UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

 

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018
     
    OR
     
¨   TRANSITION 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)

 

(860) 676-8654
(Registrant’s telephone number, including area code)

 

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 x No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer x
       
Non-accelerated filer ¨   Smaller reporting company ¨
       
Emerging growth company ¨    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act        ¨

 

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

 

The number of shares of the registrant’s common stock, $0.001 par value per share, outstanding as of October 30, 2018 was 11,532,652.

 

 

 

 

 

HORIZON TECHNOLOGY FINANCE CORPORATION

 

FORM 10-Q

TABLE OF CONTENTS

 

    Page
     
  PART I  
Item 1. Consolidated Financial Statements 3
     
  Consolidated Statements of Assets and Liabilities as of September 30, 2018 and December 31, 2017 (unaudited) 3
  Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017 (unaudited) 4
  Consolidated Statements of Changes in Net Assets for the nine months ended September 30, 2018 and 2017 (unaudited) 5
  Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (unaudited) 6
  Consolidated Schedules of Investments as of September 30, 2018 and December 31, 2017 (unaudited) 7
  Notes to the Consolidated Financial Statements (unaudited) 17
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 42
Item 3. Quantitative and Qualitative Disclosures About Market Risk 60
Item 4. Controls and Procedures 60
     
PART II
     
Item 1. Legal Proceedings 62
Item 1A. Risk Factors 62
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 66
Item 3. Defaults Upon Senior Securities 66
Item 4. Mine Safety Disclosures 66
Item 5. Other Information 66
Item 6. Exhibits 66
  Signatures 67
     
EX-31.1    
EX-31.2    
EX-32.1    
EX-32.2    

 

 2 

 

 

 

PART I: FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Assets and Liabilities (Unaudited)

(Dollars in thousands, except share and per share data)

 

   September 30,
2018
   December 31,
2017
 
         
Assets          
Non-affiliate investments at fair value (cost of $228,313 and $219,303, respectively)  $227,813   $218,600 
Non-controlled affiliate investments at fair value (cost of $7,882 and $3,774, respectively) (Note 5)   7,531    3,499 
Controlled affiliate investments at fair value (cost of $4,413 and $0, respectively) (Note 5)   4,413     
Total investments at fair value (cost of $240,608 and $223,077, respectively) (Note 4)   239,757    222,099 
Cash   5,909    6,594 
Interest receivable   4,765    3,986 
Other assets   1,731    1,467 
Total assets  $252,162   $234,146 
           
Liabilities          
Borrowings (Note 7)  $112,284   $94,075 
Distributions payable   3,459    3,456 
Base management fee payable (Note 3)   410    379 
Incentive fee payable (Note 3)   851    541 
Other accrued expenses   702    620 
Total liabilities   117,706    99,071 
           
Commitments and Contingencies (Note 8)          
           
Net assets          
Preferred stock, par value $0.001 per share, 1,000,000 shares authorized, zero shares issued and outstanding as of September 30, 2018 and December 31, 2017        
Common stock, par value $0.001 per share, 100,000,000 shares authorized, 11,698,864 and 11,687,871 shares issued and 11,531,399 and 11,520,406 shares outstanding as of September 30, 2018 and December 31, 2017, respectively   12    12 
Paid-in capital in excess of par   179,606    179,641 
Distributions in excess of net investment income   (2,372)   (1,898)
Net unrealized depreciation on investments   (851)   (978)
Net realized loss on investments   (41,939)   (41,702)
Total net assets   134,456    135,075 
Total liabilities and net assets  $252,162   $234,146 
Net asset value per common share  $11.66   $11.72 

 

See Notes to Consolidated Financial Statements

 

 3 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Operations (Unaudited)

(Dollars in thousands, except share and per share data)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30, 
   2018   2017   2018   2017 
Investment income                    
Interest income on investments                    
Interest income on non-affiliate investments  $7,094   $6,164   $20,385   $17,861 
Interest income on non-controlled affiliate investments   193    81    528    81 
Total interest income on investments   7,287    6,245    20,913    17,942 
Fee income                    
Prepayment fee income on non-affiliate investments   102    399    414    1,187 
Fee income on non-affiliate investments   325    130    875    485 
Total fee income   427    529    1,289    1,672 
Dividend income                    
Dividend income on affiliate investments   83        83     
Total dividend income   83        83     
Total investment income   7,797    6,774    22,285    19,614 
Expenses                    
Interest expense   1,681    1,140    4,616    3,540 
Base management fee (Note 3)   1,197    921    3,399    2,783 
Performance based incentive fee (Note 3)   1,297    258    2,823    1,094 
Administrative fee (Note 3)   162    194    517    575 
Professional fees   289    275    997    1,105 
General and administrative   215    189    636    600 
Total expenses   4,841    2,977    12,988    9,697 
Performance based incentive fee waived (Note 3)   (446)       (605)    
Net expenses   4,395    2,977    12,383    9,697 
Net investment income   3,402    3,797    9,902    9,917 
Net realized and unrealized gain (loss) on investments                    
Net realized gain (loss) on non-affiliate investments   66    (429)   (237)   (11,098)
Net realized gain (loss) on investments   66    (429)   (237)   (11,098)
Net unrealized appreciation (depreciation) on non-affiliate investments   761    (640)   202    8,295 
Net unrealized appreciation (depreciation) on non-controlled affiliate investments   30    (19)   (75)   (19)
Net unrealized appreciation (depreciation) on investments   791    (659)   127    8,276 
Net realized and unrealized gain (loss) on investments   857    (1,088)   (110)   (2,822)
Net increase in net assets resulting from operations  $4,259   $2,709   $9,792   $7,095 
Net investment income per common share  $0.30   $0.33   $0.86   $0.86 
Net increase in net assets per common share  $0.37   $0.24   $0.85   $0.62 
Distributions declared per share  $0.30   $0.30   $0.90   $0.90 
Weighted average shares outstanding   11,529,611    11,518,552    11,525,906    11,516,246 

 

See Notes to Consolidated Financial Statements

 

 4 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Changes in Net Assets (Unaudited)

(Dollars in thousands, except share data)

 

   Common Stock  

Paid-In

Capital in

Excess of

  

Distributions

in Excess of

Net

Investment

  

Net Unrealized

Depreciation

on

  

Net Realized

Loss on

   Total Net 
   Shares   Amount   Par   Income   Investments   Investments   Assets 
Balance at December 31, 2016   11,510,424   $12   $179,551   $(397)  $(19,463)  $(20,511)  $139,192 
Net increase in net assets resulting from operations               9,917    8,276    (11,098)   7,095 
Issuance of common stock under dividend reinvestment plan   12,278        134                134 
Repurchases of common stock   (5,923)       (59)               (59)
Distributions declared               (10,366)           (10,366)
Balance at September 30, 2017   11,516,779   $12   $179,626   $(846)  $(11,187)  $(31,609)  $135,996 
                                    
Balance at December 31, 2017   11,520,406   $12   $179,641   $(1,898)  $(978)  $(41,702)  $135,075 
Net increase in net assets resulting from operations               9,902    127    (237)   9,792 
Financing costs           (155)               (155)
Issuance of common stock under dividend reinvestment plan   10,993        120                120 
Distributions declared               (10,376)           (10,376)
Balance at September 30, 2018   11,531,399   $12   $179,606   $(2,372)  $(851)  $(41,939)  $134,456 

 

See Notes to Consolidated Financial Statements

 

 5 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

   For the Nine Months Ended 
   September 30, 
   2018   2017 
Cash flows from operating activities:          
Net increase in net assets resulting from operations  $9,792   $7,095 
Adjustments to reconcile net increase in net assets resulting from operations to net cash (used in) provided by operating activities:          
Amortization of debt issuance costs   420    383 
Net realized loss on investments   237    11,098 
Net unrealized appreciation on investments   (127)   (8,276)
Purchase of investments   (62,246)   (66,311)
Principal payments received on investments   46,503    80,062 
Investments in controlled affiliate investments   (4,413)    
Proceeds from sale of investments   3,360    1,572 
Equity received in settlement of fee income   (299)    
Warrants received in settlement of fee income   (161)    
Changes in assets and liabilities:          
(Increase) decrease in interest receivable   (48)   253 
(Increase) decrease in end-of-term payments   (731)   1,008 
Decrease in unearned income   (512)   (437)
Decrease in other assets   72    423 
Increase in other accrued expenses   82    22 
Increase (decrease) in base management fee payable   31    (33)
Increase in incentive fee payable   310    258 
Net cash (used in) provided by operating activities   (7,730)   27,117 
Cash flows from financing activities:          
Proceeds from issuance of 2022 Notes       32,500 
Advances on credit facility   28,000    34,000 
Repayment of credit facility   (10,000)   (97,000)
Distributions paid   (10,253)   (10,230)
Repurchase of common stock       (59)
Debt issuance costs   (547)   (1,137)
Financing costs   (155)    
Net cash provided by (used in) financing activities   7,045    (41,926)
Net decrease in cash   (685)   (14,809)
Cash:          
Beginning of period   6,594    37,135 
End of period  $5,909   $22,326 
Supplemental disclosure of cash flow information:          
Cash paid for interest  $4,085   $3,242 
Supplemental non-cash investing and financing activities:          
Warrant investments received and recorded as unearned income  $1,007   $1,482 
Distributions payable  $3,459   $3,455 
End-of-term payments receivable  $3,667   $3,657 
Receivable resulting from sale of investment  $59   $ 

 

See Notes to Consolidated Financial Statements

 

 6 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

September 30, 2018

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
Non-Affiliate Investments — 169.4% (8)               
Non-Affiliate Debt Investments — 155.1% (8)               
Non-Affiliate Debt Investments — Life Science — 53.0% (8)               
Celsion Corporation (2)(5)(12)  Biotechnology  Term Loan (9.73% cash (Libor + 7.63%; Floor  $2,500   $2,446   $2,446 
      9.63%), 4.00% ETP, Due 7/1/22)               
      Term Loan (9.73% cash (Libor + 7.63%; Floor   2,500    2,446    2,446 
      9.63%), 4.00% ETP, Due 7/1/22)               
      Term Loan (9.73% cash (Libor + 7.63%; Floor   2,500    2,446    2,446 
      9.63%), 4.00% ETP, Due 7/1/22)               
      Term Loan (9.73% cash (Libor + 7.63%; Floor   2,500    2,446    2,446 
      9.63%), 4.00% ETP, Due 7/1/22)               
Espero BioPharma, Inc. (2)(12)  Biotechnology  Term Loan (12.00% cash (Libor + 9.9%; Floor   5,000    4,689    4,689 
      12.00%), 4.00% ETP, Due 6/30/19)               
Palatin Technologies, Inc. (2)(5)(12)  Biotechnology  Term Loan (10.60% cash (Libor + 8.50%; Floor   500    495    495 
      9.00%), 5.00% ETP, Due 1/1/19)               
      Term Loan (10.60% cash (Libor + 8.50%; Floor   500    500    500 
      9.00%), 3.44% ETP, Due 1/1/19)               
      Term Loan (10.60% cash (Libor + 8.50%; Floor   1,667    1,652    1,652 
      9.00%), 5.00% ETP, Due 8/1/19)               
      Term Loan (10.60% cash (Libor + 8.50%; Floor   1,667    1,667    1,667 
      9.00%), 3.27% ETP, Due 8/1/19)               
vTv Therapeutics Inc. (2)(5)(12)  Biotechnology  Term Loan (12.10% cash (Libor + 10.00%; Floor   4,948    4,912    4,912 
      10.50%), 6.00% ETP, Due 5/1/20)               
      Term Loan (12.10% cash (Libor + 10.00%; Floor   3,750    3,714    3,714 
      10.50%), 6.00% ETP, Due 10/1/20)               
Titan Pharmaceuticals, Inc. (2)(5)(12)  Drug Delivery  Term Loan (10.50% cash (Libor + 8.40%; Floor   1,600    1,484    1,484 
      9.50%), 5.00% ETP, Due 6/1/21)               
Aerin Medical, Inc. (2)(12)  Medical Device  Term Loan (9.55% cash (Libor + 7.45%; Floor   4,000    3,887    3,887 
      8.75%), 4.00% ETP, Due 1/1/22)               
      Term Loan (9.55% cash (Libor + 7.45%; Floor   3,000    2,963    2,963 
      8.75%), 4.00% ETP, Due 1/1/22)               
      Term Loan (9.55% cash (Libor + 7.45%; Floor   3,000    2,963    2,963 
      8.75%), 4.00% ETP, Due 1/1/22)               
Conventus Orthopaedics, Inc. (2)(12)  Medical Device  Term Loan (10.10% cash (Libor + 8.00%; Floor   4,000    3,944    3,944 
      9.25%), 6.00% ETP, Due 6/1/21)               
      Term Loan (10.10% cash (Libor + 8.00%; Floor   4,000    3,944    3,944 
      9.25%), 6.00% ETP, Due 6/1/21)               
      Term Loan (10.10% cash (Libor + 8.00%; Floor   4,000    3,944    3,944 
      9.25%), 6.00% ETP, Due 6/1/21)               
CSA Medical, Inc. (12)  Medical Device  Term Loan (10.14% cash (Libor + 7.93%; Floor   6,000    5,761    5,761 
      10.00%), 5.00% ETP, Due 10/1/22)               
Lantos Technologies, Inc. (2)(12)  Medical Device  Term Loan (10.53% cash (Libor + 8.43%; Floor   4,000    3,522    3,522 
      10.00%), 6.00% ETP, Due 9/1/21)               
MacuLogix, Inc. (2)(12)  Medical Device  Term Loan (9.78% cash (Libor + 7.68%; Floor   3,750    3,525    3,525 
      9.50%), 4.00% ETP, Due 8/1/22)               
VERO Biotech LLC (2)(12)  Medical Device  Term Loan (10.10% cash (Libor + 8.00%; Floor   4,000    3,946    3,946 
      9.25%), 5.00% ETP, Due 1/1/22)               
      Term Loan (10.10% cash (Libor + 8.00%; Floor   4,000    3,946    3,946 
      9.25%), 5.00% ETP, Due 1/1/22)               
Total Non-Affiliate Debt Investments — Life Science        71,242    71,242 
Non-Affiliate Debt Investments — Technology — 84.7% (8)               
Audacy Corporation (2)(12)  Communications  Term Loan (10.00% cash (Libor + 7.90%; Floor   4,000    3,932    3,932 
      9.50%), 5.00% ETP, Due 7/1/22)               
Intelepeer Holdings, Inc. (2)(12)  Communications  Term Loan (12.05% cash (Libor + 9.95%; Floor   4,000    3,942    3,942 
      11.25%), 2.50% ETP, Due 7/1/21)               
      Term Loan (12.05% cash (Libor + 9.95%; Floor   4,000    3,942    3,942 
      11.25%), 2.50% ETP, Due 7/1/21)               
      Term Loan (12.05% cash (Libor + 9.95%; Floor   4,000    3,942    3,942 
      11.25%), 2.50% ETP, Due 7/1/21)               
      Term Loan (12.05% cash (Libor + 9.95%; Floor   3,000    2,952    2,952 
      11.25%), 2.50% ETP, Due 2/1/22)               
PebblePost, Inc. (2) (12)  Communications  Term Loan (11.36% cash (Libor + 9.26%; Floor   4,000    3,947    3,947 
      10.25%), 4.00% ETP, Due 7/1/21)               

 

See Notes to Consolidated Financial Statements

 

 7 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

September 30, 2018

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
      Term Loan (11.36% cash (Libor + 9.26%; Floor   4,000    3,947    3,947 
      10.25%), 4.00% ETP, Due 7/1/21)               
IgnitionOne, Inc. (2)(12)  Internet and Media  Term Loan (12.33% cash (Libor + 10.23%; Floor   3,000    2,861    2,861 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (12.33% cash (Libor + 10.23%; Floor   3,000    2,861    2,861 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (12.33% cash (Libor + 10.23%; Floor   3,000    2,861    2,861 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (12.33% cash (Libor + 10.23%; Floor   3,000    2,861    2,861 
      10.23%), 2.00% ETP, Due 4/1/22)               
Jump Ramp Games, Inc. (2)(12)  Internet and Media  Term Loan (11.83% cash (Libor + 9.73%),   4,000    3,956    3,851 
      3.00% ETP, Due 4/1/21)               
Kixeye, Inc. (2)(12)  Internet and Media  Term Loan (11.70% cash (Libor + 9.60%; Floor   2,750    2,658    2,658 
      10.75%), 2.00% ETP, Due 5/1/21)               
      Term Loan (11.70% cash (Libor + 9.60%; Floor   2,750    2,707    2,707 
      10.75%), 2.00% ETP, Due 5/1/21)               
Rocket Lawyer Incorporated (2)(12)  Internet and Media  Term Loan (11.50% cash (Libor + 9.40%; Floor   4,000    3,947    3,947 
      10.50%), 3.00% ETP, Due 7/1/21)               
      Term Loan (11.50% cash (Libor + 9.40%; Floor   4,000    3,947    3,947 
      10.50%), 3.00% ETP, Due 7/1/21)               
      Term Loan (11.50% cash (Libor + 9.40%; Floor   2,000    1,971    1,971 
      10.50%), 3.00% ETP, Due 11/1/21)               
Verve Wireless, Inc. (2)(12)  Internet and Media  Term Loan (10.90% cash (Libor + 8.80%; Floor   3,600    3,460    3,460 
      10.80%), 3.33% ETP, Due 9/1/21)               
Zinio Holdings, LLC (2)(12)  Internet and Media  Term Loan (13.35% cash (Libor + 11.25%; Floor   3,400    3,386    3,386 
      11.75%), 6.00% ETP, Due 2/1/20)               
The NanoSteel Company, Inc. (2)(12)  Materials  Term Loan (11.60% cash (Libor + 9.50%; Floor   3,959    3,891    3,891 
      10.00%), 7.20% ETP, Due 5/1/20)               
      Term Loan (11.60% cash (Libor + 9.50%; Floor   1,980    1,955    1,955 
      10.00%), 6.45% ETP, Due 5/1/20)               
      Term Loan (11.60% cash (Libor + 9.50%; Floor   2,188    2,159    2,159 
      10.00%), 5.85% ETP, Due 7/1/20)               
Powerhouse Dynamics, Inc. (2)(12)  Power Management  Term Loan (12.80% cash (Libor + 10.70%; Floor   700    682    682 
      11.20%), 3.32% ETP, Due 9/1/19)               
Luxtera, Inc. (12)  Semiconductors  Term Loan (12.00% cash (Prime + 6.75%),   2,000    1,934    1,934 
      Due 3/28/20)               
      Term Loan (12.00% cash (Prime + 6.75%),   1,500    1,462    1,462 
      Due 3/28/20)               
Bridge2 Solutions, LLC. (2)(12)  Software  Term Loan (11.35% cash (Libor + 9.25%; Floor   5,000    4,821    4,821 
      10.50%), 2.00% ETP, Due 11/1/21)               
      Term Loan (11.35% cash (Libor + 9.25%; Floor   5,000    4,821    4,821 
      10.50%), 2.00% ETP, Due 11/1/21)               
Education Elements, Inc. (2)(12)  Software  Term Loan (12.10% cash (Libor + 10.00%; Floor   200    197    197 
      10.50%), 4.00% ETP, Due 1/1/19)               
      Term Loan (12.10% cash (Libor + 10.00%; Floor   500    493    493 
      10.50%), 4.00% ETP, Due 8/1/19)               
New Signature US, Inc. (2)(12)(13)  Software  Term Loan (10.60% cash (Libor + 8.50%; Floor   2,750    2,697    2,697 
      10.50%), 3.50% ETP, Due 7/1/22)               
ShopKeep.com, Inc. (2)(12)  Software  Term Loan (12.05% cash (Libor + 9.95%; Floor   4,900    4,825    4,825 
      10.45%), 4.08% ETP, Due 10/1/20)               
      Term Loan (12.05% cash (Libor + 9.95%; Floor   3,600    3,542    3,542 
      10.45%), 3.55% ETP, Due 2/1/21)               
SIGNiX, Inc. (12)  Software  Term Loan (13.10% cash (Libor + 11.00%; Floor   1,995    1,927    1,605 
      11.50%), 6.17% ETP, Due 2/1/20)               
xAd, Inc. (2)(12)  Software  Term Loan (10.80% cash (Libor + 8.70%; Floor   5,000    4,916    4,916 
      10.00%), 4.75% ETP, Due 11/1/21)               
      Term Loan (10.80% cash (Libor + 8.70%; Floor   5,000    4,916    4,916 
      10.00%), 4.75% ETP, Due 11/1/21)               
      Term Loan (10.80% cash (Libor + 8.70%; Floor   3,000    2,950    2,950 
      10.00%), 4.75% ETP, Due 11/1/21)               
      Term Loan (10.80% cash (Libor + 8.70%; Floor   2,000    1,966    1,966 

 

See Notes to Consolidated Financial Statements

 

 8 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

September 30, 2018

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
      10.00%), 4.75% ETP, Due 11/1/21)               
Total Non-Affiliate Debt Investments — Technology        114,234    113,807 
Non-Affiliate Debt Investments — Healthcare information and services — 17.4% (8)          
Catasys, Inc. (2)(5)(12)  Software  Term Loan (9.85% cash (Libor + 7.75%;   2,500    2,477    2,477 
      Floor 9.75%), 6.00% ETP, Due 3/1/22)               
      Term Loan (9.85% cash (Libor + 7.75%;   2,500    2,477    2,477 
      Floor 9.75%), 6.00% ETP, Due 3/1/22)               
      Term Loan (9.85% cash (Libor + 7.75%;   2,500    2,476    2,476 
      Floor 9.75%), 6.00% ETP, Due 3/1/22)               
HealthEdge Software, Inc. (2)(12)  Software  Term Loan (10.35% cash (Libor + 8.25%;   5,000    4,905    4,905 
      Floor 9.25%), 3.00% ETP, Due 7/1/22)               
      Term Loan (10.35% cash (Libor + 8.25%;   3,750    3,701    3,701 
      Floor 9.25%), 3.00% ETP, Due 1/1/23)               
      Term Loan (10.35% cash (Libor + 8.25%;   3,750    3,698    3,698 
      Floor 9.25%), 3.00% ETP, Due 4/1/23)               
      Term Loan (10.46% cash (Libor + 8.25%;   3,750    3,696    3,696 
      Floor 9.25%), 3.00% ETP, Due 10/1/23)               
Total Non-Affiliate Debt Investments — Healthcare information and services        23,430    23,430 
Total Non- Affiliate Debt Investments        208,906    208,479 
                      
Non-Affiliate Warrant Investments — 7.7% (8)               
Non-Affiliate Warrants — Life Science — 1.7% (8)               
ACT Biotech Corporation  Biotechnology  130,872 Preferred Stock Warrants        12     
Alpine Immune Sciences, Inc. (5)(12)  Biotechnology  4,634 Common Stock Warrants        122     
Argos Therapeutics, Inc. (2)(5)(12)  Biotechnology  3,656 Common Stock Warrants        33     
Celsion Corporation (2)(5)(12)  Biotechnology  190,522 Common Stock Warrants        145    107 
Espero BioPharma, Inc. (2)(5)(12)  Biotechnology  833,792 Common Stock Warrants        184    184 
Rocket Pharmaceuticals Corporation (5)(12)  Biotechnology  1,763 Common Stock Warrants        17     
Palatin Technologies, Inc. (2)(5)(12)  Biotechnology  608,058 Common Stock Warrants        51    153 
Revance Therapeutics, Inc. (5)(12)  Biotechnology  34,113 Common Stock Warrants        68    367 
Sample6, Inc. (2)(12)  Biotechnology  661,956 Preferred Stock Warrants        53    26 
Strongbridge U.S. Inc. (2)(5)(12)  Biotechnology  160,714 Common Stock Warrants        72    419 
Sunesis Pharmaceuticals, Inc. (5)(12)  Biotechnology  2,050 Common Stock Warrants        5     
vTv Therapeutics Inc. (2)(5)(12)  Biotechnology  95,293 Common Stock Warrants        44     
Titan Pharmaceuticals, Inc. (2)(5)(12)  Drug Delivery  320,612 Common Stock Warrants        95     
AccuVein Inc. (2)(12)  Medical Device  1,174,881 Preferred Stock Warrants        24    29 
Aerin Medical, Inc. (2)(12)  Medical Device  1,818,182 Preferred Stock Warrants        66    71 
Conventus Orthopaedics, Inc. (2)(12)  Medical Device  720,000 Preferred Stock Warrants        95    102 
CSA Medical, Inc. (12)  Medical Device  1,569,577 Preferred Stock Warrants        89    89 
Lantos Technologies, Inc. (2)(12)  Medical Device  1,715,926 Common Stock Warrants        253    285 
MacuLogix, Inc. (2)(12)  Medical Device  158,451 Preferred Stock Warrants        156    156 
Mitralign, Inc. (2)(12)  Medical Device  64,190 Common Stock Warrants        52    1 
NinePoint Medical, Inc. (2)(12)  Medical Device  29,102 Preferred Stock Warrants        33     
ReShape Lifesciences Inc. (5)(12)  Medical Device  134 Common Stock Warrants        347     
Tryton Medical, Inc. (2)(12)  Medical Device  122,362 Preferred Stock Warrants        15    13 
VERO Biotech LLC (2)(12)  Medical Device  800 Common Stock Warrants        53    334 
ViOptix, Inc. (12)  Medical Device  375,763 Preferred Stock Warrants        13     
Total Non-Affiliate Warrants — Life Science        2,097    2,336 
Non-Affiliate Warrants — Technology — 5.4% (8)               
Audacy Corporation (2)(12)  Communications  1,017,173 Preferred Stock Warrants        194    195 
Ekahau, Inc. (2)(12)  Communications  978,261 Preferred Stock Warrants        33    899 
Intelepeer Holdings, Inc. (2)(12)  Communications  2,451,549 Preferred Stock Warrants        160    128 
PebblePost, Inc. (2)(12)  Communications  598,850 Preferred Stock Warrants        92    163 
Additech, Inc. (2)(12)  Consumer-related Technologies  150,000 Preferred Stock Warrants        32     
Gwynnie Bee, Inc. (2)(12)  Consumer-related Technologies  268,591 Preferred Stock Warrants        68    823 
Le Tote, Inc. (2)(12)  Consumer-related Technologies  202,974 Preferred Stock Warrants        63    373 
Rhapsody International Inc. (2)(12)  Consumer-related Technologies  852,273 Common Stock Warrants        164     
IgnitionOne, Inc. (2)(12)  Internet and Media  262,910 Preferred Stock Warrants        672    666 
Jump Ramp Games, Inc. (2)(12)  Internet and Media  159,766 Preferred Stock Warrants        32    8 
Kixeye, Inc. (2)(12)  Internet and Media  791,251 Preferred Stock Warrants        75    62 
Rocket Lawyer Incorporated (2)(12)  Internet and Media  261,721 Preferred Stock Warrants        92    78 
Verve Wireless, Inc. (2)(12)  Internet and Media  112,805 Common Stock Warrants        120    120 

 

See Notes to Consolidated Financial Statements

 

 9 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

September 30, 2018

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
                      
The NanoSteel Company, Inc. (2)(12)  Materials  379,360 Preferred Stock Warrants        187    528 
Powerhouse Dynamics, Inc. (2)(12)  Power Management  348,838 Preferred Stock Warrants        33    34 
Avalanche Technology, Inc. (2)(12)  Semiconductors  202,602 Preferred Stock Warrants        101    38 
Kaminario, Inc. (12)  Semiconductors  4,800,000 Preferred Stock Warrants        59    97 
Luxtera, Inc.(2)(12)  Semiconductors  3,546,553 Preferred Stock Warrants        213    401 
Soraa, Inc. (2)(12)  Semiconductors  203,616 Preferred Stock Warrants        80    430 
Bolt Solutions Inc. (2)(12)  Software  202,892 Preferred Stock Warrants        113    106 
Bridge2 Solutions, Inc. (2)(12)  Software  125,458 Common Stock Warrants        432    767 
BSI Platform Holdings, LLC (2)(12)(13)  Software  137,500 Preferred Stock Warrants        19    19 
Clarabridge, Inc. (12)  Software  53,486 Preferred Stock Warrants        14    106 
Education Elements, Inc. (2)(12)  Software  238,121 Preferred Stock Warrants        28    30 
Lotame Solutions, Inc. (2)(12)  Software  288,115 Preferred Stock Warrants        22    289 
Metricly, Inc. (12)  Software  41,569 Common Stock Warrants        48     
Riv Data Corp. (2)(12)  Software  321,428 Preferred Stock Warrants        12    37 
ShopKeep.com, Inc. (2)(12)  Software  193,962 Preferred Stock Warrants        118    117 
SIGNiX, Inc. (12)  Software  133,560 Preferred Stock Warrants        225    36 
Skyword, Inc. (12)  Software  301,056 Preferred Stock Warrants        48    3 
Sys-Tech Solutions, Inc. (2)(12)  Software  375,000 Preferred Stock Warrants        242    444 
Weblinc Corporation (2)(12)  Software  195,122 Preferred Stock Warrants        42     
xAd, Inc. (2)(12)  Software  4,343,350 Preferred Stock Warrants        177    299 
Total Non-Affiliate Warrants — Technology        4,010    7,296 
Non-Affiliate Warrants — Cleantech — 0.1% (8)               
Renmatix, Inc. (2)(12)  Alternative Energy  53,022 Preferred Stock Warrants        68     
Tigo Energy, Inc. (2)(12)  Energy Efficiency  804,604 Preferred Stock Warrants        100    113 
Total Non-Affiliate Warrants — Cleantech        168    113 
Non-Affiliate Warrants — Healthcare information and services — 0.5% (8)               
LifePrint Group, Inc. (2)(12)  Diagnostics  49,000 Preferred Stock Warrants        29    2 
ProterixBio, Inc. (2)(12)  Diagnostics  2,676 Common Stock Warrants        42     
Singulex, Inc. (12)  Other Healthcare  294,231 Preferred Stock Warrants        44    46 
Verity Solutions Group, Inc. (12)  Other Healthcare  300,360 Preferred Stock Warrants        100    67 
Watermark Medical, Inc. (2)(12)  Other Healthcare  27,373 Preferred Stock Warrants        74    63 
HealthEdge Software, Inc. (2)(12)  Software  205,481 Preferred Stock Warrants        83    72 
Medsphere Systems Corporation (2)(12)  Software  7,097,792 Preferred Stock Warrants        60    216 
Recondo Technology, Inc. (2)(12)  Software  556,796 Preferred Stock Warrants        95    215 
Total Non-Affiliate Warrants — Healthcare information and services        527    681 
Total Non-Affiliate Warrants              6,802    10,426 
                      
Non-Affiliate Other Investments — 5.7% (8)               
Espero Pharmaceuticals, Inc. (12)  Biotechnology  Royalty Agreement        5,300    4,700 
ZetrOZ, Inc. (12)  Medical Device  Royalty Agreement        179    700 
Vette Technology, LLC (12)  Data Storage  Royalty Agreement Due 4/18/2019        4,183    60 
Triple Double Holdings, LLC (12)  Software  License Agreement        2,200    2,200 
Total Non-Affiliate Other Investments        11,862    7,660 
                      
Non-Affiliate Equity — 0.9% (8)               
Insmed Incorporated (5)  Biotechnology  33,208 Common Stock        238    671 
Revance Therapeutics, Inc.(5)  Biotechnology  5,125 Common Stock        73    127 
Sunesis Pharmaceuticals, Inc. (5)  Biotechnology  13,082 Common Stock        83    27 
SnagAJob.com, Inc. (12)  Consumer-related Technologies  82,974 Common Stock        9    83 
Verve Wireless, Inc. (2)(12)  Internet and Media  100,598 Preferred Stock        225    225 
Formetrix, Inc. (2)(12)  Materials  74,286 Common Stock        74    74 
TruSignal, Inc. (12)  Software  32,637 Common Stock        41    41 
Total Non-Affiliate Equity              743    1,248 
Total Non-Affiliate Portfolio Investment Assets       $228,313   $227,813 
                      
Non-controlled Affiliate Investments — 5.6% (8)               
Non-controlled Affiliate Debt Investments — Technology — 5.0% (8)               
Decisyon, Inc. (12)  Software  Term Loan (14.408% cash (Libor + 12.308%; Floor  $1,523   $1,522   $1,449 
      12.50%), 8.00% ETP, Due 12/1/20)               
      Term Loan (14.408% cash (Libor + 12.308%; Floor   833    790    752 
      12.50%), 8.00% ETP, Due 12/1/20)               
      Term Loan (12.02% cash, Due 12/31/19)   250    250    238 

 

See Notes to Consolidated Financial Statements

 

 10 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

September 30, 2018

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
      Term Loan (12.03% cash, Due 12/31/19)   250    250    238 
      Term Loan (12.24% cash, Due 12/31/19)   750    750    714 
      Term Loan (13.08% cash, Due 12/31/19)   300    300    286 
      Term Loan (13.10% cash, Due 12/31/19)   200    200    190 
StereoVision Imaging, Inc. (12)  Software  Term Loan (9.13% PIK (Libor + 7.03%; Floor   3,200    2,798    2,798 
      8.50%), 8.50% ETP, Due 9/1/21) (11)               
Total Non-controlled Affiliate Debt Investments — Technology        6,860    6,665 
                       
Non-controlled Affiliate Warrants — Technology — 0.0% (8)               
Decisyon, Inc. (12)  Software  82,967 Common Stock Warrants        46     
Total Non-controlled Affiliate Warrants — Technology        46     
                      
Non-controlled Affiliate Equity — Technology — 0.6% (8)               
Decisyon, Inc. (12)  Software  45,365,936 Common Stock        185    75 
StereoVision Imaging, Inc. (12)  Software  1,943,572 Common Stock        791    791 
Total Non-controlled Affiliate Equity              976    866 
Total Non-controlled Affiliate Portfolio Investment Assets      $7,882   $7,531 
                      
                      
Controlled Affiliate Investments — 3.3% (8)               
Controlled Affiliate Equity — Financial — 3.3% (8)               
Horizon Secured Loan Fund I LLC (12)(14)  Investment funds          $4,413   $4,413 
Total Controlled Affiliate Equity              4,413    4,413 
Total Controlled Affiliate Portfolio Investment Assets       $4,413   $4,413 
                      
Total Portfolio Investment Assets — 178.3%(8)      $240,608   $239,757  

 

 
(1)   All investments of the Company are in entities which are organized under the laws of the United States and have a principal place of business in the United States.
     
(2)   Has been pledged as collateral under the Key Facility.
     
(3)   All non-affiliate investments are investments in which the Company owns less than 5% of the voting securities of the portfolio company. All non-controlled affiliate investments are investments in which the Company owns 5% or more of the voting securities of the portfolio company but not more than 25% of the voting securities of the portfolio company. All controlled affiliate investments are investments in which the Company owns more than 25% of the portfolio company’s outstanding voting securities or has the power to exercise control over management or policies of such portfolio company (including through a management agreement).
     
(4)   All interest is payable in cash due monthly in arrears, unless otherwise indicated, and applies only to the Company’s debt investments. Interest rate is the annual interest rate on the debt investment and does not include end-of-term payments (“ETPs”) and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. Debt investments are at variable rates for the term of the debt investment, unless otherwise indicated. All debt investments based on the London InterBank Offered Rate (“LIBOR”) are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of September 30, 2018 is provided.
     
(5)   Portfolio company is a public company.
     
(6)   For debt investments, represents principal balance less unearned income.
     
(7)   Warrants, Equity and Other Investments are non-income producing.
     
(8)   Value as a percent of net assets.
     
(9)   As of September 30, 2018, 1.8% of the Company’s total investments on a cost and fair value basis are in non-qualifying assets. Under the Investment Company Act of 1940, as amended (the “1940 Act”), the Company may not acquire any non-qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets.
     
(10)  

ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid. Therefore, a portion of the incentive fee the Company may pay its Advisor will be based on income that the Company has not yet received in cash.

     
(11)   Debt investment has a payment-in-kind (“PIK”) feature.
     
(12)   The fair value of the investment was valued using significant unobservable inputs.
     
(13)   New Signature US, Inc. is a subsidiary of BSI Platform Holdings, LLC.
     
(14)   On June 1, 2018, the Company entered into an agreement with Arena Sunset SPV, LLC (“Arena”) to co-invest through Horizon Secured Loan Fund I (“HSLFI”), a joint venture, which is expected to make investments, either directly or indirectly through subsidiaries, primarily in the form of secured loans to development-stage companies in the technology, life science, healthcare information and services and cleantech industries. All HSLFI investment decisions require unanimous approval of a quorum of HSLFI’s board of managers. Although the Company owns more than 25% of the voting securities of HSLFI, the Company does not believe it controls HSLFI for purposes of the 1940 Act or otherwise.

 

See Notes to Consolidated Financial Statements

 11 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

December 31, 2017

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
Non-Affiliate Investments — 161.8% (8)               
Non-Affiliate Debt Investments — 148.4% (8)               
Non-Affiliate Debt Investments — Life Science — 43.0% (8)               
Palatin Technologies, Inc. (2)(5)(14)  Biotechnology  Term Loan (9.87% cash (Libor + 8.50%; Floor  $2,000   $1,980   $1,980 
      9.00%), 5.00% ETP, Due 1/1/19)               
      Term Loan (9.87% cash (Libor + 8.50%; Floor   3,167    3,139    3,139 
      9.00%), 5.00% ETP, Due 8/1/19)               
vTv Therapeutics Inc. (2)(5)(14)  Biotechnology  Term Loan (11.37% cash (Libor + 10.00%; Floor   6,250    6,196    6,196 
      10.50%), 6.00% ETP, Due 5/1/20)               
      Term Loan (11.37% cash (Libor + 10.00%; Floor   3,750    3,700    3,700 
      10.50%), 6.00% ETP, Due 10/1/20)               
Titan Pharmaceuticals, Inc. (2)(5)(14)  Drug Delivery  Term Loan (9.77% cash (Libor + 8.40%; Floor   3,500    3,400    3,400 
      9.50%), 5.00% ETP, Due 6/1/21)               
      Term Loan (9.77% cash (Libor + 8.40%; Floor   3,500    3,430    3,430 
      9.50%), 5.00% ETP, Due 6/1/21)               
Aerin Medical, Inc. (2)(14)  Medical Device  Term Loan (8.85% cash (Libor + 7.45%; Floor   4,000    3,876    3,876 
      8.75%), 4.00% ETP, Due 1/1/22)               
      Term Loan (8.85% cash (Libor + 7.45%; Floor   3,000    2,954    2,954 
      8.75%), 4.00% ETP, Due 1/1/22)               
      Term Loan (8.85% cash (Libor + 7.45%; Floor   3,000    2,954    2,954 
      8.75%), 4.00% ETP, Due 1/1/22)               
Conventus Orthopaedics, Inc. (2)(14)  Medical Device  Term Loan (9.49% cash (Libor + 8.00%; Floor   4,000    3,928    3,928 
      9.25%), 6.00% ETP, Due 6/1/21)               
      Term Loan (9.49% cash (Libor + 8.00%; Floor   4,000    3,928    3,928 
      9.25%), 6.00% ETP, Due 6/1/21)               
      Term Loan (9.49% cash (Libor + 8.00%; Floor   4,000    3,928    3,928 
      9.25%), 6.00% ETP, Due 6/1/21)               
Lantos Technologies, Inc. (2)(14)  Medical Device  Term Loan (11.87% PIK (Libor + 10.50%; Floor   2,479    2,466    2,466 
      11.50%), 8.91% ETP, Due 5/1/19) (13)               
Mederi Therapeutics, Inc. (2)(14)  Medical Device  Term Loan (13.01% cash (Libor + 11.82%; Floor   173    173    163 
      12.00%), 6.00% ETP, Due 12/1/17)               
      Term Loan (13.01% cash (Libor + 11.82%; Floor   173    173    163 
      12.00%), 6.00% ETP, Due 12/1/17)               
NinePoint Medical, Inc. (2)(14)  Medical Device  Term Loan (10.12% cash (Libor + 8.75%; Floor   2,667    2,645    2,645 
      9.25%), 4.50% ETP, Due 3/1/19)               
      Term Loan (10.12% cash (Libor + 8.75%; Floor   1,333    1,320    1,320 
      9.25%), 4.50% ETP, Due 3/1/19)               
VERO Biotech LLC (2)(14)  Medical Device  Term Loan (9.33% cash (Libor + 8.00%; Floor   4,000    3,914    3,914 
      9.25%), 5.00% ETP, Due 1/1/22)               
      Term Loan (9.33% cash (Libor + 8.00%; Floor   4,000    3,934    3,934 
      9.25%), 5.00% ETP, Due 1/1/22)               
Total Non-Affiliate Debt Investments — Life Science       58,038    58,018 
Non-Affiliate Debt Investments — Technology — 99.1% (8)               
Intelepeer Holdings, Inc. (14)  Communications  Term Loan (11.39% cash (Libor + 9.95%; Floor   4,000    3,888    3,888 
      11.25%), 2.50% ETP, Due 7/1/21)               
      Term Loan (11.39% cash (Libor + 9.95%; Floor   4,000    3,927    3,927 
      11.25%), 2.50% ETP, Due 7/1/21)               
      Term Loan (11.39% cash (Libor + 9.95%; Floor   4,000    3,927    3,927 
      11.25%), 2.50% ETP, Due 7/1/21)               
PebblePost, Inc. (2)(14)  Communications  Term Loan (10.63% cash (Libor + 9.26%; Floor   4,000    3,874    3,874 
      10.25%), 4.00% ETP, Due 7/1/21)               
      Term Loan (10.63% cash (Libor + 9.26%; Floor   4,000    3,933    3,933 
      10.25%), 4.00% ETP, Due 7/1/21)               
Le Tote, Inc. (2)(14)  Consumer-related Technologies  Term Loan (11.02% cash (Libor + 9.65%; Floor   4,000    3,960    3,960 
      10.15%), 5.00% ETP, Due 3/1/20)               
      Term Loan (11.02% cash (Libor + 9.65%; Floor   3,000    2,969    2,969 
      10.15%), 5.00% ETP, Due 3/1/20)               
SavingStar, Inc. (2)(14)  Consumer-related Technologies  Term Loan (11.77% cash (Libor + 10.40%; Floor   2,167    2,140    2,140 
      10.90%), 4.25% ETP, Due 6/1/20)               
      Term Loan (11.77% cash (Libor + 10.40%; Floor   1,911    1,849    1,849 
      10.90%), 3.80% ETP, Due 11/1/20)               
IgnitionOne, Inc. (2)(14)  Internet and Media  Term Loan (11.60% cash (Libor + 10.23%; Floor   3,000    2,832    2,832 

 

See Notes to Consolidated Financial Statements

 

 12 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

December 31, 2017

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (11.60% cash (Libor + 10.23%; Floor   3,000    2,832    2,832 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (11.60% cash (Libor + 10.23%; Floor   3,000    2,832    2,832 
      10.23%), 2.00% ETP, Due 4/1/22)               
      Term Loan (11.60% cash (Libor + 10.23%; Floor   3,000    2,832    2,832 
      10.23%), 2.00% ETP, Due 4/1/22)               
Jump Ramp Games, Inc. (2)(14)  Internet and Media  Term Loan (11.10% cash (Libor + 9.73%),   4,000    3,942    3,942 
      3.00% ETP, Due 4/1/21)               
Kixeye, Inc. (2)(14)  Internet and Media  Term Loan (10.97% cash (Libor + 9.60%; Floor   3,000    2,900    2,900 
      10.75%), 2.00% ETP, Due 9/1/21)               
      Term Loan (10.97% cash (Libor + 9.60%; Floor   3,000    2,945    2,945 
      10.75%), 2.00% ETP, Due 9/1/21)               
MediaBrix, Inc. (2)(14)  Internet and Media  Term Loan (12.37% cash (Libor + 11.00%; Floor   4,000    3,977    3,977 
      11.50%), 3.00% ETP, Due 1/1/20)               
Rocket Lawyer Incorporated (2)(14)  Internet and Media  Term Loan (10.77% cash (Libor + 9.40%; Floor   4,000    3,933    3,933 
      10.50%), 3.00% ETP, Due 7/1/21)               
      Term Loan (10.77% cash (Libor + 9.40%; Floor   4,000    3,933    3,933 
      10.50%), 3.00% ETP, Due 7/1/21)               
      Term Loan (10.77% cash (Libor + 9.40%; Floor   2,000    1,963    1,963 
      10.50%), 3.00% ETP, Due 11/1/21)               
Zinio Holdings, LLC (2)(14)  Internet and Media  Term Loan (12.62% cash (Libor + 11.25%; Floor   4,000    3,978    3,978 
      11.75%), 6.00% ETP, Due 2/1/20)               
The NanoSteel Company, Inc. (2)(14)  Materials  Term Loan (10.87% cash (Libor + 9.50%; Floor   4,653    4,578    4,578 
      10.00%), 7.20% ETP, Due 1/1/20)               
      Term Loan (10.87% cash (Libor + 9.50%; Floor   2,327    2,289    2,289 
      10.00%), 6.45% ETP, Due 1/1/20)               
      Term Loan (10.87% cash (Libor + 9.50%; Floor   2,500    2,457    2,457 
      10.00%), 5.85% ETP, Due 3/1/20)               
Powerhouse Dynamics, Inc. (2)(14)  Power Management  Term Loan (12.07% cash (Libor + 10.70%; Floor   1,250    1,234    1,234 
      11.20%), 3.00% ETP, Due 3/1/19)               
Luxtera, Inc. (14)  Semiconductors  Term Loan (11.25% cash (Prime + 6.75%),   2,000    1,902    1,902 
      Due 3/28/20)               
      Term Loan (11.25% cash (Prime + 6.75%),   1,500    1,443    1,443 
      Due 3/28/20)               
Bridge2 Solutions, LLC. (2)(14)  Software  Term Loan (10.62% cash (Libor + 9.25%; Floor   5,000    4,777    4,777 
      10.50%), 2.00% ETP, Due 11/1/21)               
      Term Loan (10.62% cash (Libor + 9.25%; Floor   5,000    4,777    4,777 
      10.50%), 2.00% ETP, Due 11/1/21)               
Digital Signal Corporation (11)(12)(14)  Software  Term Loan (11.62% cash (Libor + 10.25%; Floor   1,290    1,256    1,210 
      10.43%), 5.00% ETP, Due 7/1/19)               
      Term Loan (11.62% cash (Libor + 10.25%; Floor   1,290    1,256    1,210 
      10.43%), 5.00% ETP, Due 7/1/19)               
      Term Loan (10.00% cash, Due 12/31/17)   501    501    483 
Education Elements, Inc. (2)(14)  Software  Term Loan (11.37% cash (Libor + 10.00%; Floor   800    789    789 
      10.50%), 4.00% ETP, Due 1/1/19)               
      Term Loan (11.37% cash (Libor + 10.00%; Floor   950    937    937 
      10.50%), 4.00% ETP, Due 8/1/19)               
Metricly, Inc. (14)  Software  Term Loan (13.62% cash (Libor + 12.25%; Floor   184    184    184 
      12.50%), 3.33% ETP, Due 9/1/18)               
ShopKeep.com, Inc. (2)(14)  Software  Term Loan (11.32% cash (Libor + 9.95%; Floor   6,000    5,897    5,897 
      10.45%), 4.08% ETP, Due 10/1/20)               
      Term Loan (11.32% cash (Libor + 9.95%; Floor   4,000    3,924    3,924 
      10.45%), 3.55% ETP, Due 2/1/21)               
SIGNiX, Inc. (14)  Software  Term Loan (12.37% cash (Libor + 11.00%; Floor   2,180    2,073    1,930 
      11.50%), 5.33% ETP, Due 2/1/20)               
SilkRoad Technology, Inc. (2)(14)  Software  Term Loan (11.72% cash (Libor + 10.35%; Floor   7,000    6,904    6,904 
      10.85%; Ceiling 12.85%), 5.00% ETP, Due 6/1/20)               
Weblinc Corporation (2)(14)  Software  Term Loan (11.62% cash (Libor + 10.25%; Floor   3,000    2,913    2,913 
      11.25%), 3.00% ETP, Due 3/1/21)               
xAd, Inc. (2)(14)  Software  Term Loan (10.07% cash (Libor + 8.70%; Floor   5,000    4,895    4,895 
      10.00%), 4.75% ETP, Due 11/1/21)               
      Term Loan (10.07% cash (Libor + 8.70%; Floor   5,000    4,895    4,895 
      10.00%), 4.75% ETP, Due 11/1/21)               

 

See Notes to Consolidated Financial Statements

 

 13 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

December 31, 2017

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
      Term Loan (10.07% cash (Libor + 8.70%; Floor   3,000    2,937    2,937 
      10.00%), 4.75% ETP, Due 11/1/21)               
      Term Loan (10.07% cash (Libor + 8.70%; Floor   2,000    1,958    1,958 
      10.00%), 4.75% ETP, Due 11/1/21)               
Total Non-Affiliate Debt Investments — Technology       134,142     133,889 
Non-Affiliate Debt Investments — Healthcare information and services — 6.3% (8)               
HealthEdge Software, Inc. (2)(14)  Software  Term Loan (9.62% cash (Libor + 8.25%;   5,000    4,819    4,819 
      Floor 9.25%), 3.00% ETP, Due 7/1/22)               
      Term Loan (9.68% cash (Libor + 8.25%;   3,750    3,693    3,693 
      Floor 9.25%), 3.00% ETP, Due 1/1/23)               
Total Non-Affiliate Debt Investments — Healthcare information and services         8,512    8,512 
Total Non- Affiliate Debt Investments        200,692    200,419 
                      
Non-Affiliate Warrant Investments — 6.7% (8)               
Non-Affiliate Warrants — Life Science — 1.6% (8)               
ACT Biotech Corporation (14)  Biotechnology  604,038 Preferred Stock Warrants        60     
Alpine Immune Sciences, Inc. (5)(14)  Biotechnology  4,634 Common Stock Warrants        122     
Argos Therapeutics, Inc. (2)(5)(14)  Biotechnology  73,112 Common Stock Warrants        33     
Celsion Corporation (5)(14)  Biotechnology  408 Common Stock Warrants        15     
Rocket Pharmaceuticals Corporation (5)(14)  Biotechnology  7,051 Common Stock Warrants        17     
Palatin Technologies, Inc. (2)(5)(14)  Biotechnology  608,058 Common Stock Warrants        51    82 
Revance Therapeutics, Inc. (5)(14)  Biotechnology  34,113 Common Stock Warrants        68    729 
Sample6, Inc. (2)(14)  Biotechnology  661,956 Preferred Stock Warrants        53    25 
Strongbridge U.S. Inc. (5)(14)  Biotechnology  160,714 Common Stock Warrants        72    794 
Sunesis Pharmaceuticals, Inc. (5)(14)  Biotechnology  2,050 Common Stock Warrants        5     
vTv Therapeutics Inc. (2)(5)(14)  Biotechnology  95,293 Common Stock Warrants        44    82 
Titan Pharmaceuticals, Inc. (2)(5)(14)  Drug Delivery  280,612 Common Stock Warrants        88    30 
AccuVein Inc. (2)(14)  Medical Device  75,769 Preferred Stock Warrants        24    27 
Aerin Medical, Inc. (2)(14)  Medical Device  1,818,182 Preferred Stock Warrants        66    66 
Conventus Orthopaedics, Inc. (2)(14)  Medical Device  720,000 Preferred Stock Warrants        95    95 
IntegenX, Inc. (2)(14)  Medical Device  170,646 Preferred Stock Warrants        35    32 
Lantos Technologies, Inc. (2)(14)  Medical Device  471,979 Common Stock Warrants        39    145 
Mederi Therapeutics, Inc. (2)(14)  Medical Device  248,736 Preferred Stock Warrants        26     
Mitralign, Inc. (2)(14)  Medical Device  64,190 Common Stock Warrants        52    1 
NinePoint Medical, Inc. (2)(14)  Medical Device  29,102 Preferred Stock Warrants        33    2 
OraMetrix, Inc. (2)(14)  Medical Device  812,348 Preferred Stock Warrants        78     
ReShape Lifesciences Inc. (5)(14)  Medical Device  134 Common Stock Warrants        347     
Tryton Medical, Inc. (2)(14)  Medical Device  122,362 Preferred Stock Warrants        15    12 
VERO Biotech LLC (2)(14)  Medical Device  800,000 Common Stock Warrants        53    53 
ViOptix, Inc. (14)  Medical Device  375,763 Preferred Stock Warrants        13     
Total Non-Affiliate Warrants — Life Science        1,504    2,175 
Non-Affiliate Warrants — Technology — 4.6% (8)                  
Ekahau, Inc. (2)(14)  Communications  978,261 Preferred Stock Warrants        32    22 
Intelepeer Holdings, Inc. (14)  Communications  2,256,549 Preferred Stock Warrants        149    110 
PebblePost, Inc. (2)(14)  Communications  598,850 Preferred Stock Warrants        92    92 
Additech, Inc. (2)(14)  Consumer-related Technologies  150,000 Preferred Stock Warrants        33    31 
Gwynnie Bee, Inc. (2)(14)  Consumer-related Technologies  268,591 Preferred Stock Warrants        68    816 
Le Tote, Inc. (2)(14)  Consumer-related Technologies  202,974 Preferred Stock Warrants        63    363 
Rhapsody International Inc. (2)(14)  Consumer-related Technologies  852,273 Common Stock Warrants        164     
SavingStar, Inc. (2)(14)  Consumer-related Technologies  850,439 Preferred Stock Warrants        104    103 
IgnitionOne, Inc. (2)(14)  Internet and Media  262,910 Preferred Stock Warrants        672    668 
Jump Ramp Games, Inc. (2)(14)  Internet and Media  159,766 Preferred Stock Warrants        31    31 
Kixeye, Inc. (2)(14)  Internet and Media  791,251 Preferred Stock Warrants        75    74 
Rocket Lawyer Incorporated (2)(14)  Internet and Media  261,721 Preferred Stock Warrants        91    91 
The NanoSteel Company, Inc. (2)(14)  Materials  379,360 Preferred Stock Warrants        187    448 
Nanocomp Technologies, Inc. (2)(14)  Networking  1,440,489 Preferred Stock Warrants        67     
Powerhouse Dynamics, Inc. (2)(14)  Power Management  290,698 Preferred Stock Warrants        28    26 
Avalanche Technology, Inc. (2)(14)  Semiconductors  202,602 Preferred Stock Warrants        101    40 
eASIC Corporation (2)(14)  Semiconductors  40,445 Preferred Stock Warrants        25    28 
Kaminario, Inc.(14)  Semiconductors  1,087,203 Preferred Stock Warrants        59    44 
Luxtera, Inc.(2)(14)  Semiconductors  3,546,553 Preferred Stock Warrants        213    361 

 

See Notes to Consolidated Financial Statements

 

 14 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

December 31, 2017

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
Soraa, Inc. (2)(14)  Semiconductors  203,616 Preferred Stock Warrants        80    438 
Bolt Solutions Inc. (2)(14)  Software  202,892 Preferred Stock Warrants        113    99 
Bridge2 Solutions, Inc. (2)(14)  Software  125,458 Common Stock Warrants        433    760 
Clarabridge, Inc. (14)  Software  53,486 Preferred Stock Warrants        14    82 
Digital Signal Corporation (14)  Software  125,116 Common Stock Warrants        32     
Education Elements, Inc. (2)(14)  Software  238,121 Preferred Stock Warrants        28    28 
Lotame Solutions, Inc. (2)(14)  Software  288,115 Preferred Stock Warrants        22    281 
Metricly, Inc. (14)  Software  41,569 Common Stock Warrants        48     
Riv Data Corp. (2)(14)  Software  321,428 Preferred Stock Warrants        12    38 
ShopKeep.com, Inc. (2)(14)  Software  193,962 Preferred Stock Warrants        118    138 
SIGNiX, Inc. (14)  Software  133,560 Preferred Stock Warrants        225    109 
Skyword, Inc. (14)  Software  301,056 Preferred Stock Warrants        48    32 
SpringCM, Inc. (2)(14)  Software  2,385,686 Preferred Stock Warrants        55    132 
Sys-Tech Solutions, Inc. (14)  Software  375,000 Preferred Stock Warrants        242    464 
Visage Mobile, Inc. (14)  Software  1,692,047 Preferred Stock Warrants        19    2 
Weblinc Corporation (2)(14)  Software  195,122 Preferred Stock Warrants        42    42 
xAd, Inc. (2)(14)  Software  4,343,350 Preferred Stock Warrants        177    177 
Total Non-Affiliate Warrants — Technology        3,962    6,170 
Non-Affiliate Warrants — Cleantech — 0.1% (8)               
Renmatix, Inc. (14)  Alternative Energy  53,022 Preferred Stock Warrants        68     
Tigo Energy, Inc. (2)(14)  Energy Efficiency  804,604 Preferred Stock Warrants        100    117 
Total Non-Affiliate Warrants — Cleantech        168    117 
Non-Affiliate Warrants — Healthcare information and services — 0.4% (8)               
LifePrint Group, Inc. (2)(14)  Diagnostics  49,000 Preferred Stock Warrants        29    2 
ProterixBio, Inc. (2)(14)  Diagnostics  3,156 Common Stock Warrants        54     
Singulex, Inc. (14)  Other Healthcare  294,231 Preferred Stock Warrants        44    44 
Verity Solutions Group, Inc. (14)  Other Healthcare  300,360 Preferred Stock Warrants        100    62 
Watermark Medical, Inc. (2)(14)  Other Healthcare  27,373 Preferred Stock Warrants        74    59 
HealthEdge Software, Inc. (2)(14)  Software  110,644 Preferred Stock Warrants        46    46 
Medsphere Systems Corporation (2)(14)  Software  7,097,792 Preferred Stock Warrants        60    208 
Recondo Technology, Inc. (2)(14)  Software  556,796 Preferred Stock Warrants        95    207 
Total Non-Affiliate Warrants — Healthcare information and services        502    628  
Total Non-Affiliate Warrants              6,136    9,090 
                      
Non-Affiliate Other Investments — 5.7% (8)               
Espero Pharmaceuticals, Inc. (14)  Biotechnology  Royalty Agreement        5,300    4,700 
ZetrOZ, Inc. (14)  Medical Device  Royalty Agreement        305    700 
Vette Technology, LLC (14)  Data Storage  Royalty Agreement Due 4/18/2019        4,226    100 
Triple Double Holdings, LLC (14)  Software  License Agreement        2,200    2,200 
Total Non-Affiliate Other Investments              12,031    7,700 
                      
Non-Affiliate Equity — 1.0% (8)                     
Insmed Incorporated (5)  Biotechnology  33,208 Common Stock        238    1,035 
Revance Therapeutics, Inc.(5)  Biotechnology  5,125 Common Stock        73    183 
Sunesis Pharmaceuticals, Inc. (5)  Biotechnology  13,082 Common Stock        83    49 
SnagAJob.com, Inc. (14)  Consumer-related Technologies  82,974 Common Stock        9    83 
TruSignal, Inc. (14)  Software  32,637 Common Stock        41    41 
Total Non-Affiliate Equity              444    1,391 
Total Non-Affiliate Portfolio Investment Assets      $219,303   $218,600  
                      
Affiliate Investments — 2.6% (8)                     
Affiliate Debt Investments — Technology — 2.5% (8)               
Decisyon, Inc. (14)  Software  Term Loan (13.678% cash (Libor + 12.308%; Floor  $1,523   $1,522   $1,449 
      12.50%), 8.00% ETP, Due 1/1/20)               
      Term Loan (13.678% cash (Libor + 12.308%; Floor   833    771    735 
      12.50%), 8.00% ETP, Due 1/1/20)               
      Term Loan (12.02% PIK, Due 4/15/19) (13)   250    250    238 
      Term Loan (12.03% PIK, Due 4/15/19) (13)   250    250    238 
      Term Loan (12.24% PIK, Due 4/15/19) (13)   750    750    714 
Total Affiliate Debt Investments — Technology               3,543    3,374  

 

See Notes to Consolidated Financial Statements

 

 15 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Consolidated Schedule of Investments (Unaudited)

December 31, 2017

(Dollars in thousands)

 

         Principal   Cost of   Fair 
Portfolio Company (1)(3)  Sector  Type of Investment (4)(7)(9)(10)  Amount   Investments (6)   Value 
Affiliate Warrants — Technology — 0.0% (8)               
Decisyon, Inc. (14)  Software  82,967 Common Stock Warrants        46     
Total Affiliate Warrants — Technology              46     
                      
Affiliate Equity — Technology — 0.1% (8)          
Decisyon, Inc. (14)  Software  45,365,936 Common Stock        185    125 
Total Affiliate Equity              185    125 
Total Affiliate Portfolio Investment Assets             $3,774   $3,499  
                      
Total Portfolio Investment Assets — 164.4%(8)       $223,077   $222,099 

 

 
(1)   All investments of the Company are in entities which are organized under the laws of the United States and have a principal place of business in the United States.
     
(2)   Has been pledged as collateral under the Key Facility.
     
(3)   All non-affiliate investments are investments in which the Company owns less than 5% ownership of the voting securities of the portfolio company. All affiliate investments are investments in which the Company owns 5% or more of the voting securities 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. Interest rate is the annual interest rate on the debt investment and does not include ETPs and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. Debt investments are at fixed rates for the term of the debt investment, unless otherwise indicated. All debt investments based on LIBOR are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of December 31, 2017 is provided.
     
(5)   Portfolio company is a public company.
     
(6)   For debt investments, represents principal balance less unearned income.
     
(7)   Warrants, Equity and Other Investments are non-income producing.
     
(8)   Value as a percent of net assets.
     
(9)   The Company did not have any non-qualifying assets under Section 55(a) of the 1940 Act as of December 31, 2017. Under the 1940 Act, the Company may not acquire any non-qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets.
     
(10)  

ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid. Therefore, a portion of the incentive fee the Company may pay its Advisor will be based on income that the Company has not yet received in cash.

     
(11)   Debt investment is on non-accrual status as of December 31, 2017.
     
(12)  

Digital Signal Corporation, a Delaware corporation (“DSC”), made an assignment for the benefit of its creditors whereby DSC assigned all of its assets to DSC (assignment for the benefit of creditors), LLC, a Delaware limited liability company, established under Delaware law to effectuate the Assignment for the Benefit of Creditors of DSC.

     
(13)   Debt investment has a PIK feature.
     
(14)   The fair value of the investment was valued using significant unobservable inputs.

 

See Notes to Consolidated Financial Statements

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

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 1940 Act. In addition, for tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) as defined under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). As a RIC, the Company generally is not subject to corporate-level federal income tax on the portion of its taxable income (including net capital gains) the Company distributes to its stockholders. The Company primarily makes secured debt investments to development-stage companies in the technology, life science, healthcare information and services and cleantech industries. All of the Company’s debt investments consist of loans secured by all of, or a portion of, the applicable debtor company’s tangible and intangible assets.

 

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, a Delaware limited liability company, which commenced operations in March 2008 and became the Company’s wholly owned subsidiary upon the completion of the Company’s IPO.

 

Horizon Credit II LLC (“Credit II”) was formed as a Delaware limited liability company on June 28, 2011, with the Company as its 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.

 

The Company has also established an additional wholly owned subsidiary, which is structured as a Delaware limited liability company, to hold the assets of a portfolio company acquired in connection with foreclosure or bankruptcy, which is a separate legal entity from the Company.

 

The Company’s investment strategy is to maximize the investment portfolio’s return by generating current income from the debt investments the Company makes and capital appreciation from the warrants the Company receives when making such debt investments. The Company has entered into an investment management agreement (the “Investment Management Agreement”) with Horizon Technology Finance Management LLC (the “Advisor”) under which the Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company.

 

Note 2.  Basis of presentation and significant accounting policies

 

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 and 10 of Regulation S-X (“Regulation S-X”) under the Securities Act of 1933, as amended (the “Securities Act”). 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. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. Therefore, the unaudited financial statements and notes should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2017.

 

Principles of consolidation

 

As required under GAAP and Regulation S-X, the Company will generally consolidate its investment in a company that is 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 wholly-owned subsidiaries in its consolidated financial statements. The Company does not consolidate its non-controlling interest in HSLFI.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to 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 investments.

 

Fair value

 

The Company records all of its investments at fair value 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 6. 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.

 

See Note 6 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 debt investments 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 (the “Board”) determines the fair value of the Company’s portfolio investments. The Company has the intent to hold its debt investments 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. Generally, when a debt investment becomes 90 days or more past due, or if the Company otherwise does not expect to receive interest and principal repayments, the debt investment is placed on non-accrual status and the recognition of interest income may be discontinued. Interest payments received on non-accrual debt investments may be recognized as income, on a cash basis, or applied to principal depending upon management’s judgment at the time the debt investment is placed on non-accrual status. As of September 30, 2018, there were no debt investments on non-accrual status. As of December 31, 2017, there was one investment on non-accrual status with a cost of $3.0 million and a fair value of $2.9 million. For the three and nine months ended September 30, 2018, the Company did not recognize any interest income from debt investments on non-accrual status. For the three and nine months ended September 30, 2017, the Company recognized $0.1 million in interest income from debt investments on non-accrual status.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

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, success fees and prepayment fees. In a limited number of cases, the Company may also receive a non-refundable deposit earned upon the termination of a transaction. Debt investment 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 debt investment. All other income is recognized when earned. Fees for counterparty debt investment commitments with multiple debt investments are allocated to each debt investment based upon each debt investment’s relative fair value. When a debt investment is placed on non-accrual status, the amortization of the related fees and unearned income is discontinued until the debt investment is returned to accrual status.

 

Certain debt investment agreements also require the borrower to make an ETP, that is accrued into interest receivable and taken into income over the life of the debt investment 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 the ETP when due. The proportion of the Company’s total investment income that resulted from the portion of ETPs not received in cash for the three months ended September 30, 2018 and 2017 was 7.6% and 4.8%, respectively. The proportion of the Company’s total investment income that resulted from the portion of ETPs not received in cash for the nine months ended September 30, 2018 and 2017 was 7.3% and 6.6%, respectively.

 

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 recorded as unearned income on the grant date. The unearned income is recognized as interest income over the contractual life of the related debt investment in accordance with the Company’s income recognition policy. Subsequent to debt investment origination, the fair value of the warrants is determined using the Black-Scholes valuation model. Any adjustment to fair value is recorded through earnings as net unrealized appreciation or depreciation on investments. Gains and losses from the disposition of the warrants or stock acquired from the exercise of warrants are recognized as realized gains and losses on investments.

 

Distributions from HSLFI are evaluated at the time of distribution to determine if the distribution should be recorded as dividend income or a return of capital. Generally, the Company will not record distributions from HSLFI as dividend income unless there are sufficient accumulated tax-basis earnings and profit in HSLFI prior to distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. For the three months ended September, 30, 2018, HSLFI distributed $0.1 million as dividend income to the Company. For the period June 1, 2018 (the commencement of HSLFI’s operations) through September 30, 2018, HSLFI distributed $0.1 million as dividend income to the Company.

 

Realized gains or losses on the sale of investments, or upon the determination that an investment balance, or portion thereof, is not recoverable, are calculated using the specific identification method. The Company measures realized gains or losses by calculating the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment. Net change in unrealized appreciation or depreciation reflects the change in the fair values of the Company’s portfolio investments during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

 

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. The unamortized balance of debt issuance costs as of September 30, 2018 and December 31, 2017 was $2.3 million and $2.1 million, respectively. These amounts are amortized and included in interest expense in the consolidated statements of operations over the life of the borrowings. The accumulated amortization balances as of September 30, 2018 and December 31, 2017 were $2.3 million and $1.8 million, respectively. The amortization expense for the three months ended September 30, 2018 and 2017 was $0.1 million. The amortization expense for the nine months ended September 30, 2018 and 2017 was $0.4 million.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Income taxes

 

As a BDC, the Company has 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 and to avoid the imposition of corporate-level income tax on the portion of its taxable income distributed to stockholders, among other things, the Company is required to meet certain source of income and asset diversification requirements and to timely distribute dividends out of assets legally available for distribution to its stockholders of an amount generally at least equal to 90% of its investment company taxable income, as defined by the Code and determined without regard to any deduction for dividends paid, for each tax year. The Company, among other things, has made and intends to continue to make the requisite distributions to its stockholders, which generally relieves the Company from corporate-level U.S. federal income taxes. Accordingly, no provision for federal income tax has been recorded in the financial statements. Differences between taxable income and net increase in net assets resulting from operations either can be temporary, meaning they will reverse in the future, or permanent. In accordance with Topic 946, Financial ServicesInvestment Companies, of the Financial Accounting Standards Board’s (“FASB’s”), Accounting Standards Codification, as amended (“ASC”), permanent tax differences, such as non-deductible excise taxes paid, are reclassified from distributions in excess of net investment income and net realized loss on investments to paid-in-capital at the end of each fiscal year. These permanent book-to-tax differences are reclassified on the consolidated statements of changes in net assets to reflect their tax character but have no impact on total net assets. For the year ended December 31, 2017, the Company reclassified $0.03 million to paid-in capital from distributions in excess of net investment income, which related to excise taxes payable.

 

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 distributions into the next tax year and incur a 4% U.S. federal 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 distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the three and nine months ended September 30, 2018 and 2017, there was no U.S. federal excise tax recorded.

 

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 in accordance with ASC Topic 740, Income Taxes, as modified by ASC Topic 946. 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. The Company had no material uncertain tax positions at September 30, 2018 and December 31, 2017. The Company’s income tax returns for the 2017, 2016 and 2015 tax years remain subject to examination by U.S. federal and state tax authorities.

 

Distributions

 

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

 

The Company has adopted a dividend reinvestment plan that provides for reinvestment of cash distributions on behalf of its stockholders, unless a stockholder elects to receive cash. As a result, if the Board declares a cash distribution, then stockholders who have not “opted out” of the dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution. The Company may use newly issued shares to implement the plan or the Company may purchase shares in the open market to fulfill its obligations under the plan.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Stock Repurchase Program

 

On April 27, 2018, the Board extended a previously authorized stock repurchase program which allows the Company to repurchase up to $5.0 million of its common stock at prices below the Company’s net asset value per share as reported in its most recent consolidated financial statements. Under the repurchase program, the Company may, but is not obligated to, repurchase shares of its outstanding common stock in the open market or in privately negotiated transactions from time to time. Any repurchases by the Company will comply with the requirements of Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and any applicable requirements of the 1940 Act. Unless extended by the Board, the repurchase program will terminate on the earlier of June 30, 2019 or the repurchase of $5.0 million of the Company’s common stock. During the three and nine months ended September 30, 2018, the Company did not make any repurchases of its common stock. During the three and nine months ended September 30, 2017, the Company repurchased 5,923 shares of its common stock at an average price of $9.97 on the open market at a total cost of $0.1 million. From the inception of the stock repurchase program through September 30, 2018, the Company repurchased 167,465 shares of its common stock at an average price of $11.22 on the open market at a total cost of $1.9 million.

 

Transfers of financial assets

 

Assets related to transactions that do not meet the requirements under ASC Topic 860, Transfers and Servicing for sale treatment under GAAP are reflected in the Company’s consolidated statements of assets and liabilities as investments. Those assets are owned by special purpose entities that are consolidated in the Company’s financial statements. The creditors of the special purpose entities have received security interests in such assets and such assets are not intended to be available to the creditors of the Company (or any other affiliate of the Company).

 

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.

 

Recently adopted accounting pronouncement

 

In April 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amends existing revenue recognition guidance to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017. As required, the Company adopted ASU 2014-09 effective January 1, 2018, and such adoption did not have an impact on the Company’s consolidated financial statements and disclosures.

 

Note 3.  Related party transactions

 

Investment Management Agreement

 

The Investment Management Agreement was reapproved by the Board on July 27, 2018. On October 30, 2018, the shareholders, at a special meeting of the stockholders, approved a new Investment Management Agreement to replace the existing Investment Management Agreement which was terminated due to a change of control of the Advisor. 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 adviser with the U.S. Securities and Exchange Commission. The Advisor receives fees for providing services to the Company under the Investment Management Agreement, consisting of two components, a base management fee and an incentive fee.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The base management fee is calculated at an annual rate of 2.00% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. From and after October 31, 2018, the first date on which the reduced asset coverage requirements in Section 61(a)(2) of the 1940 Act apply to the Company, the base management fee will be calculated at an annual rate of 2.00% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage; provided, that, to the extent the Company’s gross assets (less cash and cash equivalents) exceed $250 million, the base management fee on the amount of such excess over $250 million will be calculated at an annual rate of 1.60% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. The base management fee is payable monthly in arrears and is prorated for any partial month.

 

The base management fee payable at September 30, 2018 and December 31, 2017 was $0.4 million. The base management fee expense was $1.2 million and $0.9 million for the three months ended September 30, 2018 and 2017, respectively. The base management fee expense was $3.4 million and $2.8 million for the nine months ended September 30, 2018 and 2017, respectively.

 

The incentive fee has two parts, as follows:

 

The first part, which is subject to the Incentive Fee Cap and Deferral Mechanism, as defined below, 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 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 the Company has not yet received in cash. The incentive fee with respect to the Pre-Incentive Fee Net Investment 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 hurdle rate of 1.75% (which is 7.00% annualized) of the Company’s net assets at the end of the immediately preceding calendar quarter, subject to 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 Pre-Incentive Fee 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% quarterly (which is 8.75% annualized). The effect of this “catch-up” 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 the hurdle rate did not apply.

 

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 up to the Incentive Fee Cap, defined below, 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.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Commencing with the calendar quarter beginning July 1, 2014, the incentive fee on Pre-Incentive Fee Net Investment Income is subject to a fee cap and deferral mechanism which is determined based upon a look-back period of up to three years and is expensed when incurred. For this purpose, the look-back period for the incentive fee based on Pre-Incentive Fee Net Investment Income (the “Incentive Fee Look-back Period”) commenced on July 1, 2014 and increased by one quarter in length at the end of each calendar quarter until June 30, 2017, after which time, the Incentive Fee Look-back Period includes the relevant calendar quarter and the 11 preceding full calendar quarters. Each quarterly incentive fee payable on Pre-Incentive Fee Net Investment Income is subject to a cap (the “Incentive Fee Cap”) and a deferral mechanism through which the Advisor may recoup a portion of such deferred incentive fees (collectively, the “Incentive Fee Cap and Deferral Mechanism”). The Incentive Fee Cap is equal to (a) 20.00% of Cumulative Pre-Incentive Fee Net Return (as defined below) during the Incentive Fee Look-back Period less (b) cumulative incentive fees of any kind paid to the Advisor during the Incentive Fee Look-back Period. To the extent the Incentive Fee Cap is zero or a negative value in any calendar quarter, the Company will not pay an incentive fee on Pre-Incentive Fee Net Investment Income to the Advisor in that quarter. To the extent that the payment of incentive fees on Pre-Incentive Fee Net Investment Income is limited by the Incentive Fee Cap, the payment of such fees will be deferred and paid in subsequent calendar quarters up to three years after their date of deferment, subject to certain limitations, which are set forth in the Investment Management Agreement. The Company only pays incentive fees on Pre-Incentive Fee Net Investment Income to the extent allowed by the Incentive Fee Cap and Deferral Mechanism. “Cumulative Pre-Incentive Fee Net Return” during any Incentive Fee Look-back Period means the sum of (a) Pre-Incentive Fee Net Investment Income and the base management fee for each calendar quarter during the Incentive Fee Look-back Period and (b) the sum of cumulative realized capital gains and losses, cumulative unrealized capital appreciation and cumulative unrealized capital depreciation during the applicable Incentive Fee Look-back Period.

 

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 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 on a cumulative basis through the end of such year, less all previous amounts paid in respect of the capital gain incentive fee. However, in accordance with GAAP, the Company is required to include the aggregate unrealized capital appreciation on investments in the calculation and accrue a capital gain incentive fee on a quarterly basis, as if such unrealized capital appreciation were realized, even though such unrealized capital appreciation is not permitted to be considered in calculating the fee actually payable under the Investment Management Agreement.

 

On March 6, 2018, the Advisor irrevocably waived the receipt of incentive fees related to the amounts previously deferred that it may be entitled to receive under the Investment Management Agreement for the period commencing on January 1, 2018 and ending on December 31, 2018. Such waived incentive fees will not be subject to recoupment. During the three and nine months ended September 30, 2018, the Advisor waived performance based incentive fees of $0.4 million and $0.6 million, respectively, which the Advisor would have otherwise earned.

 

The net performance based incentive fee expense was $0.9 million and $0.3 million for the three months ended September 30, 2018 and 2017, respectively. The incentive fee on Pre-Incentive Fee Net Investment Income was subject to the Incentive Fee Cap and Deferral Mechanism for the three months ended September 30, 2017, which resulted in $0.6 million of reduced expense and additional net investment income. The net performance based incentive fee expense was $2.2 million and $1.1 million for the nine months ended September 30, 2018 and 2017, respectively. The incentive fee on Pre-Incentive Fee Net Investment Income was subject to the Incentive Fee Cap and Deferral Mechanism for the nine months ended September 30, 2017, which resulted in $1.3 million of reduced expense and additional net investment income. The performance based incentive fee payable as of September 30, 2018 and December 31, 2017 was $0.9 million and $0.5 million, respectively. The entire incentive fee payable as of September 30, 2018 and December 31, 2017 represented part one of the incentive fee.

 

Administration Agreement

 

The Company entered into an administration agreement (the “Administration Agreement”) with the Advisor to provide administrative services to the Company. For providing these services, facilities and personnel, the Company reimburses 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 Financial Officer and Chief Compliance Officer and their respective staffs. The administrative fee expense was $0.2 million for the three months ended September 30, 2018 and 2017. The administrative fee expense was $0.5 million and $0.6 million for the nine months ended September 30, 2018 and 2017, respectively.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Note 4.  Investments

 

The following table shows the Company’s investments as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
   Cost   Fair Value   Cost   Fair Value 
   (In thousands) 
Investments                    
Debt  $215,766   $215,144   $204,235   $203,793 
Warrants   6,848    10,426    6,182    9,090 
Other   11,862    7,660    12,031    7,700 
Equity   1,719    2,114    629    1,516 
Equity interest in HSLFI   4,413    4,413         
Total investments  $240,608   $239,757   $223,077   $222,099 

 

The following table shows the Company’s investments by industry sector as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
   Cost   Fair Value   Cost   Fair Value 
   (In thousands) 
Life Science                    
Biotechnology  $33,913   $34,194   $21,249   $22,694 
Drug Delivery   1,579    1,484    6,918    6,860 
Medical Device   43,720    44,125    37,374    37,306 
Technology                    
Communications   27,083    27,989    19,823    19,773 
Consumer-Related   336    1,279    11,359    12,314 
Data Storage   4,183    60    4,226    100 
Internet and Media   38,692    38,530    39,768    39,763 
Materials   8,266    8,607    9,511    9,772 
Networking           66     
Power Management   715    716    1,262    1,260 
Semiconductors   3,849    4,362    3,823    4,256 
Software   49,734    49,774    58,516    58,744 
Cleantech                    
Alternative Energy   68        68     
Energy Efficiency   100    113    100    117 
Healthcare Information and Services                    
Diagnostics   71    2    83    2 
Other   218    176    218    165 
Software   23,668    23,933    8,713    8,973 
Investment funds                    
HSLFI   4,413    4,413         
Total investments  $240,608   $239,757   $223,077   $222,099 

 

 24 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Horizon Secured Loan Fund I LLC

 

On June, 1 2018, the Company and Arena formed a joint venture, HSLFI, to make investments, either directly or indirectly through subsidiaries, primarily in secured loans to development-stage companies in the technology, life science, healthcare information and services and cleantech industries. HSLFI was formed as a Delaware limited liability company and is not consolidated by either the Company or Arena for financial reporting purposes. Investments held by HSLFI are measured at fair value using the same valuation methodology as described in Note 6. As of September 30, 2018, HSLFI had total assets of $9.8 million. As of September 30, 2018, HSLFI had no investments on non-accrual status. As of September 30, 2018, HSLFI’s portfolio consisted of debt investments in one portfolio company. HSLFI invests in portfolio companies in the same industries in which the Company may directly invest.

 

The Company provides capital (in the form of cash or securities in portfolio companies) to HSLFI in exchange for limited liability company equity interests in HSLFI. As of September 30, 2018, the Company and Arena each owned 50.0% of the equity interests of HSLFI. The Company’s investment in HSLFI consisted of an equity contribution of $4.3 million as of September 30, 2018. As of September 30, 2018, the Company had commitments to fund equity interests in HSLFI of $25.0 million, of which $20.7 million was unfunded.

 

The Company and Arena each appointed two members to HSLFI’s four-person board of managers. All material decisions with respect to HSLFI, including those involving its investment portfolio, require unanimous approval of a quorum of the board of managers. Quorum is defined as (i) the presence of two members of the board of managers; provided that at least one individual is present that was elected, designated or appointed by each member; (ii) the presence of three members of the board of managers, provided that the individual that was elected, designated or appointed by the member with only one individual present will be entitled to cast two votes on each matter; or (iii) the presence of all four members of the board of managers.

 

Horizon Funding I, LLC (“HFI”) was formed as a Delaware limited liability company on May 9, 2018, with HSLFI as its sole equity member. HFI is a special purpose bankruptcy-remote entity and is a separate legal entity from HSLFI. Any assets conveyed to HFI are not available to creditors of HSLFI or any other entity other than HFI’s lenders.

 

In addition, on June 1, 2018, HSLFI entered into a sale and servicing agreement with HFI, as Issuer, and the Company, as Servicer, pursuant to which HSLFI will sell or contribute to HFI certain secured loans made to certain portfolio companies. HFI entered into a Note Funding Agreement with several entities owned or affiliated with New York Life Insurance Company (“Noteholders”) for an aggregate purchase price of up to $100.0 million, with an accordion feature of up to $200.0 million at the mutual discretion and agreement of HSLFI and the Noteholders. The Note Funding Agreement has an investment period that ends on June 1, 2020, if not extended, followed by a five year amortization period and a scheduled final payment date of June 10, 2025, subject to any extension of the investment period. Any notes issued by HFI will be collateralized by all investments held by HFI and permit an advance rate of up to 67% of the aggregate principal amount of eligible debt investments. The interest rate is based on the three year USD mid-market swap rate plus a margin of between 2.75% and 3.25% depending on the rating of the notes at the time the amount is borrowed. There were no advances made by the Noteholders as of September 30, 2018.

 

 25 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following table shows HSLFI’s individual investments as of September 30, 2018:

 

         Principal   Cost of   Fair 
Portfolio Company (1)  Sector  Type of Investment (2)(3)(4)  Amount   Investments(5)   Value (6) 
       (Dollars in thousands)  
Debt Investments — Technology                     
New Signature US, Inc. (7)  Software  Term Loan (10.60% cash (Libor + 8.50%; Floor 10.50%), 3.50% ETP, Due 7/1/21)  $8,250   $8,089   $8,089 
Total Debt Investments — Technology              8,089    8,089 
                      
Warrant Investments — Technology                     
BSI Platform Holdings, LLC (7)  Software  412,500 Preferred Stock Warrants        57    58 
Total Warrant Investments — Technology              57    58 
                      
Total Portfolio Investment Assets             $8,146   $8,147 

 

 
(1) All investments of HSLFI are in entities which are organized under the laws of the United States and have a principal place of business in the United States.
   
(2) All interest is payable in cash due monthly in arrears, unless otherwise indicated, and applies only to HSLFI’s debt investments. Interest rate is the annual interest rate on the debt investment and does not include ETPs and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. Debt investments are at variable rates for the term of the debt investment, unless otherwise indicated. All debt investments based on LIBOR are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of September 30, 2018 is provided.
   
(3) ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid.
   
(4) Warrants are non-income producing.
   
(5) For debt investments, represents principal balance less unearned income.
   
(6) The fair value of the investment was valued using significant unobservable inputs.
   
(7) New Signature US, Inc. is a subsidiary of BSI Platform Holdings, LLC.

 

The following table provides HSLFI’s unfunded commitments by portfolio company as of September 30, 2018:

 

   September 30, 2018 
   Principal
Balance
   Fair Value of
Unfunded
Commitment
Liability
 
   (In thousands) 
New Signature US, Inc.  $3,000   $30 
Total  $3,000   $30 

 

 26 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following tables show certain summarized financial information for HSLFI as of September 30, 2018 and for the three months ended September 30, 2018 and for the period June 1, 2018 through September 30, 2018:

 

   September 30,
2018
 
   (In thousands) 
Selected Statement of Assets and Liabilities Information     
Total investments at fair value (cost of $8,146)  $8,147 
Cash and cash equivalents   236 
Other assets   1,448 
Total assets  $9,831 
      
Other liabilities  $1,112 
Total liabilities   1,112 
      
Members’ equity   8,719 
Total liabilities and members’ equity  $9,831 

 

   For the three
months ended,
   For the period
June 1, 2018
through
 
   September 30, 2018   September 30, 2018 
   (In thousands) 
Selected Statements of Operations Information          
Interest income on investments  $250   $255 
Total expenses  $68   $90 
Net investment income  $182   $165 
Net unrealized appreciation on investments  $1   $1 
Net increase in net assets resulting from operations  $183   $166 

 

 27 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Note 5.  Transactions with affiliated companies

 

A non-controlled affiliated company is generally a portfolio company in which the Company owns 5% or more of such portfolio company’s voting securities but not more than 25% of such portfolio company’s voting securities. Transactions related to investments in non-controlled affiliated companies for the nine months ended September 30, 2018 were as follows:

 

           Nine months ended September 30, 2018             
Portfolio
Company
  Fair value at
December 31,
2017
   Purchases   Sales   Transfers
in/(out) at
fair value
   Discount
accretion
   Net
unrealized
gain/(loss)
   Fair value at
September 30,
2018
   Net realized
gain/(loss)
   Interest
income
 
   (In thousands) 
Decisyon, Inc.  $1,449   $   $   $   $   $   $1,449   $   $203 
    735                18    (1)   752        124 
    238                        238        27 
    238                        238        27 
    714                        714        80 
        300                (14)   286        10 
        200                (10)   190        2 
    125                    (50)   75         
StereoVision, Inc.       2,798                    2,798        55 
        791                    791         
Total Non-controlled Affiliates  $3,499   $4,089   $   $   $18   $(75)  $7,531   $   $528 

 

Transactions related to investments in affiliated companies for the year ended December 31, 2017 were as follows:

 

           Year ended December 31, 2017             
Portfolio
Company
  Fair value at
December 31,
2016
   Purchases   Sales   Transfers
in at fair
value
   Discount
accretion
   Net
unrealized
gain (loss)
   Fair value at
December 31,
2017
   Net realized
gain (loss)
   Interest
income
 
   (In thousands) 
Decisyon, Inc. (1)  $   $   $   $1,440   $   $9   $1,449   $   $122 
                715    16    4    735        63 
                237        1    238        8 
                237        1    238        8 
        750                (36)   714        24 
                125            125         
Total Non-controlled Affiliates  $   $750   $   $2,754   $16   $(21)  $3,499   $   $225 

 

 
(1) During the year ended December 31, 2017, the Company's ownership in the portfolio company increased to five percent of the portfolio company's voting securities.

 

 28 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

A controlled affiliated company is generally a portfolio company in which the Company owns more than 25% of such portfolio company’s voting securities or has the power to exercise control over management or policies of such portfolio company (including through a management agreement). Transactions related to investments in controlled affiliated companies for the nine months ended September 30, 2018 were as follows:

 

           Nine months ended September 30, 2018             
Portfolio
Company
  Fair value at
December 31,
2017
   Purchases   Sales   Transfers
in/(out) at
fair value
   Discount
accretion
   Net
unrealized
gain/(loss)
   Fair value at
September 30,
2018
   Net realized
gain/(loss)
   Dividend
income
 
   (In thousands) 
HSLFI(1)  $   $4,413   $   $   $   $   $4,413   $   $83 
Total Controlled Affiliates  $   $4,413   $   $   $   $   $4,413   $   $83 

 

 
(1) The Company and Arena are the members of HSLFI, a joint venture formed as a Delaware limited liability company that is not consolidated by either member for financial reporting purposes. The members make investments in HSLFI in the form of LLC equity interests as HSLFI makes investments, and all portfolio and other material decisions regarding HSLFI must be submitted to HSLFI’s board of managers which is comprised of an equal number of managers appointed by each of the Company and Arena. Because management of HSLFI is shared equally between the Company and Arena, the Company does not believe it controls HSLFI for purposes of the 1940 Act or otherwise.

 

There were no transactions related to investments in controlled affiliated companies for the year ended December 31, 2017.

 

Note 6.  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 in accordance with ASC Topic 820, Fair Value Measurement, 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.

 

 29 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

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 which are engaged at the direction of the Board to assist in the valuation of each portfolio investment lacking 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 at least 25% (based on fair value) of the Company’s valuation of portfolio companies lacking readily available market quotations subject to review by an independent valuation firm.

 

Because there is not a readily available market value for most of the investments in its portfolio, the Company values substantially all of its portfolio investments at fair value as determined in good faith by the Board, as described herein. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company's investments may fluctuate from period to period. Additionally, the fair value of the Company's investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate a portfolio investment in a forced or liquidation sale, the Company could realize significantly less than the value at which the Company has recorded such portfolio investment.

 

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.

 

Debt investments:  The fair value of debt investments is estimated by discounting the expected future cash flows using the period end rates at which similar debt investments would be made to borrowers with similar credit ratings and for the same remaining maturities. At September 30, 2018 and December 31, 2017, the hypothetical market yields used ranged from 10% 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. 

 

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 indices of publicly traded companies similar in nature to the underlying company issuing the warrant. A total of seven such indices are used. 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.

 

Other adjustments, including a marketability discount on private company warrants, are estimated based on management’s judgment about the general industry environment.

 

 30 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Historical portfolio experience on cancellations and exercises of the Company’s warrants are utilized as the basis for determining the estimated time to exit of the warrants in each financial reporting period. Warrants may be exercised in the event of acquisitions, mergers or initial public offerings, and cancelled due to events such as bankruptcies, restructuring activities or additional financings. These events cause the expected remaining life assumption to be shorter than the contractual term of the warrants. Significant increases (decreases) in this unobservable input would result in significantly higher (lower) 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. 

 

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 assets are recorded at fair value on a recurring basis.

 

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.

 

Other investments: Other investments are valued based on the facts and circumstances of the underlying contractual agreement. The Company currently values these contractual agreements using a multiple probability weighted cash flow model as the contractual future cash flows contain elements of variability. Significant changes in the estimated cash flows and probability weightings would result in a significantly higher or lower fair value measurement. The Company has categorized these other investments as Level 3 within the fair value hierarchy described above. These other investments are recorded at fair value on a recurring basis.

 

The following tables provide a summary of quantitative information about the Company’s Level 3 fair value measurements of its investments as of September 30, 2018 and December 31, 2017. In addition to the techniques and inputs noted in the table below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining its fair value measurements.

 

 31 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of September 30, 2018:

 

September 30, 2018
   Fair   Valuation Techniques/  Unobservable     Weighted
Investment Type  Value   Methodologies  Input  Range  Average
(Dollars in thousands, except per share data)
Debt investments  $215,144   Discounted Expected Future Cash Flows  Hypothetical Market Yield  10% – 25%  13%
                  
Warrant investments   8,481   Black-Scholes Valuation Model  Price Per Share  $0.00 – $980.00  $42.05
           Average Industry Volatility  20%  20%
           Marketability Discount  20%  20%
           Estimated Time to Exit  1 to 5 years  3 years
                  
    899   Estimated Proceeds  Price Per Share  $0.92  $0.92
                  
Other investments   7,660   Multiple Probability Weighted Cash Flow Model  Discount Rate  18% – 25%  18%
           Probability Weighting  0% – 100%  36%
                  
Equity investments   1,289   Last Equity Financing  Price Per Share  $0.00 – $2.24  $0.80
Total Level 3 investments  $233,473             

 

The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of December 31, 2017:

 

December 31, 2017
   Fair   Valuation Techniques/  Unobservable     Weighted
Investment Type  Value   Methodologies  Input  Range  Average
(Dollars in thousands, except per share data)
Debt investments  $200,893   Discounted Expected Future Cash Flows  Hypothetical Market Yield  10% – 25%  13%
                  
    2,900   Liquidation Scenario  Discount Rate  18%  18%
           Marketability Discount  20%  20%
           Uncertainty Discount  20%  20%
                  
Warrant investments   7,371   Black-Scholes Valuation Model  Price Per Share  $0.00 – $22.38  $3.69
           Average Industry Volatility  20%  20%
           Marketability Discount  20%  20%
           Estimated Time to Exit  1 to 5 years  3 years
                  
    2   Expected Proceeds  Price Per Share  $0.001  $0.001
                  
Other investments   7,700   Multiple Probability Weighted Cash Flow Model  Discount Rate  18% – 25%  19%
           Probability Weighting  0% – 100%  36%
                  
Equity investments   249   Last Equity Financing  Price Per Share  $0.00 – $1.26  $0.54
Total Level 3 investments  $219,115             

 

Borrowings:  The carrying amount of borrowings under the Company’s revolving credit facility (the “Key Facility”) with KeyBank National Association (“Key”) approximates fair value due to the variable interest rate of the Key Facility and is 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 the fixed-rate 2022 Notes (as defined in Note 7) is based on the closing public share price on the date of measurement. On September 30, 2018, the closing price of the 2022 Notes on the New York Stock Exchange was $25.52 per note, or $38.2 million. Therefore, the Company has categorized this borrowing as Level 1 within the fair value hierarchy described above.

 

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.

 

 32 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following tables detail the assets that are carried at fair value and measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

 

   September 30, 2018 
   Level 1   Level 2   Level 3   Total 
   (In thousands) 
Debt investments  $   $   $215,144   $215,144 
Warrant investments       1,046    9,380    10,426 
Other investments           7,660    7,660 
Equity investments   825        1,289    2,114 
Equity interest in HSLFI(1)               4,413 
Total investments  $825   $1,046   $233,473   $239,757 

 

 
(1)The fair value of Company’s equity interest in HSLFI is determined using the net asset value of the Company’s ownership interest in member’s capital.

 

   December 31, 2017 
   Level 1   Level 2   Level 3   Total 
   (In thousands) 
Debt investments  $   $   $203,793   $203,793 
Warrant investments       1,717    7,373    9,090 
Other investments           7,700    7,700 
Equity investments   1,267        249    1,516 
Total investments  $1,267   $1,717   $219,115   $222,099 

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the three months ended September 30, 2018:

 

   Three Months Ended September 30, 2018 
   Debt
Investments
   Warrant
Investments
   Equity
Investments
   Other
Investments
   Total 
   (In thousands) 
Level 3 assets, beginning of period  $203,459   $7,729   $1,215   $7,700   $220,103 
Purchase of investments   24,200                24,200 
Warrants and equity received and classified as Level 3       618    74        692 
Principal payments received on investments   (12,168)           (33)   (12,201)
Proceeds from sale of investments   (3)   (291)           (294)
Net realized (loss) gain on investments   (17)   82            65 
Unrealized (depreciation) appreciation included in earnings   (20)   1,242        (7)   1,215 
Other   (307)               (307)
Level 3 assets, end of period  $215,144   $9,380   $1,289   $7,660   $233,473 

 

The Company’s transfers between levels are recognized at the end of each reporting period. During the three months ended September 30 2018, there were no transfers between levels.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the three months ended September 30, 2017:

 

   Three Months Ended September 30, 2017 
   Debt
Investments
   Warrant
Investments
   Equity
Investments
   Other
Investments
   Total 
   (In thousands) 
Level 3 assets, beginning of period  $164,895   $6,107   $208   $5,900   $177,110 
Purchase of investments   18,321                18,321 
Warrants and equity received and classified as Level 3       307            307 
Principal payments received on investments   (19,778)           (24)   (19,802)
Net realized loss on investments   (3)   (426)           (429)
Unrealized (depreciation) appreciation included in earnings   (1,936)   726        24    (1,186)
Other   (207)               (207)
Level 3 assets, end of period  $161,292   $6,714   $208   $5,900   $174,114 

 

The Company’s transfers between levels are recognized at the end of each reporting period. During the three months ended September 30, 2017, there were no transfers between levels.

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the nine months ended September 30, 2018:

 

   Nine Months Ended September 30, 2018 
   Debt
Investments
   Warrant
Investments
   Equity
Investments
   Other
Investments
   Total 
   (In thousands) 
Level 3 assets, beginning of period  $203,793   $7,373   $249   $7,700   $219,115 
Purchase of investments   62,246                62,246 
Warrants and equity received and classified as Level 3       1,030    1,090        2,120 
Principal payments received on investments   (46,334)           (169)   (46,503)
Proceeds from sale of investments   (3,064)   (296)           (3,360)
Net realized loss on investments   (32)   (205)           (237)
Unrealized (depreciation) appreciation included in earnings   (180)   1,478    (50)   129    1,377 
Other   (1,285)               (1,285)
Level 3 assets, end of period  $215,144   $9,380   $1,289   $7,660   $233,473 

 

The Company’s transfers between levels are recognized at the end of each reporting period. During the nine months ended September 30 2018, there were no transfers between levels.

 

The change in unrealized appreciation included in the consolidated statement of operations attributable to Level 3 investments still held at September 30, 2018 includes $0.2 million in unrealized depreciation on debt and other investments, $1.3 million in unrealized appreciation on warrant investments and $0.05 million in unrealized depreciation on equity investments.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the nine months ended September 30, 2017:

 

   Nine Months Ended September 30, 2017 
   Debt
Investments
   Warrant
Investments
   Equity
Investments
   Other
Investments
   Total 
   (In thousands) 
Level 3 assets, beginning of period  $186,186   $5,857   $268   $600   $192,911 
Purchase of investments   66,311                66,311 
Warrants and equity received and classified as Level 3       1,374            1,374 
Principal payments received on investments   (79,961)           (101)   (80,062)
Proceeds from sale of investments       (1,537)           (1,537)
Net realized (loss) gain on investments   (11,162)   631            (10,531)
Unrealized appreciation (depreciation) included in earnings   6,249    389    (60)   101    6,679 
Transfer from debt investments to other investments   (5,300)           5,300     
Other   (1,031)               (1,031)
Level 3 assets, end of period  $161,292   $6,714   $208   $5,900   $174,114 

 

The Company’s transfers between levels are recognized at the end of each reporting period. During the nine months ended September 30, 2017, there were no transfers between levels.

 

The change in unrealized appreciation included in the consolidated statement of operations attributable to Level 3 investments still held at September 30, 2017 includes $4.5 million in unrealized depreciation on debt and other investments, $0.01 million in unrealized depreciation on warrant investments and $0.01 million in unrealized appreciation on equity investments.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated 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 September 30, 2018 and December 31, 2017, all of the balances of the Company’s financial instruments were recorded at fair value, except for the Company’s 2022 Notes, as previously described.

 

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 debt investments and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Note 7.  Borrowings

 

The following table shows the Company’s borrowings as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
   Total
Commitment
   Balance
Outstanding
   Unused
Commitment
   Total
Commitment
   Balance
Outstanding
   Unused
Commitment
 
           (In thousands)         
Key Facility  $100,000   $76,000   $24,000   $95,000   $58,000   $37,000 
2022 Notes   37,375    37,375        37,375    37,375     
Total before debt issuance costs   137,375    113,375    24,000    132,375    95,375    37,000 
Unamortized debt issuance costs attributable to term borrowings       (1,091)           (1,300)    
Total borrowings outstanding, net  $137,375   $112,284   $24,000   $132,375   $94,075   $37,000 

 

Currently, with certain limited exceptions, as a BDC, the Company is only allowed to borrow amounts such that the Company’s asset coverage, as defined in the 1940 Act, is at least 200% after such borrowings. As of September 30, 2018, the Company’s asset coverage for borrowed amounts was 219%.

 

On March 23, 2018, President Trump signed into law the Small Business Credit Availability Act as part of an omnibus spending bill, which, among other things, amends the 1940 Act to reduce the minimum required asset coverage applicable to BDCs under the 1940 Act from 200% to 150% if certain approval and disclosure requirements are met. Before such reduced asset coverage requirement can apply to the Company, such reduced asset coverage requirement must be approved by either (a) a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Board, in which case such reduced asset coverage requirement would take effect on the first anniversary of the date of such Board approval, or (b) a majority of votes cast by the stockholders of the Company at a special or annual meeting at which a quorum is present, in which case such reduced asset coverage requirement shall take effect on the day after such approval. On June 7, 2018, a “required majority” of the Board approved the reduced asset coverage requirements and separately recommended that the Company’s stockholders approve the reduced asset coverage requirements at a special meeting of the Company’s stockholders. The Company held a special meeting on October 30, 2018 during which the reduced asset coverage requirements were approved by stockholders. The reduced asset coverage requirements take effect October 31, 2018.

 

The Company entered into the Key Facility with Key effective November 4, 2013. The Key Facility has an accordion feature which allows for an increase in the total loan commitment to $150 million from the $100 million commitment. The Key Facility is collateralized by all debt investments and warrants held by Credit II and permits an advance rate of up to 50% of eligible debt investments held by Credit II. The Key Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the debt investments securing the Key Facility to certain criteria for qualified debt investments and includes portfolio company concentration limits as defined in the related loan agreement. The Key Facility has a revolving period that extends to April 6, 2021, followed by a two-year amortization period and is scheduled to mature on April 6, 2023. The interest rate is based upon the one-month LIBOR, plus a spread of 3.25%, with a LIBOR floor of 0.75%. The LIBOR rate was 2.26% and 1.56% on September 30, 2018 and December 31, 2017, respectively. The average interest rate for the three months ended September 30, 2018 and 2017 was 5.34% and 4.48%, respectively. The average interest rate for the nine months ended September 30, 2018 and 2017 was 5.12% and 4.26%, respectively. The Key Facility requires the payment of an unused line fee in an amount equal to 0.50% of any unborrowed amount available under the facility annually. As of September 30, 2018 and December 31, 2017, the Company had borrowing capacity under the Key Facility of $24.0 million and $37.0 million, respectively. At September 30, 2018 and December 31, 2017, $14.2 million and $23.6 million, respectively, was available, subject to existing terms and advance rates.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

On March 23, 2012, the Company issued and sold an aggregate principal amount of $30.0 million of 7.375% senior unsecured notes due in 2019 and on April 18, 2012, pursuant to the underwriters’ 30 day option to purchase additional notes, the Company sold an additional $3.0 million of such notes (collectively, the “2019 Notes”). The 2019 Notes had a stated maturity of March 15, 2019 and were redeemable in whole or in part at the Company’s option at any time or from time to time at a redemption price of $25 per security plus accrued and unpaid interest. The 2019 Notes bore interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The 2019 Notes were the Company’s direct unsecured obligations and (i) ranked equally in right of payment with the Company’s future unsecured indebtedness; (ii) were senior in right of payment to any of the Company’s future indebtedness that expressly provided it was subordinated to the 2019 Notes; (iii) were effectively subordinated to all of the Company’s existing and future secured indebtedness (including indebtedness that was initially unsecured to which the Company subsequently granted security), to the extent of the value of the assets securing such indebtedness, and (iv) were structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries. On October 30, 2017 (the “Redemption Date”), the Company redeemed all of the issued and outstanding 2019 Notes in an aggregate principal amount of $33.0 million and paid accrued interest of $0.3 million. The Company accelerated $0.2 million of unamortized debt issuance costs related to the 2019 Notes. The 2019 Notes were delisted effective on the Redemption Date.

 

On September 29, 2017, the Company issued and sold an aggregate principal amount of $32.5 million of 6.25% notes due in 2022 and on October 11, 2017, pursuant to the underwriters’ 30 day option to purchase additional notes, the Company sold an additional $4.9 million of such notes (collectively, the “2022 Notes”). The 2022 Notes have a stated maturity of September 15, 2022 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 September 15, 2019 at a redemption price of $25 per security plus accrued and unpaid interest. The 2022 Notes bear interest at a rate of 6.25% per year, payable quarterly on March 15, June 15, September 15 and December 15 of each year. The 2022 Notes are the Company’s direct unsecured obligations and (i) rank equally in right of payment with the Company’s current and future unsecured indebtedness; (ii) are senior in right of payment to any of the Company’s future indebtedness that expressly provides it is subordinated to the 2022 Notes; (iii) are effectively subordinated to all of the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness, and (iv) are structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries. As of September 30, 2018, the Company was in material compliance with the terms of the 2022 Notes. The 2022 Notes are listed on the New York Stock Exchange under the symbol “HTFA”.

 

Note 8.  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 statement 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 $35.0 million and $33.3 million as of September 30, 2018 and December 31, 2017, 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. These commitments are often subject to financial or non-financial milestones and other conditions to borrow that must be achieved before the commitment can be drawn. In addition, the 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.

 

 37 

 

 

 

Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

The following table provides the Company’s unfunded commitments by portfolio company as of September 30, 2018:

 

   September 30, 2018 
   Principal
Balance
   Fair Value of
Unfunded
Commitment
Liability
 
   (In thousands) 
Aerin Medical, Inc.  $5,000   $63 
CSA Medical, Inc.   9,000    104 
Espero Biopharma, Inc.   10,000    100 
HealthEdge Software, Inc.   3,750    37 
MacuLogix, Inc.   3,750    90 
New Signature US, Inc.(1)   2,500    10 
StereoVision Imaging, Inc.   1,000     
Total  $35,000   $404 

 

 
(1)Includes the Company’s portion of HSLFI’s commitment.

 

The table above also provides the fair value of the Company’s unfunded commitment liability as of September 30, 2018, which totaled $0.4 million. The fair value at inception of the delay draw credit agreements is equal to the fees and/or warrants received to enter into these agreements, taking into account the remaining terms of the agreements and the counterparties’ credit profile. The unfunded commitment liability reflects the fair value of these future funding commitments and is included in the Company’s consolidated statement of assets and liabilities.

 

Note 9.  Concentrations of credit risk

 

The Company’s debt investments consist 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 Company’s largest debt investments may vary from period to period as new debt investments are recorded and existing debt investments are repaid. The Company’s five largest debt investments, at cost, represented 32% and 29% of total debt investments outstanding as of September 30, 2018 and December 31, 2017, respectively. No single debt investment represented more than 10% of the total debt investments as of September 30, 2018 and December 31, 2017. Investment income, consisting of interest and fees, can fluctuate significantly upon repayment of large debt investments. Interest income from the five largest debt investments accounted for 31% and 26% of total interest and fee income on investments for the three months ended September 30, 2018 and 2017, respectively. Interest income from the five largest debt investments accounted for 31% and 22% of total interest and fee income on investments for the nine months ended September 30, 2018 and 2017, respectively.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

Note 10. Distributions

 

The Company’s distributions are recorded on the declaration date. The following table summarizes the Company’s distribution activity for the nine months ended September 30, 2018 and for the years ended December 31, 2017 and 2016:

 

Date
Declared
  Record Date  Payment Date  Amount
Per Share
   Cash
Distribution
   DRIP
Shares
Issued
   DRIP
Share
Value
 
   (In thousands, except share and per share data) 
Nine Months Ended September 30, 2018                    
7/27/18  11/19/18  12/14/18  $0.10   $       $ 
7/27/18  10/18/18  11/15/18   0.10             
7/27/18  9/18/18  10/16/18   0.10    1,138    1,253    15 
4/27/18  8/17/18  9/14/18   0.10    1,139    1,212    14 
4/27/18  7/19/18  8/15/18   0.10    1,139    1,202    14 
4/27/18  6/19/18  7/17/18   0.10    1,140    1,221    13 
3/1/18  5/17/18  6/15/18   0.10    1,140    1,271    13 
3/1/18  4/19/18  5/15/18   0.10    1,140    1,287    13 
3/1/18  3/19/18  4/17/18   0.10    1,139    1,255    13 
         $0.90   $7,975    8,701   $95 
Year Ended December 31, 2017                    
10/27/17  2/21/18  3/15/18  $0.10   $1,138    1,241   $14 
10/27/17  1/22/18  2/15/18   0.10    1,139    1,185    13 
10/27/17  12/20/17  1/17/18   0.10    1,139    1,119    13 
7/28/17  11/20/17  12/15/17   0.10    1,139    1,227    13 
7/28/17  10/19/17  11/15/17   0.10    1,139    1,195    13 
7/28/17  9/20/17  10/16/17   0.10    1,138    1,205    14 
4/27/17  8/18/17  9/15/17   0.10    1,140    1,199    13 
4/27/17  7/20/17  8/15/17   0.10    1,140    1,159    12 
4/27/17  6/20/17  7/14/17   0.10    1,138    1,164    13 
3/3/17  5/19/17  6/15/17   0.10    1,137    1,202    14 
3/3/17  4/21/17  5/16/17   0.10    1,137    1,287    15 
3/3/17  3/20/17  4/18/17   0.10    1,134    1,510    18 
         $1.20   $13,658    14,693   $165 
Year Ended December 31, 2016                    
10/28/16  2/22/17  3/15/17  $0.10   $1,134    1,665   $16 
10/28/16  1/19/17  2/15/17   0.10    1,133    1,542    17 
10/28/16  12/20/16  1/13/17   0.10    1,137    1,550    16 
7/29/16  11/18/16  12/15/16   0.115    1,308    1,712    19 
7/29/16  10/20/16  11/15/16   0.115    1,308    1,896    21 
7/29/16  9/20/16  10/17/16   0.115    1,305    1,716    22 
4/28/16  8/19/16  9/15/16   0.115    1,307    1,535    21 
4/28/16  7/20/16  8/15/16   0.115    1,302    1,842    25 
4/28/16  6/20/16  7/15/16   0.115    1,305    1,734    23 
3/3/16  5/19/16  6/15/16   0.115    1,305    1,898    23 
3/3/16  4/20/16  5/16/16   0.115    1,283    3,821    44 
3/3/16  3/18/16  4/15/16   0.115    1,306    1,840    21 
         $1.335   $15,133    22,751   $268 

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

On October 26, 2018, the Board declared monthly distributions per share, payable as set forth in the following table:

 

Ex-Dividend Date  Record Date  Payment Date  Distributions Declared 
February 19, 2019  February 20, 2019  March 15, 2019  $0.10 
January 16, 2019  January 17, 2019  February 15, 2019  $0.10 
December 17, 2018  December 18, 2018  January 15, 2019  $0.10 

 

After paying distributions of $0.30 per share and earning $0.30 per share for the quarter, the Company’s undistributed spillover income as of September 30, 2018 was $0.05 per share. Spillover income includes any ordinary income and net capital gains from the preceding tax years that were not distributed during such tax years.

 

Note 11. Financial highlights

 

The following table shows financial highlights for the Company:

 

   Nine Months Ended September 30, 
   2018   2017 
   (In thousands, except share and per share data) 
Per share data:          
Net asset value at beginning of period  $11.72   $12.09 
Net investment income   0.86    0.86 
Realized loss on investments   (0.02)   (0.96)
Unrealized appreciation on investments   0.01    0.72 
Net increase in net assets resulting from operations   0.85    0.62 
Distributions declared(1)   (0.90)   (0.90)
From net investment income   (0.90)   (0.90)
From net realized gain on investments        
Return of capital        
Other   (0.01)    
Net asset value at end of period  $11.66   $11.81 
Per share market value, beginning of period  $11.22   $10.53 
Per share market value, end of period  $11.41   $11.11 
Total return based on a market value(2)   9.7%   14.1%
Shares outstanding at end of period   11,531,399    11,516,779 
Ratios, net of waiver, to average net assets:          
Expenses without incentive fees   10.1%(3)   8.3%(3)
Incentive fees   2.2%(3)   1.1%(3)
Net expenses   12.3%(3)   9.4%(3)
Net investment income with incentive fees   9.8%(3)   9.6%(3)
Ratios, without waiver, to average net assets:          
Expenses without incentive fees(4)   10.1%(3)   8.3%(3)
Incentive fees(4)   2.8%(3)   1.1%(3)
Net expenses(4)   12.9%(3)   9.4%(3)
Net investment income with incentive fees(4)   9.2%(3)   9.6%(3)
Net assets at the end of the period  $134,456   $135,996 
Average net asset value  $134,391   $137,847 
Average debt per share  $8.38   $5.88 
Portfolio turnover ratio   31.1%   39.4%

 

 
(1)Distributions are determined based on taxable income calculated in accordance with income tax regulations, which may differ from amounts determined under GAAP due to (i) changes in unrealized appreciation and depreciation, (ii) temporary and permanent differences in income and expense recognition, and (iii) the amount of spillover income carried over from a given tax year for distribution in the following tax year. The final determination of taxable income for each tax year, as well as the tax attributes for distributions in such tax year, will be made after the close of the tax year.

 

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Horizon Technology Finance Corporation and Subsidiaries

 

Notes to Consolidated Financial Statements

 

(2) The total return equals the change in the ending market value over the beginning of period price per share plus distributions paid per share during the period, divided by the beginning price.
(3) Annualized.
(4) During the nine months ended September 30, 2018, the Advisor waived $0.6 million of performance based incentive fee.

 

Note 12. Subsequent Event

 

The Company held a special meeting on October 11, 2018 to consider proposals to (1) approve the application to the Company of the reduced asset coverage requirements in Section 61(a)(2) of the 1940 Act, which would permit the Company to reduce the asset coverage requirements applicable to the Company from 200% to 150%, such that the Company would have a debt to equity ratio of a maximum of 2.0x as compared to a current maximum of 1.0x and (2) to approve a new Investment Management Agreement between the Company and the Company’s Advisor in which the base management fee is calculated at an annual rate of 2.00% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. From and after the first date on which the reduced asset coverage requirements in Section 61(a)(2) of the 1940 Act apply to the Company, the base management fee will be calculated at an annual rate of 2.00% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage; provided, that, to the extent the Company’s gross assets (less cash and cash equivalents) exceed $250 million, the base management fee on the amount of such excess over $250 million will be calculated at an annual rate of 1.60% of the Company’s gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. The base management fee is payable monthly in arrears and is prorated for any partial month.

 

The special meeting was adjourned to October 30, 2018 during which the reduced asset coverage requirements and the new Investment Management Agreement were each approved by stockholders. The reduced asset coverage requirements and the new Investment Management Agreement take effect October 31, 2018.

 

 41 

 

 

 

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

 

In this quarterly report on Form 10-Q, except where the context suggests otherwise, the terms “we,” “us,” “our” and “Horizon Technology Finance” refer to Horizon Technology Finance Corporation and its consolidated subsidiaries. The information contained in this section should be read in conjunction with our consolidated financial statements and related notes thereto appearing elsewhere in this quarterly report on Form 10-Q.

 

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 debt investments, warrants and other investments;
the introduction, withdrawal, success and timing of business initiatives and strategies;
changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of our assets;
the relative and absolute investment performance and operations of our investment advisor, Horizon Technology Finance Management LLC, or the Advisor;
the impact of increased competition;
the impact of investments we intend to make and future acquisitions and divestitures;
the unfavorable resolution of legal proceedings;
our business prospects and the prospects of our portfolio companies;
the impact, extent and timing of technological changes and the adequacy of intellectual property protection;
our regulatory structure and tax status;
our ability to qualify and maintain qualification as a regulated investment company, or RIC, and as a business development company, or BDC;
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;
the impact of legislative and regulatory actions and reforms and regulatory supervisory or enforcement actions of government agencies relating to us or our Advisor;
the impact of the Small Business Credit Availability Act on our operations and the BDC industry;
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;
the impact of changes to tax legislation and, generally, our tax position; and
our ability to fund the unfunded commitments of Horizon Secured Loan Fund I, or HSLFI, to the extent approved by each member of HSLFI.

 

We use words such as “anticipates,” “believes,” “expects,” “intends,” “seeks” and similar expressions to identify forward-looking statements. Undue influence should not be placed on the forward looking statements as our actual results could differ materially from those projected in the forward-looking statements for any reason, including the factors in “Risk Factors” and elsewhere in our annual report on Form 10-K for the year ended December 31, 2017, and elsewhere in this quarterly report on Form 10-Q.

 

We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements in this quarterly report on Form 10-Q, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the U.S. Securities and Exchange Commission, or the SEC, including periodic reports on Form 10-Q and Form 10-K and current reports on Form 8-K.

 

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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 maximize our investment portfolio’s total return by generating current income from the debt investments we make and capital appreciation from the warrants we receive when making such debt investments. We are focused on making secured debt investments, which we refer to collectively as “Venture Loans,” to venture capital backed companies in our Target Industries, which we refer to as “Venture Lending.” We also selectively provide Venture Loans to publicly traded companies in our Target Industries. Our debt investments are typically secured by first liens or first liens behind a secured revolving line of credit, or Senior Term Loans. As of September 30, 2018, 98.4%, or $211.7 million, of our debt investment portfolio at fair value consisted of Senior Term Loans. Venture Lending is typically characterized by (1) the making of a secured debt investment after a venture capital or equity investment in the portfolio company has been made, which investment provides a source of cash to fund the portfolio company’s debt service obligations under the Venture Loan, (2) the senior priority of the Venture Loan which requires repayment of the Venture Loan prior to the equity investors realizing a return on their capital, (3) the relatively rapid amortization of the Venture Loan and (4) the lender’s receipt of warrants or other success fees with the making of the Venture Loan.

 

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, for U.S. federal income tax purposes, we have elected to be treated as a RIC under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. As a BDC, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our investments through borrowings. However, as a BDC, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% through October 30, 2018 and 150% thereafter, subject to certain disclosure requirements. The amount of leverage that we employ depends on our assessment of market conditions and other factors at the time of any proposed borrowing. As a RIC, we generally are not subject to corporate-level income taxes on our investment company taxable income, determined without regard to any deductions for dividends paid, and our net capital gain that we distribute as dividends for U.S. federal income tax purposes to our stockholders as long as we meet certain source-of-income, distribution, asset diversification and other requirements.

 

Compass Horizon Funding Company LLC, or Compass Horizon, our predecessor company, commenced operations in March 2008. We were formed in March 2010 for the purpose of acquiring Compass Horizon and continuing its business as a public entity.

 

Our investment activities, and our day-to-day operations, are managed by our Advisor and supervised by our board of directors, or the Board, of which a majority of the members are independent of us. Under an amended and restated investment management agreement, or the Investment Management Agreement, we have agreed to pay our Advisor a base management fee and an incentive fee for its advisory services to us. We have also entered into an administration agreement, or the Administration Agreement, with our Advisor under which we have agreed to reimburse our Advisor for our allocable portion of overhead and other expenses incurred by our Advisor in performing its obligations under the Administration Agreement.

 

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Portfolio composition and investment activity

 

The following table shows our portfolio by type of investment as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018  December 31, 2017
   Number of
Investments
  Fair
Value
   Percentage
of Total
Portfolio
   Number of
Investments
  Fair
Value
   Percentage
of Total
Portfolio
 
   (Dollars in thousands) 
Debt investments  33  $215,144    89.8%  33  $203,793    91.8%
Warrants  69   10,426    4.3   72   9,090    4.0 
Other investments  4   7,660    3.2   4   7,700    3.5 
Equity  9   2,114    0.9   6   1,516    0.7 
Equity interest in HSLFI  1   4,413    1.8            
Total     $239,757    100.0%     $222,099    100.0%

 

The following table shows total portfolio investment activity as of and for the three and nine months ended September 30, 2018 and 2017:

 

   For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
 
   2018   2017   2018   2017 
       (In thousands)     
Beginning portfolio  $226,467   $179,084   $222,099   $194,003 
New debt investments   24,200    18,321    64,725    66,311 
Less refinanced debt investments           (2,479)    
Net new debt investments   24,200    18,321    62,246    66,311 
Investment in controlled affiliate investments   344        4,413     
Principal payments received on investments   (5,591)   (7,202)   (19,568)   (27,536)
Early pay-offs   (6,610)   (12,600)   (26,935)   (52,117)
Accretion of debt investment fees   524    459    1,605    1,397 
New debt investment fees   (375)   (270)   (1,884)   (960)
New equity   74        1,090     
Warrants received in settlement of fee income   161        161     
Proceeds from sale of investments   (294)       (3,360)   (1,572)
Net realized gain (loss) on investments   66    (429)   (237)   (11,098)
Net unrealized appreciation (depreciation) on investments   791    (659)   127    8,276 
Ending portfolio  $239,757   $176,704   $239,757   $176,704 

 

We receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our debt investments prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period.

 

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The following table shows our debt investments by industry sector as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
   Debt
Investments at
Fair Value
   Percentage
of Total
Portfolio
   Debt
Investments at
Fair Value
   Percentage
of Total
Portfolio
 
       (Dollars in thousands)     
Life Science                    
Biotechnology  $27,413    12.7%  $15,015    7.4%
Drug Delivery   1,484    0.7    6,830    3.4 
Medical Device   42,345    19.7    36,173    17.7 
Technology                    
Communications   26,604    12.4    19,549    9.6 
Consumer-Related           10,918    5.3 
Internet and Media   37,371    17.4    38,899    19.1 
Materials   8,005    3.7    9,324    4.6 
Power Management   682    0.3    1,234    0.6 
Semiconductors   3,396    1.6    3,345    1.6 
Software   44,414    20.6    53,994    26.5 
Healthcare Information and Services                    
Software   23,430    10.9    8,512    4.2 
Total  $215,144    100.0%  $203,793    100.0%

 

The largest debt investments in our portfolio may vary from period to period as new debt investments are originated and existing debt investments are repaid. Our five largest debt investments represented 32% and 29% of total debt investments outstanding as of September 30, 2018 and December 31, 2017, respectively. No single debt investment represented more than 10% of our total debt investments as of September 30, 2018 and December 31, 2017.

 

Debt investment asset quality

 

We use an internal credit rating system which rates each debt investment on a scale of 4 to 1, with 4 being the highest credit quality rating and 3 being the rating for a standard level of risk. A rating of 2 represents an increased level of risk and, while no loss is currently anticipated for a 2-rated debt investment, there is potential for future loss of principal. A rating of 1 represents a deteriorating credit quality and a high degree of risk of loss of principal. Our internal credit rating system is not a national credit rating system. As of September 30, 2018 and December 31, 2017, our debt investments had a weighted average credit rating of 3.0. The following table shows the classification of our debt investment portfolio by credit rating as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018  December 31, 2017
   Number of
Investments
  Debt
Investments at
Fair Value
   Percentage
of Debt Investments
   Number of
Investments
  Debt
Investments at
Fair Value
   Percentage
of Debt
Investments
 
   (Dollars in thousands) 
Credit Rating                          
4  4  $30,646    14.2%  4  $18,701    9.2%
3  24   163,753    76.1   25   176,560    86.6 
2  5   20,745    9.7   3   5,632    2.8 
1            1   2,900    1.4 
Total  33  $215,144    100.0%  33  $203,793    100.0%

 

As of September 30, 2018, there were no debt investments with an internal credit rating of 1. As of December 31, 2017, there was one debt investment with an internal credit rating of 1, with a cost of $3.0 million and a fair value of $2.9 million.

 

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Horizon Secured Loan Fund I LLC

 

On June, 1 2018, we and Arena Sunset SPV, LLC (“Arena”) formed a joint venture, HSLFI, to make investments, either directly or indirectly through subsidiaries, primarily in the form of secured loans to development-stage companies in the technology, life science, healthcare information and services and cleantech industries. HSLFI was formed as a Delaware limited liability company and is not consolidated by either us or Arena for financial reporting purposes. Investments held by HSLFI are measured at fair value. As of September 30, 2018, HSLFI had total assets of $9.8 million. HSLFI’s portfolio consisted of debt investments in one portfolio company as of September 30, 2018. As of September 30, 2018, HSLFI had no investments on non-accrual status. HSLFI invests in portfolio companies in the same industries in which we may directly invest.

 

We provide capital (in the form of cash or securities in portfolio companies) to HSLFI in exchange for limited liability company equity interests in HSLFI. As of September 30, 2018, we and Arena each owned 50.0% of the equity interests of HSLFI. Our investment in HSLFI consisted of an equity contribution of $4.3 million as of September 30, 2018. As of September 30, 2018, we had commitments to fund equity interests in HSLFI of $25.0 million, of which $20.7 was unfunded.

 

We and Arena each appointed two members to HSLFI’s four-person board of managers. All material decisions with respect to HSLFI, including those involving its investment portfolio, require unanimous approval of a quorum of the board of managers. Quorum is defined as (i) the presence of two members of the board of managers; provided that at least one individual is present that was elected, designated or appointed by each member; (ii) the presence of three members of the board of managers, provided that the individual that was elected, designated or appointed by the member with only one individual present will be entitled to cast two votes on each matter; or (iii) the presence of all four members of the board of managers.

 

Horizon Funding I, LLC (“HFI”) was formed as a Delaware limited liability company on June 1, 2018, with HSLFI as its sole equity member. HFI is a special purpose bankruptcy-remote entity and is a separate legal entity from HSLFI. Any assets conveyed to HFI are not available to creditors of HSLFI or any other entity other than HFI’s lenders.

 

In addition, on June 1, 2018, HSLFI entered into a sale and servicing agreement with HFI, as Issuer, and us, as Servicer, pursuant to which HSLFI will sell or contribute to HFI certain secured loans made to certain portfolio companies. HFI entered into a Note Funding Agreement with several entities owned or affiliated with New York Life Insurance Company (“Noteholders”) for an aggregate purchase price of up to $100.0 million, with an accordion feature of up to $200.0 million at the mutual discretion and agreement of HSLFI and the Noteholders. The Note Funding Agreement has an investment period that ends on June 1, 2020, if not extended, followed by a five year amortization period and a scheduled final payment date of June 10, 2025, subject to any extension of the investment period. Any notes issued by HFI will be collateralized by all investments held by HFI and permit an advance rate of up to 67% of the aggregate principal amount of eligible debt investments. The interest rate is based on the three year USD mid-market swap rate plus a margin of between 2.75% and 3.25% depending on the rating of the notes at the time the amount is borrowed. There were no advances made by the Noteholders as of September 30, 2018.

 

The following table shows a summary of HSLFI’s investment portfolio:

 

   For the three
months ended,
   For the period
June 1, 2018
through
 
   September 30,
2018
   September 30,
2018
 
   (Dollars in thousands) 
Total investments at fair value  $8,147   $8,147 
Dollar-weighted annualized yield on average debt investments(1)   12.4%   12.2%
Number of portfolio companies in HSLFI   1    1 
Largest portfolio company investment at fair value  $8,147   $8,147 

 

 
(1)HSLFI calculates the yield on dollar-weighted average debt investments for any period measured as (1) total investment income during the period divided by (2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The yield on dollar-weighted average debt investments represents the portfolio yield and does not reflect expenses.

 

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The following table shows HSLFI’s individual investments as of September 30, 2018:

 

         Principal   Cost of   Fair 
Portfolio Company (1)  Sector  Type of Investment (2)(3)(4)  Amount   Investments(5)   Value (6) 
     (Dollars in thousands)   
Debt Investments — Technology                     
New Signature US, Inc. (7)  Software  Term Loan (10.60% cash (Libor + 8.50%; Floor 10.50%), 3.50% ETP, Due 7/1/21)  $8,250   $8,089   $8,089 
Total Debt Investments — Technology              8,089    8,089 
                      
Warrant Investments — Technology                     
BSI Platform Holdings, LLC (7)  Software  412,500 Preferred Stock Warrants        57    58 
Total Warrant Investments — Technology              57    58 
                      
Total Portfolio Investment Assets             $8,146   $8,147 

 

 
(1) All investments of HSLFI are in entities which are organized under the laws of the United States and have a principal place of business in the United States.
   
(2) All interest is payable in cash due monthly in arrears, unless otherwise indicated, and applies only to HSLFI’s debt investments. Interest rate is the annual interest rate on the debt investment and does not include ETPs and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. Debt investments are at variable rates for the term of the debt investment, unless otherwise indicated. All debt investments based on the London InterBank Offered Rate, or LIBOR, are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of September 30, 2018 is provided.
   
(3) ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid.
   
(4) Warrants are non-income producing.
   
(5) For debt investments, represents principal balance less unearned income.
   
(6) The fair value of the investment was valued using significant unobservable inputs.
   
(7) New Signature US, Inc. is a subsidiary of BSI Platform Holdings, LLC.

 

The following table provides HSLFI’s unfunded commitments by portfolio company as of September 30, 2018:

 

   September 30, 2018 
   Principal
Balance
   Fair Value of
Unfunded
Commitment
Liability
 
   (In thousands) 
New Signature US, Inc.  $3,000   $30 
Total  $3,000   $30 

 

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The following tables show certain summarized financial information for HSLFI as of September 30, 2018, for the three months ended September 30, 2018 and for the period June 1, 2018 through September 30, 2018:

 

  

September 30,

2018

 
   (In thousands) 
Selected Statement of Assets and Liabilities Information     
Total investments at fair value (cost of $8,146)  $8,147 
Cash and cash equivalents   236 
Other assets   1,448 
Total assets  $9,831 
      
Other liabilities  $1,112 
Total liabilities   1,112 
      
Members’ equity   8,719 
Total liabilities and members’ equity  $9,831 

 

  

For the three

months ended,

  

For the period

June 1, 2018

through

 
   September 30, 2018   September 30, 2018 
   (In thousands) 
Selected Statements of Operations Information          
Interest income on investments  $250   $255 
Total expenses  $68   $90 
Net investment income  $182   $165 
Net unrealized appreciation on investments  $1   $1 
Net increase in net assets resulting from operations  $183   $166 

 

Consolidated results of operations

 

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

 

Comparison of the three months ended September 30, 2018 and 2017

 

The following table shows consolidated results of operations for the three months ended September 30, 2018 and 2017:

 

   For the Three Months Ended 
   September 30, 
   2018   2017 
   (In thousands) 
Total investment income  $7,797   $6,774 
Total expenses   4,841    2,977 
Performance based incentive fee waived   (446)    
Net expenses   4,395    2,977 
Net investment income   3,402    3,797 
Net realized gain (loss) on investments   66    (429)
Net unrealized appreciation (depreciation) on investments   791    (659)
Net increase in net assets resulting from operations  $4,259   $2,709 
Average debt investments, at fair value  $207,942   $163,797 
Average borrowings outstanding  $105,636   $60,261 

 

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Net increase in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation on investments. As a result, quarterly comparisons of net increase in net assets resulting from operations may not be meaningful.

 

Investment income

 

Total investment income increased by $1.0 million, or 15.1%, to $7.8 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. For the three months ended September 30, 2018, total investment income consisted primarily of $7.3 million in interest income from investments, which included $1.3 million in income from the accretion of origination fees and end-of-term payments, or ETPs, and $0.4 million in fee income. Interest income on debt investments increased by $1.0 million, or 16.7%, for the three months ended September 30, 2018 compared to the three months ended September 30, 2017. Interest income on debt investments increased primarily due to an increase of $44.1 million, or 27.0%, in the average size of our debt investment portfolio which was partially offset by a decrease in accelerated ETPs related to prepayments for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Fee income, which includes success fee and prepayment fee income on debt investments, decreased by $0.1 million, or 19.3%, to $0.4 million for the three months ended September 30, 2018 compared to the three months ended September 30, 2017 primarily due to a decrease in fees earned on lower principal prepayments received.

 

For the three months ended September 30, 2018 and 2017, our dollar-weighted annualized yield on average debt investments (excluding any yield from warrants, equity, other investments and HSLFI) was 14.8% and 16.5%, respectively. We calculate the dollar-weighted yield on average debt investments for any period as (1) total investment income (excluding income from HSLFI) during the period divided by (2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted annualized yield on average debt investments is higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

 

For the three months ended September 30, 2018 and 2017, our investment portfolio (including any yield from warrants, equity and other investments but excluding any yield from HSLFI) had an overall total yield of 13.6% and 15.2%, respectively. We calculate the dollar-weighted yield on average investments for any period as (1) total investment income (excluding income from HSLFI) during the period divided by (2) the average of the fair value of investments outstanding (excluding HSLFI) on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted annualized yield on average investments is higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

 

Investment income, consisting of interest income and fees on debt investments, can fluctuate significantly upon repayment of large debt investments. Interest income from the five largest debt investments in the aggregate accounted for 31% and 26% of investment income for the three months ended September 30, 2018 and 2017, respectively.

 

Expenses

 

Net expenses increased by $1.4 million, or 47.6%, to $4.4 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Total expenses for each period consisted of interest expense, base management fee, incentive and administrative fees, professional fees and general and administrative expenses.

 

Interest expense increased by $0.5 million, or 47.5%, to $1.7 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Interest expense, which includes the amortization of debt issuance costs, increased primarily due to an increase in average borrowings of $45.4 million, or 75.3%, for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, which was partially offset by a decrease in our effective cost of debt.

 

Base management fee expense increased by $0.3 million, or 30.0%, to $1.2 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Base management fee increased primarily due to an increase of $44.1 million, or 27.0%, in the average size of our investment portfolio for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017.

 

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On March 6, 2018, our Advisor irrevocably waived the receipt of incentive fees related to the amounts previously deferred that it may be entitled to receive under the Investment Management Agreement for the period commencing on January 1, 2018 and ending on December 31, 2018. Such waived incentive fees will not be subject to recoupment. During the three months ended September 30, 2018, our Advisor waived performance based incentive fees of $0.4 million which our Advisor would have otherwise earned. This resulted in $0.4 million of reduced expense and additional net investment income for the three months ended September 30, 2018.

 

Performance based incentive fee expense, net of the waiver above, increased by $0.6 million, or 229.8%, to $0.9 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 due to an increase in the cap on incentive fees, or the Incentive Fee Cap, calculated based on the incentive fee cap and deferral mechanism in our Investment Management Agreement. The effect of the increase in the Incentive Fee Cap resulted in $0.6 million of reduced expense and additional net investment income for the three months ended September 30, 2017. The incentive fee on pre-incentive fee net investment income was subject to the Incentive Fee Cap for the three months ended September 30, 2017 due to the cumulative incentive fees paid exceeding 20% of cumulative pre-incentive fee net return since July 1, 2014.

 

Administrative fee expense, professional fees and general and administrative remained flat at $0.7 million for the three months ended September 30, 2018 compared to the three months ended September 30, 2017.

 

Net realized gains and losses and net unrealized appreciation and depreciation

 

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

 

During the three months ended September 30, 2018, we realized net gains totaling $0.1 million primarily due to the termination of warrants upon the sale of two portfolio companies. During the three months ended September 30, 2017, we realized net losses totaling $0.4 million primarily due to the write off of warrants in two portfolio companies.

 

During the three months ended September 30, 2018, net unrealized appreciation on investments totaled $0.8 million which was primarily due to unrealized appreciation on our warrant investments. During the three months ended September 30, 2017, net unrealized depreciation on investments totaled $0.7 million which was primarily due to the unrealized depreciation on one debt investment.

 

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Comparison of the nine months ended September 30, 2018 and 2017

 

The following table shows consolidated results of operations for the nine months ended September 30, 2018 and 2017:

 

   For the Nine Months Ended 
   September 30, 
   2018   2017 
   (In thousands) 
Total investment income  $22,285   $19,614 
Total expenses   12,988    9,697 
Performance based incentive fee waived   (605)    
Net expenses   12,383    9,697 
Net investment income   9,902    9,917 
Net realized loss on investments   (237)   (11,098)
Net unrealized appreciation (depreciation) on investments   127    8,276 
Net increase in net assets resulting from operations  $9,792   $7,095 
Average debt investments, at fair value  $200,131   $168,187 
Average borrowings outstanding  $96,598   $67,674 

 

Net increase in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation on investments. As a result, quarterly comparisons of net increase in net assets resulting from operations may not be meaningful.

 

Investment income

 

Total investment income increased by $2.7 million, or 13.6%, to $22.3 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. For the nine months ended September 30, 2018, total investment income consisted primarily of $20.9 million in interest income from investments, which included $3.9 million in income from the accretion of origination fees and ETPs and $1.3 million in fee income. Interest income on debt investments increased by $3.0 million, or 16.6%, for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. Interest income on debt investments increased primarily due to an increase of $31.9 million, or 19.0%, in the average size of our debt investment portfolio which was partially offset by a decrease in accelerated ETPs related to prepayments for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Fee income, which includes success fee and prepayment fee income on debt investments, decreased by $0.4 million, or 22.9%, to $1.3 million primarily due to a decrease in fees earned on lower principal prepayments received during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017.

 

For the nine months ended September 30, 2018 and 2017, our dollar-weighted annualized yield on average debt investments (excluding any yield from warrants, equity, other investments and HSLFI) was 14.8% and 15.5%, respectively. We calculate the dollar-weighted yield on average debt investments for any period as (1) total investment income (excluding income from HSLFI) during the period divided by (2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted annualized yield on average debt investments is higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

 

For the nine months ended September 30, 2018 and 2017, our investment portfolio (including any yield from warrants, equity and other investments but excluding any yield from HSLFI) had an overall total yield of 13.5% and 14.5%, respectively. We calculate the dollar-weighted yield on average investments for any period as (1) total investment income (excluding income from HSLFI) during the period divided by (2) the average of the fair value of investments outstanding (excluding HSLFI) on (a) the last day of the calendar month immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted annualized yield on average investments is higher than what investors will realize because it does not reflect our expenses or any sales load paid by investors.

 

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Investment income, consisting of interest income and fees on debt investments, can fluctuate significantly upon repayment of large debt investments. Interest income from the five largest debt investments in the aggregate accounted for 31% and 22% of investment income for the nine months ended September 30, 2018 and 2017, respectively.

 

Expenses

 

Net expenses increased by $2.7 million, or 27.7%, to $12.4 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Total expenses for each period consisted of interest expense, base management fee, incentive and administrative fees, professional fees and general and administrative expenses.

 

Interest expense increased by $1.1 million, or 30.4%, to $4.6 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Interest expense, which includes the amortization of debt issuance costs, increased primarily due to an increase in average borrowings of $28.9 million, or 42.7%, for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, which was partially offset by a decrease in our effective cost of debt.

 

Base management fee expense increased by $0.6 million, or 22.1%, to $3.4 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Base management fee increased primarily due to an increase of $31.9 million, or 19.0%, in the average size of our investment portfolio for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.

 

On March 6, 2018, our Advisor irrevocably waived the receipt of incentive fees related to the amounts previously deferred that it may be entitled to receive under the Investment Management Agreement for the period commencing on January 1, 2018 and ending on December 31, 2018. Such waived incentive fees will not be subject to recoupment. During the nine months ended September 30, 2018, our Advisor waived performance based incentive fees of $0.6 million which our Advisor would have otherwise earned. This resulted in $0.6 million of reduced expense and additional net investment income for the nine months ended September 30, 2018.

 

Performance based incentive fee expense, net of waiver, increased by $1.1 million, or 102.7%, to $2.2 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due to an increase in the Incentive Fee Cap calculated based on the incentive fee cap and deferral mechanism in our Investment Management Agreement. The effect of the Incentive Fee Cap resulted in $0.2 million and $1.3 million, respectively, of reduced expense and additional net investment income for the nine months ended September 30, 2018 and 2017. The incentive fee on pre-incentive fee net investment income was subject to the Incentive Fee Cap for the nine months ended September 30, 2018 and 2017 due to the cumulative incentive fees paid exceeding 20% of cumulative pre-incentive fee net return during the applicable quarter and the 11 preceding full calendar quarters.

 

Administrative fee expense, professional fees and general and administrative remained flat for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017.

 

Net realized gains and losses and net unrealized appreciation and depreciation

 

Realized gains or losses on investments are measured by the difference between the net proceeds from the repayment or sale and the cost basis of our investments without regard to unrealized appreciation or depreciation previously recognized. Realized gains or losses on investments include 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 nine months ended September 30, 2018, we realized net losses totaling $0.2 million primarily due to the write off of warrants in nine portfolio companies partially offset by realized gains on the termination of warrants upon the sale of two portfolio companies. During the nine months ended September 30, 2017, we realized net losses totaling $11.1 million primarily due to the resolution of two debt investments partially offset by realized gains on the sale of equity received upon the exercise of warrants.

 

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During the nine months ended September 30, 2018, net unrealized appreciation on investments totaled $0.1 million which was primarily due to the unrealized appreciation on one warrant investment partially offset by the depreciation on one public equity investment and two public warrant investments. During the nine months ended September 30, 2017, net unrealized appreciation on investments totaled $8.3 million which was primarily due to the reversal of previously recorded unrealized depreciation on two debt investments that were settled during the period, partially offset by the unrealized depreciation on two debt investments.

 

Liquidity and capital resources

 

As of September 30, 2018 and December 31, 2017, we had cash of $5.9 million and $6.6 million, respectively. Cash is available to fund new investments, reduce borrowings, pay expenses, repurchase common stock and pay distributions. Our primary sources of capital have been from our public and private equity offerings, use of our revolving credit facilities and issuance of our public debt offerings.

 

On April 27, 2018, our Board extended a previously authorized stock repurchase program which allows us to repurchase up to $5.0 million of our common stock at prices below our net asset value per share as reported in our most recent consolidated financial statements. Under the repurchase program, we may, but are not obligated to, repurchase shares of our outstanding common stock in the open market or in privately negotiated transactions from time to time. Any repurchases by us will comply with the requirements of Rule 10b-18 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and any applicable requirements of the 1940 Act. Unless extended by our Board, the repurchase program will terminate on the earlier of June 30, 2019 or the repurchase of $5.0 million of our common stock. During the three and nine months ended September 30, 2018, we did not make any repurchases of our common stock. During the three and nine months ended September 30, 2017, we repurchased 5,923 shares of our common stock at an average price of $9.97 on the open market at a total cost of $0.1 million. From the inception of the stock repurchase program through September 30, 2018, we repurchased 167,465 shares of our common stock at an average price of $11.22 on the open market at a total cost of $1.9 million.

 

At September 30, 2018 and December 31, 2017, the outstanding principal balance under our revolving credit facility, or the Key Facility, with KeyBank National Association was $76.0 million and $58.0 million, respectively. As of September 30, 2018 and December 31, 2017, we had borrowing capacity under the Key Facility of $24.0 million and $37.0 million, respectively. At September 30, 2018 and December 31, 2017, $14.2 million and $23.6 million, respectively, was available, subject to existing terms and advance rates.

 

Our operating activities used cash of $7.7 million for the nine months ended September 30, 2018, and our financing activities provided cash of $7.0 million for the same period. Our operating activities used cash primarily to purchase investments in portfolio companies partially offset by principal payments received on our debt investments. Our financing activities provided cash primarily from advances on our Key Facility, partially offset by cash used to repay our Key Facility and pay distributions to our stockholders.

 

Our operating activities provided cash of $27.1 million for the nine months ended September 30, 2017, and our financing activities used cash of $41.9 million for the same period. Our operating activities provided cash primarily from principal payments received on our debt investments, partially offset by investments made in portfolio companies. Our financing activities used cash primarily to repay the Key Facility and pay distributions to our stockholders.

 

Our primary use of available funds is to make debt investments in portfolio companies and for general corporate purposes. We expect to raise additional equity and debt capital opportunistically as needed and, subject to market conditions, to support our future growth to the extent permitted by the 1940 Act.

 

In order to remain subject to taxation as a RIC, we intend to distribute to our stockholders all or substantially all of our investment company taxable income. In addition, as a BDC, we are currently required to maintain asset coverage of at least 200%. This requirement limits the amount that we may borrow.

 

On March 23, 2018, President Trump signed into law the Small Business Credit Availability Act as part of an omnibus spending bill, which, among other things, amends the 1940 Act to reduce the minimum required asset coverage applicable to BDCs under the 1940 Act from 200% to 150% if certain approval and disclosure requirements are met. Before such reduced asset coverage requirement can apply to us, such reduced asset coverage requirement must be approved by either (a) a “required majority” (as defined in Section 57(o) of the 1940 Act) of our Board, in which case such reduced asset coverage requirement would take effect on the first anniversary of the date of such Board approval, or (b) a majority of votes cast by our stockholders at a special or annual meeting at which a quorum is present, in which case such reduced asset coverage requirement shall take effect on the day after such approval. On June 7, 2018, a “required majority” of our Board approved the reduced asset coverage requirements and separately recommended that our stockholders approve the reduced asset coverage requirements at a special meeting of our stockholders. We held a special meeting on October 30, 2018 to consider a proposal to permit the reduced asset coverage requirements during which the reduced asset coverage requirements were approved by stockholders. The reduced asset coverage requirements take effect October 31, 2018.

 

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We believe that our current cash, cash generated from operations, and funds available from our Key Facility will be sufficient to meet our working capital and capital expenditure commitments for at least the next 12 months.

 

Current borrowings

 

The following table shows our borrowings as of September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
  

Total

Commitment

  

Balance

Outstanding

  

Unused

Commitment

  

Total

Commitment

  

Balance

Outstanding

  

Unused

Commitment

 
           (In thousands)         
Key Facility  $100,000   $76,000   $24,000   $95,000   $58,000   $37,000 
2022 Notes   37,375    37,375        37,375    37,375     
Total before debt issuance costs   137,375    113,375    24,000    132,375    95,375    37,000 
Unamortized debt issuance costs attributable to term borrowings       (1,091)           (1,300)    
Total borrowings outstanding, net  $137,375   $112,284   $24,000   $132,375   $94,075   $37,000 

 

We entered into the Key Facility effective November 4, 2013. The interest rate on the Key Facility is based upon the one-month LIBOR plus a spread of 3.25%, with a LIBOR floor of 0.75%. The LIBOR rate was 2.26% and 1.56% as of September 30, 2018 and December 31, 2017, respectively. The interest rates in effect were 5.35% and 4.61% as of September 30, 2018 and December 31, 2017, respectively. The Key Facility requires the payment of an unused line fee in an amount equal to 0.50% of any unborrowed amount available under the facility annually.

 

The Key Facility has an accordion feature which allows for an increase in the total loan commitment to $150 million. The Key Facility is collateralized by debt investments held by Horizon Credit II LLC, or Credit II, and permits an advance rate of up to fifty percent (50%) of eligible debt investments held by Credit II. The Key Facility contains covenants that, among other things, require us to maintain a minimum net worth, to restrict the debt investments securing the Key Facility to certain criteria for qualified debt investments and to comply with portfolio company concentration limits as defined in the related loan agreement. The period during which we may request advances under the Key Facility, or the Revolving Period, extends through April 6, 2021. After the Revolving Period, we may not request new advances, and we must repay the outstanding advances under the Key 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 Key Facility, particularly the condition that the principal balance of the Key Facility not exceed fifty percent (50%) of the aggregate principal balance of our eligible debt investments to our portfolio companies. The maturity of the Key Facility, the date on which all outstanding advances under the Key Facility are due and payable, is on April 6, 2023.

 

On March 23, 2012, we issued and sold an aggregate principal amount of $30.0 million of our 7.375% notes due 2019, or the 2019 Notes, and on April 18, 2012, pursuant to the underwriters’ 30-day option to purchase additional notes, we sold an additional $3.0 million of the 2019 Notes. The 2019 Notes had a stated maturity of March 15, 2019 and were redeemable in whole or in part at our option at any time or from time to time at a redemption price of $25 per security plus accrued and unpaid interest. The 2019 Notes bore interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The 2019 Notes were our direct, unsecured obligations and (1) ranked equally in right of payment with our future unsecured indebtedness; (2) were senior in right of payment to any of our future indebtedness that expressly provided it was subordinated to the 2019 Notes; (3) were effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that was initially unsecured to which we subsequently granted security), to the extent of the value of the assets securing such indebtedness and (4) were structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries. On October 30, 2017, or the Redemption Date, we redeemed all of the issued and outstanding 2019 Notes in an aggregate principal amount of $33.0 million and paid accrued interest of $0.3 million. The 2019 Notes were delisted effective on the Redemption Date.

 

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On September 29, 2017, we issued and sold an aggregate principal amount of $32.5 million of our 6.25% notes due 2022, or the 2022 Notes, and on October 11, 2017, pursuant to the underwriters’ 30-day option to purchase additional notes, we sold an additional $4.9 million of the 2022 Notes. The 2022 Notes have a stated maturity of September 15, 2022 and may be redeemed in whole or in part at our option at any time or from time to time on or after September 15, 2019 at a redemption price of $25 per security plus accrued and unpaid interest. The 2022 Notes bear interest at a rate of 6.25% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The 2022 Notes are our direct, unsecured obligations and (1) rank equally in right of payment with our current and future unsecured indebtedness; (2) are senior in right of payment to any of our future indebtedness that expressly provides it is subordinated to the 2022 Notes; (3) are 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 and (4) are structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries. As of September 30, 2018, we were in material compliance with the terms of the 2022 Notes. The 2022 Notes are listed on the New York Stock Exchange under the symbol “HTFA”.

 

Other assets

 

As of September 30, 2018 and December 31, 2017, other assets were $1.7 million and $1.5 million, respectively, which is primarily comprised of debt issuance costs and prepaid expenses.

 

Contractual obligations and off-balance sheet arrangements

 

The following table shows our significant contractual payment obligations and off-balance sheet arrangements as of September 30, 2018:

 

   Payments due by period 
   Total  

Less than

1 year

  

1 – 3

Years

  

3 – 5

Years

  

After 5

years

 
   (In thousands) 
Borrowings  $113,375   $9,541   $59,032   $44,802   $ 
Unfunded commitments(1)   35,000    31,000    4,000         
Total  $148,375   $40,541   $63,032   $44,802   $ 

 

 

(1)Includes our portion of HSLFI’s commitment.

 

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 September 30, 2018, we had unfunded commitments of $35.0 million. These commitments are subject to the same underwriting and ongoing portfolio maintenance requirements as are the financial instruments that we hold on our balance sheet. In addition, these commitments are often subject to financial or non-financial milestones and other conditions to borrowing that must be achieved before the commitment can be drawn. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We regularly monitor our unfunded commitments and anticipated refinancings, maturities and capital raising, to ensure that we have sufficient liquidity to fund such unfunded commitments. As of September 30, 2018, we reasonably believed that our assets would provide adequate financial resources to satisfy all of our unfunded commitments.

 

In addition to the Key Facility, 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 (1) a base management fee equal to a percentage of the value of our gross assets less cash or cash equivalents, 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 obligations 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 staffs. See Note 3 to our consolidated financial statements for additional information regarding our Investment Management Agreement and our Administration Agreement.

 

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Distributions

 

In order to qualify and be subject to tax as a RIC, we must meet certain source-of-income, asset diversification and annual distribution requirements. Generally, in order to qualify as a RIC, we must derive at least 90% of our gross income for each tax year from dividends, interest, payments with respect to certain securities, loans, gains from the sale or other disposition of stock, securities or foreign currencies, or other income derived with respect to its business of investing in stock or other securities. We must also meet certain asset diversification requirements at the end of each quarter of each tax year. Failure to meet these diversification requirements on the last day of a quarter may result in us having to dispose of certain investments quickly in order to prevent the loss of RIC status. Any such dispositions could be made at disadvantageous prices or times, and may cause us to incur substantial losses.

 

In addition, in order to be subject to tax as a RIC and to avoid the imposition of corporate-level tax on the income and gains we distribute to our stockholders in respect of any tax year, we are required under the Code to distribute as dividends to our stockholders out of assets legally available for distribution each tax year an amount generally at least equal to 90% of the sum of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any. Additionally, in order to avoid the imposition of a U.S. federal excise tax, we are required to distribute, in respect of each calendar year, dividends to our stockholders of an amount at least equal to the sum of 98% of our calendar year net ordinary income (taking into account certain deferrals and elections); 98.2% of our capital gain net income (adjusted for certain ordinary losses) for the one year period ending on October 31 of such calendar year; and any net ordinary income and capital gain net income for preceding calendar years that were not distributed during such calendar years and on which we previously did not incur any U.S. federal income tax. If we fail to qualify as a RIC for any reason and become subject to corporate tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on us and our stockholders. In addition, we could be required to recognize unrealized gains, incur substantial taxes and interest and make substantial distributions in order to re-qualify as a RIC. We cannot assure stockholders that they will receive any distributions.

 

To the extent our taxable earnings in a tax year fall below the total amount of our distributions made to stockholders in respect of such tax 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 review any written disclosure accompanying a distribution 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, or DRIP, 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 DRIP. 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, stockholders participating in our DRIP will not receive any corresponding cash distributions with which to pay any such applicable taxes. If our common stock is trading above net asset value, a stockholder receiving distributions in the form of additional shares of our common stock will be treated as receiving a distribution of an amount equal to the fair market value of such shares of our common stock. We may use newly issued shares to implement the DRIP, or we may purchase shares in the open market in connection with our obligations under the DRIP.

 

Related party transactions

 

We have entered into the Investment Management Agreement with the Advisor. The Advisor is registered as an investment adviser under the Investment Advisers Act of 1940, as amended. Our investment activities are managed by the Advisor and supervised by the Board, the majority of whom are independent directors. Under the Investment Management Agreement, we have agreed to pay the Advisor a base management fee as well as an incentive fee. During the three months ended September 30, 2018 and 2017, we paid the Advisor $2.0 million and $1.2 million, respectively, pursuant to the Investment Management Agreement. During the nine months ended September 30, 2018 and 2017, we paid the Advisor $5.6 million and $3.9 million, respectively, pursuant to the Investment Management Agreement.

 

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Our Advisor is 60% owned by HTF Holdings LLC, which is 100% owned by Horizon Technology Finance, LLC. By virtue of their ownership interest in Horizon Technology Finance, LLC, our Chief Executive Officer, Robert D. Pomeroy, Jr. and our President, Gerald A. Michaud, may be deemed to control our Advisor.

 

We have also entered into the Administration Agreement with the Advisor. Under the Administration Agreement, we have agreed to reimburse the Advisor for our allocable portion of overhead and other expenses incurred by the Advisor in performing its obligations under the Administration Agreement, including rent and our allocable portion of the costs of compensation and related expenses of our Chief Financial Officer and Chief Compliance Officer and their respective staffs. In addition, pursuant to the terms of the Administration Agreement the Advisor provides us with the office facilities and administrative services necessary to conduct our day-to-day operations. During the three months ended September 30, 2018 and 2017, we paid the Advisor $0.2 million pursuant to the Administration Agreement. During the nine months ended September 30, 2018 and 2017, we paid the Advisor $0.5 million and $0.6 million, respectively, pursuant to the Administration Agreement.

 

The predecessor of the Advisor has granted the Company a non-exclusive, royalty-free license to use the name “Horizon Technology Finance.”

 

We believe that we derive substantial benefits from our relationship with our Advisor. Our Advisor may manage other investment vehicles, or Advisor Funds, with the same investment strategy as us. The Advisor may provide us an opportunity to co-invest with the Advisor Funds. Under the 1940 Act, absent receipt of exemptive relief from the SEC, we and our affiliates are precluded from co-investing in negotiated investments. On November 27, 2017, we were granted exemptive relief from the SEC which permits us to co-invest with Advisor Funds, subject to certain conditions.

 

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. 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 our portfolio investments. We apply fair value to substantially all of our investments in accordance with Topic 820, Fair Value Measurement, of the Financial Accounting Standards Board’s, or FASB’s, Accounting Standards Codification as amended, or ASC, 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:

 

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

 

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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 3 Unobservable 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.

 

Our Board determines the fair value of investments in good faith, based on the input of management, the audit committee and independent valuation firms that have been engaged at the direction of our 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 our valuation policy and a consistently applied valuation process. The Board conducts this valuation process at the end of each fiscal quarter, with 25% (based on fair value) of our valuation of portfolio companies that do not have a readily available market quotations subject to review by an independent valuation firm.

 

Income recognition

 

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. Generally, when a debt investment becomes 90 days or more past due, or if we otherwise do not expect to receive interest and principal repayments, the debt investment is placed on non-accrual status and the recognition of interest income may be discontinued. Interest payments received on non-accrual debt investments may be recognized as income, on a cash basis, or applied to principal depending upon management’s judgment at the time the debt investment is placed on non-accrual status. For the three and nine months ended September 30, 2018, we did not recognize any interest income from debt investments on non-accrual status. For the three and nine months ended September 30, 2017, we recognized $0.1 million in interest income from debt investments on non-accrual status.

 

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, success fees and prepayment fees. In a limited number of cases, we may also receive a non-refundable deposit earned upon the termination of a transaction. Debt investment 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 debt investment. All other income is recorded into income when earned. Fees for counterparty debt investment commitments with multiple debt investments are allocated to each debt investment based upon each debt investment’s relative fair value. When a debt investment is placed on non-accrual status, the amortization of the related fees and unearned income is discontinued until the debt investment is returned to accrual status.

 

Certain debt investment agreements also require the borrower to make an ETP that is accrued into income over the life of the debt investment 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. We record the warrants as assets at estimated fair value on the grant date using the Black-Scholes valuation model. We consider the warrants as loan fees and record them as unearned income on the grant date. The unearned income is recognized as interest income over the contractual life of the related debt investment in accordance with our income recognition policy. Subsequent to 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 and losses from the disposition of the warrants or stock acquired from the exercise of warrants are recognized as realized gains and losses on investments.

 

Distributions from HSLFI are evaluated at the time of distribution to determine if the distribution should be recorded as dividend income or a return of capital. Generally, we will not record distributions from HSLFI as dividend income unless there are sufficient accumulated tax-basis earnings and profit in HSLFI prior to distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. For the three months ended September 30, 2018 and the period June 1, 2018 (the commencement of HSLFI’s operations) through September 30, 2018, HSLFI distributed $0.1 million as dividend income to us.

 

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Realized gains or losses on the sale of investments, or upon the determination that an investment balance, or portion thereof, is not recoverable, are calculated using the specific identification method. We measure realized gains or losses by calculating the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment. Net change in unrealized appreciation or depreciation reflects the change in the fair values of our portfolio investments during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

 

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 and to avoid the imposition of corporate-level U.S. federal income tax on the amounts we distribute to our stockholders, among other things, we are required to meet certain source of income and asset diversification requirements, and we must timely distribute dividends to our stockholders out of assets legally available for distribution each tax year of an amount generally at least equal to 90% of our investment company taxable income, as defined by the Code and determined without regard to any deduction for dividends paid. We, among other things, have made and intend to continue to make the requisite distributions to our stockholders, which will generally relieve us from incurring any material liability for 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 distributions into the next tax year and incur 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 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 in accordance with ASC Topic 740, Income Taxes, as modified by ASC Topic 946, Financial Services Investment Companies. Tax benefits of positions not deemed to meet the more-likely-than-not threshold, or uncertain tax positions, are 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. We had no material uncertain tax positions at September 30, 2018 and December 31, 2017.

 

Recently adopted accounting pronouncement

 

In April 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), or ASU 2014-09, which amends existing revenue recognition guidance to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017. As required, we adopted ASU 2014-09 effective January 1, 2018, and such adoption did not have an impact on our consolidated financial statements and disclosures.

 

Recent development

 

We held a special meeting on October 11, 2018 to consider proposals to (1) approve the application to us of the reduced asset coverage requirements in Section 61(a)(2) of the 1940 Act, which would permit us to reduce the asset coverage requirements applicable to us from 200% to 150%, such that we would have a debt to equity ratio of a maximum of 2.0x as compared to a current maximum of 1.0x and (2) to approve a new Investment Management Agreement between the us and our Advisor in which the base management fee is calculated at an annual rate of 2.00% of our gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. From and after the first date on which the reduced asset coverage requirements in Section 61(a)(2) of the 1940 Act apply to us, the base management fee will be calculated at an annual rate of 2.00% of our gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage; provided, that, to the extent our gross assets (less cash and cash equivalents) exceed $250 million, the base management fee on the amount of such excess over $250 million will be calculated at an annual rate of 1.60% of our gross assets (less cash and cash equivalents) including any assets acquired with the proceeds of leverage. The base management fee is payable monthly in arrears and is prorated for any partial month.

 

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The special meeting was adjourned to October 30, 2018 during which the reduced asset coverage requirements and the new Investment Management Agreement were each approved by stockholders. The reduced asset coverage requirements and the new Investment Management Agreement take effect October 31, 2018.

 

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 debt investments within our portfolio were primarily at floating rates. We expect that our debt investments in the future will primarily have floating interest rates. As of September 30, 2018 and December 31, 2017, 99% of the outstanding principal amount of our debt investments bore interest at floating rates. The initial commitments to lend to our portfolio companies are usually based on a floating LIBOR index.

 

Based on our September 30, 2018 consolidated statement of assets and liabilities (without adjustment for potential changes in the credit market, credit quality, size and composition of assets on the consolidated statement of assets and liabilities or other business developments that could affect net income) and the base index rates at September 30, 2018, the following table shows the annual impact on the change in net assets resulting from operations of changes in interest rates, which assumes no changes in our investments and borrowings:

 

   Interest
Income
   Interest
Expense
  

Change in

Net Assets(1)

 
Change in basis points  (In thousands) 
Up 300 basis points  $6,588   $2,312   $4,276 
Up 200 basis points  $4,394   $1,541   $2,853 
Up 100 basis points  $2,199   $771   $1,428 
Down 300 basis points  $(2,079)  $(1,043)  $(1,036)
Down 200 basis points  $(2,055)  $(1,043)  $(1,012)
Down 100 basis points  $(1,615)  $(771)  $(844)

 

(1)Excludes the impact of incentive fees based on pre-incentive fee net investment income.

 

While our 2022 Notes bear interest at a fixed rate, our Key Facility has a floating interest rate provision, subject to a floor of 0.75% per annum, based on a LIBOR index which resets monthly, and 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 caps, 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 expect to 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 could increase, which would reduce our net investment income.

 

Item 4.  Controls and Procedures

 

(a) Evaluation of disclosure controls and procedures

 

As of September 30, 2018, 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) under the Exchange Act). Based on that evaluation, our management, including our 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.

 

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(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) under 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.

 

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PART II

 

Item 1: Legal Proceedings.

 

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

 

Item 1A: Risk Factors.

 

In addition to other information set forth in this report, you should carefully consider the factors set forth below and in “Item 1A Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2017, 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. Other than the item set forth below, there have been no material changes during the nine months ended September 30, 2018 to the risk factors set forth in “Item 1A. Risk Factors” of our annual report on Form 10-K for the year ended December 31, 2017.

 

We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.

 

Leverage is generally considered a speculative investment technique, and we intend to continue to borrow money as part of our business plan. The use of leverage magnifies the potential for gain or loss on amounts invested and, therefore, increases the risks associated with investing in us. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Liquidity and capital resources.” Lenders of senior debt securities have fixed dollar claims on our assets that are superior to the claims of our common stockholders. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not leveraged. However, any decrease in our income would cause net income to decline more sharply than it would have had we not leveraged. This decline could adversely affect our ability to make common stock distribution payments. In addition, because our investments may be illiquid, we may be unable to dispose of them or unable to do so at a favorable price in the event we need to do so, if we are unable to refinance any indebtedness upon maturity, and, as a result, we may suffer losses.

 

Our ability to service any debt that we incur depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures. Moreover, as our Advisor’s management fee is payable to our Advisor based on our gross assets less cash and cash equivalents, including those assets acquired through the use of leverage, our Advisor may have a financial incentive to incur leverage which may not be consistent with our stockholders’ interests. As leverage magnifies gains, if any, on our portfolio, as discussed above, our pre-incentive fee net investment income may exceed the quarterly hurdle rate for the incentive fee on income payable pursuant to the management fee at a lower average return on our portfolio. Thus, if we incur additional leverage, the incentive fees payable to the Advisor may increase without any corresponding increase in our performance. Holders of our common stock bear the burden of any increase in our expenses as a result of leverage, including any increase in the management fee or incentive fee payable to our Advisor.

 

In addition to the leverage described above, in the past, we have securitized a large portion of our debt investments to generate cash for funding new investments and may seek to securitize additional debt investments in the future to the extent permitted by the 1940 Act and the risk retention rules adopted pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. To securitize additional debt investments in the future, we may create a wholly-owned subsidiary and sell and/or contribute a pool of debt investments to such subsidiary. This could include the sale of interests in the subsidiary on a non-recourse basis to purchasers, who we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools. We would retain all or a portion of the equity in any such securitized pool of loans. An inability to securitize part of our debt investments in the future could limit our ability to grow our business, fully execute our business strategy and increase our earnings. Moreover, certain types of securitization transactions may expose us to greater risk of loss than would other types of financing.

 

On June 7, 2018, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our Board approved the reduced asset coverage requirements and separately recommended that our stockholders approve the reduced asset coverage requirements at a special meeting of our stockholders. The Company held a special meeting on October 30, 2018 during which the reduced asset coverage requirements were approved by stockholders. The reduced asset coverage requirements take effect October 31, 2018.

 

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Illustration: The following table illustrates the effect of leverage on returns from an investment in our common stock assuming that we employ leverage such that our asset coverage equals (1) our actual asset coverage as of September 30, 2018 and (2) 150% at various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below:

 

   Assumed Return on Portfolio
(Net of Expenses)
 
   -10%   -5%   0%   5%   10% 
Corresponding return to common stockholder assuming actual asset coverage as of September 30, 2018(1)   (23.66)%   (14.26)%   (4.86)%   4.54%   13.95%
Corresponding return to common stockholder assuming 150% asset coverage(2)   (41.90)%   (26.71)%   (11.52)%   3.66%   18.85%

 

 

 

(1)Assumes $252 million in total assets, $113 million in outstanding debt, $134 million in net assets, and an average cost of borrowed funds of 5.76% at September 30, 2018.

 

(2)Assumes $407 million in total assets, $268 million in outstanding debt, $134 million in net assets, and an average cost of borrowed funds of 5.76% at September 30, 2018.

 

Based on our outstanding indebtedness of $113 million as of September 30, 2018 and the average cost of borrowed funds of 5.76% as of that date, our investment portfolio would have been required to experience an annual return of at least 3.03% to cover annual interest payments on the outstanding debt. Actual interest payments may be different.

 

Based on an outstanding indebtedness of $268 million on an assumed 150% asset coverage ratio and an average cost of borrowed funds of 5.76%, our investment portfolio would be required to experience an annual return of at least 4.17% to cover annual interest payments on the outstanding debt. Actual interest payments may be different.

 

Because we distribute all or substantially all of our investment company taxable income to our stockholders, we will need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow will be impaired.

 

To satisfy the requirements applicable to a RIC, to avoid incurring excise taxes and to minimize or to avoid incurring corporate-level federal income taxes, we intend to distribute to our stockholders all or substantially all of our investment company taxable income and net capital gains. However, we may retain all or a portion of our net capital gains, incur any applicable income taxes with respect thereto, and elect to treat such retained net capital gains as deemed distributions to our stockholders. As a BDC, we generally are required to maintain coverage of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at least 200% through October 30, 2018 and 150% thereafter, subject to certain disclosure requirements. This requirement limits the amount that we may borrow. Because we continue to need capital to grow our debt investment portfolio, this limitation may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. In addition, as a BDC, we are limited in our ability to issue equity securities at a price below the then-current net asset value per share. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities, and our net asset value could decline.

 

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Regulations governing our operation as a BDC affect our ability to, and the way in which, we raise additional capital, which may expose us to additional risks.

 

Our business plans contemplate a need for a substantial amount of capital in addition to our current amount of capital. We may obtain additional capital through the issuance of debt securities or preferred stock, and we may borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. If we issue senior securities, we would be exposed to typical risks associated with leverage, including an increased risk of loss. In addition, if we issue preferred stock, it would rank senior to common stock in our capital structure and preferred stockholders would have separate voting rights and may have rights, preferences or privileges more favorable than those of holders of our common stock.

 

The 1940 Act permits us to issue senior securities in amounts such that our asset coverage, as defined in the 1940 Act, after each issuance of senior securities equals at least 200% through October 30, 2018 and 150% thereafter, subject to certain disclosure requirements. If our asset coverage is not at least 200% or 150% as applicable, we are not permitted to pay distributions or issue additional senior securities. As a result, we may have difficulty meeting the annual distribution requirement necessary to maintain RIC tax treatment. Moreover, if the value of our assets declines, we may be unable to satisfy this asset coverage test. If that happens, we may be required to liquidate a portion of our investments and repay a portion of our indebtedness at a time when we may be unable to do so or unable to do so on favorable terms.

 

As a BDC, we generally are not able to issue our common stock at a price below net asset value per share without first obtaining the approval of our stockholders and our independent directors. Our stockholder approval expired in January 2016, but we may seek such approval again in the future. If our common stock trades at a price below net asset value per share and we do not receive approval from our stockholders and our independent directors to issue common stock at a price below net asset value per share, we cannot raise capital through the issuance of equity securities. This may limit our ability: to grow and make new investments; to attract and retain top investment professionals; to maintain deal flow and relations with top companies in our Target Industries and related entities such as venture capital and private equity sponsors; and to sustain a minimum efficient scale for a public company. The stockholder approval requirement does not apply to stock issued upon the exercise of options, warrants or rights that we may issue from time to time. If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our stockholders at that time would decrease, and you may experience dilution.

 

Recently passed legislation may allow us to incur additional leverage.

 

A BDC has historically been able to issue “senior securities,” including borrowing money from banks or other financial institutions, only in amounts such that its asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. On March 23, 2018, the Small Business Credit Availability Act was signed into law and amended the 1940 Act to decrease the asset coverage requirements applicable to BDCs from 200% to 150% if such lower asset coverage requirements have been approved by either (a) a majority of a BDC’s directors who have no financial interest in such approval and a majority of the BDC’s directors who are not interested persons, as defined by the 1940 Act (a “required majority” as defined in Section 57(o) of the 1940 Act), of such BDC, in which case such reduced asset coverage requirements would take effect on the first anniversary of the date of such approval, or (b) a majority of votes cast by the stockholders of such BDC at a special or annual meeting at which a quorum is present, in which case such reduced asset coverage requirements shall take effect on the day after such approval. On June 7, 2018, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our Board approved the reduced asset coverage requirements and separately recommended that our stockholders approve the reduced asset coverage requirements at a special meeting of our stockholders. The Company held a special meeting on October 30, 2018 during which the reduced asset coverage requirements were approved by stockholders. The reduced asset coverage requirements take effect October 31, 2018.

 

As a result, if we comply with certain disclosure requirements, we will be able to incur additional indebtedness, which may increase the risk of investing in us. See “We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.” In addition, since our base management fee is payable based upon our gross assets (less cash and cash equivalents), which includes any assets acquired with the proceeds of borrowings, the base management fee expense will increase if we incur additional leverage.

 

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The indenture governing our debt securities contains limited protection for holders of our debt securities.

 

The indenture governing our debt securities offers limited protection to holders of our debt securities. The terms of the indenture do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on investments in our debt securities. In particular, the terms of the indenture do not place any restrictions on our or our subsidiaries’ ability to:

 

issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to our debt securities, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to our debt securities to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to our debt securities and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to our debt securities with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) of the 1940 Act as modified by Section 61(a)(l) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, (these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act after such borrowings, equals at least 200% through October 30, 2018 and 150% thereafter, subject to certain disclosure requirements);

 

pay dividends on, or purchase or redeem or make any payments in respect of capital stock or other securities ranking junior in right of payment to our debt securities, including subordinated indebtedness, in each case other than dividends, purchases, redemptions or payments that would cause a violation of Section 18(a)(1)(B) of the 1940 Act as modified by Section 61(a)(l) of the 1940 Act or any successor provisions giving effect to any exemptive relief granted to us by the SEC (these provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock unless our asset coverage, as defined in the 1940 Act, at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase equals at least 200% through October 30, 2018 and 150% thereafter, subject to certain disclosure requirements);

 

sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);

 

enter into transactions with affiliates;

 

create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;

 

make investments; or

 

create restrictions on the payment of dividends or other amounts to us from our subsidiaries.

 

In addition, the indenture does not require us to offer to purchase our debt securities in connection with a change of control or any other event.

 

Furthermore, the terms of the indenture do not protect holders of our debt securities in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.

 

Our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by the terms of our debt securities may have important consequences for holders of our debt securities, including making it more difficult for us to satisfy our obligations with respect to our debt securities or negatively affecting the trading value of our debt securities.

 

Certain of our current debt instruments include more protections for their holders than the indenture. In addition, other debt we issue or incur in the future could contain more protections for its holders than the indenture including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for and trading levels and prices of our debt securities.

 

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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

 

Exhibit

No.

  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, as amended
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, as amended
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, as amended
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, as amended

 

 

*Filed herewith

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, 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: October 30, 2018   By: /s/ Robert D. Pomeroy, Jr.
      Name: Robert D. Pomeroy, Jr.
      Title: Chief Executive Officer and Chairman of the Board
         
Date: October 30, 2018   By: /s/ Daniel R. Trolio
      Name: Daniel R. Trolio
      Title: Chief Financial Officer

 

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