Hercules Capital Inc (HTGC) 2008 Q2 法說會逐字稿

Good afternoon and welcome to the Hercules Technology Growth Capital Inc. second-quarter 2008 financial results conference call. (OPERATOR INSTRUCTIONS). I would like to remind everyone that today's call is being recorded.

Please note that this call is the property of Hercules Technology Growth Capital and that unauthorized broadcast of this call in any form is strictly prohibited. I will now turn the call over to DeDe Sheel of FD Ashton Partners, Investor Relations Counsel to Hercules. You may go ahead, Ms. Sheel.

Thank you, operator, and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules' co-Founder, Chairman and CEO, and David Lund, CFO.

Our second-quarter 2008 financial results were released just after today's market close. They can be accessed from the Company's website at herculestech.com or HTGC.com. We have arranged for a taped replay of today's call, which will be available through our website or by using the telephone numbers and passcodes 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. We ask that you refer to our most recent filings with the SEC for important risk 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 attain 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 co-Founder, Chairman and CEO. Manuel?

Thank you, Dede, and good afternoon, and thank you everybody for joining us today. I would like to start by reminding everyone that Hercules is a highly specialized business development company, and we've specialized and focused exclusively on the venture capital and private equity technology and life sciences companies.

On today's call I would like to discuss four key items -- our second-quarter performance, our current liquidity position, our credit performance and credit quality of our portfolio and, of course, the current venture capital environment in our portfolio exits. I will then turn the call over to David Lund who will discuss our financial results in more details. After that, I will be happy to answer any of your questions, along with David.

Now to summarize the results of our second-quarter results. We had continued growth in commitments for a record of $236 million and $161 million in fundings and loan renewals during the quarter. This was primarily driven by a robust venture capital market and the hard work of our organization and our investment professionals.

During that period of time, we also maintained our historical solid credit performance. We continue to build upon the diversity and strength of our investment portfolio with continued focus on and towards more later stage EBITDA positive type companies as you continue to build our portfolio.

We finished the quarter with approximately $602 million of investment assets on our balance sheet and an unfunded backlog of $193 million, giving us visibility for the next two to three quarters out of additional investment activities, of which David will discuss further during his portion of the presentation.

We also achieved a weighted average yield for the quarter of 12.67% compared to a 12.64% during the first quarter, all while short-term LIBOR rates were declining. Our effective yield, however, during the same period of time went up quite significantly to 14.3%, of which David will also discuss further during his portion of the presentation.

I'm happy to report that we have also surpassed our goal which we outlined during our fourth quarter and reiterated during our first quarter of this year on the number of exits that we expect to realize during fiscal 2008 of eight to 10 exits. I'm happy to report that as of the end of the June period, we have now achieved 11 exits in our portfolio, already surpassing our goal of eight to 10 liquidity or exit events during the year.

Now turning to liquidity, we are confident that our current liquidity position will allow us to continue to fund our operations for the next couple of quarters, while the addition of our new credit facility will allow us to continue to fund the operations well into 2009. I will expand further about our credit facility during our Q&A session to discuss the impending credit facility that we expect to have in place here shortly.

Continuing on, during the quarter we continued to deploy capital from our new credit facility thanks to our partnership with both Deutsche Bank and Citibank, which we continue to draw capital from those credit facilities which renewed in the middle of the second quarter. And again, David will speak further about the cost of credit on those two facilities.

We currently are only leveraged 53% of our portfolio, and I would like to remind everybody that we have a SBIC exemption from the SEC which allows Hercules to leverage above and beyond the one to one debt-to-equity ratio to an optimal leverage point of 130% or 1.3 to 1 leverage ratio. So we have a significant amount of liquidity that we can actually continue to leverage our balance sheet to fund our existing operations for the next few quarters.

Now let me take a moment and turn to credit quality. I'm very confident of our achievement of our organization in maintaining our high credit standards, especially during this current credit environment and credit crisis that we seem to be experiencing in the broader market and certainly many of our commercial bank partners out there as well. We continue to remain very disciplined in our selecting process of new investment opportunities, and we remain extremely vigilant in monitoring and tracking our existing portfolio for the first signs of trouble, which have allowed us to navigate these difficult credit times by avoiding any significant credit losses as evidenced in our portfolio's performance so far.

In terms of a weighted average loan grade in our portfolio, I'm happy to report that that weighted average loan grade has also improved during the quarter to 2.1 compared to 2.2% in the previous quarter. Given the current environment, we remain very selective in our investments, and we seek to make strategic decisions and emphasize in the near-term away from early stage investing and migrating more towards later stage, more established EBITDA positive companies. You will continue to see us migrate more towards mature companies in the preceding two to three quarters as we continue to see the markets fill out that we're experiencing today.

Further, as we focus on more mature companies, we are looking to continue to enhance our investments in more EBITDA positive companies, which we believe is a very attractive market opportunity for us to pursue, realizing very attractive yields at historically low EBITDA multiple levels today. While we believe there are many great opportunities from an investment perspective, we have elongated our due diligence process and extended out our initial fundings of companies where we have purposefully increased our due diligence timeframe anywhere from two to three weeks above our historical norms in order to continue to ensure that we are vetting the proper investment opportunities as we make our final investment selection process. This has enabled us to both garner meaningful terms and conditions on our new credit facilities with our portfolio companies, as well as ensure that we complete a very thorough and continued due diligence process as we have done historically to ensure a continued preservation of our credit performance.

We continue to believe these actions are prudent in order to maintain our high-quality standards, which we do not expect to deviate very significantly from if at all as we continue to build our assets over the preceding two to four quarters in the future.

Now let me turn to portfolio exits. As I said earlier on, we have now exceeded our exits of eight to 10 events now achieving 11. This was achieved by having five of our companies achieve exits during the second quarter, all of which achieved positive IRRs for Hercules.

We have successfully worked out and received payoffs of an additional two to three companies during the quarter as well as part of our continued effort to ensure principal reservation as we work through difficult credit situations with our companies in conjunction with the venture capital partners.

Now let me turn to our work portfolio and potential future liquidity opportunities from our portfolio derived from those existing warrant positions.

Today our warrant portfolio has consistently provided us with realized gains, which we will distribute to our shareholders in the form of additional dividends or retain for future investments by paying the appropriate corporate tax and retain those earnings in order to fund our future operations. We continue to build our warrant positions during the quarter, and I'm happy to report at the end of the second quarter Hercules now holds warrants in 96 venture-backed life sciences and technology companies which we carry on a fair value basis of approximately $25 million.

In contrast, if we were to exercise all 96 warrant positions, we would have a cash outlay of approximately $60 million representing the full exercise price of those warrants. As I have done historically, I want to caution our investors and remind our investors that you should not expect nor do we expect to see full realization from our warrant portfolio, and we continued to say that you should only model approximately 50% or less of that warrant portfolio will ever monetize into any upside. And we will expand that further in our Q&A session as well.

The increase in our warrant position from the second quarter to the first quarter represents approximately a 70% increase in our warrant portfolio position. This is important as we continue to build our warrant portfolio in hopes of in the future harvesting those gains for additional capital gains and create a self-funding mechanism for the Hercules model.

As I have now seen and heard many of the other BC calls out there, Hercules is certainly one of the most unique business models out there where we are generally receiving warrant positions in all of our venture-backed companies, allowing us this potential for future upside for our shareholders in the event these warrants were to monetize.

This is important as our warrant portfolio does allow or should allow Hercules to provide a venture capital type return to our shareholders with limited downside risk.

In conclusion, we believe Hercules Technology Growth Capital in this current marketing environment has continued to navigate very difficult waters and continues to perform quite well for our shareholders while avoiding any significant hardships from realized loans losses in our portfolio. It is, frankly, a testimony to the quality and integrity of our business professional people we have here, the vast majority of which all have significant credit training programs and lesser extent business development. It is certainly a critical differentiating factor for Hercules that its investment professional staff has a significant credit training background which has afforded us the ability to scrutinize and evaluate investment opportunities as we have done historically in these current times.

We believe our short-term strategy of shifting to later stage companies, more mature EBITDA positive companies, continued with and coupled with the vigilance on our credit quality and credit performance, will allow us to continue to build our portfolio and to continue to build shareholder value for underlying shareholders.

I would like to remind the audience on today's call that the third quarter is traditionally our slowest quarter in terms of both originations and funding. The third quarter traditionally represents anywhere between 10 to 15% of our investment activities for the year during the third quarter. Given the current economic times, we are certainly expecting that the third quarter will probably be on a seasonally low-end of expected originations given the current environment that we are in.

Overall I'm extremely pleased with the continued performance of our investment portfolio, the dedication and commitment of our investment professionals and (inaudible) their absolute vigilance and hawkish approach to our credit position ensuring that we maintain the solid credit performance that we have done. Our success is clearly attributed to their dedication and their performance on behalf of our shareholders.

I would now like to turn the call over to David Lund who will elaborate upon our quarterly financials and financial performance. David?

Thank you. Today I will provide more details on our commitments and fundings, income statement, key portfolio metrics, balance sheet and also provide an update on our credit facility.

With our record level of commitments and fundings this period, our commitments since conception have exceeded $1.3 billion and our fundings approaches $950 million.

Turning to the income statement, total investment income, which is comprised of interest and fee income, was $19 million, which was an increase of approximately 43% over the second quarter of 2007 investment income of $13.3 million. This increase reflects an above-average level of income from event-driven fees and acceleration of deferred revenue.

The effective yield on our debt investments during the quarter was 14.3%. The increase from last quarter's effective yield of 12.6% was due to the acceleration of the event-driven fees.

Interest expense and loan fees on borrowings were $3.5 million for the second quarter of 2008 as compared to $2 million in the second quarter of 2007. The change was attributed to higher average loan balances outstanding and fees related to the SBA drawdowns.

During the quarter our average loan balance outstanding was $181 million, of which $98 million was attributed to our credit facility and $83 million was attributed to our SBA facility.

The effective cost of debt during the quarter was approximately 7.7% compared to 6.4% in the first quarter. This increase reflects the higher cost under our credit facility. I would like to remind our investors that the credit facility was renewed on May 10, 2008, and this cost only reflects a half quarter of increase.

During March 2008 Hercules securitized its borrowing rate on $58 million of borrowings under the SBA program at a rate of 6.37%, which is comprised of the interest rate of 5.47% and an annual fee of approximately 0.9%. Subsequent SBA borrowings will bear interest at an interim rate of LIBOR plus a spread of approximately 30 basis points until fixed at the semiannual meeting of the SBA in September.

As a reminder, the rate becomes fixed at that time of the SBA pooling, which generally occurs in September and March each year and is set to the 10-year treasury rate at that time, plus a spread at an annual SBA charge.

Operating expenses for the quarter, excluding interest expense and loan fees, were $5.6 million as compared to $4 million during the same period last year. The increase as compared to the second quarter of 2007 was primarily attributable to an increase in the number of employees, as well as increased legal and workout-related expenses.

Net investment income for the quarter was $10 million or $0.30 per share based on 32.8 million basic shares outstanding. This is compared to $7.2 million or $0.29 per share in the second quarter of 2007 based on 25.2 million shares outstanding, representing an increase of 3.4% on a per-share basis. Taxable income for the quarter was $0.39 per share, including realized gains and tax timing differences totaling $2.5 million or approximately $0.08 per share.

During the second quarter, we also recognized realized gains of $1.9 million. These gains were primarily attributed to the gain on sale of our warrants in Sirtris Pharmaceuticals. Net unrealized depreciation on investments in the second quarter was $3.5 million compared with unrealized depreciation of $1.4 million in the second quarter of 2007.

I would 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 improved to 2.1 as compared to 2.21 at the end of the prior quarter. As a reminder, most of our portfolio of companies are dependent on future events of venture capital investment, and we downgrade our portfolio of companies as they approach a period in which they will need to close additional rounds of financing.

I would 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 continued to diversify our investment portfolio, which mitigates investment risk in any single industry subsector.

Now turning to the balance sheet, effective January 1, 2008 the Company adopted FAS 157. There was no material effect on the investment valuation as a result of the adoption of this accounting principle. During the quarter we also reviewed certain warrants valuations with our consultants, Houlihan Lokey.

In the second quarter, we placed two of our loans with an aggregate value of approximately $5 million, representing only 1% of our total investment portfolio on a non-accrual basis, $4 million of which is currently in receivership and is being sold.

During the quarter we borrowed $46 million under our warehouse credit facility. The debt balance under the facility was $119 million at June 30, 2008. We also drew an additional $25 million from the SBA, bringing the SBA debenture total to $95 million at the end of the quarter.

$16 million remains available under the Citibank credit facility, and $32 million remains available under the SBA program as of the end of June.

Turning to our liquidity, as Manuel mentioned, we expect to announce later during the month of August a new revolving credit facility for potentially up to $300 million providing the ability to add additional lenders of credit facility over its term as needed.

The facility is expected to be structured as a two-year committed facility with a one-year optional extension. The initial facility is expected to close with commitments of $50 million and possibly expanding to $100 million with the addition of one to two potential lenders. We're currently in the process of finalizing the loan and security agreements. However, until this transaction is fully closed, I would like to remind everyone that it is still a pending transaction and subject to closure.

I would like to point out that based on our existing stockholders equity and our SEC exempt of relief for borrowings available under the SBA debenture program, the Company has the potential to leverage its balance sheet in excess of $500 million. We had approximately $180 million in debt outstanding as of June 30, 2008, representing a leverage ratio of approximately 53%.

Turning to our dividend, our Board of Directors declared a dividend of $0.34 per share, representing a 13% increase over the second-quarter dividend of 2007. The dividend will be payable on September 15, 2008 to shareholders of record as of August 15, 2008. This is our 12th consecutive quarterly dividend declaration, bringing the total cumulative dividend declared to date to $3.41 per share.

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

(OPERATOR INSTRUCTIONS). Troy Ward, Stifel Nicolaus.

The obvious question that comes to mind, unless I just missed this, did you speak to the cost, the potential cost of the facility that you are in process of getting?

No, the answer is we have not because until the deal is done, we don't feel as comfortable to say that. I will say the following, however.

That all the terms and conditions of the credit facility are and have been completely negotiated and complete. We are literally within probably five, maybe at worse 10 days away from finalizing the loan and secure agreement with the lender.

I can say the following, however. That the borrowing cost of the facility is materially less than the current Deutsche Bank/Citibank credit facility that is in place today.

So it's at least [Dow] plus 499 then?

No, I think that our credit performance, which you have emphasized very strongly, has allowed us to significantly show our difference between us and other specialty finance companies. And so we have received what I consider to be one, the proper partner that we have found to provide the credit facility, and we think that the credit facility terms reflect our ability to continue to perform in these current market conditions. So we are very happy with our arrangement that we have and will soon to have in place with this particular lender.

That is fantastic, especially in light of hearing that one of the peer BDCs had one pulled in the 11th hour. Hopefully that will not happen here.

Quickly, not much, it seems to be a very clean quarter. Moving on to income statement, was there something in the G&A this quarter that was kind of a onetime or it looked like that was higher than normal?

Yes, we had some slightly higher legal fees. We had some workout-related expenses for one deal that has been resolved and one that is in process. And so it has been more related to SEC filings and things of that nature.

There's probably about $250,000 (inaudible) $300,000 of I guess onetime fees that we expect or will be getting reimbursed on when this particular workout transaction we just identified is completed later on in the third quarter, and that will provide some reimbursement. The accounting rules are, as we incur these expenses, they must be expensed and the quarter recognized.

Okay, great.

Gentlemen, this is Greg Mason. Can you talk a little bit more about just the overall venture capital environment, particularly on the debt side? What kind of competition is out there, opportunities that are presenting themselves for new investments and then exit opportunities? Obviously the IPO market is slow. M&A. Can you just give us kind of a little overview there?

Sure. Well, let me first talk on the macrolevel, which, frankly, surprised me on how favorable the numbers are that came out.

As you may look at the transcripts from Q4 of last year and Q1 of this year, I have always said all along that I expect for 2008 to be slightly lower than the investment activity in 2007, which to remind everybody did about $30 billion in venture investment activities.

In Q2 the venture capital community invested approximately $7.4 billion into 990 different transactions as compared to $7.5 billion in Q1, giving a run-rate of investment activities close to $16 billion year-to-date or $32 billion for the year, which are surprisingly strong. That is important because that venture capital investment into technology life sciences companies is one of our primary sources of repayment. So unlike every other BDC out there, we're experiencing a very robust in a very good market in the venture capital sector.

Another important leading indicator onto the health of our industry is the amount of capital that the venture funds themselves raised from limited partners, and that number absolutely surprised me on how strong it was in the second quarter. The venture capitalists themselves raised $9.1 billion into 71 new venture funds. That is compared to $7.1 billion in Q1 '08 to 70 funds, making the year-to-date number exactly matching their outflows of $16.2 billion.

And just to remind everybody, venture capitalists typically invest their funds between three to five years, and they take on investment horizon for their portfolio companies anywhere between eight to 10 years for liquidity. So even though we may be experiencing some difficult times in today's current marketplace, the venture capitalists take a longer-term perspective on supporting investing in their companies, which again has allowed us to have and select the proper companies, which is reflected in our credit performance.

Now turning to competition, the wonderful thing is that because we are such a specialty investment practice, very few people either have the franchise, the knowledge or the experience to work with and deal with early stage, mid stage, late stage venture capital-backed companies. It is a highly specialized practice of lending, and traditional asset-based lenders don't necessarily are able to do that.

Because of that we have seen a significant curtailment or abatement in competition from many of our competitors, some of which were doing what we consider to be extremely silly deals by doing very, very large dollar sized deals with no warrant coverage or significantly very, very low-cost capital.

Hercules is not a low-cost capital provider. We are highly selective in our portfolio, and as such we have seen our competition who went out and did a lot of deals now suddenly running into significant credit problems, and more importantly, they are significantly underperforming on a P&L basis when somebody compares them to Hercules, and they are running into capital fund raising problems today.

So we're seeing the competitive landscape shifting quite a bit. We are still seeing pretty significant healthy competition on the other hand from the venture banks who are more focused on giving away loans in order to secure deposits as a source of funding to support their real estate efforts or their middle market efforts today.

Great. That is great color. Thank you.

John Hecht, JMP Securities.

Forgive me, I have been jumping from conference call to conference call. Manuel, it looks like -- you may have addressed this on the call, too. It looks like your yield on your loans as we calculate it, just interest income divided by the average portfolio size, jumps pretty nicely in the quarter. Yet you are talking about going after larger deals, later stage companies with lower multiples.

Is this a factor that you're just entering a market that has either less competition and you're able to get better spreads on it? Or is there something else going on with the yield that is enabling you to pass up the increased credit spreads to your customer base at a more rapid rate?

We're certainly able to -- let me answer the first part. We are absolutely going upstream into more established later stage companies. And some of these companies we may forego a warrant coverage, for example, because of the more stability nature of the Company but garner current higher cash yield and some of which have some big component to it, but our (inaudible) exposure sale is very minimal even to this date.

So it so much, much healthier, stronger, current cash income and a higher yield spread. And certainly we have seen and continue to see a declining level of competition on assets below the $30 million range.

So it is a little bit of getting higher current income without warrants in the bigger deals along with higher yields in the smaller deals? Is that a combination of what we're seeing in your portfolio yields?

It is still a combination of both of those items, yes.

And also to be clear, we had some acceleration of interest income, some event-driven fees where people have paid off that boost to the current quarter's interest income as well.

Okay. And I missed that. Did you divulge what the credit prepayment fees were in the quarter?

Yes, prepayment fees and this is strictly dollars in the quarter were $236,000. That is not necessarily an increase quarter over quarter but just within the quarter. And we had onetime fees of $1.1 million. Now that is slightly higher than the previous periods as well. So we are seeing some additional fees thus quarter obviously.

And we prefer -- we are going to start shifting the terminology because I am not particularly fan of onetime fees. There better and more appropriate terminology I think it is is more event-driven fees such as a company paying early, a company being acquired, a company going public, and they have access proceeds. They pay down a loan, which will cause either an acceleration of unrecognized deferred revenues that gets accelerated or coupled with any loan amendment fees or, frankly, any prepayment penalties that are then recognized because of an event-driven situation.

And then the last question would be, if you have a comment on it, I would like to hear your update on what industries are more enticing to you right now where you are seeing better investment opportunities, and from a regional perspective, if you are seeing any activity in Israel still and maybe where you are seeing it in the US relatively speaking?

Certainly. The investors have been following us all along and have probably heard me say this now for about six to nine quarters, maybe longer, that we have historically deemphasized software investments. We then said at the beginning of Q1 of this year that we have now begun to relook at software investment activities, and you are seeing a shift from our focus became sort of software companies today, and you see the portfolio basically jump from 6.5% in software investing in Q1 to approximately 11% software investments in Q2.

So that has been a material shift for us in the short-term. We're continuing to cautiously reduce our exposure in the life sciences area not because we don't like life sciences. We think that the market is going through a little bit of an adjustment period right now.

So life sciences as a percent of our portfolio exposure declined from a 37.5% portfolio concentration in the first quarter to about 32.5% portfolio concentration in the first quarter. And that is something that we did consciously. However, I think the life sciences concentration, that has dipped below much more of a 30% level, and you will start seeing that increase probably in the fourth quarter.

We all know if you don't follow the technology area, semiconductors is going through a fairly significant rough patch right now. We're somewhat net neutral to that exposure now. We do have some exposure to semiconductor. We're watching some of our companies very, very closely. They are going through a very significant sector recession, if you will, for lack of a better word. And you are seeing some additional hiccups going on right now in our com exposure, but we're continuing to monitor that quite well. We think they are well-positioned in that area, but com is going through a little bit of an adjustment period right now, which represents about 20% of our portfolio today.

Jon Arfstrom, RBC Capital Markets.

Just a clarification on the event-driven fees. I just want to make sure I understand it. The typical run-rate has been about $1.5 million a quarter. And Manuel, I understand what you're saying about about how they are event-driven and not necessarily one time. But would you characterize any of that that might have been pulled in from what would have occurred in the third quarter that was pulled into the second quarter, or do we expect that to drop back to the typical run-rate?

It is a drop back to the more typical run-rate. Our increase in fee interest income was about $1.8 million over the quarter. About $1.2 million of that was event-driven, and it is event-driven that would have been even longer-term out because we had deals to pay off or more mature companies to pay it off. We had some back-end fees paid off. So I expect it to go to the more normal run-rates.

Let me clarify further. As much as you may believe, we can't affect any events in our Company.

Yes, I understand.

These are M&A activities. These are -- some companies are doing so well that they raise even higher amounts of equity capital at significantly higher valuations, and they decide they don't need the equity. Sorry -- they don't need the debt anymore. And its a combination of many different things of that nature, but nothing in which we can pull forward at all.

Okay. And then just to follow-up on the shift to more mature companies, I just want to make sure I understand that you do expect some rising investment yields over time as you continue to recycle the portfolio and move into more mature companies? Did I understand that correctly?

Absolutely. Whether we have done I guess a very good job on it, is discussing the microlevel analysis as we do in our portfolio. We have probably anywhere between conservatively 60 to $100 million of loans that are ostensibly below what our new yield requirements would be, for example, that are maturing. And, as those portfolios run off, you will actually start seeing us redeploy that capital into new investments.

And again, another very important distinction between Hercules and almost every other BDC out there is because we rely so heavily upon rapidly amortizing credit investments, we received anywhere between 30 to $50 million a quarter in cash flows back that we were able to redeploy. So looked at it differently, a lot of it is to delever ourselves to redeploy that capital very effectively, thereby getting new fees and new warrants in our deals.

Good and then just one more thing. In terms of -- I understand your comments on Q3 originations, but assuming your new debt facility closes as planned, can you comment a little bit on your appetite for overall balance sheet growth? Do you feel like the environment supports an opportunity to grow the balance sheet faster maybe after the third quarter, or would you say regardless of your -- the size of your facility you're still a bit cautious on growth?

Our credit facility does not drive originations. We could have zero leverage in our balance sheet and an ordinary amount of liquidity, and that doesn't mean we simply accelerate originations. So we are very true to what we do, and that is if the opportunities are not there that we feel fit from a credit risk profile, potential economic upside in the warrants, and repayment of our principal, we're not going to make the investment regardless of having liquidity.

So I don't think liquidity is going to change our stats, our positioning for the third quarter, or it is going to materially change our investment activities for the fourth quarter.

So liquidity aside, we're going to go slow and steady as we have done and continue to build our portfolio with the right quality asset if we see them.

Now that said, we're seeing a disproportionate amount of very good solid deal flow coming in, but even then it does not make the reason to go out and overrun your liquidity position today.

Right. Okay. Great. I understand that. And then I guess the last question on your nonaccrual, David, you said $4 million of it is being sold. And I guess can you give us a little clarification on that? Does that mean it is in the process of being sold right now or you're planning on selling it eventually?

No, it is in the process of being closed. I would anticipate that we would actually see that deal close in this third quarter here.

That transaction (multiple speakers) the buyer has already been identified, and it is like our credit facility in the final throes of finalizing the loan to sell -- the purchase to sell agreement.

Great. Nice job, guys.

Bob Napoli, Piper Jaffray.

Nice to see strong numbers out of at least one company this quarter. But no, you guys are in a different sector that should be a lot less affected by what is going on in the economy, so we are not too surprised by what we see I guess.

I have another call going on too, so I missed a little bit of your call. So I apologize if the question was asked. But what type of pricing do you expect on the $300 million facility that you hope to get by the end of this month?

We expect to say an improvement, but we have not disclosed or discussed that. We think it would be too premature to do that at this point. We have nailed down the terms. We have discussed those. We're in the final throes of the actual agreement itself, but we will disclose that in the next couple of weeks.

And I can assure you it is lower than the current facility today.

Okay.

Across the board.

Okay. And if for some reason that transaction does not happen, when would you have to -- how much can you invest if for some reason that deal were not to happen in the timeframe you are expecting?

Well, we have run -- as you can imagine in this current environment, we have run an inordinate amount of scenarios on originations and fundings in our business. We can actually make it all throughout 2008 without having to raise any additional capital whatsoever.

Another important point that I think we should emphasize and I will take this opportunity to do it, is our dividend basically for the whole -- our dividend for the year is pretty much already baked in-house done. Between our spillover, our realized gains on our warrant positions and our continuing economic NII performance in our portfolio, our dividend is more than covered already by all the operations and the spillover of 2007.

So there's actually no risk whatsoever to the dividend. Unless we see some unforeseen losses that we're not aware of or don't anticipate right now, the dividend is fully covered.

With that, we can also modulate downward if we need to the originations in the first -- in the third quarter and fourth quarter and make it to all out calendar 2008 without any additional capital raised. Because, as we said earlier a minute ago, we are throwing off now anywhere between 30 to $50 million of normalized principal repayment. In this quarter alone, I think we had $70 million of principal repaid.

So we are having a very healthy return of capital back that we like, and that allows us to continue to fund our business for the next three quarters easily.

You said you had 11 takeouts in the first six months?

We have had 11 exits that are both repayments in full of the principal amounts whether in M&A activity, an IPO or an even-driven event -- such as the liquidation where they repaid back the loan.

How many were -- can you break it down by which -- the event it was? Like how many were M&As, how many were full repays?

Let me take a quick shot at it for you. We had one, two, three, four -- looks like we had four repayment events in the quarter. Excuse me, five repayment events, no, no, four repayment events in the quarter, and then we had M&A, and we had one, two, three -- it looks like three M&A events in the quarter. I apologize, add two more to the first column I said earlier.

Okay.

So -- and then we had one IPO of that such as Sirtris.

It is actually for the six months, not the --

Okay.

Yes.

Okay. I just wondered with the IPO market so bad, do you have -- do you know of a number of your companies that are just biding their time waiting for the IPO markets to open?

I want to reemphasize what we have said all along. We're not dependent at all on the IPO market. The IPO market if and when it opens up again will be highly accretive. The venture industry (inaudible) does not rely upon the IPO market. In the M&A, despite what the broader media is saying, we're not seeing any abatement in our portfolio of M&A activity. I mean we're seeing an incredible amount of M&A going on in our portfolio mainly because we are fortunate enough, we're picking the right companies, but we are not seeing any down downward trend in M&A activities whatsoever.

Right. No, I understand that. We need IPOs more than you do probably (multiple speakers) but I just wondering what you're seeing is good from an economic -- the economy standpoint if what you're companies are telling you, the ones that may be looking to go the IPO route if they feel like they are going to go that direction sooner rather than later or just any color you had on that?

Sure. We all know and different sectors play differently, oftentimes companies in the life sciences sectors will pursue an S1 filing to go public as a way of triggering a M&A event that it may be looming. And I don't think that's going to change at all. I think that we're going to be seeing probably two or three additional IPO filings in our portfolio in the second half of this year.

Okay. Let me ask the question about structure of your Company. Being a BDC is -- it's not an easy thing to do because you are reliant on raising equity capital for growth. You have done a good job of raising more capital than when you need, when you seem like you don't need it, which is a nice way from a long-term perspective. But -- and your assets I understand are not traditional bank assets, but you keep pretty low leverage. There has got to be more unfortunately bank depositories out there that have had problems that could be available. I mean I'm sure you are aware of what CapitalSource did on a much grander scale. But I just wondered what your thoughts were on long-term, on capital structure, and if you've thought about or you do have venture banks out there, if you have -- if that is a direction that you should go with this company long-term, or if you are just totally comfortable with the BDC structure?

That is a meaty question. The answer is clearly our Board of Directors and the management team of this Company is constantly evaluating alternative sources of capital to grow one you just mentioned is the depository relationship whether it has as an affiliate relationship or even the possibility of somewhere down the road of structuring a venture with a bank. It is always something that we will be and are looking at long-term, especially after CapitalSource did what it did as a source of funding. So that is certainly on the table that we are evaluating that opportunity.

We're also looking at and we talking historically, somewhere as the market improves establishing the possibility of having affiliate funds that we manage on behalf of our shareholders where we have source of capital to invest in specialty practices such as, for example, venture leasing, for example, where we actually have a leasing product that is derived with a pool of capital we manage. Because of the BDC there is really no cash play or benefit for a leasing asset inside the BDC because of the risk status. But we are seeing in a market opportunity that is emerging there, that we will probably look to capitalize sometime in the next two to six quarters out, maybe longer. It's all (inaudible) on the market.

But we're certainly actively looking at alternative strategic directions to continue to grow the Company. We are fine with the BDC veneer. We actually don't have much problem with the BDC structure because, as you said, we tend to manage it on a much more conservative leverage basis, and given our asset class and amortization, we're not running up against a ceiling as other folks are.

[Brandon Mohl], Lehman Brothers.

Great quarter. I just wanted to ask real quick about two things. One, can you guys walk me through the spillover from last year, the realized gains this year, and what you can keep in-house versus what is required to be paid out? I think there is some weird rule there that I don't remember exactly.

And then two, you spoke about in your talk about you took down life sciences exposure by about 5% because of an adjustment you saw going on. I'm just interested in what adjustment you guys see going and how you feel about that going forward?

Well, let me answer the latter part of the question, while David gets the documentation to walk you through on the spillover.

It is not that we don't like and we're deemphasizing life sciences. That is not the impression I wanted to give. We are still very bullish and extremely committed to the life sciences sector.

However, as we have seen in our own public life sciences holdings, it is a very volatile choppy market right now. And what we're seeing is we're seeing, frankly, really good opportunities in public life sciences companies that, frankly, should go private they may have gone out too early.

And you're seeing a dislocation and valuation differential between the private sector and the public sector in the life sciences areas where ironically you're seeing higher valuation occurring in the private sector compared to the public side.

So we think that is not generally a good trend, and we think that that trend needs to kind of flip-flop and gets fixed. And I think we're going to wait it out a little bit for one or two quarters to see how that takes place. But we're certainly seeing a good opportunity to go the private route on some of these publicly traded life sciences companies.

Okay. What do you guys see going forward just in terms of clearly this quarter the sector consolidation in life sciences started in a big way. Do you expect to see an acceleration in your M&A portfolio going forward there?

Well, we have certainly seen with obviously Genzyme now being in play, that a lot of pharma companies are much more inclined given their declining product lines coming off patent that they have no choice but to go out and buy biologics or biotechnology type drugs in order to put in they're distribution.

So we think certainly that many of our portfolio companies will be executing through pharma partner M&A events over the next couple of quarters, and we're pretty optimistic about that outlook.

Okay. Great.

With regards to the first part of your question, the spillover from prior year was approximately $0.13 that needs to get paid out in the course of this year. We do have the ability to either distribute long-term capital gains, pay an excise tax and carry those over the following year and pay those out to shareholders in the subsequent year.

We also have the ability to pay the normal corporate tax rate on those and actually use them as permanent capital. We have not done that so far. We believe that the amount that we have had in capital gains at this point warrants distribution as opposed to retention. But I would be more than happy to discuss this further if you would even care to give me a call and go through the details.

Let me get a little more specific. We are certainly looking at right now, and again I'm going to caveat all of this because it can change subject to performance. But right now we're looking at probably $0.11 or so in short-term gains in the portfolio realized so far. We have another $0.05 of long-term gains in the portfolio and approximately $0.13 in 2007 to 2008 spillover that have taken place in the portfolio by itself. And you see from our press release today, we have already realized another $0.01 approximately, which does not include these numbers of long-term gains or so on one of our investments, Epicept, which we just realized some security gains on.

So again, we are well-positioned from our work trailing taxable earnings and the spillovers and these long-term gains and short-term gains, too well-positioned to more than cover the dividend.

Okay, great. Sorry, you said short-term (multiple speakers) gains was $0.11 and long-term was what?

Short-term was approximately $0.11, long-term was approximately $0.05, and spillover is approximately $0.13.

And that is on the year-to-date basis.

Okay, great. Thank you very much.

Quinton Maynard, Morehead Capital.

Congratulations on a good quarter, guys. Most of my questions have been answered. I just wanted a little bit of color on the $3.4 million, I thing that may be $3.5 million of depreciation, particularly in the light of the general loan quality improving in the quarter?

Right. It is made up of some unrealized losses that we had on some loans where we have actually written them down to an estimated realized value based on the company's performance so far. The net of that was about $718,000.

We have also had unrealized appreciation of a small amount in our equity portfolio and that was very nominal. The biggest part was just net unrealized depreciation in the warrant portfolio of about $2.8 million. And that is -- a lot of that is based -- we do the calculation on a Black-Scholes basis, and a lot of the depreciation has to do with volatility in the market and the way that the metrics are put into the Black-Scholes calculation. And also just some flat rounds or even down rounds of some of the private companies we have had recently. But again the biggest part of this is really related to the warrant portfolio which fluctuates quarter to quarter.

And let me say it further, it is broadly distributed with no one sale concentration making up that number. So it's not two or three companies. It is a basket of probably 15 to 20 different companies that make that up.

I really appreciate the color. It makes a lot of sense. As you look at the $4 million that you're preparing for sale, how much of the loan are you expecting to get back in that sale? Do you have any estimate internally on that?

Yes, we do actually. The number right now ranges from 98% to 99%.

That is a great number. Last question for you. With your stock being where it is right now, I don't know with the [RSCRs] whether this is even something you can do, but have you all given any consideration to buying back any stock? It looks like the stock is yielding about the same as the effective yield on the whole portfolio if not a little bit stronger.

Well, look, if you question every BDC right now that is asking themselves and you saw I think one of our other BDC brethren out there, BlackRock, announce a share buyback, we continue to look at that share buyback program. And clearly, you know, obviously your point is well taken that look at the yield on it.

But conversely we believe we can originate very similar yields anyway on the underlying investments that we are making. So it is a little bit of a push to either buy when you can actually originate the same yields, so I don't want to signal to the market that we cannot find good quality assets to underwrite. But clearly if the stock has sustained itself at these levels, it is certainly something that we will probably consider looking at it more deeper than we have.

But in the short-term, I think we are just going through a tough patch right now, and we're not seeing any abatement of good investment opportunities out there to take that precious capital and buy back our stock.

Alright, guys. Thanks so much. Congratulations and I will look forward to next quarter.

At this time we have no further questions in the queue, so I will turn the call back over to management for any additional or closing remarks.

Okay. Well, thank you, everybody, for joining us today. Thank you, operator. I want to reemphasize what I've said all along in each one of our calls, if any investor would like to meet with management as we prepare to be on a non-deal roadshow here over the next couple of weeks, please feel free to contact us at 650-289-3060, and we will be happy to arrange a meeting if we happen to be in one of the respective cities. But certainly management expects to be on the road here shortly to meet with the different investors in the Chicago, Boston, New York and California markets, as well as in any other markets that we see enough interest in meeting.

So again, thank you very much for your confidence in our team and Hercules and for being our shareholders. Thank you very much.

This does conclude today's teleconference. You may now disconnect, and have a great day.