Hercules Capital Inc (HTGC) 2007 Q4 法說會逐字稿

Good afternoon and welcome to the Hercules Technology Growth Capital fourth-quarter and fiscal 2007 year-end 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 would like to remind everyone that this 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. And not I'd like to turn the call over to Ms. [Dede Schue], Investor Relations Counsel to Hercules. Please go ahead.

Dede Schue Thank you and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules' Co-Founder, Chairman and CEO; David Lund, CFO. Our fourth-quarter 2007 financial results were released just after today's market close. They can be accessed from the Company's website at www.HerculesTech.coms or HTGC.com. We've arranged for a taped replay of today's call which will be available through our website or by using the telephone numbers and pass code provided in today's earnings release.

I would like to call your attention to the Safe Harbor disclosure in our earnings 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 take any obligations to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit SEC.gov or visit our website at HerculesTech.com. I would now like to turn the call over to Manuel Henriquez, Hercules' Founder, Chairman and CEO. Manuel?

Thank you, Dede. Good afternoon and thank you, everybody, for joining us today. At this point most of you have already seen or are reviewing our most recent earnings report that we've issued this afternoon along with our dividend announcement.

On today's call I'd like to discuss a couple key items, specifically our achievements during the quarter, our strong liquidity position, our continued solid credit performance and the state of the venture capital marketplace which we operate. In addition to that, I'd also like to talk about Hercules' unique position within the BDC marketplace as it's a specialized investor rather than being a broad middle market general investor, and of course speak to the direction of Hercules in 2008 and some of our objectives that we are planning on for 2008. After that I'll be happy to answer any questions.

Now let's talk about the fantastic quarter we just achieved. I'm very pleased and very happy to report to our shareholders that we posted yet another quarter of record-breaking financial and operations performance due to the continuous hard work of our team and the growing awareness and brand of Hercules Technology in the marketplace.

Unlike other BDCs, we remain and continue to be very focused in the venture capital marketplace, primarily working with and investing in high-growth technology and life sciences companies. This affords us the ability to continue to see very robust deal flow unlike some of our other existing BDC players in the marketplace. Before I start however, I'd like to remind everybody on what Hercules does not invest in or does not have exposure to.

For example, Hercules does not have subprime exposure. Hercules has no real estate exposure. Nor do we have consumer debt exposure and we do not invest or provide capital to highly leveraged middle market buyout transactions. Most of these are what is currently in the media and experiencing difficult credit environment, none of which our portfolio of companies are experiencing today. We do on the other hand work very exclusively with the venture capital industry and the venture capital industry continues to exhibit very strong growth of which I'll elaborate as I continue my discussion.

Now regarding the quarter specifically -- we saw very, very solid and strong revenue growth at the top line and very solid net investment income performance for the quarter and for the year. We continue to see very strong demand for venture debt into venture capital backed technology life sciences companies. This is shown by our originations during the quarter.

We achieved record commitments and fundings during the quarter, closing $198 million of transactions made up of both debt and equity transactions during the quarter, bringing our total inception to date to $960 million of transactions closed since our founding or our first-quarter origination back in October 2004.

A major achievement during the quarter and something we indicated to our investors that was our main objective in 2007 and that was to prove to our investors our capabilities of earning our dividend entirely from net investment income. I am happy to report that in the fourth quarter, for the second consecutive quarter in a row, we earned more than our dividend of $0.30 per share, and in the fourth quarter we earned $0.31 per share in net investment income or for an aggregate of $10 million, hitting our goal for 2007. This represents a 185% increase over the same period last year. This has allowed us to pay our ninth consecutive dividend and declare our 10th consecutive dividend of $0.30 per share.

We continue to build upon the diversity and strength of our investment portfolio. We are constantly and continuously monitoring the distribution of the portfolio by staging the development of our companies as well as industry and some industry or subsector specialty as we continue to diversify our portfolio.

We finished in a very strong balance sheet position with $530 million of investments in our balance sheet and strong visibility in the quarter of $130 million of unfunded commitments giving us visibility into the next one to two quarters out on additional filings that we expect to take place.

Despite the continued drop in the index rates, whether it's LIBOR or the prime rates, we were able to maintain an average yield to maturity of 12.7% during the quarter and, again, this despite over a 200 point drop in LIBOR rates and, correspondingly, a significant drop in the prime rate of which some of our loans index from.

On an effective yield basis, we continue to perform very strongly there as well. We achieved a 13.9% effective yield in our portfolio and this of course is made up of interest income, early prepayment payoffs and accelerations and restructuring fees during the quarter of which David Lund will elaborate further on as we go through the discussion.

Again, we continue to focus on portfolio growth. As you'll see from our numbers of $198 million during the quarter, I can assure you that we could have closed more transactions, but we felt that given our pipeline and visibility into transactions and the continued drop in the environment we became even more selective during the fourth quarter in ensuring that we only invest in some of the top-quality transactions during the quarter.

We also achieved a liquidity. We indicated back to our investors in December 2006 that we expect to see 10 to 12 liquidity events in our portfolio and I'm happy to report that we achieved those goals. We had seven acquisitions completed in 2007 for our portfolio companies; we had three completed IPOs during the year, Sirtris, Power Medical, and Rubicon. We also successfully in the fourth quarter sold off two investments that we had deemed to be troubled investments in the third quarter successfully receiving for repayment of principal on those two transactions as well.

Our warrant portfolio continues to grow as well. We currently have one warrant positions in over 80 countries with a venture size value of approximately $50 million for future outside potential for our investors. As an example of that warrant monetization potential, during the fourth quarter we successfully received the final proceeds from the sale of two of our companies, one of which being Sling Media representing a significant portion of the capital gains.

We had approximately $2.8 million of capital gains in the fourth quarter related to Sling Media and Interwise and a select smaller amount of other investments we successfully sold off. David will also provide more color and depth into the dividend and the special dividend that may be paid out to our shareholders in 2008.

In terms of the venture capital marketplace, I received numerous phone calls and e-mails from various of our investors asking for better clarity into the venture capital marketplace and how does it differ from now to the middle market and the credit crisis that we're currently experiencing in the broader markets of which Hercules has us far been insulated from.

I'm happy to report that according to the Dow Jones venture source, the venture capital community had a record, record year. They successfully invested in $29.9 billion into venture capital backed companies during 2007. We also saw a significant liquidity that happened during 2007 for the venture industry.

The venture industry saw unprecedented liquidity during the quarter of $53 billion from both M&A transactions and IPOs that occurred in the quarter. In the fourth quarter alone we saw over $18 billion of that $53 billion realized during the quarter, $16 billion of which were realized from M&A transactions to 106 venture backed companies and of course $2 billion in liquidity through IPOs to 26 companies during the quarter.

This is very important as we continue to look at the health and vibrancy of the venture community as our primary source of deal flow. I'm also happy to report that the venture community itself experienced also significant growth by having additional capital be received by the venture capital firms to their limited partners to also a record level of $35 billion of new investment community capital to the venture industry.

I'd also like to remind everybody that the venture capital industry is somewhat insulated from the current market occurrences since they generally invest in early stage high-growth companies that generally do not expect to achieve liquidity for five to seven years from the initial date of investments thereby making current market volatilities somewhat a less important issue within the venture capital community.

As I stated earlier, of the IPOs that took place during 2007 Hercules successfully had participation in three of those companies, again through Rubicon, Sirtris and Power Medical. Again, on the M&A side we saw one of the highest levels of M&A activity during the quarter and during the year that we have not seen since back in 2000.

Now liquidity. I've also received numerous questions from investors and e-mails from investors asking for and clarification on our liquidity positions and at which point I will now answer those questions from some of our investors. I am happy to report that Hercules is well-positioned for 2008 with having a leveraged position of only 33% leverage currently today for regulatory capital giving us the potential or access to over $400 million of investable capital during 2008.

I'd also like to point out our balance sheet and our liquidity position. We currently have a committed credit facility from Citibank and Deutsche Bank for $250 million. We also have access to and have been drawing upon our SBIC which gives us access to $127 million. And for those who may not recall, our SBIC leverage is entirely exempted from the BDC test of one to one of which David Lund will further explain as we go into liquidity discussions further.

In addition to our liquidity position we also are receiving in a normal course between $20 million to $25 million of quarterly principal repayment in a normal course of our debt investment because, unlike the vast majority of the BDCs, Hercules generally relies and principally invests in rapidly amortizing 36-month credit facilities, not five-year or seven-year bullets.

This is a crucial differentiation between us and the rest of the BDCs because the pressure to raise capital becomes mitigated by our normal amortization of principal that we expect to receive during the quarter. Said differently, our expected amortization in calendar 2008 will yield an additional $70 million to $80 million of additional principal repayment that we're able to reinvest during the year.

We also have a strong pipeline. We finished the year with a strong pipeline and visibility transactions with over $30 million (inaudible) and again $130 million of unfunded commitments. Let me expand upon our warrant portfolio which is becoming a very vertical and integral part of our business.

Today we hold approximately 82 warrant positions in high-growth technology and life sciences companies. On a fair value basis we carry those warrant positions at approximately $22 million on our balance sheet. On the face value of that, if we were to fully exercise those warrants we would have to invest approximately $50 million to exercise those warrants. As an example of the potential future monetization of those warrants, here are some examples of realized gains that we've had with some of our warrant positions in our portfolio.

Sling Media -- Sling Media translated into an 8.7 times multiple return from our warrant exercised price. [Ockem], one of our oldest investments, had a 5.1 times warrant multiple return. [Inadiana], a female incontinence device company had a 3.6 times warrant multiple returns. And to show also the variability in the warrant, multiple we had Insight Software that was acquired by Business Objects had a 1.2 times warrant multiple.

I would like to caution and remind our investors that our warrant portfolios will not only monetize to 100%. We expect to see generally only a monetization of approximately 50% on our warrant portfolio and the multiples of that can range anywhere between 1 times to 5 times (inaudible) market conditions that we operate under.

Now I would like to talk to you about our focus and our movement and what we want to do in 2008. We continue to expand our presence by expanding our office in San Diego and most recently hiring a Ph.D. in molecular biology for our San Diego office and two equity professionals who are also in our San Diego office focused on the communications and the technology areas. We've expanded our Boston office further, adding to both our life sciences team and adding to our technology team.

We view this current market environment as a good growth opportunity for us to build solid assets as we're seeing a shift in the competitive environment and for many players who (inaudible) access to capital that we have today in the marketplace. We continue to grow very methodically and very cautiously by focusing on credit and credit only, not on warrant gains. I believe that we're well positioned to deliver long-term value to our shareholders and that our business model strategy will allow us to sustain growth through this current economic cycle.

Our solid liquidity and credit performance to date coupled with financial strength will work in our favor throughout 2008. In spite of the U.S. economy being on the verge of a recession, the venture capital marketplace is expected to post another solid year of growth in 2008. As we continue to grow we remain committed to serving our portfolio companies and our shareholders and we're focus on achieving our goals by continuing to run and grow a profitable organization, continuing to add and expand our team and continue to diversify and build upon our portfolio by seeking greater diversification from industry and industry sub sectors and more importantly stage.

Overall I'm very pleased with the continued performance of our individuals, our investment professionals, and the entire Hercules organization. Our success is clearly attributed to solely and only their hard work and the performance and benefits for our shareholders. With that I'd like to turn over the call to David.

Thank you, Manuel. Today I will provide more details on our commitments and fundings, income statement, key metrics and balance sheet. Commitments totaled $198 million in the quarter comprised of $191 million in debt commitments and $7 million of equity commitments. Fundings for the quarter totaled approximately $149 million.

Both the commitment and funding levels significantly exceeded our previous records set in the second quarter of 2007. This brings our commitments in funding since inception to approximately $966 million and $759 million, respectively. The average funding level during the quarter was $65 million and the average outstanding imbalance of our loan portfolio was $432 million during the quarter.

Turning to the income statement, total investment income, which is comprised of interest and fee income, increased to $15.8 million, which was an increase of 82% over the fourth-quarter of 2006 investment income of $8.7 million. For the full year 2007 total investment income was $53.9 million compared to $29.5 million in 2006, an increase of 83%. The increases in interest and fee income are directly attributed to the high dollar amount of loans funded during the period as well as the average outstanding loan balances in their respective periods.

The effective yield on our debt investments during the quarter was 13.9%; the weighted average yield to maturity on the Company's loan portfolio was 12.7% as of December 31, 2007. The difference in the weighted average yield and the effective yield is attributed to fees related to loan restructurings and acceleration of fee income recognition from early loan repayments. The decrease in the effective yield in the current quarter as compared to the previous quarter of 14.9% was attributable to decreases in yield on our floating-rate loans and lower fees related to loan restructurings and early loan repayments.

I would like to point out that the net investment margin spread on our loans was not significantly impacted by the prime and LIBOR decreases as our borrowings under our credit facilities are also floating and decreased during the period.

Interest expense and loan fees on borrowings were $1.8 million for the fourth quarter of 2007 as compared to $1.4 million in the fourth quarter of 2006. The increase was attributed to higher average loan balances during 2007 as compared to 2006. During the fourth quarter of 2007 our average loan balance outstanding was $85 million of which $50 million was attributed to our credit facility and $35 million was attributed to our SBA facility.

I would like to remind you that our SBA borrowings bear interest at an interim rate of LIBOR plus 35 basis points until fixed at the semiannual meeting of the SBA. The rate becomes fixed at the time of the SBA pooling, which generally occurs in March and September each year and is set to the 10-year treasury rate at that time, plus a spread and an annual SBA charge which, taken together, currently approximates between 150 and 180 basis points.

Operating expenses for the quarter, excluding interest expense and loan fees, were $4.1 million as compared to $3.8 million during the same period last year. The increase as compared to the quarter ended December 31, 2006 was primarily attributable to higher compensation expense related to an increase in new employees and compensation related accruals offset by lower general and administrative expenses.

During the fourth quarter we recovered approximately $400,000 of legal and workout related expenses on two portfolio companies that were previously sold in the second and third quarters. We expect the run rate for our general and administrative expenses to return to a normal run rate between $1.4 million and $1.5 million per quarter.

Net investment income for the quarter before taxes increased to $10 million or $0.31 per share based on 32.5 million basic shares outstanding. This is compared to $3.5 million or $0.21 per share in the fourth quarter of 2006 based on 16.9 million shares outstanding, representing an increase of 186% year to year.

The fourth-quarter's NII represented the second quarter in a row in which our GAAP NII exceeded our dividend of $0.30 per share. And full-year 2007 NII was $42.4 million or $1.15 per share compared to $11.4 million or $0.83 per share in 2006. We also recognized realized gains of $2.8 million in the fourth quarter of 2007. As Manuel indicated, these gains were primarily attributed to our gain in Sling Media which was acquired by EchoStar.

On a tax basis our net realized gains were approximately $3.3 million for 2007, the difference between the GAAP and taxable net realized gains is attributable to the tax treatment of accelerated fee income and certain tax elections we made at the time we became a RIC which created a timing difference for book and tax purposes. Net unrealized gain on investments in the fourth quarter was $8 million compared with an unrealized loss of $972,000 in the fourth quarter of 2006. This unrealized gain in the fourth quarter of 2007 was due to net unrealized gains on the valuations of the warrant and equity positions of companies within our portfolio.

I'd like now to briefly address credit quality. We continued our high credit quality standard and discipline of loan monitoring during the quarter. The weighted average loan rating of our portfolio was 2.2, even as we grew the portfolio by approximately $100 million during the quarter. As a reminder, most of our portfolio companies are dependent on future events of venture capital investments and we downgrade our portfolio companies as they approach a period in which they will need to close additional rounds of financing.

I would also like to note that the makeup of the companies in the various grading categories will change period to period based on operating results and funding activities. Also, as we had identified in our earnings release today, we continue to diversify our investment portfolio which mitigates investment risk in any single industry subsector.

Now turning to the balance sheet -- as of December 31, 2007 we ended the quarter with $542 million in total assets, of which is $7.9 million was in cash and cash equivalents, all of which was invested subsequent to year-end. During the quarter we drew a net additional $47 million under our warehouse credit facility bringing the debt balance under the facility to $79 million at December 31, 2007. We also drew an additional $35 million from the SBA bringing the SBA debenture total to $55 million at December 31, 2007. Of which $43 million in the outstanding borrowings will have the interest rate fixed at the upcoming March meeting.

Turning to our liquidity, as I just mentioned, we ended the quarter with $7.9 million in cash. In addition, we had approximately $243 million of combined borrowings under our credit facility and SBA program subject to certain credit and regulatory limitations.

I would like to point out that the based on our existing stockholders and our SEC exemptive relief for borrowings available under the SBA debenture program, the Company has the potential to leverage its balance sheet in excess of $500 million. This figure assumes Hercules is able to renew and expanded its existing credit facilities which it anticipates renewing by May 2008. The Company had $134 million in debt outstanding as of December 31, 2007 representing a leverage ratio of 33%.

Finally, our Board of Directors has approved a dividend of $0.30 per share that will be payable on March 17, 2008 for shareholders of record on February 15, 2008. This will be our 10th consecutive quarterly dividend bringing total dividends declared to $2.73 per share since our IPO in June 2005. Operator, we are now ready to open the call for questions.

(OPERATOR INSTRUCTIONS). John Hecht, JMP Securities.

Great quarter. A couple things I want to touch on. First of all, with respect to originations, can give us a little bit more color on how many transactions occurred during the quarter? Are you seeing any changes with respect to the average size of commitment activity or where you're investing in the lifecycle of your portfolio companies?

Sure. I'll answer the bottom question. We did approximately about 15 companies when you take into account some of the renewals we may have had during the quarter, but we'll get you a specific number in a second. In terms of the sector diversification, the state diversification, we are consciously looking to and managing the distribution of the portfolio by sector specifically and also by stage.

We indicated back in November 2006 that we had brought on board a later stage team focusing on later stage venture capital opportunities and what's called lower middle market or pre IPO type (inaudible) deposits acknowledging companies that we have been consciously building that effort with our three individuals who are focused in that area. And we're doing that because we believe strongly that the IPO market will continue to be at the similar levels we saw in 2007 and firming up a lot more in the second half of 2008.

And with that we felt very strongly we were going to be in a position that we had the ability to monetize some of those later stage opportunities within our portfolio. So we have consciously been deemphasizing in the short-term, but that will be changing here shortly, early stage Series A/Series B companies that we will be moving towards in the second half of '08, making more effort on building some of those assets. Those assets in particular are generally under $3 million in size, so they won't move much of the needle in terms from an origination point of view.

We funded -- or had commitments for approximately 22 companies. But I'd also like to point out that we also funded approximately 30 to 32 companies during the quarter.

Okay. 30 to 32. You guys, there's a lot of visibility given the unfunded commitment on the pipeline. I guess what can you say given the visibility into the venture capital community pipeline and your own pipeline about maybe the next two quarters of originations?

Sure, the one thing is that what's fueling the venture capital marketplace continuously is all in the news every day. You saw recently Sun buying MySQL for $1 billion; Microsoft making a move for Yahoo!; Oracle has been an insatiable acquirer, having acquired over 11 companies in 10 months; IBM acquiring Cognos; Dell acquiring EqualLogic, another venture backed company. So there's been a lot of consolidation, specifically in the software industry.

And also we believe strongly growing consolidation will happen in the life sciences industry. As we all know, a lot of large pharma today has had numerous busted drug trials trying to go to the FDA and there have been a lot of drugs coming off patent. So they are in a very acquisitive mood right now looking for new inventory, new product to run through their distribution cycle.

So we're not seeing any significant abatement on the venture capital industry. In fact, the true indication of health that I look to was what I indicated earlier, Thomson recently put out a report showing that -- Thomson Financial, showing that the venture capitalists themselves had received $35 billion in new capital that they'll expect to deploy over the next one to two years out and sometimes even longer than that.

So we're seeing very, very solid continued investment performance and support by the venture capitalists into their technology and life sciences companies. So we're not seeing the broader market retraction that is going on in the middle market sector. But I also want to caution that what makes this asset class quite unique is it is a very specialized asset class and it takes a very skilled group of investment professionals because we deal in the world of intangibles and not hard assets, which makes it very difficult for a traditional asset based lender to simply venture into this asset class.

Okay. And then the next question is related to I guess spreads and maybe that in the context of what you're seeing in the competitive landscape. We had 150, 200 basis point decline in the LIBOR and your yields were constant. I guess that would reflect -- indicate that incremental spreads should be widening. Are you seeing competition just go away or people just pricing more risk-adjusted returns or what do you see going on there?

It goes back to a statement I've made all along, competition and pricing all relate to stage. Certainly early stage deals, is remains fairly competitive with the venture banks looking to aggregate deposits, it's one of their key areas. So that remains a fairly fierce competitive area of which we have sub 10% exposure to from a portfolio distribution.

On the mid stage deals that we define as -- called expansion stage companies, we are certainly seeing a retraction of some of the competitive landscape there because some of our competitors who now have either lack of liquidity or have not been able to expand their franchises in a way that we have, we're able to continue to see various solid deal flow and be able to maintain our pricing.

Now I do not believe that pricing levels in terms of yields will be maintained. As you just rightly pointed out, we experienced now 200 basis points of LIBOR which we believe will bounce back in the second half of '08. But that said, we've maintain our spreads and since we match fund on a floating basis against our credit facilities we have approximately 50% of our portfolio is floating-rate loans and that is then equating to approximately call it $240 million of loans that are floating versus outstandings on the credit side of about $134 million on the credit side.

And we kind of match fund that as much as we can, but certainly in 2008 we'll be looking to hedge the interest rate volatility as we go into 2008. But again, I want to caution one more item. Although we generally underwrite 36-month credit facilities, the average life of our loans ranges from 22 to 25 months or so and the hedging requirement, because of the amortization of those deals, becomes less of a concern. But we'll be looking to do some more hedging techniques in 2008 to reduce any volatility on interest rates.

Thanks for the color. I'll get back in the queue. Thanks very much.

Henry Coffey, Ferris Baker Watts.

It's a great quarter. I'd sing you a song except my voice is kind of shot. Let me just focus on some of the minutia here. In terms of the performance of the existing portfolio, Manuel, are any of your more adversely related assets on nonaccrual or what's the status of the four rated asset that you have here? It's really the only ones; you don't have any fives I noticed, which is good.

that's right, Henry. As we've shown all along since our inception, we continue to be fairly judicious and, for lack of a better word, hawkish on our credit position here. We are very diligent in intervening and trying to ensure principal preservation of our investments. And we've successfully sold off two companies that we reported just now in this earnings call. And then we also just recently -- in the press release you'll see that I'm happy to report that Agia, a company that we actually like quite a bit, was just recently acquired by NVIDIA that we had as a troubled credit, a Grade 3 credit, not because the company was in trouble, but because they were approaching around the financing.

Right.

On the number fours that we have today, I'm not in the near term significantly concerned about any of those. In fact, I'm happy to report that of the two fours that we have in there -- actually three fours that we had in there, we had two of those companies closed subsequent around the financing post the year-end and so we're monitoring them closely because they're somewhat off plan.

But I don't have in the short-term any real critical principal concern on the rated fours. One company in particular is currently engaged with three suitors to be acquired. If that were to change, for example if the suitors would go away, that would change my color on that particular company. But with everything I know today I think that acquisition is imminent as well.

Are any of those Grade 4 loans on nonaccrual?

No, we have no non nonaccrual loans today.

Great. And then you had mentioned taxable income of $0.33 a share. That $0.02 is just a GAAP tax difference based on fees and points and that kind of stuff?

Yes, and it's an acceleration of fees like you indicated there as well as just some tax timing differences for collections that we made when we became a RIC and so on.

And then the spillover situation for next year is how much?

We've got about $4.2 million of spillover from the capital gains and operations that our Board will be looking to consider a dividend in the course of 2008.

And Henry, that's on a taxable basis which is different than GAAP.

Right, right. And finally in terms of your willingness to take on leverage given how -- well, probably tomorrow your stock will be higher. But given your view on your balance sheet and your growth potential, how much leverage would you absorb going through 2008 before you really were compelled to do something on the equity front?

Well, as I'm sure most people are now aware of, and we're now making it even more obvious for folks, having the exemptive order from the SBIC --.

Right, gives you a lot of flexibility.

-- gives us a lot of flexibility. And if you want to look at, for example, from an absolute basis -- we would have the ability to go to the optimal leverage of 1.3 to 1 which of course we won't do. But I don't want to handicap myself by putting the stock in a box here, but I would say that we're probably comfortable going anywhere between 0.9 to 0.1.1 as a basis, but that's really clearly subject to market conditions and what's going on out there. But again, a great mitigating factor of that is that we get -- or we expect to receive I should say -- between $70 million to $100 million of principal repayment during the year anyways and that's a good delevering device that we have built into our portfolio.

So you could just continue to fund an awful lot of growth just with the existing equity base is what you're saying?

That's right. We do not need in the short-term to ever tap the equity markets right now and given this current stock price and stock market. We believe very strongly that we're one of the better positioned BDCs out there for having less than basically a third of leverage and having the most significant available capital in order to continue to build our portfolio.

I remember back early in '07 when you outlined what you thought you could accomplish and you've done it all, so congratulations.

I appreciate that, Henry. But it's not me; it's more of our team here.

Well, I know you didn't do anything, Manuel. No, listen, guys, great quarter. Congratulations on an exceptional year.

Thank you very much.

Bob Napoli, Piper Jaffray.

I'll follow on the congratulations. Nice to see somebody beating the quarter. This quarter has not seen that very often. I think I am getting sick just listening to Henry as well.

A question on the capital side. Obviously, you guys are performing very well, but the credit markets are very funky. Your credit facility gets renewed at what point in time? Is it March of this year?

It comes up on May 1 for renewal, but we are already in discussions obviously with our bankers on this.

And what do you expect -- do you expect no problems in renewal? Do you expect higher pricing? I mean, I think a lot of people were asking for wider spreads, even though you guys are a more mature company than the last time you put the credit facility together. What are you expecting out of the banks?

The only thing I can tell you with any kind of certainty that I know right now is that in our preliminary conversations with the banks, there has been no discussion on any of those front. And I would be handicapping myself to speculating if there is any change on that front as well.

I can tell you that our conversation with Deutsche Bank and Citibank which both continue to be exceptionally good partners to us, they have not indicated anything to that accord, but we will see when it comes down to documenting the transaction. But as of right now, things are progressing well. We have, as David earlier said, we have engaged and commenced discussions with our particular partners because we do not want to wait until the May timeframe.

Under the common terms of those loan agreements, can you get your leverage up to 1 to 1?

I am not aware --.

Well, right now we are capped at the $250 million capacity of the loan facility itself, that that would cap us at the 1 to 1, but we're looking to obviously expand our relationships there.

But within that agreement, even if it was -- are there any -- I'm trying to remember the leverage restrictions.

What you are looking for, Bob, is the advance rate. We have a 55% advance rate, I guess at credit facilities right now. That is what you're looking for. So the answer is, in all honesty, I'm not aware of any BDC that ever goes to the 1 to 1 anyways. Most BDCs tend to cap out at 85% to 90% leverage anyways. So I think you'll see us behave very similarly on the core leverage pools with Citibank and Deutsche Bank, and then with our SBIC, you'll probably see that creep up into the 1.1 range or so, because we get $127 million from the SBA that is excluded from the leverage tests.

I know you have just now attained the dividend level that you set out for two quarters in a row, but with the trends that you see in the business, are you anticipating raising the dividend in the near-term, or would you rather leave it where it's at for several more quarters?

So to clarify, we've actually achieved our dividend from a tax basis for three quarters in a row now. And on a GAAP basis, which I heard the Street loud and clear, that they want to see BDCs truly and earnestly earn their dividend from an NII basis which we plan on showing and continuing to perform to that level expectation.

So to answer the second part of your question, I think our Board of Directors would probably defer to consistently showing unequivocally the ability to outperform the dividend of NII. But certainly, as you know, a BDC is required to make a 90% distribution of income and if we continue this pace I think that will obviously lead to creep in the dividend increasing.

Within the portfolio, and we've seen some relatively weak numbers out of some technology companies this quarter and obviously they're a lot bigger than the companies you guys are investing in, but are you seeing anything on the trend side and within your portfolio on later stage companies, on tech companies or -- are the investments you're making -- are the companies so young that the economic cycle is not having much of an effect?

There's embedded two things, there's still product lifecycle issues and there are revenue lifecycle issues. Obviously it's no secret; Cisco last night issued its warning. But I think Cisco inherently is a very, very large company which is why they've been looking for acquisition to continue to bring new DNA, new products into their product mix and offering. And you've seen Sun acquisitions recently -- Oracle. And I think that the venture capital community is particularly very happy about that because technology companies are being acquired in order to run through that distribution cycle.

But we're not seeing -- I don't want to be contrary here, but I have to honestly tell you, I am not as a big proponent of the recessionary fears that we're hearing in the marketplace. I personally do not see it in the technology, early stage technology companies. Those companies are generally insulated from the current economic cycles because they're building technologies that will be in the market two, three, four years out from today. So we're not seeing it.

However, on the more mature side you may be seeing that some -- I don't want to say flattening necessarily out of the revenue, but if a later stage company is unable to get liquidity from an IPO point of view, it needs to continue to access working capital. Debt becomes a very, very important issue for them because they're able to access the debt markets, meaning from Hercules, without having to be cognizant of any material impact dilution. So debt becomes a much bigger component to the capitalizations of later stage companies when you enter into a possible recessionary period. So that's a growth opportunity for us, by the way.

Within your portfolio what types of companies are you finding are working the best, what type of investments are you most attracted to at this point, what sectors?

You'll see that we've consciously made some shifts in our portfolio. We actually have slightly shifted downward, not demonstrably, but we've been consciously doing that on the life sciences side where we're looking to balance out more from a technology later stage portfolio point of view to position the portfolio for liquidity events. So we've been moving -- let me just answer it differently -- what we like.

We like (inaudible) device in certain areas. It's a big area for us to continue to invest in. Communications is an area that we're very, very bullish on. We're not as bullish on the vogue issues right now like Clean Tech. I think Clean Tech seems to be a little bit overstated in the marketplace. We think those business models are oftentimes flawed. If you can't prove business models sustainable at $125 a barrel of oil. So we're very, very careful about Clean Tech investments.

We have historically materially deemphasized software and I think that with the most recent level of consolidations going on with Oracle, with SAP, with Dell, with IBM and Cognos and Sun, I think that there's now a new need for a crop of early stage software companies to be spawned. And I think that we are now consciously looking to buildout our software practice over the next three years very slowly. So we're getting back into that.

One of our most successful companies in our portfolio this year has been a sector that's been somewhat under leveraged or underinvested by the venture community and that is material sciences. And that company was called Rubicon, and Rubicon for example alone today was up 10% -- today alone and it's a company that continues to perform very solidly. And it's in the semiconductor material sciences area which is very important technology in order to reduce resistance of transporting the -- I just went blank on my software terminology -- electrons without resistance creating heat. And heat's a very bad thing right now.

Google, Sun, Cisco and others have actually mandated that the new level of technology that's being deployed in the marketplace be much more energy-efficient, almost a version of Clean Tech, and we actually happen to have a portfolio company that is right in the wheelhouse of the Clean Tech movement in terms of power management in our portfolio company called iWatt. And iWatt is specifically focused on energy utilization of the electronic technologies deployed in either servers or portable computing devices.

Do you still hold your Rubicon investment?

Yes, we do. We are -- believe that they're locked up still. We generally, although not all the time -- we generally have probably a 50-50 split between investment banking lockups and non-lockups on our transaction. But Rubicon is on lockup and Sirtris on the other hand is off lockup. And Power Medical I believe is still on lockup.

Thank you. Congratulations.

Jon Arfstrom, RBC Capital Markets.

Good afternoon, guys. A couple of questions for you. I'm just adding up some of the numbers and it looks like you have about 50 -- a little over $50 million announced thus far this quarter, which is obviously a good pace. But when you go back to the fourth quarter is there anything unusual in there, any larger credits that drove that or does it look like you can continue this pace I guess is another way to talk about the backlog?

I need to be clear. I think you may be including some spillover from '07 to '08. I think that the number of new deals that are completed are a little under the $50 million you stated. We have not obviously fully disclosed all of our investments, but I think it's more in the hovering the $30 million level rather than $50 million thus far in '08 that we've disclosed.

But you reminded me of a very important issue. Our fourth quarter is historically our strongest, strongest quarter and it usually has a weighting of approximately 35% of which then 25% is in the first quarter and then generally 20 to 25% is in the second quarter and then we go into what I affectionately call the nuclear winter of the third quarter which is about 15% originations. So seasonally speaking the fourth quarter is the highest quarter, so you should not model out that the fourth quarter is sustainable throughout the year.

Okay, great, that helps. In your prepared comments, Manuel, you talked about how you could have closed more transactions but you wanted to maintain your high-quality. And I'm just curious if there's been any change in the quality of deals that you're seeing?

No, in all honesty the problem that we're having right now -- this is kind of a good quality problem -- is we have oftentimes too much deal flow. And the problem with too much deal flow is that you still have to sort through the wheat and the chaff efficiently. And what happens is when you have more wheat running through the system you've got to be able to try to -- sorry, more chaff -- you've got to actually grab the nice kernels of wheat. And so it becomes a challenge.

And we have actually increased our information systems to help us better sort through the transaction volume more and more efficiently. And in doing so we felt very strongly that we had such a strong fourth quarter that close to $240 million, for example, in the fourth quarter was, frankly, unnecessary and (inaudible) continue to grow the business at a very sustained controlled growth.

And then just one question -- David, you may have mentioned this, but previous quarter you had a $4 million Grade 5 credit and I'm just curious what happened to that.

We actually had converted part of that to equity. There was a restructuring of the Company, we converted part of that to equity and left part of it outstanding in the debt. And the Company has now actually made some great strides in turning the Company around and moving forward on the operations. Sales are coming up so they're cutting expenses and we're very happy with what they're doing right now.

And John, (inaudible) that company also, since we've closed, they're very solid. You asked me about the financing, the Company has been recapitalized. And so what we did as partners to the Company, we like the credit, we like the investment, rather than being strong-armed we chose to continue to support the current investors and also encourage the new investors coming in. So we stayed in the deal and worked with them.

Okay. And is that in Grade 4 at this point?

It is actually now in Grade 3. I'd migrated up and it could actually by the end of the first quarter migrate to a Grade 2.

Okay, thank you.

Douglas Harter, Credit Suisse.

Thanks. I was just wondering if you could talk about the opportunity to hedge out some of the SBA before it locks in and sort of how you think about that.

Well, had you asked me that question 90 days ago I would have told you that I was looking to hedge that spread between the 10-year treasury rates. But had I done that, I've seen the 10-year treasury rates now drop almost precipitously 55 basis points in that period of time. So I think that as we approach the lock-in year we are closely looking at that right now. And as David indicated, we expect to have between $50 million to $60 million that will be locked in at the March time; it could creep up a little higher than that. But right now we're not looking to mitigate the near-term volatility on the 10-year treasuries.

Absolutely, Doug. As we've indicated, we had about $43 million that we'll lock in as of December 31st when we come to the March meeting. And we continue to borrow aggressively under that facility because we think it's obviously a good rate to borrow. Right now 10-year treasury is at 361 and adding 35 basis points for the LIBOR rate that goes on top of that for our borrowings, it certainly makes an attractive facility right now.

I think you meant to say that the interim rate is LIBOR at 35 basis points.

It's LIBOR plus 35 basis points.

Right, in the intra rate until you lock in at the 10-year treasury rate.

So in the short run the interest expense goes up, but obviously you've got the benefit of getting much longer term locked in financing?

That's right, once we lock in the 10-year treasury rate, let's say for the sake of argument, you're locking at 360 1-year treasury plus, make it easy, a 160 spread. You're looking at something a little over 5% on the deal for 10 years locked in and you're underwriting currently at 12.7 to 12.8%. That may go down maybe in the short-term, but that will bounce up again and you're looking at still attractive net spreads or net interest margins on that paper.

And that debt stays outstanding, it isn't tied to the loans that you have outstanding currently (multiple speakers)?

No, the way the SBA works is that we issue a pool of loans almost like collateral and then that pool of loans is then securitized if you will by that pool of loans and then the SBA encourages a long-term investment in American Enterprises, so they want that money to remain outstanding to spawn new employment and create new jobs and that's why it's a 10-year paper. It actually starts amortizing after year five I think it is.

Yes, we have the opportunity to pay it down. I think we can pay down at any point -- but, yes.

So for the first five years you can continue to put new loans into that facility?

That's right; we can professionally recycle that money for 10 years.

So assuming that at some point interest rates are higher and you can charge higher rates, the spread on that could get even higher?

That is correct.

And do any of those floating-rate loans you have have floors that they can't go below or could those keep falling if (multiple speakers)?

No, we actually have introduced recently the cost of a floor on some of our deals. Historically -- the reason why it's not that big of a deal is of that 50% exposure that we have in floating-rate loans, somewhere between 25% of those loans are what's called one-year credit facilities, AR-based revolvers. So the whole concept of that is somewhat immaterial because we match fund it anyway, so the net spread remains the same. If short-term LIBORs drop the commensurate spreads stay the same.

But isn't your return on equity since you are so under levered drop significantly with the lower prime on those?

What happens is your yield would drop, if you will. But our point is we're still growing our portfolio. So the answer is I don't think it will have that much of an impact on ROE. If we weren't growing the answer to that question would be yes. If we stop the growth it will have an adverse impact on our ROE.

Right, because you're still growing and increasing the leverage.

That's right; we're continuing to build the portfolio well beyond these other deals.

Okay, that makes sense. Thank you.

Greg Mason, Stifel Nicolaus.

Good afternoon, gentlemen. I apologize; I'm still trying to get my head around the VC market outlook. I know that the outlook is pretty rosy here because of strong M&A demand from large companies and the significant amount of capital on the sideline. But if we go into a recession it would seem logical that some of those large companies would decrease their demand for VC and some of those VC funds would postpone some of their investments. Can you talk historically how the VC market has reacted to recessions?

Believe it or not it's not that affected. And what happens is the VCs invest in horizons of five -- let me start it from a larger level. when you form a venture fund it's generally a 10-year commitment by the limited partners. Once the limited partners commit to that capital they cannot back away from their commitments without losing a significant amount of their capital, usually 50% of the commitment gets lost if they back away from it. That's why it's rare to see limited partners backing away from their commitment.

This despite even what happened in 2000 you did not see a demonstrable amount of LPs, limited partners, backing away from their commitments because they know and are fully cognizant that they're invested in an illiquid instrument that will not have liquidity for five to seven years at a minimum. So the VCs invest in the same time horizon, and so although they cure from a conscious point of view that the current market may be volatile from an IPO, we're seeing anything but that in the M&A market.

We're now going on three solid years of strong M&A activity and seeing $54 billion in M&A activities alone -- sorry, in transactional liquidity alone in 2007 was a very strong year. But I've got to tell you, I don't see -- and I've been doing this since 1987, doing equity capital investment, I do not see and have not seen any demonstrable curtailment by the venture capitalists due to a recessionary period, especially when they just raised $35 billion of commitments for their new funds.

Okay. You also made a quick statement that you were looking forward moving back into earlier stage VC rather than your focus over the last year on later stage VC. What are you seeing in the marketplace that makes you want to make that transition?

I think that there are a couple of things going on in the marketplace. I think that some of our competitors that historically existed are now undercapitalized and having some troubles out there. We certainly have a lot stronger balance sheet and we've proven ourselves to be very, very good partners within the venture industry and our willingness to stick around and work with the companies in times of trouble and also fund the companies when it's needed as a partner. That has caused a great differentiation between us and some of our competitors.

As an example, some of our competitors' total fund sizes in the venture industry are about $160 million to $200 million in size. We just invested $150 million in the fourth quarter and we had commitments of approximately $200 million in the fourth quarter. So we're seen now as a very large player and partner and that breeds stability and comfort within the venture community that will be around there. So that's an important differentiating factor.

But the broader part of your question is that if I believe and if you believe that the economic cycle that we're in will eventually ebb and improve, I believe just like anything else when you buildout for example a baseball team, you have to have a good farm camp. And I believe that we need to start consciously looking at building an early stage portfolio that will benefit from in five or seven years down the road that will have very little impact in terms of commitment levels and moving the needle from a revenue point of view, but they'll become meaningful companies for us five years down the road from today. And so we're looking to the future to start investing in those promising future companies later on.

For those early stage investments, typically you get in, provide the debt, next round of financing you're taken out. How will you play these early stage financings over multiple rounds of capital raising and will you be able to stay in them?

Well, generally speaking we prefer -- we don't get taken out upon the closing of the next round of financing. We are long-term capital partners to our companies, just like the VCs are. We use debt, they use equity. So we do not ask for nor do we request to get paid out at the next round of financing. They can if they would like but we do not require it and we don't seek it. So we stick with our companies as they continue to develop and morph into the next level of growth that they're experiencing.

Okay, great. And finally, can you give us the number of investment professionals you have now following your buildout? And what do you view as your current capacity for reviewing deals after your buildout?

Well, we have plenty of capacity. We have approximately 14 investment professionals supported by another layer of probably 10 or so analysts and associates and principal. So we are -- although we're looking to hire, we are being very opportunistic on where we hire geographically, sector, meaning life sciences versus tech, and stage of companies. Because we firmly believe that the skill sets required to due early stage deals are materially different than that of what is required to do a late stage later stage deal.

And conversely it's also true that when you look at a life sciences investment it is entirely different than looking at a technology investment. So we prefer to look at what we call athletes who have strong core credit underwriting skills, but also have a very strong technology or life sciences understanding to help mitigate the risk as we underwrite new investments.

So we have plenty of capacity to achieve our operating plan in 2008, but we're certainly looking to continuously add layers who are associates at an analyst level throughout the year.

Great, thanks, guys.

Henry Coffey, Ferris Baker Watts.

Can you talk a little bit about your outlook in terms of liquidity events for '08?

Good follow-up question, Henry. I purposely did not talk about that yet because, in all honesty, I am still scrubbing the entire portfolio to get my own level of comfort. If you ask me anecdotally, and don't hold me to this, I'll be more clear on this issue sometime in the middle of the first quarter and certainly by the end of the first quarter. I will tell you anecdotally I expect to see probably eight to 10 liquidity events in 2008. But as I scrub the portfolio that may creep up again. But right now -- from what I know right now it's about eight to 10 that I feel probably is the right number. But I will have better visibility for you and the rest of the community sometime in the middle of the first quarter.

Is there anything going on -- because obviously you get sort of monthly fundamental data from your companies -- is there anything going on that has either really surprised you on the positive side or the negative side in the last few months?

I'll be honest, the level of insatiable appetite for acquisitions in the software industry has frankly surprised me. We have two portfolio companies in the software area that are well-positioned that we think are very attractive companies that are building out their business models further that I think will be a liquidity event in 2008.

We have another company that we're very proud of in our portfolio that continues to perform outstanding [below] performance at one of its direct peer group was recently acquired in December. And if you look at those market comps that company was acquired by, that would mean our company would have a lot more legs to run as it continues to build its business models further.

So we're very encouraged by the level of maturation that we're seeing in our portfolio companies and we remain optimistic. Despite the rest of the community, I remain fairly optimistic that the second half of 2008 will be a good year and certainly 2009 I continue to believe will be a very promising year for technology IPOs.

Very good.

John Hecht, JMP Securities.

Actually most of my questions have been asked, but one quick modeling question. In the last two years you've had Q4 to Q1 decrease in comp expense. I guess you probably had some bonus accruals in Q4. Given the recent hires and how you accrued bonuses this year, should we expect that to occur again in Q1 of '08?

The answer is, yes, on our '08. The real issue was -- it's no secret now -- a lot of our guys here knocked the cover off the ball. We have investment professionals here who had done an outstanding job and who are incredible providers to the Company. And the level of commitment goes down through our operating team as well who have performed outstanding to allow Hercules to grow the way it has and I feel very strongly on rewarding people for their achievements and their accomplishments. So you'll see slightly higher bonus accruals in the fourth quarter because I think some of the folks here have done a fantastic job and they deserve to get rewarded for that effort.

And then offsetting that we should need G&A return to normal levels due to the reversal of legal expense accrual that took place in Q4 of this year?

That's right, we should expect about 1.4 to 1.5 as a normal run rate.

All right. Thanks very much, guys.

There appear to be no further questions at this time. I'd like to turn the call back to our speakers for any additional or closing comments.

Thank you. I'd like to thank everybody for being an investor in Hercules and for continuing to support the Company and believing in the team. I'd like to make you aware that David and myself will be visiting with many investors in the next coming weeks and months. We're going to be visiting New York City next week. For those who would like to have meetings with us when we're in New York City next week, please contact Sally Borg at 650-289-3060 and well try to fit you in that schedule. And then we'll also be in Boston on Thursday and Friday this week followed by Chicago at the end of February as well.

We are currently working on and planning an investor and analyst day sometime in the second part of Q2. We're still trying to firm those days up and we'll certainly get back to you when that comes together. So with that, thank you, everybody, and -- thank you very much.

That does conclude today's conference call. Thank you for your participation, you may disconnect at this time.