Hercules Capital Inc (HTGC) 2007 Q2 法說會逐字稿

Good afternoon, and welcome to the Hercules Technology Growth Capital Second Quarter 2007 Financial Results Conference Call.

(OPERATOR INSTRUCTIONS).

I would like to remind everyone that today's call is being recorded. Today's date is August 2nd, 2007. Please note that this call is the property of Hercules Technology Growth [mat] Capital and that any unauthorized broadcast of this call in any form is strictly prohibited. I will now turn the call over to [Jason Gold], Investor Relations Counsel to Hercules. You may go ahead, sir.

Thank you, Jeremy, and good afternoon everyone. On the call today are Manuel Henriquez, Hercules Chairman and CEO, and David Lund, the CFO. Our second quarter 2007 financial results were released just after today's market close, and they can be accessed from the company's website at herculestec.com or at htgc.com.

I'd like to remind everyone that today's call is being recorded. We have arranged for an audio replay of the call, which will be available through our website or by using the telephone numbers and pass code provided in our press release.

I'd like to -- I'd like to call your attention to the Safe Harbor disclosure statement as follows. Today's conference call may include statements or information that are not purely historical in our forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including without limitation the risks, uncertainties and other factors we identify from time to time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which these forward-looking statements are reasonable, any of those assumptions could prove to be inaccurate and as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made of -- made as of today's date, and Hercules assumes no obligation to update the forward-looking statements for subsequent events unless required by law.

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

Thank you Jason, and good afternoon everybody. And thank you for joining us today for the Hercules Technology Conference Call. I am pleased to say that Hercules had another record financial and operating -- operational quarter. Before we discuss the details of our quarter, I'd like to address what is happening in the financial marketplace, specifically the ongoings of the subprime, middle market, consumer credit, none of which Hercules has exposure to.

We are, however, focused on the venture capital marketplace. We invest exclusively in life sciences technology companies backed by venture capitalists, which tend to have a long-term investment perspective. In the first half of 2007, the venture capitalists invested $14.5 billion, this according to the National Venture Capital Association or the NVCA.

This is the highest level since 2001 and the ninth consecutive quarter, year-over-year growth in Venture Capital investment activities. The markets we serve are poised to offer significant and strong growth opportunities for new investment as we continue to build our portfolio for the benefit of our shareholders.

As most of you are aware, most of the [Double B] traded BDCs in our space are going through an adjustment period. They're being affected by the various capital markets and credit markets, attributed to the ongoings of the middle market and the subprime marketplace, again, a market of which we have no exposure to.

As a reminder, while we are at BDC, we are distinctly different. We focus, again, in the venture capital marketplace, and the relations within the venture capitalists are a critical part of our business and have little to nothing to do with the overall, ongoings of the capital markets and the middle-market activities going on today.

Accordingly, as I said a minute ago, subprime market is something we have not exposure to, real estate, no exposure to, middle-market buyouts, we have no exposure to, and of course, consumer credit. This is important to draw this distinction because as a BDC, we seem to have been most recently, rolled up in the whole ongoings of the ongoing market in general and the BDC landscape. We are very distinctly different, and we focus primarily and exclusively on the venture capital marketplace in its sector.

In terms of Hercules, we continue to see strong support for venture-backed technology life sciences companies, which is evidenced by our record quarter of commitments of $144 million. As of June 30th, 2007, we also had unfunded commitments of approximately $111 million and unsigned term sheets of approximately $48 million, giving us strong visibility into the next two quarters in terms of originations and closing of transactions.

In terms of credit, we've maintained strong credit discipline and performance during the quarter well within our targeted ranges. We would like to note that we have no non-performing loans with the exception of one workout credit, which is currently being liquidated, which we expect to close sometime in the third quarter.

In addition, in June, we successfully completed our fourth public capital raise, raising approximately $124 million in gross proceeds from the sale of our common stock. We believe that this capital raise, combined with our existing credit facilities, will enable us to fund new and existing investments for the proceeding four to five quarters.

This is important because as we continue to scale the business, the reliance on the public markets in the near term is not necessary to fund and continue our growth. This capital, which we recently raised coupled with our credit lines, strengthens our balance sheet and positions us for future growth. We currently have approximately $400 million of permanent capital on our balance sheet.

In terms of the quarterly results, we reported net investment income of $7.2 million or $0.29 per share, representing growth of over 193% as compared to the same period last year and representing another record for us. We also have paid our seventh consecutive quarterly dividend, bringing total distributed dividends to our shareholders of $1.83 a share since our public offering in June of 2005. We remain confident in our progress towards our short-term goals of paying dividends completely out of earnings in the fourth quarter, a key milestone for the company.

I am pleased to report that our warrant portfolio continues to grow and today, consists of approximately 70 venture-backed technology and life sciences companies. This growing warrant portfolio represents an option to invest of approximately $42 million in the aggregate equities of our underlying 70 companies and provides our shareholders with the potential to achieve venture-capital type returns and long-term capital appreciation as we continue to grow our organization.

As I will explain later, we are very excited about this part of our strategy continuing to grow our warrant portfolio as we expect to monetize that in the coming quarters. In terms of some of our operational highlights, now I'd like to take a moment to review some of our achievements and key operating highlights accomplished during the quarter.

During the quarter, we continued to build our total investment portfolio, which now stands at $417 million as of June 30th, while maintaining a weighted average yield to maturity of 12.75%, which is slightly up from the first quarter. As our portfolio continues to grow, we continue to focus on diversifying our portfolio within technology and life sciences sectors while maintaining a high level of credit performance.

We also had numerous, important financial achievements during the quarter. In addition to the capital raise I mentioned earlier, we've also expanded our credit facilities to $250 million with the addition of Deutsche Bank in conjunction with our existing partner, Citibank. The addition of Deutsche Bank will provide us the capabilities, along with Citibank, to continue to expand our credit facility as we need to grow our organization and provide additional capital and a diversified source of capital to continue to grow our portfolio in the coming quarters.

In addition to that, on July 30th, 2007, the SBA issued a commitment allowing us to borrow up to the full amount of $127 million under our previously disclosed SBIC, Small Business Investment Act Company. This capital is permanent capital. And in a sense, it's ten-year, long-term capital that we will expect to draw in the coming quarters as well as to further diversify our funding sources as we grow our business. We see this as an alternative source or complementary source from our existing credit lines to fund the operation of our business.

Additionally, as you may recall from our most recent filings, we received an exempt award from the SEC allowing us to exclude any leverage obtained under our SBA program from the BDC test of one-to-one debt-to-equity ratio. Allowing us to leverage our balance sheet beyond the one-to-one restrictions that most normal BDCs have today, the inclusion of the SBA, our most recent capital raise and Deutsche Bank inter-syndicate, we have the capabilities of leveraging our balance sheet in excess of $500 million to fund the next coming quarters' growth in our portfolio.

It was a great quarter for our portfolio companies as well. We believe that we're still on track to achieve ten to twelve liquidity events in calendar '07 within our portfolio and tracking towards that process or tracking towards that goal, excuse me, on a year-to-date basis. We've had one company go public this year. We've had another [twelve] to go public. We've had four announced acquisitions in our portfolio, and we remain optimistic that we'll achieve our goals of ten to twelve liquidity events in this calendar year.

In addition to that, we've seen very strong performance in our online portfolio companies, ten of which have successfully raised additional rounds of equity capital during the 2007, or I should say year-to-date in 2007, those companies that generally raise capital at higher valuations allowing us to record increase in unrealized appreciation in our portfolio and our warrant holdings today.

Now, let me talk about the market conditions. As I alluded to at the beginning of my comments, we are seeing greater volatility in the financial services sectors today. Again, I'd like to remind everybody that Hercules has no exposure to the subprime market, the LBO market and the middle market in general.

Our focus remains within the venture capital marketplace. We're working with high-growth technology and life sciences companies, which continue to receive and experience strong capital investment activities for the venture capitalists, which make up the underlying source of repayments for loans.

Within the venture capital marketplace itself, in the first half of 2007, $14.5 billion were invested by the venture capitalists, putting them at a run rate to see a $28 billion investment rate versus $26 billion invested in 2006. This continued support for technology and life sciences companies is indicative of the investment opportunities that we see in the marketplace today and our growing pipeline, giving us visibility for Q3, Q4 and beyond.

Next, let me provide some color on the liquidity within the venture marketplace and venture capital backed technology and life sciences companies, specifically within the M&A and the IPO activity, which continued to be very strong in the second quarter of 2007. The most important trend we've seen this year is the IPO market for technology companies starting to open up.

According to the National Venture Capital Association, or the NVCA, there are approximately 26 IPOs raising over $4 billion in the second quarter alone, a 112% increase over the same period last year. Of the 26 IPOs completed in the second quarter, 13 of those were in the technology sector and 11 were in the life sciences sector. We believe this trend implies an IPO market that should continue to be strong for the remainder of 2007 and 2008, affording us the capabilities to begin to recognize realized gains for our portfolio of warrants in the coming quarters.

The venture capital marketplace activity also was strong, albeit slightly lower than that of the first quarter with approximately 67 transactions being completed for total M&A value, or [mandatory] acquisition value of 7. -- $2.7 billion, this according to Thomson Financial and the NVCA.

We view our growing warrant portfolio as a representative example or sample of the venture capital world. Our warrant portfolio represents the potential for high multiple returns that exist within the venture capital community that we can harvest over time with limited downside to our investors.

Looking ahead to the third quarter, I want to remind our shareholders that this period is generally the lightest in terms of originating and investment activities while the fourth quarter is seasonally stronger.

Overall, I am very proud of our team's performance and contributions so far this year. I believe that we are well positioned to deliver long-term value to our shareholders with $390 million of permanent capital on our balance sheet coupled with our credit lines with Deutsche Bank and Citibank and that of the SBA have positioned us to make investments for the next four to five quarters without having to go to the public markets.

Our success has come from our ability to continue to build our relationships and our brand within the venture capital industry, affording new relationships within the venture capital industry and selectively in the private equity industry as well. And we continue to have a very strong pipeline because of relation with the venture capitalists giving us very good visibility for the next two to three quarters out.

Now, I'd like to turn the call over to David Lund, our CFO.

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 second quarter of 2007. We closed record commitments and fundings and achieved net investment income of $0.29 per share. Fundings for the quarter were $100 million, which represents a 205% increase over the comparable quarter in 2006 with $33 million in fundings.

Now, I will provide some of the income statement details on the quarter. To begin, total investment income increased to $13.3 million, a 96% increase over the second quarter of 2006 investment income of $6.8 million.

Two primary factors contributed to the growth of our investment income. First, our investment portfolio at fair value grew to $417 million compared to $194 million at the end of the second quarter of 2006, representing a 115% increase year-over-year.

The second factor is the higher amount of fee income generated from the quarter as a result of early repayments from portfolio companies that were acquired during the quarter. Fee income during the quarter was $1.5 million as compared to approximately $612,000 in the second quarter of 2006. Of the current-quarter fee income, approximately $782,000 was attributable to early repayments.

We continued to achieve solid deals on our portfolio investments in the quarter while maintaining credit quality. The weighted average yield to maturity on the company's loan portfolio was 12.75% as of June 30th, 2007.

Interest expense and loan fees were approximately $2 million for the second quarter of 2007 as compared to $1.6 million in the second quarter of 2006. The increase was due to higher average debt balance outstanding of $108 million during the second quarter compared to $76 million in the comparable period last year. This was offset by a lower average interest rate in the current quarter.

Operating expenses for the quarter, excluding interest expense and loan fees, were $4 million, and increase of 50% over $2.7 million during the same period last year. This increase is primarily attributed to increased general and administrative expenses due to legal fees associated with two workouts, which we anticipate to recover in the third quarter as well as our growth associated with increased headcount and expansion of our office facilities in Boston, Boulder, Chicago, Southern California and Palo Alto.

Net investment income for the quarter before taxes increased to $7.2 million or $0.29 per share, based on 25.2 million basic shares outstanding. This is compared to $2.5 million or $0.19 per share in the second quarter of 2006, based on 12.9 million shares outstanding, representing an increase of 39%. This increase in net investment income reflects the improvement in our operating efficiency and increase on leverage during the quarter.

We also had a net realized loss of $336,000 in the second quarter of 2007. This loss was attributed to the realized loss in a warrant in two portfolio companies, one of which was sold and the other, which was liquidated.

Net unrealized gain on investments in the second quarter was $1.4 million compared with an unrealized loss of $1.5 million in the second quarter of 2006. This unrealized loss in the second quarter of 2006 was due to the conversion of an unrealized gain to a realized gain, primarily attributed to one portfolio company while the net unrealized gain in 2007 was primarily a result of increased valuations of our warrant and equity portfolio in public and private companies.

I'd like now to briefly address credit quality. We continued our high credit standards during the quarter. The weighted average loan grade of our portfolio maintained a rating of 2.6 -- 2.16, even as we grew the portfolio during the quarter. As a reminder, most of our portfolio companies are dependent on future rounds of venture capital investment.

During the quarter, one previously rated [poor] credit sold its intellectual property and fixed assets, allowing us a full recovery of principal during the quarter. A second company has already repaid a portion of its original principal, and we expect to receive the balance in full in the third quarter.

In both situations, our team demonstrated its ability to effectively manage workout credit to a positive outcome. Also, as we had identified in our earnings release today, we continue to diversity our investment portfolio, which mitigates investment risk in any single industry sub-sector.

As Manuel mentioned earlier, we distributed our seventh consecutive dividend during the quarter of $0.30 per share, bringing total dividends paid to our shareholders of $1.82 per share since our IPO in June of 2005.

Now turning to the balance sheet, at June 30, 2007, we had approximately $7.5 million in cash and cash equivalents. This balance is considerably lower than the $41 million on the balance sheet at the end of the first quarter. As we mentioned during the first quarter earnings call, we carried a higher cash balance than we would normally do -- hold due to fundings that were delayed into the early part of April.

During the quarter, we made net borrowings and repayments of $91 million under our credit facility, bringing the debt balance under the facility to $21.7 million at June 30, 2007. By adding Deutsche Bank to our lending syndicate, we increase our borrowing capacity by $100 million to a total of $250 million on this facility.

In addition, we borrowed $12 million under the FBA program and recently received approval to draw up to the full $127 million currently available under the program. To date, these credit facilities allow access to $377 million of which we have already $34 million outstanding.

As Manuel mentioned earlier, we believe our recent capital raise combined with our existing credit facilities will enable us to fund new and existing investments for four to five quarters out.

Finally, our Board of Directors has approved a dividend of $0.30 per share that will be payable on September 19th, 2007, for shareholders of record on August 16th, 2007. This will be our eight consecutive quarterly dividend bringing total dividends declared to $2.13 per share since our IPO in June of 2005.

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

Thank you.

(OPERATOR INSTRUCTIONS).

And your first question comes from the line of John Hecht with JMP Securities. You may proceed.

Good afternoon, guys. Congratulations on a great quarter.

Thanks, John.

Manuel, I'm wondering if you could comment on the sectors' heightened venture capital activity and of those, which are particularly interesting to you from an investment perspective? And then beyond that, if you comment on the Market Bridges partnership in Israel and what type of activity you're seeing out of that region?

Sure. Let me first start with your first part of your question with the venture capital in venture capital marketplace activities. As I'm sure aware of and many of the investment banks on this call are probably aware of, the technology sector is now beginning to see some very promising exits in the marketplace today, PLAYLOGIC and others who have gone out, seen some very nice run-up in their stocks. We're very optimistic that the technology IPO market and specifically, the investors seem to be looking for appetite of growth stocks. And I think the technology portfolio is well positioned for that.

So, within the technology sector, we're seeing things in the area of semiconductors, communications, authentication software to the very interesting areas of continued investment. What is commonly known as Web 2.0 continues to be an interesting area with the whole movement within Google, MySpace and others out there. There seems to be a lot of demand for that area, so we're seeing good investment activities continuing to be invested by the venture capitalists in those markets.

In terms of emerging markets, we're seeing obviously Cleantech continues to be a very area that's hotly pursued by the venture capitalists today. And that ranges things from biodiesel to ethanol plays to hydrogen plays to fuel cells, and we're seeing a very robust investment activity in that sub-sector as well.

In terms of the life sciences side where our portfolio also has exposure to, we're seeing continued robust M&A activities and liquidity event with acquisitions going on quite strong in the life sciences areas. And I think that's -- that continues to hold promise in the future to come as well. But, we -- we're really seeing a lot of very promising activities in the technology side where I think we're very well positioned with over 50% plus of our portfolio positioned in the technology sector itself.

In terms of our Israeli expansion interest, as we did in the first quarter by opening offices in Southern California, we are beginning to embark on our strategic growth efforts over the next five years, which includes initiatives of expanding our operations into Israel and internationally, meaning London as well. So, we think London and Israel are very interesting areas.

I just came back from Israel, visiting many Israel companies while I was there and also their partnership with Market Bridges. And we just remind our investors, we actually had one of our companies, Omrix, which is an Israeli company, which I believe in 2006, was viewed as the fastest growing biotechnology company on the NASDAQ in 2006, that was an Israeli company, and we have one or two additional exposure to Israel.

So we're -- we remain very optimistic that the Israeli market is a very interesting growth area for us to pursue as well to expand into our five and seven-year growth plans here.

Okay, I appreciate the color. You guys had a small pickup over last quarter in yields. And when comparing it with last year, it was a bigger pickup. I'm wondering how much of that might be associated with prepayment fees, et cetera, and how much is related to actual increases in coupon rates out in the marketplace.

Well, there's two folds to that issue. When we disclose the so-called yields of maturity, the prepayment concept doesn't really affect it. The effective interest rate when you calculate that in our P&L, that actually has gone up quite a bit. And that was, in fact, affected by the prepayments of approximately $700,000 or so. I think the -- well, prepayments and acceleration of OID contributed about $700,000.

But, the answer to your specific question, the yields of maturity clipped up here by a couple of basis points, primarily because of our holding onto the interest rates. And we really -- as a testimony to our team here, we actually had a record growth of $140 million in new commitments while maintaining both credit disciplines and pricing discipline. We frankly feel that's indicative of what the competitive landscape is there that we are continuing to grow our brand and our franchise. And our relation with the venture capital community continues to be very strong as a source of deal flow.

So, it's really a testimony to the team's ability to hold to pricing and our growing awareness and presence in the marketplace that allows us to maintain that underwriting discipline.

Okay. And last question is, I believe your SBA facility you -- once you started drawing down, you fixed pricing off of the ten-year part of the curve. It's -- now that you're actually drawing on it, has that taken place? And can you tell me what the cost we should assume on that facility?

So John, the -- when we do draw downs, you're fixed every six months, so every September and May. So, if we draw during this period of time, it'll be fixed at December, the time. And then, if we draw in the following six months, it'll be fixed at the May meeting at that time. So, it's fixed every six months.

And the rate, John, is -- ten-year treasuries I think today, is at 475 or 477. I haven't looked at it since I started the call this morning.

Yes.

Plus a spread of about 180.

Right. And right now, our -- currently, our facility is about LIBOR plus 0.30 until they actually fix the rate in September.

Okay. Thanks very much, guys.

John, one more thing as a reminder, once we draw down the SBA, it's ten-year permanent capital. So, we have locked-in cost of funds at that rate with no necessarily interest volatility on that fixed capital.

Okay. I appreciate the detail, thanks.

Thanks, John.

And your next question is from the line of Henry Coffey of Ferris Baker Watts. You may proceed.

Good afternoon everyone, obviously great quarter. We're very excited to see this much going on. Just to rehash a couple of things real quickly, you're SBA data, you said was 460 plus 180 spread plus 180 spread plus fees? Or, is that the net cost to you all?

No, no. If you look at -- and a very -- take a step backwards. When we have our commitments to the government, the SBA, we actually pay approximately a 1% commitment fee on the entire amounts that's amortized over the life of the loan.

Yes.

For GAAP purposes in ten years, for example

Right.

So, the 1% fees amortized over the life of that -- the term of that loan. Once we then draw capital and it's fixed, it is fixed off ten-year treasuries, which is today I think approximately 475, 477 plus about a 180 or so spread.

Yes.

On top of that, so you're looking at effectively 6.5 or so rate.

And there's a 1% fee when you actually draw the funds as well. There's one on the commitment and one on the effective -

So, what is the all-in cost? What would the all-in cost look like in today's market just for (inaudible)?

Well, you're taking basically two points, amortizing over a ten-year period of time.

Right.

So, that will probably -- I don't know. I don't have a calculator in front of me. It'll probably add ten [bps] on it.

Right. So, it's like 7.50 to eight, depending on when you --?

No, that's high.

It's high.

It's too high?

Yes. I think the effective rate, you're probably looking at a -- under seven I guess.

Yes.

I would say.

Okay.

Let me get that -- we can get that for you. I don't have it in front of me. We can --.

And then, the borrowing cost on your current facility is L+ --?

120.

120?

Floating.

Next question, you did mention you had two loans in workouts, one which was successfully liquidated this quarter and the other, which is in essence pending liquidation sort of as we speak during the summer quarter?

It's actually more certain than that. It's not a question of if. It's a question of only when. And that when is expected to occur sometime in the next three to four weeks. And it's pretty much -- it -- there's -- nothing in life's a done deal. This is certainly --

Yes, of course.

We've certainly tried to do that. We've gotten the bankruptcy court in Canada has rendered the, I guess, the appropriate things to get completed. So it's on auto-pilot to close in the next two -- next 3 to 4 weeks. And if that occurs the way, as we expected, it'll be a full recovery of all our expenses and fees on that deal as well.

And then you would have no non-accruals at that point?

That is correct.

And then David, what -- you said that you would be recovering on legal fees. Can you give us some sense of what sort of extraordinary legal fees you might have seen in the current quarter?

Well we look at some work out fees as well as legal fees and so on deals to the tune of about $470,000. And not all that will be recovered, but we expect several hundred thousand, anywhere from 2 to $300,000 to be recovered in this following period.

Alright. Thank you very much. Great quarter.

Thanks Henry.

Your next question from the line of Bob Napoli with Jaffray. Go ahead.

Good afternoon. Reiterate what Henry just said, nice job, nice trends. On the fee income lines, just trying to understand if you had 780,000, I think you said of pre-payment penalty fees?

There were prepayment fees that we had charged as a result of the loan agreements and then there was some acceleration of the original issue discount and so on that gets amortized. So yes, the 7 -- about $782,000 in fees that were collected or accelerated as a result of the acquisition.

Okay. Now I guess I mean that's going to be a lump -- is the -- should I view the rest of that as kind of the smooth piece of the fee income?

Yes, because that's -- the other part is the normal amortization of fee income that we take in over the course of time. And then the acceleration and one-time fees and things of that nature, as you can appreciate, are lumpy depending upon the transactions that happen in any given quarter.

Okay. And as far as -- I mean, spreads have widened dramatically in the market for, as you know, for all different types of debt and in response to that lenders are raising rates and sometimes in some cases significantly. While you are not, with your, first of all you're leveraging your borrowing very little and you have committed facilities at certain rates, so you're not -- those securitizations, you're not affected by the spread widening. I was just wondering if maybe this environment is giving you an opportunity to bump up your yields or the amount of equity that you take. Were you able to -- do you have any pricing power in this environment that you could take advantage of?

Well I wouldn't mind it really again. Because of our -- we operate and live within the confines of the venture capital community, the venture capital community as a whole tends to be much lagging than the overall public capital markets in terms of rate adjustments if you will. Because they have a longer term horizon of how they view things.

That said, I think that you can take comfort in the statement that we had a record quarter of $140 million of commitments and you saw yields actually stay basically the same, not slightly go up.

We are certainly seeing defense in different sub-sectors, by the way, because I believe the statement also requires you to put a little finer point on it because life science technologies are slightly different due to pricing and structure and then also stages of development. The companies at early stage, expansion stage and advantaged stage are all experiencing different levels of either competition or pricing. That said, we are certainly holding very strong on our pricing and credit terms and it is not increasing some of those in the preceding quarter or so.

Okay. I'm sorry, I missed the very beginning where you talked about your pipeline. I was just hoping you could kind of reiterate a couple of the statistics?

In terms of the venture capital industry, in terms of, in terms of -?

Your own pipeline.

Sure. So today, excuse me, as of June 30, we ended the quarter with $111 million of unfunded commitments and behind that we had approximately $48 million of signed term sheets. Clearly that number has actually gone up since the June 30 time period. That is important because in essence we have very strong visibility into fundings that will occur in the next two quarters, being Q3 and Q4, but also getting strong disability in the early part of Q3 in terms of having to sign term sheets of the $48 million into the quarter itself.

However, we believe that the third quarter will start experiencing the expected seasonality or seasoning of a slower period of time that we sort of have seen in the venture industry this year with vacations and having the weather we're having. I think you'll see a lot more companies, a lot more bench capital firms, embarking on vacations during this period of time, which means when the venture capitalists are out, the ability to hold Board meetings and approve debt financings generally gets deferred until the September period of time.

Okay. And what were the unfunded commitments in the signed term sheets at March 31st.

At March 31st we had approximately give me a sec here to get you that number. Let's see here. We had approximately 106 -- we had, sorry, we had unfunded commitments of, it's a different number, this is the signed term sheets.

I -- you can give it to me later.

Okay. Sorry, Bob, I didn't have that at my fingertips here. Actually, the unfunded commitments? We'll get them to you. Sorry, Bob.

Okay. And then just last question, within the investments that you have are -- currently are you aware of -- I mean, what are the hotter segments of -- where you already have made investments and are you expecting several more IPOs given the ramp up this year? Are you aware of several of your companies that have not yet gone for IPOs that are moving in that direction or?

I think that it's safe to say that we're very much aware of numerous companies in our portfolio that are either engaging in or interviewing investment banks to go public. We are also aware, as we alluded to in the press release, a handful of companies that are engaged in MA discussions right now that as I'm sure you know as well as I do, not all of them do close. But we certainly still believe confidently that the 10 to 12 expected events calendar '07 should occur.

On specifically we're very optimistic on some of our more mature companies that will achieving liquidity events in the consumer services area, in the consumer electronics areas, in others, all technology driven in essence.

Okay. And just last question, any update on the competitive environment?

No, the answer is we saw some competition kind of creeping in, in the beginning of the second quarter. We saw some new players coming into the space, doing a little bit of what I would call sloppy underwriting. And I think the wonderful thing about the most recent turbulence in the financial markets is that these edge players who are thinking about coming into the space and who are not well funded, who are most likely having their financings curtailed and the industry will restabilize again. I think that we're certainly seeing the ability to start stabilizing pricing if not modestly increase pricing over the next quarter or so. But I think that the benefit of the most recent shake out in the financial services sector really bodes well for our business because we now have the capability to draw upon $500 million of capital for the next four to five quarters. Really giving us a strong balance sheet in order to build a portfolio while others may not have the ability to do that.

Great. Thank you.

Bob, just to get back to your earlier question, at the end of the first quarter, we had 70 -- roughly $75 million of unfunded commitments and $142 million of binding term sheets that were across us.

Great. Thank you.

And your next question is from the line of Douglas Harter with Credit Suisse. Go ahead.

Sure. Thanks. Manuel, I was wondering if you talk about the sort of the capacity that your current team has to continue to grow originations versus sort of the need to sort of add originators?

Sure. Nice having you on the call, Doug. And the answer to your question is the following, as we said all along, the best way to kind of dial into operating metrics is, for our business, is that originator stage and industry diagnostics for this discussion is you assume a 25 to $35 million of originating capacity in the first calendar year. And the second calendar year gives you between 35 and $45 million and the third calendar year they do between 45 and $55 million. We currently have approximately, I believe, it's 11 originators on the team at various levels of seasoning and so simply extrapolate 11 individuals on an average say of say $30 million to make the math easy, that's $330 million of capacity. Or if you assume a $40 million average, you have $440 million of capacity.

That said, it is absolutely true with the expansion into Southern California, which does approximately $4 billion a year in new investment activities, we have no physical presence in terms of originating capacity in Southern California. So we are actively looking to extend our reach to the Southern California market with 1 or 2 additional originators in that marketplace to give us a better presence there, to take advantage of the market opportunities that we see there.

And in terms of internationally, Israel, we're treading a little more cautious there and going with our partner and market bridges where we have a relationship with market bridges as a source of deal flow. And as I said at the beginning of my comments, I just came back from Israel and really see a very good growth opportunity for us in Israel.

That said, the marketplace may represent 25 to $100 million a year in investment activity as it matures over the next 2 to 3 years as we establish a relationship further. And then of course we're looking to expand selectively into other international markets such as either Canada and/or London as we also grow the business.

So today we have a capacity I feel comfortable about, $440 million in -- 400 to $450 million of originating capacity today. As we add additional talent, that capability will probably rise to the 5 to $600 million level as we go into calendar '08.

And if you could sort of, along those lines, could you talk sort of about your capacity especially as you're adding new geographies for you to sort of be able to sort of be the final approver in all of this?

I want to be clear. I'm not the arbiter or approver. We have an investors committee that's staffed by our CFO, David Lund, our Chief Legal Officer and Co-Founder, Scott Harvey, our Chief Credit Officer, James Crumpton and myself as the CEO of the organization. That requires a unanimous credit approval process. And frankly, I think the testimony of that committee and the integrity of that committee is quite important because that committee has - has, is overseeing the originations essentially of over $700 million in credit facilities. And I think the last time I checked, the gross loss, pre-any realized gains is approximately $5 million in a gross basis and on a net basis it's slightly $1 million, slightly above $1 million on a net basis. So that committee has done a spectacular job of being, for lack of a better word, hawkish on its credit stance and really focusing on credit and mitigating risk as we scale the portfolio. So I think that committee has a lot more bandwidth to scale the operation.

And I'd like to remind you as well, that we have -- although we don't talk about this a lot publicly I think we probably should as we progress. We have very sophisticated internal systems that we've designed that we'll probably brand here very shortly from a technological point of view. That allows us to scale the business, it allows us to have incredible visibility into all facets of our portfolio from credit monitoring [audio gap]. So that helps us scale the business.

And Doug, just to be also clear, the investment committee does in fact approve all deals, whether they're U.S. based or international.

Okay. And then sort of just one numbers question for you, David. Last quarter you gave us the average investment portfolio. I was wondering if you had that?

Let me see if I've got that here for you. It's going to be probably right around 370, but let met see if I've got it. If I don't, I'll get right back with you, Doug.

Thank, David.

I don't have it at my fingertips, I will have it for you shortly though.

Your next question comes from the line of Jed Bonnem with Cadmus. Go right ahead.

Hi guys. How are you?

Hi, Jed. How are you?

I'm good. I'm just trying to make sure I understand what will happen when you deploy the remaining $343 million of capital? Does that mean your portfolio will be roughly a $700 million portfolio at that point? Is that correct?

Well the investment, from a similar revenue point of view, that is correct. But right now, we're experiencing probably with prepayments and normal amortization run off anywhere between 25 to $35 million a quarter is expected to be kind of the natural run off that we are putting into the model. And you're seeing us, I guess, on a run rate, we're funding approximately, on a net basis, probably $70 million on a net funded basis and a quarter rate, run rate.

So your 320 or so, you're talking about, will take us probably four quarters out so that's 320, it's $320 million of fundings and we're at 470 today. So that gives you close to $700 million in the portfolio. So you're not off on a 12-month basis.

Okay. And at that point, how much will be -- you talked about amortizations and pay downs. How much will be amortizing yearly at that point? Is it roughly a third, is that the simple way to think of it?

No, because you have to remember we have various -- depending again, depending on the sector, and depending on the stage of the company then, we have interest only periods that can range from three months to as high as, I would say, 15 months on more mature and more stable companies. And so the principle run off, as it is today, we're running about 25 to 35 million a quarter. So you're looking at say $100 million, $120 million a year would be the expected principle run off on an annual basis.

Great. But once you reach 700 million, would it be about a third of that, which I guess would be about 220, 230?

It's about --.

That sounds about right doesn't it?

Well the answer -- from a simple arithmetic point of view, it does sound right. The issue is, depending on the maturity on when the companies originated. Because if that -- say for example, $400 million of that was put on the books six months prior to the $700 million milestone and you still have another 3 to 6 months of interest only to run off, we -- the principle amortization would be a lot less than that.

Okay. Now getting to the real question, which is when you reach that state, when you have about 700 million of loans on your books and you're experiencing that type of run off, what -- how much bigger will your cost structure be? This is kind of an adjunct to the previous question that was asked. But how much bigger does your cost structure have to be to support that type of loan book?

I don't believe it will be significantly greater than it is today. We are very big on automation of systems. I -- we have, as you probably have heard me talking about in terms of the [passage] I just alluded to now, we rely heavily upon proprietary management systems that we've designed internally to give us all facets of deal origination and portfolio monitoring and management that we have today, which in essence, takes the place of a significant amount of human labor if you will by using an automated system.

The real, if you just look at capacity, we'll certainly be adding additional administrative functions in our operation groups in accounting and finance and probably official paralegal. In terms of the origination side, as I indicated already, we're probably looking to hire 2 or 3 additional people. As we turn into calendar '08 from the originating capacity, but I don't think there'll be significantly more than there is today.

Okay. And sorry to belabor this whole thing, but the -- I'm just trying to calculate what type of earnings you will generate when you get there. So if you -- assuming you get finance fees the rest of your investment capacity, so the additional 340 million, then you're earning, let's say 12.5% once the 6.5% funding rate on three. So, that's about 20 to 21 million of net interest income and let's say there's an extra 2 million of expenses against that. That's 18 million of income divided by 25 million shares. So it's another $0.75 roughly on top of your current earnings base. Do you guys do that sort of math? Does that sound roughly correct?

Well the response to your question, we certainly do that kind of math and we certainly are looking at both our '07 numbers and budgets and '08 forecasts, which we are currently working on for our Board. But as a reminder, we don't display from our guidance and get into specifics in terms of the visibility of forecasting. But the only thing I would say from your high-level assumptions are that when you took the 6% cost of capital, you forgot to do a leverage component. So you have to make sure you don't take the 6% cost of capital, which is slightly higher than that on a leveraged basis, which means you're only taking a 3% leveraged charge on it.

Oh, right. Because you -- on the equity funded portion, you get the higher --

That's correct. So, on a high level, that's one of the things -- I'm not necessarily rendering an opinion on your math, but that's some of the things I heard in your logic that I think that would just point to.

Okay. Directionally I'm correct, but I then need to gross it up by the equity funded, the fact that you do not debt finance the entire portfolio.

Again, without -- I'm not necessarily rendering an opinion on your numbers. I think that the logic that you're pursuing certainly sounds sound.

Okay. Great. Thank you guys.

Your next question is from the line of Greg Mason with A.G. Edwards. Go ahead.

Hi. Good afternoon guys. Nice quarter. Can you talk about, again, kind of distinctions between the VC market and the middle market? You said the VC market was a little bit of a laggard and the financial shakeout has driven out some of the competition. So is there some connection between the credit concerns, the liquidity concerns we're seeing in the middle market that could eventually have an impact on the VC market?

Well I'm not too partial to your words, I don't think you -- I don't think I said that. I think that the venture capital market is certainly never a laggard to the private equity market. I think that you probably offend half of the venture capital community by making that connection. And the reason being is very simple. The private equity market -- or excuse me, the buy-out market and the middle market is really a market that is predicated upon leverage. And that leverage is generally a factor on the amount of EBITDA a company is producing and what the market will bear for a multiple on a purchase price being in today's day and age, in between 7 to 9 times EBITDA on a leveraged buy out. And you have to go into the credit components of that, which is you still -- you divide it into your senior strip in the middle market anywhere between I guess conservatively, 2 to 4 times senior turn of EBITDA with the sub-debt players sometimes going as high as 10 times on the sub-debt play.

Because the investment capital marketplace is a highly specialized practice and these companies are in high growth mode, there is no EBITDA. So the frothiness that you're seeing in terms of leveraging on the middle market space has certainly not seen or anticipating ever seen in the venture capital marketplace. It's a market that's driven primarily and almost exclusively by equity investments with a long-term investment horizon of generally, if you look at the data that just came out, most companies are now achieving liquidity events in terms of IPO or M&A until they approach their six years of maturity. So it's a good market in the sense that you don't see this rush to quick turn and flip a company out. It's a much more methodical, much more disciplined market. And in terms of the numbers, we kind of contrast a little bit the statement. The last time I checked, according to a source called Deal Logic, the middle market buy-out world received somewhere in the order of $582 billion of capital and the venture capital marketplace during the same period of time in 2007 was $14.5 billion.

So there's a long way to go, to use a golfing metaphor, that's a hell of a long putt to get from here to there. So the venture capital marketplace and really defending the venture capital industry, is going through a very controlled and managed growth, which is very good because you're seeing that both in the discipline of LP dollars flowing into it, but also you're seeing it with the controlled liquidity exit that's going on today. So it is not really driven by any frothiness on exit that we're not seeing in 2000 time frame where you had 2 to 300 IPOs going on a year and you're not seeing this incredibly out of control M&A market. It is both a controlled exit in liquidity on technology and the IPO side and a very controlled liquidity on the M&A side. And that I think really bodes well for our sector and our industry.

The other element I would like to remind everybody is because of the sector that we operate in. It's a highly specialized industry practice. So the area or the sector is very difficult to really build an organization because it's really something that is a highly specialized practice for the team. Hercules has, I believe, one of the best teams in the industry. It's a very, disciplined team at that. And that team is highly seasoned and experienced and cohesive that allows us -- the team to build the traction and the branding that we have in the marketplace, giving us the ability to have a record quarter of $140 million of commitments while maintaining pricing discipline and more importantly credit discipline during that period of time.

Okay. Great. And just talked kind of in the past that the capital raise in the VC market has been historically pretty strong recently. Can you talk about if we're seeing that being methodically put to work, what is the potential for the market to start getting too accelerated because of these VC raises or that these VC capital -- this kind of dries up and gets scared? What are those two possibilities?

Well I think the expression that's used historically in the media quite a bit is called the so-called capital overhang. It's based on terminology by which defines the amount of new capital that the venture industry may have at its fingertips. For example, the venture industry is deploying 25 or $20 billion a year. And the venture industry last time I checked has raised about 75 to $80 million of new capital in recent funds. That would indicate that it has an investment cycle of the next three years to deploy that capital. And so that's one of the ways that you look at the health of the industry. You don't have a 5 year, 6 year capital overhang to deploy the capital. And that's an important, I guess, metric to the health of the business.

The industry is growing in a very controlled way, not overinvesting into funds. It is dispersing capital to companies very selectively. But also it's dispersing capital in broad industry stages and sectors and I think that it's a much better controlled environment than we saw in 2000 and certainly since '99. And if you may recall, the '99 and 2000 time frame was primarily driven by a very frothy technology market, driven by the Internet companies, followed by the communications companies later on in that cycle. We have no evidence of that today because we have a very controlled, not out-of-hand, technology IPO market with only 26 IPOs happening in the first quarter.

Great. And then can you give us a little more historical perspective? If we were to go into a recession, how has that historically impacted the VC market?

Well I think there's two things in the recession we had talked about. One, a recession in this business would be something that I would find hard to accept because if you look, most recently, I think it was the U.S. Commerce data on capital expenditures by corporation, I think that you're starting to see an expenditure on technology by Corporate America, especially as it begins to deploy or migrate its existing legacy desktop systems, for example, the Vista. Or the advent and the strong initiative by organizations such as Google and others out there, Sun as well, who are mitigating that their server forms, starting using less energy less power. In order to do that, you need new technologies to design new semiconductors that use less energy or more efficient use of server systems out there that are running at higher capacities with less energy.

And so that alone, as a new wave of technology, will really spawn that. We're seeing technology bell weathers such Cisco and Sun for example having very strong quarters as well. So I think that you're seeing a recession in technology, I still see in the near term, and maybe I'm wrong, but I certainly do not expect, nor am I anticipating, any real technology recession. In fact, if anything, I'm seeing a very strong venture capital marketplace that I would almost characterize as either 1995 or 1997 in terms of its evolution or cycle again.

Okay. And just I guess for our knowledge, if the recession were to happen, even though it's not likely, how has that impacted the VC market in terms of capital raising, assets put to work and your ability to exit?

Clearly, I can't speculate what can happen in the future. I can certainly share with you some of the experience that we saw in the past, if you will.

That would be great.

What we've seen in the past is that the venture industry basically curtailed itself or contracted from 100 -- $90 billion a year in capital deployment too. I believe last time I checked was 1993 -- I'm sorry, 2003, when it kind of hit the floor of $20 billion and has steadily risen since 2003 up to the $28 billion or $27 billion run rate that we're at today. So I don't think that the venture industry is one that would dramatically pull back from a recession point of view. I think that if you see a recession take place, you'll probably see the industry sustain itself at the 22 to $25 billion invested run rate. It will not disappear. And that's the wonderful thing about the venture capital industry that it primarily looks towards exits occurring in terms of the IPO and M&A as its driver rather than broader economic activities.

Great. Very, helpful color. Taking a look at your portfolio, can you talk about the increase of grade three assets by 15 million and is this just because some of the investments are approaching funding or is it fundamental factors there?

As we said all along, it's important to note that the vast majority of our portfolio is highly dependent upon the next round of financing as a source of repayment. And as -- and that generally -- our portfolio will generally cycle through every 9 to 14 month cycle, all of our companies -- or I should say the vast majority of our companies swill require a new round of equity financing in order to continue to sustain itself.

We are now approaching a level in our portfolio companies that the natural process of the next round of financing is taking place. Because until that round of financing has occurred, we will naturally and automatically downgrade those portfolio companies, given the looming next equity round of close that until we close that equity round, we want to signal to our investors that we're closely monitoring those portfolio companies as it approaches the next round of financing.

As a reminder however, that so far in calendar '07 through June we've had now 9 or 10 of our companies have now closed subsequent rounds of equity financing. And so I believe the next tier of rated three companies that we see, we'll certainly see I think another 3 to 5 are in the middle of closing rounds of financings that are coming up right now. So that is why they have naturally been degraded that way.

Thank you. And in terms of long-term planning into London and Israel, any timing on when you expect to move into those markets?

No. There is no rush to move to any of those markets. I think that we, as everything we do, we tend to take a much more controlled view about it. I think that we've gone now on a couple of exploratory meetings and trips to build London and Israel. I think that we remain very interested in expanding to those markets. But does it occur in the next quarter, no. I think it's something that our Board has asked us to continue to expand our franchise and operations. So I think that you'll see us expanding to those markets over the next, honestly, 2 to 8 quarters.

I'm not honestly a big fan of moving to London right now in terms of operations at the pound sterling being 2 to 1 against the dollar. So that's pretty expensive market to go after right now.

Great. Thank you guys.

Okay.

Okay. Thank you Operator and thank you everyone for your continued interest and support in Hercules Technology Growth Capital. If you want to arrange a meeting or have additional questions, please contact David Lund our CFO or myself at 650-289-3060 and again thank you very much for being our shareholders and thank you for being part of the Hercules Technology story. Thank you.

Thank you for your participation in today's conference, ladies and gentlemen. This does conclude the presentation and you may now disconnect. Have a great day.