Hercules Capital Inc (HTGC) 2009 Q3 法說會逐字稿

Good afternoon, and welcome to the Hercules Technology Growth Capital, Incorporated Third Quarter Earnings 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 any unauthorized broadcast of this call in any form is strictly prohibited.

I will now turn the call over to [Sharifa Afhousalam], Investor Relations Counsel to Hercules. You may go ahead, Ms. Afhousalam.

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 third quarter 2009 financial results were released just after today's market close. They can be accessed from the Company's website, at www.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 pass code provided in today's earnings release.

I'd 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 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' Co-Founder, Chairman, and CEO. Manuel?

Well, thank you, Sharifa. And thank you, everyone, for joining us this afternoon and for participating on this call.

I am very pleased, if not extremely happy, to report another solid quarter of performance for Hercules in an otherwise challenging environment, which seems to be improving.

We had a very solid net interest income -- or net investment income quarter of $0.30 a share, for $10.3 million. And our NIM, our net interest margin, continues to remain strong, at 13.7%. We also declared a dividend earlier this quarter for $0.30, which is more than covered by our operating income, something that most VCs can't necessarily say these days.

Beyond that, I turn my attention to the balance sheet. Again, our slow and steady strategy that we've adhered to for the last four or five quarters has proven to be a very effective strategy. We have a high level of cash balance at liquidity in our balance sheet, a solid balance sheet; in order to now commence new investment originations, which I'll talk to you more about during this call. That strong balance sheet has afforded us the ability to now look at other transactions larger in size, as we now turn our attention to more later-stage, more mature companies to continue to build our portfolio.

Also in the quarter, as we disclosed in the prior quarter, we realized a $14 million loss, attributed primarily to two companies which we had previously disclosed in the second quarter. And we still remain diligently attempting to sell some of the intellectual properties on one of those companies in order to hopefully, in the future, reverse or recover some of that loss that we'd experienced in the third quarter.

Beyond that, I want to remind everybody of a very important statement -- that although we took a $14 million realized loss in the third quarter, our total losses, inception to date, continued to be less than 1% of total committed capital since we started Hercules. Again, that is not what we had last quarter; it is, inception to date, less than 1%. I frankly believe it's an outstanding track record in this otherwise challenging credit environment and a testimony to the hard work of our investment professionals here at Hercules.

A positive note is the venture capital marketplace. I think the media has made much about nothing about the venture capital continued investment pace. We're delighted to see that the venture capitalists in fact deployed over $5 billion in new investment activities in the third quarter, which actually is in the upper end of our range, as we've been talking about in the last two or three earnings calls. That $5 billion investment rate is critical, because it was one of the catalysts that we were looking for in order to reignite or restart new investment activities, which we have begun here in the fourth quarter.

The $5 billion-plus invested by the venture capitalists in the third quarter was in 616 deals. And later-stage opportunities or, I should say, more mature companies, represented approximately 59% of the recipients of that capital, which goes right into our focus area of new investment activities. Conversely, only 16% of that capital was deployed at early-stage companies, an area which we have materially deemphasized for the last eight to 12 quarters.

Now, turning to a positive note, further -- the M&A and IPO market also has very strong signs of recovery underway. Although the number is still small on a historical basis, with $2.8 billion of activities taking place during the third quarter, we are nonetheless encouraged, because we were actively participant in the marketplace activities.

What I mean specifically to that is that we had two companies in IPO registration during the third quarter, one of which, I'm proud to announce, went public this morning -- Ancestry.com, which priced its IPO last evening at $13.50 a share and had a very successful first day of trading. In addition to that, we had Gomez, one of our companies which was in IPO registration -- also successfully reported after the quarter close; an acquisition with Compuware -- Computerware, excuse me -- for approximately $295 million, which we expect to see come to a closure sometime by the end of November; also boding well as a positive event in our portfolio.

In particular, the appreciation attributed to the Gomez is not reflected in a net asset value but in adherence to the requirements [that] we were making a disclosure that in our footnotes, we have an event that took place after the quarter on October 6.

Again, turning to the positive activities -- we're seeing a very strong pipeline of IPO activity in the fourth quarter. We're seeing an extremely robust M&A activity so far in the fourth quarter. So we're very encouraged by the size that we're seeing. And in fact, we believe that we're in an upswing, with liquidity expected to occur in the fourth quarter, somewhere in the neighborhood of over $1 billion of activities that we are aware of that are expected to occur in the fourth quarter.

Now, in terms of the overall landscape -- as we said, we have engaged in a slow and steady strategy for the four to five quarters in arrears. We have indicated in our second quarter earnings call that if the venture capital activity were to turn above a $5 billion level, we would once again recommence origination activities. I want to assure everybody that given our strong balance sheet and strong liquidity position that we have in fact commenced new investment activities. Because the typical nature on how Hercules underwrites activities, you can expect to see those assets start coming onto our balance sheet at the end of December, and most likely start showing a material impact to the (inaudible) balance sheet in the first quarter.

Now, that is important, because we continue to see a shrinking of our competitors. Liquidity remains a challenging issue for many of our competitors, with having no access to capital markets for credit lines, and [still the] inability to raise any equity capital, because the vast majority of our competitors are structured as LPGP interests, which means they have to go out and solicit capital from limited partners on a 10-year fund basis. And those capital pools are currently very difficult to gain access to.

Because of the lack of competitive nature out there, we're able to continue to see the best deals that are out there and able to cherry-pick the better deals, as we continue to do our underwriting platform and hopefully maintain the credit standard and discipline that we've shown in the past as we build new assets to our portfolio.

Now, the third quarter, as David will talk to you about shortly, was, as we expected, very slow to modest new investment activities, something that we had anticipated and we purposely wanted to do as we see the venture capital activity.

To change direction -- we continue to look at and broaden our reach within the marketplace. We're actively engaged right now in looking at hiring a number of new investment professionals and analysts as we continue to ramp up our new origination process into the first, and quarters beyond the next couple quarters in the future.

Because the economy is in the state that it's in, we're able to look at some of the best investment opportunities, but conversely also be able to identify and recruit very attractive individuals that this economy has afforded us to do, further bolstering our investment professional staff. That is critical as we continue to expand that new investment opportunities.

Now, with that, I'll turn the call over to David. And we will be more than happy to get into more specific issues related to the broader economy, the venture capital activity, and our investment performance in the Q&A session of the call. David?

Thank you, Manuel.

Despite a marketplace that continues to be a challenge in which to invest, we believe our results from operations for the quarter proves out the conservative investment strategy that we have taken over the last several quarters.

Today, I'd like to focus on a couple things -- continued strong NII achievements, and liquidity and capital resources. During Q&A, Manuel and I will be more than happy to respond to questions you have on other operating results that I do not specifically address during my discussion.

First I will touch on Q3 operating results. As we reported today, year-over-year, we had growth in NII and net interest margin. We achieved approximately $17.7 million of investment income for the quarter and maintained a strong net interest margin at 13.68% for the quarter.

We continued to generate a solid effective yield on our debt investments during the quarter at 15.1%, compared to 16.1% in the preceding quarter. While down slightly from the second quarter, due to lower income from acceleration of fees and interest from early loan repayments and loan amendments, this yield still exceeds the yield we have generated since the third quarter of 2007. I would like to remind our investors that fee income is often composed of one-time event-driven fees, and we currently anticipate that our Q4 fee income will not be as high as Q3.

Compared to the same quarter last year, we were able to reduce our cost of debt from $4.5 million to $2.4 million by decreasing our average debt balance outstanding from $221 million to $130.6 million, primarily due to the repayment of the [Citibank] credit facility in March of this year.

All of these factors -- maintaining effective yield, reducing our cost of debt and managing operating expenses -- contributed to our Q3 net investment income of $10.3 million, or $0.30 per share; and distributable taxable income of $9.9 million, or $0.29 per share.

Turning to credit performance -- we continued to be vigilant in monitoring our portfolio and mitigating losses by identifying troubled credits early. The weighted average loan rating of our portfolio improved slightly to 2.66, compared to 2.70 at the end of the last quarter. This slight improvement in grading was primarily attributable to the decrease in companies rated 4 and 5 from approximately 21.7% to 20.3% of the total debt portfolio on a cost basis.

We posted net unrealized appreciation on the portfolio of $17.5 million, primarily attributed to the reversal of unrealized losses when writing investments off to realized losses. As of the end of the quarter, we had four companies that are on non-accrual, with a combined carrying value of approximately $2.4 million, or less than 0.6% of the fair value of our loan portfolio; and less than 6.4% on a cost basis.

Our portfolio is not impervious to the vagaries of the current financial markets. In the quarter, we had three portfolio companies cease operations. And consequently, we took realized losses of $14.6 million on these investments. As Manuel indicated, since inception, net realized losses total approximately $15.2 million and represent less than 1% of total loan commitments since inception of greater than $1.5 billion of commitments.

While the economy is showing signs of improvement, it is by no means what we consider healthy. We anticipate that we will have additional realized losses, as our portfolio companies work through this prolonged economic downturn.

As we have indicated before, liquidity remains one of our top priorities. On that note, I'd like to discuss Hercules' liquidity and capital resources.

Our strategy for the last few quarters has been, and is, to remain as liquid as possible, until we are comfortable that the VC investment activities have normalized. While VC investments increased to $5 billion in the third quarter, we are looking to the investment activity in the fourth quarter of this year as an indicator of the upward trend and return to a normal activity base. With our cash, low leverage and steady cash flows from loan repayments, we believe we will be in a strong position to increase the pace of our investing as the market improves.

I'm pleased to announce that in this tight credit market, on October 28th, 2009, we agreed to a term sheet with Union Bank of California for a $20 million one-year revolving credit facility. Cost of debt under the facility is LIBOR plus 2.25%, with a floor of 4%; an advance rate of 50% against eligible loans, and secured by loans in the borrowing base. Finalization of the facility is subject to completion of the loan documents.

As of September 30th, we had $77.2 million in cash, and our only debt was $130.6 million in our SBA loan. In addition, we have access to $50 million of borrowings under the credit facility with Wells Fargo, subject to advance rates. And the $150 million maximum available under the SBA program provides us with an additional borrowing capacity of $19.4 million, subject to regulatory limitations.

The combined access to capital from these potential sources and our cash on hand as of quarter end totals approximately $167 million. Combined with future principal collections, this access to capital places us in an advantageous position to invest as we enter the fourth quarter.

In addition, I'd like to note that we have submitted our application for our second license with the SBA, which would allow us to borrow up to $225 million. Based upon our first license approval history and current indications, we anticipate that our license would be approved in Q1 or early Q2 of 2010. Finally, as we finish -- finally, as we announced in October, our Board of Directors has authorized a cash dividend of $0.30 per share payable on November 23rd for shareholders of record of October 20th.

At the end of the year, we may also pay a fifth dividend, such that we may distribute approximate 98% of our annual taxable income in the year it was earned, instead of spilling over excess taxable income. The payment of a fifth dividend is subject to the approval of our Board of Directors.

In closing, we believe we are in a strong financial position and will be ready to increase the pace of our new commitments as the market turns.

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

(Operator instructions) John Hecht, JMP Securities.

Good afternoon. Congratulations on another good quarter.

Just a couple quick questions -- one, Manuel -- you mentioned we're getting toward a ramp-up of, I think, about $5 billion a quarter. And historically, you've talked that you'd get more comfort in the $6 billion range in terms of venture capital deployment, where you think you'd be able to really improve your investment volume. Is that still the case? What trajectory are we on, in order to kind of assess what time you might be ramping up your investments?

Well, let's make sure we kind of go through our historical chronology on our expectations of the venture capital industry that we've been talking about now since the -- [almost, in essence], third quarter of 2008.

Just to give you a recap -- the venture capital activity in 2008 was approximately $31 billion or so of the investment activity. We had said in the fourth quarter 2008 that we expected the venture capital marketplace would do about $22 billion to $24 billion in 2009. So we already had expected, and factored into our origination activities, a shrinking, if you will, of the venture capital industry.

Then we were all, of course, surprised by the Q1 result, about $3.9 billion, $4 billion of venture capital activity in Q1, which allowed us to somewhat remain affirmed on our slow-and-steady policy of now putting capital to work. We then updated that in Q2 by saying that we're looking for calendar 2009 to be anywhere between an $18 billion and $20 billion investment activity before we really want to start originating a meaningful amount of capital.

So today, right now, we're at run rate at about an $18 billion, $20 billion level today. And as most people may or may not recall, the third quarter is generally the lowest origination volume for the venture capital industry itself. So having a $5 billion number, although down year-over-year, is certainly a very positive [note] that I was expecting to see at least $4.5 billion to $5 billion.

So that said, without -- not being shy about it, I'm expecting to see greater than $5 billion in Q4 to kind of top us off at an over $20 billion run rate of investment activities by the venture capital, which really strongly affirms our interest in continuing to look at those deals. The fact now that we don't have a lot of competitors out there -- we're now able to kind of look at those transactions and have our first bite at the apple.

Great. Thanks very much.

The -- on the fee line, you've had pretty consistent fees, in the $2.5 million to $3 million-plus range, despite low origination activity. And I know part of that's in the way you conservatively account for them. But as you ramp up, should we still expect to see pretty strong fee income? Or is there something else we need to consider in that regard?

John, I think as we indicated earlier, we expect the fourth quarter to be down. We've done a lot of restructurings over the course of the second and third quarter, where we had $3.6 million in the second quarter and $3.1 million this quarter in fees. So we're certainly expecting it to be south of that, as we've been able to stabilize our portfolio.

John, we feel like a broken record on this. We constantly tell everybody that even we have difficulties trying to project and model out the so-called one-time fee that eventually turn into a perpetuity of one-time fees. So it's hard. I think that we've always said that the one -- the so-called fee income line has probably a $1 million swing to it, on a quarter-by-quarter basis. I mean, conservatively $600,000; aggressively $1 million swing to it. And it just is very, very hard to predict.

But I want to expand on something you said. I think we're one of the few VDCs that do take a very conservative stand on fee recognition. We have approximately $3.2 million of deferred fees on our balance sheet, which is quite sizeable, from earnings that are there to bring current.

Okay, yes.

And then, Manuel, what industries right now make you most excited? I know you -- historically, you've stayed a little away from clean tech, given all the hype around it. Is that changing? Where are you, in sort of the biotech software industries? And where do you expect to deploy the most capital in 2010?

I think that our portfolio's indicative of sort of what we believe in, from an investment piece, in terms of asset originations and asset focus. I continue to revel that we have made the right decision on not jumping into the whole clean tech phenomenon, or clean tech euphoria. As was indicated, the venture capital activity in the third quarter -- that saw the greatest contraction of venture capital flows of any industry.

Conversely, IT did quite strong in the fourth quarter. IT did about -- excuse me, third quarter. IT, information technologies, actually had about $1.9 billion of activities, with healthcare having $1.7 billion.

In terms of specific industry verticals that we like, we still remain very strongly committed to communications and networking. We still think those are areas that are underinvested. We're seeing very good backlog buildup from our semiconductor portfolio. It's a very contradictory segment of the market to invest in, but we're seeing early indications from our semiconductor companies, via their backlogs and bookings building up, that are quite encouraging. So we're seeing that as an area that we like quite a bit. And we've been making more investments in that area.

Software, which has been an underinvested area -- we're beginning to see very promising signs of hope there. And in the life sciences, I think that we have a portfolio that we've managed down to, I think, too low a level. I think we're about a 30% or so investment level in the life sciences area. And I'd like to see that, in calendar 2010, get up to probably a 35% to 40% range area. And life sciences now -- been somewhat underinvested, I believe. And that's an area we'll probably start bolstering up in 2010.

Great. Thank you guys very much for answering my questions.

Greg Mason, Stifel Nicolaus.

Good afternoon.

Manuel, can you talk a little bit about the dividend? Last quarter, you announced that you were going to go to a quarterly dividend policy of 90% to 95% of taxable income, and then do a true-up as a fifth dividend. As we look at numbers this quarter, you announced $0.29 of taxable and the $0.30 dividend. Is there a change in kind of what your thoughts were, last quarter to this quarter, regarding the dividend?

No, not at all. I think our dividend policy remains consistent to that. I think that we are well on our way to making a fifth distribution. I believe that the numbers that we have declared are now $1.22 in dividends.

[Right].

And we've paid out approximately $0.92 of that. And so the final payment is at the end of November.

November 23rd.

November 23rd for that. And you look at -- the earnings that will happen between now and the end of the year will further bolster the taxable income for calendar 2009.

In addition to the carryover we had from --

In addition to the carryover.

Okay. Great.

And can you talk about -- once you finally get all your origination ramped up and running, what type of run rate do you foresee? Back in -- when you were fully originating before, you were running on average $90 million to $100 million a quarter. What do you think of your pace this time, once you get fully up and running?

Well, I'm going to caution the statement by saying -- I'm going to answer in a very general way, because I -- by any stretch of the imagination want to infer or give guidance to what that number may look like.

I think that the historical performance of Hercules is probably indicative of what that investment pace would be. Just to remind everybody again -- the busiest quarter in a normalized market is Q4 and Q1, and the slowest quarter is being Q3. So you're probably seeing Q1 this year will probably be disproportionally greater, with probably some spillover happening in Q2.

So broadly speaking, on a normalized market, Hercules can do between $250 million to $450 million a year in kind of investment activities. However, we have to be cognizant of the environment that we're in. And that is the credit lines are not something that are easily available out there, which is why we've been diligently pursuing our SBA second license, in order to have adequate capital to continue to fund our growth.

But we remain cautious on not overspending on liquidity until we see very strong affirmation in the marketplace of credit lines being available. And I cannot tell you right now that I have a high reliance that credit lines are all available [after] today.

Right, makes sense.

And then one final question -- on the comp and benefit line, on the income statement -- looked low this quarter, at least relative to the last two quarters. What was the cause for that, and what should we think about on a go-forward basis?

I think that the comp and benefit -- some of it was just taxes coming down. Some of it was employees that had left. And then, we were normalizing our bonus for the year as well.

And also, we had options that had vested already, that are no longer being accounted for [on a 123].

And last year in the fourth quarter, the comp and benefit went up significantly for an accrual. Should we think of something happening like that this year, or is it relatively stable?

No, I think it's relatively stable. I'm not anticipating -- and again, this is -- it is entirely out of my control, [the] Board's [compensation] -- but we're not anticipating any disproportionally spike or out of the ordinary last-minute accrual.

Great. Thank you, gentlemen.

Vernon Plack, BB&T Capital Markets.

Thanks, but my questions have all been answered.

All right.

Jasper Birch; Fox-Pitt, Kelton.

Good afternoon, gentlemen.

Going back to comp and benefit -- sorry if I missed this; I hopped on the call late. In expanding your employee base, can you give us an idea of where headcount is now, where it's going to go, and what sort of long-term run rate on your --

Sure. I think we have approximately 43 FTEs, full-time headcount, in the Company today. And we're looking at adding anywhere between three to seven people. It's really market opportunity-driven and talent-driven, to be honest with you. But that three to seven people will be added over the next two quarters. You could probably see one or two added before year end and probably two or three added sometime in the middle of Q1.

But again, just like we have done historically, this is not a jump in, both feet first, into the pond and start paddling. I mean, we're all about walking in gently, looking at the marketplace. And just like we manage our investment portfolio, we manage our hiring processes as well. So this is not suddenly seeing a spike in SG&A without seeing [gil traction]. But SG&A will always lead -- SG&A expenses always lead originations.

Okay. So I guess I'll just figure out -- [the new] guidance on how high it's going to go, you expect?

We don't give guidance on any of our numbers. But again, I think that you can probably extrapolate from my comments on hiring two to three people between now and year end, and hiring three to four people sometime in the first quarter, with some kind of an average estimate, what you think comp should be for those people, as a way of kind of putting your model. I think that would be a practical way of looking at the equation. But we don't give guidance on our numbers.

Okay. Yes, that's good enough.

In terms of the SBA fee license, thank you for the timeline. Are there any more milestones that we'll see before you actually get it?

Well, let me be clear. We have to caution everything that we're doing with the US government. So we are at the mercy of the process and at mercy of our regulators and our congressional leaders, if anything changes or not.

I think that the new administration, the SBA, and the streamlining at the SBA staff is done. And I frankly think that the new SBA staff and their improvements are moving things along very diligently. I think that they have a -- I won't call it "mandate;" that may be too strong a word. But they certainly have a mission to attempt to get the final application -- which is submitted, which is what we just did -- to approval somewhere in the neighborhood of under four months.

Now, what that means I don't know. But we're encouraged by those words by the SBA and the staff, which has been very helpful to us in this process on moving that along. So we remain very encouraged that sometime in the first quarter -- and I would be surprised if it spills over to the second quarter, but to be cautious, it may spill over to the first month of so of the second quarter -- will get approved. But I remain fairly optimistic, given my words with the SBA and the SBA staff, on seeing something come to fruition here in the first quarter of 2010.

Excellent.

In terms of -- thank you for the added color you always give on the venture capital marketplace, it's always helpful. In terms of continuing strong pace of investment, has that really carried over into enterprise values in your company?

As I indicated in my -- some of my remarks, and certainly in the press release, we're seeing that stabilization of valuations happening in our portfolio. I mean, I'm happy to say that. Some of our companies now we're seeing in multiple term sheets, something I could not have said a year ago, or even nine months ago. The fact that companies are getting term sheets in itself is a good sign. And getting multiple term sheets allows the whole nature of capitalism to now, once again, rear its beautiful head on having a competitive nature on bidding for transactions.

So we're not in the heydays of '99, where you've seen multiple -- five or six term sheets coming in. With the sheer fact that we're seeing one or two term sheets now being in the bidding process for our companies only serves to bolster valuations for the underlying companies. So it's encouraging.

But again, I don't want to call two quarters a trajectory that we're on. We're certainly very encouraged by what we're seeing. And Q4 results north of $5 billion will certainly make us now much more comfortable that we're in the right pace. But it's nonetheless encouraging in seeing stabilization on valuations going on.

Okay.

And then, just would you guys remind me, what was your carryover into this year?

The dividend carryover?

Yes.

Of $0.18.

$0.18, okay. Thank you guys a lot.

Jon Arfstrom, RBC Capital Markets.

Thanks. Good afternoon, guys.

Hey, Jon.

Just one more question on the pipeline -- would you say that -- is the pipeline growing as a result of your willingness to be more active, or is there more organic activity, if you will? And then also, maybe comment on the quality of the pipeline compared to maybe how it looked one and two quarters ago?

Well, your question, academically, is a lot more -- deeper than you think. And there's a lot of things that would drive the demand, is what you're basically referring to.

Yes.

There is one -- certainly, the propensity for companies seeking venture capital dollars, with the contraction that's taken place in the venture capital community, that suddenly the debt market becomes a highly coveted, highly sought-out form of less dilutive capital. So believe it or not, the contraction of the venture capital industry in itself has caused a mushrooming of demand for venture debt.

Now, that also yields [a bad] issue, which is more demand does not necessarily equate to quality with the companies, which means our workload has now gone up even higher, where you have to sort through a lot more potential candidates for investment opportunities and have to adhere to the credit underwriting standards of Hercules, which arguably are quite tough; I'm not going to deny that.

The third element of that is that we are the only guys, or meaningful only player out there, who has any rapidly available liquidity to help fund that demand out there. So we are now being sought after by many of the venture capital and private companies for a source of funding that the other ones would not get either from a commercial bank, which is limited in its capability; or some of our private competitors who have no liquidity whatsoever to fulfill that demand. So we have that working for us as well.

So to values as a proverbial perfect storm, you have the three elements of the venture capital marketplace not having the [historically] freely available equity capital coming in. Venture capital companies looking for alternative sources of capital are less dilutive. And now, our ability to have capital available is causing quite a significant demand for our capital.

So these are all good things. But like anything that's good, you have to drink in moderation, and just not lose control of your checks and balances that you underwrite as you deal. So we're going to maintain a discipline in that origination activity that will probably be slower than we should. But I'm happy starting off slower than too aggressive.

Okay. And the hiring is originators. Is that -- am I reading that correctly?

The hiring is almost entirely earmarked for origination activities, both at the managing director level but also in our analyst level as well. It is all earmarked for new investment-origination activities. It's to fulfill this growing market demand that we have, as I just described, that as we're getting more and more deal volume through, we're getting buried with opportunities. And we want to be able to sort through that deal -- the pipeline greater and faster than our current staffing levels really permit us to, and not cut corners and find ourselves underwriting an inferior credit, just because we don't have the right staffing. That would be a silly thing to do.

Okay, makes sense.

And then, just a question on a comment you made earlier about larger-size deals and more focus on later-stage -- just wondering how your appetite has changed for what would be a typical-size credit maybe a year ago versus today, and then how the warrant equation might change as you get into the later-stage.

Well, I think you have a lot of those companies in our portfolio we've got to point to right now. I mean, Ancestry.com is probably one of the best examples of a later-stage deal that we did, that also had an equity derivative or equity component to it in the form of, in this case, equity into the Company with a debt transaction.

So we like later-stage companies, because they have two benefits that are accretive to our shareholders. You have one, they're [highly] likely than not to go public sooner than later than an early-stage Series A or Series B company; and two, there's a greater propensity that as a company continues to mature and develop, that it's highly likely that our debt eventually get refinanced out by a more traditional large-cap commercial bank to fulfill the needs of that growing company, which means our objective [is] to be paid sooner than later.

Yes.

So you have the ability to harvest equity upside sooner, and you have the ability to recycle your capital faster. And you have greater credit stability in those credits that we're talking about in more mature companies.

And then, just in terms of credit size, maybe you're willing --

Credit size is not going to really move much. You're looking at, in all honesty -- $10 million to $20 million as kind of the broad range, with a sweet spot of probably $15 million to $17 million, is probably what you're looking at there. But to caution the statement -- those companies will typically be much more ABL-type loans, which means they have asset-based lending types, where you actually advance and get some multiple of EBITDA. And you're [both] looking at the downside from an intellectual property point of view as a further governor of downside risk. So it's a hybrid of traditional asset-based lending and what we do in the venture-stage companies.

We're now looking to do what's called HLTs, high-leverage transactions. We're not looking to do any of that. We do not like deals greater than 4.5 times leverage on EBITDA in those transactions.

Okay. Okay, thanks, Manuel. Thanks, David.

Bob Napoli, Piper Jaffray.

Good afternoon.

Well, welcome, Bob.

Thank you, Manuel.

Question -- the healthcare bill -- you guys have a lot of investments in the healthcare sector, and healthcare bills, which healthcare bill. But have you guys been trying to track closely what is going on in Washington, D.C.? And do you have any thoughts, good or bad, on the direction that if something gets passed, what effects it may have on some of your investments?

Well, Bob, we all know the labyrinth of our congressional legislators. And that labyrinth to navigate is one that even my compass can't get me through. It is a very, very difficult thing to ascertain. We think, however, it will be accretive to us in a [process]. We think it might benefit medical device companies probably a little bit better than some of the compounds. On the biologic side of the business, we think it'll definitely be accretive to medical devices. We have shifted more attention towards medical devices out there.

That said, we still have, as we saw evidenced in the third quarter, one of our companies, Quatrex, was a company that just received FDA approval, which was very favorable. That occurred in the third quarter, which is important to us. And we have other companies right now, that are in the FDA process, that we think will benefit from that.

But honestly, I'll be totally -- I have no idea what in the world, or which bill --

Right.

-- is going to pass, whether the healthcare for all, or healthcare limited for all. I mean, I don't know.

If anything.

If anything -- well, I think something will pass.

Yes.

But we're positioned either way for that. I mean, if you look at the statute itself, or the [legislated] that's moving through, there are segments of the market that will benefit from it. I mean, you're talking about -- automated record-management systems will benefit. Information technologies and healthcare industries are going be very benefitted from that automation requirement.

The whole gist of the healthcare plan is removing costs in the system. And the only way to remove costs in the system is automation, in order to be able to track and get fraud out of the process. And you need systems and technologies to do that. So healthcare information technologies is actually quite an interesting area that we're seeing receiving some levels of rejuvenation out there.

Makes sense. Okay.

With regards to pricing -- being the only provider of capital to the market -- and obviously, pricing comes in yield, and it comes in warrants -- shouldn't you be able to continue to modestly ratchet your pricing? I mean, it's -- I think in the business that you're in, there are high risks. And I think that the returns you get probably wouldn't -- I mean, I think you could probably price up a little bit and still be reasonable.

Well, I mean, "reasonable" is in the eye of the beholder, or the eye of the recipient. I mean, what you think is reasonable and what I think is reasonable [as a] venture capitalist or CEO, we [just started this company], I think that's outrageous and extortionist.

So it really varies. I mean, in all honesty, there's a point in time where there's a natural equilibrium that takes place in the business that we do. And that is when the cost of debt starts exceeding that of the equity capital. And so there's an inherent glass ceiling that actually does take place. And you start bumping up against it right now, in the 14% range or so, that you see on a current yield basis.

So I personally would like to see the venture industry modulate right back down to where I think it should be, which is more in the 11.5% to 13.5% range. And you see more mature companies, the later-stage companies, should modulate down to a 12.5% to 14% range today. And in the marketplace, on the more mature companies, the average yields you're seeing are more in the neighborhood of 14% and 16% current cash yields, while the venture-stage companies are probably the 14% -- I would say 13% to 15% range or so. That's not sustainable, and I don't think our investors should model that in.

I expect certainly to see those pricings start coming down a bit in the 2010 calendar timeframe. Because eventually, you start stepping on the equity dollar's toes, and that doesn't make a lot of sense. Because if the debt differential to equity is only 500 basis points, the company's going to go and do an equity deal and just take the dilution.

Okay. Makes sense, Manuel.

Question on the bank lending market -- you've done a nice job on the funding side. But are you sensing any discussions with lenders, or any additional activity from lenders, any additional willingness to lend from banks to companies like yours?

We remain the eligible bachelorette. We are continuously looking for structured finance products. We continue to work with our partners. I think that Union Bank was clearly a testimony to our underlying credit performance. Wells Fargo continues and remains a very good partner for us. We are in discus with them to probably increase that line.

As we turn to the renewals sometime in the early part of 2010, as we start initiating those discussions, I am encouraged. However, [of] my conversation over the last couple of months with other credit providers that are out there, I think that some of the VDCs that are all know, that have now fixed themselves or are now righting the ship a bit better, is helping to improve the market outlook.

So I remain optimistic that in the first quarter to the second quarter of 2010 that we should be able to add additional lenders into that syndicate.

Great. Thank you.

(Operator instructions) Douglas Harter, Credit Suisse.

Thanks.

I was wondering if you talk about the repayment activity you guys had in this most recent quarter, and sort of the outlook for the coming quarter.

Sure. David, why don't you --

We had about $29 million from early repayments that happened this quarter. We will see additional repayments come in ahead of schedule, I think, in the fourth quarter. But at this point in time, I don't know that we're looking at a significant dollar amount for that. I think we're going to return to more of a normalized amount.

Yes, Doug, we've been -- how do I say this politely -- we've been strongly encouraging certain companies to pay us back as opposed to others. And so, if we feel that you're on kind of the margin or the cusp of the credit risk, we will be more than encouraging you to potentially cycle out and pay us off early, if you will, as a way of further mitigating credit risk in our balance sheet, as we've been doing all along. But I think that we're kind of reaching a plateau of that, which is why we're turning our attention now to new origination. I think that that cycling through, or that strong encouragement, is coming to an end.

Is that, sort of cycling through -- is that because you've kind of already gone through the entire portfolio? Or is that kind of because you're seeing more signs of stability within the portfolio companies? Just sort of help us --

I think it's a combination of both. I feel pretty strongly that the net asset value right now adequately reflects our near-term credit concerns from what we know today. So I think that the impairments and mark-to-markets that have been taken in the net asset value as unrealized or depreciated assets really reflect what we strongly believe is our credit position exposure to our companies today. So I'm not anticipating any surprises.

Now, I will couch that by saying that I have two companies that are in SBA clinical trial processes that -- those are always surprises that you can't mitigate, [whether favorable positively]. But that's part of the underlying business model that we do. That's a calculated risk that we take on the life sciences companies, where they have the somewhat binary events that take place, that are totally out of our control. Either the animal trials worked, or they didn't work. Or the human trials worked, or they didn't work.

But that said, I think that the underlying portfolio adequately reflects, on an appreciated basis, what we think that the credit concerns for the near term look like.

All right. Thank you, that's helpful.

John Sites, Sterne, Agee.

Good afternoon, everyone.

Hey, John.

I just had a question about just general strategy. What kind of signposts are you looking for as a signal to diversify your investments more in the growth cycle, going more towards early-stage? Is it the move in pricing down to 10% to 12% that will precipitate that? Or kind of what are you looking for there?

Look, we remain believers in early-stage companies. I don't want to throw early-stage companies under the bus here, and necessarily so. I think that would be an imprudent thing to do, and not a wise thing to do.

I think that the real indications for early-stage investing is -- one are the venture capital investment activities. Until you return to a more normalized market of venture capital activities, which is an ecosystem which I've talked about in the past, which is quite important -- without the liquidity markets being open, meaning M&A and IPO activities, the venture capitalist cannot harvest returns which then need to get paid out to limited partners. If the limited partners don't receive capital return, they can't make new pledges to venture capital firms.

So the ecosystem has been broken for quite a long time. However, turning now to the third quarter, and certainly strongly into the fourth quarter, that ecosystem is showing very much signs of resilience that allow me to get more comfortable that sometime in 2010 -- probably Q3 and beyond -- remaking a conscious deployment to early-stage venture capital firms is something that we'll shift some attention to. However, early-stage deals are typically $1 million to $4 million in size, while later-stage deals are anywhere [between] $10 million to $20 million in size. So it takes a lot more work to do early-stage deals.

So early-stage deals are less driven by current cash yields and more driven by the predictability of a secondary follow-on equity [round] of financing to take place, and the Company be able to achieve its milestones to garner that [next round of] financing. When that [net] equity charge to capital is at risk, it doesn't make a lot of sense to put capital deploying in early-stage companies. So you automatically shift your attention to the more later-stage companies, as what we're doing today.

Okay, that makes sense. Thanks for your time, guys.

You're very welcome.

And with no further questions in queue, I'd like to turn it back over to Mr. Henriquez for any additional comments and closing remarks.

Well, thank you, operator. And thank you everyone for your continued interest in supporting Hercules Technology Growth Capital.

If you would like to arrange a meeting with us, as we continue to plan our (inaudible) road show here, as we typically do at the end of the earnings call, please give a call to David Lund or myself, at 650-289-3061. We still anticipate being on the road here in the next couple weeks, as we typically do in meeting with investors. And happy to take meetings with any investor we can fit in our schedule.

Again, thank you very much for participating and being our shareholder of Hercules. And have a good day.

That does conclude today's Conference. Thank you for your participation.