Hercules Capital Inc (HTGC) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2010 Hercules Technology Growth Capital conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, this conference may be recorded.

I would now like to turn this conference over to your host today, Mr. Jason Golz. You may begin, sir.

Thank you, Regina, and good afternoon, everyone. On today's call are Manuel Henriquez, Hercules' Co-founder, Chairman and CEO, and David Lund, our CFO.

Our first-quarter 2010 results were released just after today's market close. They can be accessed from the Company's website at Herculestech.com or HTGC.com.

We have arranged for a taped replay of today's call, which will be available through our website or by using the telephone numbers and passcode provided in today's earnings release.

I would like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information. Today's conference call may include forward-looking statements and projections. We ask that you refer to our most recent filing 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 at Herculestech.com.

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

Thank you, Jason, and let me first start off -- thank you for everybody being on the call after today's one crazy, volatile day. So I hope that we have a lot of folks on the call today and looking forward to answering a lot of questions after -- today was quite an interesting day, being a financial services company and a technology company, like we are.

So let me first start off by saying that I am very happy about everything that has been going on in our organization and the continued transition as we go from a capital preservation mode to now a new and growing portfolio mode. And I will be speaking about this and quite significant details throughout this call, and certainly look forward to expanding upon those issues at the Q&A session.

Let me first start off by saying that once again we did a fantastic job, reporting $5.6 million of GAAP earnings or $0.16 a share that also matched our taxable income of $0.16, as we turned the portfolio from a harvesting mode to a growth mode. And I'll be talking a lot about that as I go along.

We also did $90 million of new commitments in the quarter. That is a fantastic turnaround from going from zero for mature originations in 2009 to suddenly coming out in Q1 with $90 million in commitments and an extremely strong pipeline, a pipeline I have not seen this robust in over two years -- or I should say over the year and a half -- of this level of a pipeline of over $1 billion in opportunity.

So I am extremely optimistic and bullish about the future ahead, despite today's fairly volatile stock market. Our business looks and remains very, very robust. And our concern as we go along is not overrunning our liquidity as we try to fulfill this growing backlog that we have today of demand.

Our credit performance has improved dramatically from Q4. David will start getting into the specifics of the credit performance, but you will see in our detailed financial release that we saw significant credit improvement in the portfolio, which is also indicative of how our business is growing and improving as well.

Embedded in that is also nonaccruals. Nonaccruals basically have become almost a non-issue, a non-item. They are insignificant at this point compared to Q4, and I believe we have one loan only in nonaccrual, which David, our CFO, will also speak more to that situation.

I am also happy to report to our shareholders that earlier this month, we received notice from the SBA that we were approved by the Divisional Committee Level, which is one of the most difficult committees to go through, and we have our final Committee approval for our second license expected to be on Monday, May 10. From what we believe, we expect that license to be approved granting us the capability to have an additional $75 million of leverage from the SBA, giving us, more importantly, long-term, 10-year capital at a fixed interest rate, which David will talk about further during his presentation as well.

Now let me turn to some of the more specific issues related to our new business activity, pipeline and continued growth of signed term sheets that we are receiving every week, almost every day in the organization.

Yesterday, you saw us report that even after the close of Q1, we closed an additional $35 million of term sheets that we converted into contractual loan obligations or commitments from us. It is important that we start segregating, as I used to do in 2007, the difference between a nonbinding term sheet, a commitment and a funding. And I will talk about it a lot more on the call, because it is important to understanding the uniqueness of Hercules, which focuses on the venture industry, as opposed to other BDCs that rely primarily in the lower middle market or middle market industries, where companies fully draw down their capital.

Now, continuing on that thread, you saw us close $35 million of deals in Q2 so far, leaving, by the way, another $125 million of -- excuse me -- outstanding term sheet that we expect to convert in the next 30 to 45 days into obligations. What this means is that it gives me an incredible comfort on being able to see over $220 million of new investment activities that will close in the first half of 2010. So we are certainly on track to our pace that we expected.

Now, where the differences is, and it's important to talk about is, a closed commitment doesn't necessarily equate to an immediate funding, because venture-stage companies oftentimes have three to six months to draw down the capital from our commitments, which then become performing loans for us. So you will see a lag from closed commitment to actual funding, and you will see how that will take place in the second half of 2010, as those commitments turn into fully funded transactions.

Going further, our portfolio is positioned for growth. We have hired over the course of the last four to five months five to six new originators. As I said at the beginning of our first quarter -- excuse me -- our fourth-quarter earnings call, it generally takes between five to six months to get a new originator conditioned to the Hercules underwriting criteria and also have them understand the profile of the [underlying companies] we look for.

And you will see those individuals start becoming productive at the end of the second quarter, and you will see that asset growth happen in the second half of the year, as those new hires begin to become very accretive to us.

Asset quality, as I said earlier, our asset quality has improved from a rating of 2.7 weighted credit score average to 2.35 in Q1. And for those who may not recall, a rate of 2 happens to be a very good rating. So you are seeing us continue to increase the performance of portfolios.

Now, as I've done in every call, it is important to really understand that Hercules has a high reliance on the venture capital industry. Any earnings call that we do not provide color to the venture capital industry would do a disservice to understanding on how Hercules operates as a BDC when compared to other BDCs out there who don't have much exposure to the venture industry.

With that said, let me spend a few seconds here and talk to you about the venture capital environment and the industry itself. In 2001 -- excuse me -- in the first quarter of 2010 -- pardon me -- we saw eight IPOs raise $711 million. You may think this is a small number. However, those eight companies in Q1 represent the total number of venture capital companies that went public in 2009. That in itself is a significant achievement.

I'm happy to report Hercules currently has two companies in IPO registration, one which completed an IPO in Q1 called AVEO. Today we have both NEXX, and we have Everyday Health currently in registration.

Further to that point, M&A; the M&A activity is an important part of established companies gaining access to emerging technologies from privately-funded venture-stage companies. In the first quarter, we saw 77 transactions completed for $4 billion in value, which was the same amount of deals completed in the first quarter of 2009. We currently have as an industry 44 venture-stage companies in IPO registration. That is the most companies seen in IPO registration since the fourth quarter of 2007. This should give you some indication on the dethawing of the venture capital marketplace and pursuing liquidity through the IPO market.

Now let's talk about the inflows, meaning the venture capital's investment into technology and life sciences companies. Some very interesting developments are afoot in the venture industry, and some which I will highlight right now which are indicative of our own portfolio morphing to match that of the venture industry.

First, on the numbers. The venture capitalists invested $4.7 billion in the first quarter of 2009 to 597 different transactions or companies. That is up, by the way, 12% from the same period last year, which did $4.2 billion, so a very good indication.

Now, the interesting observation, which I conclude by looking at these most recent capital outflows by the venture capital, was the industry shifts that are going on. IT remains and will continue to be the largest recipient of venture capital dollars, receiving approximately 32% of the venture capital dollars, or about approximately $1.5 billion to 192 companies. That coincides quite nicely with Hercules' loan portfolio, which has about a 45% to 50% IT exposure to it. Healthcare, on the other hand, received about $1.2 billion into about 141 companies.

Now, the interesting shift was in the industries specifically where we saw consumer goods and services receive 75% growth year over year -- or I should say receiving $288 million of venture capital dollars over the same period last year, while energy and utilities, a description I generally hate, it is more referred to as renewable energy areas, received $351 million of capital or 69% increase over the same period last year. Business services, in turn, up 33% from their prior year, received $808 million of venture capital dollars.

So it's an interesting shift going on that you see in our own portfolio that emulates that of the venture industry.

Now, let me finish off by two critical components of the venture industry further. First, is the stage of companies. Of the $4 billion plus that was invested, 59% of that capital flowed into later-stage companies. It so happens to be our core focus, and has been the core focus of Hercules now for over 3.5 years. The early-stage side received 17% of the capital, but as I indicated in the fourth quarter, Hercules has made a conscious decision to commence investing, albeit few dollars, into early-stage companies, because we think that is representing a very interesting growth area.

But I'll caution everybody that our investment in early-stage companies may aggregate to $25 million to $50 million. It will not be a significant size today, but it's an important size in securing additional warrants in our portfolio, which I will talk about further in a moment.

Lastly, to fully understand the venture industry, we have to understand the venture capital source of financing, which are from limited partners, endowments and pension plans and what have you. The venture industry itself continues to contract. That contraction in itself is not bad, because what is happening is as the venture capital industry contracts, venture investors find ourselves competing more and more for better deals, and companies are now being more selected by venture capitalists, which means there is less competition, which means only the better companies are getting financed.

Now to bring that all together, the venture capitalists raised $3.6 billion in the first quarter of 2010 to 32 funds. That is down 31% on a year-over-year basis. These statistics all come from either Dow Jones VentureSource or the NVCA Thomson Reuters, which are a good source of reference to the venture industry itself.

Now, let me turn to the overall understanding of our environment from a competitive point of view. The contraction that took place in the market from a liquidity point of view, the other competitors who do not have the credit discipline such as Hercules has in its business model or the conservative nature of Hercules have seen their portfolios contract dramatically and have seen their access to liquidity dissipate. That means that we are seeing a growing pipeline of opportunities as our competitors continue to shrink or focus into other segments of the market.

Understanding the disciplines, the subtleties, the technology and life sciences know-how of how the venture industry operates is a key competitive advantage for Hercules, and one that I think will lead us to significant portfolio growth over the coming years as we see that focus become a valuable asset for us.

Growth incentives. We are well-positioned for growth in 2010. We have over $195 million in liquidity, $106 million of that in cash. We are actively engaged in negotiations and discussions with various other credit warehouse providers to give us access to additional growth capital in the form of leverage in our portfolio, which today, by the way, is unleveraged. We have no leverage in our portfolio outside of the SBA, which David will talk about.

We are extremely well-positioned for growth. Our robust pipeline and currently signed term sheets give us confidence in our ability to see our dividend grow over the pursuing quarters in 2010, as we convert successfully those commitments into fundings and those fundings end up becoming working assets for us, earning interest and yield in our portfolio.

Lastly and in closing, let me please go back and help our investors and analysts recall the conversation that we've had in 2007 and 2006 on how to think about Hercules on its origination efforts, because we are slightly different from middle market or lower middle market companies.

Again, a term sheet becomes a pledge of capital to a company. Once that term sheet is successfully executed by us, it becomes a signed commitment. We issue a press release every time we secure closed commitments.

However, I want to caution everybody that, for example, $100 million of closed commitments does not translate into $100 million of fundings right away. It may take us one or two quarters -- or I prefer to think about it, three- to six-month period of time when those commitments will then fund over a period of time and become working assets.

So when you look at Hercules, you really should be looking at the continued pace of closed commitments, and that will lag into fundings over the next three to five months or six months as those commitments become fundings. So you will see a very significant upward slope in the second half of the year, as these commitments end up becoming closed financings or assets that are working for us, a very, very important part of our model.

Lastly, one of the things that surprised us a bit was early payoffs. It is extremely difficult for us to predict or anticipate early payoffs. As an example of that, in the first quarter, we received approximately $35 million -- pardon me -- $32 million of early payoffs. A payoff of that nature that would happen at the beginning of the quarter could have an effect on earnings as much as $0.01 to $0.04, depending on the yield of those particular assets.

So we have this volatility in our earnings, which is extremely hard for us to predict, of anywhere between $0.01 to $0.04 on these early payoffs that may occur.

Because of that surprise we had in the first quarter, I have personally gone through and scrubbed line item by line item, as best as we possibly can, what early payoffs may occur in the second quarter. I am happy to say that from our analysis, it appeared that we could have $20 million to $25 million of possible early payoffs.

However, I need to caution everybody, we have no true indications for underlying portfolio companies if that in fact may occur, because often times these payoffs are attributed to milestones that the company itself is working towards that could trigger these payoffs.

But because of this potential early payoff exists, I feel strongly that it is important for our shareholders and our analysts to have a better indication of these potential early payoffs that could occur, that could cause a swing in earnings of $0.01 to $0.03, $0.01 to $0.04, depending on the yield itself.

Now, I'll be happy to answer more questions about this in our Q&A session. With that, I will turn the call over to David Lund, our CFO, to speak about the specific results of the quarter, and Dave and I both look forward to answering your questions in Q&A. David?

Thank you, Manuel. Between our new loan pipeline, credit quality and liquidity position, we believe we remain in a strong position to grow our portfolio during the remainder of 2010. Today, I would like to focus on three key areas, summary of first-quarter results; liquidity and capital resources; and portfolio highlights.

As Manuel indicated, during the Q&A, we will be more than happy to answer any questions that I do not specifically address during my presentation.

To begin. I will touch on first-quarter results. We achieved approximately $5.6 million of investment income for the quarter, while significantly improving our portfolio of credit quality, which improved to a weighted average rating of 2.35 from 2.71 in the prior quarter. As we anticipated and indicated last quarter, our investment income was lower in the first quarter as we transitioned to growth mode with the portfolio, and as a result, have credit quality of the portfolio improving.

The lower income compared to the fourth quarter of 2009 was driven particularly by lower one-time fees of approximately $1.7 million and lower interest income, which was accelerated, of approximately $1.3 million due to restructurings which occurred in the fourth quarter. We anticipate that income from these types of activities will continue to be lower in the coming quarters as the credit quality of the portfolio has improved significantly.

To that point, I would like to note that we have only one loan on nonaccrual, as Manuel mentioned, at the end of the first quarter. This one loan represented less than 1% of our loan investments on a cost basis.

Our net interest margin dropped to 9.34% in the quarter from 12.82% in the last quarter due to unplanned early payoffs of $32 million during the quarter and a decline in investment income from restructurings, as I just described. We anticipate that it will return to a more normal range between 10% to 11% as we build the portfolio in the coming months in and quarters and grow our investment income.

Our effective yield on our debt investments during the quarter was 14.5% compared to 13.3% in the fourth quarter of 2009. It was attributed to unanticipated early payoffs of $32 million and normal amortization, resulting in a lower average asset base relative to the income that we earned. We expect the yields to be between 12% and 13% as we build the portfolio, which excludes the impact of any possible early payoff.

Compared to the same quarter last year, our interest expense declined from $4.1 million to $2.3 million, as the only debt we had outstanding during the quarter is the SBA debentures of approximately $131 million. As a reminder, we incur nonuse fees on our Wells Fargo and Union Bank credit facilities of approximately 25 basis points and amortize origination fees associated with these facilities ratably over their availability periods.

Our interest expense will increase in the coming quarters as we draw on these facilities, as well as our SBA debentures, to facilitate the funding of new and existing portfolio companies.

Operating expenses for the quarter, excluding interest expense and loan fees, were $4.6 million as compared to $4.8 million during the same period last year. This decrease was primarily attributable to a decrease in variable compensation expense.

Both our Q1 net investment income and distributable taxable income was $5.6 million or $0.16 per share for the quarter. Note that unlike in Q4 2009, the $32 million of loans which were paid off early in the first quarter of 2010 did not have significant fees related to original issue discount or OID, and unearned fees that were accelerated, which are recognized as ordinary income on a GAAP basis, but are recognized as a capital gains for tax purposes.

Turning to liquidity, our solid liquidity and capital resources positions us for portfolio growth. On that note, I would like to discuss Hercules' liquidity and capital resources.

As of March 31, we have over $195 million of liquidity, comprised of $106 million in cash, access to $50 million of borrowings under the facility with Wells Fargo and approximately $20 million of borrowing capacity with Union Bank, subject to advance rates, and approximately $20 million of capacity under the SBIC program, subject to regulatory limitations.

In addition, as I pointed out earlier, our only debt outstanding was approximately $131 million under our SBA debentures.

I am also pleased to announce that we were approved at the Division Committee level of the SBA for our second SBIC license that would provide up to an additional $75 million of borrowings. We believe this facility will be approved later this month. This second license will require that we contribute $37.5 million to the SBIC subsidiary, which will be used for investment purposes, along with the available borrowings under the debenture program.

With the combined access to capital from these potential sources, our cash on hand at the end of the quarter would be in excess of $270 million.

Now I would like to discuss the [run-up of] our portfolio. We have normal principal collections of approximately $20 million to $25 million a quarter. Additionally, as Manuel indicated, we are unable to forecast what early repayments are. As a reminder, we had unanticipated payoffs of $32 million in the first quarter.

Potentially, based on preliminary notifications from two portfolio companies, we could receive $20 million in early payoffs, but that collection is uncertain at this point in time until the companies resolve their financing situations.

The impact of early payoffs could be $0.01 to $0.03 per share on NII, depending on the payoff amounts and the timing of the payoff within a quarter.

We believe our liquidity position as I have just discussed places us in a very advantageous position to invest in 2010.

Turning to our dividends, we distributed a dividend of $0.20 per share during the first quarter, and announced today that we have declared a $0.20 dividend payable in the second quarter.

I'll also further note we had our stock repurchase program of $35 million that was approved by our Board of Directors in February, and under that program, during the quarter we repurchased 25,125 common shares of our common stock at a total cost of approximately $234,000.

In conclusion, we believe we have laid a very solid foundation for growth in 2010. We have the most robust pipeline in the Company's history, high credit quality, an enviable liquidity position, which we will continue to leverage as a competitive advantage and will be ready to discuss the pace of our new commitments in 2010.

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

(Operator Instructions) John Hecht.

Thanks for taking my questions. One question is trying to compare interest income versus a couple quarters ago, when you were accruing interest from Spa Chakra and InfoLogix. Can you tell me first how much interest income you were at the peak of those investments, getting from those investments? And the second, I know they both provided income during the quarter. How are you recognizing that income right now?

As David looks up the answer to the interest income, we've got to make sure that we be really careful. Because Spa Chakra went through a [previously three] bankruptcy process, all the prior debt was converted to equity. So the new debt that is in the company, $2.3 million, $2.4 million of debt, is all new, revolver-based credit facility.

So all the old prior debt was force-converted, what is called a credit bid, into the full equity ownership of the company itself. So that is a very important point we have to make sure you understand.

As to the specific, David?

John, it was roughly about $100,000 on a monthly basis for Spa Chakra, that we had from that entity.

Do you recall InfoLogix?

We will get that out here for you in a moment, though.

You are recognizing income from both of these entities now. Is that through -- recognized through the P&L or just an adjustment to the cost or value -- excuse me -- of the companies at this point?

No, we recognized it through the company itself, through interest income.

Well, hold on, John. The Spa Chakra component -- again, all the old debt no longer accrues and recognizes any interest. So that is now gone. So the only interest that you are accruing in Spa Chakra would be on a $2.3 million, $2.4 million new outstanding that is out there.

The InfoLogix itself continues to accrue interest as it did in the fourth quarter, and we continue to be actively supporting the company. And as we indicated in our press release, the company currently has a delisting notice and we kind of work it through those challenges there. And the company has some continued working capital challenges as it migrates from an old product line to new product line itself.

So we do not anticipate any material change on the interest-paying capabilities of that entity right now.

With regards to InfoLogix, we were earning about $450,000 a quarter on that particular entity. During this quarter, we earned about $820,000 on InfoLogix and about $156,000 on Spa Chakra through --

For the quarter?

Yes, for the quarter, for both interest as well as the fee amortization.

Thanks very much for those details. The other question on sort of the modeling side is is there going to be any fees associated with your second SBA line? And then if you could just remind me how you finance those before you fix them against the 10 year.

We will pay a 1% fee for the SBA borrowing, so 1% on $75 million, so we are going to be paying approximately $750,000. And that will get amortized over the course of the 10-year facility.

And then what's the -- when you kind of warehouse things before you fix them, what is the rate?

Before the -- there is actually a fixed rate at March and September of every year. It is 30 basis points over LIBOR.

Okay.

So that will then be fixed on every March and every September, and that has generally been running about 6.5% on an interest rate basis.

Okay. And then the last question, clearly, the loan demand environment for borrowing in your segment appears to be heating up pretty quickly. What do you expect will happen to pricing as demand percolates up and maybe some others attempt to enter the market?

As I indicated in our fourth-quarter earnings call, I don't think historical yields are sustainable. I think that you will see a gradual yield compression, as, I guess, alluded to in the fourth-quarter earnings call and I will do further here now.

I think that today, you may be realizing yields in a 12% to 13% range for the vendor-stage companies, but a little higher for lower middle market. I think you will see that yield compress back to the norms of 2007, early to mid-2008, where you will see those yields probably give up 100 basis points for the year, between now and year-end, you will see that further tightening right now.

It is -- although there is not a lot of competition, there is an interesting competitor that is rising, which are the investor capitalists themselves looking to put more equity capital in their companies. So it's an interesting competitor that you otherwise would not have had a couple years ago.

Great, guys. Thanks very much for the color.

Troy Ward, Stifel Nicolaus.

Thank you and good afternoon, gentlemen.

Thanks for being on after today's afternoon.

Yes, it was a very interesting half-hour in the middle of the afternoon.

Can you speak to the (inaudible) expense line and kind of the run rate expected there, with the new hires and how much of that is already baked in?

I think the expense line itself is probably pretty well baked at this level. You probably have, I would say, anywhere between $200,000 to $400,000 that may be added on a quarterly basis, all contingent upon performance milestones of the individuals themselves.

The line is not actually anticipated to dramatically increase from here, unless we do some significant new hires. We are still looking to hire anywhere between three to five additional people, but we are just very selective in that process. If that happens, obviously, that will cause it to go up. But I don't think organically it is going to go up much more than it is right now.

Okay, great. Thanks. And then on the non-accruals, I know you said you had one nonaccrual; sounded like a rather small company. I think in the previous quarters, you had two or three, and I know probably Spa Chakra was in there. And now of course, with the restructuring, they are not. Can you give us any more color on what is going on in the nonaccrual line the last couple quarters?

Clearly, as the quarters have improved, the economy's improved, we've seen significant improvement at the portfolio companies themselves with regard to their operations. And we've seen funding that's coming into these companies from venture capital and private equity.

So you are seeing a much more stable portfolio of companies. And as you indicated, we do only have one company, TransMedics, which is on nonaccrual. It is about a $2.8 million loan at cost and it represents less than 1% of the portfolio at cost.

I'm sorry, Dave -- it is now (multiple speakers) --

I'm sorry -- you're right.

Sorry, Troy. We have so many different companies. It is Gelesis, not TransMedics. TransMedics, they just raised a lot of equity, so it's not them.

Okay.

No, they are doing fantastic. And Gelesis, by the way, although it is a nonaccrual, the company has -- without getting into confidentiality issues -- the company has some very interesting technology that they are working on that could have a significant breakthrough here sometime in the end of the fourth quarter. They have some promising developments that just recently achieved with some of their product development.

And you can learn more about Gelesis from their website. I would rather not get into specifically what they are working on because of confidentiality issues, but it is something that we currently hold on a zero fair value basis, meaning fully written down by us. But there could be some reversal of that some time in the fourth quarter if the continued progress of the company is still going on by then.

Okay. And then Manuel, can you just speak broadly about your leverage capacity? You said you are still speaking with potential new lenders in the marketplace. You have Wells, you have Union. I think if we look relative to others in the space, your leverage look pretty expensive. How do you think about leverage going forward on the portfolio, and do you think that cost of leverage can come down?

I certainly don't think our leverage looks expensive. I think that where it may be expensive is when you look at the SBA cost of capital, that certainly does look expensive at 6.5%, 6.7%, from a cost point of view. But, that said, if you believe, like I do, that you're facing a rising environment, I will take my 6.5% cost of capital locked in for 10 years any day of the week. So it is expensive right now, but over the course of the next nine or 10 years down the road, I'll take it. It is accretive form me on a spread basis.

As to the Wells Fargo line, I actually don't think it is any more expensive. In fact, my historical line we have right now is actually cheaper than some of the other BDCs that are out there. I believe, if I remember correctly, our Wells Fargo line has a 5% floor, and our Union Bank has a 4% floor. So those are pretty damn good rates. And I'm seeing renewals from other BDCs out there that are a little higher than that.

You're right, I was reading that incorrectly. I'm sorry.

(Multiple speakers) That's okay. I don't mean to -- that's okay. That is one of the things we are trying to do a better job of right now, I think, is creating a lot better transparency of our cost of capital, our cost of leverage, as well as understanding the subtleties of our business model to other BDCs.

So if I sound pejorative, I apologize. I am just trying to make sure that people really understand on how to derive interest income, how to derive what the right yields to use are and what are the right assets to focus on and how to think about originations, commitments, funding and asset growth, all of which, by the way, are looking and going in the right direction.

Thank you, Manuel.

Jason Deleeuw, Piper Jaffray.

My first question is on the percentage of commitments that typically turn into fundings. I understand the timing issue and the lag, but typically, historically -- I mean, I am assuming a very high percentage of those commitments turn into fundings.

Let me talk about that. The best way I can give you an indication of how you should look at it is no different than I look at it. If you have $100 million of commitments, we expect 75% of that will convert into a loan, a working asset for us. So for every $100 million, $75 million of that will be come invested assets.

That commitment of $100 million would generally be dribbled out in pieces of loans up to $75 million over the preceding three- to six-month period of time. It is called a drawdown period that a company has.

Unlike middle-market companies, where you sign a $100 million commitment -- they will draw down almost immediately because there is a tangible use for it right away -- recapitalization, a dividend recap, an acquisition or what have you. Venture-stage companies tend to use it more as a credit line to fund their business and use it as a just-in-time source of financing. So it's a little bit different as to why and how they draw it down.

Great. That's very helpful. And then with asset values across the board really improving, I guess, except for today, but generally -- I'm just --. And then with this IPO activity picking up and M&A activity picking up, I'm trying to understand a little bit better what value could be embedded with the warrant portfolio. It would seem that there would be more value than -- a lot more value potentially than what you guys are carrying it at.

Absolutely -- that is a fantastic question, and I appreciate Jason asking it, because we've [potentially] forgotten over the last two years why Hercules is such a different BDC than the rest of the BDCs out there. And it is in fact this hidden value that we have called these warrants. However -- and to put a little caution into that, because we are a public company, so I have to make sure people understand both sides of the equation.

So today, we approximately have warrants in I think 77 portfolio companies, that have a -- exercise value. They take the warrant strike price of all of our warrants in aggregate, would equate to approximately $49 million in aggregate values, if we were to exercise those warrants, indifferent to whether they are in the money or out of the money.

So to make this illustration easier for me, let's assume it is a $50 million warrant pool. However, we've cautioned this all along. We do not expect that more than 50% of those warrants will ever monetize into value, giving you $25 million of that $50 million in aggregate will become an in-the-money warrant.

On our website, we have posted the historical performance of 16 or 18 of our realized warrant gains that range from multiples of as low as 1.7 to as high as 8.9. We don't believe you should use 1.9, and we don't believe you should use 8 times warrant multiple. You should factor somewhere in the neighborhood of either 2, 3, 4 or 5 or 6 times warrant multiple in your example to kind of drive its value.

So for this illustration purpose, let's assume we use that 4 times warrant multiple on the $25 million that I said that may become in-the-money. That means that the $50 million in warrant value today gets haircutted by 50% -- so those will not monetize -- giving you a base of the $25 million. Take the $25 million, in this example, assume a 4X multiple will give you $100 million in fair value of those warrants.

Those warrants at $100 million we carry on our books today at $13.7 million in fair value accounting using Black-Scholes. Which means that sometime in the next 12, 24, 36 months or some timeframe thereafter, you have the opportunity with the existing assets that you have in-house today, if they were to monetize, you could have a potential of recognizing $87 million in value, or somewhere in the neighborhood of $2.20, $2.40 in net asset value growth today.

Because of our tax loss that we have, we actually take all those gains -- or a significant part of those gains, insulate it from having to pay -- our shareholder to pay taxes on it, to first absorb our tax loss carryforward, allowing us to retain that $87 million or so in value to continue to grow our net asset value organically.

So it is a highly accretive vehicle. And with the IPO market opening up again, I am certainly now happy to be able to talk about something that we have not spoken about in almost two years.

That's great. It is very helpful. And then just lastly, when you do get -- assuming you get the final round for the financing of the SBA financing, when will you have access to that money? And can you just -- am I understanding correctly -- would the rate be 6.5% on this financing, too?

We are going to final committee next week for approval. We think that will happen without any issue. Then over the course of the next 30 days, we would be putting in our leverage request and so on to borrow against those funds. And we will point out we do need to downstream $37.5 million to access the funds.

So over the course of the next six to nine months, I believe we will be accessing the $75 million from the SBA. It is not going to be immediately, and it will be dependent upon the fundings that we do out of the SBA.

Sorry to interrupt, David. The whole growth of the SBA is really contingent upon our continued acceleration of our pipeline. If we continue to see growing access to additional liquidity through the SBA and the other credit line negotiations that we are truly, actively involved in, that would further potentially accelerate our asset growth right now.

We have good liquidity, but I don't want to overrun my liquidity that we have today. If I have higher confidence level of additional liquidity opening up, you will certainly see us take advantage of that and accelerate our pace of growth of our assets, and that will translate to earnings growth.

And to your other question, the rate, with the fees and everything being fully amortized, is running about 6.5 points -- or 650 basis points on a fully amortized basis.

Great. Thank you very much.

(Operator Instructions) Vernon Plack, BB&T Capital.

I guess I'm limited right now in terms of number of questions, but --.

Go ahead, don't worry --.

The $95 million in commitments, how many companies was that to?

I believe it was eight.

Eight companies, okay. And does that eight total new plus existing?

No, I believe that is eight unique, new credits -- new companies -- pardon me. We call them credit companies, portfolio companies. Those are eight, new unique relationships.

Okay. And just trying to -- help me with the math here. It looks at the portfolio grew on a net basis and on a fair value basis about $9.5 million for the quarter.

Yes, the problem is, as I said, the commitments will lag fundings. So you will see that funding growth start happening in Q2. You will see it really start kicking in by Q3, as you start seeing all these commitments now translate into working assets, funded assets.

Right. The fundings, I thought I saw somewhere where fundings for the quarter -- was that $87 million?

The fundings for the quarter --.

That's correct.

That included restructuring and amendments of some existing credits. I think we footnoted that -- about $26 million.

Yes. It was $68 million of cash out, and then we had some refundings -- restructurings and refundings for the balance.

Okay, so basically $68 million. And then if you look at repayments, I think it was $59 million. That basically gets the math to get to a net growth of around $9 million.

That is right. With the $32 million, as I said earlier, that kind of that [bloop]; it is very difficult for us to anticipate, but it was what it was.

Okay, great. Thank you very much.

Henry Coffey, Sterne, Agee.

With the SBA facility in place, the new access to cash, are those loans going to have a specific characteristic, and will you be able to get lending facilities in place kind of with a similar level of durability -- for loans that don't fit the SBA model?

That's a very good question. Always the tough ones, Henry. The second license of the SBA has the same kind of underwriting attributes and characteristics that are required by the first license.

The only challenge would be the single-credit obligor limit under the second license is a bit smaller. It is generally 30% of our regulatory (inaudible) capital, so you are limited somewhere in the neighborhood of $10.5 million, $11 million from a single obligor under the SBA program on the second license. While the first license is more in the neighborhood of $21.5 million or so. So we've got to balance the underlying new credit, new company, to kind of conform into that size of the SBA itself.

But beyond that, it doesn't change much characteristic in the first or the second license. It is the same kind of underwriting attributes.

Now, the second part of your question is actually a very good one, because what we are seeing right now as we engage in new negotiation with a potential credit warehouse provider is an interesting phenomenon that I did not witness as little as 18, 24 months ago. And that is now the new warehouse credit providers are having this notion that they ostensibly re-underwrite the credit -- the potential portfolio companies submit under the credit facility. Their own underwriting groups are now embarking on re-underwriting it as a further risk mitigation assessment of the collateral value that they are doing.

You need an approval every time you put something into it.

Well, they'll never say that word. I wish they would, but they don't say that. They simply call it a re-review process of the underlying collateral. But yes, we can call it what it is, it's an approval.

Now, the other elements of that that is different from what it was a couple years ago is that they are attempting to ascribe their own arbitrary credit rating and then that will translate into some form of an advance rate against this artificial, realistic whatever credit rating they ascribed to it. They are ascribing different levels of advance rate for a credit facility.

So, for example, let's say you believe you have a 70% advance rate under your credit facility, but the underlying new bank may deem it to be a 50% advance rate because they think it is a lower credit rating than you have it, for example.

So it is an interesting evolution that is going on in the market (multiple speakers).

But do you think this will be -- once they take you through all this, do you think you end up with a more durable credit line?

Right now, the good news about that is we are seeing that terms are actually being pushed out more to the two- to three-year level, as opposed to the one- to two-year level. So I think that is encouraging in itself.

So it is still a work in process -- the SBA is still your best money?

The SBA is certainly the most reliable cornerstone of the Hercules liquidity strategy of continuing to build the organization with reliance on the SBA. It's a 10-year cost of money, fixed rate of interest rate in a rising interest-rate environment. When all of our deals are fully (inaudible) interest rates, we get to maintain and have a growing spread on our deals.

So could you build a business just around the opportunities within an SBIC, or do you need really both to have a meaningful future growth? The whole issue is how do you build the earnings back up to that $0.30, $0.40 level that we've seen you moving towards in the past, if you do it with just the SBA as a partner -- or do you need to bring in one of those other people?

I think the answer to your question, the optimal asset growth would be a portfolio that has SBA fully leveraged at about 50% leverage on its core regulatory assets to leverage on the BDC side. So having $200 million in credit facilities outstanding outside the SBA, plus fully drawn SBA, I'll take that business any day of the week.

How quickly do you think the business kind of rebuilds to where it was in the last, say, 12 to 18 months ago?

Given the pipeline and opportunity I am seeing right now, if I have real access to liquidity, I think that you will see us return to that run rate at $0.30 sometime in the fourth quarter, first quarter next year.

I know this will upset you, but you will recognize the name of the trading firm implicated in today's fat finger that drove the market down. But it's former associates of yours.

Don't associate me with that. Hold on, Henry.

No, no, no -- former lenders.

Oh, I don't want to be surprised. The rumor that we are seeing on the web was that that former lender you are referring to, who gave us a credit facility, allegedly mis-entered an order, allegedly.

Maybe next time it will be on your loan, just accidentally give you $1.2 billion loan facility and then take it from there. Well, thank you for answering my questions. Congratulations on the progress.

Thanks, Henry. Thank you very much.

Jason Arnold, RBC Capital Markets.

Manuel, I was curious if you could expand upon a comment you made earlier about the VC sponsors putting more equity into deals.

Sure. It is very interesting. I've been doing this now for 25 years, and you have a phenomenon right now where the venture capitalists are sitting on a portfolio that may be down 40%, 50%, and they have some dry powder. And they've circled the wagons on their better deals.

And suddenly, when the IPO market starts opening up, they see an opportunity to quickly monetize and get a quick return or multiple on their money. So suddenly debt, which is still a very attractive alternative for them from a dilution point of view, they would rather go in and place more equity capital in this company, overequitize it, if you will, because of the ability to arbitrage the prior valuation to the public valuation, and see a higher multiples on their companies.

The last time I saw the phenomenon, by the way, was 1998, 1999, where you are investing in a $100 million private round and the company was pricing an IPO six months later at $500 million in valuation. So I'm a little surprised to see that phenomenon now, but that phenomenon is now driven for other reasons than it was driven in '98 and '99. This time, it is driven by trying to lift the overall funds, the venture fund's performance, back into the 75 percentile, 80 percentile, in order to cure the next capital raise against the fund itself.

It is a short-lived game, I think that will run its course here very shortly, because the venture capitalists oftentimes have structural difficulties on taking new capital to invest for old investments investment in older funds. So that is a difficult thing for them to do for an extended period of time.

But I have seen it and seen a bit more of that over the last two or three months, with the IPO opening up the way it is.

Interesting.

But it's not sustainable.

Yes, interesting. So from a competitive perspective, it seems like, yes, short term, it might crowd out a little bit on the new lending side. But intermediate to longer term, as these companies grow and put business -- new business on the loan demand, it certainly seems to come in time.

Well, that's pretty good. The smart venture capital money is doing both. They are putting more equity in and still taking debt in it. They may have -- instead of taking, say, a $15 million debt piece, they may take a $10 million debt piece and overequitize it.

But the smart money is still putting a little -- the layers of debt into it, which is why we are seeing the demand that we are seeing.

Makes sense. Okay, perfect. Thank you very much. I appreciate it.

Douglas Harter, Credit Suisse.

Thanks. My questions have been asked and answered.

Okay, Doug. Well, listen. Thanks for joining, and thanks -- you weren't (inaudible) to the wrong trade, right? No, I'm kidding.

Hopefully not.

Thanks, Doug.

Matthew Howlett, Macquarie.

Thanks for taking my question. Just on the bringing of the other parties, the other lenders, into the facility, the Wells facility, I know you are in negotiations. Any more color you can give us, Manuel, on where you are? And are you shooting for the three-year, pushing out the three years? Did I hear you right?

First of all, I didn't say that we are bringing them into the Wells Fargo facility. If I inferred that, I apologize. That was not my intent.

The intent is to bring new credit facilities period. If they conform to Wells Fargo, that's fantastic. Wells is a great partner and continues to be a great partner. But as I've learned, the large money-center banks all have sharp elbows, and they don't tend to want to cohabitate with each other on a common credit facility.

So I think that it is highly likely that we will probably have this new credit provider that we are speaking to probably be an independent, standalone credit facility, outside of the Wells.

Got you.

In terms of their progress, look it, we've had now four, five conversations with them. We expect to be entering into some form of a -- more of an LOI. We've been sorting through what their underwriting parameters are, if you will, and getting a better assessment as to what are the mechanics that would be associated with tendering their loans for them to consider to put their collateral forwards.

I need to make sure I understand that quite well to ensure that there is a lag time issue that I don't commit funding to a company that that credit facility may not conform to and find myself being longer on a credit than I want to be.

Got you.

So we are spending a lot of time in the front end, really working through what the mechanics of that would look like. And I believe that should get resolved here in the next week or two. And then once we have that, they will go to their committees to get a soft circle kind of, I guess, commitment, more or less, or an expression of interest. And then we go into documentation if everything seems to work out.

So it is encouraging, but it is not something I am going to bank on in the next 31 days. I think it's certainly warm enough with a pulse that it has legs to close in 60 to 90 days, potentially.

Great. good. That would be a big step forward.

And then just getting back to -- I mean obviously you are ramping up. You are going to put a lot of money to work really the next 12, 18 months. What are you seeing? You held back the reins for a while. What are you seeing now in terms of the quality deals? I know there is obviously more equity.

But is it just your better outlook on the tech and the healthcare space, or better quality companies coming through? Maybe elaborate on that a little bit more, why now is sort of good time to really move forward with the investment process.

You are being nice to me. I have been yelled at as being too conservative and overly tight on the reins. And both I will take as compliments, because being conservative and holding back the reins for 2009, I still strongly believe was the right thing to do.

And revenue growth will happen. I am as optimistic and as bullish as I've been in the last two years. Our team is kicking butt. Our team is seeing strong deals. Our team has been hardened through the credit storm of 2009. They know what we like. They know what we look for. If we would decide, for example, to free up our credit underwriting parameters, I could double originations and closing deals. I don't think that is the right thing to do.

I do believe strongly in controlled growth. I think that you deploy capital as you see your liquidity horizon to match your fundings, and you will see us do that. And because of the nature of the venture industry, the lagging of a closed commitment to funding, I have a built-in six-month window to what I commit to fund a company to allow additional progress in the marketplace to get the funding needed to continue to build that backlog.

And most people may not recall, in 2009 and '07 and 2008, we were running sometimes with $100 million, $120 million of unfunded commitments of drawdowns that were pending with our Company. So I look forward to returning to the days of having a $500 million, $700 million portfolio and having $100 million of unfunded commitments behind me. That gives me very strong visibility into assets that I can deploy over the preceding three to six months.

And all that we are doing right now is we are rebuilding that whole backlog of those signed term sheets and commitments that we expect to fund over the next three to six months. And today, this team has done a fantastic job from zero to May of having almost $228 million of term sheets that we have in-house and we've converted to transactions.

Most people don't remember that in January, very much like today, the sky was falling. We held back in January. We were very conservative in January. We were extremely apprehensive in February. During the February conference call on earnings for the fourth quarter, we said, we want to go slow because we are not sure that everything is in the right direction.

Today, I have eight IPOs completed in Q1. I had a 12% increase year-over-year of venture capital deployment of capital. M&A activity remains very robust and strong. IBM, record quarter earnings. Intel, record quarter earnings. You've had continued capital deployment by institutions. Microsoft deployment of Windows 7 is causing corporations to revisit capital expenditure and upgrade their hardware infrastructure.

We are in a good place right now, but we want to make sure that we control with growth and not just grow to grow earnings for the wrong reasons. After going through the pains of 2009, the last thing I want to do is let go of the reins and originate $400 million without taking into account credit quality.

And maybe I am being an old dog here, but I am conservative. I like the growth that we are on. I like the earnings growth of Q4 that I am seeing. And it will all come together in the second half of the year without hopefully sacrificing credit quality. And I am very, very happy with our strong pipeline and strong deal flow that we are seeing today.

Great. Well, thanks, guys. We are looking forward to it.

I am showing no more questions in queue.

Thank you, operator, and thank you, everyone, for your continued interest and support of Hercules, especially in today's market and volatility that we saw today.

We will be attending a conference on Monday, the JMP Conference, to present as part of their financial conference. We will be taking meetings with investors on that day as well.

And as we do and say at every earnings call, Dave and I will be on the road over the next two to three weeks, meeting with investors. If you would like to have a meeting with us, we are happy to coordinate that if it fits in our schedule in the cities that we are in. Feel free to contact David Lund at 650-289-3060, or myself, and we will be happy to coordinate a time to meet with you.

Thank you very much, and thank you again for being our shareholders. And have a good day.

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day.