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:
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our future operating results, including the performance of our existing debt investments and warrants;
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the introduction, withdrawal, success and timing of business initiatives and strategies;
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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;
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the relative and absolute investment performance and operations of our investment advisor, Horizon
Technology Finance Management LLC, or the Advisor;
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the impact of increased competition;
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the impact of investments we intend to make and future acquisitions and divestitures;
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the unfavorable resolution of legal proceedings;
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our business prospects and the prospects of our portfolio companies;
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the impact, extent and timing of technological changes and the adequacy of intellectual property
protection;
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our regulatory structure and tax status;
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our ability to qualify and maintain qualification as a regulated investment company, or RIC, and
as a business development company, or BDC;
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the adequacy of our cash resources and working capital;
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the timing of cash flows, if any, from the operations of our portfolio companies;
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the impact of interest rate volatility on our results, particularly if we use leverage as part
of our investment strategy;
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the ability of our portfolio companies to achieve their objective;
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the impact of legislative and regulatory actions and reforms and regulatory supervisory or enforcement
actions of government agencies relating to us or our Advisor;
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our contractual arrangements and relationships with third parties;
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our ability to access capital and any future financings by us;
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the ability of our Advisor to attract and retain highly talented professionals; and
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the impact of changes to tax legislation and, generally, our tax position.
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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, 2015, and elsewhere
in this quarterly report on Form 10-Q.
We have based the
forward-looking statements included in this report on information available to us on the date of this report, and we assume no
obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking
statements in this quarterly report on Form 10-Q, whether as a result of new information, future events or otherwise, you
are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may
file with the U.S. Securities and Exchange Commission, or the SEC, including periodic reports on Form 10-Q and Form 10-K and
current reports on Form 8-K.
Overview
We are a specialty finance
company that lends to and invests in development-stage companies in the technology, life science, healthcare information and services
and cleantech industries, which we refer to as our “Target Industries.” Our investment objective is to 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 revolving line of credit, or Senior Term Loans.
As of September 30, 2016, 97.5%, or $196.0 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% after such borrowing. The amount of leverage that we employ depends on our assessment of
market conditions and other factors at the time of any proposed borrowing. As a RIC, we generally do not have to pay corporate-level
federal income taxes on our investment company taxable income and our net capital gain that we distribute to our stockholders as
long as we meet certain source-of-income, distribution, asset diversification and other requirements.
Compass Horizon Funding
Company LLC, or Compass Horizon, our predecessor company, commenced operations in March 2008. We were formed in March 2010 for
the purpose of acquiring Compass Horizon and continuing its business as a public entity.
Our investment activities,
and our day-to-day operations, are managed by 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.
Portfolio composition and investment activity
The following table shows
our portfolio by type of investment as of September 30, 2016 and December 31, 2015:
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September 30, 2016
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December 31, 2015
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Number of
Investments
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Fair
Value
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Percentage
of Total
Portfolio
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Number of
Investments
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Fair
Value
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Percentage
of Total
Portfolio
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(Dollars in thousands)
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Term loans
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47
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$
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201,078
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96.6
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%
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52
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$
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242,167
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96.8
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%
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Warrants
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82
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5,730
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2.8
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83
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6,645
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2.6
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Other investments
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2
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500
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0.2
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1
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300
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0.1
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Equity
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5
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869
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0.4
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6
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1,155
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0.5
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Total
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$
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208,177
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100.0
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%
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$
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250,267
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100.0
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%
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The following table shows
total portfolio investment activity as of and for the three and nine months ended September 30, 2016 and 2015:
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For the Three Months Ended
September 30,
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For the Nine Months Ended
September 30,
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2016
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2015
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2016
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2015
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(In thousands)
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Beginning portfolio
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$
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233,266
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$
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240,148
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$
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250,267
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$
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205,101
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New debt investments
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13,536
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32,848
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45,223
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104,781
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Principal payments received on investments
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(11,839
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)
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(5,820
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)
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(35,625
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)
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(18,975
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)
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Early pay-offs
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(16,961
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)
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(16,196
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)
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(33,690
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)
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(39,618
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Accretion of debt investment fees
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382
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411
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1,123
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1,015
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New debt investment fees
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(195
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)
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(258
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)
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(714
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)
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(959
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)
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New equity
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11
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—
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67
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—
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Sale of investments
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(5
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)
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(1,578
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)
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(939
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)
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(1,578
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)
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Net realized gain (loss) on investments
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5
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(1,462
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)
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(2,783
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)
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(1,692
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)
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Net unrealized (depreciation) appreciation on investments
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(10,023
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)
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|
940
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|
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(14,752
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)
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|
|
958
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Ending portfolio
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$
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208,177
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$
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249,033
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$
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208,177
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$
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249,033
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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.
The following table shows
our debt investments by industry sector as of September 30, 2016 and December 31, 2015:
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September 30, 2016
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December 31, 2015
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Debt
Investments at
Fair Value
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Percentage
of Total
Portfolio
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Debt
Investments at
Fair Value
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Percentage
of Total
Portfolio
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(Dollars in thousands)
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Life Science
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Biotechnology
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$
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29,085
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14.5
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%
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$
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36,005
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14.9
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%
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Medical Device
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14,793
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7.4
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|
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|
22,472
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9.2
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Technology
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|
|
|
|
|
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|
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|
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Communications
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|
|
301
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|
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0.2
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|
|
|
19,511
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|
8.1
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Consumer-Related
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|
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25,213
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|
|
|
12.5
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|
|
|
18,268
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|
|
7.5
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Internet and Media
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|
|
7,927
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|
|
|
3.9
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|
|
|
—
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|
|
|
—
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|
Materials
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|
|
9,861
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|
|
|
4.9
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|
|
|
9,825
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|
|
|
4.1
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|
Networking
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|
|
3,377
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|
|
|
1.7
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|
|
|
693
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|
|
|
0.3
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|
Power Management
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|
|
2,466
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|
|
|
1.2
|
|
|
|
2,456
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|
|
|
1.0
|
|
Semiconductors
|
|
|
14,340
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|
|
|
7.1
|
|
|
|
18,237
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|
|
|
7.5
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|
Software
|
|
|
57,015
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|
|
|
28.4
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|
|
|
59,664
|
|
|
|
24.6
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|
Cleantech
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alternative Energy
|
|
|
—
|
|
|
|
—
|
|
|
|
2,849
|
|
|
|
1.2
|
|
Energy Efficiency
|
|
|
2,496
|
|
|
|
1.2
|
|
|
|
3,227
|
|
|
|
1.3
|
|
Waste Recycling
|
|
|
5,960
|
|
|
|
2.9
|
|
|
|
5,936
|
|
|
|
2.5
|
|
Healthcare Information and Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diagnostics
|
|
|
4,171
|
|
|
|
2.1
|
|
|
|
7,247
|
|
|
|
3.0
|
|
Other
|
|
|
6,782
|
|
|
|
3.4
|
|
|
|
8,236
|
|
|
|
3.4
|
|
Software
|
|
|
17,291
|
|
|
|
8.6
|
|
|
|
27,541
|
|
|
|
11.4
|
|
Total
|
|
$
|
201,078
|
|
|
|
100.0
|
%
|
|
$
|
242,167
|
|
|
|
100.0
|
%
|
The largest debt investments
in our portfolio may vary from year to year as new debt investments are originated and existing debt investments are repaid. Our
five largest debt investments represented 23% and 21% of total debt investments outstanding as of September 30, 2016 and December
31, 2015, respectively. No single debt investment represented more than 10% of our total debt investments as of September 30, 2016
and December 31, 2015.
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, 2016 and December 31, 2015, our debt investments had a weighted average credit rating of 2.9 and 3.0, respectively.
The following table shows the classification of our debt investment portfolio by credit rating as of September 30, 2016 and December
31, 2015:
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|
September 30, 2016
|
|
December 31, 2015
|
|
|
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
|
|
7
|
|
$
|
32,068
|
|
|
|
15.9
|
%
|
|
7
|
|
$
|
23,603
|
|
|
|
9.8
|
%
|
3
|
|
28
|
|
|
137,220
|
|
|
|
68.3
|
|
|
37
|
|
|
199,185
|
|
|
|
82.2
|
|
2
|
|
8
|
|
|
19,769
|
|
|
|
9.8
|
|
|
7
|
|
|
18,879
|
|
|
|
7.8
|
|
1
|
|
4
|
|
|
12,021
|
|
|
|
6.0
|
|
|
1
|
|
|
500
|
|
|
|
0.2
|
|
Total
|
|
47
|
|
$
|
201,078
|
|
|
|
100.0
|
%
|
|
52
|
|
$
|
242,167
|
|
|
|
100.0
|
%
|
As of September 30, 2016, there were four debt
investments with an internal credit rating of 1, with a cost of $27.7 million and a fair value of $12.0 million. As of December
31, 2015, there was one debt investment with an internal credit rating of 1, with a cost of $2.7 million and a fair value of $0.5
million.
Consolidated results of operations
As a BDC and a RIC, we
are subject to certain constraints on our operations, including limitations imposed by the 1940 Act and the Code. The consolidated
results of operations described below may not be indicative of the results we report in future periods.
Comparison of the three months ended September
30, 2016 and 2015
The following table shows
consolidated results of operations for the three months ended September 30, 2016 and 2015:
|
|
For the Three Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(In thousands)
|
|
Total investment income
|
|
$
|
7,608
|
|
|
$
|
8,427
|
|
Total net expenses
|
|
|
3,285
|
|
|
|
4,386
|
|
Net investment income before excise tax
|
|
|
4,323
|
|
|
|
4,041
|
|
Credit for excise tax
|
|
|
(52
|
)
|
|
|
(20
|
)
|
Net investment income
|
|
|
4,375
|
|
|
|
4,061
|
|
Net realized gain (loss) on investments
|
|
|
5
|
|
|
|
(1,463
|
)
|
Net unrealized (depreciation) appreciation on investments
|
|
|
(10,023
|
)
|
|
|
940
|
|
Net (decrease) increase in net assets resulting from operations
|
|
$
|
(5,643
|
)
|
|
$
|
3,538
|
|
Average debt investments, at fair value
|
|
$
|
214,358
|
|
|
$
|
237,400
|
|
Average borrowings outstanding
|
|
$
|
96,543
|
|
|
$
|
98,090
|
|
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
decreased by $0.8 million, or 9.7%, to $7.6 million for the three months ended September 30, 2016 as compared to the three months
ended September 30, 2015. For the three months ended September 30, 2016, total investment income consisted primarily of $6.8 million
in interest income from investments, which included $1.4 million in income from the accretion of origination fees and end-of-term
payments, or ETPs, and $0.8 million in fee income. For the three months ended September 30, 2015, total investment income consisted
primarily of $7.7 million in interest income from investments, which included $1.1 million in income from the accretion
of origination fees and ETPs and $0.7 million in fee income. Interest income on investments decreased by $0.9 million, or 11.5%,
for the three months ended September 30, 2016 compared to the three months ended September 30, 2015. Interest income on investments
decreased primarily due to a decrease of $23.0 million, or 9.7%, in the average size of our investment portfolio. Fee income, which
includes success fee and prepayment fee income on debt investments, increased by $0.1 million, or 9.3%, to $0.8 million primarily
due to fees earned on higher principal prepayments received during the three months ended September 30, 2016 compared to the three
months ended September 30, 2015.
For the three months ended
September 30, 2016 and 2015, our dollar-weighted annualized yield on average debt investments was 14.2%. We calculate the yield
on dollar-weighted average debt investments for any period measured as (1) total investment income during the period divided by
(2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month immediately preceding
the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted annualized yield
represents the portfolio yield and will be higher than what investors will realize because it does not reflect our expenses or
any sales load paid by investors.
Investment income, consisting
of interest income and fees on debt investments, can fluctuate significantly upon repayment of large debt investments. Interest
income from the five largest debt investments in the aggregate accounted for 18% of investment income for the three months ended
September 30, 2016 and 2015.
Expenses
Total net expenses decreased
by $1.1 million, or 25.1%, to $3.3 million for the three months ended September 30, 2016 as compared to the three months
ended September 30, 2015. 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 decreased
by $0.02 million, or 1.5%, to $1.4 million for the three months ended September 30, 2016 as compared to the three months
ended September 30, 2015. Interest expense, which includes the amortization of debt issuance costs, decreased primarily due to
a decrease in average borrowings of $1.5 million, or 1.6%, for the three months ended September 30, 2016 as compared to the three
months ended September 30, 2015.
Base management fee expense
remained flat at $1.1 million for the three months ended September 30, 2016 as compared to the three months ended September 30,
2015, after giving effect to a waiver of $0.1 million for the three months ended September 30, 2015. Base management fee was flat
primarily due to a decrease of $23.0 million, or 9.7%, in the average size of our investment portfolio, offset by the waiver of
$0.1 million of base management fee for the three months ended September 30, 2015.
For the three months ended
September 30, 2016, the incentive fee expense was effectively zero as the incentive fee on pre-incentive fee net investment income
was subject to the incentive fee cap and deferral mechanism under our Investment Management Agreement which resulted in $0.9 million
of reduced expense and additional net investment income. The incentive fee on pre-incentive fee net investment income was subject
to the incentive fee cap and deferral mechanism due to net realized and unrealized losses in the portfolio during the three months
ended September 30, 2016 totaling $10.0 million. Performance based incentive fee expense was $1.0 million for the three months
ended September 30, 2015.
Administrative fee expense
decreased by $0.1 million, or 34.3%, to $0.2 million for the three months ended September 30, 2016 as compared to the
three months ended September 30, 2015. Administrative fee expense decreased primarily due to a decrease in expenses incurred by
the Advisor on our behalf for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015.
Professional fees and
general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses, in the aggregate,
remained flat at $0.5 million for the three months ended September 30, 2016 as compared to the three months ended September 30,
2015.
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, 2016, we realized net gains totaling less than $0.01 million. During the three months ended September 30, 2015,
we realized net losses totaling $1.5 million primarily due to the resolution of one debt investment partially offset by realized
gains on the sale of warrants. The debt investment was settled for a net cash payment of $4.9 million, which resulted in a realized
loss of $1.8 million and unrealized appreciation of $1.8 million as the fair value of the debt investment was adjusted on June
30, 2015 to reflect the outcome of this resolution.
During the three months
ended September 30, 2016, net unrealized depreciation on investments totaled $10.0 million which was primarily due to the unrealized
depreciation on three debt investments. During the three months ended September 30, 2015, net unrealized appreciation on investments
totaled $0.9 million which was primarily due to the reversal of previously recorded unrealized depreciation on one debt investment
that was settled during the period, described above, partially offset by changes in fair values of our investment portfolio.
Comparison of the nine months ended September
30, 2016 and 2015
The following table shows
consolidated results of operations for the nine months ended September 30, 2016 and 2015:
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(In thousands)
|
|
Total investment income
|
|
$
|
25,997
|
|
|
$
|
22,549
|
|
Total net expenses
|
|
|
12,851
|
|
|
|
12,657
|
|
Net investment income before excise tax
|
|
|
13,146
|
|
|
|
9,892
|
|
Credit for excise tax
|
|
|
(138
|
)
|
|
|
—
|
|
Net investment income
|
|
|
13,284
|
|
|
|
9,892
|
|
Net realized loss on investments
|
|
|
(2,857
|
)
|
|
|
(1,723
|
)
|
Net unrealized (depreciation) appreciation on investments
|
|
|
(14,752
|
)
|
|
|
958
|
|
Net (decrease) increase in net assets resulting from operations
|
|
$
|
(4,325
|
)
|
|
$
|
9,127
|
|
Average debt investments, at fair value
|
|
$
|
229,069
|
|
|
$
|
213,249
|
|
Average borrowings outstanding
|
|
$
|
105,183
|
|
|
$
|
83,211
|
|
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 $3.4 million, or 15.3%, to $26.0 million for the nine months ended September 30, 2016 as compared to the nine months
ended September 30, 2015. For the nine months ended September 30, 2016, total investment income consisted primarily of $24.6 million
in interest income from investments, which included $6.6 million in income from the accretion of origination fees and ETPs
and $1.4 million in fee income. For the nine months ended September 30, 2015, total investment income consisted primarily of $20.9 million
in interest income from investments, which included $3.3 million in income from the accretion of origination fees and ETPs
and $1.7 million in fee income. Interest income on investments increased by $3.7 million, or 17.9%, for the nine months ended September
30, 2016 compared to the nine months ended September 30, 2015. Interest income on investments increased primarily due to an increase
of $15.8 million, or 7.4%, in the average size of our investment portfolio and a larger amount of ETPs earned during the nine months
ended September 30, 2016 compared to the nine months ended September 30, 2015. Fee income, which includes success fee and prepayment
fee income on debt investments, decreased by $0.3 million, or 17.6%, primarily due to seven prepayments during the nine months
ended September 30, 2016 compared to 11 prepayments during the nine months ended September 30, 2015.
For the nine months ended
September 30, 2016 and 2015, our dollar-weighted annualized yield on average debt investments was 15.1% and 14.1%, respectively.
We calculate the yield on dollar-weighted average debt investments for any period measured as (1) total investment income during
the period divided by (2) the average of the fair value of debt investments outstanding on (a) the last day of the calendar month
immediately preceding the first day of the period and (b) the last day of each calendar month during the period. The dollar-weighted
annualized yield represents the portfolio yield and will be higher than what investors will realize because it does not reflect
our expenses or any sales load paid by investors.
Investment income, consisting
of interest income and fees on debt investments, can fluctuate significantly upon repayment of large debt investments. Interest
income from the five largest debt investments in the aggregate accounted for 18% of investment income for the nine months ended
September 30, 2016 and 2015.
Expenses
Total net expenses increased
by $0.2 million, or 1.5%, to $12.9 million for the nine months ended September 30, 2016 as compared to the nine months
ended September 30, 2015. 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 $0.2 million, or 4.1%, to $4.5 million for the nine months ended September 30, 2016 as compared to the nine
months ended September 30, 2015. Interest expense, which includes the amortization of debt issuance costs, increased primarily
due to an increase in average borrowings of $22.0 million, or 26.4%, which was partially offset by a
decrease
in our effective cost of debt for the nine months ended September 30, 2016.
Base management fee expense
increased by $0.4 million, or 12.8%, to $3.7 million for the nine months ended September 30, 2016 as compared to the nine months
ended September 30, 2015, after giving effect to a waiver of $0.2 million for the nine months ended September 30, 2015, which increase
was primarily due to an increase of $15.8 million, or 7.4%, in the average size of our investment portfolio.
Performance based incentive
fee expense decreased by $0.3 million, or 14.0%, to $2.1 million for the nine months ended September 30, 2016 as compared to the
nine months ended September 30, 2015. Performance based incentive fee expense decreased because the incentive fee expense for the
three months ended September 30, 2016 was effectively zero due to the incentive fee cap and deferral mechanism under our Investment
Management Agreement. This resulted in $0.9 million of reduced expense and additional net investment income for the nine months
ended September 30, 2016. The incentive fee on pre-incentive fee net investment income was subject to the incentive fee cap and
deferral mechanism due to net realized and unrealized losses in the portfolio during the nine months ended September 30, 2016 totaling
$17.6 million.
Administrative fee expense
decreased by $0.1 million, or 14.1%, to $0.8 million for the nine months ended September 30, 2016 as compared to the
nine months ended September 30, 2015. Administrative fee expense decreased primarily due to a decrease in expenses incurred by
the Advisor on our behalf for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.
Professional fees and
general and administrative expenses primarily include legal and audit fees and insurance premiums. These expenses were unchanged
at $1.8 million for the nine months ended September 30, 2016 and 2015.
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, 2016, we realized net losses totaling $2.9 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. One debt investment was settled
for net cash proceeds of $0.1 million and a royalty and sale agreement fair valued at $0.4 million, which resulted in a realized
loss and unrealized appreciation of $2.2 million. The other debt investment was settled for cash proceeds which resulted in a realized
loss of $1.0 million and unrealized appreciation of $0.7 million. During the nine months ended September 30, 2015, we realized
net losses totaling $1.7 million primarily due to the resolution of one debt investment partially offset by realized gains on the
sale of warrants. The debt investment was settled for a net cash payment of $4.9 million, which resulted in a realized loss of
$1.8 million and unrealized appreciation of $1.8 million as the fair value of the debt investment was adjusted on June 30, 2015
to reflect the outcome of this resolution.
During the nine months
ended September 30, 2016, net unrealized depreciation on investments totaled $14.8 million which was primarily due to the unrealized
depreciation on four debt investments. During the nine months ended September 30, 2015, net unrealized appreciation on investments
totaled $1.0 million which was primarily due to the reversal of previously recorded unrealized depreciation on one debt investment
that was settled during the period, as described above, partially offset by changes in fair values of our investment portfolio.
Liquidity and capital
resources
As of September 30, 2016
and December 31, 2015, we had cash and investments in money market funds of $26.2 million and $21.1 million, respectively.
Cash and investments in money market funds are available to fund new investments, reduce borrowings, pay expenses, repurchase common
stock and pay distributions. In addition, as of December 31, 2015, we had $1.1 million of restricted investments in money market
funds. Restricted investments in money market funds were primarily used to make monthly interest and principal payments on our
asset-backed notes, or the Asset-Backed Notes. Our primary sources of capital have been from our public and private equity offerings,
use of our revolving credit facilities and issuance of our 7.375% notes due 2019, or the 2019 Notes, and the Asset-Backed Notes.
On March 24, 2015, we
completed a public offering of 2.0 million shares of common stock for net proceeds of $26.5 million, after deducting underwriting
commission and discounts and other offering expenses. We generally used the net proceeds from this offering to make investments,
to repurchase or pay down liabilities and for general corporate purposes.
On July 29, 2016, 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 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, 2017 or the repurchase of $5.0 million of our common stock. During the three and nine months ended September
30, 2016, we repurchased 1,319 shares of our common stock at an average price of $11.54 on the open market at a total cost of $0.02
million. From the inception of the stock repurchase program through September 30, 2016, we repurchased 114,704 shares of our common
stock at an average price of $11.53 on the open market at a total cost of $1.3 million.
At September 30, 2016
and December 31, 2015, the outstanding principal balance under our revolving credit facility, or the Key Facility, with KeyBank
National Association, or Key, was $63.0 million and $68.0 million, respectively. At September 30, 2016, we had borrowing capacity
under the Key Facility of $32.0 million, of which $10.6 million was available, subject to existing terms and advance rates. At
December 31, 2015, we had available borrowing capacity under the Key Facility of $2.0 million, subject to existing terms and
advance rates.
Our operating activities
provided cash of $36.9 million for the nine months ended September 30, 2016, and our financing activities used cash of $31.5 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 pay off our Asset-Backed
Notes and pay distributions to our stockholders.
Our operating activities
used cash of $33.6 million for the nine months ended September 30, 2015, and our financing activities provided cash of $37.7 million
for the same period. Our operating activities, in such period, used cash primarily for investments made in portfolio companies,
partially offset by principal payments received on our debt investments. Our financing activities, in such period, provided cash
primarily from the completion of a follow-on public offering of 2.0 million shares of common stock for net proceeds of $26.5 million,
after deducting underwriting commission and discounts and other offering expenses, and advances on our Key Facility of $42.0 million,
which was partially offset by cash used to pay down our Asset-Backed Notes 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 satisfy the
Code requirements applicable to 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 required to maintain asset coverage of at least 200%. This requirement limits the
amount that we may borrow.
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, 2016 and December 31, 2015:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
|
|
Total
Commitment
|
|
|
Balance
Outstanding
|
|
|
Unused
Commitment
|
|
|
Total
Commitment
|
|
|
Balance
Outstanding
|
|
|
Unused
Commitment
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
Asset-Backed Notes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
14,546
|
|
|
$
|
14,546
|
|
|
$
|
—
|
|
Key Facility
|
|
|
95,000
|
|
|
|
63,000
|
|
|
|
32,000
|
|
|
|
70,000
|
|
|
|
68,000
|
|
|
|
2,000
|
|
2019 Notes
|
|
|
33,000
|
|
|
|
33,000
|
|
|
|
—
|
|
|
|
33,000
|
|
|
|
33,000
|
|
|
|
—
|
|
Total before debt issuance costs
|
|
|
128,000
|
|
|
|
96,000
|
|
|
|
32,000
|
|
|
|
117,546
|
|
|
|
115,546
|
|
|
|
2,000
|
|
Unamortized debt issuance costs attributable to term borrowings
|
|
|
—
|
|
|
|
(450
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(592
|
)
|
|
|
—
|
|
Total borrowings outstanding, net
|
|
$
|
128,000
|
|
|
$
|
95,550
|
|
|
$
|
32,000
|
|
|
$
|
117,546
|
|
|
$
|
114,954
|
|
|
$
|
2,000
|
|
On August 12, 2015, we
amended the Key Facility to (1) add a $20 million commitment to the existing $50 million commitment and (2) extend the term of
the Key Facility. On April 27, 2016, we further added a $25 million commitment to our existing $70 million commitment. The interest
rate on the Key Facility is based upon the one-month London Interbank Offered Rate, or LIBOR, plus a spread of 3.25%, with a LIBOR
floor of 0.75%. Based on a LIBOR rate of 0.53% and 0.43% on September 30, 2016 and December 31, 2015, respectively, the interest
rate was 4.00% as of September 30, 2016 and December 31, 2015.
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 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. We may request advances under the Key Facility through
August 12, 2018, or the Revolving Period. 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. All outstanding
advances under the Key Facility are due and payable on August 12, 2020.
On March 23, 2012, we
issued and sold an aggregate principal amount of $30 million 2019 Notes, and on April 18, 2012, pursuant to the underwriters’
30-day option to purchase additional notes, we sold an additional $3 million of the 2019 Notes. The 2019 Notes will mature on March
15, 2019 and may be redeemed in whole or in part at our option at any time or from time to time at a redemption price of $25 per
security plus accrued and unpaid interest. The 2019 Notes bear interest at a rate of 7.375% per year payable quarterly on March
15, June 15, September 15 and December 15 of each year. The 2019 Notes are our direct, unsecured obligations and (1) rank equally
in right of payment with our future unsecured indebtedness; (2) are senior in right of payment to any of our future indebtedness
that expressly provides it is subordinated to the 2019 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. A
s of
September
30
, 2016, we were in material compliance with the terms of the 2019 Notes.
The 2019 Notes are listed on the New York Stock Exchange under the symbol “HTF”.
On June 28, 2013, we completed
the 2013-1 Securitization. In connection with the 2013-1 Securitization, 2013-1 Trust, a wholly owned subsidiary of ours, issued
$90 million in the Asset-Backed Notes, which were rated A1(sf) by Moody’s Investors Service, Inc. The Asset-Backed Notes
were issued by 2013-1 Trust and were backed by a pool of loans made to certain portfolio companies of ours and secured by certain
assets of such portfolio companies. The Asset-Backed Notes were secured obligations of 2013-1 Trust and non-recourse to us. In
connection with the issuance and sale of the Asset-Backed Notes, we made customary representations, warranties and covenants. The
Asset-Backed Notes bore interest at a fixed rate of 3.00% per annum and had a stated maturity of May 15, 2018. As of September
30, 2016 the Asset-Backed Notes were repaid in full.
Under the terms of the
Asset-Backed Notes, we were required to maintain a reserve cash balance, funded through principal collections from the underlying
securitized debt portfolio, which could have been used to make monthly interest and principal payments on the Asset-Backed Notes.
As of September 30, 2016
and December 31, 2015, other assets were $2.0 million and $2.2 million, respectively, which were 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, 2016:
|
|
Payments due by period
|
|
|
|
Total
|
|
|
Less than
1 year
|
|
|
1 – 3
Years
|
|
|
3 – 5
Years
|
|
|
After 5
years
|
|
|
|
(In thousands)
|
|
Borrowings
|
|
$
|
96,000
|
|
|
$
|
13,270
|
|
|
$
|
80,257
|
|
|
$
|
2,473
|
|
|
$
|
—
|
|
Unfunded commitments
|
|
|
7,000
|
|
|
|
7,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
103,000
|
|
|
$
|
20,270
|
|
|
$
|
80,257
|
|
|
$
|
2,473
|
|
|
$
|
—
|
|
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, 2016, we
had unfunded commitments of $7.0 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, 2016, 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.
Distributions
On October 28,
2016, the Board declared monthly cash distributions of $0.10 per share payable in each of January, February and March 2017,
representing a reduction from the prior rate of $0.115 per month.
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 eligible for the special tax treatment accorded to RICs and to avoid corporate level tax on the income and gains we distribute
to our stockholders in any tax year, we are required under the Code to annually distribute as dividends to our stockholders out
of assets legally available for distribution an amount generally at least equal to 90% 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 paid no 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, pay 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 for a fiscal year fall below the total amount of our distributions for that fiscal year, a portion of those distributions
may be deemed a return of capital to our stockholders for U.S. federal income tax purposes. Thus, the source of a distribution
to our stockholders may be the original capital invested by the stockholder rather than our income or gains. Stockholders should
read any written disclosure accompanying a 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, 2016 and 2015, we paid the Advisor $1.1 million and $2.2
million, respectively, pursuant to the Investment Management Agreement. During the nine months ended September 30, 2016 and 2015,
we paid the Advisor $5.8 million and $5.7 million, respectively, pursuant to the Investment Management Agreement.
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 Administrator. Under the Administration Agreement, we have agreed to reimburse the Administrator
for our allocable portion of overhead and other expenses incurred by the Administrator 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 Administrator provides us with the office facilities and administrative services necessary to conduct our day-to-day
operations. During the three months ended September 30, 2016 and 2015, we paid the Advisor $0.2 million and $0.3 million, respectively,
pursuant to the Administration Agreement. During the nine months ended September 30, 2016 and 2015, we paid the Advisor $0.8 million
and $0.9 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 such investments. Accordingly, we may apply for exemptive relief which would permit us to co-invest subject to certain conditions,
including, without limitation, approval of such investments by both a majority of our directors who have no financial interest
in such transaction and a majority of directors who are not interested persons of us as defined in the 1940 Act.
Critical accounting policies
The discussion of our
financial condition and results of operation is based upon our financial statements, which have been prepared in accordance with
U.S. generally accepted accounting principles, or GAAP. The preparation of these consolidated financial statements requires
management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes
in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results
to differ. In addition to the discussion below, we describe our significant accounting policies in the notes to our consolidated
financial statements.
We have identified the
following items as critical accounting policies.
Valuation of investments
Investments are recorded
at fair value. Our Board determines the fair value of our portfolio investments. We apply fair value to substantially all of our
investments in accordance with GAAP, which establishes a framework used to measure fair value and requires disclosures for fair
value measurements. We have categorized our investments carried at fair value, based on the priority of the valuation technique,
into a three-level fair value hierarchy. Fair value is a market-based measure considered from the perspective of the market participant
who holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available,
our own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument
at the measurement date.
The availability of observable
inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the
type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market and
the current market conditions. To the extent that the valuation is based on models or inputs that are less observable or unobservable
in the market, the determination of fair value requires more judgment. The three categories within the hierarchy are as follows:
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Level 1
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Quoted prices in active markets for identical assets and liabilities.
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Level 2
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Observable 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.
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Level 3
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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.
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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, 2015, we recognized
as interest income interest payments of $0.04 million and $0.2 million, respectively, received from one portfolio company whose
debt investment was 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.
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 corporate-level U.S. federal income tax on the income distributed to 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 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,
for each tax year. We, among other things, have made and intend to continue to make the requisite distributions to our stockholders,
which will generally relieve us from U.S. federal income taxes.
Depending on the level
of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into
the next tax year and pay a 4% excise tax on such income, as required. To the extent that we determine that our estimated current
year annual taxable income will be in excess of estimated current year 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 Topic 740, as modified by Topic 946, of the Financial Accounting
Standards Board’s, or FASB’s, Accounting Standards Codification, as amended. 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, 2016 and December 31, 2015.
Recently adopted accounting pronouncement
In April 2015, the FASB
issued Accounting Standards Update (“ASU”) 2015-03,
Interest—Imputation of Interest (Subtopic 835-30): Simplifying
the Presentation of Debt Issuance Costs,
or ASU 2015-03, as clarified by ASU 2015-15,
Interest—Imputation of Interest:
Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements
, or ASU 2015-15,
containing guidance that requires debt issuance costs related to a recognized debt liability to be presented in the balance
sheet as a direct deduction from the carrying amount of that debt liability, instead of being recorded as a separate asset. ASU
2015-15 allows an entity to defer and present debt issuance costs for line-of-credit arrangements as an asset and subsequently
amortize these deferred costs over the term of the line-of-credit arrangement. We have adopted ASU 2015-03, as clarified by ASU
2015-15, which did not have a material impact on our consolidated financial statements other than corresponding reductions to total
assets and total liabilities on the consolidated statements of assets and liabilities. Prior to adoption, we recorded debt issuance
costs in other assets as an asset on the consolidated statements of assets and liabilities. Upon adoption, we reclassified these
costs as unamortized debt issuance costs that reduce debt in the liabilities on the consolidated statements of assets and liabilities
and retrospectively reclassified the debt issuance costs that were previously presented in other assets as an asset as of December
31, 2015.