Hercules Capital Inc (HTGC) 2010 Q3 法說會逐字稿

Good afternoon, and welcome to the Hercules Technology Growth Capital, Incorporated Third Quarter Earnings Conference Call. (Operator instructions)

Please note that this call is property of Hercules Technology Growth Capital, and any unauthorized broadcast of this call in any form is strictly prohibited.

I would now like to turn the call over to Mr. Scott Gable, Chief Operating Officer for Hercules. Sir, you may begin.

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

Our third quarter 2010 financial results were just released after today's market close. They can be accessed from the Company's website, at www.htgc.com. We've arranged for a taped replay of today's call as well, which will be available through our website or by using the telephone numbers and pass code provided in today's earnings release.

I would also like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information. Today's Conference may include forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important risk factors that could cause actual results to differ materially from these projections. We do not take any obligations to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit sec.gov or visit our website at www.htgc.com.

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

Thanks, Scott. And good afternoon, and thank you, everyone, for joining us today. I will start the call, as I traditionally do, by providing a quick summary of our operating results and achievements, and then followed by a few observations and discussion points on the environment as a whole and [that efisively] of the venture industry and any impact that we are seeing manifest itself in the venture industry to our portfolio.

That said, we completed and executed a very strong third quarter, in spite of a very weak and very, very frustrating July period of time, where we saw an [amazing] decline in activities in July and August on both new businesses, as well as we saw manifest themselves in the public markets with lack of trading.

Now with saying that, we actually generated for our shareholders $8.1 million and net investment income or GAAP earnings of approximately $0.23 per share, which, I think at last estimate, is a penny above the street consensus on our performance.

In addition to that, starting in Q3 of this year, we're going to start reporting DNOI, which was approximately $0.25 per share, which I'll allow David Lund, our CFO, to kind of expand upon the DNOI reporting -- I apologize. It's a new word for me -- to report upon.

In terms of total commitments -- despite a fairly soft Q3 and something that we have forewarned previously, the quarter was actually not a bad quarter. It was completed with [20 to the] $83 million of new commitments were executed in the quarter, of which $55 million were to new companies, and the balance to existing companies which we renewed or restructured credit facilities.

Beyond that, we saw approximately $44 million of fundings -- excuse me, my mistake -- we are seeing a very good momentum in Q4, as we now have seen $44 million -- pardon me -- of commitments that we have closed in the first month of the fourth quarter. And the issue with that, and why I'm raising it, is that [part of those] transaction closed in the first week of October. And we're seeing, at least in the third quarter, a longer delay in getting transactions closed that we had forecast and anticipated closing in the third quarter, which basically closed in the first week or so of October, representing $44 million.

Beyond that, we have approximately $100 million of signed term sheets leading into Q4. And we have a pipeline that is now exceeding $1 billion, and giving us very strong visibility to Q4 and Q1 and beyond in terms of closing new commitments.

But I have to once again give attention to this statement. Commitments do not necessarily reflect fundings. It is frustrating for us, because we cannot control the actual amount and date of fundings. But that is evidenced on our continually building backlog you'll see us report here every quarter, which is called the unfunded commitments that we talked about.

More importantly, we just achieved a significant milestone. Since going public, we have now reached and exceeded a total of $2 billion in committed capital to venture stage and life sciences companies in technology life sciences industry.

Personally, it's a very proud achievement. And that was to over 150 companies. And that would not have been done without the extremely hard work and dedication of all the employees at Hercules Technology who have worked diligently to perform very, very hard to realize this $2 billion [number]. But more importantly than the $2 billion achievement is the credit performance by which that was done.

We achieved over $2 billion of commitments to technology and life science companies, with only $42 million in total losses net during our six-year period of time, which of course I'll let David Lund, our CFO, provide a bit more color on that as well.

In terms of our assets -- we finished the quarter at approximately $408 million in assets, slightly down from that of the third quarter. And as I said earlier, that was primarily driven by early payoff that took place at the end of the quarter. And most of those assets have already been recouped in terms of new investments leading into the fourth quarter as we look forward.

In addition to that, we've successfully received the ability to lock in our SBIC debentures at a interest rate of 3.215 on $29 million of capital. This affords us a very strong visibility to having locked in costs of capital that are quite accretive in the event that interest rates were to go up in the future.

Lastly, on our performance -- the Board of Directors had once again declared a $0.20 dividend which, as we continue to build our dividend and our earnings, it is highly [unlikely] that we'll see some form of either a dividend at the end of the fourth quarter or potentially a spillover as we continue to originate assets. During the fourth quarter, we will periodically revisit that and make any appropriate announcements to our shareholders on that. But I am proud to say that as evidenced in our earnings, we are continuing to focus on earnings growth, and you're seeing that manifest itself into that with our EPS of $0.23 in earnings.

Now, let's turn our attention to the venture capital industry. Despite all the media claiming that the venture capital industry is dead, it is far but that. Personally, I saw that the third quarter originations were quite robust. In fact, we were expecting to see a number lower than $5.5 billion, and we actually saw a number of $5.5 billion take place in Q3 to approximately 660 companies, representing a 2% increase from that of 2009.

On a year-to-date basis, we saw $18 billion of venture capital invested so far in calendar 2010 to over 2,000 companies, representing a 10% increase over the same period last year. These are critical factors as we look to the venture industry to continue to show resilience and commitment to deploy capital to various companies in different sectors.

Now, on sector-specific -- the largest sector receiving capital continues to be information technology, which received approximately $1.8 billion or up 35% for the same period last year, making it the largest recipient of capital during the third quarter. Life sciences, on the other hand, the second-largest category, received $1.7 billion of capital. However, it was down approximately 11% as compared to the same time last year, with medical devices, making up the lion's share of that decline, being down 26% over the same period last year.

We also saw business services and financial services receive $841 million of capital, up 19% over the same period last year; while consumer services, as even evidenced in our own portfolio, which -- we have been declining consumer services -- is down 20%, to approximately $560 million from the same period last year. And our newest category that we're now breaking out and reporting -- clean tech, also known as green technologies -- received approximately $359 million. And although the number is down 28% year-over-year, it is primarily driven down lower by two large investments that were made in calendar '09.

Now, no conversation on the venture industry is complete without looking at the totality of the ecosystem. And that means that I'm turning my attention to venture capital exits, also known as liquidity, achieved in the venture industry. In the third period, we saw 111 venture capital companies achieve exits totaling $6.4 billion. One hundred two of those exits were in the form of M&A, representing approximately $5.7 billion, up 5% from the prior year, the same period.

Now, the most important part of this statement is IPOs. Albeit on a historical basis the IPO activity is still nascent -- but when compared to the same period in 2005, we basically saw a 500% increase in IPO activity in Q3 2010 as compared to Q3 '09, meaning we saw nine IPOs go effective in the third quarter, raising $723 million. This is up from two IPO events in the same period in 2009.

Now, what makes this interesting is that currently today, there are approximately 49 venture stage companies who have on file IPO registration statements, five of which -- or, said differently, 10% of those -- are Hercules portfolio companies. We currently have, at the end of the third quarter, five companies in registration, one of which was declared effective. Aegerion Pharmaceuticals went effective in October, giving us a net four companies in IPO registration as of this call today.

These are important signs and encouraging signs. But let me share with you some insight, after my 25 years of doing this business, that are important, and I consider very, very critical details on why my optimism is running so high currently. M&A companies are seeing a 20% decline from the first round of venture capital investment in the Company to an exit event have declined by 20%. They also saw a 30% increase in more capital to achieve this liquidity event.

Why it's important is, if you look back to what occurred in 1993, '95 and '99 -- to draw some historical correlations -- the tighter the compression of time to liquidity means that additional capital is needed to differentiate yourself to arbitrage the valuation differential between public comps and that of the private comps. In layman's terms, [you] start seeing a lift in valuations of private companies to start matching the increase in valuations we're seeing in the public marketplace. This bodes extremely well for our [warrant] portfolio, but also makes debt a highly sought-after asset class because it's less dilutive for companies to accelerate their windows for liquidity.

Conversely, we're seeing a 60% decline in the timeframe for the last -- from the venture capital dollars invested in the Company to a liquidity event declining by 16%, while the capital committed is decreasing by 21%. These are actually very, very good signs and very important signs that I look to in the venture industry themselves. And I'm happy to expand those in the Q&A session.

Lastly, the environment is not complete until we see the totality of the picture. And that is venture capitalists receiving additional rounds of capital from the limited partners. In Q3, the venture capitalists received approximately $3 billion of capital to 45 funds. This is up 40% from the same period last year.

As a whole, for the year-to-date for Q3, $9.1 billion was invested into new venture capital funds. This data has been provided to us by Dow Jones Venture Source and Thomson-Reuters MBCA data.

Now, in closing, asset quality -- overall, the asset quality remained quite strong during the quarter. Clearly, we had some impairments that we chose to take during the quarter, which we felt was prudent and in keeping with historical performance of Hercules on one particular asset that so far seems to be improving its performance. But we decided that given what we were seeing, it was prudent to take an impairment to reflect the appropriate carrying value for that asset. Overall, we have the lowest grade 5 rating we've had in quite a long time in the portfolio today, and we're seeing an improvement in credit quality in the portfolio.

On liquidity situation -- remains quite strong. Over $218 million of liquidity we have in the portfolio today. And that is against a growing backlog of approximately $120 million of unfunded commitments followed by the $100 million or so of new signed terms that we received today.

With that, I'd like to turn the call over to David Lund, our CFO, to continue the conversation or discussion.

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 and into 2011.

Today, I'd like to focus on a few key areas -- summary of second quarter results and operating metrics, and liquidity [in] capital resources. During Q&A, Manuel and I will be more than happy to respond to questions you have on other operating results that I do not specifically address during my discussion.

Let me first provide some current highlights. We closed $67 million in commitment to new and existing companies and restructured one $15 million loan, for total commitments of $83 million in the quarter. Additionally, this quarter end, we have closed an additional $44 million of commitments. And as Manuel indicated, we have over $100 million of pending commitments. While our third quarter was light on origination, as was historically the case, we believe these pipeline figures signal that our strategy for growth is on track for the year.

Further evidence that we have turned the corner from asset protection to growth mode is improvement in our net investment income. Our diligence in adding high-quality assets has resulted in the growth of our total investment income to $15.5 million, or 8%, as compared to the prior quarter.

Our net interest margin increased to 12.3% in the quarter from 11.3% in the last quarter, as we added higher-yielding debt investments during the quarter. Our effective yield on our debt investments during the quarter was 16.2% compared to 16.7% in the second quarter of 2010. This slight decrease was driven by a quarter-over-quarter drop and one-time fees of approximately $600,000. We see this metric, the reduction of one-time fees, as an additional indicator that our portfolio is stabilizing and we are entering into new quality originations. That being said, one-time fees and early repayments are highly unpredictable, and we have limited control over when they [may occur].

Operating expenses for the quarter, excluding interest expense and loan fees, was $5 million, as compared to $5.3 million for the second quarter of 2010. This decrease is primarily attributed to lower compensation-related expenses.

Our Q3 net investment income was $8.2 million, or $0.23 per share for the quarter; as compared to $6.9 million, or $0.19 per share in the prior quarter, reflecting a 19% decrease in NII. As Manuel indicated, we are now disclosing DNOI, or distributable net operating income. And this is comprised of our NII and then add back for noncash compensated related to our stock options. And that was approximately $751,000 in the third quarter. And that reflected a $0.25-per share DNOI for the quarter. I'd like to note that we have four loans on nonaccrual at the end of the quarter, representing less than one tenth of 1% of our portfolio at value, relatively consistent with prior quarter.

As to our realized loss in the quarter, we were forced to liquidate one investment and, as a result, realized $18.7 million loss on the investment. As you may recall from our second quarter call, this company was severely impacted by these unprecedented economic times and would have required significant additional capital in order to stabilize the Company. This loss was fully written down on an unrealized basis in the second quarter.

I would like to point out that this realized loss brings the total net realized losses since inception to just $41.6 million, representing just 2% of total commitments of $2 billion since inception. On an annualized basis, this represents just 35 basis points based on the total commitments for the same period. The net realized and unrealized gains and losses we recognized during the quarter were the primary contributors to the decrease in our net asset value, or NAV, during the quarter.

Turning to liquidity -- we have maintained solid liquidity and capital resources, which positions us to meet the capital requirement that was [height lined to] statistics I just reported to you. As of September 30th, we have over $218 million of liquidity, comprised of $83 million in cash, access to $50 million of borrowings under the facility with Wells Fargo, and $20 million of borrowing capacity with Union Bank subject to advance rates; and approximately $65 million of capacity under our second SBA license subject to regulatory limitations.

In addition, our only debt outstanding was approximately $160 million under the SBA program. Again, as Manuel indicated, we did lock in $29 million of borrowings under the SBA program at a historic low rate of 3.215% exclusive of the annual fees.

I would also like to remind our investors about the amortization of our portfolio. Our normal principal collections are approximately $20 million to $25 million a quarter. However, we are unable to forecast with clarity what early repayments may occur during future periods, evidenced by the early payoff of $30 million in the third quarter. We believe our liquidity position, based on available capital and principal repayments, as I have just discussed, places us in a very advantageous position to invest in the remainder of 2010 and into 2011.

Moving on to dividends -- we distributed a dividend of $0.20 per share during the third quarter and announced that we have declared a $0.20 dividend payable in the fourth quarter. As I have indicated, we expect to continue to see earnings growth over the next several quarters as we grow our investment portfolio, which should result in higher earnings and dividend growth for our shareholders.

Would also remind our shareholders that in August, Hercules extended its share repurchase program through February of 2011. However, during the third quarter, the Company did not repurchase any of its shares of common stock.

In conclusion, we believe we have laid a very solid foundation for continued growth. We have a robust pipeline and enviable liquidity position, which we will continue to leverage as a competitive advantage.

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

(Operator instructions) John Hecht, JMP.

Afternoon, guys. Thanks for taking my questions.

A couple things -- one is, can you guys talk about Infologix? You talk about it in your press release, and you'd said there's a fair value of impact that it sounds like you recognized in Q3. Maybe, can you just give some more details on that?

Sure. Infologix is a significant investment for us and a control investment for us. But it's not a consolidated investment for Hercules, since Hercules does not control the Board, nor do we control the operation of the business.

With that, the Company most recently -- want to say on or about October 21st, 22nd -- did in fact receive its delisting notice. It was unable to comply with the various exchange requirements to remain listed. And it fell -- it actually failed to remain in compliance and is now traded on the [bulletin] boards.

With that, we own basically two classes of securities there. We have registered shares and unregistered shares. And we felt strongly that the issues on the unregistered shares should receive some additional impairment in the carrying value. And those securities were written down post-event given the materiality of the investment to reflect a more cautious carrying value for the securities themselves.

We do not, at this point, feel the need to make any impairment or adjustments on the carrying value of the debt instruments that we have in the Company, as the Company has continued to be a [going] concern [in] operations, and it also is continuing to explore numerous strategic options for itself.

Beyond that, I would feel uncomfortable getting into any additional color that really should be directed more towards the Company itself, in the independent board members of Infologix, as opposed to me getting into more proprietary color there.

Okay. Well, I guess a little further on credit -- I mean, you guys had a dramatic decrease in your grade 4 and grade 5 levels. So I wonder if you could comment on that -- just the way you see the [world] from a credit perspective, and how you feel about the character of credit quality for the new loans you're writing.

Yes. As an example, if you turn to -- and if you've seen the subsequent disclosure events we have in the earnings release, we have a lot of events that have taken place post the quarter end that would have a fairly accretive impact in the credit portfolio as a positive. We have -- Aegerion was increased in credit rating when it successfully completed its IPO in capitalizing on the business quite successfully. So that would automatically cause an increase in the credit rating [attributable] to that.

We also have another transaction of [AO], also announced completion of a pipe further recapitalizing the Company in a very strong balance sheet, which definitely makes the credit outlook for that company even stronger than we had reflected as of the end of Q3. And that's also a subsequent event that took place. So you have a lot of events that have taken place post the quarter that would be accretive from a credit rating -- credit performance point of view, that continue to develop in the portfolio itself.

I would also like to say that we are in fact aware of two additional portfolio companies of ours that are -- have indicated to us the possibility of completing an M&A event between now and year end. But as I always do, I don't put a lot of reliance on M&A pre-announcement, until I see a much more solid footing that the M&A event will be imminent as opposed to simply giving us a heads-up that they're pursuing that. I'm encouraged by those signs, clearly. But till they happen, we're going to be cautious, as we always are.

Okay. And final question related to portfolio trends -- it sounds like you're off to a pretty strong start Q4, terms of commitment levels. Is this kind of a seasonal flip from Q3, people trying to rush to get things done before the end of the calendar year?

And the second question, second part of that question, is -- how do you feel about repayment rates in Q4, given the trend you're seeing right now?

Sure. Unlike the lower-middle market, middle market, especially finance companies, Hercules' business model is not predicated upon changes in tax laws or imminent issues in tax laws triggering an M&A event. They're less catalyst-driven and more simply seasonality that is typical in the portfolio.

Just to remind our investors, both new and old, that we generally experience -- about 35% of new commitments are experienced in the fourth quarter, while historically 10% to 15% -- and this year is more at a lower end, 10% -- is typically seen in the third quarter. As I said in my opening remarks, July and August were horrific. There's no way of putting it but just blatantly that way. It was just dry out there.

September was certainly a lot more perky, and October has been a roaring lion from new business activity. And November so far shows no let-up in demand for capital right now that we're seeing from portfolio companies. So that's all encouraging.

Your last question related to anticipated early payoffs -- unlike the -- and I use the word that I traditionally don't like using -- unlike the guidance or update we provide investors in the second quarter, we don't have any visibility in the third -- in the fourth quarter, excuse me -- of any anticipated early payoffs as of right now. Unlike in the second quarter, we had some belief on expectations of $20 million or $30 million. They actually did come in. But interesting enough, they came in almost all at the end of the quarter as opposed to more in the beginning and the middle of the quarter, which is why you see a strong earnings performance, but yet the overall assets are lower at the end of the quarter [when] we take a snapshot.

But we don't anticipate, from what we know today -- and I have to preface that -- with what we know today, any expected material early payoffs right now.

Thanks for the color, Manuel.

Thank you.

Troy Ward, Stifel Nicolaus.

Great, thank you.

Manuel, can you -- just a follow-up on John's question on Infologix -- did I hear you correctly and say that the debt in Infologix is still market par? And do you expect full repayment of that debt?

As of what I know today, in the various options that the Company's exploring, we feel that the carrying value for the debt more than adequately reflects the ability to recover that [invest] transaction event that we have to do so. The mere fact on fair-value accounting as it relates to the equity -- we have to take into account the event of delisting on a prospective basis as well as -- and I can't remember the whole FASB 1-through-7 issue related to this -- but it's somewhat complicated. You have take into account an event that occurred even after the quarter in your consideration that had you known these variables, you adjust your fair value on your equity securities.

And as a reminder to everybody -- the securities for Infologix at the end of the quarter were approximately $4.22. And post the delisting, the shares traded as low as, I believe, $1.35 and stabilized somewhere in the neighborhood of $1.75 to $2 a share. We felt strongly that carrying a higher value of the equity security at the end of the quarter without taking account of delisting would have been an over-inflation of our net asset value given the events that have taken place on a delisting issue. But at this point, we feel the debt is adequately covered in the enterprise value of the Company itself.

Okay. And can you remind us -- do a little bit of history behind Infologix -- when was that made -- what's the -- what's kind of the group it falls in? Is this one of your middle-market loans?

No, I would say that Infologix is arguably a [tweener]. Not to use a technical term. It truly is a -- and lower than [a] market credit. The company's interesting. The company at one point had north of $100 million plus in revenues. It's well-positioned for the healthcare reform. And it has a very good foundation of clients in the various hospitals and healthcare practitioners.

What has fallen, unfortunately, is it has not adequately and fast enough adjusted its working capital needs to counter the shifts in business that we saw develop in '09 and the early part of 2010. But the company's making great strides in that area. But again, I have to encourage everybody to direct those more specific questions related to Infologix's performance to the Infologix board members and company itself.

Very well. Okay.

And then, just quickly on the balance sheet -- when you think about the SBIC availability of $65 million [and] the $83 million of cash -- how do you look at those two buckets, as you think about putting capital to work? Obviously, the SBIC next lock will be in March. And if it's anywhere near as low as it was this time, it would seem like you'd want to get a lot of that locked by March. How do you think about that?

Well, [I have to be sure] people [temper] and understand that the equation is not as simple as being asked. The SBA in particular has multiple different requirements of the underlying asset [to] conform to. But notwithstanding that, there's also -- since we have two licenses, each license has a different cap on the aggregate securities that can be places into that from a single obligor, meaning a single credit.

So [we're] constantly tempering the different assets that we're originating with the different qualifications of the respective credit buckets that we have, meaning we have a Union Bank of California credit bucket, we have a Wells Fargo credit bucket, and we have two SBIC licenses. From a qualification point of view, the assets are the same. But the size of the assets [that can be placed] in license number one versus license number two are slightly different.

For example, now -- I'll let David answer the actual size of license one versus license two, [C.A.]

License one allows us to put in a loan at $22.5 million, whereas license number two allows us to put in a loan as high as $11.25 million. So there are restrictions on the sides for each one of the individual licenses.

In answer [to] your first question -- absolutely, I want to maximize the earnings for our shareholders by minimizing the cost of capital in doing so. So it remains our mission to look to first leverage the balance sheet as we continue to grow the portfolio. But credits still remain quite aloof out there. As you've seen, most BDCs [suddenly] report -- three particular BDCs have decided to go out the securitization route because of the difficulties in securing long-term and stable commercial lines of credit from commercial banks. And we're not seeing any difference in that, and the [constination] of commercial banks extending credit to companies out there. Not much has changed right now on that front.

Thanks, gentlemen.

Jason Deleeuw, Piper Jaffray.

Good evening, and thanks.

Just following up on what you were just discussing, can you give us a little bit more color on your appetite for seeking out new credit facilities at this point, just given the portfolio growth you're expecting and what you've already done? And also, if you could talk about other sources of capital, equity capital? What are your thoughts regarding capital needs to grow the business from here?

Well, my thirst for leverage capital is insatiable. My ability to quench that thirst is painful. We -- ostensibly as of Q3, we have zero leverage in our balance sheet. I would love to see us leverage the balance sheet first and foremost as we continue to build assets. The processes by which to secure a line of credit from a commercial bank in this country remain extremely difficult and extremely elongated.

We are still continuing to dance with three to four different credit providers, who have all indicated that they are substantially either complete or materially through most of their diligence process, but somehow, term sheets don't seem to come. And it's a painful process.

We continue to look to leverage the balance sheet first. That is our first and foremost preference. However, with a very, very strong pipeline, with continued weak competitors, demand for Hercules capital continues to increase every day more and more. The pipeline for the fourth quarter is getting stronger.

There's a balance that we constantly walk on looking at new asset origination that are earnings-accretive and hopefully based on capital that's not book-dilutive. And so our preference is [continuing], as we've now done -- and just to remind everybody -- the last time Hercules Technology raised capital, equity capital, was June of 2007. We have shown our discipline to manage through and maintain liquidity in the most difficult times, but also be cognizant to our desire to continue to have earnings growth and dividend growth with that of minimizing dilution to our shareholders.

Leverage is first. But we have not ruled out the ability to raise equity capital in the next -- I don't know -- foreseeable future is what I would say. I mean, given the fact that you have $120 million or so unfunded commitments, $100 million in signed term sheets and $200 million of liquidity, it doesn't take much to do the math that we're probably approaching those points.

Okay. That's helpful.

And then, can you give us an update on the competitive environment, especially with -- it seems like more deals -- the deal activity really started to ramp up in September, and even more, it sounds like, in October. Can you just give us an update on what you're seeing on the competitive front?

It goes back to more of the same. Hercules has never been, and nor will ever be, the cheapest provider of capital. Many of our competitors that we've seen chose the route of being the early -- the lowest-cost provider of capital out there. And they've either experienced credit losses or curtailment of their own access to capital because they either have negative spreads or no margin on their new asset origination.

So we maintain a very disciplinary approach in how we originate new assets. And we will toggle originations directly correlated to our cost of capital and our spreads on how we look at the business. And that discipline will not change much.

That said, as the liquidity markets -- as I indicated in my opening remarks -- seem to be accelerating, you're seeing a more rapid desire to arbitrage the valuations that are being seen in the public markets with the lag in valuations being had in the private markets. And this is a fairly typical arbitration that takes place, more typically seen on the wave of '97 through '99, and more seen again from 2003 to 2007.

I think that you're seeing the technology [tape] rally pretty strongly recently. You're seeing large pharma reigniting their acquisitive interest, meaning acquisition interest, that they have [for] life sciences [and in private] companies. These data points all bode extremely well for our portfolio.

And with that, companies are now more willing to accept that slightly higher cost of capital from a more stable capital provider such as Hercules, one that has the depth, the breadth and the liquidity on a very transparent basis of over $2 billion in commitments [since] inception -- that our venture capital partners are seeing a much more comfort in dealing with a larger player than some of these small $100 million, $150 million capital providers that exist out there, that are only able to do $5 million or $4 million transactions. Those transactions are coming more and more our way.

Great. That's the benefit of being in a strong position coming out of the downturn. So that's great. Thanks a lot.

Thank you.

Vernon Plack, BB&T.

-- much, Manuel. I want to make sure that I understood you. You mentioned at the beginning of the call something about the dividend. Did you mention that there may be a special dividend at the end of the year, or there's the thought of a dividend increase? Or -- I wasn't sure exactly what you said there.

Sure. Well, no, let me not mince words and not be ambiguous.

It remains a policy of the Hercules Board of Directors that we want to match our earnings capability to our dividend on [at least a] rolling four-quarter basis is what we do. And I would say that fact that we've made $0.23 in GAAP NII and $0.25 in DNOI -- for the third quarter, we only paid out a $0.20 dividend, meaning that they'll give rise to some form of a carryover to the fourth quarter, and probably some carryover that may occur with the earnings momentum in Q4, that will lead to one of two things -- either, A, the Board of Directors may elect at the end of the year to actually declare a special dividend -- a fifth dividend, if you will -- or they may elect to simply have a spillover to determine [if any were] between $0.00 to $0.01 or $0.02 or $0.03. It all depends on the continued momentum in the third quarter.

But our policy remains the same -- that we reevaluate every year, at the beginning of the year, what the earnings rate will be. And we establish a fixed dividend by which point we unequivocally earn, and then relook at topping it off if required -- if need be at the end of the year. So that would revisit here in the next 60 days or so.

Okay. So we should know something in terms of what you're thinking about regarding the dividend within the next 50 days.

Think of it as a Hanukah present or a Christmas present that will hopefully manifest itself as the asset growth and earnings growth occur in the fourth quarter, as it will signal if a special dividend or spillover is approved by the Board of Directors, yes.

Okay. Well, happy holidays, and looking forward to that.

Okay.

[That's it.] Sort of a bigger-picture question -- and I know that you don't provide guidance, and I'm not looking for guidance, per se -- but one of the -- it's a benefit as well as a challenge that your investments pay off relatively quickly. And we've been through some challenging times here lately. And with that, how you feeling about growth? How you really -- should we see, over the next -- over the next 12 months, some meaningful growth in the portfolio? I know you've talked about what a more normalized rate is in terms of repayments, which is around $20 million a quarter. But for at least the past five quarters, that number's been way above that. And it's obviously a very difficult thing to gauge. But should we see meaningful net portfolio growth over the next 12 months?

My response may surprise you. I see enormous growth ahead of us. My biggest constraint to achieving that growth is a form of liquidity to fund that growth. And it is strongly my preference, for the benefit of our shareholders, to fund a substantial portion of that growth by leveraging our balance sheet, which is not leveraged today.

Not having that strong visibility, or, said differently, that strong confidence that I have a stable, predictable access to leverage beyond my SBA, growth may be limited by making sure that it's driven by equity capital raises -- that those equity capital raises are done with discipline and are accretive to shareholders, and not merely done as a [sloppy] capital raise.

And why I say it that way -- Hercules is one of the few remaining internally managed BDCs. And internally managed BDCs have thus far shown a greater discipline on ensuring that there don't [be] dilutive capital raises for the benefit of aggregating assets from management fees. And I remain steadfast in that interest. As one of the largest shareholders of Hercules, I hate dilution myself, personally.

And so I'm looking to drive growth, first and foremost, with access to leverage. But leverage becomes more and more challenging. But I am seeing signs of improvement.

Now, we got a little gift this week. And that is, if I remember correctly, the House -- excuse me -- the Senate had originally passed -- and I may have this backwards, so I apologize if I do -- the Senate had passed originally HR 3854, or 3654. I always get those permutations wrong. That's Small Business Lending Act --

Yes.

-- that increases the SBA leverage cap from $225 million to $350 million in capital. Now that the Republicans control the House, it is highly likely than not that the passage of that bill should occur, making it a highly accretive event whereby Hercules will be able to tap another $125 million of SBA capital at a very effective cost of capital, which would be a dramatic accretive event for our shareholders as we're seeing assets originated in a 12% to 14% range today, with a cost of capital of anywhere between 3% to 3.5%, more or less, range. So --

Okay. That's very helpful. Do you think the repayment rate is going to go back to normal level?

Well, let's talk about normal level.

Yes.

As -- just as a reminder, it's typically that when new assets are originated on a very high-level average basis, [typically], a new asset originated has anywhere between a six- to nine-month interest-only --

Yes.

-- which means a big, significant portion of the assets originated. And what most people don't realize -- and I should've highlighted this -- Hercules is on track right now to have a record year since inception of the largest new capital committed in a single year.

Yes.

Could be this year --

Yes.

-- already, with what's going on right now.

Sure.

That seems to be lost in all the noise, because there's so much stuff going on. But we're going to have -- we're on trajectory, have a record year of over -- potentially over $500 million of new assets -- new asset commitments this year, which dwarfs the majority of our competitors in the private, and most recent public, in size in terms of their capacity -- what we'll do this fiscal year alone.

Okay. That's great, thanks.

Henry Coffey, Sterne Agee.

Good afternoon, everyone.

Obviously, making tremendous progress here. How much, Manuel, of your thinking -- and maybe this should be transparent -- your portfolio has actually always had a fairly high turnover rate. But in days gone by, you had fairly regular access to liquidity, so you were able to be out there as an aggressive originator. And both -- the liquidation of existing assets wasn't that big of an issue because you were quick to replace that.

So how much of your current liquidity situation is being defined -- I mean, I'm sorry -- your current view on originations is being defined as your ability or inability to have kind of ready access to funding? And how much of it is really a direct function of the marketplace, and where you think pricing is?

We are feeling the same pain, that you read about in the media that you hear about in the news, about main-street America not getting access to credit and credit availability. It is absolutely a governor or an impediment for us to realize the greater value for our shareholders. Because without having readily available and stable, predictable sources of leverage capital, I have to then look to run the business with the combination of SBA capital as well as equity capital. And as I said, I don't want to go out and do excessive equity capital raises that are not accretive to shareholders.

But I need to temper that, of course, by saying that strategically deployed capital raises -- maybe doing smaller, bite-sized capital raises -- is probably a better solution than doing a large, significant capital raise to deploy the capital, make it accretive, and go back out again as the market improves from a credit performance.

So there's no question, Henry, that the inability to have strong visibility and confidence into predictable lines of credit -- it is serving as a governor to the growth that I'm seeing available to us in 2011. 2011 could be a dramatic year for us in terms of asset originations, had we [have] a predictable, stable source of growth capital in front of us to leverage the balance sheet. No question about that.

Could the SBA funding -- should you get this second additional round -- I mean, should the new bill be approved -- and the amount of rhetoric on this subject is amazing relative to the amount of action -- but should Congress actually expand the SBA program, and over some relatively reasonable period of time give you access to an additional license as you're suggesting -- and I'm assuming that's how it would work -- would you need another license? Or [would] they just expanding the capacity of the existing licenses that you have in place?

I think that you may have asked and answered the question on your own. I think that the notion of a third license is a concept that has been tossed around certainly, within many parties and many constituents. But there is no clarity as to whether or not it will be done -- the third license -- will be done as simply increasing the leverage from a two-to-one leverage or three-to-one leverage, or will be done by increasing the cap to [350], but maintain a two-to-one leverage, which means you have to fund additional equity contributed to capital into your license.

All these factors, Henry, are totally unknown at this point. And I would wish that are newly elected legislators would get their act in gear and help this country get back in doing what it does best, and get capital flowing to all parties. Because we are seeing an inordinate amount of opportunities we could help companies grow and get employment going again. But this constraint on capital is a problem.

So -- but under the assumption that this door was open to you, do you believe that you could build a viable business model around SBA lending given some of the restrictions that are inherent in these programs? Or do you think you would still be struggling with the current situation?

I think that a way of looking at it as a merely simply math -- if you look at the Hercules organization, and you presume that we have, for example, 12 originators or 14 originators, if you will, in each of the capacities -- say, for example, $40 million, $30 million -- whatever number you want to choose -- you're looking at the ability to do $500 million, $600 million of new assets next year alone, with the embedded capacity that we have today from origination machine.

So therein lies the rub. It is our preference to go and attack a market in 2011 to the tune of $300 million, $400 million, $500 million, $600 million a year -- even more, if you will. But we'd rather leverage the balance sheet, which is zero leverage today. I have the ability to go up to something [at] $360 million of leverage --

Yes.

-- without tipping up any of my BDCs' one-to-one ratios. I can easily exhaust that capital. Then you lump on an additional $125 million from the SBIC program. That gives you the visibility to say, for example, $480 million of new loan capacity, of which I expect to generate between $20 million and $25 million a quarter in amortization. However, by Q3, Q4 of next year, that number will probably be in the neighborhood of $25 million, $35 million in amortization.

So it's a toggle that is [complete] contingent upon the legislators from the SBA point of view, which would be highly accretive; and the various large commercial regional banks that we're talking to on releasing liquidity in the form of leverage to us that would further accelerate the growth that we're seeing in front of us.

Thank you.

Jason Arnold, RBC Capital Markets.

Hi, guys.

In terms of the new investment opportunities in the pipeline, are you seeing more concentration still in the IT-related end of the equation, or is it more across the board in the sub industries that you're participating in right now?

If you look at the portfolio -- excuse me, if you look at the pipeline for October and the early part of November, it is squarely broadly distributed right now through all of our sectors that are out there. It is a -- it's a [title] change difference from what it was just July and August. I mean, it is completely different world, starting in October, from what we're seeing. It's encouraging signs, by no stretch of the imagination.

But with that, I don't want to lose our stream of credit discipline that we've built and successfully managed Hercules through one of the most challenging periods of time in this country's history, and lose our compass on credit simply to originate. We will maintain that strong [rigors] of credit underwriting as best as we can, as we've done historically, to maintain that credit performance. But it is a dramatically different -- with a lot of our competitors having limited capital pools available to themselves. And we're just seeing this massive increase in demand.

Now, I want to couch that by saying that just because I see a over $1.2 billion pipeline does not mean that all of those opportunities are worthy of the credit underwriting standards of Hercules. So I need to couch that. Because we still [kill] -- on 90% of the transactions that we review, we still pass on.

Okay, terrific. Thank you very much for the color. And nice job this quarter.

Thank you.

Jasper Birch, Macquarie.

Just starting off with -- sticking on the topic of credit, I believe the Wells facility matures in August next year. Just on that one specifically, are you -- do you think you'll be able to extend that facility? Or are most of the people -- or are most of the lenders you're talking to looking at new facilities?

No, I mean, we are in dialogue with Wells Fargo. And what we really want to do (inaudible) in our discussions with Wells Fargo has been around putting in the new credit facility. We'll let the other one pass away, and then we'll put in a new one -- new, complete facility that we prefer to have somewhere in the two-, three-year longevity to it.

Let me defend Wells a little bit here. In all fairness to Wells, we haven't borrowed yet. So I think that they're a bank [and they want to] see asset growth themselves. So we're culpable on not giving them what they're looking for from their business. And that is, they want to have outstandings.

And it really wasn't until the fourth quarter that I could say that we would have the visibility of having outstandings. There's no question, as I look to the fourth quarter, growing pipeline -- and certainly look to the first quarter -- that we will have outstandings for Wells Fargo and their facility, as well as any new lender coming into the facilities. That goes a long way on getting lenders to participate into the accordion credit line we have with Wells Fargo, for example.

Yes. We have a great relationship with Wells Fargo. I don't mean to imply anything else in that. They've been a great partner.

Okay. Well, thank you. And as always, thank you guys for all the frankness on the calls.

Sticking with the topic -- you just mentioned maybe two, three year for Wells. And the SBA's obviously long-term and reliable funding. If you were to look at even longer-term funding, maybe in the range of notes or preferred equity, sort of how would you look at sort of an acceptable interest rate on that? And I guess, to phrase another way, sort of what do you think is a long-term return across multiple cycles in your business model, on the equity side? And what sort of spread would you require?

Now, Jasper, you're asking me to opine on your piece you wrote a couple weeks ago, which is [a] very good piece, on this spread over 10-year treasuries and spread over BBB-rated bonds?

Look, I'm old-school. I believe that BDCs should probably trade anywhere between [350] to [450] over 10-year treasuries, is the way I look at the business. So that's one way of saying that BDC yields should be somewhere in the neighborhood of -- and I know this is different than your view, and so I'm not necessarily taking issue with your view. But that certainly advocates a view of anywhere between 7% to 8% BDC yields (inaudible) more in the 8% to 10% yields, if not a little higher.

I think that with the Treasury -- or the Fed, excuse me -- going into the open markets and doing this quantitative approach, I think that you'll see a drive towards lower interest rates that will naturally gravitate and spill over to the BDCs -- will naturally drift down into the 7% to 8% yield range.

Now, you're asking a very important question, and you left out a very important element. And that is securitization, [no dissimilar] than some of -- three other BDCs have done. I think that the securitization market is certainly a very interesting market and one that's emerging as a promising area even for us to look at.

So we are actively involved. Dave and I are actively involved, looking at every permutation of capital raising that is accretive to our shareholders, and the lowest cost to our shareholders as possible. And clearly, you've seen a fairly broad bid and a half spread between securitizations on a 30-year securitization was completed versus a three-year or a five-year securitization was completed. We have a little bit of all these different flavors in the market.

I think that unless the commercial banks in this country step up to the plate, I think you'll see more and more BDCs gravitate to a securitization type approach on a five- to seven-year type of credit facilities from a debt conduit.

Okay. Thank you for your commentary. That's helpful.

Sort of changing tacts here -- looking at the SBA funding being fixed-rate and pretty reliable, are you thinking about changing sort of your mix of fixed- to floating-rate assets, and maybe picking up a little bit more yield on moving into fixed-rate assets?

Well, I think that people need to be careful here. If I remember correctly, (inaudible) at a higher level. Close to 90% or 93% of our assets are all first-lien [CD] secured credit facilities. We don't rely on mezzanine or sub debt, or masking [of] a so-called one-stop shop to try to inflate our yields. Our yields are being gotten by first security interests in the assets of our companies themselves.

The next issue is some of [that] seems to be loss. And I grappled whether or not to start including it in these disclosures. I believe it's in our 10-Q. And that is substantial large portion, 80-plus, maybe 85% or so of our portfolio is in fact floating-rate loan, with a floating rate [in] a spread. And some of those have a floating rate with a hard LIBOR floor.

So we would be quite happy in a rising interest rate environment, given our $160 million or so of fixed cost of debt today that is making up the significant portion of the capital for our portfolio. So we benefit in a rising interest rate environment quite tremendously. And we're downside-protected, as I had forecasted, with the declining LIBOR. Some folks took out LIBOR swaps with the fear of LIBOR going up. And LIBOR's going down. The last thing I want to do is be [locked in on a] LIBOR swap.

Okay. And in terms of the floor, the interest rate floors -- where are those -- or how much would interest rates have to rise in order for you to start appreciating that spread expansion?

Immediately. I mean, the way the portfolio's structured, especially the floating-rate loans -- any increase in the index rate of LIBOR will automatically cause an accretion in earnings to our shareholders.

Right. I mean, I guess, on the 80% that does have a floor, what's the average floor there?

No, no, no, you're misunderstanding. The floor -- the way the floor -- let me explain the floor. For example, let's say you have a deal priced at -- just thinking of a number here -- L700. And you may have a LIBOR floor of 2.

Yes.

And LIBOR today could be up 30 basis points or 80 basis points. So it doesn't matter what LIBOR does. So before you get an increase, you [add this fee to] LIBOR -- to your point, LIBOR has to go from the 30 basis points or 40 basis points up to the 200 basis points before you see a change in rates in that (inaudible) --

Yes.

-- for us.

So --

So that's referring to -- that's the -- I hope I'm answering the question.

Is 200 basis points a typical LIBOR floor on your asset --

It varies. It range from 200 -- there's some that are 300, some that are 400. I mean, every transaction is different. And every credit is different. Every risk is a different risk.

Okay. That's [all] -- and I guess just one more quick question before I hop off -- just looking at what happened with Infologix this, I guess, post-quarter end, when you have a liquidity event, or specifically an IPO, sort of how do you determine when you actually fully exit the investment? And what sort of lockup periods are you seeing?

Well, in 25 years, I've maintained a belief that you do not deviate from your underlying thesis on -- once an investment achieves a hurdle rate IRR return, you don't look to [top take] the investment. In other words, I don't run a public hedge fund, I don't run long investments from a public securities point of view. Our investors do that. Our mutual funds do that.

So once an investment has achieved an expected return that we've modeled in when we first did the investment, and gets reevaluated, upon achieving that strike price on a security, we will vacate or liquidate the position generally in a controlled manner.

Now, the second part of your question -- it varies. Not all of our public securities have a mandate that we're locked up for the traditional 180 days post-IPO. It is a negotiated item. Because when you're a minority investor [earning] less than 100 basis points or 50 points of the deal, getting locked up seems a little bit silly.

So every transaction is different. And not all transactions have prerequisite lockup periods associated with them. But the vast majority that do are 180 days.

Okay. Well, great. Thank you guys very much. And good job this past quarter.

Thank you.

Douglas Harter, Credit Suisse.

Thanks. My questions have been asked and answered.

Thanks, Doug.

Troy Ward, Stifel Nicolaus.

Great. This is Greg Mason.

Just wanted to -- you started talking about DNOI this quarter, distributable net operating income. So how are you thinking on the dividend going forward? Are you going to be matching it closer to this distributable net operating income that you're now reporting, or closer to the traditional NII?

No. Let me explain why we're doing DNOI. It'll take me awhile to get this little acronym going here.

We've been -- self-evident to us -- as we go on our periodic [non-deal] road shows and meet with investors at the end of every quarter -- that there seems to be a lack of commonality as to comparing BDCs. You have the BDCs that report taxable income; other BDCs don't report taxable income. Some BDCs report NII; other people report net operating income -- NOI. Others report DNOI.

And my advice to the whole BDC industry is let's all coalesce around a standard reporting mechanism, so our shareholders can [ratably] review all the investments equally. Because everyone has a little different messaging out there. So Hercules decided to take the high road and basically started disclosing the two other items so people could see [it].

Now, as a caution to you, DNOI is not a direct proxy to that of taxable income. And I'll defer to our CFO. Because I can't even explain what [the] amalgamations going into deriving a taxable income.

Right. As you're aware, Greg, that taxable income will be impacted by certain items that have to be treated as capital gains, when you have de-accelerations and so on. You may also have stock options that are exercised in a quarter that are deductable [for] tax purposes but are not necessarily deducted for GAAP purposes.

So there's a myriad of reasons why there is a difference between book and tax. And so we typically as a company want to make sure that we're paying a dividend based on taxable income. Because we don't like to see -- and we're very deadest against -- wanting to have a return of capital to our shareholders.

The best thing to tell you is that the greatest [influence] to deriving of the taxable income versus DNOI will be in the acceleration of early payoffs. I mean, that is by far the largest driver. What that means in layman's term is, because Hercules adopted the most conservative accounting principles -- being that any fees that we derive upon the onset, or a substantial majority of the fees we derive on the onset of a new investment, are actually accretive using the interest rate method over the life of the duration of the loan.

So this is why, unlike most BDCs, Hercules has this very large -- or growing, I should say -- deferred income number that simply grows every time originating new assets. In the event of an asset paying off earlier than initially planned, you would see an acceleration of those deferred revenues that will impact the issue related to taxable income.

That's the high level. Beyond that, I suggest you can talk to David on the more specific issues off-line. But those are kind of the high-level differences between NII, DNOI and taxable income.

Great. Thanks, guys.

I'm showing no further questions at this time.

Well, first of all, great questions, everybody. [I'm tired.] Great questions. Thank you, operator, and thank you, everyone, for your continued interest and support of Hercules Technology Growth Capital.

As we always historically have done, over the course of the next few weeks, holidays aside, David and myself will be planning on visiting with investors across the country over the coming weeks. If you're interested in meeting with us, please notify your respected investment bankers and -- or, sorry, your research analysts, and feel free to contact David Lund or myself here at Hercules, at 650-289-3060.

Again, thank you very much. Thank you for being our shareholders. And go, Giants.

Ladies and gentlemen, thank you for participating in today's Conference. This concludes our program for today. You may all disconnect, and have a wonderful day.