Hercules Capital Inc (HTGC) 2009 Q4 法說會逐字稿

Good day and welcome to the Fourth Quarter 2009 Hercules Technology Growth Capital Conference Call. This call is being recorded. Now, at this time I'd like to turn the conference over to Mr. Jason Golz. Please, go ahead.

Thank you, Anthony. Good afternoon, everyone. Presenting on today's call are Manuel Henriquez, Hercules' Co-Founder, Chairman, and CEO; and David Lund, the CFO. Our fourth quarter 2009 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've arranged for a taped replay of today's call which will be available through our website or by using the telephone numbers and pass code provided in today's earning 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 to do so by law. To obtain copies of our latest SEC filings, please visit SEC.gov or visit our website.

I would now like to turn the call over to Manuel Henriquez, Hercules Co-Founder, Chairman and CEO. Manuel?

Thank you, Jason. Good afternoon, everybody. Thanks for joining us today on our fourth quarter and 2009 earnings call. Most of you have now received and probably reviewed the three releases we issued after the market closed. It includes our stock dividend, our stock repurchase, and of course our Q4 and 2009 earnings call press release, all of which we'll be discussing during this call and certainly during the Q&A session.

Let me first start off by saying that we completed another terrific quarter. We worked through what I consider to be one of the most difficult periods of time in American history as we continue to perform and excel in a very difficult time and the Hercules team once again delivered solid results by continuing to protect the balance sheet and increase our liquidity as evidenced in our ending liquidity balance and our outstanding credit performance in this most difficult time.

Let me now take an opportunity to talk to you about some of the quarterly high level results on which David Lund will expand during his section as to some of our achievements. Net interest income or net investment income, excuse me, more repurchase NII of $9.4 million during the quarter for GAAP earnings of $0.27 per share and taxable earnings of $0.20 a share which David again will discuss further in his section.

Our net interest margin remains quite solid. Our net interest margin was at 12.82% while our effective yield was at over 13%, further showing you the earning capabilities of our portfolio. As must people here have seen that we have continued to consciously manage down our investment portfolio as we bolster up our liquidity resources and therefore you'll see that as our portfolio continues to climb, we made the conscious decision to also adjust our dividend to reflect our current portfolio earnings power.

That portfolio we anticipate to once again start to rebuild during 2010 and of course using a variable dividend, you'll see the dividend be adjusted on a quarter by quarter basis up as we see the earning assets continue to build. Because of that, I'm happy to report that in 2009, our board of directors declared and paid a dividend of $1.26 per share of which $0.04 was a special dividend paid to our shareholders at year end. This, by the way, is a reminder that Hercules maintained and continued to pay its dividend throughout 2009 while many of our publically traded BDC peers were either cutting or fully eliminating the dividends during 2009 as they suffered through the tough credit environment that they encountered.

On that, let me take a moment to speak about asset quality and credit. Again, credit and credit performance is a core area of focus in competency here for Hercules. We take credit very, very seriously. That credit performance has translated into a very high performing portfolio and I'd like to remind everybody that during the course or I should say since inception, we've originated over $1.6 billion of new investment commitments to technology and life sciences companies and we have suffered an aggregated total principle loss of less than 1.8% of our entire portfolio or, said differently, about 30 basis points per year on a realized credit loss. That is not last quarter, last year. That is the entire life span since we started his Company. That is an important part on how we view the marketplace and make new investment decisions as we continue to build our portfolio.

Now, let me give you some examples of how we mitigate this credit performance and how we managed to avoid losing capital. We take a very active and very proactive approach with our portfolio companies and their financial sponsors. If and when it's mandated, we will take on a more active position with the companies such as we've done with companies in the past called Concuity and most recently companies such as iBAHN, InfoLogix, and currently working on a transaction like Spa Chakra.

In the example of Concuity, most of you may recall that when we took on the board seats of that Company, we successfully were able to protect our downside and turn around and sell the transaction of the Company in the future for full recovery of our debt investment and a small gain. iBAHN is another example of that. iBAHN is a wireless, microwave, antenna manufacturer who is now handling and the leader in the 70 to 80 megawatts band of backhauling traffic on telecommunications companies. iBAHN is a fantastic testament to Hercules working with management, restructuring the company and it's now a poster child of an incredibly well performing company that we see very good long-term capital appreciation potential from that investment.

InfoLogix is a very similar situation where we have recently restructured our credit facility. We currently have three of the board seats of the seven at the Company and we're actively engaged in the company; however, InfoLogix, similar to what you'd expect to see happen is currently working through a lot of its ongoing operational issues and we're continuing to work diligently with the company. And although we're very optimistic about the outcome of the company, we still have some near-term changes that we're working with management in order to ensure a long-term, vibrant, survivability of the company.

Now, continuing to move along in our credit portfolio, we're currently involved also in a company called Spa Chakra which is currently engaged in a 363 bankruptcy process. Although we're one of the bidders, interested bidders for that asset, we are not at all assured that we may be the winning bidder. So, we will be elaborating further on the Spa Chakra situation as the bankruptcy process continues and we feel very optimistic that in the event that we're outfitted, that mean the recoverably of our debt is almost assure to be 100%. If we're not updated and we take control of the company, we believe the company represents a potential interesting opportunity to recoup all of our investment and if not also capital gains somewhere down the road. But it will require a quite significant amount of time on our behalf to ensure the successful turnaround of that situation.

Again, these are what our Hercules core competency both in underwriting and in managing our downside credit risks. It's a key differentiation between us and the rest of the BDC industry. That said, our overall credit quality remains quite strong and in fact the weighted average credit rating to the portfolio this quarter was 2.7, slightly up from the previous quarter but nothing significant. And of that 2.7 weighted rating, I'm happy to report that three companies that had been recently downgraded are in the midst of closing new equity rounds of financing that we anticipate occurring as early as next week or within the next two weeks starting the process of closing as we speak.

In closing on this section, the real story is Hercules' ability to successfully manage through one off the worst credit crises in the history of this country. I'm very proud of the achievement, hard work, and dedication of the entire Hercules team that has successfully allowed us to navigate these most difficult times by managing a credit loss to less than 1.8% of our entire commitment investment portfolio. That in itself is not a small feat. It is clearly something that should be recognized as the talent of the investment professionals and individuals we have in this organization. Without them, we would not have a Hercules.

I want to emphasize that Hercules' credit performance is also due to our expectations and managing of the broader venture capital marketplace activities and our expectations of what that venture capital market activity was going in a direction, meaning that back in 2003 in the third quarter, you may recall that we had at that point had forecasted a shrinking of the venture capital investment community. We had indicated at that point back in 2003 that we expected the venture capital community to shrink from a $31 billion investment activity for 2008 and to somewhere in the order of $24 billion to $26 billion. Upon the closing of 2008 when the venture capital results came out, we then came back and adjusted our expectations for the venture capital industry to around $20 billion to $22 billion which I'm happy to report the number for 2009 came in around $21.4 billion, right where we expected. But that's important because we actually took steps to take modifying our business processes and start managing credit and start enhancing our liquidity position in anticipation of this contraction in the venture capital industry that ended up happening.

Now, let me speak to some of the venture capital activities and what has gone on and transpired both in 2009 and the fourth quarter 2009 and where the venture industry is going in our view. As I indicated, 2008 represented $31 billion of venture capital activity. 2009 finished at $21.4 billion venture invested activities. This data of course is from Dow Jones VentureSource. The contraction was expected. The contraction represented about 30% of the investment dollars. I would like to remind everybody that I've been in this business for over 25 years. I weathered through the S&L crisis of 1980 as well as the early 90s S&L crisis followed by the dot-com bust of 2000 and 2001. This team including myself is well adapt into managing through difficult environments as you've seen translated in our performance.

Now, the venture capital industry, despite a lot of the media is alive and well. It is smaller but certainly quite vibrant. $21 billion of investment activity is nothing to ignore. Not only is it anything you should ignore, it's also beneficial to us because although it's $21 billion, our competitors are also significantly reduced if not gone. We're not seeing a lot of competition that is at all threatening from a lot of our private fund type structured venture investors that are out there -- excuse me -- venture debt investors that are out there.

The venture capital activity had a fairly robust fourth quarter, deploying $6.3 billion of investor capital as compared to $5.4 billion in the prior quarter to 743 different companies. Our life sciences group is benefiting from that investment activity while the venture capitalists made significant investments in the life sciences sector and we're seeing that translated into our pipeline of new investment activities or potential investments in the life sciences sector.

I'm proud to say I consider us having one of the best venture life science investors in the industry, Parag Shah, who heads up our life sciences and who has an exceptional talent and a great, great ability to manage through very difficult times in a life sciences portfolio. We are looking to Parag in the first quarter to continue to lead our investment origination efforts with our life sciences team and we're seeing a very robust and a very attractive pipeline in life sciences investments.

Another key takeaway is the stage of venture capital activity. This is quite important because it falls into Hercules' core focus. Today, we are overly weighted into later stage capital investments. We still haven't received 37% of the venture capital dollars in the fourth quarter. Conversely, we've been historically under invested in early stage venture capital which many of you may recall for the last four years we have made a conscious effort to deemphasize or not make material investments in early stage venture capital companies. I am happy to report that that prohibition is now lifted. We will be actively and aggressively pursuing early stage venture activities and pursuing early stage venture companies because we think the valuations are quite attractive and their lack of competition makes it a very interesting area for us to continue to build up our portfolio. So, you'll see us over the next four to eight quarters start making a conscious effort to also build out our early stage venture focus.

Conversely, many of you have seen that we've also been hiring private equity or I should say low or middle market experienced individuals. We've been bolstering our ranks in the lower middle market specifically with a focus towards healthcare related investment and technology related investment in lower middle market. We'll be speaking to that more in detail in the first quarter as those investment activities start coming on line.

Now, let me turn my attention to the venture capital liquidity, of very important health of the business. Despite much of the media, M&A activities in 2008 were quite good as $17 billion of M&A activities. Conversely, the IPO market albeit anemic in nature and truth be told, eight companies is not something to get excited about, but when you had a dearth or lack of IPOs, having eight companies complete IPOs in 2009 is quite important, one which by the way I'm happy to report was one of our companies, Ancestry.com. Now, to give some perspective of that number, in a more healthy venture capital market, you typically see 75 to 100 IPOs being completed per year with the peak being 2009 seeing 250 IPOs being completed.

We are by no means delusional that we're far from being in a very robust IPO market but we are nonetheless encouraged by this IPO market. And we're encouraged by that because as we turn to the first quarter, Hercules has two companies currently in IPO registration -- Everyday Health, formally known as Waterfront Media which has filed for a $100 million IPO and we have [Avail] Pharmaceutical filing its IPO in late December and which will raise approximately $80 million. It's currently in registration. These are very good signs and further indication that we have selected and picked the right companies. By no stretch of the imagination can I give you any assurances that those companies will in fact be declared effective and start trading but we're encouraged by those signs.

Conversely, we also saw some very good M&A activity in our portfolio. We saw it during the first quarter and at the end of the fourth quarter, we saw Gomez acquired by Compuware and in the first quarter we saw Savvion, our other portfolio company be acquired by Progress Software, further indications that we are selecting the right companies and seeing good transactions on our M&A portfolio.

Now, let me turn my attention to the overall marketplace and our expectations for 2010. I'm happy to report that our judicious slow and steady strategy of 2009 has worked well. It's served its purpose of protecting our balance sheet, bolstering our liquidity, and we did this while leveraging our balance sheet 100%. We currently have no leverage on our balance sheet when you exclude the SBIC leverage. This gives us and has afforded us a very strong balance sheet for new originations as we turn our attention to 2010.

That said, some of you realize with have a very proprietary and sophisticated SQL database system that tracks over 21,000 companies around the world that are venture backed or private equity supported. We currently have a pipeline and not just a mere pipeline as many other BDCs have reported. We have a qualified pipeline where we now have confirmation that the underlying company is looking for capital and they fit our initial screen. I'm happy to report that that pipeline as of today represents an aggregate value of over $850 million of potential investment opportunities into 127 companies.

However, in our nature, I want to caution everybody that we do not expect, nor should you expect us to see a huge conversion of that. We're only expecting to see a 15% to 25% conversion of that $850 million pipeline into potential deals that we expect to close over the next two quarters. We are not at all looking to merely originate assets to simply pay a dividend. We are looking originate high quality assets that don't place our balance sheet at risk, that become long-term value accretive to our shareholders to have a nice steady dividend and a very strong, solid balance sheet. That is tantamount to how we look at the business.

Now, turning my attention to our growth expectations for 2010, clearly we look to 2010 by building up our origination ranks. We've hired four individuals during the fourth quarter and first quarter of 2010 to start going after the new origination activities. We have a very strong, solid balance sheet. Over $200 million of liquidity, no leverage in our balance sheet. David Lund will expand upon that. We will also look to grow our portfolio. We look to start growing our dividend in 2010 and we prefer to refer to our dividend as a variable dividend that as taxable earnings begin to increase, our dividend will increase in kind as well.

We've also bolstered our executive ranks. We've hired Scott Gable as our COO to continue to focus on building and deploying our infrastructure in order to ensure that we have a foundation to continue to grow our organization and our portfolio as we expect to do in 2010 and beyond.

With that, I'll turn the call over to David Lund who will provide a financial overview and discuss the current liquidity. David?

Thank you, Manuel. We believe our thesis of building liquidity and managing credit has placed us in a uniquely strong position going into 2010. Our results from operations for the quarter also prove out the conservative investment strategy that we have taken over the last several quarters has been appropriate given the adverse market conditions.

Today, I'd like to focus on a couple key areas; summary of Q4 '09 and full year results, liquidity and capital resources, and finally an overview of our dividend. 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 the fourth quarter and full year operating results. We achieve approximately $16.7 million of investment income for the quarter and maintained a strong net interest margin at 12.82% for the quarter while managing our portfolio credit. For the full year 2009, total investment income was $7 Thank you, Manuel. We believe our thesis of building liquidity and managing credit has placed us in a uniquely strong position going into 2010. Our results from operations for the quarter also prove out the conservative investment strategy that we have taken over the last several quarters has been appropriate given the adverse market conditions.

Today, I'd like to focus on a couple key areas; summary of Q4 '09 and full year results, liquidity and capital resources, and finally an overview of our dividend. 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 the fourth quarter and full year operating results. We achieve approximately $16.7 million of investment income for the quarter and maintained a strong net interest margin at 12.82% for the quarter while managing our portfolio credit. For the full year 2009, total investment income was $74.3 million compared to $75.8 million. This slight decrease was due to the smaller average debt portfolio as we were deleveraging our balance sheet in the first quarter of 2009 to pay off the $135 million of Citibank and Deutsche Bank credit facility in just five months and building liquidity in the second half of 2009.

We continued to generate a solid net interest margin on our debt investments during the quarter at 12.8% compared to 11.4% in the fourth quarter of 2008. This increase is primarily attributed to the lower cost of borrowings. Our fee income during the fourth quarter was down slightly from the third quarter and was largely made up of one time event driven fees and we anticipate that our Q1 2010 fee income will not be as high as Q4 2009.

Compared to the same quarter last year, we were able to reduce our cost of debt from $5.5 million to $2.4 million by decreasing our average debt balance outstanding from $245 million to $130.6 million primarily due to repayment of the Citibank credit facility in March of last year.

Operating expenses for the quarter, excluding interest expense and loan fees where $4.9 million as compared to $5.4 million during the same period last year. This decrease was primarily attributable to lower compensation expenses offset by slightly higher work out related expenses and consulting fees.

All of these factors, maintaining a strong new interest margin, reducing our cost of debt, and managing operating expenses contributed to our Q4 net investment income of $9.4 million or $0.27 per share and distributable, taxable income of $7.1 million or $0.20 per share. Our net investment income for 2009 was $43.1 million, an increase of $3.1 million of 7.8% as compared to $40 million in 2008.

The net realized losses of $11.3 million recognized during the fourth quarter were primarily attributed to net losses on loans and warrants in two portfolio companies which were disclosed during our third quarter earnings call. Our unrealized gains of $10.4 million during the quarter are primarily due to reversing the unrealized losses on these two companies to realized losses. Since inception, net realized losses total approximately $26.5 million which represent less than 1.7% of total commitments since inception of greater than $1.6 billion as we have indicated for liquidity remains, one of our top priorities.

On that note, I'd like to discuss Hercules' liquidity and capital resources. With our cash position, credit availability, low leverage, and steady cash flows from loan repayments, we believe we are in a strong position to increase the pace of our investing as the market continues to improve and investment opportunities increase.

As of December 31, we had approximately $194 million of liquidity comprised of $125 million in cash, access to $50 million of borrowings under the facility with Wells Fargo subject to advance rates and approximately $20 million of borrowing capacity under the SBIC program subject to regulatory limitations. In addition, our only debt outstanding was $130 million on our SBA loan.

I'm pleased to announce two recent significant Hercules achievements in this tight credit market. In February 2010 we entered into a $20 million one year revolving credit facility with Union Bank. The cost of debt under the facility is LIBOR plus 2.25% for the floor, up 4%, an advance rate of 50% against eligible loans and secured by loans in the borrowing base.

Secondly, we extended the Wells Fargo Foothill facility maturity to August of 2011 from the current maturity of August 2010 under the same terms and conditions of the existing agreement. In addition, we have recently commenced discussions on renewing our credit facility that we expect to report progress on in Q2.

Access to these two credit facilities with these highly respected financial institutions is a reflection of the performance of Hercules in one of the most adverse credit markets in recent decades.

In addition, I would like to remind our investors that our application for our second SBIC license for an additional $75 million of borrowings is under review by the SBA. We anticipate that the license will be approved during the first half of 2010; however there can be no assurance that the SBA will grant Hercules a second license or when the license will be approved.

The combination of existing liquidity, the $20 million new credit facility with Union Bank provides us with $215 million of liquidity today and the expected increase in our borrowing capacity with the SBA will provide us with $289 million of liquidity in 2010.

I would like to remind the investors we have no leverage on our balance sheet at this time.

Finally, we distributed a dividend of $0.30 per share during the fourth quarter and we paid an additional or special fifth dividend of $0.04 per share to our shareholders in December 2009 in order to distribute approximately 98% to 100% of our annual taxable income in the year in which it was earned. As a result, we distributed a total of $1.26 of taxable earnings to our shareholders in 2009.

In conclusion, we have laid a solid foundation for growth in 2010. We have an unenviable liquidity position which we will continue to leverage as a competitive advantage and we will be ready to increase the pace of our commitments in 2010.

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

Thank you. (Operator Instructions) Our first question will come from John Hecht with JMP Securities.

Good afternoon, guys. Thanks for taking my questions. With respect to the large potential pipeline Manuel referred to and you guys referred to $180 million of term out there, how fast do you think you can convert these opportunities and what industries and regions are they in?

Well, the pipelines as we indicated are like many -- we're happy to get into most specifics. We actually have anywhere between around $50 million of ready in house besides term sheet. We probably have another $150 million to $160 million that we are active negotiation of balance that we are currently meeting what's qualified the companies further. So, I expect to see the first quarter will start off a little more lighter and you'll start see origination really start ramping up in the second, third, and fourth quarter.

We have purposely and consciously, unlike others out there, rather wade into the water slowly than more aggressively. It does not take any effort to put $100 million or $200 million into the books. We could've done that quite easily. It's a lot harder to ensure that you're picking the right companies and looking at the quality of you balance sheet and your earnings as opposed to just looking at asset generation, which we could've done quite easily. So, we expect to see starting off the first quarter somewhere -- without giving guidance here because we don't necessarily give guidance, somewhere in the I would say $30 million to $50 million level starting off and then building from there.

Okay. So, growing from Q4 levels and then growing as the year occurs?

There's no question that the originations in Q1 will be higher than that of Q4.

And then, Manuel, what is the March revenue pipeline as you see it?

There's a lot that's been stated on a lot of the earnings calls I've been listening to recently. There's been a lot of hyperbole out there, a lot of which I think is just a lot of noise. The truth of the matter is that we were seeing, certainly in quality deals, and this is where I think the differentiation becomes some of the hyperbole that we're hearing and what we're seeing is quality deals are seeing tighter yield spreads. There's no question about that. More marginal deals are seeing and continue to see widening yield spreads that are out there. So, it's indicative of what is going on in the marketplace. Apparently we seem to be fishing in the high quality bucket which is why we're seeing a little tighter yield spread. So, I still think that the yields that we're seeing are going to hold and what we've been kind of forecasting in the 12.5% to 14% range I think is a pretty good area to still be looking at. I think that we're pretty comfortable in the short-term looking at that but I do expect that throughout 2010 that those yield spreads were tightening a little bit to probably more in the 11% to 13% range as the calendar 2010 continues to mature.

Great. Thanks very much. David, I hate to get into the tax here but can you just quickly describe the primary differences between operating income and the taxable income just to get a sense for the modeling in the next few quarters.

Yes, the difference is attributable to for instance acceleration or OID and timing matters. So, for tax income, where we might have something on the top line such as an OID, when we have an acceleration, the IRS continues these to be capital gains. So, that's why you'll see the difference between our cap income and the taxable income.

Okay. Is this kind of difference than OID and timing difference because it's going to be consistent for the next couple quarters or is it going to be volatile as well?

It depends quarter to quarter about what's happening. But certainly this quarter I think we saw more of it happening with some of the restructurings and so on. So, I think you'll see a more normalized difference similar to what you've seen in prior quarters and this last quarter.

Thank you very much. Take care.

Thank you. We'll take our next question from Jason Deleeuw with Piper Jaffray.

Thank you. Just the $30 million to $50 million in originations, that's not net of pay downs? That's true origination that you guys expect to do this quarter?

That's correct. That's gross originations.

Okay. And then you've ramped up the work force. Do you think there's anything more you need to do there to build out the platform to reach the growth objectives that you want to achieve this year?

Let me talk about that a little bit. We still have two to three open hires that we're looking for just like our new investment activities for perspective portfolio companies. We're also seeing an abundance of talent of hiring you can do out there. But just like our potential pipeline of deals, not all that talent is what we're looking for, meaning it does not match our screen. There is an ordinary amount of business development talent out there with very little credit training and skill sets out there which doesn't quite meet our screen. I would also like the same analogy to what's going on in our pipeline. There's a lot of noise out there. Doesn't mean it's all good in terms of looking at deal flow. So, we're looking to probably hire one to three additional people. Assuming that we find the profile of what we're looking for over the next quarter or two. And I want to remind everybody that it typically takes about six months to get a new hire conditioned to and understanding the Hercules underwriting processes and criteria of what we look for before they become productive, generating assets if you will.

Okay. And then just lastly, with the share repurchases that authorization was increased. Can you tell us your philosophy with the share repurchases? Especially with the share below book value?

Sure. There is no question that as we're sitting on this level of liquidity and we're seeing or expect to see anywhere between $15 million to $20 million in normal principle amortization coming on a quarterly basis, that we cannot prudently and I would not feel comfortable simply going out and originating $200 million of assets in one quarter simply to do that. Because of that and because of the current yields on cash are a whopping 15 to 25 basis points, it is probably better served for our shareholders that we opportunistically go into the market when the stock is trading below book value to actually buy back stock as a good return for our shareholders.

And it certainly makes sense when you're trading at below book value as the discipline that will look to do in calendar '09. Sorry. 2010. As to whether or not we fully fulfill the $35 million allocation is to be determined by the marketplace but we certainly believe and expect to be active in looking at buying our stock when it trades under certain prices below book.

Great. Thanks for all that.

Thank you. (Operator Instructions) We'll hear next from Troy Ward: with Stifel Nicolaus.

Thanks. Good afternoon, gentlemen. Can you go back real quickly to the liquidity discussion? You talked about extending Wells and the terms were the same. What about the upfront fees? Did you pay an upfront fee? And is that the same that's being amortized from the last facility?

Yes. There was a $375,000 fee that we paid with the extension that will be amortized over the remaining period of the loan.

Do you recall last year? What was the upfront fee the last time you did it?

It was $750 but it was over a two year period. So, it's the same 75 basis point charge.

Great. Thanks. And then at the end of your liquidity discussion, David, you said something about 2010 in the next quarter you're going to be renewing credit facilities? What were you talking about with that?

We're in discussions right now with Wells Fargo to renew or put a new facility in place. We just extended this one at this point in time so what we would like to do is get into discussions with them on a new facility.

Let me put a little more color on that. What happened was the current facility has a natural window where it can be extended. Rather than let that window expire, we want to exercise that window to give us a runway and assurances that we maintained liquidity for the next 15 to 18 months. This is why we did the extension. We now have engaged with the discussions with Wells Fargo to both increase as well as renew the credit facilities for another two or three year term. We don't know that yet until we continue to engage with them in discussions right now that we're doing. But the whole reason why we paid the extension fee is to ensure that we have that runway out there.

And capabilities. So, as of the 2010 date this actually would become due?

August of 2011. Yes. That's when we come due.

Assuming it's not renewed by then.

Now we have 18 months to obviously sit down and discuss with Wells Fargo.

Alright. Okay. That's good. And then turning to the dividend and the taxable income, Manuel, if you could just put a little more color? Obviously this quarter you had $0.20 taxable income, $0.20 dividend. As you look to that, is that going to be a quarterly look or is it going to manage the dividend more towards an annual taxable income?

I think that as originations start kicking in, they should start moving more towards an annual I guess visibility of the dividend. But I have to be honest. As much as we have a good pipeline, I am still on the fence as to the direction of the economy and are we fully out of the weeds yet? Maybe I'm just a holdover of being overly conservative but what I just went through in 2009, I don't want to use up all my liquidity immediately right now in new investments.

And I certainly don't want to find myself using up all our liquidity and then having to raise capital that's diluted to our shareholders as many BDCs have done recently. We are really pretty much against issuing shares below net asset value unless there's an immediate and tangible purpose that creates value for our shareholders. I think the market right now is beginning to see the dramatic differentiation between an internally managed BDC and externally managed BDC. Internally managed BDCs really care about dilution.

Can you spend a little bit more on the fee topic just in - obviously origination fees get brought into taxable income on the quarter over origination and as you ramp up the portfolio a little bit here, that's probably going to cause some lumpiness in the taxable earnings. How are you going to look at that versus the dividend?

As collect fees, obviously as we do new originations that gets amortized both for tax and book purposes over the term of the agreement. So, you don't see a lot of difference in terms of tax and book income for that. But what you do see is when you get accelerations, when a loan pays off early. OID being accelerated, for instance, is continued a capital gain whereas for GAAP purposes, it's an interest income line item. So, the only time you really see differences is when you get a lot of the accelerations to pay off, not necessarily on originations.

Troy, let me remind everybody that the Hercules business model is a bit unique to that of the other BDCs because of working in the venture capital industry and focus on the venture capital. There are technology four and I could almost argue five different types of fees that need to be understood and they each have different implications, both from a GAAP accounting and the tax accounting point of view. Fees for example include a work out fee, a restructuring or amendment fee, an origination fee, also known as a facility fee, you could have a backend fee, and you could also have something called a commitment fee.

All four or five of those fees are uniquely different and have different treatments because of what they imply. Furthermore, with those fees, if a loan pays off early, you then find yourself with a prepayment fee that can also get triggered and as David just alluded to, an acceleration of a prior deferred backend fee and-or and acceleration of unrecognized or unearned origination fees. So, unfortunately, it's a much more complex issue when it comes to the fee income which is even why we have struggles with trying to forecast what that number can be because of early pay offs or accelerations that can occur.

So what you called the origination fee or facility fee, like you said, I know you're not similar in a lot of ways to the other BDCs but do you have an upfront 3% origination fee?

The 3% is more a change of lower middle market, middle market. In the venture industry, the fees ranged from 75 basis points to the high end of maybe 2.5 on the venture side. On the lower middle market side you're probably seeing an aggressive fee at 1.5 and you can flirt with a 3% fee on a lower middle market. So, they are a bit different, but that's correct.

It's our understanding that those fees, origination fees do hit taxable income in the quarter that they're originated. David, are you saying you amortize those?

Yes. They're amortized under the effective interest method.

Moving quickly to SBIC and I'll get back in the queue. How long do you believe, once the second facility would be -- how long till you could draw on that 75? And do you have to fund the $37.5 million of equity up front?

Well, there are two things on the SBIC front. First of all, I continue to remain very grateful to the SBA staff. They continue to be very diligent in working with us. We have very good candor and repartee with the SBA staff. I feel very comfortable and confident that we probably will be the first or one of the first or few to get the second license in place. I feel very, very optimistic about that. As to your question, we currently have a $20 million tail or stub, whatever word you want to use, on the original first license that remained that I think that the SBA will look to have us first draw that down fully before we actually start consuming or using the second facility.

As to your other question, as our application stated, it is our intention to first fund the equity, the so-called regulatory equity capital contribution of $37.5 million into the SBIC before drawing the first dollar leverage. So, I don't expect to really start drawing down on the first capital under the SBIC license until probably conservatively, end of the second quarter, sometime in the third quarter.

And I'll remind everybody that HR3654 which is the now infamous SBA bill which has been approved by the House of Representatives is still sitting idly at the Senate waiting to get approved and I am a strong advocate that if we want to get middle America funded, the SBA program is the best way of getting capital into the hands of the companies that need it and the SBA program is the best vehicle in doing that and we are more than able and willing to continue to fund a lower middle market and venture stage companies are looking for capital.

Final question, based on the new hires, where do you expect comp benefit is going to go on the expense line?

I think the comp line is not going to materially move that much. The reason why I say that is that although comp leads originations, if the market does not end up gelling the way we expect to continue to see 2009 gel, we'll make the commensurate adjustments to our operating expenses if that is in fact the case. As I said earlier, I expect compensation costs to lead originations by six months. You have four individuals. You're looking at it on an annual run rate of probably adding $1 million to SG&A but one of those hires was a swap out for head count. So, you'll probably see the SG&A costs creep up by probably $500 to $1 million over the next 12 months.

Thanks, Manuel.

We'll take our next question from Vernon Plack with BB&T Capital Markets

Thanks very much. David, what was taxable income for all of 2009?

It's 37.1.

37.1?

Yes.

And non-accruals, I believe the last quarter you reported four loans that were on non-accrual. What is that number now?

We have five loans on non-accrual at the end of the fourth quarter.

Okay. Do you have the cost basis of those and fair value?

Yes. The cost basis on that was $25.5 million. And the fair value -- I'll pull that out here in a moment for you.

Okay.

I would say the cost basis on that only represents about 7.7% of the outstanding loan value as well, just to point that out to you.

Okay. And net portfolio growth at least for the first quarter, I know Manuel talked about new investments probably in the $30 million to $50 million range. Should we expect that portfolio growth in the first quarter?

I think you'll see small net portfolio growth in the first quarter. On a net basis you're probably seeing anywhere between $10 million to possibly $20 million net portfolio growth in the first quarter. But that will start dramatically accelerating in Q2 and beyond. The reason I say that is we're getting some kind of radio noise that one of our companies is possibly engaged in an M&A activity that could end up creating an exit for us in value opportunity for us. But as we all know M&A is lots of time not necessarily closed.

Okay. Thank you very much.

And to follow-up, the securing value of those loans is about $11.3 million at the end of the quarter.

Okay. Thanks.

(Operator Instructions). We'll take our next question from Jeff Rudner with UBS.

Gentlemen, I'm having a little difficulty reconciling the answer you gave to the gentleman from Stifel Nicolaus regarding the dividend policy.

Sure.

I understand that we're paying the dividend out of the taxable income as opposed to the net investment income and you mentioned with the origination fees that they're being amortized over the life of the loan. Now, the origination fees is taxable income. Yet you mention that if the loan is prepaid, the amortization amount which has been taken into income now because the capital gain is non-taxable income. Is that correct?

Yes. That's correct. It's treated as a capital gain.

Okay. Let's say then you make a loan over a two or three year period and you've amortized the origination fee over that two to three year period and now the loan is paid back within a year so that that two years of that origination fee goes into non-taxable income. Based on the current dividend policy, that's not available for dividend payouts. Does that mean that origination fee is forever lost as a purpose for basis of dividend income?

The two years this amortizes actually in taxable income. It's in the net investment income. So, that actually gets distributed. And then if we have capital gains, for instance if we an acceleration and we have capital gain to distribute, it would get distributed in that form.

Correct.

So it would be paid at the end of the year when you even up the taxable income versus the investment income?

The use of the word "evening out" between taxable GAAP is not correct. The GAAP income versus the taxable income can and oftentimes are very separate. So, there's not a point where you true up to get to parity between the GAAP number and the taxable number.

So, at the end of the year you'll still wind up paying out the taxable income as opposed to the GAAP income?

That's correct. Not to complicate it further for you, there's another twists that oftentimes people have misunderstood and that is that there is a bit of a confusion in early 2009 where there's some misunderstanding in the marketplace by other BDCs that when you have a capital loss, for example, you can offset that against your taxable ordinary income that you're recognizing. In fact, the truth of the matter is that when you have a capital loss, you then have what's called a capital loss carry forward that you use to then offset when you have capital gains in the future but you cannot take a capital loss offset against your taxable ordinary income.

Okay. That much I understand. But getting back to the original part of my question, is that -- when we do have a capital gain on origination income and it becomes non-taxable because it's a capital gain, that means that you don't intend to pay out that portion of the origination fee as a form of a dividend?

In that case, that would be used to be applied towards any capital loss that we have first. That's correct. In the event now that we, for example, have no capital losses, we have then the option which is traditionally available to BDCs to decide whether or not you want to pay your corporate tax on that, meaning your corporate -- call it 38%, 35% effective corporate tax and then retain it to earnings or, option two, you pay your excise tax if you have to distribute your 98% and spill it over to the next calendar year which then requires it be distributed by September of the following year or thirdly you simply make a dividend distribution to your shareholders as you would normally as either a special or you simply supplement your ordinary dividend by that distribution and that part would be probably considered to be 1099 on the -- we call it the adjusted, lower taxable dividend income charge.

It would be considered capital gains.

Sorry, that's what I was looking for.

Okay. Can I assume then that the Company doesn't intend to follow the first policy whereby you pay the 38% corporate rate or any origination fees that are carried forward?

I think you are quite assured that that exactly is the case.

Okay. Thank you.

We have time for one last question. We have a follow-up from Jason Deleeuw with Piper Jaffray.

Thanks. Just was hoping to get some more color on the competitive environment and with the market healing up here and growth resuming, what are you expectations for the competitive environment as we move through the year?

I think starting in Q1 2010 I'm going to start answering that question by both the venture capital marketplace segment as well as the lower middle market private equity because they are different and I think we're at a stage of the maturation now that giving a one blanket answer is no longer applicable. On the venture capital stage, the environment only continues to get better and better for us in that area. Many of the legacy players that existed that were more fund type structure or more importantly those backed by hedge funds are having difficulties raising capital and securing additional financings. They're just basically not in the marketplace right now. In fact, we're seeing a lot of their existing portfolio companies and frankly a lot of their own employees coming to us, giving us further assurances that they are in fact in trouble. So, we're seeing a complete contraction and lack of real tangible day to day competitors that we would have seen a year and half ago, two years ago. So, the venture capital marketplace is improving.

That is not to say that the commercial banks in particular for example are not being a bit more aggressive on the really early stage companies. That in fact remains a fairly robust and very tight yield spread market on the early stage side. On the more mature side of the venture capital industry we are not seeing much competition whatsoever.

When I turn my attention to the private equity world, lower middle market, I want to make sure people understand what we call lower middle market, we're calling that defining that as companies that have $1 million to $15 million in EBITDA, are either healthcare or technology related in focus or you have some element of consumer focus as part of your product offering. But you have to be $1 million to $15 million EBITDA positive and we prefer you to be backed by a select group of financial sponsors for us to get engaged and consider you a potential candidate for Hercules Capital.

That marketplace is quite dislocated. We are seeing pricing levels all over the map to the point that it makes us a bit nervous of what we're seeing on some of the tightening yield spreads and some of the asks for what we consider to be excess leverage when we look at the legacy EBITDA of the trailing EBITDA of some of these lower middle market companies. We remain quite concerned that EBITDA may not yet have stabilized or hit the bottom yet and so there's still some room to drift down on EBITDA which means you may be underwriting a deal at 3.5, four times leverage going in only to find yourself two quarters later looking at 5.5, six times EBITDA leverage because the company's still suffering through some shrinkage of their customer base.

So, we're treading quite lightly in that area. I think that there's a lot of miscommunications in the lower middle market area as to the use of the word senior lending which we find it a little bit interesting and a bit disingenuous where the reason why you're seeing some of these widening yield spreads on the so-called senior strips where some of the other BDCs are, they're really doing last out seniors, secondly lending senior that are really behind a commercial bank of they're taking a more junior collateral position on the senior credit facilities and we think, frankly, not getting paid for it which is why we're not necessarily huge fans of Unitron's lending right now.

Great. I appreciate all the color. Thanks.

And I'd like to turn the conference back over to today's speakers for any additional or closing remarks.

Thank you, Operator. And thank you, everyone, for continuing your interest and support of Hercules Technology Growth Capital. As usual, David and myself will be making ourselves available to investors over the next 30 days as well continue to do our non-deal road show and we'll be meeting with investors throughout the US as we do our traveling schedule over the next 30 days or so. We look forward to meeting with you. If you have an interest, please contact David Lund, our CFO or myself at 650-289-3060. And again, thank you very much for being a shareholder and being part of the Hercules story. Thank you.

Once again, ladies and gentlemen, this does conclude today's conference. We thank you for your participation.