Hercules Capital Inc (HTGC) 2006 Q4 法說會逐字稿

Good afternoon and welcome to the Hercules Technology Growth Capital Fourth Quarter and Year-end conference call. At this time, all participants are in listen-only mode. Later we will open the call to your questions. Instructions for asking questions will be explained at that time. I will now turn the call over to Barry Hutton with Ashton Partners Investor Relations Group to introduce today's speakers. You may go ahead, Mr. Hutton.

Thank you, Operator, and good afternoon, for all of you joining us. On the call today are Manuel Henriquez, the founder, Chairman and CEO and David Lund, the CFO. Our fourth quarter and year-end 2006 financial results were released just after today's market closed. They can be accessed from the company website at www.herculestech.com or at www.htgc.com.

I would like to remind everyone that today's call is being recorded. Please note that this call is the property of Hercules Technology Growth Capital and that any unauthorized broadcast of this call, in any form, is strictly prohibited. An audio replay of the call will be available through our website or by using the telephone numbers and pass code provided in our press release.

I would like to call your attention to the Safe Harbor Disclosure in our press release regarding forward-looking information. Today's conference call may include forward-looking statements and projections. And we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake any obligation to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit www.sec.gov or visit our website at www.herculestech.com.

I would now like to turn the call over Manuel, Hercules' founder, Chairman and CEO. Please go ahead.

Thank you. Good afternoon, everybody, and thank you for joining us on the call today.

I would spend a few minutes discussing highlights of our operating results, our portfolio and investment activities for the fourth quarter and for 2006, as well as our perspective on the current investing landscape and our views on the current venture capital marketplace, as well. I will also briefly touch upon some potential strategic initiatives we are currently evaluating to enhance and build shareholder value in the coming years. Dave will, then, talk about the fourth quarter results and 2006 results. And, following Dave's discussion, we'll be happy to enter into a Q&A or question-answer session regarding our results.

Overall, I'm very proud of our team and their achievements during 2006. They've executed all levels and achieved record results to our shareholders in 2006. We've [inaudible] as a successful building of our platform, enhancing our team, continue to build the Hercules brand and overall, continue to grow the company. Not only were we extremely pleased with the results, we believe Hercules is well-positioned for strong growth going forward for 2007 and beyond. During the year, we successfully accessed the public markets on three occasions raising over $146 million of equity capital to enhance and increase our permanent capital base on our balance sheet. We also increased our credit facilities with Citibank with an additional $50 million for total capacity of $150 million borrowing with our relationship with Citibank.

I would like to take this moment to talk about our operating results in the fourth quarter, as well as specifically during calendar 2006. I would start by saying I am pleased with the results of our most quarter, 2006. During the quarter, we provided over $63 million of funding to 16 portfolio companies in the fourth quarter, bringing our total fundings to over $196 million in calendar 2006. The growth in our investment portfolio led to revenues of approximately $8.7 million in the fourth quarter and net investment income of $3.5 million or $0.21 per share on 16.9 million shares outstanding. This represents our ninth consecutive quarter of revenue growth for [inaudible] on our portfolio since our inception origination back in October 2004. Now let me speak about our warrant portfolio. It's a question that I'm asked continuously as we're out there meeting with investors. And it's an opportunity I'd like to be more expansive in our warrant portfolio discussion to have everybody better understand on the growing assets that that represents in our portfolio. The potential positive impact of our growing warrant portfolio is as we continue to accumulate warrants, we expect a harvest of those warrant gains in the future. We currently have approximately 54 active positions or warrant positions in various technology and life science companies in our portfolio. The warrant portfolio offers the potential to invest approximately $32 million of capital to exercise those warrants which, in turn, will allow us to become equity holds in those respective portfolio companies. As the number of warrant positions in our portfolio increases over time, it is important to understand that gains realized from those successful events in turn allow us to have or generate realized gains for the benefit of our shareholders. Clearly, the timing and number of the actual warrants that may achieve successful liquidity, is something that is entirely outside of our control and is, of course, subject to, among other things, overall market conditions.

As a BDC RIC, we may elect to use the proceeds from the gains of these warrants to either fund additional investments by retaining those gains and paying the respective withholding tax or use those gains for the benefit of our shareholders in order to pay a special dividend or increase our normal dividend. It is important to note that since its inception, all of our debt investments have included a warrant or, what we call, an equity kicker, which in turn offers the ability to have long term cap appreciation potential or higher yields and returns in our underlying debt investments. The equity kicker, as I mentioned earlier, provides as additional upside potential above and beyond our existing coupon, fees, and interest rates that we receive on our loans, originate and dead investment. Additionally, above and beyond the warrant position that we have with our companies, we also receive, in select situations, the ability to invest equity in the up and coming or future equity [rental] financing that the company may be pursuing in the near future. We've done so in the calendar 2006 on five different companies. Those companies, for example, are Sling Media, Rivulet, Simpler Networks, Atrenta and Acceleron. All of which you can see more details of those underlying companies from our website.

In terms of liquidity events in 2006. In 2006 we achieved four successful exits or realizations for our warrants and equity portfolio, generating total capital gains or total returns, I should say, of $3.3 million in gains. The combined debt and warrants and total rate of return, IROR, on the four transactions were in excess of 30% for each of those investments. For example, Affinity Express achieved an IROR of approximately 30%; Occam an IROR in excess of 45%. LaboPharm achieved an IROR in excess of 35% and Omrix an IROR in excess of 30%.

In terms of market conditions, we remain optimistic that the current M&A environment will continue and allow for our 2007 and potentially beyond. While technology IPO market is beginning to show signs of increasing signs of life, we certainly believe that 2007 and 2008 show promising and encouraging IPO market development for technology in venture backed companies.

Looking forward, we anticipate potential exits or realizations from our warrant portfolio in 2007 of 10 to 12 positions. However, I want to caution everybody that it's subject to market conditions and timings of facts and circumstances that are beyond our control with our portfolio companies.

As a reminder, the vast majority of our portfolio companies are highly dependent upon domestic capital or venture capitalists or private equity financial sponsors for additional equity capital to sustain their ability to grow and achieve liquidity in the future. However, because the vast majority of our companies may experience various challenges, attributed to the progression of the business models, it is not untypical to see one or more of our portfolio companies stumble on the path to continuing to pursue their business models. When this occurs, we assist them by working closely with management and their venture capital sponsors to ensure that we mitigate any potential capital loss that may or may not be realized in such an event.

This approach, coupled with their underwriting process, has afforded us the ability to minimize material capital losses to date. However, there can be no assurances that our historical credit performance can be maintained or given the underlying composition of our portfolio companies, meaning that they're venture backed and are highly dependent on venture capital sponsors. As an example, during 2006, we had two portfolio companies that were sold in which we recovered all but $4.9 million of our principal amount in those investments. Again, we worked active in the companies and restructured the credit to ensure we mitigate principal loss as much as possible. In addition to that, there are five additional companies in which we were fully repaid because of the active involvement and work with these companies, as well as our encouraging the companies to pursue other avenues as well.

In terms of our initiative, pardon me--in terms of our focus on the go-forward basis for 2007 and beyond, we have commenced launching of our early-stage invested initiative and our late-stage or later-stage investment initiative also known as our lower mil market investment activities.

We now have 27 months of investing track record under our belt. We feel our investment platform is now ready to scale operations and to continue to grow our investment portfolio. Through 2006, we continue to add resource at all levels including hiring specific individuals with the appropriate experiences and skills-sets to pursue these new endeavors of both the early-stage and later-stage investment activities. We also enhance our investment vessel teams with the promotion of several former associates to the expanded role as principals, as well as hiring additional investment professionals throughout the rest of our organization.

We're fortunate to continue to see a good stream of resumes of potential candidates from many of the major venture banks, established commercial banks and select leading venture capital firms as we seek to add potentially two to three additional investment professionals throughout calendar 2007 subject, of course, to overall market conditions and our continued growth. Together we believe these recent additions to our organizations are key elements needed to continued success of building Hercules in 2007 and beyond.

Now, let me expand on our recent SBIC announcement that we did at the third quarter as well as bringing you up to speed on the recent developments and the continued progress on our SBIC licensing. As you may recall, we received our SBIC license at the end of the third quarter in 2006. This will enable us to access or seek additional leverage on our balance sheet above and beyond our current credit facilities with Citibank. These additional credit facilities provided by the SBA allow us to access competitively attractive rates of financing as well as leverage our balance sheet further. However, I'd like to remind everybody that we are still pending approval from the SEC in order to receive the Exemptive Order to leverage our balance sheet above and beyond the $250 million--$260 million of effective equity capital we have today.

By using the SBA or the SBIC leverage, this allows us to eventually exceed the BDC limitations of one to one debt to equity ratios. In turn, this will allow us to free up additional capital in order to continue to grow our business effectively.

As part of the ongoing process as an SBIC, we have submitted our application for leverage to the SBA, which I'm happy to report that on January 30, 2007, the SBA has granted our application in order to be able to access leverage. What that means is that now that we are approved to access leverage, we will be seeking leverage of up to $50 million initially from the SBA in the coming two to four months in order to continue to grow our business. As a reminder, under the SBIC program, we are able to fully leverage our balance sheet, under the SBIC program, for approximately $124 million that will be adjusted in calendar '07 for inflation further.

Now, expanding on my comments earlier on the capital raise; during 2-4-2006, we successfully completed two public capital raises for approximately $110 million in gross proceeds to Hercules, again, further bolstering our balance sheet. Although this effort took considerable management time, the transaction further enhances our position on Wall Street; expanded our shareholder base and expanded the foundation for the company's near-term and long-term growth potential.

I'm also happy to report that our Board of Directors have approved our sixth consecutive dividend since our inception. The Board of Directors have approved a dividend of $0.30 a share which will be payable on March 19th to shareholders of record as of February 19th. This represents, again, our sixth consecutive quarterly dividend and brings the total dividend paid to date to $1.23 and a total dividend declared to date of $1.53 a share. In 2006, we paid dividends totaling $1.20 of which 88.5% of those dividends are considered to be taxable earnings from operations and David Lund will elaborate on the further distribution of the dividend allocation.

Now, in terms of perspective of the venture capital, the M&A and the IPO landscape. It is important to remember that our business model is highly dependent upon the investing activities of the venture capitalists and the private equity sponsors for the underlying source of capital for our technology and life sciences companies. Historically, we have financed almost exclusively venture backed life sciences and technology companies. These underlying companies in turn are highly reliant upon the venture capitalists for additional growth capital beyond what Hercules provides or can offer today. Because it's reliant, the overall health of the venture capital and the private equity landscape is material to understanding the current and future opportunities that exist for Hercules. Hercules is building its brand. It's building its brand awareness with the players of the ecosystem by expanding our product, offerings and solutions and increasing our overall portfolio diversification by now accessing further early-stage companies as later-stage companies.

As to the overall state of venture capital industry, I am delighted to see that the venture capital industry continues to expand by investing $25.5 billion during 2006 to various technology and life sciences companies. However, we also saw a slight dip in Q4 of investing activity by venture capitalists to $5.7 billion as compared to $6.6 billion during calendar--during Q3 2006. This, of course, is according to the Money Tree report published by the Price Waterhouse Coopers and The National Venture Capital Association based on data provided by Thomson Financials.

During 2006, the venture capital marketplace also saw significant growth in the life sciences sector with biotechnology and metals devices investments, both experiencing record level investment activities by the venture capitalists. We also saw a pick-up in investment activities in the various stages or focus on the venture capitalists with seed and early-stage companies receiving more financing in 2006 than the prior years. But, of course, the largest capital investment by a venture capitalist were again in the expansion-stage company which has been historically Hercules' primary area focus.

Another indication of the health of the venture capital marketplace is the fundraising activities by the venture capital firms themselves, which during 2006, successfully raised an additional $24.3 billion that was invested by limited partners into 95 different venture funds. That capital in turn will be deployed over the proceeding two to four years by the venture capitalists and become the primary source of repayment for our loans. This data is according to Dow Jones VentureOne.

The private equity community, in turn, also had a tremendous fundraising period during 2006, successfully raising over $215 billion to 322 different funds surpassing all previously records and this, of course, is according to Dow Jones Private Equity analysts. Again, the M&A marketplace and the IPO marketplace are important because they're a source of liquidity for our portfolio companies. In 2006, we continued to see a very vibrant M&A market activity. M&A environment is currently active and we would expect to see the continued strength of the M&A marketplace to progress into 2007 and beyond.

As we move forward, we anticipate that the major financing activities for Hercules will continue to be focused in the structured senior debt marketplace or focus, I should say. Additionally, we want to remind you that to date we have participated in warrants in all of our structured mezzanine transactions in 2007. As I stated earlier, we continue to believe that the M&A market that we've seen in 2006 will continue throughout 2007 and, more importantly, we're beginning to see early signs of reawakening or opening of the technology IPO marketplace and landscape. Now, with that overview, I would like to turn the call over to David to review the fourth quarter and 2006 operating results. David.

Thank you, Manuel. We were very pleased with the results for the fourth quarter and the full year of 2006. Revenues increased by 15% over the previous quarter for the ninth consecutive quarter of growth. Importantly, we continue to grow our investment portfolio, including warrants, quarter-over-quarter. We believe this part of our investment portfolio will become a key addition to our value in the next 12 to 24 months.

Our pipeline is robust and represents the positive view on the future that Manuel spoke to earlier. Coming into the first quarter of 2007, we have a definite pipeline of approximately $56 million in new transactions.

The fair value of total debt and equity investment portfolio as of year-end was $283.2 million in 56 portfolio companies. Specifically, the value of our debt portfolio included warrants was $275.1 million with investments in 55 companies. This compares to a total debt and equity portfolio of $176.7 million as of December 31, 2005, which represented investments in 31 companies.

The fair value of our equity portfolio was $8.1 million at year-end, with investments in 11 companies as compared to $4.9 million at the end of 2005, which represented investments in seven portfolio companies.

Hercules currently holds warrants at a fair value of $8.4 million representing positions in 54 companies, which is an increase of 64% from the fourth quarter of 2005. I want to remind you that the current fair value of these warrants may vary significantly from the actual value we could realize through future exit transactions. As a result, the value of the balance sheet does not reflect the potential return to our shareholders as we are able to liquidate our positions in the future.

Revenues for the quarter were $8.7 million, which is an increase of 100% compared to $4.3 million in the fourth quarter of 2005. For the year, revenues were $29.5 million, an increase of 176% compared to $10.7 million dollars in 2005.

New debt commitments increased by $38.5 million to four new companies and one existing company in the quarter. For the year, new debt fundings totaled approximately $193 million to 35 companies as compared to $175 million to 28 companies in 2005.

Unfunded debt commitments, at the end of the quarter, were approximately $56 million to 16 companies. This does not include the executed non-binding term sheets with three prospective portfolio companies representing $16 million.

Operating expenses for the quarter were $5.2 million, an increase of 53% over the same period last year. Total operating expenses for the year were $18.4 million as compared to $9.1 million in 2005. In general, the increase in operating expenses was attributed to higher interest expense on a higher average debt balance in 2006; higher compensation expense for employee bonuses and higher employee head count. In addition, it includes costs attributed to being a public company including costs associated with compliance with the Sarbanes-Oxley Act.

Net investment income for the quarter, before taxes, increased to $3.5 million or $0.21 per share based on 16.9 million weighted average shares outstanding. This is compared to $941,000 or $0.10 per share in the fourth quarter of 2005 based on 9.8 million total weighted average shares outstanding. Net investment income, before taxes, for 2006 was $11.1 million or $0.83 per share. This is compared to $1.5 million or $0.22 per share in 2005 based on 6.9 million shares outstanding.

Net realized and unrealized gains on investments in the fourth quarter was $447,000 compared to a loss of $886,000 in the fourth quarter of 2005. This is primarily the result of the gains realized on the sale of our warrant and equity positions in two portfolio companies offset by normal depreciation of the warrant portfolio.

With regards to our recollection and tax provision, we determined that we would qualify as a Registered Investment Company or RIC for 2006 and, as such, we did not have an income tax provision for the fourth quarter of 2006 as compared to a tax provision of $255,000 in the fourth quarter of 2005. For the year, we had a tax provision of approximately $643,000 related to our conversion from a C-Corp in 2005 to a RIC-reporting entity in 2006.

During 2006, we distributed dividends of $1.20 per share to our shareholders of which 88.5% was deemed to be taxable to our shareholders. Of this amount, 7.3% or $1.1 million represented distributions of accumulated earnings and profits as of December 31, 2005 which were required to be distributed in 2006.

Net income for the quarter was approximately $3.9 million or $0.23 per share, based on an average of 16.9 million basic shares outstanding measured against a loss of $200,000 or $0.02 per share on 9.8 million basic shares outstanding for the fourth quarter ended December 31, 2005. Net income for 2006 was $11.4 million or $0.85 per share compared with $2.1 million or $0.30 per share in 2005.

Moving to liquidity and capital resources at December 31, 2006, net assets totaled $255 million, with a net asset value per share of $11.65. We ended the year with $16.4 million in cash and our asset coverage was 723%. The quarter's activity was highlighted by the secondary equity offerings which raised gross proceeds of approximately $110 million dollars in the quarter. In addition, in early January, the underwriters exercised their option on the green shoe and acquired an additional 840,000 shares of our common stock with gross proceeds to us of approximately $11.4 million.

These additional capital raises allowed us to pay down $50 million of our outstanding debt with Citigroup in December and, in January, where we paid down an additional $15 million. As of year-end, we had approximately $109 million of available borrowings under our Citigroup facility, of course, subject to existing terms and advance rates.

We also received notice from the SBA that our first application for leverage of $50 million was approved and we anticipate beginning to draw on this leverage during the next two to four months.

Operator, we are now ready to open up the call for questions.

Thank you. [OPERATOR INSTRUCTIONS]. Your first question comes from the line of Jed Gore with SuNOVA. Please proceed.

Hi, thanks for taking my question. I was just looking at your expense numbers and a year ago, you were running with total expenses of about 7% of that and this quarter, you're exactly the same. I was wondering, when do we start to see expense leverage out of the model that you talked about on the road show?

Sure. As you may recall, a year ago, we had, I think, 11 people approximately. Today we're at 27 people or 26 people, excuse me, today at year-end. The leverage as you, I'm sure you understand, we can't run a public company with 11 people. You can't make the investor originations that we've done in the past with 11 people. I think today, on a go-forward basis, 2007 I think that the incremental head count adds are going to minor, and you'll see that leveraging of the fixed costs structure we have today happening in 2007. As of right now, from our expectations, we certainly believe that the dividend that is currently $1.20 will be fully earned from NII in 2007.

Now that was my second question. When do you start to earn the dividend? Do you expect that that'll happen in the first quarter, second quarter or are you looking at it on a full-year basis?

As of right now, our expectations are certainly that it will be earned in calendar 2007 and probably is slightly more than that. But at this point, we certainly feel very comfortable that the $1.20 dividend will be earned from NII in the year.

Okay. And you expect that your--this is an appropriate run rate of expense level for you in a quarterly basis of $2.2 million for compensation? Or is there something that's one time in nature in this quarter?

There is some one-time issues in there. But, as I said a minute ago, if you look at the expectations of head count in calendar '07, you're looking at adding some additional administrative functions and augmenting with additional analysts, if you will, on the investment side. So you're looking at adding anywhere conservatively between, I would say, five to seven head count, but not at the expense structure that you would otherwise see added to the organization. I don't think it'll be materially much greater than what you're seeing today.

Thank you.

Your next question comes from the line of Don Destino with JPM Securities. Please proceed.

That was close, JMP. Manuel, to drill down a little bit more on Jed's question, I missed your comp number by almost $1 million. It was up almost $1 million sequential quarter. You said that there was some one-time stuff in there. Can you talk a little bit about what that one-time stuff is and the extent to--how much I can subtract from that to kind of think about where to start 2007?

Sure. First of all, Don, let me first extend our deepest sorrow and condolences on the loss of our friend and your partner, Jerry Tuttle. So our thoughts and prayers are out to all the members of JMP in the loss of a great man and a great friend.

We appreciate that.

As to your question, I think that the expense rate that we spoke about is attributed to a lot of our members' dramatic achievement during 2006. That achievement--the bonus is entirely correlated with the multiple different things that we look at in adding shareholder value. Some of our originators and some of our team members have accomplished a tremendous amount in calendar '06 and that is why you saw a slight increase on the bonus accrual that took place in the fourth quarter for some of the achievements and expectations that we have for some of these individuals in their performance in 2007 and beyond. So it is a function of that.

In terms of the one-time head count, one-time numbers, some of the individuals did receive bonuses attributed to that achievement and, as I'm sure you're aware of, our bonus is directly tied to shareholder value and subject to performance of the individual. So that is why it may have some lumpiness, if you will. But I think that the bonus accrual numbers that you see from a compensation in 2006 will be an indication of what we believe is the trajectory for the company 2007. Again, it's all directly correlated on performance.

I think that the other element is that we added some additional head count that's probably higher than what you anticipated, or other analysts have anticipated, out there as we found the ability to continue to run a company publicly with less than enough people for the both finance department and legal department was a burden that was too high, so we actually have added additional head count to help bolster those different operating groups. And that is another factor that's contributed to the higher SG&A number, as well.

Okay. And the 10 to 12 potential liquidity events that you mentioned, can you talk a little bit about what specifically you would see in a company that would deem it on that list?

Sure. We, obviously, having 55 or 54 active companies in our portfolio, we have no real magic bullet to say it's this company or that company. However, we certainly believe that as our various companies in our portfolio are approaching the five or six year maturity mark since inception, that those particular companies who are now demonstrating material progress either on the top line revenue growth or their product development or, I should say, product traction in the marketplace, are highly likely candidates to either complete an M&A or an IPO activity in 2007. With 54 companies, it is certainly our expectations and belief that you should see 10 to 12 of those companies. But they span the gamut from a technology to life sciences spectrum. We certainly have some ideas what some of those companies may be, but I cannot give you any specific names of exactly who is going to be the company and when they will achieve a liquidity event because all of those circumstances are entirely outside of Hercules' control.

Well, I'm sorry. Just to be clear, the 10 to 12, are those--is that kind of an actuarial estimate that you would expect that kind of percentage of your portfolio to have some kind of liquidity event? Or is that--and I understand you're not going to disclose it, but is that--are those 10 to 12 names that you could write down on a piece of paper if you wanted to?

No. I think the answer is this. Invoking your actuarial comment, in this business it's very difficult to try to extrapolate anything from and actuarial point of view on a [inaudible] reliance. I think that the answer is that we have a pretty good indication, call it a gut if you will, of what we expect to see from a liquidity point of view. I certainly do believe, however, that it is not untypical to see anywhere between 10 to 20% of our portfolio, now that it's maturing, achieving liquidity events as we continue to build out the portfolio. So in the case we have 54 companies today, 10% being five; 20% being 10, if you will, I think those are numbers that we're fairly comfortable making that statement. Again, there is not a specific list. We certainly have some expectations of what some of those companies may or may not be, but I cannot indicate to you that as of right now, I know specifically these ten companies are blank. And I would encourage you to look at our website and look at some of the SEC filings on seeing the more mature companies in our portfolios which are probably the best indication of what some of those candidates may or may not be.

Your next question comes from the line of Henry Coffey with Ferris Baker Watts. Please proceed.

Hi, everyone. I wanted to focus in on this compensation issue a little more closely. I'm just going to look at some specific numbers. If I rattle one off improperly, I apologize. Salaries and benefits in the fourth quarter were $2.2 million, which is almost exactly $1 million higher than what was reported in the September quarter. And so of that--well, it's actually $956,000. How much of that was year-end accrual of bonuses? And how much of that is sort of permanent on-going costs and represents new hires, if we could get real specific about it?

Henry, our Board of Directors, in review of the performance of the managing directors and the company as a whole, decided that they were going to increase or approve a higher amount of bonuses. And it was anywhere from about 650 to $750,000 of that--

Of this amount?

--of, yeah, that we were accruing for. So that the performance--

No. So the addition was $700,000 or--

Yeah.

So--

So the delta is about--of that is about $700,000.

And then the 200--so the 250 additional cost tied to expansion of personnel?

Exactly.

Now if we use $2.2 million as a starting point, is it simple math to say that in 2007 you've hired all the people you need and it's going to be 4.--it's going to be 8.8 or is there--and I know you've indicated there's an additional new hires, so if we use 8.8 as a starting point, can you give us some sense of what you're actually budgeting on the personnel side?

Well, again, as you know, we don't give guidance on our numbers, but I think that the response to your question is the following. I think, from a head count point of view, any additional head count is not going to have a dramatic impact on the bonus, if you will, because most of them are going to be on the support and analyst level; not on the necessarily on the origination level. However, notwithstanding that comment, we are certainly looking to hire any where between two to three additional investment professionals at the senior level, but that is highly contingent upon our expectations on seeing a continued vibrant market and deal pipeline. If we do not see that pipeline materializing as we expect to see it in 2007, you will see us curtail on the hiring of additional head count to service our portfolio. So it is highly dependent upon our growth, I think from a number point of view. Again, we don't give guidance, but I think that the 8.8 that you're referring to is probably on the high side of the expectations. And I think if we're off--

Hold on. I mean, that's just--we just took 2.2 times four.

I know. I get simple math.

Yeah. That's a higher run rate than I think we probably would expect because of the additional accrual that we did this quarter.

Okay. So that's kind of what I've been trying to get at. So it's, arguably, a much lower number than this would suggest?

Yes.

I would say it's a lower number. I don't know the degrees of much.

The next question is regards to your realized gains and realized losses during the year.

Uh, huh.

You alluded to two specific realized gain events. What was the actual total gain realized there?

In the fourth quarter?

Yes.

It was approximately $1 million.

I mean just 1.1, 1.2, 1.4?

It's about 1--just a little over $1 million.

Okay. And then were there any realized losses--

No.

--in the quarter?

No, there were not. So the difference--

Right.

The reporting difference is because we did have some of the warrants flip from the unrealized to the realized category and in addition we had--

What--you know, I'm just looking at the realized gain line. Okay, so you had $1 million of realized gains in the quarter and no losses?

Correct. Now what you're seeing on the financial statements is a combination of realized and unrealized.

Right, right. I know.

So the difference between the $1 million, roughly, of realized gains that we have and the amount that we're reporting there was because of the change in the warrant portfolio; the amortization under the Black-Scholes model, and some of the flip between realized and unrealized--

Right. But you got some reversal there?

Exactly.

And then if we look at the full year, realized gain--I think, Manuel, you said what four or five realized gains?

We had four realized gains during the year which I think was approximately $3.3 million.

$3.3 million in total and what about realized losses that were reported during the year on a GAAP basis?

On a GAAP basis, we reported a little over $2 million, because part of [metria] was actually recorded last year on--

Right, right. Yeah.

--basis.

And that was just on the 2 million was simply one loan or--

It was one loan in the third quarter that--

Right.

--we reported.

Okay. And if you--I know it's difficult to extrapolate, but if you looked at just your equity and warrant position and you were to realize that value today, can you come up with some estimate as to the potential size of the gain?

Well, as I'm sure you know, Henry, we do fair value--

Right. I'm just saying if you script out just the warrant portfolio which essentially has no cost to it, what would be the sort of gross potential gain that that could generate right now?

You know, the problem with that is--I mean, I'd like to answer your question, but that's like almost trying to be Nostradamus. It would be very difficult for me to extrapolate that because I can't--as we saw--let me give you an example. Let me get a more tangible example. We saw in early part of December one of our portfolio companies, called RazorGator, for example, it's direct competitor, StubHub, was acquired by e-Bay for over $300 million or, I think, it was $285 million net. And RazorGator and StubHub are pretty much close to each other. It is hard, because you look at that valuation, if you use that as a direct proxy, you could argue that our holdings in RazorGator are potentially undervalued. The problem with that is that e-Bay may or may not see strategic value in acquiring, for example, StubHub. So we cannot necessarily directly use that as a proxy to value the underlying holdings of RazorGator in our portfolio.

And we have other examples in our portfolio, by the way, that have a similar circumstances by which some of their competitors or indirect competitors have been acquired or have gone out, on a public offering, at pretty attractive valuations. So that is why I said earlier that we're certainly optimistic that we should experience anywhere between 10 to 12 of those liquidity events in calendar '07. And not drawing anywhere from our historical performance, but if you look at $3.3 million of realized gains divided by four, that kind of gives you, I guess, a trailing indications of what things have done historically. But I'm certainly not saying that you extrapolate that outcome to a perspective basis, because it is very hard to do. With the various companies in our portfolio, some of which we have a lot of belief that should achieve liquidity events in 2007 and it could be a screaming IPO. It could be a huge M&A tank-out. But strategic buyers all have different reasons to buy companies for different valuation criteria. So that's why it's very, very hard to try to extrapolate a valuation for these exits.

If you were to take out your paper and, again, this is that list that we all want you to show us. If you were to take out that piece of paper and start writing down the number of companies that are (a) in the middle of some form of public registration event; or (b) involved in some sort of transaction, be it a sale of the company or refinancing, that puts a significantly higher value on the company. How many--I know this 10 to 12 list is somewhat actuarial, but if you were to look at just what's kind of actively going on right now, how many company names would you come up with?

You know I think that--let me say, what I call, rumor-talk--

Right. Yeah, I know. Nothing really hard, but where stuff is obviously going on.

In the interim, we're probably aware of two to three companies that may be pursuing IPO filings over the proceeding quarter or two. I'm comfortable saying that I'm aware of one or two of our companies that may be seeking M&A activities right now. But I have to tell you, things fall off the cart, as you know.

Right. Oh, exactly. No. There's no question there.

I mean relations go cold. But certainly two to three that we are cognizant of that are contemplating IPOs. That's a safe number. And certainly one or two that are engaging in--two to three potentially engaging in M&A discussions in the next quarter or two. We're probably aware of that. But as we've shown in the third quarter of last year, I think it was, or maybe second quarter of last year, we had one of our portfolio companies file to go public and it didn't. And we had another company file to go public and it did go public. So it's very hard to try to extrapolate what the eventuality of liquidity for these companies may or may not be.

On the existing portfolio, any of your loans on non-accrual?

As of right now, there's only one loan that's a non-accrual and it's a company we talked about in the third quarter. And we reiterate more in the fourth quarter and that is a publicly-listed company on the Toronto Exchange called Xillex. However, we believe, with all the information that we received including earlier this week from the bankruptcy judge in the Canadian setting, that the intellectual property at the company and the suitors around the table, more than one, will more than surpass our loan outstanding from a recovery point of view. Meaning that we don't see any risk of loss at this point and, I believe, and I may be mistaken it, but I believe the judge may have lifted our stay on that credit facility to continue to start accruing interest. But I may not have that fact 100% yet, but that may have occurred, I think it was yesterday afternoon. I'm waiting for the final legal notices from the bankruptcy judge in Canada. So that's the only non-accrual credit we have. We also, in the fourth quarter, encouraged certain companies of ours, that we deem to be underperforming from an operational point of view, that we constructively encouraged them to repay back our loans, for example. And we did that as well further mitigating any principal exposure on the down side that we may have had at some of those companies.

Your next question comes from the line of [James] Bonnem with Cadmus Capital. Please proceed.

Hey, guys. It's Jed Bonnem at Cadmus Capital. How are you?

Good, thank you. How are you?

Good. You were talking about the investment professionals that you have in place. What do you think is the capacity of what you have in place in terms of loan originations per year?

Sure. Again, without providing guidance, we sort of provide a formula by which to extrapolate that equation. And that is the following. In the first year, [inaudible] model an investment professional is the following. In the first year of investment activities, we expect that individual to generate between $25 and $35 million of gross commitments. In the second year, we expect the investment professional to do between $35 and $45 million. And in the third year, the mature year, between $45 and $55 million a year. Currently, today, we have approximately 11 investment professionals with varying degrees of maturity on that spectrum. So you can either say that the average on the 11 professionals across the board is, for example, $35 million. And, therefore, if you have the capacity, assuming $35 million, to do about $385 million of new investment commitments in calendar '07, for example.

Okay. And then looking specifically at the new debt commitments number and, I guess, what I'd look at is the backlog number, which is the unfunded debt commitments. Both of those numbers went down in the fourth quarter sequentially from the third quarter. Actually, they're at their lowest levels in the last three or four quarters. Help me understand why those numbers are low at the end of the fourth quarter.

Sure. A couple factors; one, management was actively raising capital for the company, which means the Investment Committee can't hold its sessions. Two, we strongly, strongly encouraged our companies to draw down that unfunded commitment to avoid having that overhang and forcing it to do these capital raises because eventually what happens is we have the unfunded commitment portfolio growing and you have the signed term sheets, the non-binding commitments growing. I legally cross a chasm where I'm in a pinch that I don't have the capital on my balance sheet to fully fund that demand. So we're now aggressively trying to manage that overhang not to be as large as it got in the fourth quarter, about $100 million. And ideally, let's try to manage that number between the $50 to $75 million range on a prospective basis to do that.

The second part of your question in terms of the pipeline, we also had a group of individuals that were very tired from hard work in calendar 2006 and the holidays that fell that year were as such that with management being out and the holidays, I encouraged everybody to kind of rest up so we can attack 2007 pretty aggressively.

Okay. And if you were to sort of bring us up to date, 'til that happened, there was a capital raise and sort of a pause leading up to the capital raise. Could you bring us up to date? You've done the capital raise. Just bring us up to date where you are trend-wise in terms of origination.

Sure. Obviously I can't do that specifically because we don't give perspective numbers until we either issue press releases on our progress. But I would say this. I think that we are very comfortable with the amount of transactions that we're seeing in the marketplace today. I am very encouraged by the tenacity of which the team is attacking the marketplace and the opportunities that we're seeing today. I'm grateful to the venture capitalists who are continuing to allocate deal flow to us. And I do not see any--at this point, I am not concerned with the activities leading into the first quarter of 2007 with what we see and what we have in-house today, right now.

Your next question comes from the line of Jordan Hymowitz with Philadelphia Financial. Please proceed.

Hey, guys. Question. What was the net deferred origination fees in the quarter?

Deferred origination fees were approximately $3.4 - $3.5 million--$3.450.

No, that's the balance sheet number. What was the net change in the quarter?

Oh, between what we had accrued and recognized?

No. If you start off with last quarter's balance number, which I don't have in front of me, but the equivalent of that 3.4, and some of that was amortized in this quarter.

Uh, huh.

And then there would be some capitalized number change this quarter. So what would be the net change in the quarter between--that was added less the amount that was recognized; to the amount of capitalized this quarter less the amount that was recognized in the income statement this quarter?

To last quarter, we had approximately $3.6 million of deferred revenues on the balance sheet, compared to $3.5 million this quarter.

Right. And the decrease was related to the fact that we did have three companies that paid off early so we had some acceleration out of the deferred revenue that came in as revenue in the quarter. And so that's why you see the decrease.

Jordan, it's important to note, with the companies paid us off early, whatever unrecognized deferred revenues attributed to the origination interest, we call facility fees or the back-end interest that we call back-end fees, for example. All that, upon an early payoff, is accelerated and recognized in that quarter.

So approximately $100,000 from the balance sheet last quarter was accelerated this quarter?

To the net effect, that is right.

Now my next question is, you originated $18 million in new investments and about $44 million, is that right, in follow-on investments with additional companies?

Bear with me. That sounds--

So [inaudible] $18.3 million to these four companies and $44.7 million to 12 existing.

We did $63 million on the quarter.

Right. Do you charge the origination fee on just the 18 that's deferred or on the entire amount?

No. The vast majority of our transactions pay their fees upon the closing of the loan--legal documents, regardless whether or not they're drawing or not drawing capital on the facility itself.

And that averages about a point, right?

It averages about a point, that's correct.

So if you had 63 million point 01 times, that means you added $63,000, approximately, to that balance, which means you actually amortized about $160,000 from last quarter's number. You follow my logic?

No. The only issue with your logic is that the $60 million you may be referring to may have been previously closed transactions--

Right.

--which funded; ergo, the part that the fees attributed to that transaction is already reflected in a deferred revenue number.

And they could have been reflected prior to this quarter?

That's correct, because the $63 million is part of the burn-off or run-off of the previously disclosed unfunded commitments.

Got it.

And that's already booked in the GAAP number on the balance sheet.

So it's somewhere between 100 and 160 then by that logic, depending how much was booked would be the net change?

[inaudible] of the run-off.

Yes.

Yeah, but my comment is I think your numbers sound correct, but since I don't have those figures exactly in front of me, I think your logic is probably correct. But I would have reconcile that figure to get back to you on the specifics of that actual delta.

Yeah.

Your next question comes from the line of Troy Ward with AG Edwards. Please proceed.

Thanks. Good afternoon, guys.

Hey, Troy. I hope you're staying warm out there.

Yeah. Hey, it's a little bit warmer today. Hey, I might have missed this one, but did you give the taxable earnings number for the quarter, David?

No. I must admit we didn't. We gave it for the year in total.

Can you just give it for the quarter, quickly?

Troy, I apologize. I'm going to have to get back to you on that.

Alright. I can back into it. If you gave through year, I'll go back through the transcript. Can you provide a little more color on the SBIC process? I know you filed for the exemption from the SEC. Any idea what the timing on that may be?

Your guess is as good ours. We've had this exemptive request in there for months. And we're just waiting for the SEC to respond. I know they're backed up, they're busy and we're at the whim of the SEC, at this point.

And remind me again what that prohibits you from doing now versus when you get it.

Yeah, Troy. Let me expand on that. I mean let's be clear. It's important question and issue here. Currently today, we have approximately $255 million of equity capital base. So we are legally, under the BDC, able to fully leverage that. So approximately $255 million for one to one equity ratio.

Right.

Today, we have $150 million capacity or, I should say, existing relationship with the partners of Citibank so we can tap $150 million from Citibank today. And if I would not increase that credit facility without a Citibank or another party, for example, and merely use the SBA, I can actually, in essence, use up my SBA credit facility without having to seek an Exemptive Order.

Oh, I see. So you still have the gap between the 150 and the 225 [inaudible].

Exactly. So that allows us and eventually facilitates the SEC a little more time. So the pressure of now having to get the Exemptive Order issued from the SEC has now become less of a burden because of our capital basis growing and we have the ability to expand our credit facilities. Notwithstanding that, I look forward to the SEC moving as expeditiously as they can in order to have that also as part of our strategic credit facilities to tap for future leverage.

Okay. And, I guess, what happens once that $50 million is filled? What's the next step there?

So mechanically what would occur is the following. We would then submit a second leverage request. And that second leverage request, at this point, would be to probably fully lever up to the $120 million of capital. However, as I've indicated on previous calls, the SBA has its own disciplines that we must adhere to. And those disciplines are the following. The SBICs technically must complete an annual field audit before it's able to secure above one to one leverage from the SBA program. So, in other words, what that means is, as you may recall, an SBIC has to fully fund its regulatory capital base. For this discussion, assume $60 million, for example, and so until it receives its field audit, we were technically only able to really leverage up to $60 million under the SBIC program without a special exemption from the SBA itself to exceed that, until you get the field audit.

Okay. Okay.

It's like it's a little like peeling an onion. It's in there, you just got to peel.

All right, great. Thanks, guys.

Your next question comes from the line of Douglas Harter with Credit Suisse. Please proceed.

Hi. Can you just remind us the cost of funds differential on the SBA loans versus your Citibank line?

Sure. The Citibank line is one month libor and 165 dips or basis points. And the government, SBA program, is ten-year treasuries plus a spread, which I believe can oscillate or average between 155 or 160, I think it is. And then there's another fee that's amortized over a ten-year life of the fund itself. So it's both a pricing issue as well as a leverage issue that allows you to drive the better margins or better economy scales on the SBA program.

Thanks.

Your next question is a follow-up from the line of James Bonnem with Cadmus Capital. Please proceed.

Yes. Both of my questions were just asked and answered. Thank you.

Your next question is a follow-up from the line of Henry Coffey with Ferris Baker Watts. Please proceed.

Now, greetings. Just a couple of technical stuff. David, I didn't catch the taxable number for the year that you put out.

It was $1.06.

$1.06. And your cash balances, are they all free and available or is some of that restricted cash?

No, it's all free and available.

Great. Thank you, very much.

Okay.

At this time, there are no questions in queue. I would now like to turn the call back over to management for closing remarks.

Thank you, Operator, and thank you, everyone, for your continued interest and support of Hercules Technology Growth Capital. If you want to arrange a meeting or have additional questions, please contact David Lund or myself at (650) 289-3060. And it is our expectations that we will be touring over the proceeding couple weeks and meeting with our fellow investors. And, again, thank you for your support and thank you for being shareholders of Hercules.

Thank you. This concludes today's Hercules Technology Growth Capital, Inc. fourth quarter conference call. You may now disconnect your lines and have a wonderful day.