Hercules Capital Inc (HTGC) 2007 Q1 法說會逐字稿

Good afternoon, and welcome to the Hercules Technology Growth Capital, Inc. First Quarter 2007 Financial Results Conference Call. At this time, all participants are in a 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 [Jonathan Freed] with Hercules' Investor Relations Group to introduce today's speakers. You may go ahead, Mr. Freed.

Thank you, Operator, and good afternoon. On the call today are Manuel Henriquez, Hercules' Chairman and CEO, and David Lund, the CFO.

Our first quarter 2007 financial results were released just after today's market close. They can be accessed from the Company website at www.HerculesTech.com or 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 passcode 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 to Manuel Henriquez, Hercules' Chairman and CEO. Please go ahead.

Good afternoon, and thank you for joining us today. I'm pleased to say that Hercules had a fantastic first quarter, not only financially but also operationally, as we enhanced our platform for future growth.

Financially during the quarter, we closed new debt and equity commitments of approximately $108 million and also reported net investment income of $5.2 million for an EPS of $0.23 per share, in line with estimates, representing a growth of [105%] as compared to the same period last year.

In addition, I'm happy to report that our [warrant] portfolio continues to grow and today consists of 62 warrant positions in venture-backed life sciences and technology companies as compared to 37 warrant positions for the same period last year.

Of our 62 warrant positions, we currently have two companies which have filed registration statements for an IPO earlier in the quarter. Our growing warrant portfolio represents a very significant financial up side opportunity for Hercules and shareholders as we commence to harvest future warrant gains, via liquidity through IPO M&A for shareholders' benefits.

Now, let me take a moment to review some of our other achievements and key operational milestones accomplished during the quarter.

During the quarter, we continued to build our total investment portfolio, which currently stands at $342 million while also achieving a higher average weighted yield during the period. I'm also happy to report that as our portfolio continues to grow, our credit quality continues to remain strong, which I will expand on further during our discussion.

I'm also proud to announce that on May 2, yesterday, Deutsche Bank became one of our partners and allowed us to expand our credit facility to $250 million alongside with Citibank. The increase in new credit facility, coupled with our SBIC of $124 million, affords Hercules the opportunity to have access now to over $374 million of available capital for new investment opportunities, which continue to allow us to grow our portfolio.

During the quarter, I'm happy to report we also expanded our senior management team with the addition of James Crumpton as our Chief Credit Officer. With the addition of James Crumpton to the executive team, it will allow me to focus more in time and attention to continue to build Hercules and our strategic long-term plans and initiatives while bolstering our origination capabilities and our new business initiatives.

Now, let me take this moment to provide you some color with the overall venture capital marketplace, venture capital investing activities, and M&A and IPO transactions that occurred in the first quarter for venture-backed companies.

According to Dow Jones, Venture 1, and Ernst & Young, recently quarterly Venture Capital Report, the venture capital community invested approximately $7 billion to over 580 new investment transactions during the quarter. This represents an annualized investment rate of approximately $28 billion, the highest level seen in the last five years.

This is a significant milestone since the vast majority of our companies are highly dependent upon the continuous support from the venture capital sponsors, which, in turn, provides the necessary capital to repay our loans with our technology companies.

As important to the venture capital community, investment rate is also as important as where and stages of companies of which they make investments in. We saw significant investment activities in key geographic areas where Hercules currently has offices located across the country. We currently have offices in Boston, Massachusetts, Palo Alto, California, Boulder, and of course, our most recent office in Southern California.

For example, the San Francisco Bay area, or Silicon Valley, received approximately $2 billon of new investments, while our newest location in Southern California received over $1 billion, making it the second-highest investment area for venture capital activity and representing the third consecutive quarter by which Southern California has now surpassed New England.

On the East Coast, our Boston office, or New England region, received approximately $927 million of venture capital investment activities.

Now, in talking on the different stages of distribution that the venture capitalists focus on, the venture capitalists invested in first quarter approximately 2.3 -- or $2.4 billion, excuse me, of venture capital dollars into later-stage companies which we defined as expansion in established aged companies, which so happen to comprise over 80% of our existing portfolio.

In terms of industry allocation, the venture capitalists continue to see and invest in the life sciences sectors, which saw robust new investment activity by the venture capital community of approximately $2.9 billion, or 41% of the total venture capital dollars invested during the quarter.

On the liquidity front, we also are very encouraged by the signs that we're seeing in the marketplace today, both in terms of the IPO market, as well as the M&A marketplace. We're certainly seeing solid progress as compared to prior years in both of those areas.

During the first quarter, according to Dow Jones Venture 1, 13 U.S. venture-backed IPOs were completed, raising over $1.2 billion. This is double the amount raised a year ago of $599 million. Not being left behind, the M&A marketplace -- or M&A activity of venture capital-backed companies also remained quite brisk, with some 85 companies completing M&A transactions for a total amount paid of over $9 billion, representing the most paid for venture capital-backed companies in a single quarter since the fourth quarter of 2000. This is extremely promising as the M&A marketplace and M&A activities has continued to be a source of liquidity for venture capital investment and a source of liquidity for the eventuality of some of the realizations in our warrant portfolio today.

Of the M&A activities that take place in the first quarter, over two-thirds of those M&A transactions were completed with technology companies.

The level of activity of both the M&A and the IPO market represents future liquidity events for some of our growing portfolio positions, which again stands at 62 companies today. Both of these trends are favorable to the impact of our portfolio in hopes of our ability to realize additional future profitability or [inaudible] profitable liquidity events from our portfolio.

Lastly, regarding our diversification by both stage and geographic region within our portfolio, we remain committed to our long-term strategy in building an investment portfolio diversified by stage of development, which we define as early stage, expansion stage, and established stage, also diversifying by industry sector and subsectors, as well as geographic region. We pursue this strategy in order to ensure adequate growth in our portfolio around the country but also to mitigate risk in any single market and sector and stage of an investment.

We're now consistently offering financing solutions to venture capital companies and private equity investment companies from seed to post-IPO, which now includes lower-middle-market late-stage investment opportunities.

We've also expanded our product offering from senior secured credit facilities to equipment-based financing solutions to early-stage companies to acquisition and finance opportunities to some of our later-stage, more mature companies, as well.

Commencing in the fourth quarter 2006, we put together and launched an experienced team of originators who are exclusively focused on the late-stage or lower-middle-market technology investment opportunities.

I'm happy to report that since that team has come together in the late fourth quarter, they have now completed three transactions as late-stage opportunities in the first quarter, and we're certainly seeing a very strong promise in that team's continued ability to gain market share and awareness for additional deal flow in the future.

We're working very closely with many of the middle-market technology and life sciences private equity shops, organizations who seek our desired skills from our team, on the underwriting requirement to complete those types of transactions.

We also have commenced increasing our diversification to early-stage companies, as I said earlier, by offering equipment-based financings to Series A and Series B companies. However, because of the smaller dollar size of those transactions, you'll see the portfolio will take a bit of time before we actually find a [well] distribution of balance between the three different stages that we focused on earlier.

We are continuing to work tirelessly to build a portfolio and diversify our portfolio by the three distinct areas of stage, sector, and geographic region.

Now, on to credit quality. I want to emphasize that as we continue to grow our portfolio, the disciplines that we've maintained and the underwriting standards continue. At the same time, these are companies [that are] highly dependent upon the venture capital community for additional source of financings. We remain very encouraged by the level of venture capital investment activity that was witnessed or evidenced during the first quarter of ['07], or $7 billion being invested into technology and life sciences companies. This is important because the vast majority of our portfolio companies will all require additional rounds of financing, generally speaking, in nine to 14-month intervals from the original date of our investment to continue to sustain their business operations in order to pursue their business development strategies to achieve eventuality of a liquidity event or a cash flow breakeven status.

In addition, James Crumpton as a Chief Credit Officer will help us manage our growing portfolio, and as I indicated earlier, allow me to now move away from day-to-day credit activities to focus more in building the Company and our strategic directions over the years to come.

Now, in terms of shareholder return, we continue to believe -- to have 10 to 12 additional liquidity events in our portfolio in calendar 2007. I'm happy to report that of those 10 or 12 liquidity events, we actually had one completed M&A transaction during the first quarter for a company called Adiana, and we currently have two companies currently in registration for an IPO, and we have two or three additional companies who are in different stages of securing or completing an M&A transaction.

With that strategic overview in place, I'd now like to turn the call over to David Lund, our CFO, to discuss the financial results in detail.

Thank you, Manuel, and thank you to our investors for joining us on the call today. We are very pleased with the results for the first quarter of 2007. We closed record commitments and funding and achieved net investment income of $0.23 per share, which is in line with the consensus estimates. We accomplished this despite having $97 million of the $108 million of total commitments and 65 million of the $80 million in total fundings occur in the last two weeks of the quarter.

Here are some of the details on the quarter.

As to our income statement, investment income for the quarter was $9.7 million, which is an increase of approximately 49% compared to $6.5 million in the first quarter of 2006. This growth in investment income is a reflection of the continued performance by our team in identifying quality portfolio companies to invest in for the benefit of our shareholders.

Two primary factors contribute to the growth of our investment income.

First, the growth of our investment portfolio. While we grew the investment portfolio from $283 million at year-end to $342 million at March 31, 2007, the weighted average value of our investment portfolio during this quarter was approximately $290 million. The weighted average value of the portfolio during the quarter reflects the effect of the timing of fundings occurring late in the quarter when compared to the ending portfolio value.

The second factor is our ability to maintain the average yield to maturity on our portfolio. We achieved solid yields on our portfolio investments in the quarter while maintaining credit quality and growing the overall portfolio by 21% from the end of last year.

The yield on the portfolio was 12.72% at the end of the first quarter, which was up from 12.64% at the end of 2006, while our portfolio credit remained relatively constant compared to year-end.

Interest expense and loan fees were approximately $952,000 for the first quarter of 2007, as compared to $1.9 million in the first quarter of 2006. The increase of approximately $976,000 was due to lower outstanding balances during the current quarter and a lower average interest rate compared to the same period in 2006 when we had the debt facility with Farallon outstanding.

Operating expenses for the quarter, excluding interest expense and loan fees, were $3.4 million, an increase of 36% over the $2.5 million during the same period last year. This increase is primarily attributed to our growth associated with increased headcount, expansion of our office facilities in Boston, Boulder, and Palo Alto, and other costs associated with being a public company.

I would like to point out to our shareholders that the operating expenses when compared to the fourth quarter of last year were lower by approximately $300,000. This decrease was primarily related to lower compensation expense related to bonus accruals.

Net investment income for the quarter before taxes increased to $5.2 million, or $0.23 per share, based on 22.9 million shares outstanding. This is compared to $2 million, or $0.21 per share, in the first quarter of 2006, based on our reporting as a RIC in the first quarter of last year. This increase in net investment income reflects our efficiency and growing investment income while continuing to manage operating expenses.

Net realized gains in the quarter were approximately $290,000 when compared to a net loss of $1.7 million in the first quarter of 2006. The realized gain in 2007 was a result of selling our equity and warrant position in Adiana. I would like to point out that the structure of the sale of Adiana provides for contingent payments based on earn-out provisions that could provide additional gains to Hercules.

Net unrealized gain on investments in the first quarter was $816,000, compared with an unrealized gain of $4 million in the first quarter of 2006. As you saw in the earnings release, the unrealized gain in 2007 was a result of the write-up to fair value on one loan that was previously written down and unrealized gains on our warrant portfolio. In 2006, the increase was primarily attributed to the change from an unrealized loss to a realized loss on one portfolio company.

As Manuel mentioned earlier, we distributed our sixth consecutive dividend during the quarter of $0.30 per share, bringing total dividends paid to our shareholders to $1.53 per share since our IPO in June 2005.

Now, turning to the balance sheet --

From the earnings release, you may have noted that we had approximately $41 million in cash at March 31, 2007. This is a higher cash balance than we would normally hold and can be attributed directly to fundings being delayed into the early part of April. At the end of March, we borrowed funds under our credit facility in anticipation of funding for investment by the end of March. However, the investments ended up being funded during the first 10 days of April, when we funded approximately $38 million of new investments.

During the quarter, we borrowed $72 million, bringing the debt balance under our credit facility to $113 million at March 31, 2007. However, our weighted average outstanding balance for the quarter was approximately $38 million. The low-weighted average debt balance as compared to our ending debt balance is attributed to our managing borrowings in line with our investment fundings.

Today, we also announced that Deutsche Bank has joined Citibank to provide Hercules with a combined credit facility of $250 million. The credit facility is a one-year facility and is renewable on May 1, 2008 with an interest rate of LIBOR plus 120 basis points, 45 points lower than the rate we paid in Q1.

The reduced interest cost under this expanded facility will have a direct impact on our earnings and potentially increase the portion of our dividend contributed by a net investment income. We are extremely pleased to be working with two premier banks who will be providing working capital to continue the growth of Hercules.

We also announced on April 5 that we received an exemptive order from the SBA allowing us to exclude the debt of our SBIC subsidiary from our asset coverage requirements test. This exemption will allow us to exceed the one-to-one asset test for borrowings from the SBIC. We intend to eventually seek up to $124 million of leverage from the SBIC and are presently approved to draw up to $50 million under the SBIC program once we meet certain regulatory requirements.

In April 2007, we drew $12 million of leverage under this program. Our initial borrowing rate for this draw is at LIBOR plus 30 basis points, and a final rate on this borrowing will be established by the SBA at the end of September at their biannual meeting.

Borrowings under the SBIC facility, combined with our new expanded credit facility, gives us borrowing capacity of up to $374 million.

Finally, our Board of Directors has approved a dividend of $0.30 per share that will be payable on June 28, 2007 for shareholders of record on May 16, 2007. This will be our seventh consecutive quarterly dividend, bringing total dividends declared to $1.83 per share since our IPO in June 2005.

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

Yes, sir. [OPERATOR INSTRUCTIONS]

And your first question comes from the line of Troy Ward of A.G. Edwards. Please proceed, sir.

Good afternoon, gentlemen.

Hey, Troy. How are you?

Doing all right. Hey, just a couple of quick ones. Can you -- David, can you tell us what the origination fees were in Q1 and what portion of that maybe was amortized into earnings in Q1?

With the total origination fees that we've brought in during the quarter?

Yes.

Let me pull -- get that for you here. And your other question?

Is how much of that did you actually amortize into earnings in Q1?

Okay. Bear with me.

All right. Maybe I'll go on. Manuel, if -- maybe you could -- the stock-based compensation was up in the quarter. Is that something that's going to be lumpy, or is this kind of a new run rate, or how should we look at that?

No, it's certainly the new run rate per se because with the addition of some of the new team we've brought on in the fourth quarter, we generally see a slight uptick in additional compensation that may occur sometime in the beginning of third quarter. We tend to do our annual reviews, if you will, in the June time period, and at which time the Board has -- will determine whether or not that will include just stock compensation for any of the employees, as well. So we tend to have an annual process by which everybody gets reviewed at the June timeframe. But the run rate that you can see in the first quarter is probably the right number.

Okay, good. And then, also, on the fees associated with both the expanded credit facility, and if I remember right, there was an additional fee with the SBIC, can you kind of give us a little bit of color on those and how we should be looking at the fees associated with that funding?

Sure. I'll take the SBIC first. Mechanically speaking, the SBA has, in essence, what's called a commitment fee that is paid in advance and generally is recognized over the expected term of the loan under the SBA program, which is about 10 years. So that 1% fee is paid only once on the original committed amount that you take down. In this context, we only initially applied for a commitment of $50 million, of which we've now paid a 1% fee on the $50 million that will be recognized ratably over the duration of time between the generally 8 to 10-year timeframe of that [fate].

Secondly, there's also a fee that is paid upon the drawdown of the credit facilities from the SBIC program, and that is a fee that's spread over the cost of the 10-year treasury, and that's generally a spread between 180 and 185 over a 10-year treasury.

As I think we denoted in our disclosure and press release, we are currently borrowing on an interim basis from the SBA on a LIBOR plus -- I think it's LIBOR plus 30 basis points. The SBA establishes a 10-year treasury lock-in rates, if you will, on there twice a year, which I believe it's September, and I have to apologize. I don't remember the second date by which -- when it is. I believe it's March.

[Inaudible] March, yes, March.

March timeframe. And that's the other thing.

The second part of your -- the first part of your question was related to --

The expanded credit facility. Any additional fees that we need to factor in?

Yes, so we took in $1.5 million of fees during the quarter, and we amortized $661,000 of fees during the quarter.

I'm sorry; say the first number again, David?

$1.5 million.

Okay.

On the second part of your question, on the reestablishment of the Citibank line and Deutsche Bank line --

Yes?

I believe that there is a fee on an annual basis of 25 basis points, is it, or --

On the Deutsche? 0.375.

-- 37.5 basis points on the inception of that credit, that relationship, which is recognized over the 12-month period of time.

Okay. And on the comp and benefit line, it was down nicely from -- I'm sorry, yes, it was down from fourth quarter, and it was -- and I think the commentary was lower bonus accruals. Could we expect a current run rate and then kind of a similar seasonal effect in Q4 that it seems like we've seen the last couple years?

You know, the issue -- just for clarification, we reevaluate the bonus accruals throughout the calendar quarters, and as I'm sure you realize, and we said on numerous occasions, this business that we're in is extremely lumpy, and it's very hard to have a solid predictability of closings or [state] fundings that take place, as well. And until we actually have very strong confidence in that, the bonus accrual [does honestly] get adjusted until we believe that that number will, in fact, be exceeded.

So the current run we're going to have today is, I think, the adequate run rate they should be on right now, and I do not anticipate any real meaningful adjustments in the first -- in the fourth quarter unless we are really executing amazingly well in that period of time.

But the bonus accruals weren't -- I guess you closed a lot right at the end of the quarter, so the bonus accruals -- you chose to take lower bonus accruals knowing that that was happening that way so you shouldn't necessarily see an uptick next quarter?

Oh, that is correct. We actually model our bonus accruals on our expected forecasts of originations and closings and funding throughout the year at the beginning of the year, and that is then reevaluated progressively. Obviously more important, after the second quarter, we had greater visibility [inaudible] six months of operating history [behind you], but the answer is the bonus accrual you have today, I think, is more than adequate at this point to pay out what we expect to pay out on a performance basis.

And the second part of your question is very important. Of the $108 million of commitments that we did, in fact, close in the quarter, 96 million of that was closed in the last two weeks of the quarter, again, showing the lumpiness of the business itself.

All right. Okay. Thank you, gentlemen.

You're welcome.

And your next question comes from the line of John Hecht of JMP Securities. Please proceed, sir.

Afternoon, guys, and congratulations on a good quarter.

Thanks, John.

So real quick on the -- you had an improvement in yield versus the Q4, and how much of that was related to sort of accrual or [inaudible] or approval fees of that nature? And behind that was -- your coupon rate's relatively stable during the period.

Yes, I mean [inaudible], our rates for our fees and stuff have been relatively constant, you know, between our facility and commitment fees, staying sort of around 1.25%, and it was a slight uptick with our coupon rates.

The real uptick is more attributed to a change or a shift in the asset mix of the product we're originating, meaning less of an AR working capital credit facility and more back into growth loan as the biggest driver of that.

Okay. So more kind of risk-adjusted returns in that set of loans?

That's exactly right.

Okay. And forgive me for the next question because I've recently seen coverage that you've given some statistics historically about how much unfunded commitments may convert in the next period and then term sheets, and if I look, you have a big backlog in terms of term sheets. How should one look at that in terms of what we'd expect to convert in the coming months here?

Sure. And for your benefit and anybody obviously who may not be as familiar with the story as we've been saying in the previous quarter, let me start off with kind of the waterfall as a way of giving you ability to kind of process that request.

Of the unfunded -- excuse me. Of the signed term sheets, we generally expect to see 75 to 80% of those items, those term sheets, convert into closed transactions. So if you look at it in this quarter, we had approximately -- I think it was 124 million that we said in non-binding term sheets we have in the quarter.

Of that number, 75 to 80% of that will then convert over to a closed contractual obligation for us to fund. Of that closed contractual obligation to fund, we also expect to see 75 to 80% of that commitment actually get drawn down and funded.

Of that 75 to 80% commitment that funds, depending on when it closes in the quarter, you'll see a typical distribution of that capital to be deployed or funded in the following manner -- between 35 to 50% in the quarter in which it is closed and originated with the proceeding balance of 75 to 80% in the proceeding two quarters.

So if it closes late in the quarter, as we saw occurred in the first quarter, you could generally assume that only 30% -- sorry, 35% of those actual contractual obligations funded in the quarter with the remaining overhang of the $74 million or so, that should fund over the proceeding next two quarters.

Sorry to make it complicated, but unfortunately, it is a complicated analysis of how to get this waterfall, which is what makes it difficult to really pinpoint the accuracy on forecasting.

Understand that. But the 142 million also suggests there's a reasonable visibility for continued strong origination trends in the latter part of this year, as well. That's a bigger number than I think you guys have posted over the last few quarters. Is that correct?

It certainly is that, and we said in the fourth quarter, the likeness, if you will, of the fourth quarter is basically attributed to the venture capital overall marketplace activities. By having a very solid first quarter by venture capital originations, those are, in essence, new crops or new opportunities of companies for us to invest with.

So as the venue capital closes continue to increase and grow, that is affording us the continued deal flow and pipeline of new investment opportunities. I would also say that if the venture capital closes are curtailed to an extent, you will probably see us curtail some of the origination activities, as well, to coincide with the changes of the VC investment rates that exist in the marketplace. So they're pretty much important correlations to each other.

Okay. Last question. Is there any kind of rhyme or reason why you were so late in the [inaudible]? I know you've expressed many times that this is lumpy, but was there any sort of dynamic behind such a large amount closing late in the quarter, or is that just sort of how the world worked out at this time?

You know, I have to tell you, doing this business as long as I've been doing it, we're getting to see more and more and more activities being pushed towards the end of the quarter. I don't mean to take a shot at some attorneys out there, but I think the attorneys are also causing a bit of havoc in the process by -- historically, you would see documentation to take anywhere between two to three weeks currently taking up to four to five weeks to get documentation -- documented and closed. And I think, frankly, it's more of a testimony of not the legal profession but the amount of transaction activities in the overall venture capital marketplace which is causing that [consternation] in the system.

Okay, so it's both more about -- around reporting periods than just getting things done as you wrap up a reporting period sort of by the nature of the industry itself?

Yes, despite what people may want to believe, we absolutely have zero control on when a transaction closes. I wish we would have more control of that. It's, frankly, very, very difficult to do. It's no different than doing an M&A engagement. You just never know until both sides have reached that agreement to close a deal.

Okay. Thanks very much, guys.

Thank you, John, and thanks for covering us.

And your next question comes from the line of Henry Coffey of Ferris, Baker Watts. Please proceed, sir.

Yes, good morning -- good afternoon, guys. I got a memo here from your attorney. Apparently the use of the word lumpy on conference calls has been outlawed! Great quarter, guys.

Can you help me a little bit going. I think we've got a clear picture of what -- sort of what happened during the quarter, $108 million of commitments, 80 million of fundings, and then an additional $38 million of new loans sent your way in April?

Yes, we funded $38 million in the early part of April that we thought we were actually going to be funding towards the end of March.

And so it's -- so 80 was funded and then 38 was funded within the next 30 days?

That's correct.

What does the -- if we exclude that 38, what does your existing pipeline look like?

Well, the answer is that -- I'm trying to -- I don't not want to --

I mean I don't think there are any announced deals out there at this point, right?

Well, there's been some certainly. We have basically -- the way to extrapolate this way, we have $142 million at the end of the first quarter of signed term sheets. There's absolutely no question that some of that $38 million in fundings represents deals that were converted and closed of the $142 million, but it also includes some of the portion of the $74 million in closed and unfunded commitments.

However, you're absolutely correct to assume that unfund -- that non-binding term sheets is 142, and it's continued to grow in calendar -- in the second quarter, as well, but we have not necessarily --

So you had 142 million of signed term sheets that hadn't gone to commitment or funding?

That is correct --

And then you went and funded 38 million, and you obviously have another 100 or so just sitting there, now, obviously not all of which drops into the next bucket?

That is correct. From that perspective, we have -- at the end of the first quarter, we had, in essence, $75 million of unfunded commitments and $142 million of signed term sheets. Of the combination of those two items, $38 million of that combination was actually funded in the first two weeks of April and subsequently more of that and new ones have been also funded already in the first quarter and second quarter of 2007, as well.

So it's fair to say we're setting up for a fairly strong year?

I would say that I remain very encouraged by both our team's growing capabilities in the marketplace and the continued robustness of venture capital investment dollars being invested in. However, if for some reason we see a significant curtailment of venture capital close in the second or third or fourth quarter, that will have an impact in our origination strategy or origination goals, but certainly, as of right now, I feel very comfortable with some of the consensus that exists out there in terms of what we're seeing in our deal pipeline today.

I may have missed this, but end of period loan yields right now is --

Oh, I believe 12.72.

That's correct.

And how does that compare to the new loans funded? What sort of yields were you looking on those loans?

I think that they're on or about the same level. We're not seeing a significant divergence from those numbers. In fact, as you see, the yields actually went up from the fourth quarter to the first quarter, which I believe was at 12.64, and we're at 12.72.

Excellent.

Albeit, it's 8 basis points, but on a $300 million portfolio --

Right.

-- it's important.

So that's what I mean. It looks like some of the newer loans were sort of 12.85, 12.90.

Well, [inaudible] answer like that. I think it's a shift in the asset classes that we are constantly loading -- balancing, I should say, the portfolio between product, meaning senior secured working capital revolvers and senior secured growth loans to equipment-based financings to buyout, and as well as sector has a big impact in terms of structuring of the deal, whether it's life sciences or [deck] or stage, as well, early to mid to late. All those factors weigh into the overall management of our portfolio, which is both yield and risk mitigation.

If you use your crystal ball and look forward, what do you think the mix will look like by the end of the year?

In terms of what aspect?

Either in terms of loan types more than company types in terms of equipment finance and traditional loans and growth loans and --

Well, I'm very encouraged by the tenacity of which the -- my new group in the late-stage middle -- lower/middle market initiative is currently doing. So those transactions are much more typical.

Asset-based lending deals, where you're looking at enterprise value and EBITDA multiples, are much more, for lack of a better word, stabilized credits versus the traditional asset class that we focus in, which are the venture -- purely venture-backed companies. Those transactions tend to have a slightly higher yield but offer, of course, because a lower risk profile of the transaction less economic up side in the form of warrant participation or equity participation.

All right. Thank you.

And your next question comes from the line of Bob Napoli of Piper Jaffray. Please proceed, sir.

Good afternoon. A couple questions. Manuel, the numbers that you gave on unfunded commitments and term sheets, the 75 and the 142 at March 31, what was that -- the, say, December 31 or at its peak, prior peak, before this quarter?

Give us a second. We will get that for you in one quick sec here. Let's see.

Then of those term sheets, the 142 million, did you say like on the waterfall what percentage of those turn into completed deals?

Sure. As I indicated in my waterfall discussions -- we're looking up the other number -- as I indicated in my waterfall discussion, of the $142 million, 75 to 80% of that $142 million, so to remain conservative, assume about $107 million of that will actually turn into contractually closed transactions.

Okay.

Of that $107 million, we then expect to fund 75 to 80% of that in the proceeding two to three quarters, meaning $80 million. So to go from cradle to grave, you'll see that the $142 million from a cash flow point of view can turn into approximately an $80 million in funding activities.

Yes, and, Bob, as we reported in our earnings release last quarter, we had $55 million of unfunded commitments to our portfolio companies.

Okay.

We only had $16 million of binding term sheets at that time, so it's grown, obviously, during the quarter.

16 million?

Yes.

Okay. And I mean with -- the flow seems to be pretty substantial, and you gave some very good statistics on the activity in the venture business. Are you seeing more competition in this segment? And you guys appear to have a lot of momentum, [inaudible] it seems like you're maintaining the same terms. Are you seeing new competitors attracted to this market segment?

Well, I think it attests similarly to a lot of items as a competition question or statement. I think that, one, it is the continued belief of Hercules that the franchise that Hercules has in a marketplace is really testimony to the caliber of our senior origination team. That senior origination team has a very strong longstanding relationship with many of the venture capitalists and private equity shops in this country, which is, of course, our lifeline in terms of deal flow.

That said, we also have a very important growing brand on Hercules technology in the marketplace, and that brand now is growing in significance, importance, that we are seeing more and more deal flow from those venture capitalists, from financial intermediaries, such as venture law firms, finance and accounting firms, what have you.

However, from a direct competition, it's interesting. We were seeing a fairly significant shift where some players have been in the marketplace for a long time. Like Silicon Valley Bank, for example, they have even said in their most recent earnings call that they're shifting more towards a private equity marketplace, and we are seeing a very strong deal flow in this stage of companies that we see in the venture capital marketplace. So that's an important shift.

We've also seen some of our other competitors that had historically existed in the marketplace not been able to successfully raise additional and new funds in the marketplace.

Now, I do not want anybody to take that comment to believe that we do not have competition. That is certainly not the case. We are never the only provider of a term sheet to any one of our technology companies. We're always one of two or four players to each one of our companies.

And so I think that the reason why we're continuing to see the deal flow that we're seeing is really because of our team's knowledge of the various respective subsector spaces that we operate in, and frankly, the depth and breadth of the team's experience is why a lot of these CE's, venture capitalists, and technology and life sciences companies want to partner with us.

Thanks. A question on the portfolio that you have, the 62 or 64 investments. Manuel, you talked about you expect 10 to 12 liquidity events, I think is the number this year. Of those investments, how many, like say over the last -- since you've had them over the last year have had up rounds or additional venture fundings that were either up, flat, or down round? I don't know if you could -- you just kind of try to quantify to the best of your ability what percentage would have -- that would have been and how many would've been up or flat or down?

Well, absolutely. This is probably one of the most important questions asked recently. As you get to know the venture capital marketplace in our portfolio, it's actually a significantly important question for multiple reasons.

The first -- the answer to your question directly is the vast majority, if not -- I'm not aware of actually any one of our portfolio companies as of yet to have closed, in essence, a flat round of financing. Certainly, none of them that I'm aware of has closed a down round of financing that I'm aware of. And just to make sure you understand, even if they close a down round of financing, Bob, it is fairly typical in our loan and security agreements or specifically in our warrant agreements that we have what's called [inaudible] dilution protection or some form of pricing protection that protects the warrants to reprice in that imminent down round if they were to have it.

Now, more importantly to your question is a statement of fact. It is absolutely expected that within the venture capital landscape that companies typically raise additional rounds of equity capital in fairly predictable intervals of nine to 14-month timeframes. And as our portfolio now approaches its first vintage years of 100-plus or so million dollars of companies now on the books that now have been over a year old, you'll start seeing a lot more pricing -- oh, I should say uptick in valuations that we expect within that warrant portfolio to start occurring in calendar '07 and beyond as that portfolio continues to mature.

And as those up-rounds occur, then you would recognize the increased value in the warrants, and also, you would have the opportunity to, in many cases, participate in those rounds?

That is correct. We typically have -- in our loan and secured agreements, we typically have beyond the equity of participation rights and the ability on most of our cases to also -- to protect our pro rata ownership in those companies, we also have what's called future equity rights, that in the event that that company were to secure the next round of financing, we have on most cases of our loan and secure agreements the ability to invest nominal amounts of equity, between $0.25 million and, to some case, up to $2 million of pure equity investment, in those future equity rounds of financing that may take place at our underlying companies, thereby affording us additional long-term capital appreciation for our investors in the form of equity participation rights.

Thanks. The last question, just on staffing, I mean you have some -- obviously with the growth momentum that you have, you just hired a chief credit officer. What are the key staffing needs that you need to bring on as this company continues to grow over the next year or two?

Sure. Staffing for us is a direct correlation on deal origination and future expectations of deal flow. As I'm sure you're aware of, it takes about six months to hire a new managed director, a new originator, if you will, to have that individual really become a productive asset, if you will, of the Company. So we're certainly in the marketplace looking to add additional analysts, an associate, to help further bolster up our financial analysis that we do on the companies, which further helps mitigate credit risk by having additional transaction individuals helping us build a portfolio further.

So in the course of the next six to nine months, we are certainly looking to add anywhere between two to four investment associates and analysts and opportunistically looking at maybe one or two additional managing directors as we continue to see the deal flow in our pipeline growing the way it is.

But, again, the hiring is directly correlated to our belief and confidence that that pipeline is sustainable and deal flow is there to be had.

Thank you.

And your next question comes from the line of Henry Coffey with his follow-up from Ferris, Baker Watts. Please proceed, sir.

[Unrelated discussion]

Operator, why don't we go to the next call and let Henry come back on the line.

Yes, sir. He is the final question in the queue. Mr. Coffey, your line is open. Mr. Coffey, you may proceed.

And your next question comes from the line of [Lee Markowitz] of [Pilot Advisors]. Please proceed.

Congratulations on a great quarter.

Thanks, Lee.

I was wondering, since we're applauding all these investments you're making and the idea the more investments, the better off we are, if there's any you could give us a more detailed scorecard on the progression of the investments which are like one to two years old?

Well, as I said a minute ago, if you look at the portfolio aging, and today it represents about $342 million of that, which would put $80 million on the books, so on a simple arithmetic, if you take the 342 less the $80 million we just funded, you have about $262 million of assets that are obviously greater than one-quarter old. Of that, I think we added I want to say about $140 million or so in calendar '06 that were funded. So you, in essence, have about $120 million of investments that are now approaching their, I guess, greater than 14 or 12-month mark, and so if you take a simple average of $120 million, what that means at a, say, $6 million average investment, you're going to have 20 of the 60-plus companies in our portfolio closing or expected to close new rounds of financings in calendar '07 that we're looking at.

Some of those transactions will also represent liquidity events for us, whether in the form of an IPO or M&A activities, and as I said earlier, we have two companies already in our portfolio that are in registration today, and we have approximately three others that are engaged in a M&A transaction that we're fully aware of that are expected to get closed in the next 40 to 60 days, if you will.

So the portfolios continue to mature as expected and in the typical fashion that you see a venture capital portfolio do, which is a company on a venture community currently is taking about six years from the original round of investment to achieve a liquidity event, and I believe the average year of our portfolio anecdotally -- not one of those analyses -- is probably in the order of four years since the first date of investment in our portfolio, which is why I believe that '07 and '08 will become significant years for us in liquidity of harvesting both warrant gains from M&A and IPO but, more importantly, seeing step-up in valuations from our existing legacy portfolio of warrant positions in those companies.

So the first five are doing fine, thank you, and the other 15, more or less on track as far as you could tell?

As of right now, yes, I think it's a fair statement. I'm not sure of the five or 15, but certainly in the first --

Well, the five have a liquidity thing -- have things happening?

That's correct.

Yes.

That's correct.

My next question is tied together. It's a two-part question.

Could you just review the regulations or the rules or determinants that determine what the dividend could be? And not that we're expecting much of an increase from now, but what has the -- with the rules are and when it's to happen?

And, B, with the amount of debt that we have at this time and the commitments made, how quickly do you think the next equity offering could be?

Well, I'll let David answer the first part, and I'll address your second part.

So with regards to the dividend, you know, the dividend is set by the Board. I'm not sure that there's necessarily a legal limit to what it is. We could have a return of capital.

No, there's a 90% -- 90% required distribution, so from that point of view, the statutory requirements are 90% of our NII, or taxable income, has to be distributed to our investors.

Now, let me elaborate now. If for some reason we see that our NII and our taxable income may, in fact, exceed the $1.20 recurring [inaudible] today, we are able to potentially pay a 4% excise tax, roll it over to the next calendar fiscal year, and then decide at that point whether to either increase the dividend and pay it out then or retain it.

So you could retain it if it was in the best interest of the company quite legitimately?

That, as well. The portion above the 90%, that's correct.

Yes, yes, okay.

Now, the second part of your question, the following. We clearly don't provide expectations of when we're going to go out to the marketplace and fund or raise additional capital, if you will. Clearly, the support of having Deutsche Bank now as part of our syndicate along with our longstanding partnership with Citibank certainly affords us the ability to have a much stronger balance sheet, which continues to fund our business operations.

You add to that, of course, the SBIC entity, which we talked about earlier, which affords us the ability to happen at $124 million of capital. However, I want to caution everybody from a regulatory requirement as to the -- their near-term inability to fully cap the SBIC. What does that mean? It means that under the SBIC program, Hercules is first required to fund the regulatory tiers of capital, the equity requirement capitals to fund the SBIC unit, which is approximately $64 million.

Once we do that, we then can petition or file for a funding request from the SBA in order to fully leverage that equity base of $64 million to the $124-plus billion of leverage from the SBIC.

Now, the SBIC has naturally imposed a program whereby a newly minted SBIC is unable to fully access the $124 million of capital until it completes its field audit from the SBA. I am happy to report that our field audit with the SBA is scheduled to commence mid-May, and we expect that to be completed sometime by mid to end of June and, therefore, allowing us the ability to fully access the $124 million of capital sometime in the third and the fourth quarter of calendar '07.

Now, with that statement, you have to obviously look at our existing unfunded commitments and our pipeline of closed, non-binding term sheets and extrapolate where you think we are in the process.

So, clearly, sometime in calendar '07, we will probably go out and access a capital raise, but that's really contingent upon how we continue to see our deal flow and our pipeline coming together. But certainly, the near-term pressure has certainly shifted a bit by having access to the Deutsche Bank credit facility, along with our partner at Citibank for $250 million.

Good answer. Thank you. Very good quarter.

Thank you very much.

At this time, there are no further questions in queue, and I would like to turn the call back over to Manuel Henriquez. Please proceed, sir.

Well, I'd like to thank everybody for participating and joining in this call. As we have -- historically have said, David and I already said the management team will make itself available over the next few weeks as we tour the country visiting many of our investors, and I certainly invite you to place the call into Hercules or contact our Investment Relations firm. You can certainly contact our internal Investor Relations Department at 650-289-3060, and Miss Sally Borg will be more than happy to coordinate any future investment meeting requests that anybody may have.

Again, thank you on behalf of all of us here at Hercules, and thank you for being our shareholders.