   Term Loan (2)     8.95 %     10/1/2015       2,000       1,943       1,943  
Supernus Pharmaceuticals, Inc.   Biotechnology   Term Loan (2)     11.00 %     8/1/2014       3,000       2,972       2,972  
        Term Loan (2)     11.00 %     7/1/2015       7,000       6,902       6,902  
Tranzyme, Inc. (5)   Biotechnology   Term Loan (1)     10.75 %     1/1/2014       4,104       4,088       4,088  
Xcovery Holding Company, LLC   Biotechnology   Term Loan (2)     12.00 %     10/1/2013       1,444       1,440       1,240  
        Term Loan (2)     12.00 %     7/1/2014       1,500       1,480       1,480  
OraMetrix, Inc.   Medical Device   Term Loan (1)     11.50 %     4/1/2014       4,340       4,282       4,282  
PixelOptics, Inc.   Medical Device   Term Loan (2)     10.75 %     11/1/2014       10,000       9,921       9,921  
Tengion, Inc. (5)   Medical Device   Term Loan (2)     11.75 %     1/1/2014       5,000       4,958       4,661  
ViOptix, Inc.   Medical Device   Term Loan (1)     13.55 %     11/1/2011       418       417       417  
Total Debt Investments — Life Science                             59,792       59,135  
Debt Investments — Technology — 35.7%                                        
OpenPeak, Inc.   Communications   Term Loan (1)     11.86 %     12/1/2013       5,486       5,431       5,134  
Starcite, Inc.   Consumer-related Technologies   Term Loan (1)     12.05 %     9/1/2012       1,225       1,225       1,225  
Tagged, Inc.   Consumer-related Technologies   Term Loan (1)     12.78 %     5/1/2012       343       343       343  
        Term Loan (1)     11.46 %     8/1/2012       195       194       194  
Xtera Communications, Inc.   Semiconductors   Term Loan     11.50 %     12/1/2014       10,000       9,814       9,814  
        Term Loan     11.50 %     7/1/2015       2,000       1,951       1,951  
Vette Corp.   Data Storage   Term Loan (1)     11.75 %     7/1/2014       5,000       4,937       3,437  
IntelePeer, Inc.   Networking   Term Loan (1)     12.43 %     4/1/2012       139       139       139  
        Term Loan (1)     12.33 %     6/1/2012       214       214       214  
        Term Loan (1)     12.33 %     10/1/2012       573       570       570  
Construction Software Technologies, Inc.   Software   Term Loan (2)     11.75 %     12/1/2014       4,000       3,947       3,947  
        Term Loan     11.75 %     6/1/2014       2,000       1,972       1,972  
Courion Corporation   Software   Term Loan (1)     11.45 %     9/1/2014       7,000       6,904       6,904  
Recondo Technology, Inc.   Software   Term Loan (2)     11.50 %     4/1/2015       2,000       1,927       1,927  
Seapass Solutions, Inc.   Software   Term Loan (2)     11.75 %     11/1/2014       5,000       4,933       4,933  
StreamBase Systems, Inc.   Software   Term Loan (1)     12.51 %     11/1/2013       2,816       2,787       2,787  
        Term Loan (1)     12.50 %     6/1/2014       896       884       884  
Total Debt Investments — Technology                             48,172       46,375  
Debt Investments — Cleantech — 21.7%                                        
Cereplast, Inc. (5)   Waste Recycling   Term Loan (1)     12.00 %     4/1/2014       2,356       2,313       2,004  
    Waste Recycling   Term Loan (1)     12.00 %     6/1/2014       2,500       2,451       2,451  
Aurora Algae, Inc.   Energy Efficiency   Term Loan (2)     10.50 %     5/1/2015       2,500       2,476       2,476  
Enphase Energy, Inc.   Energy Efficiency   Term Loan (1)     12.60 %     10/1/2013       5,342       5,286       5,286  
        Term Loan     10.75 %     4/1/2015       2,000       1,972       1,972  
        Term Loan     10.75 %     4/1/2015       3,000       2,945       2,945  
Satcon Technology Corporation (5)   Energy Efficiency   Term Loan (1)     12.58 %     1/1/2014       7,882       7,740       7,740  
Tigo Energy, Inc.   Energy Efficiency   Term Loan (1)     11.00 %     8/1/2014       3,500       3,371       3,371  
Total Debt Investments — Cleantech                                     28,554       28,245  

 

See Notes to Consolidated Financial Statements

 

11
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments
December 31, 2011 — (Continued)
(In thousands)

 

        Type of   Interest           Principal     Cost of     Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)     Maturity     Amount     Investments (6)     Value  
Debt Investments — Healthcare information and services — 30.4%                                        
BioScale, Inc.   Diagnostics   Term Loan (1)     12.00 %     8/1/2012       962       960       960  
        Term Loan (1)     11.51 %     1/1/2014       5,000       4,953       4,953  
Precision Therapeutics, Inc.   Diagnostics   Term Loan     10.25 %     12/1/2014       7,000       6,958       6,958  
Radisphere National Radiology Group, Inc.   Diagnostics   Term Loan (1)     12.75 %     1/1/2014       8,546       8,476       8,476  
Aperio Technologies, Inc.   Other Healthcare   Term Loan     9.64 %     5/1/2015       5,000       4,937       4,937  
Patientkeeper, Inc.   Other Healthcare   Term Loan     10.50 %     12/1/2014       5,500       5,257       5,257  
Singulex, Inc.   Other Healthcare   Term Loan (1)     11.00 %     3/1/2014       2,736       2,709       2,709  
        Term Loan (1)     11.00 %     3/1/2014       1,824       1,806       1,806  
Talyst, Inc.   Other Healthcare   Term Loan (1)     12.10 %     12/1/2013       1,765       1,739       1,739  
        Term Loan (1)     12.05 %     12/1/2013       1,764       1,736       1,736  
Total Debt Investment — Healthcare information and services                             39,531       39,531  
Total Debt Investments                                     176,049       173,286  
Warrant Investments                                                
Warrants — Life Science —0.9%                                                
ACT Biotech Corporation   Biotechnology   Preferred Stock Warrants (1)                       71       27  
Ambit Biosciences, Inc.   Biotechnology   Preferred Stock Warrants (1)                       143       131  
Anacor Pharmaceuticals, Inc. (5)   Biotechnology   Common Stock Warrants (2)                       67       42  
Anesiva, Inc. (5)   Biotechnology   Common Stock Warrants (1)                       18        
GenturaDx, Inc.   Biotechnology   Preferred Stock Warrants (2)                       63       49  
N30 Pharmaceuticals, LLC   Biotechnology   Preferred Stock Warrants (1)(2)                       122       249  
Novalar Pharmaceuticals, Inc.   Biotechnology   Preferred Stock Warrants (1)                       69        
Revance Therapeutics, Inc.   Biotechnology   Preferred Stock Warrants (1)                       224       496  
Sunesis Pharmaceuticals, Inc.   Biotechnology   Common Stock Warrants (2)                       9       9  
Supernus Pharmaceuticals, Inc.   Biotechnology   Preferred Stock Warrants (2)                       93       168  
Tranzyme, Inc. (5)   Biotechnology   Common Stock Warrants (1)                       1        
EnteroMedics, Inc. (5)   Medical Device   Common Stock Warrants (1)                       347        
OraMetrix, Inc.   Medical Device   Preferred Stock Warrants (1)                       78       1  
PixelOptics, Inc.   Medical Device   Preferred Stock Warrants (2)                       96       34  
Tengion, Inc. (5)   Medical Device   Common Stock Warrants (2)                       62        
ViOptix, Inc.   Medical Device   Preferred Stock Warrants (1)                       13        
Total Warrants — Life Science                                     1,476       1,206  
Warrants — Technology — 1.5%                                                
OpenPeak, Inc.   Communications   Preferred Stock Warrants (1)                       89        
Everyday Health, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)                       69       103  
SnagAJob.com, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)                       23       269  
Tagged, Inc.   Consumer-related Technologies   Preferred Stock Warrants (1)                       17       81  
Xtera Communications, Inc.   Semiconductors   Preferred Stock Warrants                       206       202  
Vette Corp.   Data Storage   Preferred Stock Warrants (1)                       75        
XIOtech, Inc.   Data Storage   Preferred Stock Warrants (1)                       22       72  
Cartera Commerce, Inc.   Internet and media   Preferred Stock Warrants (1)                       16       24  
Grab Networks, Inc.   Networking   Preferred Stock Warrants (1)                       74        
IntelePeer, Inc.   Networking   Preferred Stock Warrants (1)                       39       521  
Motion Computing, Inc.   Networking   Preferred Stock Warrants (1)                       7       305  
Impinj, Inc.   Semi-conductor   Preferred Stock Warrants (1)                       7        
Clarabridge, Inc.   Software   Preferred Stock Warrants (1)                       28       20  
Construction Software Technologies, Inc.   Software   Preferred Stock Warrants (2)                       45       35  
Courion Corporation   Software   Preferred Stock Warrants (1)                       85       81  
DriveCam, Inc.   Software   Preferred Stock Warrants (1)                       20       120  
Netuitive, Inc.   Software   Preferred Stock Warrants (1)                       27       18  
Recondo Technology, Inc.   Software   Preferred Stock Warrants (2)                       47       38  
Seapass Solutions, Inc.   Software   Preferred Stock Warrants (2)                       43       34  
StreamBase Systems, Inc.   Software   Preferred Stock Warrants (1)                       67       68  
Total Warrants — Technology                                     1,006       1,991  

 

See Notes to Consolidated Financial Statements

 

12
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments
December 31, 2011 — (Continued)
(In thousands)

 

        Type of   Interest           Principal     Cost of     Fair  
Portfolio Company   Sector   Investment (3)(7)   Rate (4)     Maturity     Amount     Investments (6)     Value  
Warrants — Cleantech — 0.1%                                        
Cereplast, Inc. (5)   Waste Recycling   Common Stock Warrants (1)                       112        
Enphase Energy, Inc.   Energy Efficiency   Preferred Stock Warrants (1)                       175       110  
Satcon Technology Corporation (5)   Energy Efficiency   Common Stock Warrants (1)                       285        
Tigo Energy, Inc.   Energy Efficiency   Preferred Stock Warrants (1)                       101       80  
Total Warrants — Cleantech                                     673       190  
Warrants — Healthcare information and services — 0.5%                                        
BioScale, Inc.   Diagnostics   Preferred Stock Warrants (1)                       54       51  
Precision Therapeutics, Inc.   Diagnostics   Preferred Stock Warrants                       73       158  
Radisphere National Radiology Group, Inc.   Diagnostics   Preferred Stock Warrants (1)                       167       325  
Aperio Technologies, Inc.   Other Healthcare   Preferred Stock Warrants                       34       27  
Patientkeeper, Inc.   Other Healthcare   Preferred Stock Warrants                       269       44  
Singulex, Inc.   Other Healthcare   Preferred Stock Warrants (1)                       39       25  
Talyst, Inc.   Other Healthcare   Preferred Stock Warrants (1)                       100       81  
Total Warrants — Healthcare information and services                             736       711  
Total Warrants                                     3,891       4,098  
Equity — 0.5%                                                
Insmed Incorporated (5)   Biotechnology   Common Stock (1)                       227       101  
Overture Networks Inc.   Communications   Preferred Stock (1)                       482       526  
Active Networks (5)   Consumer-related Technologies   Common Stock (1)                       2       2  
Total Equity                                     711       629  
Total Portfolio Investment Assets — 137.1%                           $ 180,651     $ 178,013  
Short Term Investments — Money Market Funds — 10.4%                                        
Blackrock Liquid Fed Funds Institutional (Fund #30)                                 $ 9,861     $ 9,861  
First American Prime Obligations Fund (Class D)                                   2,966       2,966  
Fidelity Prime Money Market (Class I Fund #690)                                   691       691  
Total Short Term Investments — Money Market Funds                           $ 13,518     $ 13,518  

 

 

(1)Has been pledged as collateral under the WestLB Facility.

 

(2)Has been pledged as collateral under the Wells Facility.

 

(3)All investments are less than 5% ownership of the class and ownership of the portfolio company.

 

(4)All interest is payable in cash due monthly in arrears, unless otherwise indicated and applies only to the Company’s debt investments. Amount is the annual interest rate on the debt investment and does not include any additional fees related to the investment, such as deferred interest, commitment fees or prepayment fees. All debt investments are at fixed rates for the term of the loan, unless otherwise indicated. For each debt investment, we have provided the current interest rate in effect as of December 31, 2011.

 

(5)Portfolio company is a public company.

 

(6)For debt investments, represents principal balance less unearned income.

 

(7)Preferred and common stock warrants and equity interests are non-income producing.

 

See Notes to Consolidated Financial Statements

 

13
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Note 1. Organization

 

Horizon Technology Finance Corporation (the “Company”) was organized as a Delaware corporation on March 16, 2010 and is an externally managed, non-diversified, closed end investment company. The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (“1940 Act”). In addition, for tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) as defined in Subtitle A, Chapter 1, under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and capital gains the Company distributes to the stockholders. The Company primarily makes secured loans to development-stage companies in the technology, life science, healthcare information and services and cleantech industries.

 

On October 28, 2010 the Company completed an initial public offering (“IPO”) and its common stock trades on the NASDAQ Global Select Market under the symbol “HRZN”. The Company was formed to continue and expand the business of Compass Horizon Funding Company LLC (“CHF”), a Delaware limited liability company, which commenced operations in March 2008 and became the Company’s wholly owned subsidiary with the completion of the IPO.

 

Horizon Credit I LLC (“Credit I”) was formed as a Delaware limited liability company on January 23, 2008, with CHF as the sole equity member. Credit I is a special purpose bankruptcy remote entity and is reported herein as a wholly owned subsidiary of the Company. Credit I is a separate legal entity from the Company and CHF and the assets conveyed to Credit I are not available to creditors of the Company or any other entity other than Credit I’s lenders.

 

Horizon Credit II LLC (“Credit II”) was formed as a Delaware limited liability company on June 28, 2011, with the Company as the sole equity member. Credit II is a special purpose bankruptcy remote entity and is a separate legal entity from the Company. Any assets conveyed to Credit II are not available to creditors of the Company or any other entity other than Credit II’s lenders.

 

Longview SBIC GP LLC and Longview SBIC LP (collectively, “Horizon SBIC”) were formed as a Delaware limited liability company and Delaware limited partnership, respectively, on February 11, 2011. Horizon SBIC are wholly owned subsidiaries of the Company and were formed in anticipation of obtaining a license to operate a small business investment company from the U. S. Small Business Administration. There has been no activity in Horizon SBIC since its inception.

 

The Company’s investment strategy is to maximize the investment portfolio’s return by generating current income from the loans made and the capital appreciation from the warrants received when making such loans. The Company has entered into an investment management agreement (the “Investment Management Agreement”) with Horizon Technology Finance Management LLC (“HTFM” or the “Advisor”), under which the Advisor will manage the day-to-day operations of, and provide investment advisory services to, the Company.

 

Note 2. Basis of Presentation and Significant Accounting Policies

 

Basis of Financial Statement Presentation

 

The consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X. In the opinion of management, the consolidated financial statements reflect all adjustments and reclassifications that are necessary for the fair presentation of financial results as of and for the periods presented. All intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation.

 

Principles of Consolidation

 

As permitted under Regulation S-X and the AICPA Audit and Accounting Guide for Investment Companies, the Company will generally not consolidate its investment in a company other than an investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company consolidated the results of the Company’s subsidiaries in its consolidated financial statements.

 

Use of Estimates

 

In preparing the consolidated financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the date of the balance sheet and income and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the valuation of debt, warrant and equity investments.

 

14
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Fair Value

 

The Company applies fair value to substantially all of its investments in accordance with relevant GAAP, which establishes a framework used to measure fair value and requires disclosures for fair value measurements. The Company has categorized its investments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy as more fully described in Note 5. Fair value is a market-based measure considered from the perspective of the market participant who holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument at the measurement date.

 

The availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market and the current market conditions. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for financial instruments classified as Level 3.

 

In May 2011, the FASB issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRSs), (ASU 2011-04). ASU 2011-04 converges the fair value measurement guidance in U.S. GAAP and IFRSs. Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle in existing guidance. In addition, ASU 2011-04 requires additional fair value disclosures. The Company adopted ASU 2011-04 in the quarter ended March 31, 2012 and included the additional required disclosures in Note 5.

 

See Note 5 for additional information regarding fair value.

 

Segments

 

The Company has determined that it has a single reporting segment and operating unit structure. The Company lends to and invests in portfolio companies in various technology, life science, healthcare information and services and cleantech industries. The Company separately evaluates the performance of each of its lending and investment relationships. However, because each of these loan and investment relationships has similar business and economic characteristics, they have been aggregated into a single lending and investment segment.

 

Investments

 

Investments are recorded at fair value. The Company’s board of directors (“Board”) determines the fair value of its portfolio investments. The Company has the intent to hold its loans for the foreseeable future or until maturity or payoff.

 

Interest on debt investments is accrued and included in income based on contractual rates applied to principal amounts outstanding. Interest income is determined using a method that results in a level rate of return on principal amounts outstanding. When a loan becomes 90 days or more past due, or if the Company otherwise does not expect to receive interest and principal repayments, the loan is placed on non-accrual status and the recognition of interest income is discontinued. Interest payments received on loans that are on non-accrual status are treated as reductions of principal until the principal is repaid. As of March 31, 2012, there was one loan on non-accrual status with an approximate cost of $4.9 million and a fair value of approximately $1.9 million. There were no loans on non-accrual status as of December 31, 2011.

 

The Company receives a variety of fees from borrowers in the ordinary course of conducting its business, including advisory fees, commitment fees, amendment fees, non-utilization fees and prepayment fees (collectively, the “Fees”). In a limited number of cases, the Company may also receive a non-refundable deposit earned upon the termination of a transaction. Loan origination fees, net of certain direct origination costs, are deferred and, along with unearned income, are amortized as a level yield adjustment over the respective term of the loan. Fees for counterparty loan commitments with multiple loans are allocated to each loan based upon each loan’s relative fair value. When a loan is placed on non-accrual status, the amortization of the related fees and unearned income is discontinued until the loan is returned to accrual status.

 

15
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Certain loan agreements also require the borrower to make an end-of-term payment that is accrued into income over the life of the loan to the extent such amounts are expected to be collected. The Company will generally cease accruing the income if there is insufficient value to support the accrual or the Company does not expect the borrower to be able to pay all principal and interest due.

 

In connection with substantially all lending arrangements, the Company receives warrants to purchase shares of stock from the borrower. The warrants are recorded as assets at estimated fair value on the grant date using the Black-Scholes valuation model. The warrants are considered loan fees and are also recorded as unearned loan income on the grant date. The unearned income is recognized as interest income over the contractual life of the related loan in accordance with the Company’s income recognition policy. Subsequent to loan origination, the warrants are also measured at fair value using the Black-Scholes valuation model. Any adjustment to fair value is recorded through earnings as net unrealized gain or loss on investments. Gains from the disposition of the warrants or stock acquired from the exercise of warrants are recognized as realized gains on investments.

 

Debt Issuance Costs

 

Debt issuance costs are fees and other direct incremental costs incurred by the Company in obtaining debt financing from its lenders and issuing debt securities. Debt issuance costs are recognized as assets and amortized as interest expense over the term of the related borrowings. The unamortized balance of debt issuance costs as of March 31, 2012 and December 31, 2011, included in other assets, was $2.1 million and $1.1 million, respectively. The accumulated amortization balances as of both March 31, 2012 and December 31, 2011 were $0.1 million. The amortization expense for the three months ended March 31, 2012 and March 31, 2011 relating to debt issuance costs was $0.1 million and $0.2 million, respectively.

 

Income Taxes

 

The Company elected to be treated as a RIC under subchapter M of the Code and operates in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, the Company is required to meet certain source of income and asset diversification requirements and timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. The Company, among other things, has made and intends to continue to make the requisite distributions to its stockholders, which will generally relieve the Company from U.S. federal income taxes.

 

Depending on the level of taxable income earned in a tax year, the Company may choose 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, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the three months ended March 31, 2012 and 2011, no amount was recorded for U.S. federal excise tax.

 

The Company evaluates tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold, or uncertain tax positions, would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. There were no material uncertain tax positions at March 31, 2012 and December 31, 2011. The 2011, 2010 and 2009 tax years remain subject to examination by U.S. federal and state tax authorities.

 

Dividends

 

Dividends and distributions to common stockholders are recorded on the declaration date. The amount to be paid out as a dividend is determined by the Board. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment.

 

The Company has adopted a dividend reinvestment plan that provides for reinvestment of cash distributions and other distributions on behalf of its stockholders, unless a stockholder elects to receive cash. As a result, if the Board authorizes, and the Company declares, a cash dividend, then stockholders who have not “opted out” of the dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash dividend. The Company may use newly issued shares to implement the plan (especially if the Company’s shares are trading at a premium to net asset value), or the Company may purchase shares in the open market in connection with the obligations under the plan.

 

16
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Interest Rate Swaps and Hedging Activities

 

The Company entered into interest rate swap agreements to manage interest rate risk. The Company does not hold or issue interest rate swap agreements or other derivative financial instruments for speculative purposes.

 

The interest rate swaps are recorded at fair value with changes in fair value reflected in net unrealized appreciation or depreciation of investments during the reporting period. The Company records the accrual of periodic interest settlements of interest rate swap agreements in net unrealized appreciation or depreciation of investments and subsequently records the amount as a net realized gain or loss on investments on the interest settlement date. Cash payments received or paid for the termination of an interest rate swap agreement would be recorded as a realized gain or loss upon termination in the consolidated statements of operations.

 

Transfers of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company — put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.

 

Note 3. Related Party Transactions

 

Investment Management Agreement

 

On October 28, 2010, the Company entered into the Investment Management Agreement with the Advisor, under which the Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company. Under the terms of the Investment Management Agreement, the Advisor determines the composition of the Company’s investment portfolio, the nature and timing of the changes to the investment portfolio and the manner of implementing such changes; identifies, evaluates and negotiates the structure of the investments the Company makes (including performing due diligence on the Company’s prospective portfolio companies); and closes, monitors and administers the investments the Company makes, including the exercise of any voting or consent rights.

 

The Advisor’s services under the Investment Management Agreement are not exclusive to the Company, and the Advisor is free to furnish similar services to other entities so long as its services to the Company are not impaired. The Advisor is a registered investment advisor with the SEC. The Advisor receives fees for providing services, consisting of two components, a base management fee and an incentive fee.

 

The base management fee under the Investment Management Agreement is calculated at an annual rate of 2.00% of the Company’s gross assets, payable monthly in arrears. For purposes of calculating the base management fee, the term “gross assets” includes any assets acquired with the proceeds of leverage. The accrued management fee as of March 31, 2012 and December 31, 2011 was $0.6 million and $0.3 million, respectively. The base management fee expense for the three months ended March 31, 2012 and 2011 was $1.0 million and $1.1 million, respectively.

 

The incentive fee has two parts, as follows:

 

The first part is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees received from portfolio companies) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement (as defined below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued income that we have not yet received in cash. The incentive fee with respect to the pre-incentive fee net income is 20.00% of the amount, if any, by which the pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds a 1.75% (which is 7.00% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, the Advisor receives no incentive fee until the net investment income equals the hurdle rate of 1.75%, but then receives, as a “catch-up,” 100.00% of the pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.1875% in any calendar quarter, the Advisor will receive 20.00% of the pre-incentive fee net investment income as if a hurdle rate did not apply.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company incurs a loss. For example, if the Company receives pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, the Company will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the 2.00% base management fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.

 

The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Management Agreement, as of the termination date), and equals 20.00% of the Company’s aggregate realized capital gains, if any, on a cumulative basis from the date of the election to be a BDC through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation through the end of such year, less all previous amounts paid in respect of the capital gain incentive fee.

 

The total performance based incentive fee expense was approximately $0.8 million and $0.5 million for the three months ended March 31, 2012 and 2011, respectively. The incentive fee payable as of March 31, 2012 and December 31, 2011 was $0.8 million and $1.8 million, respectively. The incentive payable as of March 31, 2012 includes $0.8 million for part one and no accrual for part two of the incentive fee.

 

Administration Agreement

 

The Company entered into an Administration Agreement with the Advisor to provide administrative services to the Company. For providing these services, facilities and personnel, the Company will reimburse the Advisor for the Company’s allocable portion of overhead and other expenses incurred by the Advisor in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions and the Company’s allocable portion of the costs of compensation and related expenses of the Company’s chief compliance officer and chief financial officer and their respective staffs. For the three months ended March 31, 2012 and 2011, $0.3 million was charged to operations under this agreement.

 

Note 4. Investments

 

Investments, all of which are with portfolio companies in the United States, consisted of the following:

 

   March 31, 2012   December 31, 2011 
   Cost   Fair Value   Cost   Fair Value 
Money market funds  $22,944   $22,944   $13,518   $13,518 
Non-affiliate investments                    
Debt  $165,958   $162,009   $176,049   $173,286 
Warrants   4,076    4,638    3,891    4,098 
Equity   711    649    711    629 
Total non-affiliate investments  $170,745   $167,296   $180,651   $178,013 

 

18
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

The following table shows the Company’s portfolio investments by industry sector:

 

   March 31, 2012   December 31, 2011 
   Cost   Fair Value   Cost   Fair Value 
Life Science                    
Biotechnology  $42,602   $42,366   $41,322   $41,127 
Medical Device   19,174    18,379    20,173    19,315 
Technology                    
Consumer-Related Technologies   309    651    1,871    2,217 
Networking   671    1,378    1,043    1,749 
Software   23,382    23,506    23,715    23,768 
Data Storage   5,002    2,035    5,051    3,533 
Internet and Media   1,980    1,980         
Communications   571    526    6,003    5,660 
Semiconductors   12,010    12,000    11,979    11,967 
Healthcare Information and Services                    
Diagnostics   17,180    17,426    21,640    21,881 
Other Healthcare Related Services   17,688    17,453    18,627    18,361 
Cleantech                    
Energy Efficiency   25,722    25,507    24,351    23,980 
Waste Recycling   4,454    4,089    4,876    4,455 
Total non-affiliate investments  $170,745   $167,296   $180,651   $178,013 

 

Note 5. Fair Value

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.

 

Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.

 

The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:

 

Level 1Quoted prices in active markets for identical assets and liabilities.

 

Level 2Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active and model-based valuation techniques for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

Investments are valued at fair value as determined in good faith by the Board, based on input of management, the audit committee and independent valuation firms that have been engaged at the direction of the Board to assist in the valuation of each portfolio investment without a readily available market quotation at least once during a trailing twelve-month period under a valuation policy and a consistently applied valuation process. This valuation process is conducted at the end of each fiscal quarter, with approximately 25% (based on fair value) of the Company’s valuation of portfolio companies without readily available market quotations subject to review by an independent valuation firm.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Cash and interest receivable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis and are categorized as Level 1 within the fair value hierarchy described above.

 

Money Market Funds: The carrying amounts are valued at their net asset value as of the close of business on the day of valuation. These financial instruments are recorded at fair value on a recurring basis and are categorized as Level 2 within the fair value hierarchy described above as these funds can be redeemed daily.

 

Debt Investments: For variable rate debt investments which re-price frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values. The fair value of fixed rate debt investments is estimated by discounting the expected future cash flows using the year end rates at which similar debt investments would be made to borrowers with similar credit ratings and for the same remaining maturities. At both March 31, 2012 and December 31 2011, the discount rates used ranged from 8% to 25%. Significant increases (decreases) in this unobservable input would result in a significantly lower (higher) fair value measurement. These assets are recorded at fair value on a recurring basis and are categorized as Level 3 within the fair value hierarchy described above.

 

Under certain circumstances the Company may use an alternative technique to value debt investments that better reflects its fair value such as the use of multiple probability weighted cash flow models when the expected future cash flows contain elements of variability. Prior to the year ended December 31, 2011, there were no debt investments that required valuation under alternative techniques.

 

Warrant Investments: The Company values its warrants using the Black-Scholes valuation model incorporating the following material assumptions:

 

Underlying asset value of the issuer is estimated based on information available, including any information regarding the most recent rounds of borrower funding. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement.

 

Volatility, or the amount of uncertainty or risk about the size of the changes in the warrant price, is based on guideline publicly traded companies within indices similar in nature to the underlying company issuing the warrant. A total of seven such indices were used. The weighted average volatility assumptions used for the warrant valuation at March 31, 2012 and December 31, 2011 was 24%. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement.

 

The risk-free interest rates are derived from the U.S. Treasury yield curve. The risk-free interest rates are calculated based on a weighted average of the risk-free interest rates that correspond closest to the expected remaining life of the warrant. The risk free rates used for the warrant valuations at March 31, 2012 and December 31, 2011 ranged from 0.19% to 1.04%, and 0.12% to 0.83%, respectively.

 

Other adjustments, including a marketability discount on private company warrants, are estimated based on management’s judgment about the general industry environment. The marketability discount used for the warrant valuations at both March 31, 2012 and December 31, 2011 was 20%. Significant increases (decreases) in this unobservable input would result in a significantly lower (higher) fair value measurement.

 

Under certain circumstances the Company may use an alternative technique to value warrants that better reflects the warrants fair value, such as an expected settlement of a warrant in the near term or a model that incorporates a put feature associated with the warrant. The fair value may be determined based on the expected proceeds to be received from such settlement or based on the net present value of the expected proceeds from the put option. Prior to the year ended December 31, 2011, there were no warrants that required valuation under alternative techniques.

 

The fair value of the Company’s warrants held in publicly traded companies is determined based on inputs that are readily available in public markets or can be derived from information available in public markets. Therefore, the Company has categorized these warrants as Level 2 within the fair value hierarchy described above. The fair value of the Company’s warrants held in private companies is determined using both observable and unobservable inputs and represents management’s best estimate of what market participants would use in pricing the warrants at the measurement date. Therefore, the Company has categorized these warrants as Level 3 within the fair value hierarchy described above. These financial instruments are recorded at fair value on a recurring basis.

 

20
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Equity Investments: The fair value of an equity investment in a privately held company is initially the face value of the amount invested. The Company adjusts the fair value of equity investments in private companies upon the completion of a new third-party round of equity financing. The Company may make adjustments to fair value, absent a new equity financing event, based upon positive or negative changes in a portfolio company’s financial or operational performance. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement. The Company has categorized these equity investments as Level 3 within the fair value hierarchy described above. The fair value of an equity investment in a publicly traded company is based upon the closing public share price on the date of measurement. Therefore, the Company has categorized these equity investments as Level 1 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis.

 

Borrowings: The carrying amount of borrowings under the revolving credit facilities approximate fair value due to the short duration and variable interest rate of these credit facilities and are categorized as Level 2 within the fair value hierarchy described above. Additionally, the Company considers its creditworthiness in determining the fair value of such borrowings. The fair value of our fixed rate Senior Notes is based on the closing public share price on the date of measurement and approximates the carrying value as of March 31, 2012. Therefore, the Company has categorized this borrowing as Level 1 within the fair value hierarchy described above. These financial instruments are not recorded at fair value on a recurring basis.

 

Interest Rate Swap Derivatives: The fair value of the Company’s interest rate swap derivative instruments is estimated as the amount the Company would pay to terminate its swaps at the balance sheet date, taking into account current interest rates and the creditworthiness of the counterparty for assets and the creditworthiness of the Company for liabilities. The Company has categorized these derivative instruments as Level 2 within the fair value hierarchy described above. These financial instruments are recorded at fair value on a recurring basis.

 

Off-Balance-Sheet Instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings. Therefore, the Company has categorized these instruments as Level 3 within the fair value hierarchy described above. Off-balance-sheet instruments are not recorded at fair value on a recurring basis.

 

The following tables detail the assets and liabilities that are carried at fair value and measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

 

   March 31, 2012 
   Total   Level 1   Level 2   Level 3 
Money market funds  $22,944   $   $22,944   $ 
Debt investments  $162,009   $   $   $162,009 
Warrant investments  $4,638   $   $419   $4,219 
Equity investments  $649   $123   $   $526 

 

   December 31, 2011 
   Total   Level 1   Level 2   Level 3 
Money market funds  $13,518   $   $13,518   $ 
Debt investments  $173,286   $   $   $173,286 
Warrant investments  $4,098   $   $50   $4,048 
Equity investments  $629   $103   $   $526 

 

21
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

The following tables show a reconciliation of the beginning and ending balances for Level 3 assets:

 

   Three months ended March 31, 2012 
   Debt   Warrant   Equity     
   Investments   Investments   Investments   Total 
Level 3 assets, beginning of period  $173,286   $4,048   $526   $177,860 
Purchase of investments   12,961            12,961 
Warrants and equity received and classified as Level 3       180        180 
Principal payments received on investments   (23,325)           (23,325)
Unrealized (depreciation) appreciation included in earnings   (1,186)   102        (1,084)
Transfer out of Level 3       (111)       (111)
Other   273            273 
Level 3 assets, end of period  $162,009   $4,219   $526   $166,754 

 

The Company’s transfers between levels are recognized at the end of the reporting period.  During the quarter ended March 31, 2012, there were no transfers between Level 1 and Level 2.  The transfer out of Level 3 relates to warrants held in one portfolio company, with a value of $0.1 million, that were transferred into Level 2 due to the portfolio company becoming a public company during the quarter ended March 31, 2012. Because the fair value of the portfolio company’s warrants held are determined based on inputs that are readily available in public markets or can be derived from information available in public markets, the Company has categorized the warrants as Level 2 within the fair value hierarchy described above as of March 31, 2012.

 

   Three months ended March 31, 2011 
   Debt   Warrant   Equity     
   Investments   Investments   Investments   Total 
Level 3 assets, beginning of period  $130,234   $4,249   $142   $134,625 
Purchase of investments   26,063            26,063 
Warrants and equity received and classified as Level 3       306    482    788 
Principal payments received on investments   (11,106)           (11,106)
Proceeds from sale of investments       (12)       (12)
Net realized gain on investments       12        12 
Net (depreciation) appreciation on investments   (12)   853    44    885 
Other   (513)           (513)
Level 3 assets, end of period  $144,666   $5,408   $668   $150,742 

 

The total change in unrealized appreciation (depreciation) included in the consolidated statement of operations attributable to Level 3 investments still held at March 31, 2012 includes $1.5 million depreciation on loans and $0.1 million appreciation on warrants.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the statement of assets and liabilities, for which it is practicable to estimate that value. Certain financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The fair value amounts have been measured as of the reporting date, and have not been reevaluated or updated for purposes of these financial statements subsequent to that date. As such, the fair values of these financial instruments subsequent to the reporting date may be different than amounts reported.

 

As of March 31, 2012 and December 31, 2011, the recorded book balances equaled the fair values for all of the Company’s financial instruments that are not recognized at fair value.

 

Off-balance sheet instruments

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

22
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Note 6. Borrowings

 

In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that the asset coverage, as defined in the 1940 Act, is at least 200% after such borrowings. As of March 31, 2012, the asset coverage for borrowed amounts was 278%.

 

The Company entered into a revolving credit facility (the “WestLB Facility”) with WestLB, AG, New York Branch (“WestLB”) effective March 4, 2008. The WestLB Facility had a three year initial revolving term and on March 3, 2011, the revolving term ended. The outstanding principal balance of the WestLB Facility is amortizing based on loan investment payments received through March 3, 2015. The interest rate is based upon the one-month LIBOR (0.24% as of March 31, 2012 and 0.30% as of December 31, 2011) plus a spread of 2.50%. The rates at March 31, 2012 and December 31, 2011 were 2.74% and 2.80%, respectively, and the average rates for the three months ended March 31, 2012 and 2011 were 2.79%, and 2.78%, respectively.

 

The WestLB Facility is collateralized by all loans and warrants held by Credit I and permits an advance rate of up to 75% of eligible loans held by Credit I. The WestLB Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the loans securing the WestLB Facility to certain criteria for qualified loans, and includes portfolio company concentration limits as defined in the related loan agreement. The average amounts of borrowings were approximately $41.0 million and $85.0 million for the three months ended March 31, 2012 and 2011, respectively. At March 31, 2012 and December 31, 2011, the Company had actual borrowings outstanding of approximately $35.4 million and $46.7 million, respectively, on the WestLB Facility.

 

The Company entered into a revolving credit facility (the “Wells Facility”) with Wells Fargo Capital Finance, LLC (“Wells”) effective July 14, 2011. The Wells Facility has an accordion feature which allows for an increase in the total loan commitment to $150 million from the current $75 million commitment provided by Wells. The Wells Facility has a three year revolving term followed by a three year amortization period and matures on July 14, 2017. The interest rate is based upon the one-month LIBOR plus a spread of 4.00%, with a LIBOR floor of 1.00%. The rate at March 31, 2012 was 5.00%, and the average rate for the three months ended March 31, 2012 was 5.00%.

 

The Wells Facility is collateralized by all loans and warrants held by Credit II and permits an advance rate of up to 50% of eligible loans held by Credit II. The Wells Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the loans securing the Wells Facility to certain criteria for qualified loans and includes portfolio company concentration limits as defined in the related loan agreement. The average amount of borrowings was approximately $17.0 million for the three months ended March 31, 2012. At March 31, 2012 and December 31, 2011, the Company had borrowings outstanding of approximately $4.8 million and $17.8 million on the Wells Facility.

 

On March 23, 2012, the Company issued and sold an aggregate principal amount of $30 million of 7.375% senior unsecured notes due in 2019 (the “Senior Notes”). The Senior Notes will mature on March 15, 2019 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after March 15, 2015 at a redemption price of $25 per security plus accrued and unpaid interest. The Senior Notes bear interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning June 15, 2012. The Senior Notes are the Company’s direct unsecured obligations and rank (i) pari passu with the Company’s future senior unsecured indebtedness; (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the Senior Notes; (iii) effectively subordinated to all of the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under the Company’s credit facilities and (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries. The Senior Notes are listed on the New York Stock Exchange under the symbol “HTF.”

 

In connection with the Senior Notes, the Company granted the underwriters a 30-day option to purchase up to an additional $4.5 million in aggregate principal amount of Senior Notes to cover overallotments, if any. Pursuant to this option, $3.0 million in aggregate principal amount of Senior Notes were issued and sold on April 18, 2012.

 

23
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Note 7. Financial Instruments with Off-Balance Sheet Risk

 

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its borrowers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of assets and liabilities. The Company attempts to limit its credit risk by conducting extensive due diligence and obtaining collateral where appropriate.

 

The balance of unfunded commitments to extend credit was approximately $16.0 million and $22.5 million as of March 31, 2012 and December 31, 2011, respectively. Commitments to extend credit consist principally of the unused portions of commitments that obligate the Company to extend credit, such as revolving credit arrangements or similar transactions. Commitments may also include a financial or non-financial milestone that has to be achieved before the commitment can be drawn. Commitments generally have fixed expiration dates or other termination clauses. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

Note 8. Concentrations of Credit Risk

 

The Company’s loan portfolio consists primarily of loans to development-stage companies at various stages of development in the technology, life science, healthcare information and services and cleantech industries. Many of these companies may have relatively limited operating histories and also may experience variation in operating results. Many of these companies conduct business in regulated industries and could be affected by changes in government regulations. Most of the Company’s borrowers will need additional capital to satisfy their continuing working capital needs and other requirements and, in many instances, to service the interest and principal payments on the loans.

 

The largest loans may vary from year to year as new loans are recorded and repaid. The Company’s five largest loans represented approximately 32% and 28% of total loans outstanding as of March 31, 2012 and December 31, 2011, respectively. No single loan represents more than 10% of the total loans as of March 31, 2012 and December 31, 2011. Loan income, consisting of interest and fees, can fluctuate significantly upon repayment of large loans. Interest income from the five largest loans accounted for approximately 29% and 31% of total loan interest and fee income for the three months ended March 31, 2012 and March 31, 2011, respectively.

 

Note 9: Interest Rate Swaps and Hedging Activities

 

On October 14, 2008, the Company entered into two interest rate swap agreements (collectively, the “Swap”) with WestLB, fixing the rate of $10 million at 3.58% and $15 million at 3.20% on the first advances of a like amount of variable rate WestLB Facility borrowings. The $15 million interest rate swap expired in October 2010 and the $10 million interest rate swap expired in October 2011. The objective of the Swap was to hedge the risk of changes in cash flows associated with the future interest payments on the first $25 million of the variable rate WestLB Facility debt with a combined notional amount of $25 million.

 

During the three months ended March 31, 2011, approximately $78 of net unrealized appreciation, and approximately $83 of net realized losses, from the Swap were recorded in the statement of operations.

 

Note 10: Dividends and Distributions

 

The Company’s dividends and distributions are recorded on the record date. The following table summarizes the Company’s dividend declaration and distribution activity as of March 31, 2012:

 

Date  Record   Payment   Amount   Cash   Drip Shares   Drip Shares 
Declared  Date   Date   Per Share   Distribution   Issued   Values 
12/15/10   12/28/10    12/31/10   $0.22   $1,097    38,297   $565 
5/10/11   5/19/11    5/26/11   $0.33   $2,190    20,104   $316 
8/9/11   8/23/11    8/30/11   $0.40   $2,836    13,193   $209 
11/8/11   11/23/11    11/30/11   $0.45   $3,281    9,814   $151 
3/12/12   3/23/12    3/30/12   $0.45   $3,378    3,517   $58 

 

On May 3, 2012, the Company declared a first quarter dividend of $0.45 per share, payable on May 31, 2012 to stockholders of record on May 17, 2012.

 

24
 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

(In thousands, except shares and per share data)

 

Note 11: Financial Highlights

 

The financial highlights for the Company are as follows:

 

   Three months
ended
   Three months
ended
 
   March 31, 2012   March 31, 2011 
Per share data:          
Net asset value at beginning of period  $17.01   $16.75 
Dividend declared and distributed   (0.45)    
Net investment income   0.44    0.29 
Realized gain on investments   0.00    0.03 
Unrealized (depreciation) appreciation on investments   (0.11)   0.16 
Net asset value at end of period  $16.89   $17.23 
Per share market value, end of period  $16.61   $16.07 
Total return based on market value   4.5%   11.3%
Shares outstanding at end of period   7,640,049    7,593,421 
Ratios to average net assets:          
Expenses without incentive fees   7.5%(1)   8.4%(1)
Incentive fees   2.6%(1)   1.6%(1)
Total expenses   10.1%(1)   10.0%(1)
Net investment income with incentive fees   10.4%(1)   6.9%(1)
Average net asset value  $129,465   $129,008 

 

 

(1)Annualized.

 

25
 

 

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

 

In this section, 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.

 

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 BDC under the 1940 Act. 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 (“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.

 

Portfolio Composition and Investment Activity

 

The following table shows our portfolio composition by asset class as of March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
           % of           % of 
   # of   Fair   Total   # of   Fair   Total 
   Investments   Value   Portfolio   Investments   Value   Portfolio 
Term loans   33   $158,516    94.7%   37   $172,363    96.8%
Revolving loans   1    2,943    1.8%           0.0%
Equipment loans   1    550    0.3%   1    923    0.5%
Total loans   35    162,009    96.8%   38    173,286    97.3%
Warrants   48    4,638    2.8%   47    4,098    2.3%
Equity   3    649    0.4%   3    629    0.4%
Total       $167,296    100.0%       $178,013    100.0%

 

Total portfolio investment activity for the three months ended March 31, 2012 and 2011 was as follows:

 

   For the three   For the three 
   Months ended   Months ended 
   March 31, 2012   March 31, 2011 
Beginning portfolio  $178,013   $136,810 
New loan funding   31,700    28,833 
Less refinanced balances   (18,739)   (2,770)
Net new loan funding   12,961    26,063 
Principal payments received on investments   (9,120)   (7,759)
Early pay-offs   (14,205)   (3,347)
Accretion of loan fees   642    395 
New loan fees   (182)   (513)
New equity       577 
Proceeds from sale of investments       (321)
Net realized gain on investments       289 
Net (depreciation) appreciation on investments   (813)   1,022 
Ending portfolio  $167,296   $153,216 

 

26
 

 

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 debt investments by industry sector as of March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
   Loans at   Percentage   Loans at   Percentage 
   Fair   of Total   Fair   of Total 
   Value   Portfolio   Value   Portfolio 
Life Science                    
Biotechnology  $40,979    25.3%  $39,854    23.0%
Medical Device   18,344    11.3%   19,281    11.1%
Technology                    
Consumer-Related Technologies   190    0.1%   1,762    1.0%
Networking   550    0.4%   923    0.5%
Software   22,998    14.2%   23,354    13.5%
Data Storage   1,937    1.2%   3,437    2.0%
Internet and Media   1,962    1.2%        
Communications           5,134    3.0%
Semiconductors   11,797    7.3%   11,765    6.8%
Cleantech                    
Energy Efficiency   25,162    15.5%   23,790    13.7%
Waste Recycling   4,089    2.5%   4,455    2.6%
Healthcare Information and Services                    
Diagnostics   16,756    10.4%   21,347    12.3%
Other Healthcare Related Services   17,245    10.6%   18,184    10.5%
Total  $162,009    100.0%  $173,286    100.0%

 

The largest loans may vary from year to year as new loans are recorded and repaid. Our five largest loans represented approximately 32% and 28% of total loans outstanding as of March 31, 2012 and December 31, 2011, respectively. No single loan represented more than 10% of our total loans as of March 31, 2012 and December 31, 2011.

 

Loan Portfolio Asset Quality

 

We use a credit rating system which rates each loan on a scale of 4 to 1, with 4 being the highest credit quality rating and 3 being the rating for a standard level of risk. A rating of 2 or 1 represents a deteriorating credit quality and increased risk. The following table shows the classification of our loan portfolio by credit rating as of March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
   Loans at   Percentage   Loans at   Percentage 
   Fair   of Loan   Fair   of Loan 
Credit Rating  Value   Portfolio   Value   Portfolio 
4  $38,897    24.0%  $30,108    17.4%
3   107,353    66.3%  $119,753    69.1%
2   13,822    8.5%  $23,425    13.5%
1   1,937    1.2%        
Total  $162,009    100.0%  $173,286    100.0%

 

As of March 31, 2012 and December 31, 2011, our loan portfolio had a weighted average credit rating of 3.2 and 3.1, respectively. As of March 31, 2012, there was one investment on non-accrual status with an approximate cost of $4.9 million and fair value of approximately $1.9 million. There were no loans on non-accrual status as of December 31, 2011.

 

27
 

 

Consolidated Results of Operations

 

Consolidated operating results for the three months ended March 31, 2012 and 2011 are as follows:

 

   For the three months ended
March 31,
 
   2012   2011 
Total investment income  $6,625   $5,460 
Total expenses   3,273    3,232 
Net investment income   3,352    2,228 
Net realized gains       206 
Net unrealized (depreciation) appreciation   (813)   1,194 
Net income  $2,539   $3,628 
Average debt investments, at fair value  $171,592   $140,177 
Average debt outstanding  $65,469   $85,075 

 

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, quarterly comparisons of net income may not be meaningful.

 

Investment Income

 

Investment income increased by $1.2 million, or 21.3%, for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. For the three months ended March 31, 2012, total investment income consisted primarily of $5.9 million in interest income from investments, which included $0.6 million in income from the amortization of discounts and origination fees on investments. 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 from our portfolio companies. For the three months ended March 31, 2011, total investment income consisted primarily of $4.9 million in interest income from investments, which included $0.4 million in income from the amortization of discounts and origination fees on investments. Fee income on investments for the three months ended March 31, 2011 was primarily comprised of a one-time success fee received upon the completion of an acquisition of one of our portfolio companies.

 

For both the three months ended March 31, 2012 and 2011, our dollar-weighted average annualized yield on average loans was approximately 15.4%. 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 29% and 31% of investment income for the three months ended March 31, 2012 and 2011, respectively.

 

As of March 31, 2012 and December 31, 2011, interest receivable was $2.5 million and $3.0 million, respectively, which represents one month of accrued interest income on substantially all our loans and end of term payments on a portion of our loans. The decrease in 2012 was due to the receipt of end of term payments on loan prepayments during the quarter.

 

Expenses

 

Total expenses increased by $0.1 million, or 1.3%, to $3.3 million for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. Total operating expenses for each period consisted principally of interest expense, management fees, incentive and administrative fees and, to a lesser degree, professional fees and general and administrative expenses. Interest expense, which includes the amortization of debt issuance costs, decreased for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 primarily due to a decrease in the weighted average of outstanding borrowings to $65.5 million from $85.1 million, respectively.

 

Management fee expense for the three months ended March 31, 2012 decreased compared to the three months ended March 31, 2011 as a result of a decrease in average assets as we deleveraged our portfolio. Performance based incentive fees increased by $0.3 million as a result of the increase in pre-incentive fee net investment income for the three months ended March 31, 2012 compared to the three months ended March 31, 2011.

 

Professional fees and general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses were $0.5 million for the three months ended March 31, 2012 and 2011.

 

28
 

 

Net Realized Gains and Net Unrealized Appreciation and Depreciation

 

Realized gains or losses on investments are measured by the difference between the net proceeds from the repayment or sale and the cost basis of our investments without regard to unrealized appreciation or depreciation previously recognized and includes investments charged off during the period, net of recoveries. The net change in unrealized appreciation or depreciation on investments primarily reflects the change in portfolio investment fair values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

 

During the three months ended March 31, 2012, no realized gains or losses were recognized. During the three months ended March 31, 2011, we recognized realized gains of approximately $0.2 million primarily due to the sale of warrants of two portfolio companies.

 

During the three months ended March 31, 2012, net unrealized depreciation on investments totaled approximately $0.8 million which was primarily due to $1.2 million of net unrealized depreciation on six debt investments partially offset by unrealized appreciation on our warrant and equity investments. For three months ended March 31, 2011, net unrealized appreciation on investments totaled approximately $1.2 million which was primarily due to an increase in the enterprise value of a number of private companies for which we hold warrants and an increase in the share value of a public company for which we hold warrants and common stock.  

 

Liquidity and Capital Resources

 

As of March 31, 2012 and December 31, 2011, we had cash and investments in money market funds of $28.6 million and $14.8 million, respectively. These amounts are available to fund new investments, reduce borrowings under the WestLB Facility and the Wells Facility (collectively, the “Credit Facilities”), pay operating expenses and pay dividends. Our primary sources of capital have been from our IPO, use of our Credit Facilities, issuance of our Senior Notes and from the private placement for $50 million of equity capital we completed on March 4, 2008.

 

The WestLB Facility had a three year initial revolving term which ended on March 3, 2011. The outstanding principal balance under the WestLB Facility was $35.4 million as of March 31, 2012 and is amortizing based on debt investment payments received through March 3, 2015.

 

As of March 31, 2012, we had available borrowing capacity of approximately $70.2 million under our Wells Facility, subject to existing terms and advance rates. As of March 31, 2012, the outstanding principal balance under the Wells Facility was $4.8 million. Based on eligible loans held by HCII, we had excess availability of $25.5 million as of March 31, 2012.

 

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

 

Our operating activities used cash of $14.3 million for the three months ended March 31, 2011 and our financing activities provided net cash proceeds of $5 million for the same period. Our operating activities used cash primarily for investing in portfolio companies that was provided primarily from our availability on our Credit Facilities.

 

Our primary use of available funds is to make investments in portfolio companies and for general corporate purposes. We expect to opportunistically raise additional equity and debt capital 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. In addition, as a business development company, we generally will be required to meet a coverage ratio of 200%. This requirement will limit the amount that we may borrow.

 

Current Borrowings

 

We, through our wholly owned subsidiary, Credit I, entered into the WestLB Facility. The base rate borrowings under the WestLB Facility bear interest at one-month LIBOR (0.24% as of March 31, 2012 and 0.30% as of December 31, 2011) plus 2.50%. The rates were 2.74% and 2.80% as of March 31, 2012 and December 31, 2011, respectively. We were able to request advances under the WestLB Facility through March 4, 2011. We may not request new advances and we must repay the outstanding advances under the WestLB Facility as of such date and at such times and in such amounts as are necessary to maintain compliance with the terms and conditions of the WestLB Facility, particularly the condition that the principal balance of the WestLB Facility does not exceed seventy-five percent (75%) of the aggregate principal balance of our eligible loans to our portfolio companies. All outstanding advances under the WestLB Facility are due and payable on March 4, 2015.

 

29
 

 

The WestLB Facility is collateralized by all loans and warrants held by Credit I and permits an advance rate of up to 75% of eligible loans held by Credit I. The WestLB Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the loans securing the WestLB Facility to certain criteria for qualified loans, and includes portfolio company concentration limits as defined in the related loan agreement.

 

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

 

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

 

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

 

On March 23, 2012, we issued and sold $30 million aggregate principal amount of 7.375% senior unsecured notes due in 2019 (the “Senior Notes”). The Senior Notes will mature on March 15, 2019 and may be redeemed in whole or in part at our option at any time or from time to time on or after March 15, 2015 at a redemption price of $25 per security plus accrued and unpaid interest. The Senior Notes bear interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning June 15, 2012. The Senior Notes are our direct, unsecured obligations and rank (i) pari passu with our future senior unsecured indebtedness; (ii) senior to any of our future indebtedness that expressly provides it is subordinated to the Senior Notes; (iii) effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our Credit Facilities and (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries.

 

In connection with the Senior Notes, the Company granted the underwriters a 30-day option to purchase up to an additional $4.5 million in aggregate principal amount of Senior Notes to cover overallotments, if any. Pursuant to this option, $3.0 million in aggregate principal amount of Senior Notes were issued and sold on April 18, 2012.

 

As of March 31, 2012 and December 31, 2011, other assets were $3.0 million and $2.0 million, respectively, which were comprised primarily of debt issuance costs and prepaid expenses. The increase in the first quarter of 2012 was due to the debt issuance costs of approximately $1.1 million incurred related to the Senior Notes.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

A summary of our significant contractual payment obligations and off-balance sheet arrangements as of March 31, 2012 are as follows:

 

   Payments due by period 
Contractual Obligations  Total   Less than
1 year
   1 - 3 years   3 - 5
years
   After 5
years
 
Borrowings  $70,236   $31,466   $8,770   $   $30,000 
Unfunded commitments   16,000    14,000    2,000         
Total contractual obligations  $86,236   $45,466   $10,770   $   $30,000 

 

In the normal course of business, we are party to financial instruments with off-balance sheet risk. These consist primarily of unfunded commitments to extend credit, in the form of loans, to our portfolio companies. Unfunded commitments to provide funds to portfolio companies are not reflected on our balance sheet. Our unfunded commitments may be significant from time to time. As of March 31, 2012, we had unfunded commitments of approximately $16.0 million. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.

 

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In addition to the Credit Facilities and the Senior Notes, we have certain commitments pursuant to our Investment Management Agreement entered into with our Advisor. We have agreed to pay a fee for investment advisory and management services consisting of two components — a base management fee and an incentive fee. Payments under the Investment Management Agreement are equal to (1) a base management fee equal to a percentage of the value of our average gross assets and (2) a two-part incentive fee. We have also entered into a contract with our Advisor to serve as our administrator. Payments under the Administration Agreement are equal to an amount based upon our allocable portion of our Advisor’s overhead in performing its obligation under the agreement, including rent, fees, and other expenses inclusive of our allocable portion of the compensation of our chief financial officer and chief compliance officer and their respective staff. See Note 3 to our Consolidated Financial Statements for additional information regarding our Investment Management Agreement and our Administration Agreement.

 

Distributions

 

In order to qualify as a RIC and to avoid corporate level tax on the income we distribute to our stockholders, we are required under the Code to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Additionally, we must distribute at least 98% of our ordinary income and 98.2% of our capital gain net income on an annual basis and any net ordinary income and net capital gains for preceding years that were not distributed during such years and on which we previously paid no U.S. federal income tax to avoid a U.S. federal excise tax. We intend to distribute quarterly dividends to our stockholders as determined by our Board.

 

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of our distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage requirements applicable to us as a BDC under the 1940 Act. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including the possible loss of our qualification as a RIC. We cannot assure stockholders that they will receive any distributions.

 

To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a return of capital to our stockholders for U.S. federal income tax purposes. Thus, the source of a distribution to our stockholders may be the original capital invested by the stockholder rather than our income or gains. Stockholders should read any written disclosure accompanying a dividend payment carefully and should not assume that the source of any distribution is our ordinary income or gains.

 

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock unless a stockholder specifically “opts out” of our dividend reinvestment plan. If a stockholder opts out, that stockholder will receive cash distributions. Although distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, stockholders participating in our dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes.

 

Critical Accounting Policies

 

The discussion of our financial condition and results of operation is based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or “GAAP.” The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, we describe our significant accounting policies in the notes to our consolidated financial statements.

 

We have identified the following items as critical accounting policies.

 

Valuation of Investments

 

Investments are recorded at fair value. Our Board determines the fair value of its portfolio investments. We apply fair value to substantially all of our investments in accordance with relevant GAAP, which establishes a framework used to measure fair value and requires disclosures for fair value measurements. We have categorized our investments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy. Fair value is a market-based measure considered from the perspective of the market participant who holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, our own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument at the measurement date.

 

The availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market and the current market conditions. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. The three categories within the hierarchy are as follows:

 

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Level 1Quoted prices in active markets for identical assets and liabilities.

 

Level 2Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active and model-based valuation techniques for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

Income Recognition

 

Interest on loan investments is accrued and included in income based on contractual rates applied to principal amounts outstanding. Interest income is determined using a method that results in a level rate of return on principal amounts outstanding. When a loan becomes 90 days or more past due, or if we otherwise do not expect to receive interest and principal repayments, the loan is placed on non-accrual status and the recognition of interest income is discontinued. Interest payments received on loans that are on non-accrual status are treated as reductions of principal until the principal is repaid.

 

We receive a variety of fees from borrowers in the ordinary course of conducting our business, including advisory fees, commitment fees, amendment fees, non-utilization fees and prepayment fees (collectively, the “Fees”). In a limited number of cases, we may also receive a non-refundable deposit earned upon the termination of a transaction. Loan origination fees, net of certain direct origination costs, are deferred, and along with unearned income, are amortized as a level yield adjustment over the respective term of the loan. Fees for counterparty loan commitments with multiple loans are allocated to each loan based upon each loan’s relative fair value. When a loan is placed on non-accrual status, the amortization of the related fees and unearned income is discontinued until the loan is returned to accrual status.

 

Certain loan agreements also require the borrower to make an end-of-term payment that is accrued into income over the life of the loan to the extent such amounts are expected to be collected. We will generally cease accruing the income if there is insufficient value to support the accrual or if we do not expect the borrower to be able to pay all principal and interest due.

 

In connection with substantially all lending arrangements, we receive warrants to purchase shares of stock from the borrower. The warrants are recorded as assets at estimated fair value on the grant date using the Black-Scholes valuation model. The warrants are considered loan fees and are also recorded as unearned loan income on the grant date. The unearned income is recognized as interest income over the contractual life of the related loan in accordance with our income recognition policy. Subsequent to loan origination, the warrants are also measured at fair value using the Black-Scholes valuation model. Any adjustment to fair value is recorded through earnings as net unrealized gain or loss on warrants. Gains from the disposition of the warrants or stock acquired from the exercise of warrants are recognized as realized gains on warrants.

 

Income taxes

 

We have elected to be treated as a RIC under subchapter M of the Code and operate in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, we are required to meet certain source of income and asset diversification requirements and we must timely distribute to our stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. We, among other things, have made and intend to continue to make the requisite distributions to our stockholders, which will generally relieve us from U.S. federal income taxes.

 

Depending on the level of taxable income earned in a tax year, we may choose 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, as required. To the extent that we determine that our estimated current year annual taxable income will be in excess of estimated current year dividend distributions, we will accrue excise tax, if any, on estimated excess taxable income as taxable income is earned.

 

We evaluate tax positions taken in the course of preparing our tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold, or uncertain tax positions, would be recorded as a tax expense in the current year. It is our policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. There were no material uncertain tax positions at March 31, 2012 and December 31, 2011.

 

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Recently Issued Accounting Standards

 

In May 2011, the FASB issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRs, (ASU 2011-04). ASU 2011-04 converges the fair value measurement guidance in U.S. GAAP and International Financial Reporting Standards (IFRSs). Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle in existing guidance. In addition, ASU 2011-04 requires additional fair value disclosures. The Company adopted ASU 2011-04 in the quarter ended March 31, 2012 and included the additional required disclosures in Note 5.

 

Item 3: Quantitative and Qualitative Disclosures About Market Risk.

 

We are subject to financial market risks, including changes in interest rates. During the periods covered by our financial statements, the interest rates on the loans within our portfolio were mostly at fixed rates and we expect that our loans in the future will also have primarily fixed interest rates. The initial commitments to lend to our portfolio companies are usually based on a floating LIBOR index and typically have interest rates that are fixed at the time of the loan funding and remain fixed for the term of the loan.

 

Assuming that the statement of assets and liabilities as of March 31, 2012 was to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical immediate 1% change in interest rates may affect net income by more than 1% over a one-year horizon. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets on the statement of assets and liabilities and other business developments that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.

 

Our Senior Notes bear interest at a fixed rate. Our Credit Facilities have a floating interest rate provision based on a LIBOR index which resets daily, and we expect that any other credit facilities into which we enter in the future may have floating interest rate provisions. We have used hedging instruments in the past to protect us against interest rate fluctuations and we may use them in the future. Such instruments may include swaps, futures, options and forward contracts. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to the investments in our portfolio with fixed interest rates.

 

Because we currently fund, and will continue to fund, our investments with borrowings, our net income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income.

 

Item 4: Controls and Procedures.

 

(a) Evaluation of Disclosure Controls and Procedures

 

As of March 31, 2012, we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls and procedures.

 

(b) Changes in Internal Controls Over Financial Reporting.

 

There have been no material changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during our most recently completed fiscal quarter, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Part II — Other Information

 

Item 1: Legal Proceedings.

 

Neither we nor our Advisor are currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us or against our Advisor.

 

33
 

 

Item 1A: Risk Factors.

 

In addition to other information set forth in this report, you should carefully consider the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition and/or operating results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially affect our business, financial condition and/or operating results. There have been no material changes during the three months ended March 31, 2012 to the risk factors discussed in “Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2011.

 

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3: Defaults Upon Senior Securities.

 

None.

 

Item 4: Mine Safety Disclosures.

 

Not applicable

 

Item 5: Other Information.

 

None.

 

Item 6: Exhibits.

 

EXHIBIT INDEX

 

Number   Description
31.1   Certifications by Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
31.2   Certifications by Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
     
32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

 

 

*Filed herewith

 

34
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  Horizon Technology Finance Corporation  
     
Date: May 8, 2012 By: /s/ Robert D. Pomeroy, Jr.  
    Name: Robert D. Pomeroy, Jr.  
    Title: Chief Executive Officer and
Chairman of the Board
 
         
         
Date: May 8, 2012 By: /s/ Christopher M. Mathieu  
    Name: Christopher M. Mathieu  
    Title: Chief Financial Officer and Treasurer  

 

35

 

Exhibit 31.1

 

Certification of Chief Executive Officer
of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a)

 

I, Robert D. Pomeroy, Jr., as Chairman of the Board and Chief Executive Officer of Horizon Technology Finance Corporation and Subsidiaries, certify that:

 

1) I have reviewed this quarterly report on Form10-Q of Horizon Technology Finance Corporation and Subsidiaries;

 

2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4) The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; and

 

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 8, 2012

 

By: /s/ Robert D. Pomeroy, Jr.  
  Name: Robert D. Pomeroy, Jr.  
  Title: Chief Executive Officer and Chairman of
the Board
 

 

 

 

 

 

Exhibit 31.2

 

Certification of Chief Financial Officer
of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a)

 

I, Christopher M. Mathieu, Chief Financial Officer and Treasurer of Horizon Technology Finance Corporation and Subsidiaries, certify that:

 

1) I have reviewed this quarterly report on Form10-Q of Horizon Technology Finance Corporation and Subsidiaries;

 

2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4) The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; and

 

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 8, 2012

 

By: /s/ Christopher M. Mathieu  
  Name: Christopher M. Mathieu  
  Title: Chief Financial Officer and Treasurer  

 

 

 

Exhibit 32.1

 

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report on Form 10-Q of Horizon Technology Finance Corporation and Subsidiaries, (the “Company”) for the quarterly period ended March 31, 2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert D. Pomeroy, Jr., as Chief Executive Officer and Chairman of the Board of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to our knowledge:

 

(1)The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.

 

Date: May 8, 2012 /s/ Robert D. Pomeroy, Jr.  
  Robert D. Pomeroy, Jr.  
  Chief Executive Officer and Chairman of the Board  

 

 

 

Exhibit 32.2

 

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report on Form 10-Q of Horizon Technology Finance Corporation and Subsidiaries, (the “Company”) for the quarterly period ended March 31, 2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Christopher M. Mathieu, as Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to our knowledge:

 

(1)The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.

 

Date: May 8, 2012 /s/ Christopher M. Mathieu  
  Christopher M. Mathieu  
  Chief Financial Officer and Treasurer